The full year results of Australia’s big four banks show significant pressure on earnings in a low interest-rate environment, as the banks bunker down and brace for the full economic impact of the COVID-19 crisis to hit, according to Ernst & Young (EY).
EY analysis of the Australian major banks’ 2020 full year results found their combined cash earnings decreased to $17.38 billion – down 36.5% from the same time last year – with this dip largely due to increased collective provisioning, as the banks prepare for anticipated credit losses as a result of the downturn.
Total impairment charges across the big four banks rose to $11.9 billion before tax, up $7.48 billion from the 2019 full year. Earnings were also impacted by revenue pressures associated with muted credit demand, record low interest rates and heightened mortgage competition.
EY Oceania Banking and Capital Markets Leader, Tim Dring said:
“The major banks continue to face earnings headwinds but, currently, their financial position remains sound due to strong capital and liquidity levels – with resilience further supported by the policy measures put in place to address COVID-19 stresses.”
“However, it really is a waiting game and the banks are bracing for impact, with the full effects of the economic downturn on asset quality yet to play out.
While the banks are preparing for portfolio distress, the true scale won’t be revealed until forbearance programs and income support measures draw to a planned close in the first quarter of the 2021 calendar year,” Mr Dring said.
At the same time, cost bases across the banks remain elevated, reflecting ongoing remediation, compliance and the continued investment in technology programs, and higher personnel costs as banks mobilised additional resourcing to help their customers through the initial stages of the pandemic.
These profitability constraints saw average ROE decline to 6.7%.
“Tackling costs remains one of the great challenges for the major banks, particularly in this lower for longer environment.
The banks are continuing to invest in technology, process automation, digitisation and process simplification and it will be these investments that, if well executed, should help them generate a reduced costs base,” Mr Dring said.
“We are also seeing a downward trend on average net interest margins, and further pressure is likely, particularly following this week’s rate cut by the RBA.
Household and business deposit flows combined with the Reserve Bank’s Term Funding Facility (TFF) have given the banks access to low cost funding and differential pricing is leading to wider margin spreads for higher risk lending.
However, margins do remain under pressure from ultra-low interest rates, the banks holding more liquid assets and increased competition for home loans.”
Defaults still low, but deterioration expected as support measures unwind
“Rather than v-shaped, it’s becoming increasingly likely we will see a prolonged global economic recovery period, particularly with the resurgence of further waves of the COVID-19 pandemic currently impacting the US and European economies.
In the face of this highly uncertain market outlook, the banks’ top priorities are managing credit risk and continuing the journey of process simplification and digitisation as a mechanism for controlling costs,” Mr Dring said.
“At this stage, the full impact of the economic downturn on asset quality for the Australian banks remains impossible to estimate with loan repayment deferrals, government income support and the temporary easing of loan loss recognition requirements obscuring the full extent of asset quality deterioration.”
“So far, realised losses and non-performing loans (NPLs) have remained low, however banks are anticipating higher loan losses and defaults as these relief measures are unwound and unemployment rises to its expected peak around June 2021.”
“Business insolvencies are also running at a much lower rate than usual, supported by the temporary relief measures introduced at the onset of the pandemic.
This is prompting concern over a possible jump in failed businesses once support measures are removed, with hospitality, arts and recreation and retail among the higher risk industries.”
A compassionate approach to collections needed
“The expected increase in customers entering financial difficulty as temporary pandemic support measures come to an end will create a significant challenge for the Australian banking sector in the near term.
Large numbers of customers are likely to need customised payment strategies and solutions, and this is forcing banks to rethink their collections model and scale their capabilities,” Mr Dring said.
“Banks will need to replace their traditional transactions-based approach to collections with a more customer-focused model, to create a better and more personalised experience for vulnerable consumers.”
“To make this work, banks will need to take a much more nuanced approach to measuring and monitoring credit risk. Predictive and high-frequency analytics will be essential to understanding individual customer’s probability of default.
In this way, banks can incentivise at risk customers to proactively reach out to them for a more tailored and effective service – at the same time building loyalty and improving recovery return rates.”
The way forward – rebuilding profitability
“The Australian banking sector remains resilient, but risks are clearly elevated in this challenging operating environment, brought about by the pandemic.
The economic downturn, dampened credit demand and significant asset quality risks are all weighing on the banks’ future revenues, profits and returns.”
“However, as we transition into the recovery phase, banks can still position themselves for future growth.
To help rebuild profitability in the wake of the COVID-19 crisis, we expect to see banks focused on improving their digital capabilities and developing more agile operating models that will enable them to deliver a better customer experience and create capacity to invest in further transformation,” Mr Dring said.