Slowing growth, rising capital drive banks’ ROE decline

Slow growth, rising capital drive banks’ ROE decline

Trading-off risk, capital and earnings growth key for future performance, finds KPMG Major Australian Banks Full Year 2016 Results Analysis.

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Australia’s major banks (‘the majors’) have reported a fall in aggregate profits for 2016 driven by a sluggish economic environment, slowing revenue growth and continued downward pressure on margins. KPMG’s Major Australian Banks Full Year 2016 Analysis Report finds that the majors reported a cash profit after tax of $29.6 billion for the 2016 full year, down 2.5 percent compared to 2015, in the face of rising bad and doubtful debts changes, and higher liquidity and capital requirements.

Ian Pollari, KPMG’s National Head of Banking commented: “Persistently challenging market conditions, rising regulatory capital, increasing loan impairments and margin compression are all combining to put downward pressure on industry returns.”

“Against a fairly subdued economic backdrop, with regulatory capital a constant deadweight, the majors will no doubt be re-visiting their revenue and cost productivity targets and capital efficiency efforts to preserve their current levels of profitability and sustainability of dividends,” he added.

The majors recorded net interest income growth, increasing by 5.5 percent to $60.3 billion in the year, while non-interest income fell by 3.1 percent to $23.5 billion, mainly due to weaker wealth management and markets income.

The majors have continued to experience margin erosion, recording an average net interest margin of 202 basis points (cash basis), down 0.8 basis points compared to 2015. They have found it increasingly difficult to preserve their margins through mortgage re-pricing, offset by higher wholesale funding costs, holdings of liquid assets and a falling interest rate environment.

Balance sheet momentum continues to slow, with housing credit growing by 4.2 percent and non-housing credit growth of 0.2 percent.

Andrew Yates, KPMG Partner, Financial Services commented: “With relatively weak demand for credit, the majors recorded more modest levels of lending growth, which has enabled them to meet a large proportion of their funding requirements from customer deposits.”

Despite the record low interest rate environment, difficult market conditions in parts of the economy have seen the major banks’ aggregate charge for bad and doubtful debts increase by $1.4 billion to $5.1 billion over the year (up 39 percent on FY15).

“While asset quality has broadly remained sound for the majors, rising loan impairments have continued to increase and are most prominent in sectors exposed to the resources and manufacturing industries. In a low growth environment, the majors’ management teams will need to maintain a balanced focus on pricing for risk and debt serviceability,” he said.

The majors’ capital position continued to strengthen, with their average Common Equity Tier 1 (CET1) capital ratio rising by 28 basis points over the year to 9.9 percent of risk-weighted assets (RWAs), reflecting local regulator expectations for the majors to achieve “unquestionably strong” capital levels, compared to international bank peers.

Andrew Dickinson, KPMG Partner, Financial Services noted the impact of significantly increased regulatory capital requirements saw the majors’ EPS and returns on equity falling. Average basic earnings per share (cash basis) was down from 328.8 to 309.6 per share and ROE fell by 194 basis points to an average ROE of 13.8 percent for the year.

“With all of the public commentary over the majors’ high levels of profitability, you need to take a step back and assess this profitability in light of the major’s ROEs which have fallen considerably since the GFC,” he said.

The average cost-to-income ratio increased by 116 bps across the majors to an average of 44.1 percent. The majors have seen their expense growth driven primarily by regulatory compliance obligations and the need to enhance their technology and digital capabilities.

“The majors’ ability to identify cost take-out opportunities that can be realised in the short-to-medium term - without compromising revenue growth prospects - will be critical. Importantly, these efficiency efforts are needed to create the financial capacity to invest in their customer and digital agendas,” Mr Dickinson added.

Mr Pollari concluded: “Looking ahead, it is inevitable that the majors will continue to refine their business models, being much more selective on which markets, products and customer segments to serve and those they may seek to pursue with a different approach - or exit altogether. Effectively balancing the trade-offs between risk, capital and earnings growth will dictate future performance.”

Major Australian Banks: Full Year 2016 Results Analysis

KPMG's analysis of the major Australian banks' full year financial results.

 
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Further information

Kristin Silva
Head of Communications, KPMG
T: 02 9335 8562 / 0411 110 953
E: ksilva@kpmg.com.au
 

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