Westpac leaves door ajar to dipping into capital buffers, after scrapping dividend

Peter King is prepared to dip into the bank’s capital buffers if the pandemic causes a prolonged recession.

Westpac CEO Peter King and acting CFO Gary Thursby gave a third-quarter update on Tuesday. Picture: Jane Dempster

Westpac chief executive Peter King says he is prepared to dip into the bank’s capital buffers if the pandemic causes a prolonged recession, after rising expectations of mortgage losses and pressure on capital saw it scrap a first-half dividend.

Westpac’s decision to not pay an interim dividend was dramatic, given it continued to make the payments during the global financial crisis and even when the bank teetered close to collapse in the early 90s.

On Tuesday, Westpac became the first of its major rivals to move from deferring a dividend decision to axing the payment, leading analysts to question Westpac’s ability to resume the distributions after ruling off its year on September 30.

Mr King said while the bank wanted to maintain a strong balance sheet, it was a “difficult decision” not to pay a first-half dividend and he recognised the move would hurt investors.

“We’ve just got to work on generating capital internally, making the right decisions,” he added.

“But I am prepared to use the buffer.”

The bank’s common equity tier one capital ratio remained steady at 10.8 per cent, above the banking regulator’s “unquestionably strong” threshold of 10.5 per cent which applies in a more normal operating climate.

“Their capital position is strong relative to history, but weak relative to peers,” Regal Funds Management portfolio manager Mark Nathan said.

“Whatever they do with the (final) dividend, they will be conservative.

“The issue is you don’t have the same level of certainty that earnings will be strong in that six month period.”

Last week, Commonwealth Bank and National Australia Bank capital position’s both printed at 11.6 per cent. ANZ will provide a third-quarter earnings update and clarity on its interim dividend on Wednesday, after deferring a decision in April.

Westpac’s third-quarter update showed it had increased the expected credit loss provision to $6.34bn as at June 30, from almost $5.8bn three months earlier. That partly reflected higher expected mortgage losses from customers on repayment pauses and risks from businesses in “high-risk” sectors.

The bank’s third-quarter unaudited cash earnings came in below expectations, despite rising to $1.32bn for the three months ended June 30, compared to a quarterly average in the first half of $497m. The quarterly result was helped by lower impairment charges and a fall in general insurance claims.

The earnings were up 19 per cent when “notable items” such as customer refunds and costs linked to legal action by financial crimes regulator Austrac were taken into account.

The bank is awaiting a revised legal statement of claim from Austrac next month which will increase the number of potential breaches of the law, as the regulator seeks a penalty of $1.5bn compared to the $900m set aside by Westpac.

The bank’s shares slid 2.3 per cent to $17.18 on Tuesday, outpacing declines by its major rivals, as investors reacted to the dividend axing and a warning of “early signs of deterioration” across its loan book.

Macquarie Group analysts said despite Westpac trading at a discount to its big bank peers, it and the sector continued to confront “ongoing challenges”.

Westpac’s net interest margin — what it earns on loans less funding and other costs — fell to 2.05 per cent, down eight basis points as record low interest rates continued to bite.

Westpac expects the economy to contract 4 per cent in 2020, before rebounding to 3 per cent growth next year. It anticipates unemployment will peak at 8 per cent, while residential property prices will slump 10 per cent in 2020. Its expectations are more bullish than those of the Reserve Bank, which forecasts unemployment driven by the pandemic will peak at 10 per cent.

“The situation we’re in is it’s very hard to forecast,” Mr King said.

Westpac’s update did show marked positive momentum in customers moving off mortgage repayment pauses.

There were 78,000, or $30bn, home loans on a repayment deferral at July 31, down from 135,000 or $51bn. Westpac said it had contacted 85 per cent of mortgage customers that had requested a repayment pause, and expected about half to return to making payments.

“That’s really positive sign that we’ve got a lot of customers who’ve got that intention. Of course we need to see the payments,” Mr King said.

But Westpac’s hardship category — which is separate to loan repayment pauses — was spurring increased mortgage delinquencies. Mr King also cautioned of a “steady flow” of about 2000 people still asking for COVID-19-related assistance amid the renewed lockdown in Victoria, while the bank was waiting to see how New Zealand’s situation panned out.

Westpac said repayment relief was given to more than 31,500 small business customers, reflecting about $9bn in loans.

Mr King said while “at the margin” some companies were starting to repay ahead of deferrals ending in six months, Westpac was yet to fully engage with businesses.

Mortgage repayment deferrals were for three months, with the option of extending to six after checking in with the bank.

Westpac’s 2019 interim dividend was 94c per share, which dropped to 80c for last year’s final payment.

The bank will engage with the banking regulator on its final dividend — which is capped at 50 per cent of earnings — and the treatment of capitalised software, goodwill and the valuation of its life insurance arm.

Several analysts questioned whether that would reduce statutory profit and weigh on its ability to pay a final dividend.

On the review and potential sale of units under Westpac’s specialist business division, Mr King said the bank was making “good progress”.