What Will ANZ Do With Its Surplus Capital?

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ANZ Bank has sold its life insurance operations to Zurich Financial. Most brokers consider the price reasonable and speculate about the use of the proceeds.

-Sale moves the bank from an area where it lacked competitive advantage
-ANZ returning focus to Australasia at a time when the banking environment is becoming increasingly challenged
-Buyback could be imminent with increased potential
 

By Eva Brocklehurst

ANZ Bank ((ANZ)) has completed the simplification of its wealth management division with the sale of its life insurance operations, following on from the divestment of the OnePath and aligned dealer group businesses to IOOF ((IFL)) in October.

The bank has announced the sale of life insurance operations in Australia to Zurich Financial for $2.85bn. Citi observes a decision to pursue a single transaction divestment strategy ultimately proved unsuccessful, which may have affected the sale, describing the price as "light", while Deutsche Bank suggests it is close to the multiple that Commonwealth Bank ((CBA)) received for its life business.

ANZ will need to separate out the investments business, which is set to be offloaded to IOOF, before the sale of the life insurance business can be completed in 2018. Ord Minnett believes the sale process has been successful from a financial perspective, while it moves the bank out of an area where it lacked a competitive advantage.

Macquarie considers the price reasonable and estimates the transaction to be around 1% accretive to operating earnings per share and around 50 basis points to return on equity, while Morgan Stanley suggests the sale will be dilutive to earnings at around -2.5% ahead of a capital release. Following the sale, Macquarie estimates the bank's pro forma CET1 ratio to be around 12.2%, which is1.7% above APRA's target of 10.5%.

Bell Potter's valuation is unchanged, with the bank's lower cash earnings stream offset by a higher surplus capital position. The retained businesses make sense to the broker as they are in line with the banking business, and have higher returns for a given level of risk.

Retained businesses include lenders mortgage insurance, general insurance distribution and share investing. Bell Potter, not one of the eight stockbrokers monitored daily on the FNArena database, has a Buy rating and $32.50 target.

CLSA commends the bank's zeal in exiting non-strategic business but believes the sale price is weak and the profitability of the bank mid-cycle is well below its peers. The stock is overvalued, in the broker's opinion, and the FY19 earnings gap from normalised market earnings and the non-recurring sale of Queen Street cannot be bridged by cost reductions or buybacks.

Moreover, the fact ANZ does not have surplus franking credits suggests a buyback is imminent, although as the stock is relatively expensive handing the cash back as an unfranked dividend may appeal. CLSA, not one of the eight, retains a Underperform rating and target of $27.70.

UBS considers the decision to re-balance the portfolio prudent but remains concerned that the bank is returning its focus to Australasia at a time the banking environment is becoming increasingly challenged, given the end of a multi-decade housing leveraging cycle and increasing regulatory and political burdens. In order to prosper in this environment the broker believes the strategy should be focused on speed, digital innovations and culture.

However, UBS questions whether a strategy of superior execution is sustainable given ANZ's weaker domestic franchise. The bank has now announced six businesses divestments over the last year and has shrunk its institutional business by around -25% since FY15.

Two substantial businesses remain to be sold, including AMMB Malaysia and Panin Indonesia. Macquarie envisages scope for further three large divestments which, if sold, would potentially generate an additional $2.5bn in capital.

Capital Management

Brokers generally expect the capital from the sale of these assets will be returned via on market buybacks, leaving the financial impact broadly neutral. Anticipated capital returns have become larger in size. Citi already has around $5.0bn of capital returns in forecasts and this transaction adds another $2.5bn.

Morgan Stanley envisages the prospect of a $3bn buyback late in 2018 while Ord Minnett increases its share buyback forecasts to $8bn over the next three years versus the prior forecasts of $4bn.

Shaw and Partners, also not one of the eight, has a $30.56 target and upgrades to Buy on the likelihood of a expansion in returns on equity and capital management. The broker suggests a $7-8bn buyback could be on the way. While profits should be flat over the next two years as the bank exits low-returning business, Shaw and Partners estimates earnings per share should lift 6-7% as the share count falls.

There are two Buy ratings and five Hold on FNArena's database. The consensus target is $30.10, suggesting 4.3% upside to the last share price. The dividend yield on FY18 and FY19 forecasts is 5.6%.

This stock is not covered in-house by Ord Minnett. Instead, the broker whitelabels research by JP Morgan.

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