The great bank bust begins

Via Banking Day:

The full year results of Australia’s big four banks show the negative effects of a low interest-rate environment on earnings, as the banks bunker down and brace for the full economic impact of the COVID-19 crisis to hit.

This is a common thread running between reports from two major professional services firms: Ernst and Young, and Deloitte, both released yesterday, after NAB had explained its 2019/20 profit announcement.

Their analyses of the four Australian major banks both showed combined cash earnings were A$17.4 billion, down $10.0 billion from the 2019 full year results, a decrease of 36.5 per cent.

“The bottom-line results were impacted by $6 billion of large, notable one-off items,” noted the report from Deloitte’s financial services practice.

“Even after stripping out these items, underlying cash profit from continuing operations declined by 22.6 per cent, highlighting the challenging outlook for the sector.”

EY also noted that this dip was largely due to increased collective provisioning, as the banks prepare for anticipated credit losses as a result of the downturn. Earnings were also impacted by revenue pressures associated with muted credit demand, record low interest rates and heightened mortgage competition.

The Deloitte report noted that the major banks’ funding structures have shifted from wholesale funding to more customer deposits and the Reserve Bank’s Term Funding Facility – established in March 2020 and expanded in September – to provide low-cost funding to authorised deposit-taking institutions.

“This is seen most clearly at CBA, with an 11 per cent increase, and ANZ with an 8 per cent increase in customer deposits. Overall, funding structures are now even more weighted to customer deposits, with 74 per cent of CBA’s, 65 per cent of Westpac’s, 61 per cent of ANZ’s and 57 per cent of NAB’s funding coming from customer deposits,” Deloitte reported.

“NAB drew down the full TFF Initial allowance amount of $14.3 billion, Westpac also drew down $17.9 billion and ANZ $12 billion of TFF facility provided by the RBA, as at 30 September. From its result in June, CBA had reported a draw down of $1.5 billion of its $19.1 billion initial allowance.”

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.

“Tackling costs remains one of the great challenges for the major banks, particularly in this lower for longer environment,” said Tim Dring, EY’s Oceania banking and capital markets leader.

“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.”

“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.”

Dring noted that household and business deposit flows combined with the RBA’s 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 remain under pressure from ultra-low interest rates, the banks holding more liquid assets and increased competition for home loans,” he said.

So far, realised losses and non-performing loans have remained low, while 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.

“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,” Dring said.

“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.”

“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,” Dring said.

At the peak of the crisis in June, repayments on approximately 500,000 mortgages, and more than 200,000 small business loans were paused, Deloitte reported.

This situation appears to be improving, though, with Australian Banking Association data showing almost 45 per cent of deferred mortgages are now back to normal and making regular repayments.

The share market appears happy to buy the banks on the yield play but without doubt it is a strategy of diminishing returns:

It’s the slow shuffle into zombie status and eath by nationalisation from here…

David Llewellyn-Smith
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