Bank of Queensland (ASX: BOQ) is one of Australia’s leading regional banks that has more than 165 branches across the country, run by local Owner-Managers. BOQ, together with its subsidiaries operates in retail banking, BOQ business, and other segments. BOQ Business includes the BOQ branded commercial lending activity, BOQ Finance and BOQ Specialist businesses. It offers personal banking services which comprises of savings and term deposits, and transactional accounts; debit and credit cards; home, personal, and car loans; and travel, home and content, landlord, and car insurance, as well as investment services comprising online share trading services, and self-managed superannuation funds.
The company’s retail banking division supports customers through owner-managed and corporate branch networks, third party intermediaries, Virgin Money Australia distribution channels, an Australian based customer call centre, digital services, and mobile mortgage specialists.
BOQ, just like most banks, generates most of its revenues from interest income from the loans they offer both – retailers and businesses. In addition to the interest revenues, BOQ also generates revenues from fee and commissions, and insurance segments, however, they are very minute. Looking at their lending segments, BOQ is balanced.
The revenue segments from the above chart indicates that BOQ’s business is balanced with both – retail clients and business clients playing a key role.
The JobKeeper program and other stimulus measures taken by the government has done exceptionally well to boost economic activity. The relaxation of regulations around lending has resulted in favourable operating environments for the banks, and BOQ has benefitted. We witnessed profit growth, good business momentum, strategic transformation, increasing balance sheet strength, and of course the return of dividends in the half year earnings.
Both major divisions – Retail and Business have been performing well recently. On the retail side, BOQ has been seeing an improved performance since FY2019. The measures taken by the government to spur on the economy can also be seen working. The bank deposit growth has lagged with only $214 million, while the housing loan growth has taken-off by 1.6x. On the Business segment front, deposit growth was seen to slow down as well, and housing loans, commercial loans both have swelled. Enhanced customer experience has been improving for BOQ as well.
Some of the key highlights from the half year earnings were:
- Cash earnings after tax increased 9% at $165m
- Statutory net profit after tax was 66% higher at $154m.
- Net interest margin increased by 6bps at 1.95%.
- Common Equity Tier 1 Capital ratio stood at 10.03%, 12bps higher than H1 FY2020.
- Interim dividends pay out at 17 cents per share – 66% pay-out ratio.
- Loan impairment expense reduced by 14% to $24m.
- The company’s retail division cash balance earnings after tax increased by $15m, driven by lower loan impairments, improved lending margins and mortgage growth.
- The BOQ branded commercial loan portfolio grew by $30m and continued its focus on niche market segments.
- The company announced the acquisition of ME bank in Feb 2021 and is expected to be completed by the end of the financial year.
The positive performance in challenging operating conditions, despite government relief programs operating in full swing has translated into share price growth and real momentum can be seen. The chart below compares BOQ against the ASX 200 benchmark index (orange line) and the ASX Banks Only ETF (blue line). BOQ has outperformed both. BOQ’s shares are currently trading at $9, and the price has moved by 94.71% over the past year.
The low interest rates are likely a ‘new normal’ for Australia since interest rates have been low for the last few years now. RBA has decided to keep rates at 0.1% until 2024. With this coming into the picture, the central bank now expects growth of 4.75% over 2021, rather than 3.5% which was predicted earlier. The main reason to keep the interest rates low is to achieve higher economic growth and to reduce the unemployment rate.
These low interest rates can affect the stability of the banking sector through several channels i.e., reducing their profitability and compressing net interest margins (NIM). A fall in the interest rate tends to flatten the yield curve, which can be negative for net interest incomes, reflecting that banks tend to borrow short term and lend long term. However, the low interest rate should increase borrowing, and this has been working well.
A low interest rate for the next few years will tend to reduce cash deposits. However, BOQ has still managed to increase its NIM by 2bps in H1FY21 and is expecting a positive NIM in FY21 as well. Banks are also under pressure to raise their long-term interest rates to preserve their profits amid a blow out in funding cost on global financial markets. BOQ has also raised its 4-year fixed rates by 0.3%.
In H1FY21, the company’s net interest income of $512m increased by 6% as compared to $483m in H1FY20, driven by 3% growth in average interest earning assets, strong lending balance and increase in NIM by to 1.95%. Growth in home lending with BOQ Blue, BOQ Specialist and VMA led to an increase in gross loans and advances by $1,065m. Commercial lending grew by $72m, despite a challenging environment for small business clients with the ongoing impacts of COVID-19.
BOQ’s net interest margin has been impacted by 4bps due to the low interest rate environment, however the impact of hedging cost has improved the NIM by 2bps. The increase in net interest margin by 3bps in H1FY20 was due to lower funding costs from reduced deposit rates and lower wholesale funding costs. The company is further expecting a positive NIM in FY21. While the net interest margins will get better over time given BOQ’s efficient operations, it cannot be expected to have drastic changes as low interest rates are likely to persist.
To facilitate growth, BOQ is spending money in digital projects. Their latest project is their digital retail banking arm with Virgin Money Australia. This is a crucial step as well given that banks have had to adapt to the changing operating environment. Digital retail banking is the future and the pace at which the technology is changing, our traditional banks have had to partner or acquire digital platforms to build for the future. The VMA arm launched in March 2021 with 3 new fully digital products, and Phase 2 is now underway that will include home loans and several other capabilities.
This investment has increased the operating expenses by $12 million. In the bigger picture, however, BOQ can grow its net interest margins and interest income without sacrificing on their expenses, which is a positive sign.
The company’s total growth in lending gross loans and advances (GLAs) stood at $1,065m, which comprised $997m growth in housing, $91m growth in commercial and asset finance lending and offset by a $23m reduction in consumer lending. The growth in housing led to a turnaround in the retail bank which increased housing loans by $795m and continued housing growth in BOQ Specialist. This growth was achieved across all channels, for the first time since FY16. This growth was driven by increased owner-occupied loans and due to a higher proportion of fixed rate lending compared to prior periods.
Improving economic conditions and recommencement of collection activities has reduced the BOQ’s arrears in H1FY21. BOQ comprises 97% of SME customers and 95% of housing loan customers on a Banking Relief Package. These customers are now performing well as there has been an improvement in the economic condition. BOQ Specialist home lending portfolio has also added to this growth as their major focus is on building relationships with health professionals and with the healthcare sector improving, the commercial arrears have benefitted. The company continues to benefit with the low interest rates, as it has made borrowing cheaper and attracted customers – leading to an increase in the lending business.
The Federal Reserve is not likely to take its foot off the pedal when it comes to getting the economy back in full swing, and why would they? We are off to a fantastic start in 2021, and this operating environment bodes well for BOQ.
ME Acquisition Fuels Growth
BOQ has recently announced to acquire 100% ME Bank for $1.325b and has targeted to complete this acquisition before the end of 2021 financial year. This addition of ME Bank is expected to deliver the followings advantages –
- Post-merger the group will have total assets worth more than $88b, with total deposits of more than $56b.
- The acquisition will double the size of the retail bank and increase its retail earnings contribution from 36% to more than 50%.
- With this acquisition, BOQ can now provide their banking services to approximately 1.45m people. This increased scale will help both their employees and customers and will be able to offer a wider range of services.
- This acquisition of ME and its $25b loan book of largely owner-occupier loans paying principal and interest will see the group emerge with $73.7b worth of loans.
- The ME brand is also a great fit with the BOQ and Virgin Money brands as it will create customer centric alternatives in Australia.
This acquisition provides the company with geographic diversification and the opportunity to accelerate its digital strategy. BOQ, Virgin Money and ME are all customer-centric brands that have a loyal customer base and high NPS, which makes it an ideal deal for the company and will accelerate BOQ’s growth in the future. Revenues will expand once the acquisition is complete and given the synergies of ME and BOQ, it will catapult the firm into a stronger market position, and it is expected to become the biggest lender Down Under just below the Big 4 and Macquarie.
The acquisition is also expected to bring in at least $500 million in additional revenue each year to BOQ and over $120 million in net profit after taxes.
In FY2020, the company declared a dividend of 12cps, which was in line with the revised APRA guidance representing 6 cents from H1FY20 and 6 cents from H2FY20. This regulation was mainly put in place to mitigate the liquidity risk that the pandemic posed. In H1FY21, the company declared an interim dividend of 17cps at a pay-out ratio of 66% of its earnings. The firm is looking to maintain a dividend payout ratio in the range of 60%-75% for full year FY2021.
Bank of Queensland has performed well in a largely challenging operating environment. Their acquisition of ME Bank and the launch and proposed expansion of digital assets shows a clear growth pathway. Dividends are back as well. The stock price has rallied well recently, and we recommend long-term investors to “Hold” their positions.