By Paul Rickard

Westpac’s decision to bite the bullet and announce a $3.5 billion capital raising through a share entitlement offer should come as no surprise. ANZ, Commonwealth and NAB have each undertaken capital raisings in response to the decision by Australian Prudential Regulation Authority (APRA) to increase the risk weighting for mortgages – and given that our major banks tend to move together, it is no wonder that Westpac has finally buckled to the pressure.

What is surprising is that until the last couple of weeks, some institutional investors had expected Westpac to withstand this pressure and the stock started to trade at a premium to its competitors. However in October, Westpac has only put on 2.5% compared to a 5.2% gain for ANZ and 4.5% for the NAB.

The surprising part of the statement was Westpac’s bold decision to pass on the cost of holding more capital by increasing its standard variable rate for home loans by 0.20%. Great news for shareholders (assuming the other banks follow suit) and for depositors – bad news for home loan borrowers.

Westpac’s standard variable rate for owner occupied home loans will increase on 20 November to 5.68%, and for investment home loans to 5.95%. The table below shows how Westpac’s new rates compare to their major competitors.

A solid second half

Accompanying the announcement, Westpac released its full year financial results. These are preliminary and subject to audit, and the detail still relatively scant. However, the headlines look good – and they are better than broker estimates.

Full year cash earnings of $7.82 billion were up 3% on 2014, but the second half of $4,042 million was up 7% on the first half result of $3,788 million. Retail banking was the star, with the Westpac branded retail and business bank increasing 2H earnings by 8% on 2H 14, and the St George Group up almost 6% on the corresponding period of 2014.

While jaws across the group was marginally negative (operating income over the full year increased by 4% while operating expenses grew at a faster rate of 5%), the income line was impacted by the partial sale of BT Investment Management, lower performance fees and lower trading income. Both the Westpac and St George retail banks improved their expense to income ratios.

And for the shareholder, cash earnings per share of 249.5c were up 2% on 2014. This beat current broker consensus estimates of 244.3c (source FN Arena), and importantly, the implied second half cash earnings per share of 128.2c are up 5.7% on the reported first half of 121.3c.

A final dividend of 94c will be paid, taking the full year to 187c per share compared to 182c in 2014.    

Capital raising  

The capital raising of $3.5 billion will take Westpac’s tier 1 capital ratio on a proforma basis to 9.3%, just above the group’s preferred target range of 8.75% to 9.25%. When this is complete, the bank will have boosted its capital by $6.0 billion in 2015 - $3.5 billion from this offer, $0.5 billion from the partial sale of BT Investment Management, and $2.0 billion from the first half dividend re-investment plan and partial underwriting.  

The offer structure is the same as that used by the Commonwealth and the NAB, with $3.5 billion to be raised through a fully underwritten pro-rata renounceable entitlement offer. Shareholders will be able to purchase new Westpac shares at $25.50 on the basis of one new share for every 23 ordinary shares currently held.

The new shares won’t participate in the final 2015 dividend of 94c to be paid in mid December, and based on Westpac’s last closing price of $30.44, the offer price of $25.50 represents a 13.1% discount to Westpac’s theoretical ex-rights price of $29.33. 

Over the next couple of days, institutions will confirm their participation in the offer, and will then have the opportunity to bid for shares that other institutions don’t take up. During this period, Westpac shares will remain in a trading halt.

On Monday, Westpac shares will commence trading again. Retail shareholders will then have three options in respect of the offer.

Firstly, you can sell your entitlement – which will trade on the ASX from next Monday until Wednesday 4 November under stock code WBCR.

Secondly, you can take up your entitlement by paying $25.50 for each new share. For example, if you had 1,000 Westpac shares, you would be entitled to buy 44 new shares at $25.50 – a total cost of $1,122.00. You will need to front up with the cash by Wednesday 11 November.

Or thirdly, do nothing. In this case, your entitlements will be auctioned to the institutions on 16 November. If Westpac shares are trading above $25.50, then you should receive a payment from Westpac which represents the difference between the auction price and $25.50. These payments (if any) will be made on 19 November. 

The do nothing option is usually not the best option (unless you have a really small entitlement and transaction costs prohibit the option of selling the entitlement), so shareholders are advised to either take them up or sell their entitlement on market.  Although Westpac is not my preferred bank (Switzer Super Report subscribers know that I prefer the NAB and Commonwealth), I plan to take my entitlement up.