Low growth is the new normal for Australia's banks

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The big four banks just delivered combined annual cash profit of $29.6 billion, a decrease of 2.5% on last year, breaking a run of record profits since the GFC.

The results reflect a slowing of revenue momentum, a trend of softening profit growth, pressure on return on equity (ROE) and deterioration in asset quality, according to analysis by EY.

“While shareholders and markets expect the banks to focus on improving returns, external uncertainties are increasingly challenging their efforts to deliver sustainable growth and profit,” says Tim Dring, EY’s Oceania banking and capital markets leader.

“With no signs of the external pressures easing, this low growth environment may well be the new norm and the major banks are managing their businesses accordingly.

“Cost discipline and efficiency remain top strategic priorities, and we are seeing the banks ramp up efforts to explore and develop advanced technologies to deliver the next phase of efficiencies. We are also seeing the banks simplify and de-risk their business to optimise capital.”

The 2016 full year combined results at a glance:

  • $29.6 billion in cash profit, down from $30.4 billion in the 2015, a fall of 2.5%.
  • Net interest margin up an average of 1 basis point to 2.03%.
  • Average return on equity on a cash basis falls 194 basis points, to 13.8%.
  • 40.2% increase in bad debt expenses.
  • Average Tier 1 capital ratio increased to 11.9%.

“Revenue growth has slowed in the full year results, as competitive pressures, increased funding costs and slower credit growth take their toll,” says Dring.

“There has been particularly intense competition in the residential mortgage space, where banks face an ongoing challenge to balance margin against volume.”

At the same time, regulatory constraints on lending to property investors and foreign buyers, aimed at cooling property markets, have led the banks to impose stricter requirements.

Banks have also tightened standards for higher risk lending, including locations where asset quality shows deterioration.

Average ROE across the big four has declined to 13.8%, a trend that seems likely to continue in the absence of stronger economic growth or increased demand for credit.

“Softer revenues and higher capital requirements mean ROE is challenged on both the numerator and denominator,” Dring says.

“The banks have been under increased pressure to review dividend policies to support ROE and meet the new capital rules.

“In this environment, the elevated payout ratios of some of the banks may prove unsustainable,” Dring says. “Despite this, the banks are reluctant to reduce dividends, which have been a key driver of share price.”

Ian Pollari, KPMG’s National Head of Banking, says the banks will no doubt be re-visiting costs.

“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,” he says.

“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.

“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.”

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