Bendigo and Adelaide Bank’s (Bendigo) BEN continues to chug along, with loan growth ahead of system growth and household deposit growth slowing moderately. The Australian Prudential Regulation Authority (APRA) Banking Statistics for the 12 months to end February 2013 print a positive picture for Bendigo, with home loans growing 6%, compared with 5% for system, and business loans increasing an impressive 14% from a low base for the year, compared with no change for the sector. Household deposits grew close to 7%, falling behind the 9% growth across the banking system. On the surface, the underperformance in deposit growth is negative, but consistent pricing discipline is delivering improved profitability as opposed to simply attracting ‘hot’ retail deposits to maintain market share.
We like the way Bendigo continues to grow its home loan book without compromising loan quality, by maintaining conservative underwriting standards. We make minor adjustments to our longer-term earnings forecasts and maintain our AUD 10.00 fair value estimate. At current prices we consider the stock fairly valued. Following recent discussions with management, and release of the February APRA banking statistics, we consider the bank is progressing well on a number of fronts and our view is getting more positive, largely due to lower funding costs. Our investment view is based on conservative management, steady growth in loans and deposits, further improvement in loan quality and increased effort in improving the relatively high cost-to-income ratio. Bendigo benefits from a strong brand, and loyal customers and shareholders. A very high customer satisfaction ranking, as per the most recent Roy Morgan Research report is a standout, far exceeds the results of the major banks.
Bendigo has long achieved the most satisfied bank customer ranking, with a reading close to 90%. High customer satisfaction is a real positive, and the sticky retail base underpins the solid earnings outlook. Bendigo’s bad debt expense/average loans is among the lowest in the industry, a product of a lower-risk customer base and a high proportion of high-quality home loans. Loan arrears are trending down, and we expect further moderate improvement as the broader economy chugs along at close to trend growth, around 3%. Despite the uptick in unemployment to 5.6% in March, the absolute level remains low. The moderate increase in house prices and the recovery in equity markets continue to build buffers in household finances. Importantly, we expect this positive development to continue, boosting the attractiveness of the Australian banks. Home loan prepayment rates continue to increase and we make minor adjustments to our bad debt expense forecast.
Core profitability (profits before bad debts and tax) improved 8% in first-half fiscal 2013 to AUD 272 million compared with AUD 252 million for second-half fiscal 2012, due to 8% revenue growth and moderate expense growth, up 4%. We expect further moderate growth in core profits during our five-year forecast period. Despite the solid outlook, we consider the bank does not justify a moat due to a weaker market position, limited pricing power, higher funding costs, poor return on equity and a relatively narrow business mix. Regional banks are price takers while the major banks are price makers when it comes to high-profile products like home loans. We prefer Bendigo to its regional peer Bank of Queensland, due to a more diversified revenue base and a less risky business model. Our view is reinforced by the renewal of well-respected managing director Mike Hurst for another two-year term.
Importantly, management confirmed consumer loan arrears continue to improve with both home loans and credit card delinquencies trending down. We consider this evidence reaffirms our positive view on the overall banking sector. While we have been long optimistic about the earnings outlook for the major banks, we have argued their smaller cousins suffer from structural challenges. Lower credit ratings, higher cost bases and smaller scale, combined with expensive acquisitions, have resulted in disappointing earnings growth and unimpressive dividend growth.
Pleasingly, there has been material improvement in wholesale funding costs in the past nine months, and the regional banks in particular are benefiting from lower residential mortgage backed securitisation (RMBS) costs. A reduction in wholesale funding costs is supported by falling credit default spreads for the major banks. The RMBS market has recovered so well that the federal government agency (AOFM) is withdrawing financial support, for what was a real lifeline for the regional banks and non-bank mortgage lenders. Recent RMBS issue prices from both larger and smaller competitors are very encouraging. This could prove very timely, as Bendigo’s first-half fiscal 2013 results presentation published in February highlighted the growing need for additional funding to support lending growth. Encouragingly Bendigo’s TORRENS RMBS February issue was priced at 95 basis points over the BBSW benchmark, the best (lowest) level since the global financial crisis.
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