Higher levels of impairment and new regulatory requirements have seen the Australian major banks (‘the majors’) report a fall in aggregate profits for the first half of 2016. KPMG’s Major Australian Banks Half Year Analysis Report 2015-16 finds that the majors reported a cash profit after tax of AU$14.8 billion for the 2016 half year, down 3 percent (compared to the first half of 2015), in the face of increasing non-performing loans and higher liquidity and capital requirements.
Ian Pollari, KPMG’s National Head of Banking commented: “Difficult economic and market conditions, coupled with the continued upward trajectory of regulatory capital are now starting to bite for the majors, underpinning a softer half year result.”
“The benign credit environment of recent years has begun to deteriorate and could restrain future earnings. However, credit problems are mostly restricted to a handful of institutional credits. Given credit’s cyclical nature, it is inevitable that loan impairments would eventually start to rise. What has been a positive driver of results for the industry over recent years is now becoming a slight headwind,” Mr Pollari added.
The majors recorded net interest income growth, increasing by 7 percent to AU$30.2 billion in the first half, while non-interest income fell by 3 percent to AU$12.1 billion, mainly due to weaker wealth management and markets income.
The majors have been able to preserve their margins primarily through mortgage re-pricing, offset by higher wholesale funding costs, holdings of liquid assets and the prevailing low interest rate environment. The major banks recorded an average net interest margin of 204 basis points (cash basis), up one basis point compared to the second half of 2015.
Balance sheet momentum slowed in the first half, with housing credit growth of 3.4 percent and non-housing credit flat, rising 0.1 percent.
Mr Pollari added: “In a subdued economic environment, the majors recorded more modest levels of lending and deposit growth, which has enabled them to satisfy a significant proportion of their funding requirements from customer deposits.”
Notwithstanding the record low interest rate environment and a further easing announced by the Reserve Bank of Australia earlier this week, challenging market conditions in the mining and resources sector, as well as single name institutional exposures, have seen asset quality deteriorate. The major banks’ aggregate charge for bad and doubtful debts increased AU$834 million to AU$2.5 billion in the first half (up 49 percent on 1H15).
Andrew Dickinson, KPMG Partner, Financial Services said: “Continued discipline on pricing, debt serviceability and loan to value ratios will be important to ensure the major banks’ credit quality is maintained, particularly if unemployment quickly rises and the housing market sees a more abrupt correction in the future.”
The majors’ capital position continued to strengthen, with their aggregate Common Equity Tier 1 (CET1) capital ratio rising by 43 basis points over the first half to 10.1 percent of risk-weighted assets (RWAs), reflecting the impact of increased regulatory capital requirements.
Mr Dickinson noted the impact of significantly increased regulatory capital requirements, which saw the majors’ returns on equity falling by 153 basis points to an average ROE of 13.8 percent for the half year. This compares to ten years ago when the majors had an average ROE in excess of 20 percent, reflecting the impact of increasing levels of capital over an extended period.
“Industry returns are now bearing the brunt of increasing regulatory capital buffers over the past few years and are set to continue, putting further pressure on the banks’ ability to grow and on cost management,” he said. “It will also inform their strategic decision-making around what businesses they wish to be in over the medium-to-longer term, exiting low growth, low return and capital intensive products and markets,” Mr Dickinson added.
The average cost-to-income ratio increased by 194 bps across the majors to an average of 44.6 percent. The relatively faster growth of operating expenses compared to revenues can be directly attributed to the need for banks to continue to invest in meeting regulatory compliance obligations and enhancing their digital capabilities.
Mr Pollari concluded: “Looking ahead, an operating environment which foresees a combination of further increasing capital levels, rising loan losses, weaker demand for credit and continued downward pressure on returns will force the majors heighten their focus on productivity and capital efficiency measures.”
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We examine the Half Year 2016 results of the Australian major banks, with reported combined cash earnings of $14.8 billion for the half year.