Shares in Commonwealth Bank of Australia (ASX:CBA) shed 2% this morning after Australia’s largest bank confirmed that it intends to demerge and float its asset management business as it beats a retreat from operations outside its key home loan, retail, or business banking activities.
The bank will also jettison its mortgage broking business and float the combined businesses that include the Colonial First State, Colonial First State Global Asset Management (CFSGAM), Count Financial, Financial Wisdom and Aussie Home Loans, with the deal expected to complete in 2019.
The new entity will be known as CFS Group and existing Commonwealth Bank shareholders will receive shares in it in proportion to their current CBA shareholding. For example you may receive 1 CFS Group share for every 20 CBA shares held depending on the market value and number of shares issued by the CFS Group on its floatation.
CFS Group would reportedly have posted a net profit of more than $500 million if it existed over financial year 2017.
The bank also announced its intention to sell CommInsure General Insurance separately to the proposal to list CFS Group.
Originally CBA flagged plans to just list CFSGAM and today’s news of an even more radical overhaul has caught the market by surprise and is sure to split commentators and analysts as to its rights and wrongs.
In favour of the deal is the idea that the active asset management industry is under massive (and structural) fee pressure from low-cost index-tracking exchange traded funds, which means now is a good time to sell the substantial asset management businesses.
While critics of the decision to sell off the asset management arm would claim the decision is too short-term in reaction to shifting capital adequacy requirements, while the active asset management industry is here to stay with CFS having its own options to enter the passive asset management space.
The CFSGAM business does remain high quality with plenty of potential to innovate and grow under good management. As such, I’m surprised CBA made the choice to cut and run, as it feels a little like selling off the family silver in response to short-term issues, but it’s relatively small contribution to net profit means management may fairly believe it’s the right call.
The decision to sell the mortgage broking and financial advice businesses comes as less of a surprise given the reputational shake down this space has received as a result of the royal commission among other disastrous headline-making operational blunders. These include the mis-selling of insurance, anti-money laundering breaches, and the BBSW scandal that probably made the decision to divest relatively easy for management.
The new CBA looks attractive
The key takeaway is that after the demerger CBA is going to be a slimmed down operator able to largely focus on the mega-profitable activities of home loan lending and business or retail banking.
The restructure will also mean changes to how the bank calculates how much capital it needs to hold in reserve on a basis that is proportional to the assessed risk of different loans (assets) or financial instruments on its balance sheet.
For example if the new CBA is now much more focused on home loan lending (rather than general insurance) it will be able to carry proportionally less capital in reserve as lending against good collateral in physical property is less risky than capital-market-facing financial activities.
The less capital a bank has to hold idly in reserve the higher its return on equity (as a key measure of profitability) and long-term chances of consistently growing returns for shareholders.
In other words mortgage lending is relatively low risk and still incredibly profitable for the CBA and others like Westpac Banking Corp (ASX: WBC), which is why CBA is pressing ahead with today’s plans.
“By allowing CBA and CFS Group to focus on their core businesses and market leading positions, we believe the plan will unlock value in both groups for our shareholders” commented Matt Comyn the bank’s CEO.
Although the plan may prove controversial CBA’s proposed new business model looks attractive in my opinion and if the valuation was right I’d be an interested buyer.
The combined CFS Group I’d probably give a miss as it wouldn’t tick enough boxes as a quality investment prospect, although that’s not to say it can’t perform reasonably well as a spun-off entity.
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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 Scott Phillips.