This morning Australia’s second-largest bank Westpac Banking Corp (ASX: WBC) revealed a distinctly flat set of financial results for the full year ending 30 September 2016. Below is a summary:

  • Cash earnings per share of 235.5 cents, down 5% on the prior year
  • Adjusted operating cash earnings (before impairment charges) up 3%
  • Revenue from ordinary activities down 3% to $20,985 million
  • Net interest margin up 5 basis points to 2.13%
  • Final fully franked dividend of 94 cents per share (cps), flat on prior year
  • Total annual dividend of 188 cps, up 1 cent or 0.5% on FY15
  • Cash return on equity (ROE) of 14%, down 1.85% on prior year
  • Common equity Tier 1 (CET1) capital ratio of 9.5%, flat on prior year
  • Lending and customer deposits up 6% and 9% respectively
  • Cost to income ratio at 42%, flat on prior year

On a headline basis it’s evident the bank’s cash earnings took a hit over the year from a 49% rise in bad debt charges related to a handful of corporate clients, while the declining ROE reflects pressures on the bank’s balance sheet from the tightening regulatory environment.

Otherwise, this is a typically solid result from one of Australia’s dominant banks with the net interest margin rising 5bps over the period to a healthy 2.13% despite management’s usual protestations about a “challenging operating environment”. So challenging in fact that Westpac and its profit-gouging peers have been able to deliver record-breaking profit after record-breaking profit in recent years, despite the headwind of the Basel Banking Committee’s capital adequacy requirements.

Banks turns profits by making more on what they lend than they pay on what they borrow, while lending long and borrowing short with the net interest margin reflecting the profit margins on lending versus borrowing rates.

Of course they have to hold some capital in reserve for a rainy day and APRA as the local regulator is requiring the levels of capital to be lifted as a percentage of certain risk weighted assets (loans) on the balance sheet. This is what’s lowering Westpac’s ROE as it’s forced to hold more idle capital, rather than lending it out at profitable rates of return.

Unfortunately for shareholders the capital adequacy requirements are only likely to get tougher in 2017 for Westpac and others like the Commonwealth Bank of Australia (ASX: CBA), although the good news is that Westpac grew both its core home loan and business lending books 5% over the period. Deposit growth for the respective sectors was also up 7% and 9% respectively in a good result that speaks to the underlying strength of the Australian economy and bodes well for FY17.

Outlook

The above numbers suggest Westpac is continuing to perform well in the Australian market and for dividend-focused investors in the retirement stage it remains a reasonable investment option on a medium-term time horizon.

It trades on a high price-to-book ratio compared to its international peers which reflects its higher quality and profitability, with the valuation on a multiple of earnings also in line with historical levels.

Risks remain around a housing crash or recession in Australia for example, but the bank’s strong competitive position and improving cash rate outlook mean it’s likely to be able to ride out any new capital adequacy requirements to deliver reasonable total returns now that the market has sufficiently priced in the regulatory risks to a share price of $29.90.

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Motley Fool contributor Tom Richardson has no position in any stocks mentioned.

You can find Tom on Twitter @tommyr345

The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.