'Which New Bank' Gets Some Things Right

The company secretary escorted the boss's children into the auditorium in Commonwealth Bank's money-box building for the occasion. As usual, the "direct reports" sat in the front row to the right of the podium. But this time, several of them would have been irritated because it will be a near-outsider, rather than one of them, who will be taking over from David Murray in a few weeks.

The occasion, this afternoon, was the 27th, and final, presentation to the media of the Commonwealth Bank profit by Murray, the philosopher king of Australian banking. Murray was pretty happy with his swansong profit; and chief financial officer Michael Cameron opened his briefing for investment analysts by saying the profit was "fantastic", which is an exaggeration.

But there's not much scope to throw darts at CBA's June 2005 full-year profit. CBA is two-and-a-bit years into an overdue, but welcome, project to sort out its legacy of confused information technology systems; front-line staff have tools that make work, and customer interaction, a heck of lot easier than they were recently; and management are meeting and exceeding many of the pledges they made to justify the entire "Which New Bank" exercise when they set out on this journey in 2003.

First, the profit, and this cannot be summed up in a sentence. Underlying net profit increased 13 per cent over the full year to $3.5 billion. The reported profit on a "cash" basis (which ignores deductions for goodwill and revaluation of the life insurance arm) increased 31 per cent, also to $3.5 billion. The reported, or statutory, profit, using accounting standards that banks are mostly happy to see the back of, increased 55 per cent over the year, to $4 billion, but this third stab at the profit is not much of a guide.

CBA this year has become a little more open about the components of its profit, and this is handy for serious students of bank earnings. But it is potentially confusing for the casual reader. A careful study of CBA's detailed profit announcement reveals variations on the calculation of "net profit".

One of them, used to calculate return on equity, is lower than all the profit measures reported above. This profit, at $3.3 billion for 2005, is a fraction lower than those arrived at by the other measures; and the growth over the past year was also lower, being 11 per cent higher than in 2004. This alternative measure of net profit, more so than the others, is the one that featured in the bank's briefings.

Why all these different ways of looking at a bank's profit? The chief reason is that many commentators elsewhere (on the sell-side at investment banks, and a lot of other media) use a confusing shorthand when writing about company profits, and this applies to bank profits in particular.

Sell-side analysts, like many investors, look to earnings per share as the preferred profit measure, and this is the one that drives a lot of short-term share price calculations.

CBA said its earnings per share (EPS) increased 10 per cent on an underlying basis (to 261.8 cents) over the full year. At the investor briefing, the bank's management preferred to brag about the measure of EPS on a cash basis, which increased 30 per cent (to 267.5 cents), which was at the upper end of guidance to the market of an increase of between 25 and 30 per cent.

Commonwealth, keeping its profit guidance pretty vague, said it expected to increase EPS next year by the same or better than the average of the other three big banks.

So much for the profit. How is the business going? the bank's management is keen to sell a turnaround story to investors. It says market share is rising in home loans, credit cards, personal loans and most product niches within business banking and that it estimates its market share of business lending is in decline.

The bank estimates that its share of the all important home loan market reached 19.9 per cent at June 2005, up from a low of 19.1 per cent at December 2003.

David Murray said today that the improved sales and service culture is winning business through the branches. However, the split of new home loan business between brokers and branches, which can be inferred from some of the charts published in connection with the investor webcast, appears to show that branch sales are flagging. Murray disputed this view when asked at the investor briefing this afternoon, asserting that branch sales are, in fact, rising.

The bank said its interest margin '” a measure of the gap between interest paid by borrowers on all those loans less interest paid on all those deposits '” remained stable in the second half of 2004-05 at 2.45 percentage points; and stable with the level reported in the December 2004 and June 2004 halves.

Stable margins are pretty rare in the banking business. This time last year, a string of CBA's rivals admitted to erosion in margins at a time of increasing competition for new home loan business and rising interest rates on deposits. So, in that context, Commonwealth Bank's margin management is among the best in the banking sector.

If there is a question to be asked about Commonwealth's full year profit, it is related to the treatment of bad debts and impaired loans. The bank has allowed provisions, as a percentage of troubled loans, to drift down, which in turn reduces the charge the bank would have to take to the profit and loss.

For worrywarts, there are signs of stress emerging in the ability of the bank's customers to repay their loans. The number of home loan customers falling at least three months behind on their payments increased 23 per cent over the past year, and things worsened more quickly in the June half than they did in the December half. The overall numbers are trivial, but it is a trend worth watching.

At the start of the restructuring process '” dubbed "Which New Bank" '” the most cynical analysts around the investment banks suggested that CBA was moving late to simplify systems and that it was undertaking investments that many of its peers had already made.

Those assessments were harsh.

Managing information technology systems, workflows and personnel at banks is a tricky business. And though cranky customers may wonder why it has taken CBA until now, the bank can at least be confident that its customer service staff (in call centres and branches) at last have access to a single view of customer data, and have to update data only once, rather than having to lurch from system to system, as was once the case.

The bank's new business volumes and market share in key market segments are all improving. And the profit '” using return on equity this time '” increased to a return of 15.6 per cent in 2005 from 14.6 per cent in 2004.

This means CBA, which has had a legacy of below average returns (related to the Colonial takeover) is bucking the cyclical trend to lower profits. Elsewhere in the banking industry, it is smaller banks '” challenger brands such as Adelaide, Bendigo and Bank of Queensland '” that are increasing returns.

So, to see the leviathan of Australian banking deliver on its restructuring targets, sell more product and make more money, one can only conclude that former Air New Zealand chief executive Ralph Norris will take charge of an institution shown to be capable of change and beginning to deliver.

Footnote: Any reader that cares to delve into the detail of the Commonwealth Bank profit, including the myriad alternative profit measures, can cut their reading by looking at note 19 to the accounts (page 55-57), and notes 22 and 23 (pages 65-67). CBA still does not break down its profit by division in anywhere near as much detail as either ANZ Bank or Westpac, which is a pity.

Ian Rogers is editor of the banking newsletter '” The Sheet