Capital uncertainty dominates in major banks mixed results

The Australian major banks (the majors) have reported a mixed financial result for the first half of 2015. Cash profit after tax totals $15.5 billion for the 2015 half year – up 8.4 percent, aided by a strong housing market, continued low impairments and favourable funding conditions. But downward pressure on margins, returns and regulatory uncertainty continue to dominate the landscape.

There were reasonable levels of revenue growth and ongoing robust asset quality. But whilst wholesale funding costs and competition for deposits have eased, margin compression has continued as a result of competitive pressures, higher holdings of liquid assets and the prevailing low interest rate environment.

The majors achieved solid balance sheet momentum in the first half, with housing credit growth of 4.6 percent and business credit continuing to improve, rising 5.9 percent. Deposits also grew strongly, rising by 5.4 percent. In a relatively subdued environment, good levels of lending and deposit growth has enabled them to satisfy a significant proportion of their funding requirements from customer deposits.

The positive revenue result was primarily driven by continued strong growth in house lending and wealth management, underpinned by buoyant investor demand, stock market performance and net inflows. The majors recorded an average net interest margin of 204 basis points, down 3 basis points on the prior half year.

The majors continue to maintain asset quality with a favourable property market conditions and the low rate environment.  However, the majors’ aggregate charge for bad and doubtful debts increased from $1.6 billion to $1.7 billion in the first half. But they will need to continue their vigilance on debt serviceability and loan to value ratios as borrowers could face the prospects of less favourable circumstances in the future. An environment where rates are increasing and property prices are stagnant, cannot be too far away.

The impact of significantly increased regulatory capital requirements, with the exception of NAB, saw the majors’ returns on equity falling by 45 basis points to an average ROE of 16.37 percent for the half year. Maintaining a return on equity well above the cost of capital will become increasingly difficult as APRA responds to Basel 4 and the recommendations of the Murray Inquiry, raising bank capital levels even further.

NAB’s ROE improved 560 basis points on the second half of 2014 to 14.7 percent. NAB’s 2014 result was impacted by the UK Conduct charges, but we have seen ROE normalise during the half year and be subjected to similar pressures to that of the other majors.

The average cost-to-income ratio increased across the majors, excluding NAB, by 100 basis points to an average of 43.7 percent for the 2015 half-year (down from 47.2 percent to 43.9 percent including NAB). We attribute the faster growth of costs than revenues to the need for banks to invest in meeting regulatory compliance obligations and enhancing their digital capabilities.

The majors’ capital position continues to present challenges, with their aggregate Common Equity Tier 1 (CET1) capital ratio declining by 4 basis points over the first half to 8.89 percent of risk-weighted assets (RWAs), largely reflecting the impact of increased regulatory capital requirements.

So what do we see, looking ahead?  The banking industry will be challenged by a confluence of factors, such as rising and higher quality levels of capital; customers demanding greater levels of personalisation and a seamless digital experience; the emerging threat of new entrants and, finally, investors seeking further dividend growth.

This means that, ultimately, something or someone will have to give.

Read the full report: Major Australian Banks: Half Year 2015 Results Summary 

Feature Image Copyright:  / 123RF Stock Photo

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