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Morningstar | Ex-Westpac Executive Appointed as CEO at Bank of Queensland. FVE 9.60 Maintained. See Updated Analyst Note from 05 Jun 2019

Bank of Queensland today announced the appointment of George Frazis as CEO and Managing Director, effective Sept. 5, 2019. Frazis will succeed interim CEO Anthony Rose, who took charge following the resignation of John Sutton in December 2018. We like the appointment, and see this as a sign of management stability that will help drive the Bank’s strategy and provide continuity of business momentum. Frazis is an experienced banker with 17 years of experience, most recently as Chief Executive of Westpac’s consumer bank division and CEO at St. George Banking Group. While Frazis has strong credentials and deeply understands the dynamics of Australia’s consumer banking industry, he will be taking control of a regional player with a small geographic distribution footprint, higher funding and operational costs, a lower credit rating, and tougher regulatory capital burden. There will be challenges, but the earnings outlook is positive. We reaffirm our fair value estimate of AUD 9.60 per share, and our no-moat and Standard stewardship ratings remain intact.

Frazis is an impressive executive who has led Westpac’s largest business division, consumer bank. The business is highly profitable, with returns on equity of 14.4% and 16.5% in fiscal 2018 and fiscal 2017 respectively--the highest of the group outside New Zealand. Cash NPAT was around AUD 3.1 billion for fiscal 2018, close to 40% of group profit. Frazis also oversaw the management of the large loan book of close to AUD 450 billion as at March 2019, around tenfold that of Bank of Queensland’s.

The challenge for Frazis is to assume a bigger role at a smaller organisation which lacks the market share, brand awareness, distribution capabilities and funding advantages the wide-moat-rated major banks possess. Bank of Queensland's lending growth has been subdued for several years. Based on the Australian Prudential Regulation Authority, or APRA, banking statistics for April 2019, the bank’s 12-month growth in home loans sit at just 0.3% in April, as compared with 1.7% a year ago and 11.8% three years prior. Bank system home loan growth is 3.3% for the year to April 2019. The prospects of Bank of Queensland’s loan portfolio are mostly tied to the Queensland housing market, which continues to weaken as property prices fall.

To remain competitive, the bank recently lowered fixed rates across its BOQ, Virgin Money, and BOZ Specialist brands, and passed on the latest RBA rate cut in full to most of its variable home loans. We question if further cuts are sustainable, as the bank: i) lacks access to lower-cost wholesale funding options; and ii) has a much lower return on equity than the major banks. Until we see a material improvement in the housing market, our conservative five-year forecasts remain intact. We expect Bank of Queensland’s loan growth to average 2% per year (versus a three-year average of 3.5%), and flat net interest margins averaging 1.9% per year.

Nonetheless, we think Frazis’ prior experience and success in strengthening relationships, business simplification, and improving service will kick start business momentum and underpin growth. Maintaining deep relationships and ensuring customer satisfaction is paramount to regional lenders like Bank of Queensland, which cannot compete solely on price. Under Frazis’ leadership, Westpac’s consumer bank division has seen more than a million new customers over the past four years, while the use of digital channels has increased to over one third of sales. Frazis will have to do the same at Bank of Queensland. We expect further emphasis on delivering better customer experiences, through increased digitisation and/or investment in staff training. All of this may necessitate increased investment, increasing operating costs, for the sake of longer-term volume and subsequently, earnings growth. Our fiscal 2019 forecasts for cost/income and return on equity sits at 51.2% and 8.2%, respectively, though we have this improving towards 49.3% and 8.5% by fiscal 2023.

We are confident new management can turn the bank’s fortunes around, despite the soft outlook over the near term. There is still much to like about the regional lender. The increasingly diversified business and distribution mix complements its traditional consumer and SME banking businesses. Asset quality is sound with very low home loan arrears, while capital levels are strong with the common equity Tier 1 ratio solid at 9.26%. We forecast earnings per share to grow by 2% per year from AUD 80 cents in fiscal 2019, to around AUD 86 cents in fiscal 2023.