Peter: Hello and welcome to Switzer Investing Insights brought to you by nabtrade and today we want to get to the bottom of Westpac's capital raising. Paul?
Paul: Yeah. Westpac's raising two and a half billion dollars Peter, and it's doing this really just to strengthen its balance sheet and importantly to make sure that it more than meets APRA's sort of unquestionably strong benchmark. But that means that if you haven't heard about that benchmark, is that all the major banks have to have a tier one capital ratio of at least 10.5%. Now Westpac's currently over that at 10.67, but there are some issues that are-
Peter: They're cutting it close.
Paul: Cutting it close. One is obviously there's some changes around how the ratio is measured. There's some changes in New Zealand with the Reserve Bank in New Zealand saying that they want some sort of capital set aside just to cover the Australian banks’ activities in New Zealand.
Paul: There's customer growth, there's some litigation issues potentially, and also some regulatory reactions over some question marks around some anti-money laundering. So it's really raising it to strengthen the balance sheet. It will take it to about 11.25% once it's done. It will increase the number of shares by about 3%. And of that two and a half billion dollars, $2 billion has already been done through an institutional placement. That was done at a price of $25.32. This leaves about half a billion dollars for retail investors through a share purchase plan.
Peter: And I guess what we're saying is that the big institutions, the big funds, they've been happy to take this capital rising up to the tune of $2 billion?
Paul: Yeah, they have, I mean it's not a big amount, but that went pretty quickly and so now it's a chance for retail investors to have a turn.
Peter: Okay, so why don't you talk us through the actual share purchase plan.
Paul: Yeah, so importantly, you don't have to participate. This is purely voluntary. If you don't like it, don't have the cash, whatever the reasons are, have too much exposure to banks, then this is something you that, no obligation to be in it. So it's something you either decide to be part of or not. It's a maximum of $30,000 and then that generally that'll start from a minimum of 1,000 and you can participate in $1,000 or $2,000 or $3,000 or $30,000.
Paul: And importantly the price, it's a lower of $25.32 cents. That's the price that the institution's paid for there to be a dollar rating and the average price, or how Westpac shares trade in the last week before the closing date. Now it's due to close on the second of December. And if so have Westpac shares fall between now and the 2nd of December and go below $25.32 cents, you'll actually pay that price less a 2% discount. So you are pretty insulated if you participate now in terms of any price movement. You won't pay more than $25.32. You could pay a little bit less, if Westpac shares come under pressure.
Peter: And I guess if they go up, then ...
Paul: You'll still pay $25.32 cents-
Peter: Good point.
Paul: ... so you are actually protected there. The offer opens on the 12th of November. It's due to close on the 2nd of December. You'll get the shares on the 11th of December. Importantly, it's only $500 million and Westpac may scale back applications.
Paul: Now what that means, if you bid for $30,000 and there's lots and lots of people for who want to participate, you may only end up, for example, $10,000 and you'll get a refund. So they said it's only $500 million. They do have a discretion to take on more. So we'll have to see how that plays out. But often when these things are going amongst a lot of shareholders, we do get a scale back. So that's just something to be a little mindful of.
Paul: And one last point, Peter, is that Westpac's do to pay a dividend in early December. That's 80 cents per share. These new shares won't qualify for that dividend.
Peter: Yeah, and some people who've never done this before, you have to put your money in first and then you get a rebate. If, for example, you ask for 30 and you only get 10.
Paul: Yeah, and that's the downside of a share purchase plan. You put the money out, they get the money for a little while and you've got to wait till they get it back to you. Generally, it happens pretty quickly, but you won't actually know until after the 2nd of December how many shares you'll get.
Peter: Okay. What's the outlook for Westpac?
Paul: Well, Westpac, like a lot of the other major banks has come out with a pretty subdued outlook. In fact, their outlook that they gave in their announcement for their annual results was perhaps a little bit weaker than I think many in the market had expected. So let's just go through some of the things that they said.
Paul: They expect fairly flat lending balance. In other words, their assets won't actually grow. And so that means there's no volume growth. That's the first thing. There's still pressure on the net interest margin. That's the difference between what rate they get when they lend money versus what they pay for deposits. And that margin is essentially their profit margin. So that's still under a bit of pressure. And so-called non-interest income from fees is still also under pressure. So there's not much sort of income growth. Expense growth is still expected to be around 1%. now that still sounds like growth, but they've got a lot of ongoing risk and compliance spending and also got a lot of work going to regulatory actions.
Paul: So despite all this, and despite the productivity initiatives, costs are still expected to go up a fraction and there's still uncertainty about some regulatory issues. So one, I mentioned the capital issue, what's Reserve Bank of New Zealand going to do in terms of their New Zealand subsidiary, but also some regulatory action around, they've got some class actions, they've also got some actions with ASIC. They've also got issues around some potentially anti-money laundering. So a fairly subdued outlook coming from management.
Peter: Yeah, and we also have heard that all the banks are having remediation issues, and that's basically remedying anything that's coming out of the Royal Commission, and ultimately that's a cost to the bank as well.
Paul: Yeah, we actually don't know what that's going to be. They're treating that sort of as an abnormal cost, but those costs have been building and of course they are eating into profits and their ability to pay dividends. So the actual cost of paying back the things, the sins of past are still moving in the wrong direction. So there is a little more confidence that they're getting to the bottom of these issues, but I think as we've found out with these things, once they start, you open a can of worms, it's very hard actually to close the lid back down. So that's also a potential negative.
Peter: Those worms don't like the lid being closed on them. Paul, finally, the brokers? What are they saying?
Paul: Yeah, the brokers are also a bit negative. I mean they're not sort of crying out and saying, "Westpac's a big sell," but there are not actually a lot of people saying out there, "Westpac's a buy," either. They're seeing the whole banking sector as being still pretty subdued and pressures there. Westpac did cut its dividend in its annual profit announcement spec to 160 cents. Effectively 80 cents for the final part of the year. And I think the market now expects 160 cents to be about the dividend next year.
Paul: And so the rebasing of that is probably a positive. That's going to mean that these shares at a price of $25.32 cents will still yield 6.32%, plus franking. Still makes them pretty effective. But you know, I think while the dividend of 160 cents for next year looks okay, there's a little bit of uncertainty with some of the analysts about these sort of outer years as to what that dividend could be.
Peter: Unless the economy grows strongly and borrowing starts picking up, it's going to be hard for them to make money and therefore the dividend could be under pressure for some years out.
Peter: That's Switzer Investing Insights brought to you by NAB Trade. Thanks for joining us.