It's been over 20 years since Australia experienced a recession.
So it's little wonder why we're called 'The Lucky Country'.
For Australia's big banks – and shareholders – it's been a great run. The housing and China-fuelled mining booms have played their part in allowing our big banks to continually post record profits.
Westpac Banking Corp (ASX: WBC) has been no exception, having grown profits and dividends by 180% and 80%, respectively, between 2005 and 2014.
Australia survived the worst of the Global Financial Crisis relatively unscathed. However downward revisions to forecasts for 2015's and 2016's gross domestic product (GDP) are making the economic outlook cloudy. Unemployment is also creeping higher, confidence is shot and the fallout from the resources boom is anything but over.
So perhaps now more than ever, it's vital Westpac shareholders are fully prepared for what lies ahead.
The five charts Westpac shareholders need to see
Source: Westpac Annual Report's 2009 & 2014
The above chart shows Westpac's Net Interest Margin, or NIM, versus its operating expenses (as a percentage of income) over the past 10 years. As can be seen, Westpac's operating expense ratio been cut from over 48% to below 43%.
While it may not seem like much at first glance, keeping its operating ratio down saved Westpac approximately $1,172million of expenses in 2014.
NIM is the difference between what a bank pays on deposits and what it receives on loans. It is the preferred measure of profitability for the net-interest income component of a bank's income statement. The lower the NIM, the less profitable it is to lend money. Westpac's falling NIM is likely a result of growing competition.
During the financial crisis (2008) Westpac acquired St.George. It was an acquisition which boosted the group's loan book dramatically and enabled a step change in profits. Commonwealth bank of Australia (ASX: CBA) also joined the market with the purchase of BankWest.
However it's not just Westpac's roll-up strategy which is of particular interest to shareholders. Indeed Westpac's earnings have become more dependent on net interest income over the past decade, as is evident from the chart above. Whilst 60% of its income was derived from lending activities (net interest income) a decade ago, today that figure is closer to 68% – meaning its non-interest income (insurance, funds management, superannuation etc.) now accounts for just 32% of income.
In recent years management has highlighted the funds management and superannuation sectors as growth areas for the bank.
It is sometimes interesting to see how a stock's valuation has fluctuated over time. The above graph shows the movements in price relative to earnings per share, or EPS, and tangible book value, or NTA. As can be seen, Westpac's price-earnings ratio was much more volatile during the GFC than its net tangible asset value.
Over the past 10 years, Westpac's net tangible assets per share have grown from $5.71 to $11.57, whilst its share price has jumped from approximately $21 to a current market price of $38.27.
Much of the boost in assets per share can be put down to the group's 257% increase to its loan book. Although Westpac's loan book jumped by over a third when it acquired St. George, the bank has enjoyed relatively consistent loan book growth over the past decade despite falling profitability.
However, according to the Australian Prudential Regulation Authority (APRA), between 2008 and 2014, Westpac's total housing loans to investors grew 225%, or $98.5 billion, whilst it loans to owner-occupiers grew just 102%, or $90.1 billion.
Finally, the chart above shows Australia's household debt levels and interest payments as a percentage of household disposable income. As can be seen, Australia's debt levels remain at elevated levels whilst interest payments continue to fall. Meanwhile, according to the Australian Bureau of Statistics, the household saving ratio has fallen back below 10%.
Foolish takeaway
Whilst one must be mindful to focus on the facts and not let past performance drive our investment vehicle forward, the above charts do allow us to infer some things about the future earnings of Westpac.
It's up to you, the shareholder, to make up your own mind but for me, the above charts reinforce what I already believe to be true. That is, Westpac – like each of its peers – has sought to significantly grow its loan book over the past – at the expense of profitability – as households took advantage of a stable regulatory environment and non-stop economic growth to add leverage.
Whilst it's unlikely we'll see a significant drop in house prices anytime soon, Westpac's exposure to housing investment concerns me. Coupled with its high share price and our current position in the market cycle, I think investors would be wise to avoid Westpac shares, for now.
