Return on equity from NZ's big 4 banks easily tops that of their parents with an average of 18.9% as Westpac's Gail Kelly draws 'line in the sand' at 15%

By Gareth Vaughan

As talk across the Tasman last week centred around whether the big banks could maintain their return on equity (RoE) as high as 15%, the big four Australasian banks' annual results show the kiwi subsidiaries average RoE came in 320 basis points higher than that of their parents at almost 19%.

The big four Aussie banking groups - the ANZ Banking Group, parent of New Zealand's ANZ and National banks, ASB's parent Commonwealth Bank of Australia, BNZ's parent National Australia Bank, and Westpac New Zealand owner Westpac Banking Corporation, delivered an average RoE of 15.7% for their 2012 financial year. Splitting out their New Zealand subsidiaries average RoE shows it was 320 basis points higher at 18.9%.

This comes with auditing and financial advisory firm PwC saying in its analysis of the big four Aussie banks results that the drop in their average RoE from 16.4% in 2011 reinforced its view that bank RoEs are transitioning to an era where 15% will set the upper, not the lower, limit.

"We continue to stick to the view that average return on equity for the Australian banks will ease back to a 13% to 15% range," PwC said. "This reflects intense competition, subdued demand for credit, and ongoing cost pressures, not least from IT investments."

Owners willing to accept lower rates of return?

And on this side of the ditch the Reserve Bank suggested in its Financial Stability Report last week that the higher capital adequacy requirements local banks must meet under Basel III rules from next year, means "it is likely" bank owners will be "willing" to accept lower RoE in normal years, in return for reduced volatility and lower losses in bad years.

However, the UBS outlook for the New Zealand subsidiaries of the big Aussie banks suggests rising, rather than falling, RoEs. UBS has Westpac NZ's RoE up 190 basis points this year to 19.7%, and estimates it'll hit 20.4% in each of the next two years before declining, albeit slightly, to 20.2% in 2015.

And UBS has ANZ NZ's RoE up 330 basis points this year to 22.3%. Although it forecasts a fall from here, it still has ANZ NZ's RoE coming in at 21.5% next year, 21.2% in 2014, and 21% in 2015, levels banks in much of the world would be green with envy over.

Hot on the heels of a research report from JP Morgan, which said Westpac needed to draw a line in the sand at an RoE of 15% (having seen it fall from 24% over five years) to be able to afford to continue increasing its dividend by 2 cents a share per half-year, Westpac group CEO Gail Kelly said the bank aimed to do exactly that.

"A benchmark for us, sort of drawing a line in the sand, is to ensure that in focusing on where the growth is, where the best return is, we want to make sure that we maintain our RoE above 15%," Kelly said.

Kelly said that Westpac was reorienting its business towards higher growth and higher return sectors and market segments.

"So from a product point of view that includes term deposits, it includes the wealth products of super and insurance, and it includes trade finance, it includes transactional banking," she said.

"From an industry segment or sector point of view it clearly includes natural resources, it includes health, it includes professional services. From a retail point of view it includes our pre-retire and post retire segments and also SME where we're putting significant focus. And it also includes our stepped up focus in Asia."

PwC noted that even at their reduced rates, the Aussie banks, who are paying out a record A$19 billion in annual dividends being a 7% higher rise on last year, will still have RoEs that stack up well compared with banks elsewhere in the world.

"These RoEs will be competitive relative to global peers. As a consequence, the Australian banks will continue to generate positive shareholder value, with an economic spread in the order of 1% to 3%, closer to the 1% to 2% of global peers. In other words, Australian banks will continue to be a more than competitive destination for global banking investors albeit, possibly to a lesser extent than today."

The table below shows PwC's findings for global banks and Australian banks. It suggests a sustainable outcome for global banks in this new era will see cost of equity running at 8 to 10%, which is "a few percentage points" lower than today, and RoE of 9%  to 11%%, which is a few percentage points higher, to allow positive shareholder value, or returns in excess of cost of capital, to be restored.

"While positive, the returns will nonetheless be marginal - say in the range of 1% to 2%," PwC said.

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