The banks had a great session yesterday, which may have surprised some given the negativity around housing, consumer pressure and the risk of rising bad debts. One factor receiving little attention is the excess capital sitting on bank balance sheets, with Westpac a prime example.
Westpac’s CET1 ratio stood at 12.75% at the end of March, implying surplus capital of around A$2.7 billion above its internal target. The recent sale of its RAMS mortgage portfolio to Pepper Money, KKR, and PIMCO managed funds for $15.4 billion added another 23 basis points to CET1, creating more than $1 billion of additional capital headroom.
The bank also holds approximately $3.7 billion of surplus franking credits, the largest balance among its major-bank peers and equivalent to around 3% of Westpac’s market value. That gives management a strong incentive to return capital through a fully franked special dividend rather than relying solely on buybacks.
The setup looks interesting to MM:
- Around $2.7 billion of pre-existing surplus capital.
- More than $1 billion released through the loan portfolio sale.
- A $3.7 billion surplus franking-credit balance.
- An interim dividend of 77c per share, representing a payout ratio of around 77%.
- Scope for a special dividend of perhaps 20–40c per share, although Westpac has provided no formal guidance.
Combined with ordinary dividends and buybacks, total shareholder distributions could lift the effective yield towards 7% at current prices.
There is still some execution risk. Westpac was similarly well placed to pay a special dividend in FY25 but chose not to, while underlying earnings growth remains modest and investment spending through the UNITE program is still elevated. Credit costs are also likely to move higher from unusually low levels if the housing and consumer backdrop deteriorates.
While we agree with most investors that Westpac’s near-term earnings outlook is not especially exciting relative to its current valuation, we think the capital-management story is becoming increasingly difficult to ignore. The loan sale has strengthened an already well-capitalised balance sheet, while the large franking-credit surplus makes a special dividend at the November result a realistic prospect.
- UBS upgraded WBC to a Buy from Neutral on the 3rd August, with a $45 price target, the day after they announced the $15.4 billion loan portfolio sale, though John Story, UBS’s analyst on the stock (who we think is very good), also highlighted the growth outlook for institutional banking as being another key driver of the change.
We own WBC in the Active Growth Portfolio, though we do not hold a position in the Income Portfolio at this stage – the prospect of a special dividend is enticing.
MM is cautiously bullish WBC based on the prospect of a Special Dividend
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