WBC - Westpac

[Snoopy]

To calculate 'net profit margin' figures, as used in the fourth Buffett test, I require company revenue figures. I need to identify what revenue adjustments that I need to make to allow for the removal of 'Pendal Group' and 'Ordinary Customer Financial Advice' from the overall Westpac (WBC) business. I will start by looking at the situation with the Pendal Group.

Pendal Group Revenue Adjustments

FY2015

Before 23rd June 2015, Pendal (or BTIM as it was named then), being over 50% owned by Westpac, was consolidated into the Westpac accounts. BTIM revenue for FY2015 consisting of:

a/ 'management fees',
b/ 'performance fees' and
c/ 'transaction fees'

This came to a grand total of $476.535m (BTIM AR2015 p76). Westpac owned 60% owned BTIM as a consolidated subsidiary for 268 days of a 365 day year over FY2015. This means the amount of BTIM revenue reported in the WBC FY2015 accounts should be approximately:

$476.535m x (268/365) =$320.554m

It is likely that this income appears under p135 Note 4 in WBC AR2015. 'Management fees' being probably classified under the header 'Other non-risk fee income', while 'performance fees' and 'transaction fees' might fit best subsumed in the header 'Transaction fees and commissions received'.

Once WBC's BTIM share holding dropped below 50% (after 25th June 2015), thereafter there should be no 'Pendal Revenue' as such, because Pendal then becomes an 'Associate' rather than a 'Subsidiary'. As an 'Associate' the revenue from Pendal is now in the form of:

1/ dividends and
2/ any substantial changes in capital value of the asset should it be sold down further during that year.

Any such capital gain on a sell down is booked by Westpac as 'non-interest income' in the profit and loss statement. That capital will have to be taken out of my revised WBC revenue picture.

In this case, the FY2015 capital value gain included a 'realised gain' of the 28% of BTIM sold ($492m) and an 'unrealised gain' of the 31% interest retained ($544m). This resulted in a total pre-tax gain of: $492m + $544m = $1,036m (AR2015 p77/p135/p245). This $1,036m is the 'capital revenue' that I must be remove.

The Pendal sell down in FY2015 occurred after the payment of all Pendal dividends in that year. So all the dividends from Pendal by WBC in FY2015 are from the number of shares held pre-sell-down..

=> Total of all Pendal Revenue to be removed over FY2015 = $321m + $1,036m = $1,057m


FY2016

As an 'Associate' from Westpac's perspective, Pendal dividends are the only source of revenue that came into the WBC income statement over FY2016.

	Dividend Payment Date	Dividend (cps)	Dividend Amount	Westpac Percentage Shareholding	Dividend Payout to Westpac
	02-12-2015	20cps (40% Franked)	$57.206m	31.04%	$17.75Asset following7m
	26-05-2016	18cps (40% Franked)	$52.521m	31.04%	$16.303m

=> Total of all Pendal Revenue to be removed over FY2016 = $17.757mm + $16.303m = $34m

FY2017

Pendal continued as an Associate over FY2017 until the 25th of May 2017. WBC's share of dividends over this time is presented in the table below

	Dividend Payment Date	Dividenwilld (cps)	Dividend Amount	Westpac Percentage Shareholding	Dividend Payout to Westpac
	08-12-2016	24cps (35% Franked)	$71.365m	29.54%	$21.081m
	25-05-2017	19cps (30% Franked)	$54.653m	29.54%	$16.14Asset following4m

On 26th May 2017 Westpac sold a further 19% of BTIM/Pendal (carrying value $471m) reducing their holding to 10% (residual carrying value $242m). The result was a net gain (net of transaction costs before tax) of $279m (AR2017 p139/p227). This gain is recorded in the income statement and so it becomes revenue that must be removed. (Following this sell down the remaining holding in Pendal became reclassified as an 'Available for Sale' asset.)

=> Total of all Pendal Revenue to be removed over FY2017 = $21.081m + $16.144m + $279m = $316m

FY2018

Pendal, as an 'Available for Sale' asset, paid WBC their share of dividends over the year as presented below:

	Dividend Payment Date	Dividend (cps)	Dividend Amount	Westpac Percentage Shareholding	Dividend Payout to Westpac
	07-12-2017	26cps (25% Franked)	$78.191m	8.99%	$7.029m
	25-05-2018	22cps (15% Franked)	$65.565m	8.99%	$5.894m

As an 'Available for Sale Asset', the annual change in value of that asset was recorded in the WBC income statement (AR2018 p143). Over FY2018 there was a $104m write down in the residual value of 'Pendal Group' (p160 AR2018).

=> Total of all Pendal Revenue to be removed over FY2018 = $7.029m + $5.894m - $104m = -$91m

FY2019

The WBC owned Pendal shareholding, previously classified as an 'Available for Sale' asset, has been reclassified as an 'Investment Asset', following the adoption of new accounting standard 'AASB 9'. Over FY2019 the accounting for the Pendal asset has been combined with other investment securities (p175 AR2019). Consequently for this year, it will be necessary for me to calculate the decline in Pendal asset value over the year for myself.

At EOFY2018 the Pendal share price was $8.79. This represents a capital dollar value of: $8.79 x 30.814493m = $270.859m
At EOFY2019 the Pendal share price was $7.39. This represents a capital dollar value of: $7.39 x 30.814493m = $227.719m

So the capital loss for the FY2019 year on the Pendal stake was: $227.719m - $270.859m = -$43.140m

WBC's share of dividends over the year from their Pendal 'investment asset' is presented below:

	Dividend Payment Date	Dividend (cps)	Dividend Amount	Westpac Percentage Shareholding	Dividend Payout to Westpac
	06-12-2018	30cps (15% Franked)	$89.873m	10.40%	$9.347m
	23-05-2019	20cps (10% Franked)	$59.897m	10.40%	$6.229m

=> Total of all Pendal Revenue to be removed over FY2019 = $9.347m + $6.229m - $43m = -$27m

Next I will look at part 2 of this exercise, namely removing 'Ordinary Customer Financial Advice' from my Westpac revenue picture.

SNOOPY

[Snoopy]

Next I will look at part 2 of this exercise, namely removing 'Ordinary Customer Financial Advice' from my Westpac revenue picture.

The information in this post may be principally found in the March 19th 2019 stock exchange release "Resetting Westpac's Wealth Strategy". The table is compiled 'bottom up'. That means starting with the 'net profit after tax' and working backwards.


Earnings from 'Ordinary Customer Financial Advice'

	FY2015 (estimate)	FY2016 (as presented)	FY2017 (as presented)	FY2018 (as presented)	FY2019 (estimate)
Non-interest Income	$276m	$270m	$246m	$185m	$46m
less Operating Expenses	($260m)	($260m)	($260m)	($260m)	($174m)
equals Core Earnings	$16m	$10m	($14m)	($75m)	($128m)
less Tax and Other	($5m)	($3m)	$4m	$22m	$38m
equals Net Profit After Tax	$11m	$7m	($10m)	($53m)	($90m)

Notes

1/ Where tax due/refunds are calculated, the assumed tax rate is 30% (rounded to the nearest million dollars in terms of the dollar amount of tax paid)..
2/ I have assumed that the business unit operating expenses of FY2018 are reflective of the operating expenses incurred in the preceding three years.
3/ The 'Advice to Ordinary People' profit for FY2015 is not specifically disclosed. However we do learn from the FY2016 "Full Year Financial Results Presentation" slide 99 that: "Advice Income is lower from Reduced Activity." On the same page we learn that Average funds under Management over FY2016 was: ($17.8b + $18.3b)/2 = $18b verses ($19.8b +$18.3b)/2 = $19b over FY2015. That is a drop of $1billion. I am guessing incremental retail advice fees on such a portfolio would amount to 0.5% of the value of that portfolio.

0.005 x $1billion = $5m, or $5m x 0.7 = $3.5m after tax

So if this is the amount lost over FY2016 from the previous year, that means a good estimate of the 'Advice Fees' for FY2015 is : $7m + $3.5m = $10.5m (rounds to $11m)

The most important line of figures in the table is the top one that I have highlighted in bold. That is because the 'non interest income' is actually the revenue figure for the earnings from 'Ordinary Customer Financial Advice' that I am after. Having calculated that, we can now add up the total revenue that I require to deduct from Westpac revenue as presented in the respective annual reports.

	FY2015	FY2016	FY2017	FY2018	FY2019
Revenue 'Ordinary Person Financial Advice'	$276m	$270m	$246m	$185m	$46m
Revenue 'Pendal Group'	$1,057m	$34m	$316m	($91m)	($27m)
Total Revenue for removal	$1,333m	$304m	$562m	$94m	$19m

SNOOPY

[Snoopy]

Westpac Group (WBC)	FY2016	FY2015	FY2014	FY2013	FY2012
Normalized Profit {A}	$7,605m	$7,527m	$7,338m	$6,792m	$6,328m
Gross Interest Revenue {B}	$31,822m	$32,215m	$32,248m	$33,009m	$36,873m
Net Profit Margin {A}/{B}	23.9%	23.3%	22.8%	20.6%	17.2%

A 'steady with inflation increase in margins over the last three comparative figures, and a rather stronger rise before that.

Result: Pass Test

In the previously quoted figures I have given as a comparison I did not include non-interest income in revenues. On reflection I think that was a mistake, which I have corrected in this current iteration of my calculations.

Westpac Group (WBC)	FY2019	FY2018	FY2017	FY2016	FY2015
Normalized & Adjusted Profit {A}	$8,124m	$8,400m	$7,854m	$7,549m	$7,544m
Gross Interest Revenue	$33,222m	$32,571m	$31,232m	$31,822m	$32,295m
add Gross Non-Interest Revenue	$3,742m	$5,628m	$6,286m	$5,837m	$7,375m
less Discontinued Divisional Revenue adjustment	($19m)	{$94m)	($562m)	($304m)	($1,333m)
equals Gross Revenue Total {B}	$36,945m	$38,105m	$36,956m	$37,355m	$39,319m
Net Profit Margin {A}/{B}	22.0%	22.0%	21.3%	20.2%	19.2%

Despite stalling (on a high I might note) in FY2019, the ever increasing net profit margin is clear to see.

Result: Pass Test

SNOOPY

[Snoopy]

Warren Buffett's scanning of the 'growth potential' of a company can be summarized in four quick questions.

Q1/ Does Westpac Group have a top three market position in the markets in which it chooses to operate? (Ref: my post 32)
A1/ Yes

Q2/ Does Westpac Group have a 'normalised profit' increasing 'earnings per share trend'? (Ref: my post 39)
A2/ Yes

Q3/ Does Westpac Group have a record of earning a superior ( >15% ) return on shareholder equity? (Ref: my post 41)
A3/ No

Q4/ Does Westpac Group have the capability of operating at increasing Net Profit margins? (Ref: my post 42)
A4/ Yes

Overall Conclusion

Westpac is not able to satisfy all the requirements to apply Warren Buffett's compounding growth model. This does not mean that Westpac is necessarily a poor investment going forwards. It just means that Westpac must be analyzed in a different way. It might be sensible to regard Westpac as a pure 'dividend play' from here.

Following on from my extensive look at Westpac, three long years ago, it is time to sew up my FY2019 research expedition.

I have set out to answer the question: "Would Warren Buffett invest in the Westpac bank today?" About the same time I posed this question to myself (December 2019), I found Motley Fool in Australia asked exactly the same question.

https://www.fool.com.au/2019/12/06/w...res-right-now/

As it turns out we have both come to the same conclusion, albeit for rather different reasons. The Australian banking market's 'Four Pillars' of strength (Commonwealth Bank of Australia, Westpac, ANZ and National Australia Bank) have, over the last ten years, weathered the fall out from the GFC and the subsequent rebuilding processes better than any other international scale banks I can name anywhere in the world. The scale of Westpac in Australasia means that it is 'too big to fail'. Indeed it is hard to imagine a competitor emerging to the big four, such is their size and reach across markets. With their market position secure (that is what a pass in the first Buffett test, my post 154 is all about) we can now move on to look at the 'business operating trends' by numbers.

My post 237 shows good earnings growth if you regard the FY2019 year as an allowable cyclical drop off. It is a very rare business that can increase their earnings each and every year if they have a history of 200 years of operation after all. But the 'Earnings Per Share' picture is not so flattering. Issuing more shares to fund your expansion is not necessarily a way to increase the wealth of all shareholders. 'Westpac' had a share issue in FY2016 at the 'bargain' price of $A25.50. The flat-lining in 'eps' since this capital was fully deployed in FY2017 could suggest that the incremental expansion of the business that this new capital allowed has not been well deployed. This is a very good example of why increasing 'eps' is a far more important metric than just increasing profits. So a fail for 'Westpac' on the 'Earnings per Share' test.

'Return on Shareholder Equity' is another failure, where the admittedly stretch target of 15%, has not looked like being met at any time in the last five years (my post 240). However our mate Adrian in the Reserve Bank is on record as saying that with deposit interest rates hovering at around 1%, banks should be more than happy with a 12% return on shareholder equity. I am starting to wonder if he has a point.

The fourth and final 'Buffett Test' relates to net profit margins. It is no secret that as interest rates fall there is a tendency for interest rate margins to be squeezed. But interest rate margins are only one part of the cost equation. It is clear that Westpac have managed their overall margins very well as profit margins are only increasing. That is something I didn't expect, and that result means a 'strong pass' for this Buffett test.

In summary, while Westpac has not met the high Buffett hurdles required for investment, what emerges from this analysis is evidence of a strong and enduring business. The failure on 'return on equity' for example, could also be interpreted as the company building up their equity base so that it is more resilient for that 'rainy day'. And with that rainy day, in the form of Covid-19, now here I find it hard to criticise Westpac for building up their equity reserves over the last few years. We have to remember that this whole analysis is pre-Covid-19. Just because a company fails at Buffett's test hurdles does not mean it is a poor investment. WBC has an extraordinary historical record of delivering a strong dividend stream for example. But the Australian government have put their banks on 'dividend notice' and that has seen Westpac's dividend suspended. Nevertheless it is important to 'not be too fixated on the moment' and be able to look through the current Covid-19 panic to see what kind of Westpac will emerge on the other side. To really decide if WBC is a good investment from here, we need to do some stress testing on WBC's resilience. And that is a separate exercise.

SNOOPY

[Snoopy]

Aussie banks not expected to be performing well, with new government regulations.

The above comment co-incided with the arrival of the 'bank levy' in Australia. But I haven't seen much in the NZ media about how the Australian state and federal governments are helping Aussie citizens, businesses and banks through the Covid-19 crisis. Here are some excerpts from the HY2020 report on the subject.

From p33:

"The impact of the COVID-19 pandemic on the Australian economy and the Group remains uncertain. The severity of its impact will depend on its spread and duration, customer responses, the capital markets reaction and the response of governments and central banks."

From p37:

"On 19 March 2020, the (Australian) Reserve Bank announced extensive measures aimed at providing liquidity to financial markets and to support the banks in providing credit to businesses:

1/ Lowering the cash rate, these measures included
2/ Injecting extra liquidity into the financial system through daily market operations,
3/ The purchasing of Australian Government bonds in the secondary market,
4/ Increasing the interest rate on Exchange Settlement Balances, and
5/ The introduction of the Term Funding Facility (TFF).

Introduction of the Term Funding Facility (TFF)

"The primary purpose of the TFF is to support lending to Australian businesses. In aggregate, ADIs (Authorised Deposit Taking Institutions) have access to at least $90 billion under the TFF, comprised of an Initial Allowance for each ADI, plus an Additional Allowance. Based on the terms of the facility, Westpac’s Initial Allowance is $17.9 billion and can be drawn down until 30 September 2020. The Additional Allowance is based on the growth in lending provided by the ADI to both large businesses and SMEs from the quarter ending."


From p37: Committed Liquidity Facility (CLF)

"Westpac’s CLF allocation for the 2020 calendar year, as approved by APRA, is $52 billion (2019 calendar year: $54 billion). The CLF is a commitment by the RBA to provide funds secured by high-quality collateral through a period of liquidity stress. This commitment can be counted by ADIs towards meeting the LCR requirement given the limited amount of government debt in Australia. In order to have access to a CLF, ADIs must satisfy qualifying conditions and are required to pay a fee to the RBA on the approved undrawn facility. The fee was increase by the RBA on 1 January 2020 to 17 basis points (from 15 basis points) and will increase to 20 basis points on 1 January 2021."


From p37: Non-High Quality Liquid Assets (HQLA)

"The Group also holds a portfolio of non-HQLA liquid assets that are repo-eligible (eligible for re-purchase with a central bank) with the Reserve Bank of Australia. These include private securities and self-originated AAA-rated mortgage backed securities."

From p37: High Quality Liquid Assets (HQLA)

"At 31 March 2020, Westpac held $121.0 billion in HQLA (30 September 2019: $89.9 billion). HQLA include cash, deposits with central banks, government securities and other high quality securities that are repo-eligible with the RBA. The HQLA portfolio is managed within the Group’s risk appetite and within regulatory requirements. "

Westpac now has in place (from p46) a

"$10 billion home lending fund to support the economy by assisting more Australians into home ownership as well as support for the Government’s Coronavirus SME Guarantee Scheme.

From p69 Job keeper Payments

"The Australian Government announced a $130 billion JobKeeper payment on 30 March 2020." (The JobKeeper Payment scheme is a temporary subsidy for businesses significantly affected by coronavirus (COVID-19). Eligible employers, sole traders and other entities can apply to receive $1,500 per eligible employee per fortnight.)

On 21 July the Australian government announced proposed changes to JobKeeper including an extension through to 28 March 2021. These changes do not impact JobKeeper payments until after 28 September 2020. The payment will be stepped down and paid at two rates. From 28 September 2020 to 3 January 2021, the payment rate will be $1,200 per fortnight. From 4 January 2021 to 28 March 2021, the payment rate will be $1,000 per fortnight.

All the above government support has allowed Westpac to do the following:

Westpac's Response to Government Initiatives

From p69
"In response to the current COVID-19 pandemic, Westpac has provided support to its customers by implementing a range of initiatives, such as lowering interest rates on certain products, waiving certain fees and granting deferrals of mortgage and business loan repayments to customers affected by the COVID-19 pandemic"

From p73
"The economic disruption caused by the COVID-19 pandemic has led Westpac and other major banks to offer certain mortgage and business customers a deferral of certain interest and principal repayments of between 3 and 6 months." (During this period, the deferred interest will be capitalised and the deferred principal along with the capitalised interest, will be repaid over the remaining term of the loan.)

The Australian government is fully supportive of 'mortgage repayment holidays'

From p77
"Where a support package provides an option to defer repayments for a period of time, for RWA (Risk Weighted Asset) calculation purposes, a bank need not treat the period of the repayment holiday as a period of arrears (provided the borrower had previously been meeting their repayment obligations)."

SNOOPY

[RTM]

http://nzx-prod-s7fsd7f98s.s3-websit...301/331416.pdf

recommend to the Court that Westpac pay a civil penalty of $1.3 billion in
relation to admitted contraventions of the Anti-Money Laundering and
Counter-Terrorism and Financing Act 2006 (AML/CTF Act).

Solid penalty. Guess they will be happy to have this behind them.

[Waltzing]

amazing that this industry should attract such honest types..

[Snoopy]

More bad news on potential Westpac liabilities on the customer payments for pedophilia scandal is contained within a 28th July 2020 press release.

https://stocknessmonster.com/announc...bc.nzx-356959/

"The Group had self-reported Threshold Transaction Report (TTR) issues to AUSTRAC, including TTRs filed with incomplete or inaccurate information as well as an estimated 60,000 to 90,000 TTRs that had not been reported to AUSTRAC. Following further investigations and in response to a notice from AUSTRAC, Westpac has provided AUSTRAC with updated information relating to these TTR issues, including approximately 175,000 transactions that were not reported to AUSTRAC and approximately 365,000 TTRs that were reported to AUSTRAC but may have contained incomplete or inaccurate information."

The number of 'Threshold Transaction Report' cases has near doubled. The fact that half of the reported transactions are now 'late to be reported' will not please AUSTRAC. If penalties are dished out on a per transaction basis, then we could be looking at a doubling of a potential fine for Westpac. In dollar terms that means three to four billion dollars. And that is no 'wet bus ticket' for Westpac shareholders!

http://nzx-prod-s7fsd7f98s.s3-websit...301/331416.pdf

recommend to the Court that Westpac pay a civil penalty of $1.3 billion in
relation to admitted contraventions of the Anti-Money Laundering and
Counter-Terrorism and Financing Act 2006 (AML/CTF Act).

Solid penalty. Guess they will be happy to have this behind them.

It looks like when I typed out part 6 of this series that I dropped three decimal places in my fine estimate. It should have read three to four trillion dollars. Put in that light the $1.3billion dollar actual fine seems a bargain. But it probably means no final dividend either. $1.3billion is $400m over the forecast provision for this settlement. And this is only one of several disputed matters that Westpac might be best to settle out of court.

SNOOPY

[Waltzing]

Another cap raise possible. Still got the USA case to come. Great trading stock going forward.