Getting the green light
Bank of Queensland (ASX:BOQ) last week announced that Treasurer Josh Frydenberg had approved the ME Bank acquisition, one which we view highly favourably as it will increase geographical and business line diversification at the same time as scale. This followed on the heels of Bank of Queensland announcing a provision release in a move that will bolster profits and possibly the second half dividend.
Beginning with ME Bank and like Bank of Queensland (BOQ) management we view it as a transformative acquisition. BOQ has funded the $1.325 billion deal through an equity raising completed earlier in the year. The combination will create Australia’s sixth largest bank and ticks plenty of boxes in our view, as we noted in our February coverage.
The transaction will deliver material scale and broadly double the retail bank, while providing geographic diversification (away from Queensland – which was forecast to become 31% of the pie versus 42% pre-transaction and before results later announced).
The injection of business customers will make the business/retail mix much more balanced at around 46/54. Pre-tax synergy benefits were estimated at between $70 million to $80 million a year (around 75% of which should be achieved within 2 years), making the deal low double-digit to mid-teens cash earnings per share accretive.
The multiple being paid was very reasonable with the consideration equivalent to just 8 times ME Bank’s FY20 cash earnings after tax and including the full run rate synergies. The transaction will be accretive to earnings and return on equity, while the balance sheet of the enlarged entity will remain robust.
The transaction provides increased diversity (and therefore reduces risk) both geographically, and by business lines. The deal will also provide greater leverage to the ‘V’ shaped economic recovery which is underway in Australia, and further strength in the housing market. This is also while tailwinds continue to come through to the sector as net margin pressures alleviate, provisions being written back and with a rising yield curve.
The deal will have integration risks, but we feel Bank of Queensland CEO George Frasiz should be up to the task, having implemented successful multi-brand strategies at Westpac.
The green light from the Treasurer came only a week after Bank of Queensland (ASX:BOQ) announced that the quarterly APRA Basel III Pillar 3 report for the period ending 31 May 2021 (the third quarter) is expected to include a decrease in the collective provision of $75 million.
This reflects an improved economic outlook, and additional data clarity relating to collateral. CEO George Frazis stated, “Today, Australia is experiencing strengthening business and consumer confidence driving our economic recovery, supported by strong housing growth, lower unemployment rates and increasing business investment.”
“The reduction in the collective provision during the quarter reflects this improvement in the current economic environment. We continue to prudently manage our provisions to ensure we are well covered for any potential lifetime losses arising from COVID-19.”
The move follows in the footsteps of the big banks and was not a surprise to us, as we have been of the view since late 2020 that the huge provisions set aside by the banking industry would unlikely be necessary in their entirety. We would not be surprised to see more provisions releases from BOQ going forward.
Bank of Queensland (ASX:BOQ) reported a solid first half result in our view. Statutory net profit after tax (NPAT) leapt 66% year-on-year to $154 million, as the previous period was marred by exceptional items, including restructuring charges and an intangible asset review. The preferred measure watched by the market, cash earnings, increased 9% to $165 million. Cash earnings per share edged up 3% to 35.5 cents per share, with the lower growth rate due to the capital raising undertaken by the bank. Dividends were back on the table and in a significant way, with the 17 cents per share interim dividend within guidance.
Lending growth impressed overall, with 1.6x system growth in housing loans during the half, a highlight of the result even as commercial lending slowed amid a tepid market. The key net interest margin (NIM) for the group improved 3 basis points from 2H20 to 1.95%, helped by lower funding costs. The cost-to-income ratio improved by 50 basis points year-on-year to 53.8%.
Summary
The ME Bank acquisition should be transformative for Bank of Queensland (ASX:BOQ), broadly doubling the size of the retail bank and diversifying it away from Queensland, along with balancing the business loans mix. There is a huge opportunity to take out costs, given ME Bank’s high cost-to-income ratio, with CEO George Frazis believing he can take out around 30% of ME Bank’s cost base, which will add to the earnings tailwinds that are already coming through, including the provisions release discussed above.
We viewed BOQ’s 1H21 result as a solid one, with the return of strong housing loan growth a highlight. Asset quality improved and we have no concerns on that front given current trends.
We recommend Bank of Queensland (ASX:BOQ) shares as a buy for Members without exposure.
Disclosure: Interests associated with Fat Prophets declare a holding in Bank of Queensland (ASX:BOQ).
