Turbulent start to the year hits big banks’ profits
EY analysis of the 2019 half year results of Australia’s major banks

Monday, 6 May 2019

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  • $13.9 billion in combined statutory profit, down by $1.9 billion from the 2018 half year results, a decrease of 11.8%
  • Average net interest margins decreased by an average of 11 basis points from the 2018 half year results, to 1.95%
  • Total remediation costs of $1.9 billion across the major banks for the first half of 2019

The 2019 half year results’ announcements of Australia’s major banks reflect a turbulent start to the year, with slowing revenue, higher remediation costs, a flagging economy and the delivery of the Financial Services Royal Commission’s outcomes all taking a substantial toll on the sector.

EY analysis of the big four banks’ half year results shows combined statutory profits decreased to $13.9 billion, down 11.8% from the same period last year.

EY Oceania Banking and Capital Markets Leader, Tim Dring said: “The growth outlook for the Australia’s major banks looks increasingly uncertain, with profits down, remediation costs up and margins under significant pressure.”

“The Financial Services Royal Commission has disrupted the banks’ risk appetites and business flow, propelling them to reshape their processes, simplify products and address compliance obligations, as they prepare for more intensive levels of regulatory supervision and enforcement from APRA and ASIC. It has also revealed issues in their back books,” Mr Dring said.

“While most of the major banks’ cash earnings were up from the 2018 half year, this doesn’t take into account the significant impact that growing remediation costs are having to overall profits. In the last 18 months, total remediation costs across the big four have reached $4.8 billion – with $1.9 billion set aside for remediation in their 2019 half year results alone.”

“So far, remediation costs have related mostly to misconduct issues within wealth management divisions. But, on-going investigation into product design and compliance will likely see further increases in the banks’ remediation burden that will put cost-to-income ratios under increasing pressure,” Mr Dring said.

“Adding to this pressure, the major banks are facing a stricter executive pay framework (BEAR) and more onerous regulatory regime at the same time as the market is opening up to increased competition from non-banks and foreign banks.”

Margin compression and slowing loan growth

“Returns on mortgages have stagnated over the last 12 months and, although repricing should have supported net interest margins (NIM), a combination of aggressive front book pricing and a decline in higher margin lending saw average NIM across the banks decline in the first half of the year.”

“The RBA’s call on interest rates tomorrow could also put further pressure on margins and the banks will be watching this closely,” Mr Dring said.

In terms of asset quality, EY analysis shows bad and doubtful debt charges remain at historic lows. However, a number of factors are driving concerns over the mortgage book.

“Overall, we’re seeing slower loan growth driven by a tightening of risk appetite and credit standards, falling house prices, and arrears starting to tick up slightly. Non-performing loans remain well secured but, if housing values continue to fall, some past-due housing loans could become impaired. Further risks are also likely to emerge as interest-only loan periods expire and borrowers struggle with higher repayments.”

“In this environment, the importance of technology enhancements to accelerate and improve verification processes cannot be underestimated. The race is on to see who can streamline their processes to become more efficient and compliant,” Mr Dring said.

Economic outlook

EY Chief Economist, Jo Masters said, “After 28 years of uninterrupted growth, Australia’s economy has lost considerable momentum reflecting a softening housing market – particularly in Sydney and Melbourne – and fragile consumer confidence. The economic outlook now is more challenged than it’s been for some time and this will present some headwinds for the banking sector.”

“Credit growth is slowing alongside the housing market. While the environment remains relatively benign at present, the headwinds are mounting as low-saving households face anemic wage growth, record-high debt, increasing portions of budgets being taken up by non-discretionary spending and, now, falling housing prices.”

“It seems inevitable that we are in for a period of slower economic growth and this will present another challenge for the major banks’, especially if households look to deleverage,” Ms Masters said.

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