Download 5 May 2005

Westpac – Analyst Briefing
5 May 2005
WESTPAC 2005 Interim Results
Analyst Briefing
5 May 2005
Andrew Bowden:
Good afternoon. My name is Andrew Bowden. Welcome to the announcement of Westpac’s
2005 interim results. In addition to those present here today I would also like to welcome
those who are on a direct hook up via Melbourne, on our web cast and also on our
conference call. For the benefit of you all it would be appreciated if you could please switch
off your mobile phones now. The format of today follows the similar format to other briefings
where David Morgan, our Chief Executive Officer, and Phil Chronican our CFO will present
the results and then we will open up the floor to questions. So without further delay, let me
invite David to the microphone.
David Morgan:
Thanks Andrew. Welcome and good afternoon. This is a strong high quality result. It
demonstrates that our strategy of focusing on our core markets, enhancing the sustainability
of returns and improving the resilience of the company is delivering value to all of our
stakeholders. Cash earnings per share grew strongly at 12%. This was a revenue led result
with growth of 8%. The cash return on equity improved to 21%. The strength of this result
and our confidence in the future has also enabled us to raise the dividend substantially by
17%. Profitable growth has been gained without compromising margins. Productivity has also
improved. We have taken more than a full percentage point of our costs to income ratio over
the year.
Central to our financial strategy has been to grow revenues comfortably ahead of expenses.
Over the past five years we have consistently maintained the gap between revenue growth
and cost growth and we have repeated that performance again.
Improved returns were achieved across all of our operating units. Earnings were substantially
higher in our Australian retail operations, the BT wealth business and in Institutional Banking.
New Zealand delivered an 8% uplift in earnings, a respectable result in a very highly
competitive market. Our Group Business Unit recorded a loss for the year driven principally
by a one off tax charge and reduced earnings from our Treasury operations.
There is no doubt that the past six months or so has been accompanied by a marked
increase in competitive intensity across all of our businesses. Within this environment it is
important we maintain our strategic disciplines and not be drawn into decisions that could
compromise medium term value. In particular the growth achieved from our Australian
operations over the last half clearly demonstrates the substantial value embedded in our core
markets.
In response to the increase in price based competition we have kept our eye firmly on
medium term shareholder value and not chased growth for growth’s sake. This approach has
seen us forego some market share but deliver a very strong margin performance.
Last year I talked about the potential for irrational pricing to emerge. There is no doubt that in
the last six months a number of competitor offers have emerged that could not be profitably
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delivered on a standalone basis. I also made a commitment at that time that Westpac would
continue to operate in the best interests of medium term shareholder value. In this regard we
have stayed true to form. We have not led the market lower or responded aggressively to
irrational pricing initiatives and we have carefully considered our strategic response to all
competitive challenges. Specific areas where price based competition has intensified over
the past 6-12 months having included Australian and New Zealand mortgages and deposit
markets in Australia. In each instance we analysed our options and responded in a way that
supported our franchise and sought to deliver a superior medium term earnings outcome.
Turning to our individual business units. BCB, Business & Consumer Banking had a strong
half, delivering a 17% uplift in cash earnings despite slower growth and increased
competition amongst segments. Volume growth was sound but as we pointed out in recent
presentations that performance is below where we would like it to be. We have already
implemented a number of changes in this regard and we are beginning to get traction from
initiatives that we have put in place.
In the deposit market the restructuring of our product offerings has been a success. The
simplification of our Westpac One Account and the launch of Max-i Direct have delivered us a
product suite that is competitive on both price and features, while protecting our franchise
from aggressive, and for the most part unsustainable, price offers.
The key competitive issue in New Zealand over the past six months has of course been the
mortgage price war. While we chose not to chase unprofitable growth we were not of course
immune from the price war’s effects. In particular, our housing volume growth declined and
our margins were squeezed as existing customers switched from higher margin floating rate
lending to lower margin fixed rate products. Looking beyond this event our New Zealand
operations performed well.
Business Lending grew a solid 8%, with the repositioning of our distribution paying dividends.
Deposit growth was also sound and a good spread performance has assisted in partially
offsetting the decline in mortgage spreads.
The Institutional Bank’s performance was a stand out, with a 23% lift in cash earnings.
Our strategy to reclaim the lead bank status has continued to deliver benefits with higher
asset growth and stronger transaction business generating a 12% lift in customer revenues.
Moreover, this strong deal flow achieved over the year will provide ongoing benefits as we
further develop the relationships now established. We have also delivered strong returns
across its other businesses including a good performance from our Financial Markets
activities and continued gains in our specialised Capital Group.
BT has had an excellent half. Earnings up 33% led by revenue growth up an impressive
17%. The four key factors behind this performance have been the completion of integration,
outstanding investment management performance, its sector leading platform operation and
the tailwind from favourable market conditions.
With integration now behind us the business is spending more time focused on looking
forward including the launch of a number of new innovative products over the period. Our
platform businesses continue to grow at an exponential rate with our WRAP and Corporate
Super platforms consistently ranking number one or two in industry flows. Importantly the
flows being achieved are being supported by the broader Westpac relationship with
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customers investing half a billion dollars in new WRAP business. In Corporate Super more
than half of the new money was sourced from the Westpac customer base.
I am particularly pleased this half to deliver the highest absolute dividend increase by
Westpac for almost a decade and the highest percentage increase for six years. The
combined strength of this result and our confidence in the outlook has enabled us to deliver a
substantial increase in dividends of 17% on the prior year.
Before passing on to Phil, let me highlight that we don’t look at performance mainly as a
year-to-year proposition. It is primarily a long term game. Over the past five years we have
consistently increased returns delivering an economic profit compound annual growth rate of
15%. Behind that performance our cash EPS growth has averaged 12% and our return on
equity has consistently averaged over 20%. This year we have continued that form. We have
acted responsibly when considering competitive threats while maintaining the franchise
investment that will help sustain our superior financial performance. Importantly we have
returned that value back to shareholders when it is prudent to do so.
Let me pass you on to Phil who will take you through the detail.
Phil Chronican:
Thanks David. Let me start off by saying is that what I would like to be able to show you in
the next few minutes is really the robustness of the revenue texture so that even in the face
of lower consumer lending growth we have been able to generate superior top line of
revenues. In doing so obviously we have had to be able to manage our margins and through
managing our productivity it’s turned out into a pretty strong bottom line results and ending
the half in a very strong financial position.
The primary driver of the 12% cash earnings growth and cash EPS growth over the year has
been the revenue contribution of $326 million, that is up 8% and if we adjust that for all of the
normal accounting items that don’t impact cash earnings such as the policy holder funds
issues and so on, the revenue growth is even stronger at around 9% over the year. So it is a
very compelling number. The second big driver has been the continued productivity
improvement with our cost growth once again being well below our revenue growth.
Tax rate and bad debts have not been a material impact and driving our cash earnings
number. And you will also have noted that the change in the market value of the hedge on
our 2004 hybrid was $40 million. That artificially depressed our non-interest income but
obviously is reversed out in the calculation of cash earnings.
The net interest income picture was strong. We had a 9% growth in net interest income of
13% lift in our average interest earning assets. And the margin reduction as a result was
only 8 basis points. This is despite the overlay of significantly intensified competition over and
above the normal trend factors that have been depressing margins for most of the last
decade. This 8 basis point decline is obviously well within the 5 to 10 basis point range that
we have indicated in previous periods should be considered normal for the industry through
time. So there is nothing unusual or special about that.
The total loan growth for the year was 11% and one of the key features in this result for us
was the very low reliance that this has on housing and other personal lending in Australia to
achieve this overall outcome. Unlike of course most of the four or five years when consumer
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and mortgage lending had been the primary drivers. We’ve continued to have a strength in
business banking. Our BCB business lending up 10% over the year, and very strong
contributions out of both Institutional Banking and our New Zealand business over the last 12
months. I think what that really shows is the diversification and resilience of the underlying
business model.
We did have slightly slower loan growth over the last six months. Partly that’s normal
because we usually we have about two thirds of our business loan growth in the second half
rather than the first half. It also reflects some tougher market conditions over recent months
and one or two internal factors that I can touch on later.
The 8 basis point margin decline is one of the particular strengths of this result. We consider
the environment that we’ve been operating in. Importantly it is the tactical approach that
we’ve had to the markets in both Australia and in New Zealand that has allowed us to hold
the total spread decline to only 6 basis points over the year and in that much of it in the
second half of last year. The total margin decline of course declined by 2 basis points off the
back of the lower proportion of free funds that we had following the July 2004 buyback. We
see from this that we have been able to contain the impact of what is undoubtedly a tougher
competitive environment.
Our non-interest income grew 8% over the year and that’s both at the reported level and after
adjusting for the usual accounting impacts. The three main sources of growth that we had in
non-interest income from last year was Financial Markets returning to more normal levels of
revenue after some volatility in last year’s result, a strong contribution from BT. BT is now
operating on a fully integrated basis and importantly in this result is now returning well in
excess of its cost of capital. This is a year ahead when we projected that this acquisition
would be EP positive when we made the acquisition back in 2002. The Cards business,
which has now re-established its pre-RBA reform levels of non-interest income. And we also
had a contribution from the progressive liquidation of the high yield Securities Portfolio, which
is obviously well into being run down.
Our expense to income ratio reflects the ongoing productivity improvements in the business.
Our Banking Group expense to income ratio has now fallen to below 48.5% in the half.
Importantly this is a full 5 percentage point reduction from where we were two years ago. So
you can see the impact that we’ve had progressively through time.
The merged BT business is now delivering consistent improvements in its own productivity
and clearly demonstrating the achievement of the cost synergies that we set out to achieve
as part of the acquisition.
Looking at the expenses in more detail our reported expense growth was 6%. Now this is
clearly above the 2 to 4% range that we’ve indicated as a medium term guide. Although I
think we did signal that to the markets some weeks ago. Excluding some of the non core
items, particularly the impact of the EPIC assets that we held for the first three months of the
year and the New Zealand dollar exchange range effect, our expense growth was held to just
a little over 4%, up on last year, and only about 1.5% on the immediate prior half. Within this
growth what we’ve been able to do is to ensure that we continue to invest for the future,
because we’ve had significant spend on projects designed to produce future both revenue
and productivity benefits as well as ensuring compliance of many of the key regulatory
requirements. And you can see there, there was an $80 million spend on projects - that was
expense not capitalised. You will also have noticed that the capitalised software balance has
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continued to grow in line with that investment program and along with the guidance that we
gave last year.
This investment is heavily weighted towards major initiatives such as the Australian Business
lending origination platform, the one known as , and the group wide One Bank platform
development, which is a completely consistent PC platform throughout the whole group.
Obviously the amortisation profile has been increasing and that’s now been happening for a
number of years and has become a major expense item on its own account. $68 million
charged during the half, again it is all within our overall expense growth.
As always we continue to invest to build future productivity gains through these projects.
We’ve updated our pipeline chart here and rebased it to include only those items that have
an incremental impact in 2005 and beyond. We have continued opportunities for us to
achieve expense reductions throughout the group, primarily through automation and
reengineering work and largely focused on operations and processing areas. And you can
see that it is the benefit that these programs have been delivering that is allowing us to
continue to meet the compliance needs, the business investment outlays while keeping our
expense growth well below revenue growth.
We had a $203 million net bad debt expense position pretty much in line with last year. And
this represents 21 basis points of our total gross lines and acceptances figure. That clearly is
below our medium term guidance of 25 to 35 basis points and reflects the very benign credit
environment that I think you will have seen most banks reporting.
The composition of the bad debt expense is fairly consistent with where we were last year.
But I did want to draw attention to the net increase in the general provision which is artificially
low as we’ve been carrying some provisions set aside there around some rather unusual
credit situations that were built up some years ago. The way events have transpired is that
those issues are not likely to materialise and therefore during the period we’ve released
them.
Normally, one would have expected those to see as a write back and recovery, but because
of the nature of exposure they sat in a general provision, and not a specific, and that is really
the only clarity I should provide there. So from an economic viewpoint you may well wish to
think about relocating those as a write back and recovery.
In terms of the forward credit indicators things remain pretty solid. We’ve had a minor
deterioration in the 90 day delinquencies in the mortgage portfolio but it is fairly modest and
still well below the average of the late 1990s. The principal drivers of this lift were the lower
levels of new lending. By definition new lending is never delinquent. You naturally have an
increase in the delinquency data over the whole portfolio. That’s worth about 2 basis points of
the five basis points left. The rest of it is pretty much due to the impact of Easter falling in
March and therefore fewer collection days available in March and therefore a slight slipping
out of collections activity. We pretty much expect this stuff to unwind over the second half
and don’t see it as any cause of concern. The Consumer Unsecured portfolio changes aren’t
material and the Business Banking delinquencies have actually improved over the half. So,
overall a pretty sound position.
There has been quite a lot of discussion Westpac’s mortgage portfolio over recent months,
so I will continue it. This time last year we were looking at I guess two areas of concern in the
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mortgage market. One of those was that the risk characteristics of some part of the market
were causing us concern.
You may recall the heated CBD apartment lending, primarily brokerage originated and the
rush into low dock. The other element that was concerning us last year was that the pricing
and commission structures that you were required to be successful in broker networks didn’t
seem to provide enough economic profit to warrant its sustainability. Nonetheless the market
share loss that we incurred is greater than we can ascribe to those two factors, and therefore
we need to look also at our own sales productivity and levels of broker support. We have
undertaken some recent initiatives to try and address this extent of market share decline.
We’ve had to move some pricing although only to take it in line with market. We were out of
market and not all the pricing has been downwards. We have increased some fees on some
packages. We’ve provided and enhanced broker support to make sure the service is not a
barrier to our success. We’ve been re-energising our own sales force and we have provided
some limited low doc capability to make sure that we weren’t foregoing our quality business
in that sector.
None of these steps is intended to fundamentally change even the price or risk positioning of
the company. But we are expected to impact volumes in the periods ahead and you will see
here from the applications data that that’s already started to bear fruit.
The retail deposit business has also become much more competitive. We have been working
to achieve a competitive product offering that will enable us to attract and retain valuable
customers without having to re-price the whole of the deposit book. The Max-i Direct product
which competes head on with the other cash rate offerings in the market for the high balance
accounts has proved very successful in this area and as a result our total CMA style or high
cash style account balances have grown by over $3bn in the half just gone.
Business Banking has been quite central to Westpac’s success over recent years, and that
has continued in this result. The competitive environment though is intensifying and our
competitors have become more active in this segment. To date however, this hasn’t really
been reflected in lending spreads, which have remained broadly stable. We did see growth in
the SME and middle market segments a little bit more subdued over the last six months
although in part this is due to the normal seasonal lending pattern. But partially also due to
some diversions in internal resources around training to the new automated lending
origination system. We would expect at least the latter of those issues to disappear and of
course we would expect the seasonal issue to work in our favour in the period ahead.
Institutional Banking however, had very strong loan growth with total outstandings up 23%
over the year. In support of our lead bank strategy we have seen our core term lending
growth principally to the key strategic names that have been the target customers for
Westpac. But another important feature of this growth has been in bridging and warehousing
facilities where Westpac provides short term funding to support activities where we will have
flow on deck capital markets business. We’ve achieved this without material compression
and margins over this half.
In terms of financial markets we obviously have a much improved performance on where we
were last year. We have improved customer flows leading to increased sales and trading
opportunities and this improvement has been particularly marked in the foreign exchange
business. This has enabled us to get our financial markets income back to levels that are
more solid - up 27% on last year’s first half. You can see from the VAR utilisation that it has
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not been a product of additional risk taking.
Our group business unit is always a source of intrigue in the Westpac results. So hopefully
today I can provide some clarity for you as to what is there.
It is made up of a number of things. There are real business activities in there including our
group Treasury. And you can see that our revenue from Treasury is down $41 million on last
year. I would emphasise that our first half last year was particularly strong and the result in
this half is broadly consistent with where we were on the second half of last year.
In addition to that we also have a number of clearing activities through the group business
unit, that are largely intended to insulate the business units from financial accounting
conventions that serve no useful purpose. Such as items like the gross up of the tax on policy
holders funds and the life company. We insulate the BT management accounts from that and
deal with it in group.
Similarly we’ve always run an interest gross up for tax effective income in our Institutional
Bank but we now no longer use that for external financial reporting and therefore it is
eliminated in group.
So this centre carries a lot of those items. And thirdly, it acts as a clearing house for activities
that are really charged out to business such as management of group capital . We manage
the pension fund and then recharge the cost out to businesses. And we charge out equity
compensation.
Because of some of those activities that go through there you do occasionally have situations
where we have negative income and positive expenses. So I hope that you don’t find the
thing too confusing to read.
The material changes in the centre over the year though, apart from the Treasury income
item identified is that we’ve booked a $30 million tax charge relating to what appears to have
been mistaken treatment in prior periods on some previous transactions.
Capital growth over the year has been very strong. We have funded a $550 million buyback,
and we have absorbed additional APRA deductions on deferred expenditures. We’ve fully
restored our ACE capital ratio to above last March’s levels. And we’ve obviously had a
number of contributing factors to that. The first of which, of course, is the very strong returns
on equity, but also the lower risk weighted asset growth, with annual growth of 9% in the
most recent result compared to 11% in the year to September.
What that means is that we now have a surplus of ACE capital over and above the mid-point
of our ACE target range of over $700 million. Normally in a Westpac result that might have
been a trigger for some capital management activity. But you will recall that last year we said
that the uncertainty over APRA’s treatment of the IFRS related impacts was constraining us
in terms of both capital management and dividend policy. What’s happened in the interim is
that APRA has provided clarity on some, but not all, of these issues. In particular we are still
waiting to get resolution on the treatment of bad debt provisions as part of the IFRS transition
and the ongoing position relating to hybrid equity. As a result it is not appropriate for us to
announce any further capital management initiatives at this time, but we are keeping that
under close review as the year unfolds.
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We have however, felt comfortable enough with the capital position to be able to move on the
dividend. And the dividend increase is in no small part due to the very strong capital position
that we had. Franking, of course, is not an issue for us. We have a strong franking surplus
and therefore our medium term pay out capability will be purely a function of sustainable
growth in our earnings and our risk rated asset growth that is required to achieve it.
The IFRS is going to continue to cause more volatility in our earnings and therefore it is
difficult to talk in terms of payout ratios through this period. But as a guide you should
reasonably expect that we will be seeking to at least restore the 2 cent per period growth
path on our dividend as we go through this transition.
Let me talk now about a few issues in New Zealand. Last year we submitted our proposal to
the Reserve Bank for an alternative to their policy on local incorporation. Ultimately that
proposal was not successful and the Westpac Board agreed in December to comply with the
RBNZ’s policy. We are currently working to establish just how we might best do this. It is a
complex issue, we’ve been in New Zealand as a branch for 144 years and it is not easy of
course to unwind all the commercial arrangements that you enter into over such a long
period of time.
It does mean that we need to transfer contracts, contracts with customers, with staff and with
suppliers. As a result of that it is almost inevitable that we will need legislative change in New
Zealand, and that will become a key element in our timetable.
All of this of course, also involves cost, although at this stage there is nothing to indicate that
those costs will be material by the time we roll that up at a group level.
The New Zealand tax issues continue. We have the IRD now in a pattern of issuing
assessments as each year’s transactions reach their statute bar end period. We’ve updated
the amount at risk under this tax litigation in line with the additional interest and additional
time that the transactions have been running. Since 31 March we’ve commenced the run off
process in relation to the underlying transactions and we will be placing additional capital into
New Zealand to comply with the new thin capitalisation regime, which applies from 1st July.
The earnings impact of the run down on these transactions will be moderated somewhat by
other transactions, not principally in New Zealand that we’ve been putting in place to offset
this earnings impact.
Another New Zealand issue relates to the New Zealand class shares. We have had the New
Zealand class share structure in place since 1999. We signalled last year that the future of
this issue was at risk due to the Australian debt equity legislation that was passed in 2001,
which ultimately required that Australian franking credits would have to be paid on the shares
in addition to the New Zealand imputation credits that the shares carry. The Board has now
decided to put the exchange process in place and this will be completed after the interim
dividend in New Zealand has been paid. And we would expect that process to be complete
by around 11 July.
The impact of this at a group level is really two fold. It has no impact at all on dilution
because these shares have counted as ordinary shares for all of our EPS calculations. It
does however, improve our strategic flexibility on capital management because APRA have
treated these as innovative capital and therefore we will be reducing the amount of
innovative capital for APRA purposes that we are carrying.
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Let me wrap up. The result is clearly a strong one with strong revenue growth resulting in
sector leading cash EPS growth. It demonstrates that we can continue to grow revenues
without an undue reliance on the household sector, either housing or consumer lending. It
shows that we can manage the margin impact of intensified competition and it demonstrates
that with the continued commitment to productivity improvement we can continue to drive
superior bottom line growth and it highlights that we also have our risks firmly under control.
What that means is, we’ve had another half of strong cash earnings growth, high returns on
equity, high dividends and a strong capital position to position us for the future.
Thanks for that, and I’ll pass back to David for a wrap up and comments on the outlook.
David Morgan:
Thanks. There is little doubt that the operating environment is tougher on all fronts. We have
seen a slowing in economic activity and while inflation currently appears to be under control
the capacity constraints within the economy are still a threat to the outlook for prices. We are
also dealing with a number of regulatory challenges, which are very consuming of senior
management time. The competitive environment has also become tougher. While
competition has never eased in my years in the financial services industry the difference this
year is that the competitive challenges have intensified simultaneously on a number of fronts.
Given the economic outlook we are expecting total credit growth to ease as housing lending
continues its orderly decline. We expect total credit to ease from around 13% currently to
around 10% by March 2006. Business credit buoyed by a recent resurgence in institutional
lending has picked up although we expect it to normalise to around 10% in the next year.
Housing credit we expect to ease from around 14% currently to around 11% by March 2006.
In brief, overall credit growth is returning to more normal and more sustainable levels.
While delivering a strong bottom line this half we are not short of further improvement
opportunities. In Business and Consumer Banking we achieved a good growth return mix in
the first half but continue to see opportunities to profitably lift growth closer to the system.
Initiatives implemented already are beginning to show positive signs. In BT we have got great
momentum and while we can’t expect the same market conditions to persist we have only
just begun to tap the value in our broader franchise. In the Institutional bank momentum with
our lead bank positioning is strong and we look forward to fully capitalising on that.
Driving our performance over the past year has been a very strong Executive team. This has
been a clear source of our momentum given that we have had little change in the team over
the last three years. Importantly, our strong succession planning has seen Rob Coombe
seamlessly elevated to the front bench as the CEO of BT.
Our strategy over the past five years or so has been very consistent. That is to increase the
resilience of this organisation to external shocks and heightened competitive intensity. The
benefits of that strategy are now clear with the right business mix, the right financial and
capital structure, the right team and the right culture. This leaves us very well placed to
respond to future challenges.
In conclusion, this is a strong, well balanced result. The 12% growth in cash earnings per
share and the 21% return on equity placing us at the upper end of major bank returns. The
quality of this performance is also evident with a solid margin performance and strong
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revenue growth. Finally we are sharing this success with shareholders with a 17% rise in the
dividend.
Despite the changing operating environment for banks I remain positive about the outlook for
Westpac. We are well positioned for this more challenging environment. And we have
excellent earnings momentum across our businesses. Importantly the flexibility and the
resilience in our operating model has delivered a significant uplift in earnings in a slower
growth environment. The quality of our portfolio also remains strong. Accordingly, we are
confident that Westpac will continue to deliver results at the upper end of the major bank
sector.
Questions & Answers
Thanks for your attention, we would be happy to take your questions.
Andrew: Thanks David, as per this normal protocol, would you please wait until you get a
microphone before you ask your question. I will also like to limit in the first round people to
one question at a time, please.
Thanks Andrew, you made it hard. Jeff Emmanuel from UBS. David, the guidance
you’ve given about EPS growth at the top end of your peers, it must be getting harder
with St George at 11%, ANZ 10%, Commonwealth Bank at 9% - maybe some flesh
around that guidance and if you can help us out with what you are assuming on NAB,
we always seem to have a bit of trouble … I think we will work on the assumption that
NAB is not going to be relevant for this year.
David Morgan: Jeff I take the substance of your point that – when we look at financial
performance cash EPS is the primary determinate, but ROE is also important. Our model for
shareholder value is around optimising the sustainable growth as proxied by cash EPS and
the spread of the return on equity over the cost of equity proxy by the ROE. So, in terms of
what we believe drives shareholder value we regard both of those as relevant to the
comparison vis a vis for the sector. And you are right, it is certainly getting tighter vis a vis
those two competitors, in particular amongst the major bank sector that you mentioned. Yes,
let me help you out on that. Let me be very specific. All I am doing there is relying on you,
quality analysts, to have the good sense to separate the underlying from the headline and
make those comparisons on a rational and consistent basis and I’m sure you will do that.
Thanks, Andrew, it is Nick Selvaratnam from FSFB. Under the current regulations
Westpac has been the most aggressive in terms of capital structure to deal with your
hybrids at roughly 25%. Now admittedly the conversion of New Zealand class shares
will aid that proportionality somewhat, but it is possible going forward that there may
be a requirement to reduce the ratio to 16.5%, which technically will result in almost
excess hybrids compared to what guidelines would do. How are you thinking through
this? And what implications might there be for your capital structure going forward?
Phil Chronican:
Okay, Nick. I mean clearly the New Zealand class issue does help us
move that situation, so it takes us to nearer 20% rather than 25%. The time flies in this
business so the FIRSTs issue that I was so proud to announce here a couple, three years
ago, reaches its first call date less than two years away. So there are a number of things that
are in the pipeline that can help us morph the capital structure of the company going forward.
But also just with normal growth in the balance sheet, we would expect it to be able to absorb
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that. So if we do end up in a situation, and there is no certainty yet, but if we do end up in a
situation where the hybrid ratio is between 15% and 20%, it is a relatively small adjustment
for us to make and we have a number of degrees of freedom with which we can make that
relatively seamless. And obviously the other issue coming down the track is the Basell 2
migration, which will occur roughly in that same time frame.
So we haven’t got absolute clarity until we get the Basel 2 issues resolved. But we do think
there was a reasonable migration path without having to cause any massive disturbance to
our capital structure.
Brian Johnson, JP Morgan. Phil, a question along a similar vein. Since Nick and I have
organised these questions in order, it is a good way of asking two questions. If you
have a look at the ACE ratio at the moment, your target is 6% to 6.75%, Tier 1 sitting at
7.06%, the ACE is sitting at 5.19% versus a target of 4.5% to 5%. If we were to take the
worse case, which is that every one of your hybrids disappears out of Tier 1 which is
probable given their structuring, and we were to run at the lower end of the target,
you’ve still got $700 million in capital even if you were to reduce the hybrid component
back to 15%. Now notwithstanding that that is most likely the worse case, why aren’t
we seeing a buy back now? Because you’ve basically got more than enough capital
for the worse case as everyone understands it.
Phil Chronican:
There are a couple of issues outstanding. We know what is going to
happen now with the super fund on migration, and that’s a probably a small negative that is
not material. We don’t know what is going to happen on credit provisioning. We believe that
ultimately that position will be one that will give us a little bit of a capital relief in the migration
because of the strength of the surplus provisioning that we hold. Probably enough to offset
some of the other negatives. There are a couple of technical issues, and I use that term
because they largely relate to some of the intra group transactions, that we just need to get
clarity with APRA and they are sort of advanced bean counting, if we can really get to grips
with them. But we just need to get clarity because they are quite important. So all of that
suggests that there is no urgency for us to do a buyback, as you say we have a comfortable
capital position. The issues that we’ve put out as to why we are not – one is that we want to
make sure that we’ve got capability to support the Specialised Capital Group. So they’ve
given us back $300 million capital since September. We don’t want to constrain their growth if
they want another couple of hundred million for a transaction in some point in time. And it
seems to us a few months delay in a buyback just to get clarity on the capital was a prudent
use of our time.
Ross Brown from Deutsche Bank. David, you talked about a rational competition as
one of the reasons to grow below system. I wonder if you could just flesh out which
components you think are irrational, leaving aside that the Bank West deposit offer.
And secondly, in relation to that, if irrational competition continues a bit longer can we
expect you to be below system for a lot longer?
David Morgan:
Ross, I think there are three major areas where we are standing aside
from the market waiting for more rational pricing to emerge. One was in the New Zealand
mortgage price war last December, when margins got down to about 40 basis points. And
that now appears to have passed, that was one. The second is the one you’ve already
alluded to of the HSBC deposit offer of 6% from dollar one and that is still in the market,
albeit with a limited time frame on it. The third area, Ross, is not as egregious as those two
but we still felt it was very important, and that was the level of commissions that were being
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paid by banks to the broker channel for mortgages. And we were uncompetitive in the level of
commissions that we were paying to that channel, and because we felt that the broker
channel absolutely had to share in the decline in industry profitability coming from the
definitive decline in mortgage spreads. So we held out there and that cost us a lot of share
because we thought those commission structures were at an unsustainably high level. Now
two of our major competitors in that channel have now adjusted their commission pricing.
The commission is down to our level and so we have become competitive while having a
more sustainable proposition there.
So those were the three that I was principally being focused on and as I said one’s already
gone, let’s wait and see if HSBC refreshes their offer. I doubt that they will, and the broker
channel has been resolved.
This time, in six months time we’d expect the sort of volume numbers back to system
then?
David Morgan: There are two other areas, Ross, where it is not on the pricing dimension but it
is on the risk dimension that we’ve been under weight and are probably likely to stay under
weight. One is on low doc where we, 1 or 2% of our new lending, it is 15% of new flow and
we have not been able to see a situation there, where for us is a sufficient premium there, to
justify the incremental risk, so we will play in there but only very, very selectively with
customers that we know, so we will continue to be under weight in that segment. And we
have, the other place that we’ve been under weight has been on inner city apartment lending
principally mediated through the brokers, but not only. Now that again appears largely to be
over. So there is one element there where we are likely to stay definitively below system
because of our view of the risk reward balance.
Hugh Maxwell-Davis from Morgan Stanley. In the last two mid year overviews of
Westpac strategy you’ve highlighted Victorian Business Banking as a key area of
market share capture for Westpac. Are you putting market share and business
banking in Victoria?
Mike Pratt:
Yes we are. We’ve established a task force down in Melbourne which is what
we call our business acquisition group which has been aggressively attacking that market
and no prizes for who we are attacking down there, but we’ve had a lot of success in the last
6 months. We are winning share particularly in what we would call that middle market
segment in that Melbourne environment and we are actually growing that task force given the
results that they are getting. So very pleased with the outcomes down there.
If you look at the statistics so far, ANZ has grown business lending in the past six
months by 6%, St George by 8%, and Westpac by 3%. If you make the adjustment for
the ATC volumes, if you are winning in Victoria, does that imply that you are losing in
NSW, your home turf?
Mike Pratt:
We have, as Phil alluded to, in the past half, we’ve had some challenges with
our implementation of Pinnacle in the sense that we have had more bankers tied up with
training rather than selling. So that has been an issue for us where we’ve implemented firstly
across NSW. So to that extent that’s correct. But there is also a very important point about
seasonality that Phil made and you would, as we have experienced in the past expect to see
that seasonality in the second half for us and particularly on the issue of the credit reengineering project, will be largely through that. So I would expect to see that increase in the
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second half.
Why is it that you experience seasonality when the rest of the market doesn’t?
Mike Pratt:
Look it is a particular feature of our business. You know, if you track back over
a number of years now in our business banking you will see that over that May through
August period we do exceptionally well, we generally go out with a number of packages
specially targeted over that period, and that’s been a key success for us. And if you track
back in our volume growth you will see that that is the case over both halves.
Thanks Andrew, it is Craig Williams from Citigroup here. I suppose partly running off
from Hugh’s question, some of your peers have had similar or better revenue growth
in the past six month period and have better balance sheet momentum behind them,
but they’ve also increased their head count more aggressively than Westpac has in
the past 6 to 12 months. Would you say your approach is more about harnessing your
existing customer base than some of your peers? And are you happy with the level of
investment in your personnel levels?
Mike Pratt:
Yes, yes we are. If you look at the Westpac Business Banking story it is not a
story of the last 6 months or even 12 months. Over the past two years we have put about 640
additional business bankers into the network. So this has been a key part of our distribution
strategy, supplemented by industry specialisation, by technology and by appropriate
packaging around particular segments. So we are very happy with that, ours is not an overall
FTE story in terms of total number, as you rightly pointed out, in fact, we are on the prior
corresponding period number about 11 FTE below our staff point, but ours is rather a story of
mix where we have deliberately diverted resource mix into business rather than consumer.
So what you’ve seen is that drive better business results. Our challenge now is to get back
some market share as we talked about in consumer. But frankly that can be done tomorrow
simply by driving the price lever and we are not about to do that as David and Phil indicated.
And there are a number of other issues around productivity in that space that we will drive to
get that mortgage performance where we want it.
Jonathon Reoch from ABN Amro. Just a question on expenses. Just wondering what
was the main driver behind the lift in deferred other expenditure? And just related to
that, just a feel for how hard you think it is to stick within your 2 to 4% expense
guidance over the medium term despite the cost efficiencies?
Phil Chronican:
The deferred expenditure - the big drivers on deferred were Treasury
funding programs. So we had, for example, the securitisation program we did in January. We
hadn’t done one for a number of years, therefore the deferred expenditure relating to it had
largely amortised through. We’ve had another kick up, and other funding programs impacted
deferred expenditures, relating to all the hybrid, Tier 2 and those types of instruments get run
through that line as well. So that’s principally what’s driven that one. I’m sorry - the second
half of the question was?
Just how hard it is getting to stick to the 2 to 4% range?
Phil Chronican:
It certainly is hard at the moment. For the last few years we’ve been
swimming against the tide of increasing superannuation costs and increasing capitalised
software amoritisations. We’ve built them, the investment program, and we’ve been able to
do that largely within existing expense guidelines. This year’s been made harder because of
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the number of things that we’ve been trying to achieve simultaneously like IFRS and Basel 2
and there will be a lot of flow on work next year from that and then we’ve got the Anti Money
Laundering legislation coming down the pipeline. And I think the other point that David and I
have both made is that you know the relatively easy gains in terms of cost reduction that we
made back in the 1999, 2000, and 2001 period are not easily replicated and the big
opportunities we now face, or we now have in front of us, are those that require sort of
fundamental re-engineering and automation of processes and therefore have longer lead
times. So something like the Pinnacle program, which we commenced more than 2 years
ago, is only going to get to its finality at the end of this year when the big productivity kick
from that will come. And the other programs that we are currently investing in have similarly
long lead times. So I guess the key difference is at the moment the things we do don’t pay off
necessarily straight away and in some cases it is two to three year payoff periods, which is
why we need to be looking well ahead in our investment program to make sure we are
continuing to build capability for our 2006 and 2007 expenditures. Not just focussing on
current periods.
James Freeman, Goldman Sachs JB Were. Just a question on New Zealand. Just given
the economic and regulatory changes you had there and increased competition,
wondering if you could discuss the changes in the strategy that you are looking at to
ensure you maximise shareholder value going forward in that market?
David Morgan:
The move to a single brand was part of that strategy. The move of the
head office to Auckland to catch up with the change in the loci of economic activity was
another. A third one has been much greater emphasis on trans-Tasman sharing particularly of
product and infrastructure, which is a major feature of our sustainable productivity program.
That has had a minor glitch in it while we resolve with the RBNZ, their draft outsourcing
policy, which if the draft outsourcing policy was applied in a certain way would greatly limit
the scope to the trans-Tasman platforms that we have been an advanced stage of planning,
as you might be aware, we were due to shift our main frame out of New Zealand late last
year and we were asked by the RBNZ not to do that pending finalisation of their outsourcing
policy. So to re-energise those synergies we are spending a lot of time trying to get a
sensible resolution of harmonised prudential regulations that would allow RBNZ to get
comfort in the situation but allow us to reap those trans-Tasman synergies which are
potentially very significant in terms of back office and enterprise wide platforms.
David Humphreys, Morgan Stanley. I just had a question for Phil back on investment
spend. Phil, firstly are we likely to see the current investment run rate to continue for
the next 12 to 18 months? And secondly, the efficiencies you’ve tagged productivity
improvement program, are they a collection of what’s currently being rolled out or is
this something new we should look for?
Phil Chronican:
No, it is a collection of projects that we’ve had underway this year
under a common management stream. We are not inclined to announce these as jumbo
programs ahead of time. We usually like to wait until the benefits start to be delivered. So it is
a set of initiatives that have been underway under common management. A lot of them
focussed on trying to leverage some of the enterprise wide synergies, so common platforms.
There has been some people related ones about trying to streamline, or reduce internal
costs relating to staff transfers, recruitment, deployment of people. There has been some
stuff on some of the purchasing stuff and a whole range, I’m sorry, I could think of others,
there is productivity and the operations environment. So putting new productivity tools into
the branch staffing and call centre staffing. That type of initiative, so there is no one thing, but
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it is a collection of initiatives that we’ve had underway, hence you can see that there is some
2005 delivery from it.
What happens is that we’ve increased the overall level of investment spend from where we
were in 2001 and 2002, to where we are today. Initially that run up was part of where we got
to as part of the BT integration, and after the BT integration was finished we felt that rather
than run the resource pools down, that we would move those across and try and address
some of the strategy opportunities available in terms of that automation and re-engineering.
So we’ve been running our investment pools at largely the same level for about three years
now. So what that means is that the software capitalisation balance is running up to a level at
which it will plateau. I’m not sure we’ve reached the absolute peak of it, but you certainly
should not expect that that rate of increase will continue the way it has. The only overlay to
that is that there will be some changes relating to the move to the new head office building,
where we will be taking on some fit out costs that won’t show up on software capitalisation
but will show up in some of the other capitalised expenditure. But that will be offset of course
with the large rent reductions we will get when we move from the 11 sites down to two.
Brett Le Mesurier, Wilson HTM. A question on mortgage lending. You showed one
picture where you had an increase in loan applications late in the period - you also
showed that you only had a one basis point fall in spread over the half, which is
obviously an average. Since you’ve had a large increase in applications should we
assume that the spread is actually now - that the run rate now is - a couple of basis
points below that?
Phil Chronican:
I think it is reasonable to assume that the spread will contract a little in
the second half. It seems unavoidable for that to be so. Obviously the margin itself is a
product of a whole bunch of things, some of which get better in the second half, some of
which will get worse. I can’t predict accurately at this stage where we will end up.
Hamish Carlisle, Merrill Lynch. A question for David, more broadly you’ve commented
on the economy and you’ve also indicated that you are a bit more nervous about
inflation than probably your own economists appear to be, but you’ve still got a low
probability on bad debt. I just wondered if you could comment on you how you see
this credit cycle playing out, given that we are coming into a slowing economy, not to
put a debate on that front I guess, but which areas do you think are likely to show
stress first? And which areas do you see as being the biggest differentiators across,
you know, you and your competitors given the work Westpac’s done over the last ten
years around credit processes and management.
David Morgan: Hamish, I’m still concerned about inflation - I am still concerned about inflation
because non tradables inflation has been sitting at 4% for most of the past two and half
years. We’ve only held it under that in headline rates because of an appreciating exchange
rate, which my judgement is arguably over valued at the moment. When that washes out we
have an issue, so that’s why I have a difference of view with my people. It follows from the
concern about inflation that I’m looking out at best for nine months, which is about as far
ahead as you can predict, that we are just going to return to more normal growth rates and
financial systems growth rates. I don’t see any major imbalance in the economy of which the
greatest risk would be inflation that might result in something in terms of a home grown
recession. I simply don’t see that, but it is one of the reasons why I am so keen to keep
inflation in the bottle.
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In terms of which areas will come under greater stress, if and when that downturn does
come, I think there will be pockets of ugliness in housing, particularly among the high risk
segments - inner city apartments and the low doc sectors would be the two predominant
ones. Within the context of generally orderly housing adjustment, I think the highest impact
will come in unsecured consumer lending, particularly off the back of the increased gearing in
the household sector and the unsecured personal lending, primarily off cards.
Corporate is always very hard to predict because when you get something there it is very
lumpy. That said, the corporate sector is very lowly geared, profit share is very high and my
best guess is that that will not be the predominant area. That said, it is now that the bad
debts of the future are largely being written in the corporate sector. In some segments pricing
is not adequate for the risk and it is not only price competition but terms and conditions
covenants are really incredibly aggressive in some areas of that. Certainly sufficiently
aggressive to cause us to walk away from some deals not on pricing but on the covenants
and the terms and conditions. For those of you who know the history of Westpac and the
history of the two individuals up here, you will know that we are very determined to position
Westpac over a large number of years to go into the next downturn second to none in terms
of the low risk credit portfolio and second to none in terms of provisioning, and that was
obviously out of seeing the benefits of that in the last downturn in the cost of being at the
other end. And I am very confident that we will have that positioning.
William Ammentorp, Macquarie. Question for Dr Morgan, if I may, sort of following on
from Hamish. You obviously had a great run here with Westpac, revenue is up, costs
are flat, but also your time is coming to an end, in a contractual sense.
David Morgan: I was looking forward to the day actually, maybe you’ve got some news for
me, William.
Well, John McFarlane last week mentioned that he may look to extend his tenure at
ANZ a little bit beyond when his contract runs out. Obviously there are some chairman
succession issues they have at ANZ that aren’t appropriate for Westpac’s situation. I
was wondering if you could give us a little bit of guidance on how you see this
succession playing out at Westpac, around the timing, what would cause you to
accelerate or delay your wisdom on departure, but also how can we understand, within
the internals, making sure that they all have the right skills set, the right expertise for
the required role, remembering that you of course had international experience,
wholesale experience, retail and funds management experience before?
David Morgan: Thank you William. Just in terms of the issue of accelerating my departure,
that’s something you need to put to the Board, but I certainly have no plans to accelerate my
departure. which is currently scheduled for December 07. Secondly, I choked on my
breakfast when I read the AFR Saturday morning when John McFarlane was associating me
with those remarks. It is certainly nothing that we had discussed, notwithstanding being
together the previous day. It is not a question for now, William, I have literally given no
thought to it. The ink has scarcely dried on my new contract. I am planning to see that out
and I am very focussed on leading the company and grooming this internal bench of
succession. And as far as my attitude to the job I’ve never been more energised and
passionate. You should be assured that the Board and I are spending a great deal of time on
the succession issue for precisely the reason that you’ve said. I’ve certainly found it to be an
advantage in leading this company and having led all the major operating divisions and that
is why there is a lot of activity going on with me and the Board now to think about what we
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need to provide this full bench with the variety of experiences that will give us a deep bench
for my succession. And that’s a very active dialogue as we speak.
Thanks Andrew, It is Neil Murchie from Citigroup. Just a question regarding the group
interest spread on page 54 of the result. The two biggest geographies, Australia and
New Zealand, are down 9 basis points and 11 basis points, yet the group overall only
seems down 6 basis points. I am just wondering if you could provide a bit more colour
on that?
Phil Chronican:
Yes, I don’t have any easy answers for you other than to say it is
clearly to do with the rest of the spread, but that is not a very satisfactory one. So given the
interest and I had that before, what I think is best done is if we prepare a reasonable
response to that because I don’t have enough information on what the underlying drivers are.
I’m sorry for that.
Jeff Emmanuel, UBS. David, I take it from your last comments, you haven’t put your
hand up for the rumoured CBA role that another CEO has been raised for.
David Morgan: Rest assured about that Jeff.
Jeff. David, just that the environment and the slow down we’ve seen, it just seems to
us that the Reserve Bank may have been a bit hasty with that rate rise and that the
concern in the economy is just how fragile this reality, or the strength in the economy
has been. Is it concerning you that perhaps we are more late cycle than we think?
David Morgan: I would certainly agree with that point Jeff, but possibly not in the sense you’d
expect me to be. I think the Reserve Bank made a mistake by leaving it so late to tighten.
You don’t wait for three years for 4% non-tradable goods inflation to tighten, so I would have
thought earlier action would have been more useful. As to where we are in the cycle now,
Jeff, I think it is finally balanced. That said, when you get conflicting indicators like we have
now I tend to have more faith in the labour market statistics than a lot of the others, and that
is undeniably very, very tight, Geoff. So you know, I’m a little concerned with that.
Andrew:
Thank you very much for coming today. Phil Chronican and I will be hanging
around a little bit longer. I know that David has got to move on.
Thanks for coming and good afternoon.
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