3 tough questions for Australia's big banks to answer during next week's reporting season

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  • Three of Australia’s big four banks are about to present full-year earnings, starting with ANZ next Wednesday.
  • Ahead of the results, UBS said analysts will be focused on getting clarity from the banks on a number of challenges facing the sector.
  • The UBS team highlighted three key questions concerning lending standards and customer remediation costs.

Earnings season for three of Australia’s big four banks kicks off next Wednesday, when ANZ presents its annual report.

NAB will be next up on Thursday, November 1, then Westpac the following Monday. All three banks have a financial year-end of September 30 (CBA’s year-end is March 31).

Given all the headwinds facing the sector, the results are sure to get plenty of attention.

Shares in the big banks have lost around 15% this year amid a laundry list of negative catalysts: the fallout from the Hayne royal commission, higher funding costs, and a slowdown in credit growth amid increased regulatory scrutiny.

And those are the areas where the UBS banking team expects the market will focus, as opposed to specific questions on each bank’s individual business.

UBS analysts Jon Mott, Rachel Finn and Karyn Cao highlighted three key questions for the banks to address:

1. Household Expenditure Measure (HEM)

The HEM benchmark is used by banks to calculate the estimated living expenses of mortgage applicants before approving home loans.

It’s been in focus since November last year, when bank regulator APRA expressed concern that banks were overly reliant on HEM. And research from UBS in April indicated it may be leading to material inaccuracies.

The interim report from the Royal Commission made no formal recommendations on loan assessment practices. However, UBS said Commissioner Hayne has clearly taken an interest in responsible lending standards.

The commission’s final report is scheduled for February next year, but UBS wonders whether the big banks will try and “get ahead” next week by “abandoning the HEM benchmark and moving to full expense verification”.

2. Debt-to-income limits

Another key question heading into next week’s results is whether the big banks take the opportunity to clarify their definition of “very high” debt-to-income (DTI) levels.

Back in April, APRA removed its annual 10% cap on investor credit growth, but it also added another requirement: banks will be expected to develop internal limits for borrowers who have “very high” DTIs.

DTI differs from loan-to-income (LTI), in that it includes the total debt of a prospective borrower — not just the specific loan.

JP Morgan economist Ben Jarman said at the time that the new limits were a “significant” development which would have a “meaningful impact on credit growth”.

For example, APRA’s Targeted Review released by the royal commission showed 49% of Westpac’s loan book had DTI ratios of six-times or higher.

In view of that, analysts will be keenly on the lookout for any guidance from the banks on DTI limits next week.

3. Customer remediation

Ahead of reporting season, ANZ and Westpac have both flagged big provisions relating to customer remediation costs related to misconduct in their wealth management divisions.

And recent research from Morgan Stanley said those 2018 write-downs may just be the “calm before the storm“.

MS now expects additional remediation costs in the 2019 and 2020 financial years to reach almost $3 billion.

So UBS thinks the market will take some interest in what kind of guidance the banks offer on remediation costs. And importantly, whether those changes will affect their ability to pay dividends.

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