(Bendigo Bank) Executive summary (Bendigo Bank) is a regional bank that specialises in retail banking with a focus on rural communities. It also owns Rural Bank and Delphi Bank and operates the margin lending business, Leveraged Equities At the time of writing, Bendigo Bank had offered to purchase the Rural Finance Corporation from the Victorian Government, which would increase its rural loan portfolio by approximately 50% and total assets by around 2.8%. This is subject to APRA approval but is expected to be received and the transaction completed in July 2014 Bendigo Bank offers a range of banking and wealth management services across all states and territories in Australia, with a particularly strong retail deposit franchise and community focus. Its largest operations are in Victoria and South Australia Bendigo Bank reported a solid net profit after tax of $180.7m in 1H14, a decrease of 4.7% compared to $189.4m the prior corresponding period. However, underlying cash earnings were $185.9m, an increase of 9.5% on the prior corresponding period. Bendigo Bank s capital position has improved with recent Tier 1, Tier 2 subordinated debt and equity raisings. The Tier 1 capital ratio was 9.24% as at 31 December 2013 and total capital ratio was a solid 10.72%. Following the $300m subordinated bond raising in January 2014, the total capital ratio was an impressive 11.68% on a pro-forma basis Key financials for 1H14 to 31 December 2013 Cash earnings $185.9m NPAT $180.7m Total assets $60.4bn Total liabilities $55.9bn Net assets $4.5bn Tier 1 Capital ratio 9.24% Total Capital ratio 10.72% Cost to income ratio 55.4% Net interest margin 2.24% Key financials 2H13 to 30 June 2013 Cash earnings $178.3m NPAT $162.9m Total assets $60.3bn Total liabilities $55.8bn Net assets $4.4bn Tier 1 Capital ratio 9.25% Total Capital ratio 10.71% Cost to income ratio 56.2% Net interest margin 2.20% Bendigo has a sound credit profile with strong earnings growth, low levels of bad debt and a high proportion of deposit funding. The bank is actively looking to increase its regulatory capital which will further solidify its financial position Background (Bendigo Bank), a publicly listed company, was formed in November 2007 as a result of the merger between Bendigo Bank and Adelaide Bank. The business operates four distinct brands under the Bendigo umbrella. The retail arm, Bendigo Bank, provides banking and wealth management services. Bendigo Bank is represented in all states and territories with almost 900 outlets including more than 190 company-owned branches, 301 locally-owned Community Bank branches, 90 agencies and 1,819 ATMs. Through Adelaide Bank, the group operates a substantial wholesale banking business providing mortgages via a network of brokers and mortgage managers. In addition, Adelaide Portfolio Lending funds aged care and third party credit providers. The group also has a new wealth management division that provides margin lending, managed funds and superannuation businesses through Leveraged Equities, Sandhurst Trustees and Trinity platform. Since December 2010, the group has owned 100% of Rural Bank which provides investment and financial products to rural and regional Australia and has a joint venture in Community Sector Banking (with a consortium of 20 partners from the not-for-profit sector). Sydney Melbourne Brisbane Perth FIIG Securities Limited Page 1 of 8
In 2005, Bendigo and Adelaide bank acquired Oxford Funding a provider of cash flow finance solutions, allowing businesses to use the debtor ledger for finance. The following chart details the split of revenue and profit by the four business sectors using 1H14 figures. At the time of writing (on 5 May 2014), Bendigo Bank had offered to purchase the Rural Finance Corporation from the Victorian Government for $1.78bn, which would increase its rural loan portfolio by around 50% and increase total assets by approximately 2.8%. While the acquisition is subject to APRA approval, it is expected to be received and the transaction completed in mid July 2014. The bank reported that should the transaction proceed as expected, the proforma Tier 1 capital ratio would be approximately 9.10%. Recent Events On 5 May 2014, the bank announced the acquisition (subject to APRA approval) of the business and assets of Rural Finance Corporation of Victoria from the Victorian Government for approximately $1.78bn, to be funded by a mix of debt and equity. The transaction is expected to be completed in mid July 2014 and should the transaction proceed as expected, the pro-forma Tier 1 capital ratio would be approximately 9.10% In January 2014, the bank successfully raised $300m under its institutional subordinated debt program. The debt qualifies as Tier 2 capital under the APRA Basel III capital adequacy framework and increased the total capital ratio by 96bps to a pro-forma 11.68%. The new subordinated bond is a ten year, non-call five year, with a floating coupon margin of 280bps over three month BBSW. (At the time of writing, this bond is one of our preferred AUD subordinated bonds from a risk/reward position and our preferred Bendigo Bank fixed income investment) Latest trading results 1H14 (to 31 December 2013) Bendigo reported solid half year results for the period ended 31 December 2013 with NPAT $180.7m, a slight decrease of 4.7% compared to $189.4m in the period ended 31 December 2012. However cash earnings were $185.9m in 1H14, an increase of 9.5% on the prior corresponding period. Results reflected the low growth environment, subdued demand and an increase in borrowers making additional efforts to pay down their debt. Sydney Melbourne Brisbane Perth FIIG Securities Limited Page 2 of 8
The following table details the key financial indicators for 1H14 compared to 1H13. Key financial indicators 1H14 1H13 Net interest income ($m) 551.5 507.5 Non-interest income ($m) 156.1 143.5 Bad debt expenses ($m) 42.7 32.1 Operating expenses ($m) 402.4 390.3 NPAT ($m) 180.7 189.4 Cost income ratio (%) 55.40% 57.80% NIM (%) 2.24% 2.19% ROE (%) 8.44% 9.19% Tier 1 ratio (%) 9.24% 9.31% Total capital ratio (%) 10.72% 11.07% Source: FIIG Securities, Company accounts Key points to note from the results include: Total income was up at $707.6m for 1H14 compared to $651m in 1H13 Net interest income increased 7.9% to $551.5m mainly due to the increase in net interest margin (and a small increase in total loans) Non-interest income rose to $156.1m from $143.5 in 1H13. While specific items income decreased by $26.3m (as the prior period included the sale of IOOF shares and reduction in ineffective cashflow hedges), these increases were offset by a loss on sale of RMBS notes. Homesafe trust contribution was $11.3m higher than the prior corresponding period, primarily due to an increase in the housing price index over the last six months Operating expense increased to $402.4m from $390.3m in 1H13, mainly from increased employee, rent and IT expenses, the latter associated with the implementation of the new bank website Bad and doubtful debts expense rose to $42.7m due to a $13.7m increase at Rural Bank mainly due to the struggling Queensland cattle industry. Cost to income ratio was 55.4% in 1H14, down from 57.8% 1H13 but still slightly outside the stated target of 55% Return on equity (ROE) was down to 8.44% from 9.19% in 1H13 Total provisions and reserves for doubtful debts were $276.7m ($262.3m in 1H13 and 2H13 $276.9m), a decrease of $0.2m since 2H13. General and collective provisions were 0.54% of group risk weighted assets Net interest margin improved from 2.19% in 1H13 to 2.24% in 1H14 The Tier 1 capital ratio was down 1bp from six months earlier to 9.24% as at 31 December 2013 and total capital ratio was up 1bp to a solid 10.72% over the same period Current Common Tier 1 ratio improved slightly to 7.86% and is in excess of expected Basel III requirements Retail deposits, as a proportion of the funding base increased 3.9%, from $40.7bn in June 2013 to $42.2bn at December 2013 and remained within management target of 75-80%, at the expense of securitisation. Wholesale deposits increased by $0.9bn or 17.7% to $6.1bn over the 6 months period. Term deposit retention rate has been consistently above 80% with strong growth in call deposits (the chart below demonstrates the strong retail funding mix) Sydney Melbourne Brisbane Perth FIIG Securities Limited Page 3 of 8
Historical funding mix 80% 80% 78% 79% 13% 8% 9% 11% 10% 12% 11% 10% Jun-12 Dec-12 Jun-12 Dec-13 Source: Company presentation Wholesale Securitisation Retail The income contribution break-down by division was mixed and is illustrated in table below. Contribution by business segment result 1H14 1H13 % change Retail banking Bendigo Bank 143.20 114.10 26% Adelaide Bank 100.10 77.80 29% Bendigo Wealth 7.10 15.90-55% Rural Bank 14.50 25.10-42% Source: FIIG Securities, Company accounts The bank reported low loan growth due to subdued demand and increase in borrowers making additional efforts to pay down their debt. This was most evident in the bank s mortgage and Rural Bank portfolios. As a result, fees decreased by $5.0m, or 5.8% primarily due to a decrease in transaction fees. The following chart details the bank s loan portfolio by sector with residential mortgages being the largest component by a large factor. Sydney Melbourne Brisbane Perth FIIG Securities Limited Page 4 of 8
Loan portfolio by sector ($51bn as at 31-Dec-13) 8% 4% 23% 65% Residential Commercial Consumer Margin lending Source: Company presentation Underlying the conservative nature of the loan book, over 98% is backed by security (typically residential and commercial mortgages and equity securities) with the average LVR of the residential loan portfolio at just 62.4% and the average LVR of the margin lending business just 36%. Management noted flexibility in how the business is funded and this was reflected in the increased net interest margin (2.24% in 1H14 compared to 2.19% in 1H13) as the cost of funding continues to abate. The following chart of the last four half year cash NPAT results demonstrates a pleasing upward trend. Cash NPAT ($m) 185.9 178.3 169.7 160.4 Jun-12 Dec-12 Jun-13 Dec-13 Source: Company presentation Strengths The bank has a high level of retail deposits with total deposit funding of $48.8bn. The balance sheet is 87% funded by deposits. This is a significant positive due to the low risk nature of deposit funding Bendigo Bank has a strong niche in its retail and community focused banking activities which drives loyalty. As mentioned above, it is predominately funded by sticky retail deposit and this funding model has helped drive the recent credit rating affirmation from Standard & Poor s Low risk lending book with residential mortgage average LVR of just 62.4% and margin lending average LVR of just 36% The core banking business remained profitable throughout the financial crisis and appears well placed to record sound earnings growth. The Bendigo Bank division had a very strong performance, recording 26% increase in Sydney Melbourne Brisbane Perth FIIG Securities Limited Page 5 of 8
contribution and the Adelaide Bank division recorded 29% increase. A clear positive trend can be seen in recent cash NPAT figures Acquisition growth at sustainable levels with Bank of Cyprus, currently known as Delphi Bank, purchased in March 2012, Rural Bank in December 2010 and most recently the planned acquisition of Rural Finance Corporation of Victoria. These smaller bolt-on acquisitions have added to balance sheet size and profitability but maintained the retail and community focus, albeit with increasing exposure to the rural sector Sound credit quality across bank businesses and solid total capital ratio of 10.72% as at 31 December 2013 and following the $300m subordinated bond raising in January 2014 the total capital ratio was an impressive 11.68% on a pro-forma basis Net interest margin increased to 2.24% compared to 2.20% in June 2013 and 2.19% in December 2013, attributable to the decreasing cost of funding over recent periods Risks The bank has a high exposure to residential mortgages and is susceptible to increased bad debts if house prices were to suffer a material decline As a regional bank, Bendigo Bank has faced funding cost pressures from rising deposit margins and wholesale securitisations compared to pre-gfc levels. In a crisis scenario, funding access and costs could pose issues, however, Government intervention is possible if this occurs Growing exposure to the rural sector which tends to be more volatile in terms of earnings and bad debt experience, as evidenced by the impact of falling Queensland cattle property values on Rural Bank s total contribution to the group Whilst the bank s niche retail and community focus is seen as a strength, it does provide a concentration risk for funding which is predominately from retail term deposits. Changes in the access or cost of that funding could have a material impact on profitability and funding risk. Mitigating this risk is the existence of the $250,000 government guarantee on deposits and the increased percentage of the bank s funding sourced from the wholesale markets in recent times via senior, subordinated and RMBS bond issues, with this trend expected to continue Summary Bendigo Bank is an Australian regional bank operating throughout Australia with a heavier presence in Victoria and South Australia where its predecessor operations were founded. The bank mainly specialises in traditional residential mortgages and is focused on retail and community banking. In recent years Bendigo Bank have also expanded via acquisition with Rural Bank (and the Rural Finance Corporation of Victoria likely to be acquired in July 2014) that offer agribusiness banking and Delphi Bank which was formed after the acquisition of the Bank of Cyprus in March 2012, providing consumer and SME banking for Hellenic communities. The bank has a strong retail franchise, improving profitability and solid capital. Following the January 2014 $300m subordinated bond raising, Bendigo Bank had an impressive total capital ratio of 11.68% on a pro-forma basis. The bank s balance sheet is sound and is capable of meeting any significant challenges faced by the sector. At the time of writing, our preferred investment on a risk-reward basis is the 29 January 2019 call (29 January 2024 maturity) floating rate subordinated bond paying BBSW plus a margin of 280bps (at time of issue), which is available to both wholesale and retail investors. Sydney Melbourne Brisbane Perth FIIG Securities Limited Page 6 of 8
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