Westpac provided a mixed first-quarter FY18 update, with capital generation behind our expectation but asset quality and funding both strong. We note capital ratios were affected by one-off model changes.
We continue to expect Westpac to commence capital management in first-half FY19 with a 10c per share special dividend.
We maintain our Accumulate recommendation on Westpac with a target price of $33.10.
- Capital management – Westpac’s common equity tier-1 (CET1) ratio of 10.1% was down 50bp on FY17, due mainly to model changes. Excluding these changes, risk-weighted asset (RWA) growth would have been more subdued at about 0.5% versus 1.5% headline growth. Portfolio growth was modest and there were continued tailwinds from strong asset quality. Despite the higher RWA growth, we believe Westpac will still be able to commence capital management in first-half FY19 and we forecast four consecutive 10cps special dividends.
- Asset quality – Westpac’s asset quality metrics were strong in the quarter, with total stressed assets to total committed exposures (TCE) down 2bp on the same quarter last year. This reflected reduced watch-list and substandard loans, with impaired assets and 90-plus days past due exposures both unchanged as a percentage of TCE. Only the property sector saw any deterioration worth noting, which was offset by improvements in other sectors such as manufacturing, agriculture and mining.
- Term funding – After the first four months of FY18, Westpac is more than half way towards replacing FY18 maturities. Issuance has also been reasonably long-dated, supporting the net stable funding ratio which has risen to 110%.
Our forecasts already conservatively allow for a modest deterioration in impairment expenses over the next three years, of which there is little sign at this point. However, we have increased our EPS estimates by less than 0.5% to reflect the strong asset quality trend.
Westpac is one of our sector preferences as we remain attracted to its well-positioned business segments, strong return on equity and attractive valuation. We maintain our Accumulate rating.