ANZ: Big Result, Bigger Plans

Background, by Eureka Report editor James Kirby: Australia's longest serving “big bank” chief executive, John McFarlane, kicked off the bank interim reporting season with a powerful 16% lift in interim profits earlier this week. Today he confidently predicts double-digit earnings growth for the bank for the rest of the decade.

McFarlane has personal stock now valued at $51 million in the bank, making him one of the bank's biggest individual shareholders, so his interests are exceptionally well aligned with those of retail shareholders. After reporting an improved interim profit of $1.81 billion, up from $1.48 billion, the bank rewarded shareholders with a 10% lift in interim dividend of 56¢ a share.

Although the wider result was mixed '” with margins narrowing in many divisions '” very strong returns from the retail banking division underpinned the result. McFarlane has managed the improved results by keeping a lid on expenses while increasing staff levels at the same time.

In today's interview he tells Robert Gottliebsen* the bank is aiming to cut its all-important cost-to-income ratio to 40% by the end of the decade. Whether this can be achieved is an open question; the ratio has remained stubbornly close to 45% for the past five years.

McFarlane plans to diversify the bank’s strong Australian earnings '” and flat New Zealand earnings '” through a gradual expansion in Asia. The bank has faced strong resistance in previous ventures there (especially in its attempts to buy the Thai Military Bank) but McFarlane is clearly determined to overcome every obstacle to spread the bank's operations in Asia. (Ironically, the bank sold its Asia-based Grindlay's operation in the late 1990s.)

Running a bank that is clearly in good shape '” even bad debts declined by 7% during the reporting period '” McFarlane has indicated he is willing to stay at the helm of ANZ for the foreseeable future, despite earlier intimations that he would soon be closing his account at the Melbourne-based bank.

Robert Gottliebsen: The ANZ has been increasing earnings per share by 8–10% a year for some years. Can you keep that up until 2010?

John McFarlane: Well, the priorities between now and 2010 are for us to consolidate our position in Australia and get a much larger market position, to make the New Zealand acquisition that we made work and get the synergies out of that, and then finally reach a meaningful presence in Asia/Pacific much bigger than we’ve got today. That actually implies that we’re going to invest over that period.

We also think the world economy’s going to be relatively robust over that time frame '” it’s got at least another couple of years to go at very strong growth rates, particularly because the emerging markets are so strong. So the Australian economy is likely to be relatively buoyant over that period and then New Zealand should start to bounce off its lows at that time, so we can actually keep our earnings growth going.

How are you going to increase market penetration in Australia?

We’re already doing that in most of our businesses. This product specialisation and industry specialisation that we’ve got is really starting to work because when you focus on something you tend to do it very well. The other area that’s working so well for us is our retail banking business. We’ve added about 4000 people over the past three years at ANZ, and of course that is what’s allowing us to increase revenues because we’ve added new branches, refurbished branches, we’ve added people in the branches, added people in call centres and all of that is increasing the service levels with customers, which means our shares are rising and our revenue is rising.

Are you going to keep lifting staff?

Probably, because I don’t think that you can actually get growth without increasing your staff to serve customers and your expenses. We’re underweight Australia effectively, when you think about it, and so we can’t make a big difference to that unless we actually invest.

Are the other banks doing the same thing?

Not at the moment, but you know you can’t actually cut your spending forever and grow and so it comes a point in time when that cycle of self productivity improvements as a bias changes.

So we could see a period of much greater bank hiring?

I can’t '¦ look I think there is a productivity opportunity here to raise revenues per head and we’ll all do that, but I think at the end of the day if you take the medium-term view of shareholder value and the short-term view, maximising short-term earnings is not what’s required here. What’s required is superior performance over the medium term, which actually requires growth, return, sustainability, lower risks.

Your current expense ratio is 44% of income and you aim to decrease it to 40%. How long will that take and what do you need to do to the ANZ business to achieve it?

It will be over that kind of period to 2010, broadly. We haven’t put a number on it because it’s the revenue growth number that is the more important number '” trying to get our revenues between 7% and 9% is the key priority while at the same time growing our expenses less. If we grow the revenues higher than the costs, then automatically the cost–income ratio’s going to come down. We’ve taken one point off the cost–income ratio in the past year and as a rule of thumb that might be a good measure.

So it will happen over four years?

About four years. We’re not focused extensively on that. We’re really focused on getting '¦ doing what it takes to get the revenue up.

What can go wrong? What are you most afraid of?

I don’t think that we’re too worried in the short run about the credit situation. It’s incredibly benign and the reason it’s benign is because the economies are so strong. What causes the main dislocation in a bank is really a downturn in the economy and then the lag after that is when you start to get credit losses. So I guess in the time frames that we’re talking about we’re not really likely to see that to any great extent although the [IFRS] accounting method means that as soon as an event occurs '” like the world economy does turn down, if it did '” then we’d have to start to recognise that in the P&L.

Currently Asia/Pacific contributes about 2–3% of profits. Do you plan to substantially increase your investment there?

We would invest much faster in Asia if we could actually find the assets to acquire; and, second, it does take an awful long time to negotiate transactions in Asia. So to that extent we’d love to have concluded some more transactions, particularly in China, but we’ve been negotiating in China for three years on one of these transactions '¦ it does take a while. So I do believe that we will do a number of transactions over the years to come. Remember, the most important thing here is getting the right transaction at the right value, not just doing it any way, so the important thing is doing it accretively for shareholders rather than doing it.

You have minority positions in China and Indonesia. Do you think that’s dangerous?

Well, Asia’s got higher growth than Australia; it also has higher risk than Australia, but the return on risk is acceptable.

Why do you think the market puts higher price/earnings multiples on Australian banks than, say, the United Kingdom?

Well, over the past 15 years the Australian economy has grown faster than the UK economy and we’ve had very high asset growth levels and so that’s an important point. I think another important point is that the dividend payout ratios of the Australian banks is actually very high. Third, Australia is actually now in the part of the world that’s more closely linked with the most rapidly growing region in the world, which is Asia–Pacific. It’s inevitable in my view that the Australian banks will move into Asia in a much bigger way than we are today and, of course, the anticipated growth rate rising from leveraging the faster growth in this part of the world is really the main reason why Australian banks are more highly valued. They’ve got higher growth than the British banks.

* Robert Gottliebsen is a business commentator for The Australian.