Strong economy helps the Big 4 banks rebound swiftly

It has been widely reported that the Australian economy has recovered very well from last year, on the back of a strong public health response to COVID-19, as well as assertive government fiscal and policy interventions to support jobs and the economy.

Australia’s economic performance is the most important driver of the financial performance of our banks. Last week, KPMG released its detailed report on the results for Australia’s ‘big four’ banks, showing a profit rebound for the first half year of FY21.

Our key takeout from the analysis of the results is that the Australian major banks (“the Majors”), turned the corner after last year. This is highlighted by a reported combined cash profit after tax from continuing operations of $13.8 billion, up 62.3 percent on the first half year of FY20.

It should be noted that while profits and ROE were much improved on FY20, this was partially a result of COVID-related provisions (FY20) and subsequent writebacks (1H21). After adjustments for these effects, pre-tax net profit growth against 1H20 is a modest 1.3 percent rather than the reported rate of 45.8 percent.

In an environment with an economic performance that has been better than anticipated and with household finances in a strong position, lending has grown modestly (with less than 1 per cent lending growth for the Majors compared to 2H2020). While the banks have acted as shock absorbers for the economic downturn last year, they have been beneficiaries of more favourable market conditions in 2021.

The Majors have continued to further strengthen their balance sheets. Collectively, they have chosen to retain sufficient profits and proceeds from divestments to lift their CET1 ratio by 105 bps to 12.4 percent. The sector’s capitalisation has not been this strong in decades, and provides a stark contrast to the situation during the Global Financial Crisis.

Lending rates have come down further in the current low interest rate environment resulting in a mild increase of the Majors’ NIM performance (up 1.5bps from 2H20). This has been driven by decreases in deposit rates that have more than offset the decline in lending rates, as well as the Majors’ use of the attractive Term Funding Facility (“TFF”) offered by the RBA. As deposit rates are bottoming out and the TFF closes on 25 June 2021, NIMs (and profits) will decline in the second half of FY21.

In a lower margin environment, cost management becomes ever more important. But as the Majors continue to face elevated regulatory compliance and ongoing remediation requirements, their costs remain stubbornly high. The potential for cost reduction through business and operating model simplification, end-to-end process digitisation and digital distribution remains significant.

Evolving customer needs and behaviours, as well as the competitive environment continue to drive the innovation agenda. The Majors are responding to the signals they are receiving from their customers in areas like digital channel adoption and the introduction of new products. At the same time they are making it easier for staff and third parties, like brokers, to deal with them.

For the second half of this financial year, we will be looking at how the Majors are able to grow, reduce their costs and manage their net interest margins while executing on their transformation agendas.

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