Australian banks have emerged from their most prosperous year – reporting record profit growth and strengthened balance sheets – but face considerable turmoil in 1996 and the years beyond.
The profit story of the banks has been impressive. In the reporting season which ended in November, all four major banks reported considerable gains. The combined profit of these banks was a $4.95 billion (US$3.6 billion) after taxation – a 15.2% improvement over the previous year’s a $3.9 billion. Many of the smaller regional banks reported similar gains.
Perhaps the most notable feat of the bigger Australian banks in the past three years has been the repair of balance sheets that were badly mauled in the asset-price slump that followed the worldwide stock market crash of October 1987. Since the massive write-downs of the early 1990s, the banks have been so successful at strengthening their capital bases that one or two of them – notably Westpac – might contemplate returning capital to shareholders.
With such strong performances behind them, the banks might have reasonably expected more of the same. But going into the new year, increasingly fierce competition in the domestic market, where margins have already tightened, will certainly inhibit profit growth. And there are other factors at work in the banking environment and the economy that are going to make life difficult for bankers.
In the difficult post-crash years, the banks worked hard to eliminate non-performing assets and reduce bad-debt provisioning. The very success of these operations contributed to profit improvement. But by next year, this source of improvement will have just about run its course. In addition, a highly politicized debate and a public inquiry by the Prices Surveillance Authority have imposed de facto restraints on increases in bank fees.
In addition, some political storm clouds are gathering over the banking sector. If the opinion polls prove correct, the 12-year reign of the Labor Party could end soon. Should the conservative coalition of the Liberal Party and the National Party gain power – which many political commentators think is probable – a less-restrictive attitude to bank mergers and acquisitions is likely to prevail. Some Liberal Party spokesmen have also been promoting the notion that mergers between large life offices and large banks would be permitted. Under Labor, such mergers have been out of the question.
A conservative government could unleash forces of change in banking unrivalled since the deregulation of the Australian banking system in 1982 and the subsequent opening of the Australian market to a wider range of foreign-owned banks. However, there is an alternative position on the question of mergers and takeovers which says that a new coalition government might regard takeovers as constituting a reduction in competition: competition is the central article of faith in the conservatives’ economic philosophy.
One coalition undertaking has been to open the door a little wider for the banks to enter the superannuation (pension) business through superannuation savings accounts. In Australia, superannuation has been the fastest growing source of savings since the Labor government introduced compulsory super-annuation for all employees in an effort to correct a decline in the household savings rates and to relieve future budgets of some of the burden of pension payments to an ageing population.
Although the larger banks undertake some superannuation business in a low-key way through their fund management divisions, they would like to retrieve the deposit business they lost during the 1980s when many individuals concentrated their savings on superannuation because of the tax benefits. The banks believe they would recapture much of this business if they could offer tax-deductible superannuation savings accounts. With the opposition shadow treasurer, Peter Costello, promising yet another inquiry into Australia’s financial system, the banks will be watching next year’s election with great interest.
Privatization will go ahead
Whichever political party wins, the privatization of the once wholly government-owned Commonwealth Bank of Australia will proceed. Sales of shares in the bank over the past four years have reduced the government’s holding to a narrow majority of 50.4%. In its budget papers in May, the government indicated that it would sell its remaining shares in two tranches in the 1996-97 and 1997-98 financial years. More recently, however, the deputy prime minister and minister for finance, Kim Beazley, has revealed that the government is considering an option to dispose of its holding in the bank in one tranche before June 30 1996.
Based on the December 1 price of A$10.48, the government’s shares are worth just over A$5 billion. The managing director of the Commonwealth Bank, David Murray, has said that the board would consider asking shareholder approval for the bank to buy A$1 billion of its own shares from the government. This would leave A$4 billion for the market to absorb – a biggish bite but not totally indigestible. It is most unlikely that a conservative government would upset disposal of the bank shares.
The biggest players dominate banking in Australia. Of the 49 (really about 45 because of some double-counting) authorized banks in the country, four banks hold 62% of the total Australian banking assets of A$466 billion. This does not take into account the substantial holdings all four have in New Zealand, or their banking assets in the UK, Ireland, Asia, the Pacific Islands and the US. The remaining 38% of Australian assets is shared among foreign, state and regional banks.
The state banks have disappeared rapidly in recent years – the Trust Bank of Tasmania is the only surviving state-government-owned bank. The “sold” sign first appeared in the early 1990s when the Commonwealth Bank acquired the State Savings Bank of Victoria. This was followed in December 1994, by the New South Wales government’s sale of the State Bank of New South Wales to the Colonial Mutual Life Association. Then in June 1995 the South Australian government sold the Bank of South Australia to the Sydney-based Advance Bank, and in September the Western Australian government sold the Bank of Western Australia to the Bank of Scotland. These sales have done nothing to diminish the market power of the Big Four.
The biggest of all, the National Australia Bank (NAB), with an after-tax profit of A$1.96 billion, has reported the highest corporate profit in Australian history. It is ranked second only to the diversified steel, energy and mining conglomerate BHP in terms of stock market capitalization. NAB managing director Don Argus says that 30% of NAB’s profit derives from overseas operations. The NAB owns banks in New Zealand, England, Scotland and Ireland, which have also contributed to earnings. It has yet to take into its accounts returns from the Michigan National Bank, which it purchased for about A$2 billion during the past year.
The Michigan purchase brings about A$11 billion in additional assets into the NAB fold and means that nearly half of the NAB’s assets are now located outside Australia. In terms of shareholders’ funds, the NAB is now the 45th largest bank in the world and it claims to have the second-highest return on equity among the world’s top 50 banks.
The NAB has been able to expand its domestic market share faster than the country’s economic growth. It is a little unusual among Australian banks in that its growth strategy includes spreading its business across a number of economies in order to make it less vulnerable to economic fluctuations in any one market. This seems strangely defensive for a bank that came through the early 1990s slump in better shape than its competitors. But it is hard to quarrel with such success.
Overseas investments
What is clear, and often stated inside and outside the bank, is that all its overseas growth has been located in what economists like to call the Anglo-Saxon club, the English-speaking countries comprised mostly of former colonies of the UK – such as the US, Australia and New Zealand – plus Ireland. These economies frequently move together along the same trend line during the various swings of the economic cycle. This could undermine the notion of spreading the bank’s geographic risk. Nevertheless, a NAB spokesman said the bank was confident that its “unique trans-national strategy” would enable the bank to maintain its momentum.
“Acquisitions are all about opportunity and price,” the spokesman says. “The National is not about growth for growth’s sake. We focus on opportunity and value. We focus on targets and regions we understand and where we can add value. Our overall return on offshore acquisitions is 16.9%.”
The ANZ Bank, the second largest in terms of assets (A$112.52 billion) and profits (A$1.052 billion after tax) derived 40% of its earnings from offshore assets. What is more, chief executive Don Mercer said at the profit announcement on November 22 that expansion of the bank’s international presence and development of its fund management arm would be key sources of future growth.
ANZ’s comeback from a disastrous loss of A$579 million in 1992 has put the bank into the billion-plus profit club. Mercer attributes much of the strong profit growth to the bank’s New Zealand division and other offshore interests. “I think the international business is not well understood,” Mercer says. “People have seen it as another risk, but they should see it as our most profitable business.”
The bank’s Americas group contributed A$59.7 million (up from A$27.8 million) to the ANZ’s total profit from international operations of A$346.4 million. The bank recently opened a representative office in Buenos Aires because of the increase in trade flows between Australia and Argentina. In Latin America, the ANZ also has representative offices in Brazil, Chile and Mexico, and with the bank’s branch in New York, these offices comprise the Americas group.
ANZ has become involved in providing trade credits in countries such as Vietnam and has established a successful joint venture in Indonesia, Australia’s most populous neighbour. The first financial survey in Indonesia of the 23 joint-venture banks with foreign partners found that the ANZ Panin Bank had the highest return on assets and equity for the first half of 1995. ANZ Panin scored a return on equity after tax of 21.67% and this was well ahead of Mitsubishi Buana, Sanwa Indonesia and Fuji Bank International, which all had returns of less than 20%. On its assets, ANZ Panin returned 3.43% compared with 3% for the next best three – Sanwa, Daiwa Perdania and Mitsubishi Buana.
Soon to be competing with ANZ Panin in Indonesia is the Commonwealth Bank which, after two and a half years in that country, is about to enter joint-venture banking with Bank Internasional Indonesia. This investment, the bank’s expanded activities in Singapore and Hong Kong, and the opening of representative offices in Beijing, Hanoi and Shanghai are part of Australia’s push into Asia, but do not constitute a major source of revenue for the Commonwealth Bank.
This quintessentially Australian bank derived 95% of its 1995 profit of A$983 million after tax from its Australian operations, with the bulk of the balance contributed by its New Zealand subsidiary, the ASB Bank. The Commonwealth is passing through a transition from a predominantly retail bank to one with a growing commercial and institutional business. At the same time, it is still adjusting to life as a free-standing commercial enterprise as opposed to its previous existence as a wholly government-owned bank, with an at least implied government guarantee.
Part of the Commonwealth’s transition process has been a drive to provide a full range of financial services to its personal, business and corporate customers, including fund management, life insurance, general insurance, share broking and payroll services. In the past 12 months, it has launched two new businesses – Commonwealth Connect, a general insurance subsidiary and ShareDirect, a discount stockbroker. It also acquired payroll services company Micropay.
In the late 1980s, the bank moved into fund management and life insurance and began integrating its financial services with its banking business. Nowadays, Commonwealth Life Ltd is the fifth-largest life company in Australia, and CBA Financial Services the fifth largest fund manager and the third-largest manager of retail funds. In June 1995, total funds under management stood at A$14.2 billion. CBA Financial Services contributed A$50 million to the 1995 profit.
In its comeback from the disasters of the late 1980s and early 1990s, acquisitions have scarcely been the central concern of the Westpac Banking Corporation. Yet in December, it completed its purchase of a regional bank, the Challenge Bank of Western Australia, for A$712 million. This purchase, which looks a bit like an elephant swallowing a gnat, will strengthen Westpac’s market presence in some of its less well represented areas.
Of the Big Four, Westpac suffered the most grievous wounding in the years following the 1987 crash. The asset-value collapse led to management and board upheavals at Westpac. Top management was overturned at least twice until the appointment of the present managing director, American banker Bob Joss.
Westpac posted a loss in 1992 of A$1.562 billion but managed to push into the black with a tiny profit of A$39.2 million in 1993. The recovery was firmly cemented in place in 1994 with a profit of A$704.7 million after tax. This year Westpac improved its profit by 34% to A$947 million after tax – a return on equity of 13.4%.
The biggest single contribution to the profit came from a reduction in the provision for bad and doubtful debts, which fell from A$695 million to A$330 million. This reflects the fall in net impaired assets from A$2.175 billion to A$1.24 billion. In the 12 months to September 30, total assets rose to A$105.9 billion from A$99.96 billion. Net interest income rose by 8% to A$2.98 billion. At the same time, interest margins improved a little from 3.5% to 3.8%.
Unlike the NAB and ANZ, Westpac is limiting its overseas activities. It is well established in traditional Pacific markets, notably New Zealand and Papua New Guinea. It is also active in Singapore and Hong Kong, where it seeks to service those businesses which deal with Australia. In the latest year, its New Zealand bank had a 75% increase in profit to A$106 million after tax.
Increasing competition
With the Australian economy slowing and various sorts of competition emerging, the banks clearly face a difficult task in maintaining profit growth in 1996. The Reserve Bank of Australia (the central bank) sums this up in its annual report for the 1994/95 year: “While some banks have scope for further reductions, lower charges for bad and doubtful debts have largely run their course as a general source of growth in profits.”
Picking up on this theme, KPMG’s national banking and finance chairman, John Buttle, predicts “that tumultuous times lie ahead for the banking industry. Not only is there intensive competition within the banking industry, there are external threats arising from many sources including insurance companies, computer and telecommunications organizations, and mortgage specialists. The barriers to entry are coming down and the interest in the provision of financial services is great,” he says. “Specialist mortgage managers have successfully taken away market share from the banks’ traditional business of home lending. The securitization of mortgages is set to dramatically alter the banking sector over the next decade.” (Mortgage originators are claiming a market share of about 10% of new mortgages being written.)
Westpac’s chief financial officer and group executive, Pat Handley, questions whether securitization of bank loans will grow as strongly as expected. He says very few bank mortgages or business loans are suitable for securitization simply because of the flexibility available to customers and the add-ons which differentiate bank loans from the no-frills variety suitable for securitization.
Economic slowdown
While the banks mostly concede that 1996 will be a hard graft for them, they are confident of their own competitive capacities and their ability to maintain profit improvement. While not commenting directly on the KPMG statement, ANZ’s Mercer had a bullish riposte at his profit announcement press conference: “We don’t see any blocks or rocks on the horizon and we look forward to a sustained strong performance.”
Not all bankers are quite as sanguine about the future as Mercer and they are keeping a wary eye on the Australian economy. With 17 successive quarters of continuous growth, Australia can justly claim the best contemporary growth record among the OECD countries. But clear evidence has emerged that the economy is slowing despite the national accounts showing that the economy (GDP) grew by 1.6% in the September quarter and by 3.3% for the full year to September.
The snag is that there is a statistical quirk in the figures which include a full year of improved agricultural production following the end of the four-year drought which has afflicted most of rural Australia. Since the figures were issued, BHP has reported a slide in steel orders, and there has been a sharp dip in plant and equipment investment. The governor of the Reserve Bank, Bernie Fraser, has confirmed that the economy is slowing down but says it will gather fresh impetus in late 1996.
The slowing of economic growth has arrived just as the banks are absorbing radical changes in their distribution systems that have yet to be reflected in the statistics. Questions have been raised about the efficiency of Australian banks by international accounting firm KPMG and by management consultants McKinsey and Company which looked at retail networks only.
The KPMG report accuses the four main banks of not meeting international standards. KPMG’s John Buttle says: “The average cost-to-income ratio of the Big Four banks is over 60% compared with a US national average of around 40%.” The McKinsey study says that the major cause of lower productivity is the large number of bank branches but concedes that high branch numbers relative to population is mainly the result of low population densities outside the major cities and regional centres.
For its part, the NAB rejects KPMG’s criticisms out of hand. The bank produced a series of four ratios of bank efficiency as measured by six US institutions, including Salomon Brothers, Morgan Stanley, CS First Boston and the US Federal Reserve. In all but one ratio, the NAB equalled or bettered US standards. Although he accepts the usefulness of the efficiency ratio, Westpac’s Handley says that standing by itself, the ratio was not conclusive evidence of efficiency, which could only really be judged by looking at other ratios and figures as well.
All the banks are looking at new approaches to distributing their services. The ANZ, which closed 39 branches in Australia in 1995, is experimenting with putting bank kiosks in supermarkets in New Zealand, where it has already reduced the size of its network by 20% and is planning to close another 47 branches in 1996.
If the New Zealand experience were to be translated to Australia, 30% of its 1,105 branches would go. In common with other bankers, Mercer has his reservations about bank closures. “The branch network has a huge role in the future as well as today, but somehow we’ve got to make a sensible balance between all the alternative channels,” he says.
Electronics will certainly play a large part in bank distribution systems. For example, electronic transactions already account for 60% of the Commonwealth Bank’s total transactions. The bank is also broadening its distribution channels through personal computers and telephone banking. For its medium to small business clients, the Commonwealth has developed an electronic banking system, known as Quickline, which enables business houses to transfer funds, obtain account balances, stop cheques, order statements and access information services. Other banks offer similar services.
Westpac’s Handley, an American banker with 20 years’ experience, concedes that while Australian banks may have been a little slow in adopting some new ideas, they are all working hard to cut costs and become more efficient. He professes contentment with Australia’s growth rates.
Whether this drive for efficiency can overcome the negative forces at work will not be known until May 1996, when the banking industry announces its first-half results.
