ANZ: Result 2014

In contrast to National Australia Bank ANZ has reported another record annual profit. While National Australia is preparing to offload its lousy foreign assets in the UK, ANZ is closing in on its goal of earning 30% of revenues in Asia by 2017.

You'll have to wait for a full business cycle to see whether ANZ can lay claim to being the first Australian retail bank to truly succeed overseas, by which time chief executive Mike Smith might've moved on. But for now Smith is focused on more mundane matters such as increasing productivity.

The headline numbers from the annual result were good, with revenue increasing 7% to $19.6bn. Cash profit was also up 10% to $7.1bn, with cash earnings per share increasing 9% to $2.60. Return on equity was flat at 15.4%, but Smith wants this figure to reach 16% by 2016. The final dividend was increased by 4% to 95 cents (ex date 7 Nov) for a full year dividend of $1.78, up 9%, for a current fully franked yield of 5.3%.

I still call Australia home

The Australian retail and business banking division produced a solid result. Revenue increased 5% and cash profit increased 7% to $3bn, as bad debts remained benign and expense growth was kept to 3%. The cost-to-income ratio fell half a percent to just 37%, showing how profitable the big four banks are due to their enormous size and entrenched market shares.

The retail business produced a 12% profit increase and ANZ was once again named home lender of the year for the 13^th year out of the past 16. At first glance the bank's home lending ratios look bullet proof, as the average loan-to-value ratio at origination is 71% (overall it's 50%) and 45% of home loans are ahead on repayments.

Yet 34% of ANZ's $209bn of home loans are interest-only. That suggests at one end of the spectrum there are a whole bunch of people with plenty of equity in their homes that wouldn't be impacted by lower house prices. At the other end there's a bunch of speculators – 39% of loans by value are to investors – with little equity that would cut and run at the first sign of trouble. This explains why Aussie banks are so profitable, but you wonder how long this can last.

Low interest rates are holding this delicate balance together and, while we generally avoid making macro economic calls, you should be considering how you would deal with even lower interest rates like those overseas. The RBA has backed itself into a corner by dropping rates to a record low of 2% to breathe life into the economy, but if commodity prices continue to fall while unemployment increases the RBA will likely lower interest rates further to try and support the property market.

Back to basics

All of ANZ's various divisions reported higher profits and profits from Asia and America increased 20%.  Smith acknowledged the big shift toward Asia was over now and from here on it was all about basic banking – incremental market share growth, reducing costs, minimising bad debts, increasing the number of products per customer – to reach the golden number of having 30% of revenues coming from Asia. This should be a safer strategy than making acquisitions while business and asset values are inflated by low interest rates.

Bank shareholders should be prepared for a capital raising if the recent Australian banking enquiry leads to higher regulatory capital requirements, but Smith let it be known that increasing regulation would unnecessarily make Aussie banks less competitive compare to their overseas rivals. We agree and note that higher capital and liquidity ratios alone will not solve the problem that Australia's big four banks are too exposed to residential property and too big to fail.

We've increased the prices in the recommendation guide mainly due to the passage of time, but we're still a long way from upgrading. ANZ's share price has increased slightly since ANZ: Q3 Result 2014 from 18 Aug 14 (Sell – $32.33) and because we prefer the domestic strategies of the other three majors we're sticking with SELL until Mr Market offers us a large margin of safety.

Note: Time to switch banks? provides a more comprehensive view of the Australian banking sector.