ANZ's regional strategy lifeline

ANZ's result was solid given the sluggishness of the domestic environment, and shows that its regional strategy is paying off. However returns may begin to shrink because of growing cost pressures.

The ANZ result reflects the nature of the current banking environment and, indeed the economy-at-large, where the emphasis is more on improving productivity than being carried along by growth.

It is a solid rather than spectacular result, with cash earnings up six per cent and essentially moving in line with the growth in the group’s asset base, aided by a three per cent reduction in charges for bad and doubtful debts and very good control of costs, which rose only four per cent.

With ANZ having, relative to its peers, a differentiated ‘’super regional‘’ strategy that provides a larger growth tinge to its performance – its earnings from Asia Pacific, Europe and America were up 28 per cent and now generate 21 per cent of its revenues – it is conceivable that the ANZ result could be the ‘’best in class’’ in a round of results likely to demonstrate that the Australian core of the majors is quite subdued in an environment of modest credit growth.

ANZ’s Australian operations reflect that environment, with earnings rising a meagre one per cent despite a seven per cent increase in net loans and advances. The intense competition for deposits between banks to reduce their wholesale funding requirements offset the volume growth and was reflected in a 12 basis point compression of margins within the Australian business.

It was the growth in its international business and a solid performance in New Zealand, where underlying earnings rose 12 per cent, that helped ANZ to a more than respectable bottom line outcome, although the majors’ renewed focus on costs and credit quality (ANZ’s impairments ticked up slightly in the second half) are contributing factors.

It has been notable that in recent weeks ANZ’s peers have been talking up their own Asian aspirations, albeit that they are largely planning to follow their customers and trade flows into the region rather than aggressively pursue intra-region business, in order to open their own windows for growth outside the broadly flat-lining domestic market.

Mike Smith’s measured and cautious execution of ANZ’s super regional strategy is not just a point of difference for his group but one that is delivering both growth and diversification.

While that growth slowed in the second half – net income growth in the APEA regions was 22 per cent for the year but only three per cent in the second half as competition intensified and margins came under pressure – that does illustrate Smith’s conservatism and ANZ’s balancing of the trade-off between growth and risk as the ripples from the slowdown in China’s economy over the year spread throughout Asia.

That conservatism is also reflected in the group’s balance sheet metrics. Tier one capital continues to edge up (on the Australian Prudential Regulation Authority’s Basel 3 basis it edged up from 7.8 per cent to 8 per cent) while customer deposits now provide more than 60 per cent of ANZ’s funding requirement.

Indeed, in the year ANZ increased its deposits 12 per cent against lending growth of 8 per cent, which means the proportion of wholesale funding required fell. The group has already completed its 2012 wholesale fund raisings and is a third of the way into next year’s. It is also highly liquid.

There is a price to pay for conservatism given that the combination of higher levels of capital and liquidity and the lower earnings on them flowing from a falling interest rate environment impact earnings and returns.

ANZ’s return on capital slid 60 basis points to 15.6 per cent. The mid-teens level appears to be where the major banks’ returns on equity are settling in the post-crisis environment, well down on their high-teens and 20 per cent-plus returns they enjoyed pre-crisis.

If the 16 per cent rise in credit impairment charges in ANZ’s half is indicative of a general surge in bad debts as the domestic and regional economies slow, however, the ability of the banks to hold returns at around that 15 per cent level will come under renewed pressure and force them to push even harder on costs.

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