‘We’ve delivered on our commitments’

There are also tentative signs that Allaway’s $200 million productivity program is bearing fruit, with $14 million of costs taken out during the period, including through consolidating contact centres and shedding 6000 square metres of office space, which will save BOQ $40 million over the life of its leases.

He is also taking heart from steady progress on digitising the bank which, over time, will cut BOQ’s cost to serve.

BOQ has built its end-to-end digital mortgage infrastructure, and will roll that out over the next six months, while it is ready to start shifting customers from ME Bank, which it bought in February 2021, over to its new digital banking platform.

“We’ve delivered on our commitments and what we can control, in what is obviously a very challenging environment,” Allaway tells Chanticleer.

The market was buying that on Wednesday, with BOQ shares popping 5.1 per cent to close at $6.10, but the stock is down about 4 per cent in the past 12 months.

Analysts sceptical

But this share price jump looks like an overreaction. As Evans & Partners banking analyst Azib Khan says, it’s hard to get excited about what he correctly describes as a low-quality profit beat.

The major challenge is that intense competition on both the deposit and lending side of the balance sheet, compressing NIM in a way that is increasingly looking structural, not cyclical, given the entire sector is becoming more commoditised and price becomes the biggest differentiator in the mind of customers.

Indeed, Allaway says the shift down in margins means he will need to find new ways for BOQ to hit its 2026 targets for ROE of 9.5 per cent and cost-to-income of less than 50 per cent (it’s currently 65.9 per cent).

He’s standing by those targets for now, but the analyst community remains deeply sceptical.

As we’ve seen across the banks, Allaway says the battle for deposits has turned particularly fierce as the sector seeks to replace cheap pandemic-era debt with as many deposits as possible.

For the third straight half, BOQ largely stood back from the heat of the mortgage market, allowing its loan growth to run well below the broader banking system given it cannot write loans above its cost of capital.

Allaway says there has been a slight moderation in the intensity of mortgage competition, but he is determined to hold the line on writing unprofitable mortgages.

There is a lot that can be done without undermining good outcomes for consumers and financial resilience

Put simply, he says writing more mortgages would have meant a lower profit in the half.

“We’ve actually done some work on what it would have looked like if we had grown our home lending book in this marketplace,” he says.

“With current margins, earnings would have been lower and we would have used more capital. So, clearly, we’re not generating a return above our cost of capital.

“We think it destroys shareholder value to allocate capital with current margins. We are more focused on return on equity than we are on growth.”

But there’s a cost to this. Cash earnings from BOQ’s retail bank crashed 60 per cent versus the prior period, from $123 million to just $50 million.

Now, BOQ’s profitability is heavily skewed towards business banking, which accounts for 70 per cent of group earnings; this division had a more moderate 14 per cent drop in cash earnings.

Digitisation is key

Allaway says he can grow the business bank in the second half, despite every other bank in the country also targeting this part of the market.

But his decision to stay on the sidelines of the mortgage market has left analysts scratching their heads as to how he can restore the profitability in the retail bank when it is deliberately holding back from selling mortgages and its deposit franchise is weak.

In the CEO’s mind, digitisation is the key. Digitising more, or all, of the processes of selling a mortgage will halve BOQ’s cost to serve, giving it more ability to compete, boost returns and differentiate itself in what Allaway sees as an increasingly commoditised market.

BOQ’s new app should help it win more deposits by providing a better customer experience.

But the market justifiably sees substantial execution risk around this. Bank technology projects have a chequered history, and BOQ is trying to do this as it fights through the ME Bank integration, a growing regulatory burden, and an enforceable undertaking from the prudential regulator.

Indeed, despite Wednesday’s beat on costs, analysts remain concerned about the longer-term picture given employee costs rose 14 per cent during the half amid wage inflation and the need for more resources to meet a growing compliance burden.

Allaway has been talking with the federal government and regulators about that burden, which he says has grown sharply in the five years since the Hayne royal commission; BOQ has spent $500 million in the past four years just meeting these obligations, outside remediation to customers.

For example, Allaway says BOQ is spending $30 million a year to collect statistics for regulators. It has spent $70 million on the much-vaunted open banking regime, which he says is being used by 0.11 per cent of customers.

“I think there is a lot that can be done without undermining good outcomes for consumers and financial resilience,” he says.

Allaway also keeps pushing for change to the regional banks’ capital rules, which require them to hold about 30 per cent more capital for the same loans that the big banks hold.

Unfortunately for BOQ, the pressures on the banking sector are unlikely to abate.

Margins will remain under pressure, cost inflation won’t fade quickly, and the pressure from regulators is unlikely to ease, particularly given the heightened risk environment that was underscored by the tick up in arrears that was visible in BOQ’s result.

As Allaway says, regional banks are disproportionately impacted by these forces.

So, the market is right to question how BOQ can deliver on its ROE and cost targets – because BOQ isn’t sure either.