ANZ thrives in the land of low costs

ANZ Bank's first-half increase was driven by its push to reduce costs, and if the rest of the big four can do the same the year's end should see them very strongly positioned.

There was a point last year when the chief executives of all the major banks came to a very similar conclusion. There would be no early return to the era of strong credit growth and therefore, to drive profitability in the near term, they had to drive down their costs.

The strong ANZ interim result today is a testimony to the ability of Mike Smith and his team to execute their program.

On a cash basis ANZ’s net operating income actually fell between the September and March halves, from $9.13 billion to $9.09 billion. Operating expenses, however, were 8 per cent, or $352 million, lower at $4 billion with the number of group employees (full-time equivalents) down 2 per cent from the September half and 4 per cent, or just over 2000, from the corresponding half last year.

With a modest ($89 million) reduction in charges for bad and doubtful debts, the cost-reductions were the major factor in  the 10 per cent lift in pre-tax earnings relative to the September half (11 per cent against the same half previously) and the 8 per cent increase in after-tax earnings to $3.18 billion. ANZ’s cost-to-income ratio was cut from 48 per cent to 44.4 per cent.

That productivity-driven improvement in performance (profit per average employee has risen from $58,116 a year ago to $66,847) enabled ANZ to push its return on equity back up from 14.7 per cent in the September half to 15.5 per cent, the same level that it achieved in the March half last year.

ANZ also increased its interim dividend from 66 cents to 73 cents, although this was largely due to the re-weighting of its dividend strategy previously weighted heavily towards the second half. The dividend represents a payout ratio of 63 per cent and Smith said his board believed a full-year ratio of between 65 per cent and 70 per cent was sustainable in the medium term, with a bias to the upper end of the range. The sharemarket liked that.

The result wasn’t exclusively about costs. ANZ also generated some modest volume growth, with net loans and advances up 3 per cent on the September half and 7 per cent on the previous corresponding period as ANZ experienced above-system growth in mortgages and commercial banking in its core Australian business.

Combined with a small (3 basis points excluding markets income) improvement in net interest margins in Australia, mainly because of that volume growth, the Australian division’s earnings grew 7 per cent, to $826 million.

Much stronger growth was experienced by the international and institutional banking division, where cash earnings rose $247 million, or 26 per cent, New Zealand (up 24 per cent) and global wealth (up 20 per cent).

ANZ, of course, has a differentiated strategy to its peers because of its ‘’super regional’’ ambitions, which helped the Asia Pacific, Europe and Americas network deliver 20 per cent of group revenues in the half.

While operating income within Asia grew only a modest 5 per cent between September and March, it was 11 per cent higher than the March half last year and, with nearly 16,000 staff and an annualised income base of more than $2 billion, the Asian operations are now a very material part of the group.

ANZ has deepening relationships with customers as it shifts its emphasis to 'flow' and value-added products to reduce its reliance on riskier lending and improve its returns on capital but now that it has scale in the region it is also starting to improve the productivity of its Asian network.

The group remains conservatively capitalised, with a common equity tier one ratio of 8.2 per cent and is about half-way through its $20 billion to $25 billion term wholesale funding program for this year.

While its levels of deposit funding stabilised during the half, at 61 per cent, the costs of deposits relative to wholesale funding and the swap rate has continued to rise, although wholesale funding costs are now trending down.

The majors ought to be in a position by the end of this year where their older and higher-cost term funding has been worked out of their books and their average (rather than incremental) wholesale borrowing costs start falling. That will give them some scope to either widen their margins and/or pass through some of the benefit to customers.

Later this week Westpac will produce its March half result and then it will be National Australia Bank’s turn to reveal how well it has executed its push to improve its productivity.

For the foreseeable future, in an environment of fragile business and consumer confidence and weak demand for credit, evaluations of the majors will be heavily focused on their performance on costs.

ANZ has got this round of bank reporting off to a very solid start.

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