Major banks deliver record profits, but eyes quickly return to the horizon

Tuesday, 14 November 2023

Major banks deliver record profits, but eyes quickly return to the horizon

• Cash earnings hit a record $32.5bn, up $4bn (or 14%) from $28.5bn last year, driven by loan growth, margin expansion and the continued decline in notables

• However second half earnings were down 10% as a result of competition and slowing lending growth

• Net Interest Margin (NIM) increased significantly over the year, but declined in second half as competition forced the rate-bounce to be shorter and shallower for banks 

• Credit growth remained healthy for the year despite rate tightening, with the majors growing 5% for the year. 

• At 12%, bank Return on Equity is the highest in five years. 

• Credit impairment expense returned to a more ‘normal’ level of $2.8bn after four consecutive halves in which it was either a benefit (a ‘credit’) or negligible. 

• Credit provisions rose to $21bn against impaired assets of $7bn, signalling continued caution about the economic outlook. 

• Cost pressures were evident, with a 6% rise in operating expenses (annualised 7% hoh), appearing to show the lag effect of inflation across personnel and technology costs in particular

• Capital levels remained elevated, causing three of the banks to announce buy-back initiatives 

AUSTRALIA - A record breaking year for Australia’s major banks saw cash earnings soar to an unprecedented $32.5bn, eclipsing the record last set in 2017 ($31.2bn). This was due to the combination of healthy balance sheet growth and Net Interest Margin (NIM) uplift, with net interest income rising by a never-before-seen $9bn. As notable expenses continue to fall, the result could have been higher, if it weren’t for normalising levels of credit expense and inflationary impacts on costs. 

Credit impairment expense rose just under $3bn reflecting both lending growth and a modest level of deterioration in impaired or overdue loans, signalling the banks loan books are no longer ‘benign’ but remain healthy overall. Credit provisions rose $1.5bn to $21bn against currently impaired assets of $7.4bn - indicating the cautious economic outlook of the banks and capacity to absorb an economic downturn. 

Operating expenses rose over $2bn (5.7%) which was comparable to overall inflation for the year, though also reflects the lagged effects of a prior year of very high inflation, with consumer prices rising almost 2% every quarter. 

Return on Equity was also up 138bps on the year, to 12% - the highest in five years - but well-short of the 13.6% return recorded in FY17 when the last earnings record was hit. This is because average equity, at $272bn, is up $3bn on the year and $43bn more than in FY17 and is a likely rationale for the announced share buy-backs from three of the majors. 

PwC Australia’s analysis suggests that the record result reflects a ‘Goldilocks’ monetary tightening so far but that the second half confirms the challenging competitive reality of banking in Australia and external uncertainties remain high. Banking and Capital Markets Leader at PwC Australia, Sam Garland, warns that FY24 promises more uncertainty and will require vigilance and focus from the banks. 

“On the one hand, the worst fears about the economy and the impact on the banks have not yet come to pass. Credit growth remained healthy, if slowing, and households and businesses are under strain but appear to be, on average, coping. So far, so good.” Mr Garland said. 

“While credit expenses rose and there are increasing levels of impaired or overdue loans, this remains well within expectations and is some way short of a real spike. There is no guarantee this will continue of course and whether borrowers can continue to adjust to such a rapid increase in rates.” 

However the year taken as two halves shows that competition for loans and deposits in Australian banking tempered the earnings benefit of rising rates very quickly and that banks are feeling inflationary pressures in their cost base.

“The much-anticipated margin benefit of rising rates was smaller and cut-shorter by intense competition for lending and deposits. Despite a 400bps increase in cash rates from the start of the tightening, margins rose only 11bps for the year as a whole and actually fell 7bps in the second half as competition intensified,” Mr Garland said. 

“Costs also rose faster in the second half as the lag effect of inflation in personnel and technology flowed into the results. Given the significant ongoing investment required in technology, risk and regulation, it is no surprise that cost management will be high on all banks’ agendas.” 

Mr Garland also notes that strategic challenges remain and uncertainties exist in the external environment that will require vigilance and focus from the banks.

“There remains considerable uncertainty in the external environment. At home, there are questions whether the economy can sustain this ‘Goldilocks’ tightening and the impact on bank customers while globally, the geopolitical environment could impact economies worldwide,” he said. 

PwC Australia expects four key themes to dominate the short-medium term outlook as banks remain focused on the horizon and as longer term transitions in the economy, energy, fiscal spending and technology take place: 

1. Squeeze on the core - continued competitive pressure on margins, managing investment and cost trade-offs and the potential for a more dramatic increase in credit losses. 

2. Doubling down on digital - banks will need to diligently execute and capitalise on large-scale technology transformations that are well underway and increasing. This includes the exponential impact of developments in Generative Artificial Intelligence (G-AI)

3. New sources of value and growth - searching for sources of capital-light or cost-light income in the services offered and delivery model adopted 

4. Tests of resilience and trust - Most importantly, the critical role that banks will play in protecting and supporting their customers and meeting regulator expectations. From dealing with hardship, protection from fraud, cyber-security and system reliability. 

“Overall, Australia’s major banks are very well positioned in capital, provisions and franchises to absorb and respond to uncertainty and continue their focus on transformation for the future. These will require exceptional levels of vigilance and focus to ensure they can keep delivering,” Mr Garland said. 

To view the Banking Matters - Major Banks Analysis FY23, click here.