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Earnings and returns
Cash earningsSignificant reduction on 1H23, driven by a close to 11bp reduction in margin and close to flat on the half and the second-highest half-year earning since 2017 (behind record $17bn 1H23 result). Lending growth couldn't quite offsite continued NIM contraction of 4bps hoh, while expense (and tax) increase was balanced by lower costs for credit, continued decline in notables and an uptick in non-interest income.
Over 140bp reduction on the 'rate bounce' 1H23 and flat (down 2 bps) hoh. Although down on 1H23's 12.6%, at just over 11% the RoE for the past three halves remains substantially better than anything seen since before the pandemic.
In some ways, it’s back to the future for Australian banks - a strong (amongst records), steady result providing the flexibility for returns of capital. It was the second highest half year result since 2017…however long term trends appear to be resuming. Earnings were up slightly for the half and down significantly on a year ago, with margin pressure on mortgages and deposits yet to relent and not quite balanced by growing balance sheets. Non-interest income rose for the second time in twelve months but remains a small component of income. Expenses rose but were offset by falling notables and credit expense, as the economy continued its ‘Goldilocks’ course.
Long-term challenges for the industry remain unchanged however, as ‘commodity trap’ dynamics continued in the half though the window to address them remains wide open. In principle, banks have everything they need to do just that. They have got themselves in great shape: healthy returns, simpler and safer. It’s remarkable to observe the questions now being asked include whether they might in fact be too simple or even too safe.
That’s because the slow, but significant, trends of the last 15 years combined with the expanding capabilities and challenges we see ahead may require transformation more fundamental, and faster, than anything the industry has experienced in a very long time. They are also emerging at what looks like an accelerating pace.
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Revenues
Net interest income (ex notables)Slight reduction hoh as modest overall growth in interest earning assets was short of balancing continued fall in NIM. Volume/margin tradeoffs remain critical in the outlook for NII - interest income hovered around $32b for nine consecutive halves before 2H22 before jumping to its record $38bn in the following.
For the first time since the Royal Commission, OOI rose for a reason other than markets income. 1H24 saw the first notable rise in bank fees since the Royal Commission, albeit only 2.9% hoh, or $121m.
Australia’s major banks delivered a cash earnings result for first half 2024 that was objectively strong and compares favourably to most other global banking markets. At $15.5bn, cash earnings were up slightly on 2H23 but significantly down on 1H23 and consistent with past levels to which the industry had become accustomed. Of course, with average equity up by almost half since 1H15 (the first time HY earnings broke $15bn), RoE is now 11.2%, versus 16.7% then.
The reasons behind the result are familiar subjects. NIM, having shot up during rate repricing to drive the 1H23 record, continued to be competed down, particularly in retail, and now represents only a c.5bp increase over the rate tightening cycle. On a simple basis, margins in the retail bank segments fell close to 32bps on pcp and 9bps hoh, in contrast to a more modest 5bp reduction for both periods in the business segment.
Other operating income rose slightly to $7.9bn but is still substantially eroded since 2015. Back then it represented over 30% of total income and was over $10bn for a half. Today it represents just under 18% of total income and is amongst the least diversified in global banking markets. Thus what kept earnings up outside of OOI was everything in balance. Balance sheet growth, while not sufficient to fully offset margin compression, saw growth in interest-earning assets of 1.9% hoh and 3.3% on pcp. Credit losses, were down $0.2bn, remaining fortunately benign, early tremors notwithstanding. Cost growth, arguably well-contained at 3.4% hoh (7% annualised) given the inflationary environment, nevertheless exceeded revenue growth, leading industry cost-to-income to rise.
Lending
Net interest marginNIM fell a remarkable 11bps on the 'rate bounce' pcp and 4bps hoh, indicating the continued competition in mortgages and deposits may be slowing but remained acute in the half. On a simple basis, margin reductions in retail were circa 32bps on pcp and 9bps hoh, with business margins declining only modestly. Significant competition from, and some loss of share to, non-majors continued in retail.
Lending growth slowed, driven by mortgages which continue to grow more slowly than business lending. In addition, the majors continue to lose share, accounting for just 50 percent of net lending growth in Australia for the half (net flow), versus a share (stock) of total lending which in March fell below 67% for the first time ever.
These results were delivered in the context of a ‘Goldilocks’ economy that is, for now, still going strong. Despite the fears last year about the accumulated impacts of shock after shock, the Australian economy, along with most of the world, has remained remarkably resilient.
Likewise, Australia’s major banks’ performance remains enviable on the global stage and with capital, both reputational and financial, at levels that place them arguably stronger than they’ve been in modern history. This is why we say the ‘window’ for success and transformation is as wide open as it’s ever been.
It’s so strong, in fact, that the industry is starting to ask itself whether, after 15 years or more of de-risking, up-regulating and simplification, the banking system might have become ‘too simple and too safe’ (or at least too accustomed to stability), to support and adapt to the challenges facing the industry, and indeed Australia.
Expenses
Operating expenses (ex notables)Unsurprisingly given the inflationary environment, expenses rose again. They broke $20bn (ex notables) a year ago for the first time and surpassed $21bn for the half. The increase was primarily technology spend, which rose over 8% hoh, wages which rose with inflation, and small (~1,000, or ~60bps) decrease in FTE.
Expenses rose and total income was close to flat hoh, so naturally the expense-to-income ratio rose accordingly. At over 47%, it is back at the elevated levels of the pandemic. It fell dramatically thanks to rate rises which added +$5bn to income within 12 months. As the inflation which triggered those rises persists, cost pressures continue.
There is no doubt change is needed, and probably at a faster pace than in the past. The reasons are common across many banking markets across the world and are threefold:
Asset quality
Credit impairment expense (ex notables)Impairment expense down from $1.4bn in each of the prior halves to $1.2bn. The benign environment saw another fall in impaired assets, in the cost of new impairments, and a rise in write backs and recoveries.
Similarly to the credit expenses, the loss rate has fallen 1 bp from 9 to 8 bps. Recall that it had reached 41 bps in both halves in 2020. Gross impaired assets relative to GLAA also fell 1 bp hoh to 23 bps, having come down more than 40 percent from the 40 bps it reached in 2020.
As mentioned, the window for transformation is wide open. Fortunately, the strategic themes and imperatives are well known as we’ve explained in prior reports, with some additional emphasis added:
Address the squeeze on the core
Double down on digital
Meet coming tests of resilience and trust
Find new sources of value and growth.
For this report, we pay special attention to the need for new sources of value and growth. Finding them will require more than just strategic intent. It will require taking a fresh look at the customer offer, finding new ways to create value from data and being strategic (and judicious) about embedded finance
It will also require an appetite to be more active in addressing structural impediments to many of Australia’s critical needs. From housing to climate change to many things besides, there are opportunities to put capital to use that are not (yet) going to be as straightforward as simply making loans. It will be about making new markets rather than simply winning deals.
That may require a fundamentally new operating model. We call it ‘shallow in the stack, deep into relationships’, and it may be what's possible as technology continues to advance. We aren’t suggesting it's feasible now. It could easily be a decade away (or more). But planning for such a transition is something banks must start talking about today.
Balance sheet
Provision coverProvision cover broadly flat, with total provisions (up 2% to $21.3bn) rising with GLAA as credit conditions remain benign. Despite emerging signs of stress in specific segments often seen as 'early-warning' indicators, including unsecured consumer credit, early-vintage non-bank mortgages and parts of commercial real estate, these have been slowly building for two years now, with so-far no indication (yet) of broader contagion.
CET1 rose again as RWA (and asset risk weights) fell hoh while CET1 capital rose $0.2bn. T2 capital also increased $8bn.
Barry Trubridge
Partner, Customer Transformation and Financial Services Industry Lead, PwC Australia
Tel: +61 409 564 548