Solid results for the banks amid heightened uncertainty
EY’s analysis of the 2017 half year results of Australia’s major banks

Monday, 8 May 2017

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  • $15.6 billion in combined cash earnings, up from $14.7 billion in the 2016 half year results, an increase of 6.25%.
  • Return on equity increased by an average of 8 basis points from the prior comparative period, to 13.9%.
  • Bad debt expenses decreased by 12.3% from the 2016 half year results, to $2.2 billion.
  • Average net interest margins down by an average of 7 basis points on the 2016 half year results, to 2.0%.

Australia’s major banks have collectively delivered another solid set of financial results at the 2017 half year, despite operating in an environment increasingly characterised by growth constraints, intense competition, increasing regulation and heightened economic uncertainty.

EY’s analysis of the big four banks’ 2017 half year results shows combined headline cash earnings of $15.6 billion after tax, an increase of 6.25% from the 2016 half year. Out-of-cycle rate increases in the banks’ mortgage books have supported average net interest margins (NIM), although they have continued to decline to 2.0% in the face of competition and elevated funding costs. Return on equity (ROE) has improved slightly, but banks will need to innovate if they want to drive further improvements and sustainable growth.

EY Oceania Banking and Capital Markets Leader, Tim Dring says: “The balancing act of margin versus volume is a game the banks have become well-versed in as low interest rates, intense competition, funding cost pressures and moderating credit growth, particularly in their business books, all combine to constrain growth.”

“At the same time, heightened economic uncertainty is taking a toll. Locally, this is being fueled by high household debt, low wage growth and housing affordability challenges in Sydney and Melbourne. A possible downgrade in sovereign and bank credit ratings and, further afield, lingering offshore geopolitical uncertainties bring an increased risk of volatility in wholesale funding costs,” Mr Dring says.

“All these factors are combining to create a particularly challenging operating environment for the banks. As lower growth becomes the ‘new normal’, banks need to manage the inherent tension in two very different agendas: the need to improve financial performance versus the need to keep the bank safe.”

Repricing offers near-term earnings and NIM benefits

The banks remain focused on their retail banking operations to drive growth. However, with the residential mortgage environment clouded by higher risk and increased scrutiny, the banks are adopting a more cautious approach to growing their mortgage books – tightening lending criteria and repricing portfolios.

“While rate increases benefit the banks’ earnings and margins, they also have the potential to put additional pressure on an already highly-indebted household sector. Looking ahead, the banks’ ability to extract additional margin through differential rate repricing on residential property lending will become even more of a balancing act. We are seeing mounting regulatory, government and public pressure to curtail housing price growth, particularly in the Sydney and Melbourne markets, and this is likely to continue to build,” Mr Dring says.

“Against this backdrop, banks are going to have to innovate if they want to grow profitably and drive continued improvement in ROE. Advanced technology adoption and innovation-based operating models should be central to how banks reshape their businesses and they will need to engage with an ecosystem of innovative, external digital partners.”

Pulling on cost and balance sheet levers

Disciplined cost management has seen the banks’ collective cost to income ratio (CTI) edge downwards compared to the first half of 2016. However, results were mixed across the banks as they struggle to achieve a step change in their cost base. For most of the banks, cost management has included selective headcount reductions, as they focus on digitising customer channels and increasing self-service.

“Banks are ramping up efforts to explore and develop advanced technologies that can improve agility and meaningfully reduce costs and risks,” Mr Dring says.

“Productivity and cost reduction continue to be important levers for the banks, through increasing use of process automation as well as general simplification of processes. The continued decline of over the counter transactions has not only seen the format and size of branch networks transform, but will ultimately lead to a much smaller branch footprint.”

“Portfolio allocation also remains a priority, as banks look for ways to free up capital and improve returns. Restructuring wealth operations remains high on the agenda, with expensive life insurance underwriting and manufacturing operations under review as banks focus on the more profitable distribution side.”

‘Unquestionably strong’ is still the goal

Asset quality remains generally sound across the banks, with improvements in some measures. Higher commodity prices, while volatile, have eased stress in the mining and New Zealand dairy portfolios. A low level of credit losses will remain for at least the short term, in the absence of any market shocks. Impairment ratios and bad debt charges remain low, but there are still pockets of weakness, mainly in mining-related areas.

“Increasing levels of household debt and the sensitivities of these debt levels to upwards movement in rates will place pressure on arears and we are already seeing this play out across the country, with mortgages past due 90 days trending at higher levels in the Western Australia, Queensland and South Australia, reflective of the economic cycle in those states,” Mr Dring says.

On the regulatory front, the banks are facing a full agenda. Basel III and what constitutes ‘unquestionably strong’ continues to create a degree of uncertainty about the full extent of the banks’ future regulatory capital requirements.

Managing non-financial risk more effectively

The banks are facing intense political and regulatory scrutiny, with concern over the level of competition in the Australian banking sector continuing to draw significant policy attention. Proposals for an open data framework have the potential to significantly disrupt the traditional bank-customer relationship, as alternative players compete for customers.

The banks also face ongoing political and regulatory scrutiny around conduct and culture, with high-profile issues – mainly in wealth operations but also extending into retail bank lending practices – leading to a number of reviews on the impact of remuneration incentives on customer outcomes.

“Parliamentary inquiries have put banking executives in the hot seat and debate continues over how to manage these conflicts of interest and ensure banks are acting in the best interest of their customers.”

“All the major banks are running programs designed to rebuild trust and improve customer outcomes, and these should see customers put back into the driving seat. But managing these non-financial risk areas will continue be a priority for the sector in the second half of 2017 and beyond, as banks work to regain the public’s confidence,” Mr Dring concludes.

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