Morgan's View From the Top

Background, by Eureka Report editor James Kirby: David Morgan is now the longest-serving of the “big four” bank chiefs, and his interview today with Robert Gottliebsen* highlights several of the biggest issues facing bank stocks.

Morgan explains how wealth management activities have been built up by Westpac as a defence against an extended slow period in the home lending market.

As Morgan suggests, the banking sector is expecting “a pretty long breather” in the home lending area. Wealth management '” which reflects the strength of the stockmarket '” is now 11% of total earnings.

A KPMG report on the banking sector last week revealed how all of the major banks are rushing to lift their income from wealth management. However, as banking writer Ian Rogers points out in today’s bank results feature, Banks' Blue-ish Skies, every bank, including Westpac, is struggling to adapt to rapidly changed circumstances in the industry. Among the biggest hurdles for local bank leaders is the growing power of foreign banks and the inability of the big four to achieve “system” growth in key business sectors.

Source: KPMG

Morgan also highlights the growing importance of investment platforms to Westpac. Eureka Report has consistently reminded investors how lucrative investment platforms are for financial product suppliers, and how they are often bad value for independent private investors who pay very high fees to use “wrap accounts” such as the BT wraps referred to by Morgan.

When asked whether Westpac can retain its 10%-plus share price earning growth out to 2010, Morgan implies the figure is possible. His confidence is similar, if more cautious, to the outlook presented by his rival John McFarlane of ANZ in an interview we published two weeks ago. (MAY 5 CLICK HERE)

However Morgan, as well as holding the mantle as the doyen of the big bank chiefs, is also known as the most conservative. In the business lending market, Westpac has lagged rivals such as NAB over the past year. Nevertheless, Morgan has made it clear he is not prepared to threaten the credit quality of his loan book by chasing risky loans.

Morgan also signals that the bank is bracing for tougher times in the stockmarket by planning to lift the dividend payout ratio. This would immediately make the bank’s fully franked dividends more attractive to defensive stock portfolios.

Despite the sluggish home lending market and the challenge that awaits bank stocks as some heat comes off commodity stocks, Morgan raises the prospect of takeover activity. He suggests a merger between two of three banks '” ANZ, NAB and Westpac '” will inevitably come to pass and get approved by the regulators. With Charlie Aitken today also suggesting (The Big Shift) the leading banks may move to acquire local insurers, trading in bank stocks could yet be uncertain for months to come.

The interview

Robert Gottliebsen: In the long term, what’s going to make you different to other banks?

David Morgan: I think the fact that we are one of the '” if not the '” most sustainable banks in the world will continue to make us more resilient against whatever shocks are thrown up against us, and that sustainability builds off a leading position with people in the market. A leading position in wealth, a leading position in corporate banking and a leading position in platforms.

What do you mean by platforms?

I mean the sort of things that people '¦ like our wrap platform, that people buy retail funds on; the corporate superannuation platform. These are technology platforms around our corporate transactional banking system. These are systems that our customers use to do their business with.

Have any of the other banks invested in platforms like Westpac?

They have, but to have the leadership position that we have in the leading wrap platform in the market, the leading corporate superannuation platform, the leading corporate transactional banking platform. Nobody has the leadership position in platforms that we’ve been able to establish.

What do you see as the future of your wealth management business?

Earnings today are now 11% of our total earnings from wealth. Three years ago, that was 8%. We acquired very well with BT. We didn’t overpay. We have control of our future. We didn’t go down the joint venture route. We didn’t invest in the high-risk part of the wealth chain and we got two sector leading platforms so that’s been a hugely successful acquisition. A very successful integration that’s been very well managed by cross-selling into the Westpac customer base since we acquired it, so it will continue to grow as a share of our earnings.

We’ve seen an enormous investment in brand equity by the NAB and other banks. Do you think that’s going to be an important part of future banking?

I think increasingly brand equity '” people are judging that by the actual quality of the customer experience that they have and the competitiveness of products. So advertising is important but with an increasingly discerning public I think they are judging the promise of the brand much more on what’s delivered by the experience and in the competitiveness of the products.

To date you haven’t mentioned housing. Is that going to be an important part of Westpac’s future growth?

Look I think we’ve been through a very big housing boom and I think we’re in for a pretty long breather in terms of both dwelling investment and in real house prices. That is not to say it’s not an important part of our business; it’s probably about 12% of our earnings but I think there are more propitious growth areas in the years ahead than housing.

Is the home loan business being commoditised?

Part of it has. Clearly we’ve had major new entry there and brokers now account for 45% of the flow into housing, so when you’ve got a major entry into it, returns have absolutely been a bit down. Having said that, I mean there’s still very good returns particularly the loans originated by our in house proprietary sales forces.

Leaving aside the possibility of sharp economic downturns, do you think Westpac can continue its 10% plus growth rate to 2010?

It depends on the evolution of the economy and system growth around that. We have said the sector as a whole, in normal circumstances, should be able to generate 6–10% cash earnings and maybe 7–11% earnings per share growth, earnings per share growth with capital management and the bank that executes best should be at the top of that range. Now for the past seven years we’ve been at the upper end of our peers and whatever the system turns out, we expect to continue to execute at the upper end of our peers.

Are you looking at any overseas investment growth?

We’re expanding our organic growth in Asia and opening a third outlet in Shanghai as well as going to India, so we are looking at expanding our footprint in Asia.

Westpac has been a big user of capital buybacks. Will you be increasing your dividends in future years?

Yes we are, and we signalled that in the last result that we have had a combination of dividends and buybacks, quite significant buybacks '” about $600 million a year. Going forward we will increase our payout ratio. We’ve increased it now to the high 60s (percent) from the low to mid-60s with a commensurately reduced focus on buy backs.

Taking a five-year view, do you think there’ll be mergers between the big banks?

I think the four-pillars rule will be lifted in the medium to long term. I also think it’s likely that once they are lifted it’s entirely possible that there will be one but only one combination allowed under competition policy and it remains to be seen what the ACCC would say about that, but as I read the guidelines now one would be permitted.

Does that mean that two of the NAB, Westpac and ANZ will merge and one will be left out?

Yes.

Thanks, David.

* Robert Gottliebsen is a business commentator with The Australian.