KGB: ANZ's Mike Smith

ANZ chief executive officer Mike Smith tells Business Spectator's Alan Kohler, Robert Gottliebsen and Stephen Bartholomeusz:

– The future still looks promising but there has definite slowdown and credit growth is expected to drop from around 15-16 per cent to about 4-5 per cent.

– It may be easier to increase the pace of ANZ's Asian expansion via a major acquisition in the region, and while he is open to the idea, slower organic growth is more certain.

– The bank's digital strategy will be a game changer and is developing quickly as customer expectations demand greater flexibility and ease of access.

– There is a continuing decrease in bank deposit rates and this is placing pressure on funding.

– What lower interest rates mean for home loan demand.

– There is concern about the high dollar and its impact on the economy.

Stephen Bartholomeusz: Mike, in the result that you produced there seemed to be a definite slowdown in the second half and in particular a pickup in bad and doubtfuls. Can you tell us a little bit about what happened during the year and whether we're heading into something that's a bit bleaker than you experienced early on?

Mike Smith: No. You know, I'm still relatively optimistic about the future. I think that the slowdown at the back end of the year was really more to do with the volatility which was not around, which was in the first half; so particularly the global markets income was a little less in the second half. In terms of the provisions, that was really just a two or three old names that we know were a problem we had actually earmarked under the collective provision and we actually transferred those to individual provision. So, it wasn't anything untoward in terms of a systematic issue. Looking forward, you know, I think we just have to anticipate that business volumes will be a little slower in this environment and, you know, I think there's going to be a little bit more pain in the middle market in the sort of commercial part of the portfolio, but yeah, again I don't think the numbers are going to be that big.

SB: There was also a slowing in Asia. Was that deliberate strategy or did that reflect that sort of slowdown in China and the ripples through the region?

MS: Well, I think the slowdown in China, it creates the big shock in the region where everybody was suddenly concerned that China was no longer growing at 10 per cent and was, you know, perhaps moving to a 7 or 8 per cent growth, but of course this was all a managed slowdown and I've got to say that I think there was an overreaction and we're already beginning to see that business volume is picking up again. The trouble is that the world is still in this space of almost fright, that it doesn't take very much news to create this skittish behaviour where everybody is suddenly terrified. You know, you've now got this expression ‘risk on, risk off' and it flips day to day. I think we're actually right now we're in a period of relative calm. I was at the IMF meeting a couple of weeks ago in Tokyo and I'd been saying to a couple of people, you know, the mood was actually far more upbeat than it was six months ago, particularly not only with the politicians but also with the bankers.

Alan Kohler: Mike , three or four years ago I think everybody thought that the world had changed completely after the credit crisis and that I think you were among those who thought that. Do you think it's fair to say that the world didn't change as much as everyone might have expected, including yourself?

MS: Oh no, I think it's fundamentally changed, I mean particularly for the banking industry. You know, I think that those days of credit growth of 15, 16 per cent, you know, have gone for the foreseeable future and I don't think that's necessarily a bad thing actually because I think that the growth in credit and in terms of leverage was just too much.

AK: So, what sort of credit growth do you think you can now expect in your business?

MS: Well, I think it's going to be somewhere between 4 and 5 per cent. I think that that's more a more realistic measure. Now, in some products it may be slightly higher, depending on how you push them or indeed on how you price. But I think you'll probably see slightly higher growth than that in Asia, but certainly in Australia that's what I would think.

Robert Gottliebsen: Mike, most Australian companies are saying that their cost of capital is 12 per cent and that's how they do all their investment sums and then they're of course looking for returns above that. But in this new environment the cost of capital is well below that old level. Did you believe this is causing Australian companies to be much less more inhibited about investing because they've in fact got their cost of capital wrong?

MS: I think it is an issue. I think that costs of capital haven't been adjusted correctly, even been priced properly and therefore return – their expectations are too high. But again I think you've got to be a little bit careful with this because you've got to really look at it on a more global or at least a regional basis and you could say that cost of capital of 12 per cent in China, for example, where it's probably not unrealistic. So, you know, I think you've just got to be a little careful as to how your business mix affects that cost of capital. I mean I think one of the things we do need to learn is that you do have to utilise different costs of capital for different projects when you're looking to expand internationally.

RG: Do you think the fact that it's hard to get a return in the Asian markets that equals the Australian market. Has this inhibited you in expanding in Asia, particularly taking over in Asia?

MS: It hasn't inhibited us in terms of our expansion. I mean we've been expanding our organic business. You know, it's about 21 per cent of revenue is now coming out of Asia Pacific and/or ex Australia New Zealand, and that's quite a big increase from I think it was 7 per cent in 2007. So, you know, that's a pretty significant increase and most of that has been done organically. Now, the good thing about organic is it's one times book. You know, there's no premium in it. Now assets in Asia are still pretty toppy, you know, in terms of value. Well sorry, not in value, in terms of price and price expectation. I still think that realistically those price expectations need to adjust.

RG: Yeah, but if you look at the market for Asian banks, it's not that much above one times dollar for a dollar in terms of book value.

MS: You're right, but in terms of those available for sale, which are traditionally the family banks, the market price doesn't seem to bear much relation to what the owners expect.

RG: But what are the owners expecting? Do they want twice?

MS: Well, they're still looking at two and a half, three times the book. You know, I mean it's just ludicrous.

RG: Okay.

SB: Mike, can you realise your ambitions for ANZ in Asia purely for organic growth within the timeframe that you set yourself?

MS: Look, yeah, it would be much easier to do it with a major acquisition. You know, I think that is quite clear. But you have to base a strategy around organic growth. I think if you base a strategy around acquisition, you're going to do the wrong deal at the wrong time. And so, I think that basing it on organic strategy is a sensible way to go forward. It does mean it's much slower, you know, but if I can get to 25 to 30 per cent of earnings by 2017, I still think that's a pretty good movement from where we've come from.

AK: Banks in the United States are selling for one times book. Maybe you should expand there.

MS: Well, I mean banks in Europe, some of them are at 0.3. You know, you buy a bank in Europe, get one free, but it's a question of do you really want to be in Europe or do you want to be in the US? I mean quite clearly our strategy is defined as creating a super regional strategy in the Asia Pacific region and we want to stick to that.

RG: But Mike, if you bought a reasonably small bank, even if you did pay a higher price, it would catapult you into the region into a much stronger position to then grow organically.

MS: Yeah. And we continue to look at things.

RG: It's taking a long time though.

MS: I must have Scots blood in me or something. I don't know.

SB: Mike, you would have seen some of your peers are now starting to talk about their plans for Asia.

MS: Yeah.

SB: Does that amuse you?

MS: Well, you mean Australian banks?

SB: Yes.

MS: Look, I suppose it's sort of flattering really. I mean, you know, five years ago, everybody thought I was nuts and I guess that if our competitors are now saying well yeah we are also have an Asian strategy, that's nice to hear. I mean I have to say that, you know, you don't really see very much of the other Aussie banks in the region.

AK: What about the digital strategy? Is it developing more quickly or more slowly perhaps than you might have expected?

MS: Look, I actually think this is going to be a game changer. I think it's going to actually really start to move fairly quickly and things like our own ibanking and well Android banking app, Go Money, I think has been incredibly successful and has really taken off. One of the issues, though, of course it gives you is that it does change people's behaviour and it changes people's expectations of what a bank does. Five years ago when I think about it, you know, you used to receive a paper statement once a month which gave you a balance of your accounts and a sort of reconciliation of what had happened much of which I have to say was illegible because you hadn't a clue what all that bloody code was. But now, you know, you can look at your balance ten times a day and some people do. I'm not sure why, but you know they do. And you can see exactly, you know, what the account movement has done in the last ten minutes and whatever. Now, the problem with that is that all of these enquiries are affected transactions. You know, they basically have to go through the system and you're not getting any payment for it. But now, people expect that ease of access, if you like, so we've created an expectation; we now have to deliver against it and of course we have to reduce our costs to ensure that we can actually make that viable.

RG: But Mike, your base computer systems are still way back into the historic exercise. You've never changed that. Is that going to hold you back in this new world?

MS: No, not at all. I mean, you know, we have a very different business mix to a number of the other banks. We have done an incredible amount of investment in systems and our systems roadmap I think is very, very clear. It is completely aligned with our strategy. We now have completely aligned systems for things like cash management globally. We now have a global credit card system. We have a global trade system, you know, for trade finance. Our dealing rooms are now all put together with one system. We've got one system or about to have one system in New Zealand. Our mobile banking system is again integrated. I know that some of our competitors talk about the fact that they have made vast inroads and are ahead of everyone else, but frankly the functionality and reliability of our systems are as good as anyone else's.

AK: In view of the fact that people aren't going into branches anymore and are transacting online, it's changing your ability to sell them other products. Does it mean that your metrics around product per customer also have to change?

MS: Well, I think it's true. I think the whole channel management issue is an interesting one and if you do go into branches, you often you find that most of the customers there are small business customers generally paying in cash receipts and cheques and things, or they are people who are coming in for advice, either an A to Z review or buying a mortgage or whatever. So, we actually have to change the way that the branches operate as well and indeed some of the positioning. You know, some of the positions of our branches were probably appropriate about a hundred years ago, but you know life has moved on and we need to move to be more in touch with what our customers want. I think banks have traditionally given customers what they think they want rather than ask them what they really want and I think that technology is making that transformation very much more quick than we probably anticipated.

AK: And the other thing is that mortgage brokers are now chomping into your market share quite aggressively once more, and I just wonder what you're going to do about that.

MS: Mortgage brokers in terms of?

AK: In mortgage market share. I mean in loans. They're starting to increase the share that they're taking. Is that good for you?

MS: But the brokers have to put the loan somewhere.

AK: Yeah, of course. I'm wondering whether at some point that's going to encourage the rebirth of securitisation.

MS: It would be nice to see securitisation back, but it's a question of investor appetite. You know, people who got burnt on that are in no hurry to reinvest in it. I think the big market where securitisation really needs to happen again is the US, but there's no real sign of that at the moment.

RG: Mike, bank term deposit rates are now almost all of them are now below five per cent but above four and that's across all banks. Are you seeing people going elsewhere for their income? At what point? If we lower rates on term deposits, at what point do you think the buyers will react and so no it's getting too low, I'm off elsewhere?

MS: With rates continuing in the downward trend, I mean this is an issue for us and obviously if you're a depositor right now, you've actually been having quite a good run in terms of the competitive environment and the products that have been available to depositors in the country. It is a difficult situation because there's no doubt that people will start to look for yield, but I think this is a global issue as well. I mean it's not only mom and pop, depositor, it's the major investors, institutional investors, you know, pension funds. Everybody is looking for yield right now. And of course with the sheer amount of liquidity that's flowing around, you've got increasing pressure to find good assets with good yields and places like Europe and the US, they've got the added problem of having more outflow than inflow in terms of pension funds. So, that's not being made up by investment income and therefore you've actually got a cashflow problem. The issue in Asia is not quite the same in that you've got more inflow than outflow in terms of the demographics are more suited to cash accumulation, but you've still got these businesses all looking for the same quality assets and all looking for yield.

RG: But in Australia of course self managed funds and big money have been huge investors in term deposits, but once that gets down below four per cent, it probably isn't the place for their money.

MS: You've got to say, well, what would you do? Would you buy bank shares, for example? I can think of a well known bank with a fairly good yield. But, you know, yeah, what would you tend to look for right now? And I guess also on a post tax basis you've got to look at the alternatives. So, it will put further pressure on us, yeah.

SB: Mike, the cost of your deposits put pressure on your net interest margin, took quite a slug out of them, and yet you grew your deposit base had a greater rate than you grew your loans and advances. Was that deliberate to reduce your exposure to wholesale funding or was it a function of the scale of the Asian business now?

MS: Well, it's a bit of both. We have moved our loan to deposit ratio from about a hundred and seventy-five per cent in 2007 to about a hundred and thirty per cent now and I think that's just good banking frankly. You know, I think that to have too much reliance on wholesale funding is an issue, but what you should have is the flexibility to utilise wholesale funding when there is an opportunity and you can get cheap money or Asian deposits or domestic deposits. You've really got to be able to have that flexibility which we do and it has taken us some time to build that up. I do like the principle of self-funding. Our Asian businesses are completely self-funding. Most of the business that's been written in Australia in terms of new mortgages or new commercial lending has actually been self-funded. And I think that that again is a good discipline, but it does create or it can create a squeeze on margins, particularly when it gets very competitive.

RG: Mike, as these rates going down, are you seeing much more activity in the home buying market, whether it be first homebuyers or whether it be existing people wanting to upgrade?

MS: No. Low demand for mortgages has been pretty consistent. You know, I think, you know, what effect would a quarter per cent decrease or a half a cent decrease… It's not going to have a massive impact. And if you think about it, I mean interest rates are considerably lower than they were at the beginning of the crisis when there was massive growth in mortgages.

RG: So, pretty much in terms of stimulating the home market we've done about all we can do. If we put the rates down another half a per cent, it won't make a great deal of difference.

MS: I don't think it will. You know, I don't think it's going to make a huge amount of difference, but I don't think the Reserve Bank is terribly worried about that. You know, I think the concern they would have is for another housing bubble. They would be worried about that. You know, for me the biggest concern I have at the moment is really the Aussie dollar and further strengthening of that because, you know, my logic there is that QE3 in the US and the various policies of the ECB in terms of providing liquidity to the European market is creating such a massive pool of liquidity, that there is a genuine concern in a lot of the Asian countries, particularly the Asian developing countries, that this money will go into commodity speculation and that will increase the imported inflation into these countries. Now the effect for Australia would be that if commodity prices go up again, that's going to put an upwards strain on the Aussie dollar.

RG: So you're really saying don't worry Reserve Bank about a property bubble, get those rates down.

MS: Well, I think no, I would actually say that if I was them, I would wait to look what happens with the currency because they need to probably use interest rates to just take some of the heat out of the currency.

RG: Well, the currency is pretty strong.

MS: Yeah. But it could get stronger.

RG: And you'd actually wait till it got stronger before you'd really slash them?

MS: Yeah. I mean that would be my view, but I mean I'm not the Central Bank Governor and he has far more information and certainly a much wiser character than I am

AK: Mike, we'll have to leave it there now. Thanks very much

MS: Good to talk to you guys.

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