Have we reached the tipping point?

EY’s 2013 Australian major banks’ full-year results analysis

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Monday 4 November 2013 — The 2013 full-year results announcements of Australia’s major banks may mark a tipping point when it comes to determining whether the sector is experiencing a substantive recovery or simply a repositioning in a stubbornly low growth and cautious environment.

EY’s analysis of the full-year results of the big four banks shows that they have delivered a record profit outcome of $27.4 billion. Each of the major banks has delivered an increase in cash earnings of at least 7.6% year-on-year on a post-tax basis. These strong cash earnings results have been assisted by a lower level of credit provisioning, which reflects the combination of low interest rates and low credit growth, heavy cost management and improved deposit re-pricing. Net interest margins however continue to be under pressure from intense competition, coupled with a structural shift and ongoing deleveraging from corporate Australia.

In this environment, return on equity has re-emerged as the preferred benchmark, with the banks shifting their operating models from a focus on process and business unit performance to the more granular performance of a product across its lifecycle and customer profitability across portfolios.

According to EY’s Oceania Banking and Capital Markets Leader, Paul Siviour: “The Australian banks have continued to meet the challenge of etching out at or above expected market earnings and dividends in a low growth environment. This is highly commendable amid the continuing challenges of the global banking industry.”

“This becomes even more challenging in light of the increasing demands for capital, liquidity and higher compliance expectations from regulators, both locally and globally,” Siviour said.

“Despite interest rates remaining low and increasingly competitive, the major banks continue to struggle to generate robust lending volumes across their portfolios. An increase in interest rates at this time carries the risk of unintended consequences, such as capping or impacting fragile consumer and corporate confidence.”

“The banks are enjoying a period of moderated credit provisioning as a result of lower impaired asset levels, with an overall net reduction in provisions across the big four of $1.1 billion. These results demonstrate some improved credit quality, more refined credit risk management and a general clean up through asset realisation. However, this has been conducted against a backdrop of soft business credit growth, resulting from the adaptive shift to retail lending from subdued business and corporate lending activity.”

“This raises an important question around the sustainability of this low level of provisioning. If interest rates rise and market sentiment increases, will the banks’ robust risk management practices and conservative risk appetite postures be adhered to or will the need for growth lead to a loosening of underwriting standards?”

Increasing focus on the wealth sector

The aging population is increasing the demand for wealth management and protection solutions.

As Siviour explains: “Integration of the wealth businesses within the local banking sector remains a key challenge. Driven by both organic and inorganic growth over the last decade, the banks have become among the largest providers of wealth and life insurance solutions in Australia.”

“The majors are at various stages of progressing their wealth and insurance strategies with a view to diversifying revenue streams away from traditional banking and providing more holistic financial and protection solutions for their customers.”

“While, in the long term, they remain arguably well positioned to capitalise on financial advice and superannuation reforms, banks face some nearer term challenges in these sectors.”

“Financial returns to shareholders in the wealth and insurance sectors have been challenged in recent years. Wealth manager margins have been impacted by the cost of regulatory reforms, weaker economic conditions and increasing competition. At the same time, the life insurance industry is facing its worst conditions in decades – as a result of increasing claim volumes and high customer attrition rates – with shareholder returns falling significantly.”

“Some commentators are beginning to question whether the banks can make returns in these sectors at the same levels as traditional banking, and indeed the banks’ patience in relation to wealth and insurance may well be tested over the next few years if ROE returns remain subdued.”

New infrastructure funding models needed

EY’s analysis has found that, in the post GFC landscape, it’s not only the operating models within the banking sector that are being reconfigured. Australia is facing an increasingly large gap between the need for new and improved infrastructure and the actual level of investment governments can afford.

“The Australian financial system is experiencing unprecedented change when it comes to assessing the roles of banks, government and the private sector in relation to monetary policy and funding,” Siviour said.

“The role of private sector investors in financing major projects is critical. But it’s important to remember that private investors are not primarily motivated by a sense of public good. To support the infrastructure task ahead, commercially-attractive projects need to be available with the opportunity for earnings commensurate with the level of risk.”

“This presents a challenge for government. Australian bank debt terms for infrastructure projects are seen to be materially less favorable than those available in the global market for infrastructure projects and borrowing in the last few years has been expensive and challenging.”

“Recognising this trend, governments are increasingly seeking innovation within financing structures and working with lenders to ensure the risk and return profile of projects are structured to efficiently leverage the market’s appetite. In the future, we expect to see more user-pays models and new revenue streams that capture the value created for property owners, developers and different levels of government.”

The road ahead

To meet the challenges ahead, Australian banks will require new partners, new products and new perspectives. At the same time, they will also need to manage the potential impact of the Federal Government’s ‘Son of Wallis’ enquiry, alongside additional local and global regulatory requirements.

As Siviour concludes: “It appears the crucial tipping point may be upon us, with cautionary confidence emerging but without clear signs of this converting into lending growth. The delicate balance between monetary policy actions to stimulate growth and ease the Australian dollar and the potential for asset inflation will need to be closely monitored in the coming months.”

Australian major banks’ 2013 full-year results at a glance

  • $27.4 billion in cash earnings, representing an overall increase of 10% on the prior comparative period
  • Net interest margins down by an average of 4 basis points from the prior year, to 2.1%
  • An average of a 258 basis points improvement in cost to income ratios across the board
  • Overall reduction in total net provisions of $1.1 billion, to $17.8 billion
  • Return on equity improves by an average of 20 basis points to 16.1%
  • Dividend payout ratios have increased by an average of 45 basis points (excluding special dividends)

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Contact details:

Rebecca Aley
EY Australia
Tel: +61 2 9276 9305 or 0418 835 849