Key Points: 

  • BOQ is trading around 18% below Morningstar's valuation
  • The bank is benefiting from rising interest rates
  • Three key things are weighing on the share price: Margins, loan book risks and management instability

See more on the outlook for Bank of Queensland here.

Transcript:

Nathan Zaia: The Bank of Queensland is the sixth largest home lender in Australia. It's got around 3% market share. In business lending it's smaller around 1%. So, it's got the BOQ brand, which has branches, and it's also got Virgin Money in Australia and ME Bank, and they're digital only, rely on mortgage brokers and mobile lenders.

So, what's unique about the Bank of Queensland? It's BOQ branch network. It has franchises as well. So, we think those customer relationships built within those branches supported by specialist lenders and the digital offering should help the bank hold on to its market share going forward as well.

The short answer is yes. So, around 60% of their funding is from customer deposits. So, that's money from term deposits, transaction accounts, and the savings accounts online. And we don't expect the average cost of that funding to go up by as much as what it's charging on its loan, so that will help it and make better margins. It won't benefit as much as some of the major banks which have more of those transaction accounts, but it should still benefit. The second thing is on loan growth. Bank of Queensland has been a beneficiary of some of its peers having some operational missteps, so Westpac and ANZ in particular. So, that's helped them grow really strongly in the last few years. But as rates go up now, as I mentioned, their funding cost disadvantage is widening a bit. So, we don't expect them to chase loans as hard as they have been. So, we have their loan growth slowing to about 3% per year versus 4.5% over the last five.

We recently wrote a report covering up on this topic. Bank of Queensland shares, I think, they're down about 8% year-to-date. One of its closest peers which has a similar loan book, Bendigo, it's up close to 18%, so a very big difference, and that leaves Bank of Queensland on a P/E of 10 times, dividend yield of 6. So, we think it's quite attractive.

I think there's probably three key things weighing on the stock. The first one is on margins. As I mentioned, doesn't have as much of those cheap transaction accounts as some of its peers, so that's money that's just sitting in your everyday banking account. CBA, around 30% of customer deposits are from those transactions. For BOQ, it's 6%. So, there's a lot less leverage to the higher cash rate environment. But in saying that, we're still assuming a 15-basis-point improvement. And that takes you back to where they have been on average over the last five years. I think people are overlooking the upside just because it's not as good as with some of the other peers.

Second thing is on loan losses and the risks within its loan book. Bank of Queensland, its name Queensland, everyone associates it with just being a Queensland bank. But that exposure to Queensland is 30%. It used to be 50%. So, that's come down a fair bit. Home loans used to make up 70% of the loans and we view them as lower risk. It's now 80%. So, the loan book has de-risked over a number of years. So, we think the way people perceive the riskiness of its business, it's changed over time.

The third thing is management instability. They've had a number of CEO, even CFO changes over the years. The most recent late last year was pretty unexpected. So, I think that raises question marks around the strategic outlook. But from our point of view, on paper, the capital position is strong. We haven't seen signs that they're taking real aggressive moves and dropping lending standards. And the projects they've been working on to digitize the bank, we think they're the right ones to continue to pursue to get the cost base of this business right going forward if it's going to continue to compete with the major banks. So, we think strategically things continue the way that they have been. So, in essence, we think execution has been okay, operationally performing alright. So, we think there'll be a relatively smooth changeover in management.