Major Banks first half earnings lift 23 per cent
6 May 2010
- Underlying cash earnings hit $10.4 billion
- Bad debt expenses fall 33 per cent
- Net interest margins flatten
Improved economic conditions have helped the majors rebound from the 2.4 per cent reduction in underlying cash earnings experienced in the prior year. These results this half have been driven by strong net interest income growth, falling bad debt expenses, and a solid increase in wealth management income. However, these gains were somewhat offset by decreased fee and commission income, as well as softer trading revenue.
Mike Codling, Banking Leader, PricewaterhouseCoopers said, "It's been a stellar performance on the whole, and again confirmed the resilience of Australia's banking system."
Back on a growth plan
A slight uptick in credit growth shows signs of a stronger domestic economy, as well as improving consumer and business sentiment. According to the Analysis, in the six months to March 2010, aggregate bank loans rose 3.3 per cent, while overall system credit grew 1.2 per cent. This reverses a trend where the total credit stocks shrank during the months of September, October and November 2009.Mr Codling said, "We now have significant confidence that we've passed the low-point for credit growth. As confidence continues to improve and productivity ramps up again, we expect bank loans and advances to grow roughly 10 per cent over the next year, while total system credit will increase in the range of 7-8 per cent, well above the 1.3% system growth over the past year."
The growth in deposits peaked at 25 per cent in the year to February 2009, as investors followed the "flight to safety" during the GFC, and banks sought to reduce their reliance on offshore wholesale funding. In this latest six months, core customer deposits grew 7.0 per cent annualised, and the Major Banks Analysis suggests it will stay in the 7-9 per cent range for the next year.
As a result of the volume growth, and an increase in net interest margins over the whole year, the majors' net interest income grew by 9 per cent in the half year (1H10) compared to the prior corresponding period (1H09). However, compared to the most recent half (2H09), net interest margins actually reduced slightly, and net interest income was up by only 2 per cent.
Net interest margins (NIM) dip
After widening for three consecutive six-month periods in a row, the combined net interest margins (NIM) actually dropped slightly from 2.29 per cent in 1H09 to 2.28 per cent in 1H10.Mr Codling said, "Margins have been bolstered by the upwards re-pricing of loans over the past 18 months or so. However, this has largely run its course, and we think margins are now likely to compress again."
Mr Codling said, "The main reason for expecting a decline in margins is the ongoing increase in the cost of funding. This partly reflects the banks' "terming out", replacing short-term funding with longer-term debt. We also suspect that wholesale funding costs will rise due to future competition in international markets, as governments and central banks look to de-leverage and due to the new regulatory rules requiring banks to hold more capital and high-quality assets".
Future of bank funding
The Analysis suggests that one of the enduring impacts of the GFC has been the much greater attention placed on the funding of bank balance sheets as the risks inherent in relying on offshore wholesale funding relative to customer deposits were exposed.Mr Codling said, "Certainly the heightened competition for deposits reflects the banks' recognition of how valuable a strong deposit base is."
"Wholesale funding will always have a part to play, and our Australian majors are in the enviable situation of being four of the only eight AA rated banks globally and so able are to tap the international markets. But looking ahead a year or so, there are some significant supply-demand uncertainties. And as we speak, financial markets are grappling with the depth of the problems in the 'PIGS' economies and what they might mean for the debt markets".
"So given this, and the banks' natural reluctance to overly rely on offshore wholesale funding, the prospect of slower deposit growth beyond 2011 may ultimately constrain bank lending."
Asset quality improves
The majors' results were also substantially buoyed by a 33 per cent reduction in total bad debt expenses, which fell by $2.2 billion over the prior corresponding period to $4.6 billion.Mr Codling said, "As predicted last year, Australia's major banks have now passed a 16-year peak in bad debt expenses. As long as the economy continues to improve we expect bad debt expenses will continue to reduce, and banks will start to look at releasing management/economic overlay provisions."
"However, the Analysis suggests there are potential clouds on the horizon, including the extent to which interest rates rise further and the performance of the global economy."
Focus ahead
Mr Codling said, "We expect the banks to continue performing strongly for at least the next 18 months. The possibility of softening growth thereafter and reduced margins will mean they'll need to focus on their costs base."The PwC Banking Gauge - a consensus view across leading bank analysts - predicts that the four majors will finish FY10 with underlying cash earnings growth of 29 per cent over FY09, to be followed by a further 18 per cent increase in FY11.
Mr Codling said, "It's also interesting to note that the GFC has reshaped the individual positions and strategies of the majors, creating a level of differentiation not seen in many years."
"Improving customer service and reducing costs will continue to be universal pursuits. But we are seeing the banks differentiate across areas such as: core banking versus wealth management; technology to differentiate or systems replacement; where to position the brand and reputation; and whether growth lies in Asia, Europe or at home."
"How the banks use these levers to define their businesses will be critical to future success."
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