Tony Boyd
Westpac's property problem
Westpac's interim results show that the bank suffered some indigestion from swallowing St George but it was relatively mild and certainly not enough to cause chief executive Gail Kelly any heartburn.
However, her reputation for being one of the top bankers in Australia will depend upon her ability to manage one of the largest problem property portfolios in Australia.
Westpac's portfolio of stressed commercial property including St George now totals $3.96 billion, up from $1.16 billion before Westpac bought St George.
Westpac's stressed property loans, excluding St George, at March 2009 totalled $2.4 billion or 5.8 per cent of its $41 billion property portfolio. Kelly said many of the impaired loans had gone bad very quickly in the past six months.
There were risks involved in Westpac buying St George. Under Kelly the friendly 'Dragon' expanded its balance sheet for many years expanding at a rate well in excess of the financial system growth, particularly in commercial lending. As highlighted by my colleague Robert Gottliebsen (Buying at the wrong time, May 6), St George has a property problem.
However, a closer examination of the numbers shows that part of the surge in impairments for St George is because of its loan book being brought within the Westpac fold and conforming to Westpac credit disciplines.
Maximum loan to value ratios have been reduced, minimum interest cover has been aligned between Westpac and St George and return hurdles have been increased to reflect the increased cost of funds and risk profiles.
St George has been forced to knuckle under the Westpac credit and according to today's announcement it no longer has “an appetite for higher risk areas”.
Kelly told analysts today that Westpac was very aware of its "property exposure concentration" and was working to address that by shifting lending toward other sectors of the economy.
"Over time we are absolutely reducing property exposure," she said.
Head of retail and business banking Greg Bartlett said that the level of property lending by St George had fallen from 55 per cent six months ago to 36 per cent today. "We are really driving a diversification strategy," Bartlett said.
Westpac is well placed to handle the problems because it has one of the most stable and experienced group of senior managers in Australian banking. But their fallibility is shown by the $700 million in impaired loans to ABC Learning, Allco Finance and Babcock & Brown. Those three companies alone cost an extra $357 million in provisions in the latest half.
About 4.5 per cent of St George's $33.5 billion business loan portfolio is stressed or about $1.5 billion in loans.
Only 3.8 per cent of the $42 billion in business loans in Westpac's retail and business banking division are stressed. That is about $1.5 billion.
The overall picture for the property segment is actually worse with 6.29 per cent of the combined property portfolio of $63 billion under stress. 'Stressed' means loans on watch-list, substandard, 90 days past due and impaired.
The property book will require intense management as lower valuations flow through and property developments that are not finished require Westpac to step in.
Kelly has the management to cope with the credit problems created by the $12 billion takeover of St George.
Turning to broader operational issues, she has avoided most of the nasties normally associated with an acquisition such as customer attrition, lower staff morale and declining customer satisfaction.
It is clear from the latest results that St George, which is effectively being managed by former Kelly colleague Greg Bartlett, has regained the momentum lost in the last six months under St George's former CEO Paul Fegan.
It should be remembered the bulk of the assets acquired through the St George acquisition were $76 billion in home mortgages, which carry very low levels of defaults.
A six per cent increase in cash earnings at St George to $529 million provided a welcome offset to the $1.1 billion increase in total impairment charges to $1.55 billion.
The huge jump in impairments was not unexpected in the wake of similar big bad debt increases at ANZ and NAB.
The Westpac story is similar to the other banks. It was slammed by its exposure to big name busts. Westpac's institutional bank was also hit by $156 million in impairments because of its exposure to three margin lending clients. That concentration of risk cannot be blamed on institutional banking head Phil Chronican. He inherited it from the boys over at wealth management.
Kelly is making a virtue of the decision to slash the bank's dividend by 20 per cent to 56 cents a share. She says the bank is strengthening its balance sheet to support its customers.
The dividend cut is a natural outcome of boosting equity on issue in the past six months from 1.8 billion to 2.6 billion and cutting the payout ratio. Equity rose through the St George takeover and the $4.9 billion capital raising.
With a Tier 1 capital ratio of 8.4 per cent, Westpac has the capital strength to absorb what it expects will be further high impairment charges in the second half of this year and in the first half of 2010.
Return on equity fell to 14.3 per cent, compared to 22.7 per cent in March 2008.
So although, Kelly now runs Australia's largest bank she has lost the mantle of most profitable bank.
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