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Why Australia & New Zealand Banking Group’s new strategy will deliver for investors

The Australia & New Zealand Banking Group (ASX: ANZ) handed down a half-year statutory profit of $2.9 billion this morning to kick off the bank earnings season in a positive manner for the wider market.

The statutory profit was 6% above the prior corresponding period’s, with adjusted pro-forma profit and earnings per share lifting an impressive 13% and 12% respectively over the prior period.

The group attributed the improved performance to a restructure of the business after it moved to divest several of its Asian operations and its local life insurance business over the past year.

The new CEO’s flagship strategy to dump asset-heavy insurance operations and retail banking businesses across six Asian countries is motivated by the goal to improve the bank’s capital adequacy ratio and return on equity via asset sales, rather than cutting dividends or raising equity.

The results of the strategy shine through in today’s result with return on equity up a bumper 2.1% over the prior corresponding half to 11.8% and the bank’s capital adequacy ratio lifting above 10% for the first time since 2010.

In effect the group’s operations outside the less profitable ANZ regions are being cut back, with over 50% of group capital now allocated to home loan, personal and business lending in ANZ, compared to 44% in the prior corresponding period. The likely side effect of this strategy is lifting the bank’s capital adequacy ratio as its loan book into lower risk weighted assets.

Recently regulators have toughened up requirements as to how much capital banks must keep in reserve on their balance sheets as a proportion of their lending books on a risk weighted basis and this is what has dragged down profitability (as lending restrictions are tighter) in exchange for delivering a securer and less leveraged financial system.

Like other banks, ANZ has also benefited from the strength of Australia’s residential property market with home lending up 5% and small business lending up 4% over the prior period.

The group’s net interest margin (NIM), as a key measure of profitability, contracted 7 basis points to 2%, versus 2.07% over the prior period. Banks generally lend long term and borrow short term, with the difference between what they pay on what they borrow, versus what they make on what they lend known as the NIM.

Outlook

ANZ held its interim dividend steady at 80 cents per share, with the medium-term strategy likely to be returning the payout amount to FY 2015’s higher levels on the back of a rising return on equity and elevated capital adequacy.

ANZ looks a decent prospect given the CEO’s profit-boosting Asian divestment strategy is not rocket science and it was regularly trumpeted as a key driver of the group’s improved performance metrics in today’s update. Given the strategy appears to be paying off with plenty of time ahead to deliver dividend-boosting progress, I expect the shares could do well over the next few years.

Later in the week both Westpac Banking Corp (ASX: WBC) and Macquarie Group Ltd (ASX: MQG) will reveal their financial results to the market. In the banking space I would prefer Macquarie as a long-term investment option thanks to its adaptability and flexibility to generate consistent profit growth over the long term.

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Motley Fool contributor Tom Richardson owns shares of Macquarie Group Limited.

You can find Tom on Twitter @tommyr345

The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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