Major Banks: from fair weather to headwinds as fortunes shift and capital requirements bite

Australia’s big four banks (“majors”) reported an aggregate three percent fall in profit in the first half of 2015-2016, attributed to two major factors: increasing non-performing loans and higher capital and liquidity requirements.

The majors reported a combined cash profit after tax of AUD14.8 billion for the 2016 half year.  The softer growth in the cash earnings result is due to increasing loan impairment expense, higher technology related charges, and one-off impairment and restructuring costs against flatter revenue and margin growth.

Challenging market conditions in the mining and resources sectors, coupled with large single name institutional exposures have seen the banks’ asset quality deteroriate. The aggregate charge for bad and doubtful debts increased AUD834 million to AUD2.5 billion in the first half, up 49 percent on the first half of 2015.

However, the majors credit problems are mostly isolated to a small handful of institutional credits. Given credits cyclical nature, it was always­ inevitable that loan impairments would eventually start to rise.

Looking ahead, continued discipline on pricing, debt serviceability and loan to value ratios will be important to ensure the major banks’ credit quality is maintained, particularly if national unemployment quickly rises or the housing market sees a more abrupt correction in the future.

Margin compression has continued as a result of competitive corporate lending rates, higher holdings of liquid assets and the prevailing low interest rate environment. The major banks recorded an average average net interest margin of 204 basis points (cash basis), up one basis point compared to the second half of 2015.

At the same time, industry returns are now bearing the brunt of increasing regulatory capital buffers over the past few years, with average Return on Equity falling by 153 basis points to 13.8 percent (this compares to a decade ago when the average ROE was above 20 percent)

This is set to continue (as the banks strive towards “unquestionably strong” levels of capital as desired by the regulator), putting further pressure both on the banks ability to grow, and on the imperative for further cost efficiency measures.

These pressures, coupled with increased regulatory capital and liquidity requirements, will constrain the major’s ability to continue to generate the high levels of return reported over the past five years.  As a consequence, this will require the major banks to re-visit their business models, assessing the medium-to-long term viability of their various business lines and current geographic footprints (and exiting low growth, low return and capital intensive businesses and markets).  In addition, the majors will need to heighten their focus on further improvements to their operational efficiency and productivity.

The KPMG Major Australian Banks Half Year Analysis Report 2015-16  is available for download on the KPMG website.

Follow Ian Pollari in Twitter @IP23E.

 

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