PWC biannual major banks analysis finds that annual cash earnings at Australia’s four major banks have fallen for the first time since the global financial crisis, with the result partly driven by ‘one-off’ items at individual banks, rising bad debt expense and slowing credit growth in the second half of the 2016 financial year.
Between 2009 and 2015 Australia’s major banks enjoyed an unbroken run of growth, with cash earnings rising from $17 billion to $30.6 billion over the period, fuelled by demand for residential mortgages combined with low loan losses, disciplined management of pricing, and a stable regulatory environment.
PwC Australia’s banking leader, Colin Heath, said this year’s results reflected a slowing of momentum, particularly in the latter stages of FY16, with a noticeable softening in the majors’ traditional growth drivers.
“The banks started the year strongly, with momentum from credit growth and pricing decisions linked to additional holdings of regulatory capital,” he said. “As the year progressed, that momentum began to slow. We’ve seen rising bad debt expense, some sustained pressure on margin and, more recently, signs of weaker credit growth in amongst some heavy political and community scrutiny.
“Viewed in isolation, these are solid results. However, when you look at the challenges ahead, it’s clear the majors are going to need to push very hard in the future to maintain their current level of performance, which explains some of the decisions we’ve already seen them take. Within these results we can see signals that the banks are beginning to take some of the tough decisions necessary to thrive in the new environment,” Heath said.
To simplify their businesses and to meet regulatory capital requirements, the banks have sold or restructured operations, re-assessed pay-back periods for technology investments and have raised significant capital. After adjusting for the one-off impacts of such items cash earnings rose a modest 1.1 percent over the year, but declined 0.9 percent half-on-half, supporting the view that momentum is slowing for the majors.
Return on equity (RoE) was 13.75 percent for the year and 13.66 percent for the half, down 127 and 12 basis points respectively, with the result driven by a $13 billion increase in regulatory capital, soft earnings growth, and certain one-off items.
“We’re expecting further increases in regulatory capital and funding costs, and when you combine that with a challenging growth outlook it’s likely that RoEs will be under pressure for the foreseeable future,” Heath said.
Australian domestic credit has continued to be the main driver of the major banks’ growth, but second half results indicate the rate of growth is slowing.
Housing credit in Australia grew 6.4 percent over the year, down 1.1 percent on the prior year, and 0.7 percent on the prior six months.
Demand for owner-occupied mortgage credit continued, rising 7.3 percent over the year, but this was driven by strong growth in the first couple of months which slowed sharply in the second half. Business credit growth declined to 4.7 percent, down from 6.3 percent a year ago, with growth also slowing sharply in the second half.
According to Heath, this slowing demand for credit is a key factor explaining industry concerns about the immediate outlook for profit growth from core operations.
“The story around credit shows that the engine room of growth for the major banks is likely to be more and more contested. This could be good news for customers in terms of competition but is likely to keep the banks’ margins under pressure,” he said.
Net interest margins have remained remarkably flat, at 2.02 percent for the year, down 1 basis point on the year prior and down 4 basis points for the half, which masks a more complicated story. The gains from repricing in the year only marginally offset increased pricing competition for new lending business, increased funding costs,and unfavourable movements in the treasury activities of the majors.
“With competition continuing to increase and the banks gearing up to meet the Basel III net stable funding ratio by 2018, we expect margins to remain under pressure particularly given the scrutiny that the major banks’ pricing decisions are currently under,” said Heath.
Bad-debts increased by 39 percent to $5.1 billion for the year, the highest level since 2012. Almost all of this movement relates to specific sectors, such as mining and resources or the regions associated with them. Underlying asset quality appears to be holding up in the broader portfolios.
“Whilst it appears for now that these losses are isolated to sectors and regions impacted by low commodity prices and the decline in the mining and resources sector, there are signs that bad debt expense may have been as good as it gets,” Heath said.
Looking ahead – simpler, smaller and more deeply connected
Looking ahead, Heath believes growth in the future is going to come from banks being more focussed about the markets and segments they are going to serve, more refined in terms of their product and service offering and aligning their investment priorities around these decisions.
“The majors have been working hard to respond to a new environment where customers can expect a different, more connected experience – with technology and engaged staff as key enablers,” Heath said. “This doesn’t mean the banks will be serving fewer Australians, but it does mean the banks will reassess where they are truly differentiated and both the role they can play and how they work with others in meeting their customers’ needs.
“We’ve already seen that starting to play out in some of the steps that have been taken by the majors. In a practical sense, this includes simplifying the product offering, clarifying their priority markets and their make versus buy decisions.”
Asia ‘done right’ a viable growth option
Much had been made of the majors winding back their Asia operations, but Heath believes the ‘Asia opportunity’ is “too big to ignore.”
“I don’t think it’s contradictory to be a smaller, simpler and more deeply connected bank and also be a player in Asia,” he said. “The key will be doing it in a targeted, focussed way, with the right partner in the right segment. A broad brush, expansionist strategy is probably less likely to be successful.
“The bank that can make some judicious plays in the region, with total clarity about what they are there for, can expect to reap the benefits in terms of long-term, sustainable growth.”