Major Banks Analysis: Banks deliver solid, not spectacular growth

10 May 2012

• Cash earnings up 4.7 per cent to $12.6 billion
• Margins fall in a difficult funding environment
• Funding costs remain the big challenge

Australia's four major banks delivered combined underlying cash earnings of $12.6b for the half year, a 4.7 per cent increase on the previous corresponding half, according to PwC's Major Banks' analysis.

PwC Banking & Capital Markets Leader Stuart Scoular said despite slower profit growth, Australia's banks are performing strongly compared with many Western counterparts, reporting a return on equity (ROE) of 15.9 per cent.

The main drivers this half were weaker net interest margins (down 8 basis points), improved trading income (up 159 per cent), well managed costs (up 1.5 per cent) and much higher loan impairment expense, which remains low by historic standards (up 15 per cent).

"While slower cash earnings pressures have been building since the onslaught of the GFC, banks are now struggling for revenue momentum in a low credit growth environment," Mr Scoular said.

"The big picture is that banks are responding to a landscape full of increasing regulatory burdens, technological change and innovation, evolving customer behaviours and shifting demographics. All this is compounded by global economic uncertainty. "The Australian banks are acutely aware of these developments. Each of them has their own strategy around productivity, IT investment, offshore expansion, pricing and brand positioning to assist in maintaining growth momentum."

Banks deliver solid, not spectacular growth

Net interest margins are under pressure from competitive and market developments, down 8 bpts to 2.21 per cent in the past six months.

"Bank margins during this half have been adversely affected by more expensive offshore funding and more intense competition for domestic deposits," Mr Scoular said.

"With continued volatility in international markets, we see little respite from these pressures."

Trading income improved strongly relative to a very weak performance in the previous six months – up 159 per cent.

"Unfavourable external conditions triggered poor trading results in the banks' markets businesses in the previous half," Mr Scoular said. "This half, results have improved with increased customer flows."

The banks are responding by improving productivity and efficiency and keeping a tight lid on costs. Staff costs represent 57 per cent of operating expenses. As the productivity initiatives have kicked in, full time equivalent employee numbers across the banks fell by about 3,600 to 174,000 over the past six months.

Over the same period employment in the Australian economy rose by about 20,000 people.

Bad debt expenses were up 15 per cent over the half reflecting a number of domestic and offshore factors, but bad debt expense still remains lower relative to historic experience.

Business lending remains subdued although it has returned to positive territory with business credit growing 1.3 per cent in the year to 31 March 2012. Business deposit growth has slowed to 5.2 per cent – far less than the 12.9 per cent we saw for the year to 30 September 2011.

"It is, however, too early to know if this reflects a greater willingness to invest or simply increased pressure on cash flows," Mr Scoular said.

Housing credit growth remains soft at 5.3 per cent for the year to 31 March 2012 - the lowest since statistics began.

Funding

"We can blame increased funding costs for taking the gloss off these results," Mr Scoular said.

"Banks have had to pay relatively more for both domestic deposits and wholesale funding."

The impact of this on bank margins was offset somewhat by more aggressive pricing for lending.

"With more pressure on funding costs to come, we expect the banks will continue to offset these higher funding costs via the pricing for lending assets.

"The banks responded to these pricing pressures by increasingly moving lending rates independently of the RBA cash rate, a trend we expect to continue."

Further relief can also be expected through increased use of covered bonds, which raised $25 billion last half.

"This leaves plenty of room to move given the legislation allows the banks to raise up to $130 billion using covered bonds.

"Addressing funding pressures remains work in progress," Mr Scoular said. "However, there appears little doubt that it's an issue that will once again remain front and centre for the Australian banks this half."

Growth outlook

"The task ahead for our banks is challenging but we are confident that they can continue to deliver growth. However, we should not be complacent about the headwinds – in particular from Europe and the performance of our own economy," Mr Scoular said.

"Relative to international counterparts, our banking sector remains very well placed. We continue to have a sector that is profitable, well capitalised and holds high levels of liquid assets."

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