Shayne Elliott’s radical overhaul of ANZ is a work in progress

The whirlwind of activity unleashed by Elliott is transforming ANZ but it’s too early to gauge the results.

Shayne Elliott, chief executive officer of ANZ Bank, in Hong Kong. (Picture: Michael Perini)

The new broom sweeping through the ANZ Banking Group is pushing a lot of debris through its results. Beneath the waste, however, there are some encouraging signs.

The cost of Shayne Elliott’s remaking of ANZ was reflected in the $1 billion of “specified items” that resulted in the group’s cash earnings tumbling 18 per cent to $5.9bn in the year to end-September. About half the specified items related to a more conservative approach to capitalising software costs.

If those one-off charges were removed, the result was down a more modest three per cent to just under $7bn, with an encouraging 11.7 per cent growth in second-half cash earnings.

The apparent plunge in the group’s return on equity, from 14 per cent to 10.3 per cent, wasn’t as dramatic (but was still significant) if the specified items were removed — falling from 13.8 per cent to 12.2 per cent, the weakest of the four major banks.

Elliott, after succeeding the more flamboyant Mike Smith as ANZ’s CEO at the start of this year, has presided over a whirlwind of activity that is dramatically reshaping the group.

The radical overhaul will continue with this week’s announcement of the sale of most of the group’s Asian retail banking and wealth management assets and the foreshadowing today of the possible sale of its life insurance, advice, superannuation and investment businesses in Australia.

Elliott has also overseen a $21bn reduction in the risk-weighted assets within ANZ’s institutional business and a further $5bn from the sale of the Esanda dealer finance portfolio as he pursues a simpler, less-risky and less capital-intensive strategy.

Shareholders have already borne some of the discomfort associated with the strategy after ANZ re-based its dividends with its interim result in May. Their annual dividends have been cut from $1.81 a share to $1.60 a share.

The ongoing shrinking of the institutional book was partly offset by strong ($8bn) growth in Australasian retail and commercial lending and by a focus on the higher-returning segments of its institutional business’ activities, which is similar to the strategy being pursued by Andrew Thorburn at National Australia Bank.

As we’ve seen with previous bank results, bad debts are rising, albeit from historically low levels. ANZ’s charge for credit impairments (which included the settlement of the Oswald dispute) was up 62 per cent over the year to $1.96bn.

Second-half impairments were 13 per cent higher than in the March half and ANZ expects broadly the same rate of bad and doubtful debt provisions — about 34 basis points of its loan book — this financial year, as stress shifts from the institutional market flows through to the commercial and retail sectors.

Rising bad debts and the pressure on net interest margins have been a common feature of recent bank results.

ANZ’s net interest margin fell four basis points to two per cent, although three basis points of the reduction related to lower markets and treasury income (which can be volatile) and therefore the overall outcome was relatively stable, albeit at levels low by historical standards.

Elliott also did a good job of controlling costs, with the group’s cost-to-income ratio improving from 46 per cent to 44.8 per cent, if the impact of the specified items were removed.

The changing shape of bank portfolios, most notably within ANZ and NAB, is being driven by higher regulatory capital requirements and, to a much lesser extent, higher funding costs. They are forcing the banks to be more selective about where they lend and the returns on their capital within their portfolios.

ANZ raised $3bn of new equity last year as the four majors raised more than $20bn in response to the introduction by the Australian Prudential Regulation Authority of a floor under the risk-weighting of their residential mortgage portfolios. It is likely that the major banks will have to hold even more capital once the international regulators produce more standardised risk-weightings later this year.

The combination of the dividend reduction and the shrinking of the institutional bank’s credit portfolio means that ANZ is generating organic capital, which enabled it to contain the reduction in its common equity tier one capital ratio flowing from the specified item losses and the changes to mortgage risk-weights to 20 basis points. At 9.61 per cent, ANZ’s CET1 ratio is comfortably within the international top quartile of the largest international banks in terms of capital adequacy.

The impact of the offloading of the Asian retail and wealth businesses is yet to occur — it will be executed over the next 18 months, with some indirect expenses associated with the businesses rolling off over the next two to three years.

With the foreshadowed exit from much of ANZ’s wealth management operations, the group’s shape and results remain works-in-progress and any kind of conclusive judgment on Elliott’s strategy and its longer term implications for the group and its shareholders is some distance away.

There are some encouraging early signs but whether a simpler and smaller balance sheet more focused on Australasia can generate decent long-term growth will only be known in a few years’ time.