Changing times

EY’s analysis of the Australian major banks’ 2015 full year results

Monday 2 November 2015

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Australia’s major banks have delivered another solid financial performance, reporting combined cash earnings of $30 billion for the 2015 full year – an increase of 5.4% from the same period last year.

According to EY’s analysis of the full year results of Australia’s big four banks, despite reduced pressure on funding costs, increased competition, lower rates and regulatory capital requirements are constraining interest margins and growth is slowing.   

EY’s Oceania Banking and Capital Markets Leader, Tim Dring says: “Slowing growth and declining returns are a clear signal that we’ve reached the end of the banks’ golden era.”

“At a domestic level, Australia has been struggling with the transition to a broader-based economy after a prolonged period of heightened reliance on the resources sector,” Dring says. “Despite a recent uptick, business confidence and consumer sentiment remain subdued, and the banks have experienced significant volatility in recent months, with the market showing high sensitivity to strategic announcements and unsettled global conditions.”

“While the recent lifting of mortgage rates by the majors will provide the banks with additional margin to assist in mitigating constrained growth and increasing capital requirements, there are still a number of key challenges facing the sector,” Dring says.

“Financial markets volatility, increasing regulatory capital requirements, and margin compression from low interest rates and intense competition are all adding pressure. ROE is trending downwards and cost to income ratios of 40% or less remain elusive.”

“In order to continue to prosper in this new environment, banks will need to refocus on core businesses, redefine their structure and reshape their businesses through technology,” Dring says.

Pockets of pressure emerging in asset quality

“Against all expectations, the banks have maintained strong asset quality through to the year end. But, given economic cycles, this position is not sustainable in the long term,” Mr Dring says.

We are already seeing pockets of pressure emerging, particularly in the resource-exposed states of Queensland and Western Australia, with higher levels of stressed retail loans and a slight uptick in mortgage arrears.”

“The challenges of Australia’s economic transition, coupled with a likely cooling of property markets in Sydney and Melbourne, and the impact of China’s slowdown suggest bad and doubtful debts will rise from their current low levels.”

“Australian banks have a high exposure to the housing market compared with other countries. Regulators are understandably wary of the downside risks associated with this in the current environment and the banks are tightening lending standards in response their increasing focus.”

“This is likely to remain an area that will be closely monitored for some time, with APRA indicating that it is slowly ‘turning up the dial’ in its supervisory intensity.”

Selective wealth divestments on the horizon

The banks’ wealth businesses benefitted from a lower Australian dollar and a strong performance in investment markets for most of the year. But generating acceptable ROE remains a challenge due to the capital intensive nature of wealth operations.

“Expensive life insurance underwriting and manufacturing operations are likely to come under review, as banks look for ways to free up capital and improve returns,” Dring says.

“Divestments and strategic partnerships will enable the banks to focus on more profitable product distribution.”

“The banks are also looking to implement more cost effective technology-enabled sales and advice in their wealth operations. With the rise of robo-advice, a digital financial revolution is underway that will help bridge the gap between what consumers are willing to pay for advice and what advisers are willing to charge.”

“With such a large portion of the population currently unadvised, a sector rebuilding trust and no let-up in the complexity of our financial system, robo-advice offerings have the potential to make financial advice more accessible to more people and provide increased consistency of advice.”

Restructuring for the digital age

Digital enablement and cybersecurity are also rising higher up the banks’ agendas, as an increasing number of new fintech market entrants pose a significant disruptive threat to the industry.

“Banks are seeking to harness the power of new technology to differentiate themselves and drive efficiency,” Dring says.

“Seamlessly integrating fintech into traditional banking models will be central to the banks’ ability to respond to the pressures of today’s macro environment and successfully compete with new, agile, technology-driven competitors.”

“The right level of investment by banks is critical, but balancing the need for increased technology investment with a low-growth environment remains a significant challenge,” Dring says.

Looking ahead

“During the year we have also seen the majors undertake capital raising of close to $20 billion in preparation for implementing some of the recommendations coming out of the Financial System Inquiry. The majors have reestablished a capital position that will place them in the top quartile of international banks and should see them more prepared for future regulatory changes in this area.”

“Continued investment in areas of technology and productivity will be critical in the delivery of seamless banking services, for both retail and institutional customers,” Dring says.

Australian major banks’ 2015 full year results at a glance

  • $30 billion in cash earnings up from $28.5 billion in the 2014 full year results, an increase of 5.3%.
  • Net interest margins down an average of 5 basis points from the prior comparative period, to 2.02%.
  • Cost to income ratios have increased, deteriorating by 17 basis points from the prior year.
  • Return on equity on a cash basis has declined 52 basis points to 15.01%
  • Average tier one capital has increased by 80 basis points over the prior comparative period, from 10.8% to 11.6%.

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