Bad debts to rise for regional bank, says analyst

In a research note issued this week, Morningstar analyst Nathan Zaia said Bank of Queensland (BOQ) will “have a hard time” expanding net interest margins (NIMs) as funding costs are likely to rise and competition for mortgages heats up.

“Morningstar lowered NIM expectations for the Australian major banks recently, and we see Bank of Queensland as also being impacted by this sector-wide thematic,” Mr Zaia said.

“With bad debts likely to rise off cycle lows, an expectation of falling NIM and increasingly uncertain economic conditions, we foresee Bank of Queensland lowering its dividend payout ratio,” he said.

Morningstar does not expect BOQ’s residential mortgage book, or even loans to residential apartment construction, to “blow a hole” in earnings as it did in 2012. However, Mr Zaia stressed that the current low rate of bad debt will not remain indefinitely.

The analyst expects BOQ to achieve an average NIM of 1.94 per cent during the next five years, falling to 1.9 per cent in fiscal 2020.

“This is below our forecast five-year average of 1.98 per cent for the major banks,” Mr Zaia said.

While Morningstar expects the bank’s bad debts to rise, the analyst noted that BOQ can take some credit for the current low in bad debts.

“We believe the benefit of tighter lending standards is evident from an improvement in loan arrears and impaired assets and credit rating upgrades. Bank of Queensland centralised the lending process, restricting large loan approvals to specialists, and limited sector exposures,” Mr Zaia said.

“We believe the improvement in credit control will reduce the chance of a 2012-like spike in bad debts.”

Over the six months to 29 February this year, BOQ achieved above-system loan growth of $2 billion (1.2 times system), predominantly as a result of its decision to diversify distribution channels.

Housing mortgage growth for the half was $1.7 billion (1.6 times system), driven by strong growth through BOQ Specialist and the broker network.

Growth in these channels also improved the bank’s mortgage portfolio diversification outside Queensland and increased its lower LVR lending relative to the portfolio.

BOQ’s commercial lending growth was 6 per cent (0.5 times system) for the half as it maintained a focus on credit quality and appropriate pricing for risk within its targeted niche segments.

BOQ Specialist’s commercial loan book grew 14 per cent to $2.4 billion year-on-year, while the BOQ Finance portfolio grew 1 per cent (0.6 times system).

[Related: BOQ adds $2 billion to loan book amid market 'challenges']