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Executives

Jill Craig – Head of IR

Michael Smith – CEO

Shayne Elliott – CFO

Andrew Geczy – CEO, International & Institutional Banking

Mark Whelan – Managing Director, Commercial Banking Australia

Joyce Phillips – CEO, Global Wealth Group and Managing Director, Marketing, Innovation and Digital

Analysts

Craig Wiliams – Citi

Jarrod Martin – Credit Suisse

Jon Mott – UBS

Mike Wiblin – Macquarie

James Freeman – Deutsche Bank

Richard Wiles – Morgan Stanley

Scott Manning – JPMorgan

Victor German – Nomura

Brian Johnson – CLSA

Andrew Hill – Bank of America Merrill Lynch

Brett Le Mesurier – BBY

John Buonaccorsi – CIMB

David Humphreys – JCP Investment Partners

Australia & New Zealand Banking Group Ltd. ADR (OTCPK:ANZBY) F2Q 2014 Earnings Conference Call April 30, 2014 8:00 PM ET

Operator

Jill Craig

Good morning everybody. I'm Jill Craig, I'm the Head of Investor Relations for ANZ. Welcome to those of you joining us in person in Melbourne this morning and also via link to our Sydney offices, by phone and on the web, for the presentation of ANZ's interim results for the financial year 2014.

Our CEO, Mike Smith, and our CFO, Shayne Elliott, will speak for around 30 minutes, and we'll then go to Q&A. I'll walk through the procedure for Q&A at that time.

And with that, over to you, Mike.

Michael Smith

Good morning. Good morning everyone. Today we announced a good half-year result. Cash profits for the six months was up 11% to $3.5 billion. Earnings per share were up 10% to 128.7 cents. Return on equity was steady at 15.5%, even though it was impacted by regulatory capital requirements and the strong asset growth. And for shareholders, the fully franked interim dividend was up 14% to $0.83 per share.

This is another strong, clean result that demonstrates consistent execution of our super regional strategy. What's particular pleasing is that the strategy is delivering a better bank for customers and indeed a better bank for shareholders. It also means we're making good progress towards our 2016 targets and we're on track to meet the guidance that we provided to the market last year.

Before we look at the result in more detail, let's go back to a slide that we used at our 2013 results announcements, and recap the three key pillars of our super regional strategy. The first is strengthening the core franchises that we have in our home markets of Australia and New Zealand. The second is the profitable growth in Asia by capturing trade, capital and wealth flows into and across the region. And the third pillar involves an enterprise approach to build the business on common platforms and processes to reduce unit costs and reduce complexity and risk.

Delivery of this strategy requires an integrated approach to serving our customers across 33 markets. To support this, we have multiple programs across the bank focused on four broad priorities. The first is to improve our customer experience by making it easier and more intuitive to deal with. The second is to use the growth options that our strategy provides, to diversify revenue and to improve the sustainability of our earnings.

The third is continuing to improve productivity through our centers of excellence and through process consolidation, redesign and automation. And as you know, we've set a target to reduce the cost-to-income ratio to below 43% by the end of 2016. And the final priority is to deliver stronger shareholder returns. This includes targeting an ROE of above 16% by 2016. Importantly, we've stuck to this target despite continued requirements for additional regulatory capital.

Now let's go back to the results and take you through the process in the first half.

The first pillar of our super regional strategy is delivering strong growth and returns in our home markets of Australia and New Zealand. To achieve this, we are focused on growth in core customer segments, more efficient and better service, and transforming our businesses to meet emerging customer needs. The Australia division was up by 5%. ANZ had the strongest home loan growth of the major banks over the past year, and small business banking also performed strongly, with lending up 16% without compromising credit standards. And while overall lending grew by 6%, deposits were up 7% or 1.1 times system.

For me the key measure is that we've also continued to grow customer numbers. Over the past 12 months we have added 110,000 net new customers across retail and commercial, while also reducing customer complaints by 9%. And in a constrained environment, we've continued to reduce costs, with the cost-to-income ratio down a further 80 basis points to 37.3%.

Turning to the New Zealand division, New Zealand dollar profit was up 21%, driven by market share growth, productivity and credit quality improvements. Under the single ANZ brand, we're really beginning to leverage our scale. ANZ is now number one in new mortgages in all of the larger New Zealand cities, including Christchurch and Auckland.

We're also delivering above-system growth in commercial with lending to small business up 14%, driven by a 29% increase in customers. Expenses were down again, with the cost-to-income ratio improving by 370 basis points. Importantly, we were also improving our customers' experience, with the ANZ brand consideration at an all-time high.

In Global Wealth, profit was up 11%. A highlight for wealth is further strong progress with cross-business referrals. Wealth solutions held by ANZ customers are up by 10% in the past 12 months, and over a quarter of a million customers have now signed up to ANZ Smart Choice Super.

So, how are we doing all this?

Some of the key actions we are taking in Australia and in New Zealand and in wealth to drive these results are summarized in the Investor Discussion pack -- improving our sales capability, strong cross-business referrals, better channel reach, simplified processes, and simplified products. These changes are delivering strong but sustainable results.

Now let me turn to the second pillar of our strategy: profitable expansion in Asia through an integrated network that connects customers with the faster-growing regional capital trade and wealth flows.

The International and Institutional Banking division grew 14% or 9% on a foreign exchange adjusted basis. A feature of the IIB result is our progress in building diversified sources of income growth. 52% of our income now comes from outside Australia or New Zealand. Our international businesses, particularly in Asia, are firing on all cylinders, with revenues, profits again growing very strongly, and with an improvement in return. Cash profit from Asia Pacific, Europe and America was up 43% or 31% on an FX adjusted basis.

Following the results of some of our international competitors, some commentators have asked whether there is still profitable growth in Asia. ANZ's results tell you that there is, and that the opportunity is large and that it continues to grow. We're expanding our international and institutional banking franchise with customer numbers up 12%. And once again we've been ranked as a top four corporate bank in Asia by Greenwich Associates.

We're seeing strong growth in lower-risk flow products, with Global Markets Asia up 34%, Foreign Exchange Asia up 27%, Transaction Banking Asia up 9%, including a 17% growth in payments and cash management. This is creating a less capital-intensive business, with reduced reliance on lending where competition is still intense. Other operating income now represents 55% of total income for Asia.

Our strategy is also building a higher-quality, shorter-tenor book. This has driven an ongoing reduction and impaired assets which are down by 23% on the same time last year. Even in Asia we remain focused on improving productivity with cost savings enabling further investment in the opportunities that our strategy provides.

So Asia continues to be a key driver of ANZ's growth now and in the future.

Let me give you some more detail on our performance in Asia since completing the RBS integration in 2010.

First, we've delivered strong customer-driven growth in core segments and markets. Compound annual income growth over the past four years from IIB Asia is 25%. And looking at individual segments, compound growth in markets has been 22%, loans has been 23%, trade has been 31%, and cash management 29%. And although institutional is our key growth engine in Asia, retail has also grown well and has grown at 36% compound.

Second, we have underpinned that growth with strong business, cost and risk disciplines. As we have grown the balance sheet in Asia, we've maintained an improved credit quality. We balanced liquidity risks. And we have carefully managed capital.

Finally, this has seen double-digit earnings growth and improved returns. For example, Asia share of institutional income has risen from 14% four years ago to 27% today, while the return on risk-weighted assets is also increased.

The final pillar of our super regional strategy is an enterprise approach to deliver more control and greater efficiency by standardizing processes and systems, consolidating like teams, more straight-through processing and more convenient online self-service. This involves hundreds of small process improvements throughout the enterprise and the creation of centers of excellence that together are generating a large, sustainable difference. This difference involves better service for our customers, by bringing products to market more quickly, shorter turnaround times, and fewer errors, that in turn has resulted in a 9% decrease in customer complaints across the Group.

It's also creating a more efficient bank. During the half, we absorbed business volume increases of up to 8%, while reducing operations expenses by around 4% compared to a year ago. And the Group cost-to-income ratio fell a further 20 basis points to 44.3%.

Now let me hand over to Shayne to look at the results in a bit more detail. Shayne?

Shayne Elliott

Thanks, Mike.

I'm equally pleased with the half. It shows the value of consistent execution and a balanced portfolio of businesses. As Mike said, we delivered a cash profit of $3.5 billion, up 11%, with earnings per share up 10%, and held the ROE at 15.5%. That was driven by market share growth in most of our key business lines, productivity gains across the Group, continued improvements in the quality of our loan book, and disciplined capital management.

In Australia, customers responded to this simplicity, speed in service. We delivered a 17th consecutive quarter of increased market share in mortgages, and in the commercial segment, grew share in both lending and deposits, and we're the only major to improve customer satisfaction in commercial, rising to equal first, up from fourth a year ago.

In New Zealand, our cost-to-income ratio for the geography fell below 40% for the first time ever. This positions ANZ not only as New Zealand's largest bank, but increasingly its best bank. And it validates our decision in one brand and the New Zealand simplification program.

But clearly our point of difference is our growth outside Australia and New Zealand where cash earnings grew strongly, up 43% versus a year ago. Now even adjusting for the translation benefits of the lower Australian dollar, earnings were up 31%. And looking at Asia on its own, earnings grew 59% or 45% adjusting for foreign exchange.

Now combining that growth with the strong operating leverage we have built and the low balance sheet intensity of that business, means Asia is now generating a return on equity of above our cost of capital.

And finally, our global operational strategy continues to provide cost, quality and capacity benefits, with increased use of common platforms and higher levels of straight-through processing driving cost down while absorbing increased volumes.

So all three pillars of our strategy drove shareholder value in the half.

As Mike said, this is a very clean result, and I don't need to spend time explaining how the numbers work other than a few comments on the impact of foreign exchange.

ANZ provides investors with exposure to Asia and therefore the currency movement, although we do engage in currency hedging to remove short-term volatility. We've spoken to you previously about how foreign exchange impacts the business. Obviously, revenue and expense, but also capital, provisioning and some key ratios.

In this half, the lower Australian dollar had a reasonably large and positive impact on the Group. So in addition to the reported results, it's useful to look at raw trends, that is, how the business performed assuming no hedging, but also to look at how the business performed on a fully foreign exchange adjusted business -- basis.

In raw terms, that is, assuming no hedging, revenue and expense growth was 7.5% and 6%, respectively, with cash profit growth of 13%, producing an ROE of 15.7%. But we do hedge, and the hedge profit and losses are recorded in the revenue line. And so a weaker Australian dollar results in some hedge losses this half which reduced revenue growth to 6.3%.

Now on a fully adjusted basis, that is, restating the past, assuming FX rates then were the same as now, revenue was up 3.6% and expenses 1.7%, and ROE is up 50 points -- a very good outcome. And we remain on track for full-year revenue growth above 4% and expense growth of 2%.

So turning to the result in more detail. As I said, ANZ has a unique portfolio of businesses, each at a different stage of maturity, with different growth and return dynamics. To create value, we allocate resources to get the right balance between growth and return and to respond to short-term opportunities. We did not materially change resource allocation settings in the half.

Revenue grew particularly strongly in institutional Asia, retail Australia and global wealth. Trends were a little weaker in commercial and institutional lending, particularly here in Australia. However, sales of mortgages, insurance and superannuation to Australian commercial customers grew strongly.

Expenses were well-managed everywhere, but particularly well in New Zealand, institutional Australia and group operations where costs continue to fall.

Asia remains a strong source of growth. And this half showed that we can grow Asia and improve Group returns at the same time. As you know, indiscriminate growth in Asia would dilute Group returns. But good momentum at home, our targeted Asia growth strategy, and general productivity improvements across the Group meant the ROE was up 40 half-on-half and held firm versus a year ago. That is a strong and balanced outcome.

Looking ahead, capital ratios will need to increase a little to meet new regulatory requirements. However, our performance to date plus the underlying momentum in the business means we are confident of meeting our ROE goal of 16% by 2016.

Australia remains our largest and most valuable business, and given our relative size, we will continue to grow, with the focus on great customer experience and digital channels and products like goMoney, FastPay and Smart Choice, a portfolio of fairly-priced, well-packaged products and services, a range of channels our customers can interact with us how and when they choose, and a unique Asian footprint which is increasingly of value to our corporate and wealth customers.

We remain -- we maintained our risk appetite but invested in a more integrated, better-coordinated approach to customer acquisition and sales, resulting in share gains in mortgages, household deposits, business deposits and business lending. Annualized growth rates in retail lending were strong at around 7%. And in February, our mortgage books surpassed $200 billion for the first time.

Corporate and commercial lending grew 3% versus the first half of 2013, although half-on-half lending growth was flat. Customer acquisition in that sector and new sales were strong. However, pay-downs were also high. Plus we deliberately managed to run down in our unproductive book.

Now, not all sectors of commercial were the same, where we had high-teen credit growth in small business banking, which is an excellent ROE business. And given the increased investments in our distribution footprint and our $2 billion pledge for small business, we would expect that growth to continue.

We are also starting to see good activity in the corporate health segment and parts of agribusiness, and overall we expect improving business confidence, better economic conditions and higher M&A activity to drive some commercial lending growth in the second half. Margins in Australia division fell 4 basis points, mostly driven by loan price competition in the commercial segment. But retail and commercial deposit margins improved, providing a partial offset. Costs in Australia were well-managed again, up only 0.5%, which is only $8 million half-on-half, with ongoing productivity gains funding further investment in the business.

Turning to Australian wealth, the number of insurance and superannuation products held by ANZ customers grew 10%, with sales through our branches up 13%. That good sales performance plus improved claim ratios, reduced lapse rates and strong growth in FUM drove the best revenue growth in Australia wealth for some time.

The exit of one unprofitable Group life plan and the cross-border settlement of an insurance claim in the half, combined with the favorable one-off tax consolidation adjustment last year, make prior period comparisons difficult for wealth. But stripping out the noise, underlying business trends in the Australian wealth business are good.

Overall we have made excellent progress with our Banking on Australia program and strategic initiatives in wealth. New technology and networks plus better operating models are improving the customer experience and driving productivity. And these investments are well-managed within a broad and stable Group investment pool.

As Mike said, this was a very strong half for New Zealand. Geographically, CTI dropped below 40% for the first time ever, and the return on equity for the division now exceeds the Group average. It is a credit to the New Zealand management team and the Group overall to have delivered this transformation.

And simpler, more focused business helped grow share in mortgages, commercial lending, credit cards and total deposits. Margins for the geography were up 5 basis points despite a continued shift of customer preference to fixed rate mortgages. ANZ Kiwi Saver customers grew 15% versus a year ago, with ANZ regularly winning over 40% of new member additions in the month.

The initial benefits from our investment in in one brand and the New Zealand simplification program helped deliver a strong result in New Zealand in many fronts and positioned the business well for ongoing gains in the future.

So in summary, we substantially strengthened our position in Australia and New Zealand with stronger customer propositions, better cross-sell, further improvements in productivity, and significant benefits being realized from previous and ongoing investments. These are great businesses, and we see further growth and productivity upside in retail, commercial and wealth in both countries.

The second pillar of the strategy is to drive profitable growth in Asia by intermediating trading capital flow. Our customers demand it, and it provides us with more options to grow earnings without adversely impacting risk [settings]. And this half is a terrific example of that.

With weaker corporate loan demand in Australia and those loan margins under pressure as a result, we can direct resources to areas that offer better risk-adjusted returns, like trade, foreign exchange and commodity sales, and of course institutional Asia. Internally we may take it for granted, but it's worth reflecting on just how strong our business outside Australia and New Zealand is for the IIB division and the Group overall.

Not only is it a clear differentiator for our customers, our international business has now grown to such a scale that it truly complements the strong foundations of institutional Australia and New Zealand. Almost half of global markets, 57% of trade and 17% of cash management revenue, comes from outside Australia and New Zealand, in addition to over 57% of the IIB deposit base. Plus growth remains strong. Asia foreign exchange grew 27% in the half, driven largely by sales. Asia trade grew 5% and cash management 17%.

Customer acquisition remains strong, and more institutional customers are choosing ANZ in more than one country. This is important, because we know that on average, the broader your geographic relationship with a customer, the higher the relationship return. And that's intuitively sound. As a multinational relationship, it's generally driven more by trade, foreign exchange and cash management which are all higher return than domestic lending.

Clearly the lower Australian dollar helped, but even adjusting for foreign exchange, eight of our most strategic countries in Asia grew revenues at double-digit rates. Five of them above 20%, including India and China at more than 50%, and Korea not far behind it, 46%. Greater China is a clear strategic focus. And even excluding partnerships, revenue there has grown 20% versus a year ago. And it now represents a third of revenues in the IIB Asia division.

Building scale is critical to the strategy, and to the extent possible, processing transactions consistently no matter where they originate. That leads to a better customer experience, lower unit cost, and improved quality. We continue to move volume to common platforms and consolidate activities in centers of excellence. On a constant dollar basis, operations expenses were down 4% versus a year ago despite healthy increases in volume.

We now have our payments platform, including our main customer channel transactive implemented in seven countries: global foreign exchange in eight, global cards in 17, and collateral management in 18. Both our global wholesale credit decisioning platform and trade processing systems are now deployed in all countries.

Straight-through processing of inbound Aussie dollar payments hit a new high of 87% in February, and our payment defect rate fell to an all-time low. That means faster, more accurate results for customers, lower unit costs, and ultimately more capacity for well-controlled growth.

The implementation of our super regional strategy coupled with specific management action has driven ongoing improvement in the quality of our book, particularly in IIB and in New Zealand. In addition, the overall risk environment remains benign, driving further reductions in both impaired assets and provisions. Gross impaired assets have declined on average now by over $450 million per half since 2011 and are now at their lowest dollar level since the end of 2008, despite the loan book having grown 46% in that time.

The total provision charge is down 12.5%, with individual provisions up very slightly, just $7 million, and collective provisions down $78 million. That IP charge was heavily impacted by two exposures moving into specific provisioning. One of these customers is well-known to you here in Australia, and that provision is shared between Commercial Australia as the owner of the relationship and Institutional Australia as the product provider. The other exposure relates to a legacy in institutional.

Overall we remain well-provided. While the improving quality of the book drove the CP to credit risk-weighted asset down, we did not release any management overlays. In fact, we increased overlays by $41 million, relating to some ongoing stress in the mining services sector. Now while that segment represents only 0.14% of the Group exposure at default, it is nevertheless facing unique challenges not reflected in the broader portfolio.

We continue to show discipline around commercial property exposure, despite its higher-than-average margins and ongoing demand for borrowing. Commercial property exposure is less than 6% of our lending book and remains the smallest exposure of the major Australian banks. Write-backs and recoveries continue to elevate at levels across the Group and there are no indications that this will change in the medium term. We therefore retain our view that the total provision charge this year is likely to be around 10% lower than last year.

Organic capital generation in the half is $1.9 billion. We invested in profitable risk-weighted asset growth, increased the dividend, absorbed some regulatory capital changes, and continued to drive capital efficiency. Specifically, risk-weighted assets grew 12% versus a year ago. Half-on-half, that growth was $21.5 billion, of which $12 billion is due to core asset growth, which includes $6.5 billion in Asia, of which $2 billion is trade. In addition, $3.8 billion is the translation impact of the lower Australian dollar. And finally, we absorbed around $9 billion in RWA due to one-time regulatory changes, with more than half of that offset by ongoing capital initiatives like asset sales, plus data [ph] and model improvements.

We remained well-capitalized with common equity tier 1 at 8.33% on an APRA [ph] basis or 10.5% on an internationally harmonized basis. And we're well-positioned to grow capital organically to comfortably meet the known future regulatory requirements.

So in conclusion, this is a good result, with a stronger position in Australia and New Zealand, very strong growth in Asia and good expense discipline across the Group, all of which delivered a health ROE and a strong dividend for shareholders.

Let's pass back to Mike for final comments.

Michael Smith

Okay. Many thanks, Shayne.

In closing, I said earlier that we are building a better bank for customers and a better bank for shareholders. And the key here is that we're also uniquely positioned in Asia Pacific, the fastest growth region in the world.

This half we have again made good progress. The dividend is up 14%. Earnings per share is up 10%. And we've held ROE steady.

The aim of our super regional strategy is to deliver sustainable, peer-leading EPS growth and TSR outcomes for our shareholders. We've made good progress in the first half by focusing on four priorities that we've established for the Group: improving customer experience, diversifying revenues, driving productivity, and increasing shareholder returns. These priorities and the programs that support them are seeing us deliver good outcomes and leave us on track to deliver on our commitment to reduce the cost-to-income ratio to below 43% by the end of 2016 and to achieve an ROE of above 16% over the same period.

So in summary, it's a good, high-quality result for customers and for shareholders, one that leaves us well-positioned going into the second half. And I would like to take the opportunity to thank our 48,000 people for their hard in delivering these outcomes.

Let me now pass back to Jill who will open it up for questions. Many thanks. Thank you.

Question-and-Answer Session

Jill Craig

Thanks, Mike. So the procedure will be we will go to questions in the room here in Melbourne first. I'll then cross to the room in Sydney, and we'll then go to the phone.

So with that, Craig.

Craig Wiliams – Citi

Thank you. Craig Williams from Citi.

I think in our note we described this result as perhaps one where the market will like the result more than the analysts, but I'm not sure you'll be losing too much sleep over that.

Michael Smith

You never know. I might have changed, Craig.

Craig Wiliams – Citi

I'm not betting on it. Core equity tier 1 capital of 8.33% sits about 7, 8 basis points lower than the full year. Your dividend was 4% above consensus, placing this ratio perhaps under a bit further pressure now. So on a bank with a 15.5% return on equity, can't seem to sustain a payout ratio of 70% or net 50%, with risk-weighted asset growth of 12% over the year.

So a two-part question. How do you address the risk-weighted asset intensity of the growth you're driving? And our asset divestments seen as a key part of the equation to get an assumed core equity tier 1 capital level of 9% post D-SIB world [ph]?

Shayne Elliott

So I guess I'll answer that one. As I tried to cover in my talk, the RWA growth in the year was perhaps a little extraordinary. It was impacted by some one-off changes in terms of regulation and model changes, and which was broadly about half of that growth relates to that, so that we don't -- that's obviously not going to continue. If you strip that out, Craig, I think the RWA growth we had was a little bit higher than normal, but it's certainly sustainable for us and we're able to keep the capital ratios in that kind of 8.5%, towards 9%, as you mentioned.

In terms of the dividend, sorry, your second question was really about the dividend. Absolutely the dividend is sustainable. We've seen our payout ratio between 65% and 70%, currently at the higher end of that. We see that's sustainable with the RWA growth that we forecast.

Jill Craig

Any more, do you have a follow-up or anyone else from the room? We might cross to you in Sydney, Graham [ph], please.

Unidentified Company Representative

Okay. Thank you, Jill. We've got just perhaps if you look at the camera so that I can see, and also just introduce yourselves as you go.

Jarrod Martin – Credit Suisse

Jarrod Martin from Credit Suisse. A question for Shayne, and perhaps Andrew could come in on it. On Slide 88, just in relation to institutional and international margins, NIM ex [ph] markets has come down 16 basis points in this half to 2.49%. That's similar to what it was in the previous half. I just wanted to get comments about the rate of margin decline there, how much is mix, how much is competition, and maybe some outlook statement because we've been waiting for many halves for that rate of decline to actually begin to ameliorate.

Shayne Elliott

Yes. Maybe I'll start and then I think Andrew can probably give you more flavor about the trends you're seeing right in front of you there.

I think the first point to make is that actually the nature of the business today is we're much less reliant on institutional margins than ever before. So as a source of income for the Group, it's quite -- it's relatively small, if you think about, you know, 18-odd billion dollars in revenue, the total revenue from lending and institutional is kind of 1-1/2-ish. So it's not a material driver of the Group result.

But the reality is, yes, over time we've seen competitive pressure on those margins, as you pointed out. And Andrew can give you some flavor as to what's happening there in the short and medium term.

Andrew Geczy

I think we're going to continue to see this margin piece flattening. I think that the reality is that there's a lot of appetite for the good-quality credits that we bank. So there's going to be continued that margin pressure.

Jon Mott – UBS

Hi. Jon Mott from UBS. Kind of a follow-on question from that, and you've seen this across a lot of the banks that are reporting up in Asia, is that the returns have come under quite a lot of pressure over the last while because of a lot of excess liquidity in Asia and also very low rates in the U.S. I just wanted to get a feel for what leverage you actually would anticipate to see and potentially some of the spreads, going back to the other direction, if we do see further ending -- further tapering QE coming to an end, and eventually over the next couple of years U.S. rates starting to go back up. Should that lead and have you got any numbers on the leverage that you should get to improve returns out of the Asian business above the cost of capital?

Shayne Elliott

I think probably Andrew is best-placed to talk about those market trends, and I can comment on the returns.

Andrew Geczy

Well, I think once again I would reiterate Shayne's point around the fact of our dependency upon lending and margins is going down, just how the business is continuing to develop. We're more dependent upon our foreign exchange businesses, our other operating income is helping to drive that.

As it relates to the future, I think you're generally correct. I think we're going to continue to see a lot of liquidity in the marketplace, particularly for our target markets, which are the higher-quality credits. And we're going to continue to focus on those credits. So we will continue to build our business around the less capital-intensive aspects of our customer set.

And then I think the only other point I would emphasize about our ability as institution that's perhaps different from our competitors is this fact that we're connecting our customers across our region. And it's our ability to connect our customers across the region which is our unique selling point. And that allows us to achieve certain better returns than others can achieve.

Shayne Elliott

Yes. I would just add to that, Jonathan. I think the broader is that, as -- is this on? Yes. As -- if liquidity in the region does diminish and therefore we see rates rise, that's ultimately a good thing for our business. Because the reality is the business in Asia in particular that you're talking about is not terribly reliant on balance sheet and it's got very, very strong deposit levels. And therefore, higher rates will, you know, we will get an operating leverage benefit out of that. That positions us very well.

So it'd be better return -- your question about returns, returns would absolutely improve in that environment.

The other thing I would note is that I think we've shown really good discipline in the trade business in Asia. As you know, it's relatively short term. We have managed margins well. We haven't seen margins deteriorate in that business, unlike some of our regional competitors. And we've continued to be able to grow, albeit at a slower rate than we're used to, but it's still a great business for us.

Michael Smith

Jonathan, I'd also like to add to that, in the bigger picture. If you think about where U.S. tapering is going -- and frankly it's all about U.S. tapering now, it is going to be how that is managed going forward -- when will the increase in U.S. dollar interest rates happen? I think it's still a long way away. But it is a medium-term reality. It will happen.

And when it does, of course the cash management business that we have been building up in Asia Pacific, and also here, is going to significantly benefit from those increase in rates. So the annuity flow that will come through the business at that time will be significant.

Mike Wiblin – Macquarie

Mike Wiblin from Macquarie here. My question is a bit more macro. I know you're eventually going to benefit from rising U.S. rates. But in the medium term, I suppose capital flows out of Asia, and you see China continue to slow, what risk does that actually bring to earnings in the near term? Do you see any risks there?

Michael Smith

No, very little. I mean I would say that I'm not so concerned about China slowing. China is slowing to a sustainable level. And indeed when you look at the actual numbers in terms of the growth being forecast, that's like adding the whole economy of New South Wales every year. You know, it's a pretty significant growth number in real terms.

And also looking at the region, liquidity issues are not as extreme as perhaps they might be in other emerging markets, for example Latin America or Eastern Europe. And I think it's mitigated to an extent by the amount of liquidity which is still being driven out of Japan. And that has -- actually flowing through the same water course that the U.S. liquidity flowed through.

So I think that that's a mitigant. And it helps to just to adjust those economies to enable them to adjust for that reduction in liquidity, which will eventually happen. But I don't see it as any particular problem.

James Freeman – Deutsche Bank

Great. It's James Freeman from Deutsche Bank.

Just I was interested in what the growth in Asia would have been had we actually sort of taken out some of the strong growth in the trading and down-trading -- a note on sort of Page 56, you've had close to 73% growth in the Asia Pac trading and balance sheet income. So I'd just be curious, if we took that out of some of the numbers you've given us today, does that materially change the growth numbers and the return on equity improvement you've seen in Asia?

And the second question, Shayne, can I just confirm what your target range for capital will be under a new D-SIB?

Shayne Elliott

So, yes, you're right that the trading number was a good one in the region, that obviously helps. But if you take that out, core underlying business growth, if we took that foreign exchange, was up 37 -- or 27% rather, cash management 17%, trade was 7% [ph]. So the underlying businesses out there are still doing very well. And sales and markets growth in Asia was also strong, James. I don't have the number off the top of my head, stripping it out, but I can assure you the growth in Asia excluding trading continues to be very, very strong.

Obviously the trading helps, and typically trading is a low CTI business, so it tends to be -- will help out on all the return ratios. But that's not the reason that, you know, I wouldn't be standing here today talking about ROE being above our cost of equity if it was solely reliant on a good trading quarter.

In terms of the D-SIB, obviously we've had to reconsider the longer-term targets and we would be looking in 8.5% to 9% range.

Andrew Geczy

Shayne, if I would maybe add a point there. I think as you look at the balance sheet trading element, I think you've got to compare that in addition to the compression that we've seen in credit spreads in our loan book. That's the other side of that coin. So one side we're seeing with our high-quality credits a credit compression, that then translates into my liquidity book, also an improvement in my provision. So I think you could look at it in and around in our business.

Richard Wiles – Morgan Stanley

Richard Wiles from Morgan Stanley. Australia was a bit mixed. Retail was good but in commercial and corporate you had no revenue growth despite your market share gains. Could you tell us what happened to margins in the corporate and commercial space? And could you also provide some commentary around what you expect for competition, the margin outlook, and indeed revenue growth in corporate and commercial banking for the next say six months to 24 months?

Michael Smith

Okay. Phil Chronican's not able to be here, but Mark Whelan who is running the business will answer that for you.

Mark Whelan

Yes. Thanks for that question. Look, the asset -- let me just talk about the asset growth first and I'll come to the margin issue which relates to the revenue obviously.

The asset growth that we had in C&CB PCP was up 3%, and that flattened out half on half. So you're absolutely correct, the growth that we saw in the most recent half was lower than what we've seen coming off a very good year last year. With regards to the -- and that's affected the revenue outcome obviously.

The margins though that we've seen, we've seen some contraction in the lending side. So that's down half-on-half. It's not large, if anything -- compared half-on-half versus PCP, it's actually started to flatten out, if not, improve a little bit. But it's been offset to some degree also by deposit margins, because the deposit margins have been improving across the board both in retail but also strongly in commercial.

So if you -- in answer to the last part of the question, our expectations going forward, I think first of all asset growth will improve in the second half. We tend to have that seasonality factor anyway in our business, so you need to take that in consideration in looking at your comparisons. But also more importantly, we're starting to see some M&A activity in the corporate side of the market. Small business banking growth has been very, very strong and we've invested deliberately in that part of the market. And that's up 16%. Where we've seen most of the asset -- lack of asset growth has been that middle market, still lacking business confidence.

So when I look forward, I think that we'll still see growth in small business banking. I think the middle market will start to grow, and I think corporate will also improve. Margins I think are flattening, as I said.

Scott Manning – JPMorgan

Scott Manning from JPMorgan. I just wanted to -- I have two questions, one on asset quality and one the Chinese investments.

On the asset quality, there seems to be a large provisioning charge coming through the transaction banking line, which is typically one that's seen as kind of lower risk. And if you then look at the Australian disclosure, it's lower, which is implying a write-back in the global loans business in Australia. Could you just touch on those two exposures please?

Shayne Elliott

So the transaction banking exposure is, you know, relates to trade and it relates to the, I think referred to it as a name you would be familiar with here in Australia. It's just the nature of that exposure is through guarantees and bonding lines. And that gets -- so that is a trade business and therefore the provisioning gets booked through the trade lines. So that's why the trade business has that exposure.

In terms of the write-backs in Australia, I don’t know that there's any particular name that drives it. As I mentioned, write-backs from recoveries have continued to be at elevated levels, and there's been no significant change in that trend. So there's no one-off names that drives that one.

Scott Manning – JPMorgan

Thanks. And the second one, the ownership of Bank of Tianjin is down from 18% to 14% participating in a rights issue. Still that share [ph] accounted you to a board seat. But I mean the outlook there, what do you really need to exit that exposure?

Michael Smith

Well, we're in no big hurry to exit the exposure. Basically at some stage the bank will be IPO-ed, and that's probably a suitable time to make a decision one way or another. As I've said before, we are -- we look at these partnerships on the basis of what value they have for us, where we can get control, where possible, or if we can't get control and if we can't see a route to really driving income out of them in another way, then we look to dispose of them, and as you've seen us do that.

Scott Manning – JPMorgan

Thank you.

Victor German – Nomura

It's Victor from Nomura. Just two questions if I may, one following on from an earlier discussion around institutional business unit. If excluding markets business, which obviously is doing quite well, if we look at recent performance, it appears as though there's very little earnings growth and most of the strong volume growth has been offset by margin compression which is obviously putting some pressure on capital as well, can you maybe give us a little bit more color as to what is happening in that business and what is the strategy there?

Shayne Elliott

I don't think -- I'll start, and I guess Andrew can comment.

Michael Smith

Andrew, yes.

Shayne Elliott

Yes. The strategy hasn't changed. The strategy in institutional is about intermediating trading capital flows in the region. And it's about resources and Egre [ph] and capital markets and foreign exchange and all the things we've talked about in the past.

What's going on in that business at the moment is really rotation to a much lower risk, more customer focused business. And if you -- at a very simplistic level, what's happened, you're right, we've had lending which we've said now for some years we wanted to de-emphasize in the business and reduce the weighting of that business in institutional in particular. We've seen that come under not a lot of growth in volume, and we've seen margins come down. Right? And on the other hand, we've replaced that revenue and more with good-quality flow business, foreign exchange, trade, cash management, debt capital markets, et cetera.

And so while there's not a lot of top-line growth in the net number there, the quality of that business today is just far superior than it was before, and it's well, well positioned for continued growth in the future.

And Andrew can --

Michael Smith

Andrew, do you want to add anything to that?

Andrew Geczy

Just maybe a small point, which would be to emphasize once again the strategy that was not changing is that the connectivity that we're able to offer the institutional customers that's really different. And it allows us to drive these different types of earnings that we haven't had in the past. So we are going to become less reliant upon the lending book like we've been doing in the past. We're going to become more reliant upon touching the customers with trade but doing the foreign exchange that's going with that. We'll do more capital markets business across the institution.

When the capital flows, which come into Australia and M&A transactions happening, we'll be a part of those transactions on both sides. So we're helping that and making that connection happen. And that'll be the story that you'll talk about more, not the story about what's happening in my lending book.

Shayne Elliott

I think the other --

Victor German – Nomura

Given the volume [ph] growth, it's still --

Shayne Elliott

Sorry. The other thing that we talked about on this business is, you know, this is the beauty of ANZ and having a portfolio of businesses. Look, in the past we know we've been heavily reliant on institutional, it's a great business, but a big chunk of that was lending. So when lending was under pressure, for the reason we have talked about, no demand from borrowing, margin's under pressure, what choices do you have when you're a narrowly focused business?

But today we're a broadly focused business, so we can elect to put our resources into Asia, into markets, into trade, to get that revenue growth. And that's the beauty of the portfolio that we have.

Andrew Geczy

Just one final point --

Michael Smith

Well, hang on, Andrew. I mean the other issue is that the optionality that growth into Asia gives means that you don't have to go seeking the alternative which is going up the risk curve, which is the option. And we have not done that. We have that optionality available to us.

Victor German – Nomura

I think this all makes sense. The only thing that I was noting is that your balance sheet has still grown by 10% and your risk-weighted assets have grown by 9, which doesn't imply that there is massive decline in risk profile. So I guess, what am I missing there?

Shayne Elliott

Well, you're not. Your fact is right. The reality is the balance sheet growth though is much more trade-oriented and short term, so it's, you know, it's better quality balance sheet growth, if you will, A, and B, risk-weighted asset growth there, yes, some of it is core asset growth, as I mentioned, it was about $6.5 billion which is Asia which is most of that is sitting in Andrew's business, about $2 billion of that is trade. But actually some of those regulatory impasse [ph], some of those one-time methodology changes, they've impacted institutional more than other parts of the business. So that kind of $9 billion you're talking about isn't really a -- isn't a kind of a normal business growth.

Michael Smith

Not business growth, yes.

Victor German – Nomura

Okay. Since I used up a lot of time, I'll save my second question for later.

Brian Johnson – CLSA

Brian Johnson, CLSA. I have three questions if I may and I'll try and keep them pretty quick.

Shayne, during one of the earlier questions you basically confirmed that the dividend hurt this capital ratio, whereas I wouldn't have thought, it doesn't actually flow through till the next quarter when it's physically paid.

Shayne Elliott

You're right.

Brian Johnson – CLSA

So could you confirm that? Is --

Shayne Elliott

Yes, yes, you're right. The reason it's affected this time is because the last dividend we paid was high, if you will, and so that's the part that impacted the capital ratio, you're right. Sorry, if I wasn't clear on it.

Brian Johnson – CLSA

Okay. And so when you're saying an 8.5% to 9% range at the first half and full year, it effectively hasn't got the dividend out and your capital is going to be something the third and first quarter. So when you said 8.5% to 9%, can you just give us a feeling about what that means for the third and first quarter numbers when the dividend pops out, full six months div comes out, you'll only get -- because that's quite a big impact.

Shayne Elliott

Sure. But I mean ultimately we don't manage capital ratios quarter to quarter, month to month. We manage them over the long term. We make sure we have more than sufficient comfort in meeting both our regulatory minimums which were well above, and also, you know, being capital-efficient for shareholders. And I think, you know, we don't want to get too wound up in distortions about the timing of dividends. Obviously we take it into account, Brian, but we don't, you know, run the bank based on that.

We -- the target is what I see it. It's 8.5%, 9%, true there'll be times when it dips below some of those because of dividend payments and things, and that's a sensible and right thing to do for shareholders.

Brian Johnson – CLSA

Shayne, the second one is, ANZ I think should be commended on the disclosure, and the flipside is you should be bollocked when something disappears. Now historically you've done a great job in actually putting in the economic loss. In the result you actually disclosed and you talked about the economic profit based on the economic loss. But the economic loss now has disappeared. And I think I'll echo the sentiment of everyone in the room, just because the others don't disclose doesn't mean it's the right thing to do. Could we get some commitment that you will basically put out a stock exchange announcement and reveal what it is? And could you also just give us a quick feel of how it moved in the half from the 37 bps that we saw at the FY14 -- FY13 result?

Jill Craig

Brian, just to start to answer that question. If you go to Slide 66, there's a full page on regulatory expected loss and also our historical IP loss rate. And we've given you that restated as well as if we took today's portfolio and ran it back.

Brian Johnson – CLSA

Okay. Just the final one, I still think that should be on the CFO review because that's the thing people look at.

Shayne, just a final one --

Shayne Elliott

Well, you need to give the others a bollocking then.

Jill Craig

Yes. We've actually given you more information --

Brian Johnson – CLSA

There's no way I'll do that.

Unidentified Company Representative

Well, no, he meant the other banks.

Shayne Elliott

Take it on notice, Brian.

Brian Johnson – CLSA

Okay. Shayne, just a final point, is, congratulations on making some comment today on the return on profit in the divisions. But just I'd be interested in just an observation, if we look at the way the world is moving, ANZ is a regulated bank in Australia, which means you've got to run a Level II ratio in Australia, which actually means that at the end of the day, even though you can probably thinly capitalize the offshore operations and get a great ROE, at the end of the day you still have to hold the capital in Australia for it. Could we get a feeling on what the economic profit would have been in New Zealand and APEA had you actually allocated that capital back into those operating units as in effect you really have to do? Would it still make the cost of capital?

Shayne Elliott

I don't see -- New Zealand, absolutely, because New Zealand is so, you know, so well ahead [ph], there's no reason why New Zealand wouldn't.

APEA, we calculate -- I mean we do calculate it on an eco basis. So when I'm talking to you about ROE, my comments are generally on an expected loss basis and an economic capital basis, unless you talk about it otherwise.

So if you think about -- so if your real question is talking about, you know, Asia and APEA, the ROEs, when I say they're above our cost of capital, I'm talking about on a -- the impact basis today but it's on an eco cap, not regulatory.

Brian Johnson – CLSA

But to just confirm what I'm saying, the way Level II capital works in Australia, the real Group capital would be substantially higher than the economic capital.

Shayne Elliott

It's not substantially higher.

Michael Smith

-- wouldn't be.

Shayne Elliott

There's not a whole lot in it anymore, Brian, between the two. I can come back to you with the actual numbers, but it's not a big number.

Michael Smith

Yes, it would be a very small amount.

Shayne Elliott

It used to be big.

Michael Smith

Yes.

Andrew Hill – Bank of America Merrill Lynch

Andrew Hill from Merrill Lynch. Two questions if that's okay.

Just the first one, a point of clarification around the capital ratio targets. Can you confirm that that's been agreed with APRA on a D-SIB full run rate basis and it's not subject to change?

And the second point is just around Asia and the progress there. A few of the competitors out there have made a lot of progress moving beyond standard trade finance into more investment banking related activities, particularly some of the larger guys. Just wondering where your view stands from a strategic perspective on that front.

Michael Smith

I'll answer that.

Shayne Elliott

So we'll answer the first question first. We don't specifically sit down with APRA, you know, and discuss and get an agreement on our targets. Obviously we have an ICAP [ph] and we submit that to them and that gets approved. And obviously within that ICAP [ph] there are implied targets about how we're going to manage our -- how much organic capital we're going to generate and some assumptions around that. And that is agreed with APRA.

So, are our broad targets today agreed with APRA and voted [ph]? Yes. But things change over time, as you well know.

Michael Smith

And the second part of your question is that we're a commercial bank. We don’t pretend to be an investment bank and we are not going to turn ourselves into one. Is that clear?

Andrew Hill – Bank of America Merrill Lynch

That is very clear.

Brett Le Mesurier – BBY

Brett Le Mesurier from BBY. The return on risk-weighted assets you showed for Asia was growing at 1.5%. But when we look at the return on risk-weighted assets for APEA, it was less than 1.1%. Can you reconcile those two numbers given obviously the Asia part is a subset of the APEA part and therefore it would appear that the return in the rest of the APEA business was very low?

Shayne Elliott

Yes. I mean that's -- I mean you're right. Obviously you can mathematically figure out what the other part is. It is lower than Asia. But remember, the core of our strategy and the heart of it is around building out Asia. Now, and part of doing that, we have some assets booked in London in particular, and that tends to be a heavier balance sheet intense business and therefore their returns on risk-weighted assets tend to be lower sitting in that business.

And then the other difference, and I'm being reminded by a colleague here, is partnerships. So APEA will include the partnership returns.

Brett Le Mesurier – BBY

Can you tell me the proportion of the risk-weighted assets that are in Asia out of APEA?

Shayne Elliott

We'll come back on that.

Richard Wiles – Morgan Stanley

Richard Wiles, Morgan Stanley. Ex foreign exchange, your revenue growth in the first half was around 3.5%. You've stuck with the target for the full year of 4% to 5%. Could you tell us if there are any sort of lumpy items that have affected the first half growth rate or if there's something that -- or what do you think will improve in the second half to ensure you reach your target for the full year.

Shayne Elliott

Yes, it's a good question. So there's nothing lumpy in the nature of one-offs or something there that's holding back the revenue growth in the first half. I mean our plan, if you will, just our internal plan, was always that a stronger second half than a first half, Richard. So actually that 3.6% is pretty much bang on what our expectations were internally, so there's no change there.

The difference, if you're looking for one, if you look at the underlying business drivers, obviously some are stronger than we had thought and some are weaker. As I mentioned in my note, the part that's been weaker and has been a bit of a drag on revenue growth has been lending in the -- in commercial Australia. So they're being flat for the half. We'd actually thought it would be up a little bit.

It's a big business, so the difference between flat and up a little bit is a reasonable number on revenue. We're actually more optimistic about that growth in the second half.

And as -- I mean -- there was some deliberate management down of the unproductive book in commercial as well which won't continue. So we -- second half growth, all our businesses going, continue as they are, probably a little bit stronger in commercial lending in Australia, and that will get us to the numbers we aspire to.

Unidentified Company Representative

Just a couple more here in Sydney I think, Jill.

Jill Craig

Okay.

Victor German – Nomura

It's Victor German from Nomura. I might ask that second question after all.

Just following from what Richard asked, trustee business that you've announced recently, looking at asset disclosure, it looks like the gain on sale from that is about $120 mil. Can you maybe just take us through where that number is broadly right? And how does that fit into guidance?

Shayne Elliott

So when we made guidance, it was not assuming any sale on trustee, so that's over and above it. Your number is a tad low in terms of the gain on sales. It's a little bit more than that pretax. That number will be reinvested into the business, in both revenue and expense initiatives, which we will be considering -- I mean the deal hasn't closed yet, so that we'll do that over the -- through the half. Any impact of that would be over and above guidance.

So put another way, we're not going to use the gain on that trustee [ph] guidance numbers. It will be over and above. And we'll be clear about what we do with that money.

Unidentified Company Representative

Okay. So are there any more questions here in Sydney?

No, I think we're done here in Sydney for the moment, Jill. Thanks.

Jill Craig

Thank you, Graham [ph]. We have one question on the phone I understand.

Operator

John Buonaccorsi, CIMB.

John Buonaccorsi – CIMB

Thank you and good morning. So, just two quick clarification questions if I may. Firstly, Shayne, your comment equity tier 1 target 8.5% to 9%, can you confirm if that's after the dividend comes out?

And also on Slide 56, the liquids have fallen away a bit. So given that you're going through the process with that for this year to kind [indiscernible] OCR [ph], can you confirm that the liquids build-up is finally finished?

Shayne Elliott

Sorry, what's the last part of your question? Confirm what, sorry?

John Buonaccorsi – CIMB

That the liquid build-up has actually finished?

Shayne Elliott

Yes, broadly, that's correct.

And look, the 8.5% to 9% obviously is a kind of, I don’t know what the term is, but obviously it's a through-the-year target, and as I mentioned, that will be our operating target. There will be times when it dips below 8.5%, there'll be times when it goes above 9%. Dividends are a big number today and therefore have big swings within that capital ratio. And if we had to -- if we sit here and ran the business, said to you, it has to be 8.5% even after the day dividend's paid, we'd have to be I think sitting on too much lazy capital as a buffer. So, 8.5% to 9% is really the kind of sensible most-of-the-time range, and accept that there'll be times when it dips below a little bit.

John Buonaccorsi – CIMB

Thanks.

Jill Craig

We have another one on the phone.

Operator

David Humphreys, JCP Investment Partners.

David Humphreys – JCP Investment Partners

Good morning. Question if I may on wealth. Firstly, thank you for the enhanced disclosure around insurance operating margins. The question I've got, given the enhanced disclosure, is there's lots of commentary around improved claims lapse experiences, yet when I have a look at the Australian life insurance business, it seems as though your planned profit margin has been reduced by 10% to 8% on in-force business, and your wealth experience has actually got worse. Can you please comment on that?

Michael Smith

We'll hand that to Joyce.

Joyce Phillips

Yes, hi. Is this on? Yes.

Michael Smith

Yes.

Joyce Phillips

We had a loss of business in the Group risk area and we crystallized a loss of forward claims on that. That impacted revenue about $47 million. And you can see our claims and we've maintained very good retention activity. So our lapse rates have come down and that's in the disclosures as well.

And you can see it also on the embedded value slide, that the impact of that crystallizing that loss on a Group risk base, offset by positive experience on the rest of the portfolio, has driven embedded value growth of 8%. So I think if you strip out that one-time crystallization of loss, the underlying business is growing quite nicely and performing well.

David Humphreys – JCP Investment Partners

Right. And presuming that the planned profit margin had been reduced?

Joyce Phillips

The profit margin -- the profit -- the revenue has been reduced, so I don't believe that'll impact the margin. As you know, our Group risk area, similar to the rest of the industry, is a bit of a problem. So it's unlikely that that would have a material impact on our margin.

David Humphreys – JCP Investment Partners

Thank you.

Jill Craig

Any more questions from the room? Yes.

Unidentified Participant

Hello? Yes. First of all, I'd like to commend on the super regional strategy itself, relative to the strategies of other banks. But obviously have shown in the results that we are looking after the bank itself. But the problem that puzzles me is that, how can we ensure that the jobs are being maintained in Australia to further the economy of Australia as a whole?

Michael Smith

Well, the number of jobs in Australia has actually increased slightly. So there has been no reduction.

Jill Craig

I think if -- no questions on the phone, no more questions in the room. So I think -- and Graham [ph] tells me, we're done in Sydney, so I think, unless you have any closing comments, Mike.

Michael Smith

No. I think all happy.

Jill Craig

Okay. Thank you everybody for coming along today. Obviously the Investor Relations team are available this afternoon if you have any follow-up questions, as are the executive team.

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Source: Australia & New Zealand Banking Group's CEO Discusses F2Q 2014 Results - Earnings Call Transcript

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