CBA puts its house in order

Commonwealth Bank’s exit from its managed property platform should be completed today when securityholders vote on the internalisation of the management of the $6 billion CFS Retail Property Trust Group.

Of the transactions generated by CBA’s decision last year to end its external management of three property trust groups, the CFS deal is easily the biggest and most significant. CBA is set to gain $460 million from the internalisation of the management rights to the trust as well as freeing up its ability to release another $600 million over time by selling its own securities in the trust.

With John Gandel’s 16.8 per cent holding in the trust supporting the deal and no apparent opposition to it, the transaction should go through smoothly, marking a major moment in the history of listed property trusts.

CBA announced its exits from CFS, the Commonwealth Property Office Fund (CPA) and the Kiwi Property Income Fund last July. The internalisation of management of the Kiwi fund went smoothly and released about $70 million of cash for CBA. The CPA process resulted in a bidding battle for the fund that saw Dexus Property Group prevail over GPT in a deal that saw it pay the bank a $41 million ‘facilitation fee’.

CBA’s decision to quit its externally managed property platforms is consistent with the post-crisis shift in the listed property trust model away from external management to internalisation. Arguably, this better aligns the interests of securityholders and their managers.

The next big internalisation will be the restructuring of the Westfield group. This will see Westfield merge its Australian retail property assets and management into the separately-listed Westfield Retail Trust to form the new Scentre Group while Westfield Group will be a purely international vehicle.

That proposal has been controversial, with some questioning the value implied by the terms for the management rights Westfield Group is vending into the deal. The terms see a $1.9 billion reduction in Westfield Retail Trust’s net tangible assets and an $8 billion increase in its debt.

The Lowys appear confident that once investors have received the explanatory memorandum and understand the price-tag placed on the management rights and the value that will flow from them, the scepticism will disappear. They have made it clear the terms won’t be altered.

It is instructive that, since the proposal was announced on December 4 last year, Westfield Retail securities have out-performed those of Westfield Group. They have risen 4 per cent while Westfield Group’s have fallen 3.25 per cent.

That’s inconsistent with the view that there will be a massive value transfer from Westfield Retail to Westfield Group.

If the general move away from externally-managed vehicles is a philosophical one, driven by the preference of the market for alignment of interests and the removal of potential conflicts, CBA’s decision last year was also motivated by its own self-interest. That’s mainly reflected in the CFS transaction.

Through the value of the management rights and the securities it held in the trusts to protect those management rights, CBA had more than $1 billion tied up.

In the post-crisis regulatory regime, where it has to hold 50 cents of capital for every dollar of those investments, they represent capital-intensive, low-returning exposures. (In the future, CBA will have to hold $1 of capital for each dollar of investment.)

The combination of management fee income and yield on its securities in the trust would generate an income return of roughly 8 per cent or so for CBA.

CBA itself generated a return on equity of closer to 19 per cent. You don’t need to be a mathematician to realise that the capital tied up in the funds would produce much better returns if redeployed in the group’s core banking and wealth management businesses. There’s potentially an extra $120 million or so of annual earnings to be had.

For banks, there is pressure to build up capital reserves and become as capital-efficient as possible. This is not surprising, given the uncertainty about where the eventual requirements for capital will settle once the new prudential regime is established by domestic and international regulators.

APRA, which will apply a one percentage point surcharge on the four major banks because of their systemic importance, has warned them not to conduct material capital management programs or pay special dividends until the framework is settled.

In that light, CBA’s exit from the trusts conforms to post-crisis notions of improved corporate governance and reflects its own post-crisis priorities.

The Westfield transaction doesn’t, of course, have that extra regulatory dimension. However, if securityholders can be convinced that the terms are fair and reasonable, it could result in less potential for conflicts of interest (or perceptions of conflict) between securityholders and their management and a quite rational split of high-quality, low-risk, largely passive Australasian retail property assets from the higher-risk international business with its stronger development profile.