FINANCIAL SERVICES
Regional banks: Push for Growth Financial Institutions Performance Survey 2005 BANKING
13 December 2005
Introduction Australia’s regional banks1 (“the regionals”) continued their impressive growth with another outstanding year delivered by their strategy of focusing on selected markets whilst expanding outside of their traditional geographic locations.
Operating profit Operating profit after tax for the regionals increased 25.3 percent to $2.1 billion in 2005, which is slower than the 36.5 percent achieved in 2004 but still a very impressive result considering the increasingly competitive market that the regionals operate in. The results represent recurring or “core” profits with the only significant non-recurring items of note being the sale of Bank of Queensland’s and St. George’s ATM networks realising profits of $50.6 million before tax and Suncorp realising a profit of $16.7 million on the sale of rights to investment advisory fees in relation to property fund management. These items represent only 2.2 percent of total sector operating profit before tax.
70%
600
60%
500
50%
400
40%
300
30%
200
20%
100
10%
0
0% Ad el ai de
ER
BO
2002
2003
2004
2005
.
B Be nd ig o St .G eo rg e Su nc or p
700
ER
80%
Q
90%
800
B Be nd ig o St .G eo rg e Su nc or p
900
Q
100%
Ad el ai de
1000
2001
1
Increase in Operating Profit After Tax
Operating Profit After Tax
BO
$m
2004
Refer to data sheet for details of individual banks surveyed.
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2005
Return on equity for the regionals continued its upward path from previous years increasing from 16.7 percent to 17.8 percent during 2005 and surpassed the majors’ return on equity of 17.5 percent. This is an extraordinary turnaround when it is considered that only five years ago the regionals’ return on equity was 7 percent below the majors. Return on equity
Return on equity - regionals vs majors
25%
20%
20%
15%
15%
10%
5%
10%
2000 Adelaide Bendigo
2001
2002
2003
BOQ St.George
2004
2005
ERB Suncorp
2000
2001
2002
2003
Ave - Regionals
2004
2005
Ave - Majors
ROE’s are those disclosed by the regional and major banks.
Net Interest Income Net interest income for the regionals increased by 10.4 percent to $3.3 billion in 2005, slowing slightly from the growth of 13.8 percent in 2004. The increase in net interest income was due to volume growth with total assets increasing 13.3 percent in 2005. As in previous years the increase in volume was partly offset by a further decline in interest margins which fell from 2.36 percent to 2.31 percent2. A difference to previous years however is that the decline in interest rate margins appears to have slowed, at least for now, with a number of the regionals actually increasing their margin. This is an impressive outcome considering the strong competition in the deposits market and in the markets for the regionals’ primary interest earning assets such as mortgages and small business lending. It is also compares favourably to the majors who experienced a fall in their interest margins of 10 basis points and so the gap in interest margins between the regionals and the majors continues to narrow. The key factors that impacted interest margins for the year were:
•
Retail deposits have increased. This has a mixed influence as the increase in deposits has followed the introduction of new, higher rate deposit products. Historically, retail deposits have offered more competitive funding compared to other sources such as wholesale funding. However the regionals have traditionally had lower levels of low interest transaction account balances than the majors and so their margins have been less affected by competition for deposits than the majors; and
•
A number of the regionals have had excess capital which they have been able to invest.
The picture is mixed at an individual level with a number of the regionals increasing their margin whilst others have experienced falls. Those that have experienced an increase in margin are Bank of Queensland and Suncorp. Those banks that saw a fall in their margin have not been able to offset as much the impact of competition for lending assets, especially in the mortgage market, and also for deposits. This shows that competition has started to have an impact and the banks that
2
Average net interest margin excludes Elders Rural Bank which had net interest margin for 2005 and 2004 of 3.58 and 4.12 respectively.
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will be most successful in meeting this challenge will be those that can sell their higher margin products and continue to grow their deposit base. Interest m argin
Interest m argin - regionals vs m ajors
3.0%
3.0%
2.8%
2.8%
2.6%
2.6%
2.4%
2.4%
2.2%
2.2%
2.0%
2.0%
1.8%
1.8% 2001 Adelaide St.George
2002
2003 BOQ Suncorp
2004
2005 Bendigo
2000
2001
2002
2003
Ave -Regionals
2004
2005
Ave - Majors
Note that Elders Regional Bank is excluded from the regionals’ average. Elders had net interest margin for 2005 and 2004 of 3.58 and 4.12 respectively. The interest margins are as disclosed by the regional and major banks.
Non-interest Income The rise in net interest income was exceeded by a 15.3 percent increase in non-interest income to $6.1 billion. Suncorp makes up 75 percent of total sector non-interest income, primarily due to its general insurance business. Excluding Suncorp, non-interest income was $1.6 billion in 2005, still a rise of 15.0 percent. If profits resulting from the sale of the ATM networks are stripped out, non-interest income was $1.5 billion, a rise of 11.3 percent. This is broadly consistent with total asset growth of 13.3 percent. With a larger increase in non-interest income the ratio of non-interest income to operating income increased to 38.3 percent in 2005 (excluding Suncorp and Elders Rural Bank with ratios of 85.5 percent and 6.6 percent respectively), up from 36.6 percent in 2004. Non-Interest incom e to operating incom e regional banks
Non-Interest incom e to operating incom e regionals vs m ajors
90%
45%
75%
40%
60%
35%
45%
30%
30%
25%
15%
20%
0%
15% 2000 Adelaide Bendigo
2001
2002
2003
BOQ St.George
2004
2005 ERB Suncorp
95 96
97 98
99
Regional Banks Average
00 01
02 03
04
5
Major Banks Average
Note that a significant portion of Suncorp’s non-interest income is from its insurance business. Average for regionals excludes Suncorp and Elders Rural Bank. Non-interest income to operating income ratios are as disclosed by the regional and major banks.
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The main factors in the increase in non-interest income were the following:
•
The regionals have focussed on markets outside of their traditional offerings. For example Adelaide Bank has increased its business lending partly by diversifying into portfolio lending3 (financing of loans, leases and receivables that are originated, credit approved and managed by the Bank’s partners which are then securitised with fees earned);
•
The regionals appear to have been able to increase the number of products that they can cross sell. For example Suncorp appears to be benefiting from its positioning as a “bancassurer” with 8 percent of its customers buying at least six products and an average of three products sold to its 4 million customers4. Similarly St. George sells an average of 4.2 products per Middle Market customer (up from 3.9 in 2004)5; and
•
The wealth management divisions benefited from the continued flow of funds into the equity markets following the cooling of the residential sector and the rebound of the equity markets in 2004 and 2005. Profit before tax from wealth management increased 18.9 percent to $223.8 million. $billion
Profit before tax from wealth management
160 140 120 100 80 60 40 20 0 Bendigo
St.George 2004
Suncorp 2005
Profit before tax is based on the segment analysis of Bendigo, Suncorp and St. George. The other regionals do not disclose profits from wealth management separately. The figure used for Suncorp was underlying profit which excludes investment earnings and one-off items)
The main constraints on the growth in non-interest income have been:
•
The end of the housing boom has been a factor in restricting the average growth in consumer lending (including securitisation) to 15.8 percent in 2005 compared to 23.4 percent in 2004. This is in line with data from the RBA which showed growth in housing lending (including securitisation) slowed to 13.5 percent for the year to 30 September 2005 down from 19.1 percent for the year to 30 September 2004; and
•
Competition in the market has reduced the ability for fees to be charged on new lending. For example a number of institutions have waived introduction fees for periods during 2005.
3
Adelaide Bank Limited Annual Report 2005 Suncorp Strategy Briefing Presentation 7 June 2005 5 St. George profit announcement 30 September 2005 4
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Costs A key factor in the regionals’ continuing success in 2005 was strong cost control. Operating expenses increased 10.4 percent to $5.9 billion. This was a faster rate of growth than in previous years however, as a result of the strong income performance, the cost to income ratio continued to fall to 54.9 percent6. This is an impressive result considering the regionals’ continued investment in expansion and customer service. The regionals’ IT costs and staff costs ratios to total assets are also falling which suggests that the regionals are obtaining the growth in volume to justify their cost base. Factors that impacted costs in 2005 include:
•
An 8.1 percent increase in staff costs reflecting a 4.1 percent increase in staff numbers and moderate wage and salary increases. The increase in the number of staff reflects the continuing expansion in branches and other initiatives undertaken in the regionals’ push for growth. Staff costs compared to total assets have fallen in 2005 which indicates that the investment in staff in previous years is paying dividends in asset growth;
•
IT costs decreased 7.9 percent to $287.1 million. However if St. George is excluded, IT costs actually increased 13 percent from $118.6 million to $134.1 million (St. George Bank completed large IT projects in previous years). This was in contrast to 2004 when IT costs fell and is in contrast to the majors whose IT costs fell by 3.6 percent after a number of years of large IT investment programs. Care needs to be taken when interpreting these numbers as the amounts shown as expense will include the amortisation of previous years’ expenditure; and
•
Other expenses increased 5.9 percent, reflecting a variety of expense variations combined with volume growth. Staff Costs to Total Assets
IT Costs to Total Assets
1.6%
0.45%
1.4%
0.40%
1.2%
0.35%
1.0%
0.30% 0.25%
0.8%
0.20%
0.6%
0.15%
0.4%
2002
2003
2004
2005
ER B Be nd ig St o .G eo rg e Su nc or p M aj or s
BO
Ad el ai de
ER B Be nd ig St o .G eo rg e Su nc or p M aj or s
BO
Q
0.00%
Ad el ai de
0.05%
0.0%
Q
0.10%
0.2%
2002
2003
2004
2005
BOQ’s IT function is outsourced hence their IT cost is fully absorbed cost (that is, it includes staff costs, etc.)
The regionals’ cost to income ratio continued the improvements that have been made over the past five years. The cost to income ratio now stands at 54.9 percent in 2005 down from 56.8 percent in 2004 (this ratio excludes Elders Rural Bank which with the benefit from its low cost base due to leveraging off its shareholders’ infrastructure has a ratio of 32.4 percent and 45.9 percent in 2005 and 2005 respectively). The improvement in the cost ratio reflects strong control over costs but also growth in business which is allowing the regionals to enjoy improved economies of scale from the major investments that have been made in previous years.
6
Cost to income ratios are those disclosed by the regional and major banks. Average for regionals excludes Elders Rural Bank which has a cost to income ratio of 32.4 percent and 45.9 percent in 2005 and 2004 respectively
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Cost to income ratio
Cost to income ratio - regionals vs majors
80%
80%
70%
70%
60%
60%
50%
50%
40%
40%
30%
30% 2001 2002 2003 Adelaide BOQ Bendigo St.George
2004 2005 ERB Suncorp
2001
2002
2003
Ave - Regionals
2004
2005
Ave -Majors
Cost to income ratios are those disclosed by the regional and major banks. Average for regionals excludes Elders Rural Bank which has a cost to income ratio of 32.4 percent and 45.9 percent in 2005 and 2004 respectively
In contrast to 2004 the majors have made similar progress on costs to the regionals which has meant that the gap between the majors’ and regionals’ cost to income ratio has remained stable. This reflects the large investment by the majors in previous years in projects such as “Which New Bank”. These projects are now coming to the end of the cost phase and starting to pay dividends in income growth/reduced costs. While St. George Bank and Suncorp already operate at a cost to income ratio comparable to the majors, the challenge remains for the other regionals to make further progress on their cost to income ratios. This is important if they are going to remain competitive in the market place and deliver further improvements in their return on equity. This is clearly understood by the regionals. For example Adelaide Bank stated at its annual shareholder meeting that their target is to reduce their cost to income ratio to 46 percent in three years from its present 53.6 percent.
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Assets The regionals’ individually different expansion strategies appear to be paying dividends with total assets7 up by 13.3 percent to $166.6 billion in 2005 which compares favourably with the majors’ asset growth of 6.5 percent. All of the regionals recorded growth above 10 percent. In particular Adelaide bank increased its total assets by 28.3 percent (20 percent if the $890 million dollars of assets acquired with the purchase of the Goldman Sachs JB Were Equity Finance Business are excluded), Elders Rural Bank by 25.8 percent and Bendigo Bank by 17.5 percent. Off-balance sheet assets also increased significantly in 2005, with securitised assets up 34.1 percent to $28.7 billion. Overall asset growth is 16.0 percent if securitised assets are included. Total Assets
$billion 80,000 70,000 60,000 50,000 40,000 30,000 20,000 10,000 0 Adelaide 2001
BOQ
ERB 2002
Bendigo 2003
St.George 2004
Suncorp 2005
Total assets excludes securitised assets
Consumer portfolio – same aim, different approach All of the regionals have aimed to increase lending to consumers and their various strategies appear to be paying dividends with the consumer portfolio once again showing strong asset growth of 15.8 percent in 20058. This has slowed compared to 2004 when growth of 23.4 percent was achieved; however it is in line with the slowdown of growth in personal credit. The regionals’ largest lending exposure is to residential lending. Despite the slowdown in the housing market and increasing competition, the regionals managed to grow their residential lending by 13.3 percent in 2005 which is only slightly lower than the 16.4 percent achieved in 2004 (this figure includes securitised assets). The latest RBA data shows growth in household credit including securitised assets falling to 13.5 percent compared to 19.1 percent for the year to 30 September 2004. Given the market conditions the regional banks have delivered very strong results in their consumer portfolios.
7 8
Excluding securitised loans Consumer includes housing loans and credit cards and includes securitised assets.
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Consumer Loan Growth
Credit Growth 25%
40% 35%
20%
30% 15%
25% 20%
10% 15% 10%
5%
5%
2003
2004
M aj or s
Su nc or p
eo rg e St .G
Be nd ig o
Q BO
Ad el ai de
0%
2005
0% Sep-02 Mar-03
Sep-03
Mar-04
Sep-04 Mar-05
Sep-05
-5% Housing
Personal
Business
Consumer loan growth includes securitised assets for the regionals. Elders Rural Bank data was not available. Credit growth data is from RBA’s data.
The regionals have a range of different strategies to grow their business whilst maintaining returns on their investments. For example Adelaide Bank and Suncorp remain committed to expanding through the use of brokers and other partnerships; Bank of Queensland is using an owner managed franchise approach to expanding its branch base outside of its home state; Bendigo Bank has used community banks to build its branch base and attract over one million customers in the process; and Elders Rural Bank has used the distribution network of its shareholders. Total branches increased by 6.2 percent to 1,0699 compared to an increase of only 1.5 percent for the Australian Banks sector as a whole10. This growth was driven mainly by Bank of Queensland, which increased its branches by 22 percent, and Bendigo Bank, which increased its branches by 12 percent. The favoured approach in achieving this growth in branches also differed between those two banks. Bank of Queensland has decided to follow an owner managed approach while Bendigo favours setting up Community Banks. Both of these strategies have been designed to reduce the initial upfront cost but it remains to be seen which will be the most effective approach and which model is most aligned to their owners’ objectives. The importance of the broker originated mortgage market continues. After a number of years of rapid growth their share of the market has flattened. A notable factor in this was Bank of Queensland’s strategic decision in 2004 to withdraw from the broker originated mortgage market. Excluding Bank of Queensland, the percentage of broker originated mortgages increased from 30.0 percent to 33.3 percent in 2005.
9
Excludes Elders Rural Bank branches to avoid double counting as a significant amount are Bendigo Bank branches APRA Points of Presence, June 2005
10
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New mortgages sourced from brokers 50% 40% 30% 20% 10% 0% Adelaide Bank
BOQ
2003
SGB
Suncorp
2004
2005
ERB and Bendigo data was not available. Adelaide data excludes mortgage originator lending.
Business portfolio With the cooling of the consumer market, the business lending sector is increasingly being targeted to provide future growth, by the regionals and also the majors. Most of the recent economic data suggests that it will be the business sector that will drive the economy forward in 2006 with the latest RBA data showing business lending increasing to 13.8 percent for the year to 30 September 2005 compared to growth of 7.6 percent for the year to 30 September 2004. The regionals’ business portfolio grew by 17.8 percent which is higher than the 16.5 percent growth achieved in 2004 (excluding acquisitions) and compares favourably to the majors’ growth of 9.8 percent. Business Loan Growth 35% 30% 25% 20% 15% 10% 5% 0% Adelaide
BOQ
Bendigo
2002
2003
St.Geor ge
2004
Suncorp
Majors
2005
Business is gross loans and advances less consumer plus loan acceptances. Bank of Queensland’s growth excludes acquisitions of $1.0 billion in 2004.
As in consumer lending, the regionals have different strategies to increase their business lending portfolio. Adelaide Bank has been particularly successful in increasing its exposure to the corporate sector. This has been through its focus on traditional business lending but also by entering the portfolio funding market which is another example of Adelaide Bank successfully focusing on a niche in a big market. St. George has concentrated its focus on the “Middle Market” where it has achieved lending growth of 20 percent. St. George states that it uses customer loyalty and satisfaction as a key differentiator and its average of 4.2 products per Middle Market customer (up from 3.9 in 2004)11 seems to suggest its strategy is paying off. Suncorp has focused on increasing its business lending through its relationship management model and also achieved strong interstate growth through its use of brokers. This led to 17 percent growth in business lending in 2005 and for those customers covered by the relationship model an average of 11.5 products were sold in 200512.
11 12
St. George Profit announcement 30 September 2005 Suncorp Annual Report 2005
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Asset quality The benign credit environment continues to underpin the success of the regionals. The regionals’ strong growth over the past few years does not appear to have been at the expense of asset quality. The doubtful debts expense fell by 10.9 percent to $176 million in 2005 representing 0.14 percent of gross receivables. The following factors contributed to this result:
• •
An increase in the general provision of 9.8 percent to $523.5 million. The ratio of general provisions to risk weighted assets declined slightly to 0.54 percent from 0.57 percent but this is not out of line of historical ratios or regulatory requirements; and Lower specific provision expense which is in line with the benign Australian credit environment. The level of specific provisions as a percentage of gross non-accrual loans fell from 72 percent to 59 percent during 2005. However this ratio is still at a high level compared to the five year average of 55 percent.
The decline in the bad debts expense continues a trend that has been evident since 2002 and is in line with the experience of other financial institutions. Credit quality has remained strong despite the slow down in the housing market and subsequent slowdown in consumer spending. This resilience reflects continued growth in employment and real wages and growth in business investment spending on the back of the commodities boom. Bad debts to gross receivables
Gross non-accruals to gross receivables
0.4%
0.8%
0.3%
0.6%
0.2%
0.4%
0.1%
0.2%
0.0%
0.0%
2000
2001
2002
2003
Regionals
2004
2005
2000
2001
2002
2003
2004
Regionals
Majors
2005
Majors
The key issues going forward into 2006 is whether this marks the low point in the credit cycle and if increased competition and slower growth will lead to the regionals increasing their exposure to higher risk products. Past due loans as a percentage of gross receivables increased from 0.3 percent in 2004 to 0.35 percent in 2005. This is not a significant upturn and this ratio remains at historically low levels. When combined with changes in other “forward looking” economic data such as the level of bankruptcies, there are signs that the historic lows in the level of bad debts might be coming to an end. However it is considered unlikely that there will be a significant upturn in bad debts, as the fundamentals of the economy remain strong with employment and wage growth remaining high and business investment growth continuing. Loans past due to gross receivables
Parts IV and XI Bankruptcies per quarter 7500
(Source: Insolvency and Trustee Service Australia)
0.45% 0.40%
7000
0.35% 6500
0.30%
6000
0.25%
5500
0.20% 0.15%
5000
0.10% 4500 4000 2001
0.05% 0.00% 2002
2003
2004
2005
2001
2002 Regionals
2003
2004 Majors
2005
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Deposits Retail deposits increased 11.2 percent to $81.4 billion which is higher than the 10.4 percent achieved in 2004 and is a positive result considering that the majors only managed growth of 4.0 percent. Further, the regional banks’ share of domestic deposits has remained stable at 15.0 percent13 while the majors experienced a decline of 1.4 percent to 65.8 percent13 as at 30 September 2005. This appears to suggest that the regionals have not been as affected as the majors from increased competition in the deposit market which has been lead by the foreign banks.
Retail Deposit Growth 40%
30%
20%
10%
0% Adelaide
BOQ
ERB
2002
Bendigo 2003
St.George 2004
Suncorp
Majors 2005
The regionals’ deposit growth has been built on a platform of new products and not just price. For example Suncorp introduced its “Everyday Options” transactions and savings account which has attracted $1.7 billion in retail funds since its launch in March 200414 and St George introduced two new accounts “PowerSaver” and “Freedom Plus” in 2005 while Bank of Queensland has introduced a new CMA product and revamped its term deposits. The regionals have continued to use securitisation as an additional source of funding. Securitised assets increased by 34.1 percent to $28.7 billion which represents 14.7 percent of total on and off-balance sheet assets (2004: 12.7 percent). It is likely that the growth in securitisation will continue despite securitised assets being included on the regionals’ balance sheets in 2006 under Australian equivalents to International Financial Reporting Standards.
13 14
Source: APRA Monthly Banking Statistics Suncorp Annual Report 2005
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Australian equivalents to International Financial Reporting Standards The regionals will report their results under Australian equivalents to International Financial Reporting Standards (“AIFRS”) for the first time in 2006. Disclosures in the current year financials provide an insight into the impact of AIFRS on future results. We estimate that adopting AIFRS will increase the regionals’ operating profit after tax by 8.8 percent in 200515. The main AIFRS adjustments that have been disclosed as impacting 2005 operating profit were:
•
reversing goodwill amortisation expense which will increase profit by 8.7 percent;
•
increase in employee compensation costs due to accounting for share based compensation as an expense, which is estimated to decrease profit by 0.7 percent;
•
recognition of increase in defined benefit superannuation plan which will increase profit by 0.1 percent;
•
reversing gains on revaluation of wealth management business which will reduce profits by 0.2 percent; and
•
other positive impacts that will increase profit after tax by 0.8 percent.
This does not include the impact of key areas such as credit provisioning and financial instruments which will be effective for the 2006 results onwards. In particular, there is an expectation that credit provisions will decrease under AIFRS and that the new rules for accounting for derivatives will result in additional income statement volatility. A key consideration when assessing the impact of AIFRS on the regionals is the fact that changes to financial reporting do not impact the economics of the underlying business but merely how they are reported. For instance, goodwill adjustments are by far the largest impact on the regionals adjustments reported to date (remembering that the impact of AASB 139 on credit provisioning and financial instruments has not been reported yet) but most investment analysts would already have adjusted for these items in their assessment of banking stocks. Commonly used performance measures such as cash earnings exclude the impact of goodwill amortisation.
15
This excludes Elders Rural Bank which has not quantified the impact of AIFRS in its 2005 Annual Report
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Outlook As we look to 2006 for the regional banks, we believe that the following issues will influence performance:
•
It is likely that the regionals will continue to face more competition in 2006 from the foreign banks and also the majors who are now showing a renewed focus on the rural and regional markets. In particular the rural markets are being targeted by the likes of Rabobank and BankWest. The majors have also announced a renewed focus on the regional and rural markets. The easing of the drought in most of Victoria and New South Wales in 2005 should offer more opportunities in the regionals’ markets but will there be enough for all?
•
With the increased competition will institutions, including the regionals, be tempted to increase their exposure to riskier loan products? If the credit cycle has indeed reached its low point then 2006 may see bad debts start to increase. However, we have seen little indication of this as yet.
•
Cost control has been strong but with expansion continuing the regionals’ business models will now have to deliver further gains in revenue in order to deliver the increase in return on equity that the market has come to expect. We expect to see a strong focus on cost control.
•
Margins have not been significantly impacted during 2005 from the increased level of competition partly due to the regionals success in continuing to attract retail deposits and diversifying into higher margin products. The ability to continue to raise retail deposits through innovative and competitive products and increase their assets, especially into higher margin lending, will be vital if the regionals are to continue to weather the storm of competition.
•
The regionals have been very successful individually in their push for growth outside their traditional markets. 2006 may be the year that decides whether this can continue or if the long awaited consolidation in the Australian market will be triggered by a foreign entrant. To prevent this from happening the regionals remain under pressure to deliver returns to shareholders in order to maintain their relatively high share price.
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13 © 2005 KPMG, an Australian partnership, is part of the KPMG International network. KPMG International is a Swiss cooperative. All rights reserved. The KPMG logo and name are trademarks of KPMG.