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Executives

Warwick Bryan - Head, IR

Ian Narev - CEO

David Craig - CFO

Matt Comyn - Group Executive, Retail Banking Services

Alden Toevs - Chief Risk Officer

Annabel Spring - Group Executive, Wealth Management

Analysts

James Freeman - Deutsche Bank

Jarrod Martin - Credit Suisse

Craig Williams - Citi

Victor German - Nomura

John Mott - UBS

Brian Johnson - CLSA

Richard Wiles - Morgan Stanley

Mike Wiblin - Macquarie

Brett Le Mesurier - BBY Ltd.

Commonwealth Bank of Australia-ADR (OTC:CBAUY) Q2 2014 Earnings Conference Call August 12, 2014 8:30 AM ET

Warwick Bryan

Good morning, ladies and gentlemen. And welcome to the Colonial theatre for today's presentation of Commonwealth Bank’s Results for the six months for 30th June, 2014. Similar process to normal, Ian will kick off for the overview of the results and David will then spend some time talking about the more detailed part of the results and Ian come back to talk about the outlook and then we’ll go to Q&A.

So with that further ado, I’ll hand over to Ian who is having a few voice problems this morning.

Ian Narev

I hope you all be able to be hear but thank you very much Warwick and welcome here. Thanks very much for coming to the usual discussion of the results for the financial year ended 30 June 2014. It’s been a good year. It’s been a year in which we’ve basically just continued with the strategy which is being very consistent for the Commonwealth Bank for quite some period of time. This strategy revolved around customer focus and really focusing on building those key capabilities of people, productivity, technology and strength and we started with strategy and through significant strategy we see year of very pleasant growth at the cash impact line, retail and equity line, earnings per share and dividends per share. So a sign that the continued prosecution of that strategy continues to create the right short term financial picture for the group and in our view long term financial picture of the group and the effect from the way we look at the business right across the group is still significant unmet upside in that strategy.

The numbers stat profits up 13% year-on-year to $8.631 billion, cash net profit after tax up 12%, $8.68 billion. We’ve got a lift in retail and equity of 18.7%, cash earnings per share $5.36 up 11% and the full dividend for the year at $4.01, up 10%. So solid financial metrics across all those key dimensions. Underpinning the result all the divisions have made and total contribution, very strong performance year-on-year for the retail bank 12%. You see good contribution on the income line both sides of the balance sheet outside home loans as well continued in credit cards, personal loans. So income is up 9% and the continuing focus on productivity as the cost to income ratio down 36% and as you will see in one of David’s slides later actually for the six months the cost to income ratio for the retail bank is at 35%.

Business and private banking cash net profit up 4%, business lending did well, up 4% in a pretty subdued overall lending system, cost well managed at 2% ending deposit NIMs and this is the continuation of the theme you will recall we talked about six months ago, deposit NIMs lower there putting ongoing pressure on the deposit margins, particularly in the case of local business banking if you see the segment by segment breakdown later on in the numbers.

Institutional banking and markets up 5%. Markets did very well outside the counterparty value adjustment that was up 17% year-on-year. Average lending as well up 9%. So the institutional balance sheet inside Australia and outside Australia continue to be very well particularly in the context of the system it's operating in, again a repetition of the theme that we saw in the business and private bank which is ongoing pressure on deposit margins.

Wealth management up 17%. Average funds under administration were up 19% year-on-year. Average enforced premiums up 8%. So those are good strong operating income drivers. Costs up 9%. It was driven by few different things including one very good reason which was the increased incentives related to the funds management business where 84% of the funds are performing above three year benchmarks. Also ongoing regulatory costs and is obviously it’s in this business overall where we are taking the costs of the open advanced review program. And I just want to emphasize how important it is to us to make sure that that program gets executed flawlessly for the benefit of the customer. So we made that commitment six weeks ago and we’re going to make sure as a priority going forward in coming months that we really execute that to the best of our ability.

Bankwest income up 2%, very good on the retail side. You will see on the business lending side it was down 12%. So the Bankwest business bank still very much in rebuilding phase. Expenses very well managed at 3%, down year-on-year. And then finally New Zealand driven primarily by the ASB lending up 5%, particularly strongly there on business lending. The NIM was higher other banking income down 3% year-on-year.

Across the board good volume growth on the payments results. So you can see in home lending balance growth just a notch above system across the group, household deposits just under system but roughly on system. Business lending, both business and private banking and institutional banking and market saw volume growth in excess of system. Bankwest as I said before [indiscernible] the system. Business deposits, good growth, here in the system, credit cards 2.1%. That's been a story now number of years really focusing on existing customers, putting cards in their hands, activating the cards. So the performance of that business has gone well again this year and ASB as I said, business and rural balance growth up 8.7% against the system of 3.4% that was a business in which ASB has been underweight for quite some period of time.

I’ve talked about the consistent aspect of the strategy and you can see the really right through the results. So number one the long term focus on the customer and the customer satisfaction performance here remain strong across the board. I particularly call out in the Roy Morgan measure we had all 12 months of the year and now 18 months in total for the retail bank as a number financial institution customer satisfaction. I should also point out that that’s being increasingly hard to hold on to as you would expect. The competitors have lifted well and I expect that some time during the financial year that will be challenged.

And so we’ll have to respond to the challenge by getting back there and it will be the next test for retail bank customer satisfaction. Across business and wealth, strong levels of customer satisfaction also, and you can see outside Australia the same focus delivers the same results.

And we can see significant further upside in the strategy and you can see particularly here one of the core strengths we talk about a lot in the group is the 33.1%, main financial institution share, really strong bedrock across the group. Interestingly on the right hand side you can see another story that's existed for quite some period of time for the group, which is really strong at the young ages dropping off quickly and a lot of focus is going in the retail bank and in fact right across different parts of the group to see how we can take advantage of that opportunity and it particularly fits well with the group's technology, assets and technology strategy.

Productivity culture you can see the numbers have again came up very strongly. So intensive productivity savings for the financial year, $280 million. More importantly to me than the money is the fact that from a cultural perspective we can really seeing this taking hold of the business. 94% of staff trained in productivity habits, certifications of individuals and teams, visual management boards being used right across the business and then a group wide focus on continuous improvement. So that to me is actually a better story even in the $280 million of numbers because it shows that the goal we sit out to make productivity and continuous improvement a cultural imperative is paying off.

And you can see in the examples here and turnaround times, approval times, volumes and then overall efficiency, the impact at a process by process level of the work has been done at productivity. And it’s enabling us to continue to invest. And we did previously that with the core banking investment coming off, that would be replaced by ongoing investment. You can see it has been 65% of the investments this year, now in productivity and growth.

The technology story has gone well beyond core banking. We see it again that it is going to be a story of continuous improvement over years. And you can see that in this period we've had Australian firsts for consumers, Lock & Limit and Cardless Cash and the innovation is as important in business banking. Small business App and Emmy, giving an all-in-one small business payment solution for our small business customers and then Daily IQ, which to me is probably the most exciting innovation because it brings the scale of the group's ability to analyze data and it brings some of the potential opportunities of it to small businesses who don’t have the scale to make the investment.

Finally, on strength, deposit funding continued to get stronger 64% with continued strong weighted average gain at our wholesale funding at 3.8 years, liquids in a $139 billion, up a top notch and David will talk more about capital on both in APRA basis and a globally harmonized basis, very strong organic capital generation.

We also did something from the point of view the Group's portfolio, to strengthen capital in this period since we produced the last result for the half year and we completed this three transactions, very well executed by the wealth management and his strategy teams and they have freed up a $1 billion in capital about 28 basis points of core equity Tier 1 benefit. And there’s also small gain, which David will talk on the sale of the management rights.

I’ll now hand it over to David for the detail.

David Craig

Well, thank you Ian and good morning, everybody. So as Ian said, our cash net profit after tax was up 12% for this period. Operating income was up 7% and expenses up 5%. So positive jaws of 2% drove our operating performance up 9%.

Now when you think about income and expense as I called out at the half year there have been FX impacts in this period with Australian dollar moving around and that's had an impact on both income and expense about 1.5%. So on an underlying basis, income's up around about 5.5% and expenses around 3.5%, still at 2% positive jaws. Of course, the other feature of this results, which has been continuing and which you have seen across the whole industry is loan impairment expense continues to decline, now down to $953 million and that's helped to drive that 12% growth in cash net profit after tax.

Now that’s cash net profit but if we talk about statutory profit, actually the two are as close as they have been for many years, I suspect, statutory net profit was up 13% the same consistent approach in terms of differences between cash net profit and statutory profit, although I would call out that two gains a recovery on the build group litigation and gain on the sale of management rights from the property businesses have been taken below the line.

So let’s have a look at income growth. Income was up 7% but if we look at the components of that, net interest income is at 8% and that’s purely on the back of increased volume. So margins are flat but volumes up 8%. Turning to other banking income, so commissions and fees and so on are up 3% and trading income is up 7% and that was primarily on the back of that strong trading performance that we saw in the first half. And you can see trading income for the full year up $136 million, offset by this year flat CVA, but last year there were significant CVAs so the turnaround is $94 million which moderated that line. And then funds and insurance income is up 7% on the back of very strong growth in funds and administration and strong insurance income, but offset by lower margins in the funds management area.

Now I just wanted to talk about second half. I think there has been a couple of newsletters already this morning about this because on the face of it the second half incomes flat with the first and I thought I'd just analyze that and see what’s happened. So if we start at the bottom again, net interest income on a headline basis was up 3% but you will recall that there are three fewer days in the second half that has an impact of about $122 million which means the underlying net interest income is up 4.4%.

Other banking income has been particularly impacted by the timing of the trading gain. As I said trading gains mainly in the first half. So in the second half we’ve guided for more normal trading income, which knocked a bit off. Also CVA was completely turned around in the second half which knocked something off and we also wrote down the value of our investment in Vietnam International Bank by $50 million and that went through other banking income. So on an underlying basis, other banking income is flat.

And finally in the funds and insurance space, of course we sold those property businesses during the year and so the first half and second half are not fully comparable because there was a full year of property income in the first half. On the normalized basis funds and insurance income was up 3%. So across the group the second half, the last six months income is up 3%.

Net interest income also is flat. It’s been a long time since I’ve had very little to say about net interest income but as you can see funding costs improved by 5 basis points and those costs were passed on -- well those benefits were passed on to our customers leaving flat net interest income for the second half. For the full year net interest income is up 1 basis point.

Now let’s have a look at expenses. So the headline expense is up 5.4%. In the first half you will recall that we wrote off some -- we accelerated and wrote off some software costs which have an impact of about 0.8. We’ve also increased amortization on software, both because of our increasing investment profile but also we’ve taken the opportunity to accelerate the amortization on some software and that’s cost us 0.8 of a percent. I mentioned the foreign currency impact. That’s 1.7% so our underlying expenses are up just 1.7% and that’s really off the back of what Ian was talking about, the significant productivity gains of 280 million which have significantly offset the value of cost of inflation.

Now credit quality again is a very tiny story. We’re continuing to see the trends that I’ve been describing to you for some years of increasing credit quality. Arrears are down again across the board and particularly on the bottom right hand corner of this chart you can see that both troublesome and impaired assets continue to decline and this has meant that our cost for year has been 16% basis points. And of course that decline in troublesome and impaired assets means that we don’t need to hold nearly as much individually assessed provisions and you can see those declined significantly with the decline. At the same time no credit quality improving has meant less -- lower need for collected provision but we have maintained the same economic overlays we have done in the past periods because we remain cautious about our outlook.

Now let’s have a look at some of the individual businesses starting with the retail banking. On the top left hand side you can see that income in home loans was up 11%. That’s off the back of 7% growth in home loan balances coupled with the fact that this is the first full year of rate increases. You’ll recall the extended variable home loan rate went up halfway through last year. So this is the first full year and that’s also impacted the growth in income in that space. Interestingly though when you look at deposits, deposits are up 8% in volume but we’ve had significant pressure on margins in deposits and so that’s meant that deposit income growth has been moderated. But overall this has translated through to a 9% growth in income and very good cost efficiency from the retail bank with only 4% growth in cost giving that 12% growth in operating income.

And as Ian called out in the first half you can see there that by the time we get to the second half, cost to income ratio is 35%. Now some of you will recall back at the time of core banking that we had a project to get to project 35. Then it happened that we reorganized the group in a number of capital parts of the business and retail were removed into business banking. And so we abandoned that target of 35% but it’s still there. So well done to Matt and his team.

Bottom right hand corner, another feature of this result is because of core banking and real time banking transaction accounts continue to grow significantly and you can see there that growth in transaction deposits and retail banking which is very encouraging.

So looking at corporate and the story here is a little bit more confused, if you start with the bottom left hand chart which looks at Australian business lending growth, you can see that the system grew by 3.55 and the Commonwealth Bank grew by 2%. Although Commonwealth Bank itself grew by 4.2% and as Ian called out Bankwest had a continuing run off of particularly the non-core book that we’re running off but also in the core businesses they grew a little bit below system or somewhat below system. They actually shrank slightly.

So let’s look first at business and private bank. With growth up 3.8% in lending, translated though to margin problems and so on in the statements so that in the corporate financial services area, which is our upper middle market business, they grew by 6%, but on the other hand local business banking was fairly flat for the period. You can see that CommSec continues to decline. So although we’re holding market share in CommSec with volumes going through that business continue to be low and there is almost no margin lending going on.

So this has flowed through to an overall income, up just 2%, impacted as Ian said earlier by deposit margins but costs very well controlled in the space, up 2% as well getting income up 2%. From the institutional banking space, you can see that in Australia lending grew by 4.2%. Ian mentioned that overall balances were up 9%. That’s because of strong growth internationally. Again in this business though impacted by margins particularly in deposits and so that led to institutional banking income up 5%.

Markets income affected very significantly of course by CVA. So at a headline level flat but if you back out the fact that CVA was flat for the year, the underlying markets income was up 17%, translating through to an aggregate 4% growth in income in this business. Now you can see that expenses are up 9%. This is -- firstly it was impacted by foreign currency. Of course they had significant operations offshore, but also this is a business that we’re investing in and so this has been impacted by software amortizations, software write-offs and other one-offs. So the underlying expenses in institutional banking are about 3%.

Turning to the wealth business and as you can see again from the bottom left hand corner, very strong investment performance across all of the funds that are being managed there with 84% of funds performing above benchmark, which is an extraordinary result and that translates in the top left hand corner the combination of that and the management income you get from that coupled with strong markets businesses. So 14% growth in that space. Now that’s despite the fact that property business was sold out halfway through the year but that 14% is growth. So it’s a very good result there.

Colonial First State with funds under administration as you can see on the top right hand chart growing strongly. Colonial First State had some margin issues but still grew its income strongly at 6% and CommInsure grew strongly as well at 7%. You can see in force premiums up 7%, but in this space well we've set aside a further $61 million of general reserving against that number and that’s still translated through to 7% overall.

So in the wealth management business of course aggregates impacted by lots of regulation compliance costs and remediation but overall income is up 9%, expenses up 9% very good result 10% across the board, and that as a set includes the fact that property business was sold half way through the year.

So let’s turn to the balance sheet and have a look at funding and liquidity. At the end of the year we’re 64% deposit funded. So that brought in $34 billion I should say which went a long way for what’s funding the $41 billion of incremental lending. We have extended our long-term wholesale funding profile to 3.8 years and that's the $38 billion that came in there. And on the right hand side you can see liquidity up as well. So this has all combined to enable to pay a final dividend of $2.18 which as you can see puts us very much dead on the 75% payout ratio that we’ve been trying to maintain year-over-year and the full year dividend up 10%.

The capital position on both, an international harmonized basis and APRA basis is very strong with 70 basis points of increase for the year, very strong organic capital growth and obviously the benefit as well at the sale of those listed property assets. This strong organic capital growth and strong position has enabled us to choose to neutralize this forthcoming DRP because the Board is very comfortable about the levels of capital that we're sitting on.

Now I've shown you this chart many, many times before, the internationally harmonized chart, and as you can see Commonwealth Bank is very placed globally against its peers. As you will have probably heard already in the media there is a study going on across the banking sector at the moment of relative levels of capital and that’s suggesting that actually we think conservative and stating our internationally harmonized numbers, these numbers here for us only include the four largest adjustment between us and the file standards and when we look at -- I suspect when we hear the final results you’ll see that that number will be somewhat higher.

It’s worth just looking again at how the Australian banks do operate against other regimes, It's very important from our point of view that it facts are on the table and it’s understood just how strongly Australian banking sector is from a capital point of view. And as you can see, depending on which regime around the world we might be regulated under, our capital is significantly higher in other places.

So in summary, this has been a very strong result with income up 7% translating for an operating performance up 9% and our overall cash net profit up 12. All the divisions has been contributing a very strong result particularly from retail at 12 and then as you can see double digit growth in Wealth, in Bankwest and in New Zealand. So very strong across the board. And this is something about virtual cycle from my point of view if you look at the bottom left hand story. That is strong productivity gains translate into growth or efficiency which in turn enable us to continue to invest in the business and we’ve continued to do that and as you can see at bottom right hand corner, of course in very strong capital position.

So I’ll just hand over to Ian to cover the outlook.

Ian Narev

Thank you very much David. In terms of the outlook we do see good strong foundations in the economy but it is an economy of real patchwork signs at the moment. So on one hand we do see ongoing subdued labels of customer confidence and generally business confidence. Like this week we actually had a more encouraging piece of business data. Credit card spending and other key signs of consumer activity have actually trended up but business lending remains relatively subdued. But overall what we can see is that the low interest rate environment has assisted with some part that transition that the economy away from its dependence on mining investment and in particular has been a positive for the housing and construction sector.

We can also another critical element of the economy which is the ongoing benefit of what has been dug up and sold out of the mining and business that have been done over previous years. So in terms of you can see later on in the materials the expected projection of receipts from exports of iron ore and other minerals, very strong over a number of years in that we expect Australia by 2020 to be the world’s leading exporter of liquid natural gas. The relative stability in the global economy has been a positive although as you and I will be moving into an additional interesting time over the next to 12 months as we’re all looking to see at what point the U.S. Fed will start its tightening cycle and in particular we start getting used to a world where monetary policies starting to diverge, where we have on the one hand economies like the U.S. New Zealand and the UK which are in tightening and on the other hand we got economies like Europe and Japan which is still going to be on easing cycles. And the volatility debate causes a global markets will be interesting in terms of its impact on confidence.

Overall we think that the economy will continue on its pretty good foundations and any improvements likely to be gradual and the extent that the improvements really does depend on the stability, the extent to which global markets remain relatively stable is I said, but also the importance of making sure from a domestic policy savings point of view that there is a coherent long term economic picture for the country for which particularly businesses making assessments as to whether to invest and have the confidence of the environment now going to be able to investment into in the medium to long term.

We’ll continue to take a long term view investing behind the same four capabilities of people, technology, productivity and strength and the taking account of the possibility volatility in the market but keeping our focus very much on that long term strategy.

So in sum, net strategy has continued to deliver results for shareholders in the short term while continuing to strengthen our platform for the long term, continued growth across all the key financial dimensions for the 2014 financial year, but still from management’s perspective significant upside in those key strategic things.

I’ll now hand back to Warwick to moderate the Q&A.

Question-And-Answer Session

Warwick Bryan

Thank you, Ian. Thank you, David. Just a few ground rules as normal. Please wait for the microphone, identify yourself, not more than two questions at a time. If I've got time I'll come back. We do I think have media on the line and welcome to you. But could you hold your questions till 2’o clock this afternoon. And I’ll start with questions from the floor and then go the phone. So James?

James Freeman - Deutsche Bank

It's James Freeman from Deutsche Bank. I just wanted to get a little bit more information around the business and private bank, and also IB&M. Just if I look at it half-on-half, there's actually been a quite poor result, both for the revenues line and also the cash earnings line. Now, I understand, obviously, markets have impacted the IB&M numbers, but even looking at the business and personal banking numbers, I mean we're seeing, obviously, some poor growth across most of those divisions. Just an idea as to what sort of drove that, what were the key sort of factors driving behind that and how that outlook looks for the next 12 months.

Ian Narev

Well, I think the overall system environment James in which those businesses operate is I see just continue to be relatively subdued against those that market context if you look at what’s happened in both business banking and institutional bank and markets, the underlying lending to business is actually pretty good relative to the market. But the question we’re all thinking about and this goes back to my outlook is what kind of increase we likely to see in the market and now that’s been a topic of debate. As you know for the two or three years wins the big push back in the business lending coming, our view in terms of the outlook is that that’s likely to be gradual. I don’t think we’re going to see any immediate turn to the upside but I think those businesses against that market have actually performed pretty well.

On the deposit side again from market share perspective and the overall performance they've done very well and particularly in both business banking and IB&M relying on the strong technology platform they've got. The deposit margins have hit both businesses and that’s the trend that I don’t see changing in the next six to 12 months. Again, it's going to depend really on the way the markets is. The other factor that you’ve identified is markets and that applies to both IB&M and business banking, business banking, the CommSec business you can see in the numbers held market share, held yield per contract now but overall trading volume to be very low and it’s impact of that business. Likewise in IB&M the half one half markets performance wasn’t quite as strong. We’ll see how that goes in the coming financial year.

Jarrod Martin - Credit Suisse

Jarrod Martin from Credit Suisse. Two questions. First of fall just on bad debt, third quarter bad debt number was $228 million. That implies $268 million or thereabouts for the fourth quarter. The driver of that increase because we have been seeing the trend of it going down and looking forward that will be at the end of ever improving bad debts and now the expectation is that, bad debts grow at least in line with volumes if not potentially higher. And the second question perhaps for you in financial system inquiry, sending it from report, we've seen the rating agencies globally put negative outlooks on Canadian U.K. banks due to bail in expectations. So just wanted your views on the potential impacts of the financial system inquiry on CBA and in particular major banks?

Ian Narev

Let me speak briefly about credit quality and then I might hand over to Alden and then take your second question. In terms of half on half the biggest driver of the worst second half it was about 4, relatively bigger accounts weakening in business and private banking. These were all along standing credits. There is nothing correlated between the middle. So although people who watch business things, it looks there’s always three or four they’re not going to affect any period. In this case they are all quite unique being on the book for a period of time and we don’t see that has any sign of systemic weakness. So that's a key part in terms of what happened half on half particularly in the business in private bank. We will see the half on half picture is probably weak as all in terms of how you look at the 16 basis points, you might not provide a view on that.

David Craig

It’s been running in commercial about 16 basis points for some time. And we had a recovery or so I think reduction in that is about, 14 basis points in the third quarter. And that spiked up a little bit. But if you look at how low it is, just a few credits and there are three in particular. That tipped in pretty quickly, non-related to each other in separate industries, you get sort of downward trend and then an upward trend that is really not an indication of hitting the floor and rapidly coming off of it because it’s too idiosyncratic for them. We continue to see small business, medium sized businesses de-lever consistent with, and its fragile economy, it's an uncertain thing. So there’s no real trend that we see right now in the downgrades versus upgrades which we will be leading indicator of extra need for provisioning.

Ian Narev

In terms of the financial system query obviously we like other players in the market spending a little time now preparing a response which we'll get in a couple of weeks' time. Number one, I think the approach that the panel took with its first report was actually a really constructive approach. So the idea of saying here, observations of the industry, here is certain policy options to respond to and get different protagonists in the market to respond to those as a way for recent inquiries very positive. Obviously for the major banks and generally across the banking system one of the big questions that is being debated at the moment is too big to file capital levels, whichever banner you want to put on, it's the question of what is the overall levels of capital that people are going to need to be holding.

The answer is obviously a mixture of number of things, number one was going to hit with core equity deal one ratios, number two how might bail-in debt look; number three, what’s going to be the role of hybrids and other tiers in the capital structure, all heading up to what is going to be the overall right amount of buffer that banks have in the future environment. A lot of conjecture and a lot of topics on this from our perspective. There are a number options still on the table. I do think that the panel is still very much in listen and find out mode. And in our response we will be providing some views on current levels of capital on the optimal way to achieve the balance between stability and efficiency for the economy. It’s too early to read as to whether the changes are going to be insignificant material, growing material but I do think the panels is coming at the right way.

Craig Williams - Citi

Thanks. Craig Williams from Citi. Can you please make some observations about interest margin trends, really good performance I would have thought from the Group this year in terms of stability seen in interest margin. You are seeing a quite a bit of pressure in the corporate book. Asset re-pricing would appear difficult from here. You’ve seen probably a bit more fixed rate lending in, on retail side. Can you talk about perhaps the influences of liquids holdings from here which I think were built up in the period, the replicating portfolio and I would presume that funding costs may have continued to have a positive influence on margin campaign.

Ian Narev

Certainly Craig. Look you’ve called that all of the factors and there are many of them moving in different directions. I think the thing the first point to make at least at the moment is that each of those factors is having less of an impact individually then they had sort of prior to the GFC for example. So we are dealing the smaller movements in all of them. It always had predicted at the end of the day without a doubt the most significant factor that we can’t predict at all is just degree of competitive pressures in different parts of the business. You’d know I think that we have a pretty good approach, well, sorry pretty good track record of not competing way margin for the sake of competing a way margin. So we do very carefully watch that volume margin trade off and in low interest rate environment where there is not a lot to play with, it's so even more important to be very careful about how we manage each competitive reaction. And so that’s I think what we completed this is period’s results, flat results I think in a competitive environment is tough to combine and that’s certainly what we’d be striving for going forward. But it will be what it will be.

Victor German - Nomura

Thank you. Victor German from Nomura. Question on capital of risk weighted assets. I notice that growth in risk weighted assets was lower than growth in balance sheet and it appears as one of the drivers is that your growth is standardized approach has been was actually declining while advanced methodology is growing. Are you able to just elaborate on dynamics around that? I'm assuming some of that goes to what David mentioned about running down Bankwest book. Are you able to talk about trends going forward? Is there more of that, that we should expect and is that going to likely actually to further capital improvements in future periods?

David Craig

Well I mean the main driver of risk weighted asset differences, when risk weighted assets moved differently to the actual volume of assets is that where is credit quality. So what we’re really seeing and you’ve seen across the board and everything to do with our credit quality is credit quality is improving and that automatically leads to relatively lower risk weighted assets. You’ve correctly called out that the reason standardized has dropped is because Bankwest loans are dropping and most of the standardized is just Bankwest. So the fact that Bankwest business bank is shrinking and particularly obviously problem accounts in Bankwest business bank means that risk weighted assets in that space decline.

So that piece of it I think is probably near the end of its story, in other words a decline in the piece to do with Bankwest. We’d like to see a rebound there and we’re nearly at the end of that legacy book. But as far as the risk of the credit risk weighted assets are concerned it’s going to be a function of credit quality in general and we will get to pick with that setting.

Warwick Bryan

Next is John, and then we’ll go the phones for a couple of questions and then I’ll come back to you Richard.

John Mott - UBS

John Mott from UBS. Another question on the margin but more specifically for the retail bank. If you look at -- the NIM now is up to 262 basis points, which is the pretty high number especially GFC low interest rate environment. So going forward from here on sort of medium term view, is it sustainable to have the margin of 262 basis points in a retail bank?

Ian Narev

I might give Matt a chance to proffer a view on that.

Matt Comyn

Look there is end number of factors that have influenced the margin improvements. Some of that’s being on the asset side. As you know for some time we've been growing about marketing, consumer finance, there's some benefit from that giving us a much higher margin product on the asset side of the balance sheet. Secondly, we’ve seen improvement in margin particularly in TDs on the savings book that’s observed through the market. I think we get a disproportionate benefit given our investments in core banking and we’ve also deliberately shifted our balance mix more into savings and away from TDs and as David I think mentioned transaction accounts we’ve had this year we’ve had in terms of new transaction accounts as well.

So I think we're very comfortable with the margin performance this year and it’s obviously a very key to area focus for us going forward as David said around sort of volume margin tied ups and not participating in what’s being some aggressive process particularly in the assets side of the balance sheet.

Ian Narev

Just two broader strategic points to what Matt said, John. Number one is if you look at the overflows on margins pages 42 and 43, and you say what are your assumptions on each, asset pricing, funding costs, basis risk, portfolio mix et cetera, good assumptions can go either way in sort of the near term. So the near term margin trends is a good mix of things that could be quite positive with things that could be more challenging.

In the longer term there are two fundamental views that we call as an organization number. One as you must have all your settings of margins coming down. It’s the only way to run an institution in a competitive market. And that’s one of the big drivers why we have pushed productivity so hard because we want to make sure that we’ve got productive operating base which provide some buffer to our shareholders for structural margin decline. And number two is I think the Group’s strategy over many years now consistently as David pointed out has always being to balance between margin and volume.

And actually interesting that you can see even the ASB in this period which has historically been an ongoing grower saw the opportunity in business lending has grown volumes quite well but actually pulled back home lending volumes a little bit likely a little bit under system. So that again is a philosophy right across the group to managing -- the margin volume tradeoff is a critical part of how we’re going to continue to operate.

Warwick Bryan

And I’ll go to the phones. Brian Johnson, CLSA.

Brian Johnson - CLSA

I have two questions if I may. The first one was if we have a look at Slide 97 we can see a decline in the usage of LMI. Could I get some comments as to whether in fact LMI usage will go down as you just charge higher margin, given you no longer get capital relief? And then also on Slide 102, could we get some comment on the assumption on LMI recoveries under that stressed scenario. That’s one question. And the second one is could we get some comment on the earnings gap created from the sale of the REITs?

Ian Narev

Let me talk first about the first part of LMI and then I’ll hand over to Alden about your question on Page 102. As you know with the LMI, over 80% of standard practice to ensure all loans with LVRs over 80% other than those for which we charge the LDP the low deposit premium and those are actually as you probably aware risks that we decided to keep on and not insure because the characteristics of the individual counterparty is very positive and it’s proven to be pretty good for us because we found that the LDP performance of the book is actually stronger than the performance of the book as a whole.

So we do have advertised a little bit more of that and that conversely has an impact on the LMI numbers you see. The capital treatment of LMI has been consistent for some period of time. So we’ve actually never done it for capital relief. It never actually makes sense from a capital relief point of view. We’re just done LMI because we think it’s a belts and braces way and it probably makes us sleep a little bit better at night. In terms of the page 102, Alden, any assumptions behind the LMI recovery numbers? You might want to talk to this.

Alden Toevs

So the stress test that we use is given in the key assumptions in the upper right hand corner of page 102, and then what we do is we apply that to all parts of the portfolio, including the portfolio that’s insured. The insured portfolio stress outcomes has been taken to the LMI providers, dominantly Genworth but also, well in this case it’s RBS. So it’s Genworth. Bankwest is covered by QBE.

The portfolios played through and then we look at the ability of Genworth to basically support and pay off of this on an assumption of I think about 70% payout. Is that right to -- if you CapEx just? The insurance payout of perfection if you is 70% on the dollar. So it’s a conservative number in terms of the claim that we think that we will be paid by our insurer. I might also point out that APRA does not give us any credit for LMI coverage of the portfolio even though there is a very real cover of loss against that portfolio.

Ian Narev

In terms of the second question, I might hand over to Annabel, respond.

Annabel Spring

Brian, just a really quick response on that one. Just looking at the numbers last year compared with this year you will notice that the wealth management business actually made more this year than last year, even excluding the property business. So you can see that through organic growth just in wealth management business the loan in essence we have already replaced the REIT income and I think that’s an important aspect really just underlining the growth of the wealth management business. That being said, as we look to grow and continue to invest in the CFS scan business you will notice also a significant investment and you see the expense of that investment but you’ll also see the outcome of that investment with respect to our opening in Dubai and considerable also building up manufacturing capability as a very conscious choice in that business in our more traditional asset classes.

Richard Wiles - Morgan Stanley

Richard Wiles, Morgan Stanley. I want to ask you about the growth in institutional banking. You said that volume growth was 4% in Australia but 9% for the division. That obviously implies very strong growth internationally, leads me to ask two questions about that. Firstly we’ve seen what’s happened to ANZs return on equity from their expansion in institutional banking outside Australia. Why are you comfortable pursuing such strong growth? What does that mean for your ROA outlook?

And secondly in 2001 the Australian banks all had a lot of problem exposures from offshore institutional lending at the time most of the banks said that that strategy was non-core and that stepped away from that. It seems that more than a decade later you’re heading back into that territory. So why are you comfortable with taking on the risk profile of lending to institutional investors offshore, when that may not be core to your Australian franchise.

Ian Narev

Richard its good question. Number one, I mean the 9% growth is a spot balanced growth year-on-year for institutional banking markets, which is good core growth here and as you see some growth overseas. Number one, in terms of aspirations with our strategy, the likelihood that it will have any real impact on the group's ROE that kind of level is very low. The view that we’ve taken consistent with the capability based strategy we’ve got generally in the group is that there are four areas we’re based on the market we’ve been operating and here we think we’ve developed globally competitive capabilities. Those are infrastructure, transport, resources and financial institutions.

So and those four areas have various reasons that sort of part I have the answer. So it’s very focused on areas where we believe we built capability and have been able to taste that capability and have got confidence to do it overseas. Number two is we’re making sure that from a risk appetite perspective and a risk process perspective things have done respect of that book, and this is primarily in London, exactly as we have done in Australia, which Chief Risk Officer flying from Australia into the UK, risk team built around, the Chief Risk Officer properly resourced and again real product capability in those areas and proper CBA standard risk teams. So it’s not, we’ve actually resourced the head of the business growth, not on a rubber band.

And number three, the really unique aspect of this environment over the last few years has been that as a double-A rated bank with real capabilities in these areas and areas like infrastructure, resources et cetera, are real core the way the world is going. In environments like the UK whereas 10, 15 years ago the global banks ruled great raising and we’re able to compete and therefore you’re picking up the detritus here over the last three, four years we saw significant local players in Europe significantly pull back and that meant that rather than dealing with the people around the fringes, you were actually dealing with very high counter, PLC counter parties in areas we knew well because they like that credit rating and of course we’re right into business. And that’s enabled us over a few years to build a good business. Now to the extent to which the environment changes, the competitive environment changes to see if we’re or our strategy will evolve to do it. So we’re certainly not setting targets. If next year there isn’t lending to be done, we'll happily have the lending come back year-on-year but it was a conservative strategy there’s been executed over few years and we’ve recapped with you how it’s going.

Mike Wiblin - Macquarie

Mike Wiblin from Macquarie. Just a question on capital strong, excuse me, that it’s just a little bit on how you’re thinking about the appropriate capital level, given I guess 9% APRA ratio on the Colonial debt and then just a second question around investment obviously very strong on Page 44 there, core banking disappeared, productivity and growth there picking up the slack. Can you just talk about how of much is that, is actually tech focused and some of things you’re looking at and what is the positive CapEx series. Is it looks like it’s trending down there but the psychology at some point in this I have just costs during business given disruptors and the like.

Ian Narev

Why don’t I get David to talk about capital and I’ll take the investment question after that.

David Craig

Yes. I think I know that different analysts at different time have chances to come out with a couple of progress. I think that the clear thing so far is no point in having capital targets because the rules keep changing. APRA is still clarifying some aspects even now of how the current rules are to be managed and obviously we have financial systems inquiry. The board considers our capital level obviously very regularly, They look at the level that we’re at, they look at the strong capital generation and I feel very comfortable about where we are, but we -- so we won't be coming out with any formal targets or anything until such time as it's clear, what it is we’re aiming for.

Ian Narev

So I turn to investment spend and maybe look at the bottom right of Page 21. How much was technology in this? Number one you can see that 11% of its just ongoing on the branch network that we’ve got now to 255 IDMs in the branches net. So within those sorts of numbers you can even see technology in that. So even in the branch number you’re seeing technology being a big driver what used to be just cut away a few counters and put a few licks of paint in the branches.

The risk and compliance it’s a big spend. It's $300 million roughly for the year. That’s going to continue. That has technology aspects to it, but I wouldn’t describe that has been a technology spend per se, though in some areas for example we spent a lot of money putting the catalyst supervision and monitoring system in the financial advice business in last two or three years. We consider that to be sort of pretty industry leading and although it may not feel like to many people at the moment, from the point of those sort of investments in the business I think they will have strategic value.

Then that bottom of 65%. To me this is just part of what the bank has got to need to be forever now, which is a technology innovator and the environment that we’re moving into, having got this stable platform of SAP and core is what we described as a lot more create and destruct, a lot more test and learn. So you’ve got world leading innovation like Kaching a few years ago, which gets superseded by the CommBank App, which after seven months is 2.3 unique user on it, 2.3 million unique users. And this is going to be ongoing part of how we operate as a bank. You can see in the character of the executives that we appoint. You can see the investment profiles.

Critically we’ve also got to make sure that the way we account of all this reflects that new reality. So we write off -- everything under $10 million has now capitalizing of it. We’ve got a pretty aggressive, so I can say the capitalization policy, you see in the materials relative to other major banks, our levels of capital software are actually quite low now. And we’re going through a process where you can again see in this half and the previous half we’re taking a more aggressive approach to looking it capitalized software levels, looking at amortization levels and taking the hit where we think things are out of date this is now going to be the way the bank operates over the coming years.

David Craig

But to be really clear, there’s no way investment spend is declining. This is again forever.

Brett Le Mesurier - BBY Ltd.

(Indiscernible) volume and expenses declining the first half, you’ve commented that they increased a lot but you didn’t tell us why. Could you give us the reason for the increase that we have 30% from 2013 to 2014 financial year, while income increased by 10% over that period?

Ian Narev

And David do you want to take that?

Annabel Spring

Looking at the expenses just off Colonial First State, you can see a number of different trends. You can see the ongoing OP expense or compliance and regulatory reform. You can see continued investment in the business and you can also see some element of the compliance spend associated with the advice business.

Brett Le Mesurier - BBY Ltd.

In expenses?

Annabel Spring

The volume expenses in particular if you can see the change there that is in particular with respect to the advice business. You need to see change in that?

Brett Le Mesurier - BBY Ltd.

Yes, but why did they increase so much. Presumably you've increased commission rates. Would that be right?

Annabel Spring

It’s with respect to the change in the advice business. So the expenses have increased.

Brett Le Mesurier - BBY Ltd.

Faster than the volumes in the business is.

David Craig

On the cost -- to be very clear your cost of doing giving advice these days particularly for us is much higher than it used to be?

Warwick Bryan

I have one more question on the phone so Brian you’re on again?

Brian Johnson - CLSA

I apologize if I keep on rambling about stuff. In the RCAP review, Australia was largely compliant but one of the things I called out is that residential investment property lending should perhaps be traded as commercial property lending? So when we talk about internationally harmonized numbers, I was wondering if you could share what that would do those same comparatives?

Ian Narev

Well, the answer is a little bit Brian but I'm surprised you didn’t called out the large number of items that went the other way. So I think that that particular point was worth about 25 basis points but they were about 120 basis points of other things that you forgot to mention going favorably to us in the RCAP prices. So I am glad you’re getting into the detail.

Warwick Bryan

Thanks Brian. Anymore questions in the room? If not we will close up and I thank you very much for coming.

Ian Narev

That’s great.

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