Maria Trinci

KPMG’s Major Australian Banks Full Year Analysis Report 2022 finds that the Majors reported a combined cash profit after tax from continuing operations of $28.5 billion, up 7.2% on FY21.

The Australian economy has continued its strong post-COVID recovery, with the impacts of the RBA’s seven successive interest rate rises since May 2022 yet to drive any material slowdown in business and consumer activity. As a result, the Majors have benefited from continued credit growth in their FY22 results.

Also behind the improved profit performance, we are starting to see the impact of rising interest rates, driving an increase in average net interest margin (NIM) of 3 basis points compared to 1H22. This is still however 9.5 basis points lower than in FY21, demonstrating that the benefit of rising interest rates is only just starting to flow through to bank profitability. This comes after over a decade of extremely low interest rates which have created prolonged pressure on the Majors’ margins, which are now beginning to rise from a low base.

However, there is a more challenging outlook for the Majors with inflation putting pressure on their cost bases and new provisions being taken for potential economic stress ahead.

The Majors have worked hard throughout the year to address their cost bases, however overall costs have increased only marginally, with the average across the Majors’ being 1.3%. All of the major banks have signalled that their cost targets will be either adjusted or abandoned as these inflationary pressures continue.

The average cost-to-income ratio decreased from 2021 by 30 basis points to 49.2%. A number of factors including continued regulatory compliance requirements, ongoing customer remediation (albeit declining) and increased labour and FTE costs are putting pressure on the overall cost to income ratios.

KPMG Banking Partner Maria Trinci added: “What will prove interesting is how the costs will play out, with inflation putting further pressure on the pace of transformation. With the backdrop of a tight labour market, competition for skilled resources will place pressure on staff costs as banks respond to attract and retain the right skill sets.”

Having recently weathered the pandemic from a credit perspective and written back a combined $925 million in provisions in FY22, the Majors have now returned to more normalised provisioning. While credit quality remains strong at this point with delinquencies at their lowest level since 2018, with interest rates anticipated to continue rising into 2023, the Majors are signalling a likely economic slowdown, increasing unemployment and falling house prices. These factors are expected to lead to raised provisions in the years ahead.

Of particular focus for the Majors and their mortgage books is the rolling over of a large volume of low fixed rate loans that were written during the COVID pandemic when residential valuations were at their peak. As these loans come up for refinancing, borrowers will be re-assessed at significantly higher interest rates, creating the potential for mortgage stress in some cases, which is expected to begin to materialise into mid-FY23 where $237 billion of loans are scheduled for roll-over across the Majors.

Balance sheet strength has remained a core focus for the Majors with average CET1 of 11.65%. This is down from 12.7% in FY21, however still above APRA’s ‘unquestionably strong’ benchmark.

Steve Jackson, KPMG Australia’s Head of Banking commented: “After over a decade of ultra low rates weighing on bank profitability, the recent rapid rises in interest rates are starting to provide some initial margin relief for the Majors.

However, the monetary policy tightening cycle is also introducing inflationary pressure which is working against the Majors’ efforts to reduce their cost bases and, depending on the pace and strength of rate rises, contributes to the potential for economic slowdown and a rise in bad debts.

Banks are signalling challenging times ahead for the economy and the big question is whether a ‘soft landing’ will be achieved that avoids the harsher potential outcomes.”

Key highlights of the results are as follows:

• The Majors reported a combined cash profit after tax from continuing operations of $28.5 billion for the year, an increase of 6.5 per cent on FY21 and an increase of 65 per cent on FY20. This result reflects strong growth in housing credit, with improved asset quality leading to reductions in provisions and increasing net interest margins compared with 1H22 on average across the four Majors.

• The average net interest margin (cash basis) increased by 3 basis points compared to 1H22, although it is 10 basis points lower than FY21. As such, the Majors’ FY22 results include early indications of the positive impact of increased interest rates.

• Cost-to-income ratios have decreased modestly from an average of 52.0 per cent in FY21 to 50.2 per cent. Excluding notable items, operating costs increased by 1.3 per cent to $39.2 billion, reflecting lower remediation and provisioning costs, although offset by an increase in personnel costs and investment spend.

• The average ratio of impaired loans continued to decrease in FY22, down 8 basis points from FY21 to 0.23 per cent. This is a result of a decline in delinquencies to the lowest levels since 2018, as well as a natural lag in the impact of interest rate increases on mortgage holders.

• The Majors continue to have strong capital buffers, although the average Common Equity Tier 1 (CET1) ratio decreased by 102 bps to 11.65 per cent. The strong capital position saw each Major announce share-buy backs totaling $14.0 billion during the year, in a move to deliver stronger returns to shareholders.

• Dividend pay-out ratios remained steady at 71.0 per cent, although this remains lower than FY19 of 81.3 per cent.

• Continued growth in earnings have seen Returns on Equity (ROE) increase by an average of 67 basis points compared with FY21 to 10.58 per cent, returning to the double-digit standards experienced prior to the pandemic. Maintaining shareholder returns in an inflationary environment will continue to challenge ROEs for the foreseeable future.

2022 saw growth across both housing (up 5.7 per cent on 2021) and non-housing lending (up 13.2 per cent on 2021). Much of this growth has been the result of strong increases in house prices in the first half of FY22 and the continued post-COVID economic recovery. The Majors are signalling they expect this growth to soften as we move into 2023.

“Now more than ever is the moment for the Majors to accelerate their digital transformation efforts, to reduce their reliance on (increasingly expensive) FTE and bring efficient, technology-enabled solutions to their core middle and back office processes, where much of the scale of their cost bases exist. The Majors will be striving to enter a potential economic contraction with strong credit quality, a lean cost base and a strong digital capability”, said Jackson.

The post Australian banking – the last calm before the storm: KPMG Major Australian Banks Full Year Analysis 2022 appeared first on AdviserVoice.

Steve Jackson

KPMG analysis has found that the Australian major banks (‘the Majors’) have reported improved profits and returns for the first half of the financial year 2022, despite ongoing pressure on their interest margins.

KPMG’s Major Australian Banks First Half Year Analysis Report 2022 finds that the Majors reported a combined cash profit after tax from continuing operations of $14.4 billion, up 5.1 per cent on 1H21.

After the disruptions of recent years, profits have almost returned to pre-COVID levels with cash profits after tax still slightly down 0.4 per cent on the 1H19 results from three years ago, signalling a relatively flat medium-term growth path. The increase in total operating income (on a cash basis), up 0.8 per cent on 1H21 and rising from $39.6 billion to $39.9 billion, has been a cause of the growth in cash profits. Off the back of this earnings growth, the Majors’ return on equity (ROE) has risen to 10.6 per cent from 10.4 per cent in FY21.

The underlying drivers of the Majors’ operating income growth have been the continued strong volumes in both mortgage and business lending. As Australia powered ahead in the first half of FY22, both areas saw continued high demand. The value of mortgage loans was up 2.5 per cent on 2H22, growing to $1,812 billion. At the same time, business lending grew 4.8 per cent in the last half year, to a figure of $1,077 billion.

Steve Jackson, KPMG Australia’s newly appointed Head of Banking and Capital Markets commented: “The major banks have successfully used the recovery of the Australian economy and the strong housing market performance to deliver improved financial results. With returns on equity in the sector now again restored to double digits but with uncertainty ahead, it will be interesting to see how they maintain their current momentum.”

As expected given the continued low interest rates (the RBA only just increased interest rates for the first time since November 2010), net interest margins (NIM) have continued to decrease and have acted as a drag on financial performance. For the majors, the average NIM dropped to 175 basis points, down 13 basis points from FY21. The industry-wide depressed NIMs have been the primary brake on the Majors’ profit growth.

Hessel Verbeek, KPMG’s Banking Strategy Lead, commented: “The market dynamic has been dominated by the NIM decrease resulting from low lending rates in a very competitive market and strong demand for low margin fixed rate mortgages. This downward pressure has only partially been offset by lower funding costs from near-zero deposit rates. The impacts of an extended period of low interest rates are deeply baked into net interest margins.”

In the context of both Australia’s COVID recovery and a higher inflation future (driven in part by the war in Ukraine), the story on loan loss provisions has changed from recent times. On a net basis, provisions of $218 million have been released during the period to bring overall provisioning closer to pre-COVID levels due to the strong performance of the economy.

Another interesting development has been the decrease in balance sheet strength, with the average CET1 ratio declining by 90 basis points to a still very strong 11.8 per cent. While in recent years the Majors have been shoring up their capital position through divestments and lower dividend pay-out ratios, this trend appears to have ended.

KPMG Banking Partner Maria Trinci added: “We may have reached an inflection point on balance sheet strength. This signals that the Majors have left the recent disruptions behind them, and are now charting a new course. They are starting to ‘draw down’ on the balance sheet ‘deposits’ they have been making since 2020.”

With strong operating income growth and lower margins, the third major profit lever is cost performance. As has been the case in recent years, the Majors have again struggled to structurally reduce costs. Total operating expenses across the Majors decreased by 1.0 per cent to $4.9 billion. As a result, the average cost-to-income ratio decreased from 2021 by 73 basis points to 49.6 per cent.

Hessel Verbeek added: “While the overall outcome has been an almost flat cost trajectory for the Majors, there are three things happening which are netting each other out. Inflation has driven up ‘run-the-bank’ costs, further growth and transformation costs have been added and meanwhile some cost reductions from efficiency programs have been realised. Unfortunately this means that the Majors are not on a path of significant sustainable cost improvements.”

Key highlights of the results are as follows:

• The Majors reported a combined cash profit after tax from continuing operations of $14.4 billion, up 5.1 per cent from the prior comparative period (PCP). This result reflects strong growth in lending and reductions in large one-off notables including remediation/regulatory and impairment expenses.
• The average net interest margin (cash basis) saw continued compression, decreasing 13 basis points from the first half of 2021 to 175 basis points. Declining margins were driven by low lending rates, a shift in the housing lending mix towards lower margin fixed rate lending and higher holdings of low-yielding treasury assets and.
• Cost-to-income ratios decreased modestly from an average of 50.3 per cent in HY21 to 49.6 per cent. The Majors reported a decrease in operating costs of 1 per cent to $19.7 billion, reflecting reductions in notable items, offset by higher staffing expenses in response to increased lending volumes, wage inflation, and increased investment in growth and productivity.
• Write-backs to aggregate loan impairment expenses of $218 million were driven by continued improvements in the economic outlook and strengthened asset quality. These releases were offset in part by targeted provisioning to capture potential downside in the evolving macro-environment and monetary policy changes.
• On average the Majors’ Common Equity Tier 1 (CET1) ratio decreased by 90 basis points to 11.8 per cent as all four of the Majors completed share buy-backs over the half and lending growth has driven higher Credit Risk-Weighted Asset (CRWA) usage. The Majors’ CET1 ratio still remains comfortably above APRA ‘unquestionably strong’ benchmark of 10.5 per cent.
• Dividend pay-out ratios increased to 66.0 per cent from 63.2 per cent in the prior comparative period.
• Higher earnings have seen Returns on equity (ROE) increase by 21 basis points from the PCP to 10.6 per cent, returning to the double-digit standards from before the pandemic.

Going forward, the RBA rate rise from 3 May signalled the end of a prolonged period of ultra-low interest rates. There is a general expectation that this will support a recovery of NIMs. The impact of interest rate increases will likely be tempered by continued strong competition for lending volumes, the recent peak volumes of fixed rate loans and the upcoming unwinding of the COVID-related cheap Term Funding Facility funding from the RBA. In addition, a combination of higher interest rates and high household debt levels will over time result in increased mortgage impairments.

“We expect to see the dual impacts of both net interest margin relief and higher levels of mortgage book stress, as RBA interest rates are expected to increase several times. However, these impacts will take their time to pull through as both margins and book quality have built up their momentum over a long period of low rates,” said Verbeek.

Read the full report.

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