Westpac: H1 2020 Results Affected by Higher Provisions Relating to COVID-19 and AUSTRAC Investigation

Westpac Banking Corporation (Westpac or the Group) reported statutory net profit attributable to owners of AUD 1,190 million in 1H20, down 62% year-on-year. The results reflect a substantial increase in impairment charges as a result of the COVID-19 pandemic, as well as a material provision for a potential penalty from the ongoing AUSTRAC proceedings (for more information see press release "DBRS Morningstar Confirms Westpac at AA / R-1 (high); Trend Revised to Negative", dated November 27, 2019). The Group reported return on average ordinary equity of 3.5% in H1 2020, down from 10.1% in H1 2019.

Statutory total revenues were up 6% on H1 2019 and totalled AUD 10.6 billion, benefitting from a 9% growth yoy in net interest income and from lower remediation and litigation costs compared to those taken in H1 2019.

However, operating expenses increased to AUD 6.2 billion, or 21% higher than in H1 2019, with the substantial increase mainly reflecting a provision for a potential penalty of AUD 900 million relating to AUSTRAC's civil proceedings.

Credit impairment charges increased 6.7 times yoy and totalled AUD 2,238 million, of which AUD 1,619 million relate to the buildup of credit reserves in light of the deterioration in the economic outlook from the COVID-19 pandemic (including a $443m overlay) along with an increase in the overlay relating to bushfires (representing combined 72% of total credit impairment charges). These represented approximately 51% of the Group's pre-provision income of AUD 4.4 billion in H1 2020, compared to 7% in H1 2019. Westpac's annualised cost of risk (as a proportion of gross loans) jumped to 62 bps in H1 2020, from 9 bps in H1 2019 and 13 bps in H2 2019 .

In relation to the implementation of COVID-19 relief measures, the Commonwealth of Australia's key fiscal measures include a "JobKeeper wage subsidy" to enable corporates to retain staff on lower hours, as well as a guarantee program for SMEs up to AUD 40 billion. In this context, the Group disclosed that it provided payment relief to approximately 105,000 home loans in Australia (AUD 39 billion) and 15,000 in New Zealand (NZD 6 billion) . On the business side, Westpac has provided payment relief packages on AUD 8 billion of loans . Gross impaired assets increased 22% yoy albeit the gross impaired loans ratio (including the loans 90+ DPD, or otherwise in default, but not impaired) remains low at 1.04% .

The Group reported an APRA Common Equity Tier 1 (CET1) ratio of 10.81% at end-H1 2020, slightly up from 10.67% at end-FY19 , as organic capital generation and the AUD 2.8 million capital raising completed in December 2019 more than offset the impact from the 2H19 dividend payment, growth in RWAs and the impact from the notable items (i.e. estimated customer refunds, payments, associated costs and litigation and provisions along with costs associated with the AUSTRAC proceedings and the Response Plan). Nonetheless, and even though APRA has announced a temporary relaxation with regards to the 10.5% ‘unquestionably strong’ CET1 benchmark, Westpac has decided to defer its decision on the 2020 interim dividend In light of the uncertainty surrounding economic activity due to the COVID-19 crisis.

Under DBRS Morningstar's moderate macro-economic scenario, GDP growth in Australia falls -4.5% in 2020, with a 4% rebound in 2021 and 2.5% in 2022, while the average unemployment is estimated at 9% in 2020, 8% in 2021, and 6.5% in 2022. As a result, we expect the economic effects resulting from the coronavirus pandemic will likely translate in 2020 into weaker lending growth, lower fees and commissions as well as higher loan loss provisions. Nevertheless, DBRS Morningstar also considers that Westpac´s strong underlying profitability, solid capital levels, and sound asset quality metrics should help to mitigate some of the negative impact of this crisis on its credit fundamentals.