The half year results of Australia’s big four banks have been buoyed by a faster and stronger than expected economic recovery, although earnings and profits remain under pressure according to Ernst & Young Australia (EY) analysis.
The EY review of the Australian major banks’ 2021 half year results shows an improvement in combined cash earnings, which are up 62% from the same time last year to $13.8 billion, following significant credit provisioning undertaken in the first half of 2020.
At the same time, organic capital generation and a reduction in Risk Weighted Assets (RWA) have further strengthened the banks’ capital position, ensuring they have substantial buffers against potential future shocks.
But headwinds for the sector remain.
Net interest margin declined 6 basis points from the prior comparative period to 1.87% and is expected to remain an ongoing challenge for the banks over the medium term, with a shift in asset mix towards lower-margin fixed rate mortgages adding additional pressure.
Average return on equity improved, 10.4% from 6.5% in the comparative period.
EY Oceania Banking and Capital Markets Leader, Tim Dring said: “The Australian major banks’ half year results reflect a more positive operating environment than might have been expected this time last year.”
“Fears of large-scale defaults on housing and business debt have begun to ease and, while the banks still face an increase in non-performing loans as a result of the economic downturn, it appears at this stage that the rise will be more modest than anticipated.”
“Despite the stronger economic outlook though, risks remain elevated and the banks will need to ensure they stay the course while navigating an environment of ultra-low interest rates and aggressive mortgage competition.”
“The full impact of the economic downturn on asset quality is also still playing out, with forbearance programs and income support measures only recently drawing to a close.”
“Added to this is the uncertainty that remains around the potential impact of further domestic COVID-19 outbreaks, new variants of the virus and a delayed vaccination roll out that could prolong the pandemic and slow down the economic recovery,” Mr Dring said.
Flush with capital, focused on costs
Divestment benefits, lower levels of RWAs, lower dividends and the impact of APRA’s concessional capital treatment of repayment-deferred loans drove solid improvements in banks’ capital positions in the 2021 half year.
“Having shored up their balance sheets in anticipation of a wave of loan defaults which have not, yet, eventuated, the banks are flush with capital,” Mr Dring said.
“All banks have increased their CET1 ratios, well above prudential minimum requirements, and upcoming asset sales are expected to further support banks’ capital positions.”
“Operating costs generally declined for most of the banks this half, there are however ongoing remediation programs and the need for accelerated technology investment to enhance digital capabilities and continue to innovate for future growth and further cost reduction.”
“With earnings growth and margins remaining under pressure, reducing costs and increasing productivity is an imperative for the banks.”
“They are continuing efforts to tighten their cost bases and increase efficiencies, by focusing on simplification of their businesses and re-engineering processes.”
Reducing ‘time to yes’ and ‘time to cash’
Housing loans have underpinned credit growth for the banks, with new home loan commitments reaching record high levels – although the major banks have grown below system amid a fiercely competitive market.
Mortgage growth has been largely driven by lending to owner-occupiers, including first home buyers taking advantage of government incentives and low interest rates.
As the economy recovers, some banks have noted signs of a pick-up in business lending.
Small businesses are reporting that access to finance remains challenging with banks taking a cautious approach and focusing on the more profitable customers and sectors which are likely to see good growth as the economy recovers.
“The pandemic highlighted the need for more efficient and flexible lending models, with some banks facing challenges evaluating and processing larger volumes of mortgage loans and refinancing applications as housing credit activity has soared,” Mr Dring said.
“In response, the banks have been focused on reducing the ‘time to yes’ and ‘time to cash’, investing heavily in their systems to streamline processes, including compliance with responsible lending requirements.”
“This has led to improved home loan approval times over recent months and enabled the banks that were losing ground to regain some momentum.”
“Looking ahead, the banks have a real opportunity to build on these initial changes and accelerate the transformation of their lending operations.”
“Tech-enabled processes and data-driven decision-making will drive the development of smarter lending models and, rather than confining their role to conventional mortgage servicing, banks can make smarter use of the data they already have to target customers with more personalised propositions that will help retain and grow their customer base.”
Prioritising the sustainability agenda
“The COVID-19 pandemic has also reinforced a focus on sustainability as a means towards resilient recovery. This is more than just a reputational imperative.”
“Investors and customers are increasingly using environmental, social and governance (ESG) metrics to determine a business’s value, considering not only its resiliency against short-terms shocks, but also how its purpose aligns to long-term value creation.”
“So, while this was already on the banks’ agendas, we can expect to see it moving even higher up the priority list post-pandemic.”
“Meeting consumer and regulatory expectations in this space will require the banks to build stronger connections between financial and non-financial performance.”
“They will need to identify not just risks, but also new opportunities presented by ESG, notably in sustainable finance. Greater consistency and transparency in reporting on how progress is being made will also be important.”
“The pandemic has presented Australia’s banks with a unique opportunity to really accelerate their transformation journeys and cultivate the type of innovation that will help them build a more successful and sustainable future for the sector.”
“To do this though, they will need to increase their focus on resilience, strategic cost management and enhanced customer-centricity, while navigating a still unfolding post-crisis environment,” Mr Dring said.