Sam Garland

Key points

• Record cash earnings of $17b, up $3b on half, driven by net interest margin (NIM), trading income, strong cost management and non-recurrence of notables
• Return on equity (ROE) over 12.5% evokes returns of a prior era, sparked by same drivers as earnings, augmented by significant capital return over past two years
• NIM considerably increased, 10 bps hoh, however benefit was shorter and smaller than many anticipated – driven by fierce competition
• Other operating income (OOI) (ex notables) up 3% hoh, with $1b increase in trading income more than offsetting reductions in other areas due to sale of businesses
• Operating expenses tightly managed given inflation, inching toward $20b – there was a 2.7% increase hoh, less than overall inflation but still significant
• Expense-to-income (ex notables) decreased to 44%, a substantial fall, with the growth in interest and other income more than offsetting a well-managed increase in operating expenses
• Credit impairment expenses rose to over $1.4b, though this is still a less-than-average percentage of gross loans and advances (GLAs) than historic periods
• Seventh consecutive half of falling notable expenses for remediation (from record $2.8b in 2H19), and the third half in a row under $500m
• Lending growth smaller than normal (4.8% annualised) and falling, with a decline of 231 bps hoh

Australia’s major banks delivered record half year results and appear to be on track for a record full year 2023 result, with cash earnings of $17.1 billion in the first half of 2023, exceeding the previous half year peak of $15.8 billion in 2015. This growth was driven by a significant 14 bps increase in NIM, modest lending growth, large increases in trading income and notable expenses which fell to under $0.5 billion, over $1.3 billion less than the prior half.

Despite inflationary pressures, operating expenses rose only 2.7% half-on-half with a 7% rise in personnel costs offset by lower property and technology costs. Credit expenses remained low but more significant at $1.4 billion for the half. Provision levels now exceed $20 billion in anticipation of a difficult economic environment, with very limited loss experience to date.

However, this extraordinary earnings result was greeted with limited enthusiasm as it demonstrated the competitive reality of a simpler banking industry and the need for both discipline and diversification in the outlook.

Sam Garland, Banking and Capital Markets Leader at PwC Australia said, “With over $3.9 trillion in interest-earning assets, the recent NIM uptick has had a dramatic impact on bank income. However, given a 350 basis point increase in cash rates in the 10 months to March, that margin benefit has been shorter-lived and smaller than many anticipated – reflecting a highly competitive lending and deposit market.

“This is the reality of a much simpler set of banks – the base of income is now heavily focused in lending and deposits, which are extremely competitive and most banks described the NIM benefit as having peaked already. In the core business, the ability to continue controlling costs will therefore be key, as will the impact of a changing credit loss environment.”

Provisions for credit loss say more about the banks’ expectations than the experience they are seeing in borrowers today. At $20.6 billion they compare to gross impaired assets of $7 billion, illustrating both the lack of significant stress to date, but also the caution in the banks’ outlook.

Solid lending growth continued to boost net interest income which exceeded $37.5 billion in the first half of 2023, a rise of close to $4 billion half-on-half. This is $9 billion more than in 1H15, the last record for half year cash earnings. Underlying profit (ex notables) also rose $3.8 billion, the largest increase ever, and notable expenses, which averaged almost $3 billion per half in FY18-20, were under $0.5 billion.

“The good news for Australia’s major banks is that they appear to be arresting share loss, with last quarter’s lending growth rate approximating that of their nearest large competitors for the first time since pre-COVID.

“As for OOI, this increased again half-on-half, with a strong period of trading income returns more than offsetting continued decreases from sales of businesses. We see other sources of income as a key focus for the banks in the medium term given the tightening returns in the core business.”

Four key themes expected in the medium term requiring discipline and diversification

PwC Australia expects four key themes to play out in the medium term as a result of the economic, digital, energy and fiscal transitions Australia is experiencing, all of which will require commercial and execution discipline and some degree of diversification:

1. Squeeze on the core: continued competition, inflation pressure on costs and a more normal credit loss environment.
2. Doubling-down on digital: completing transitions to cloud and reaping the efficiency and change benefits while embarking on larger core transformations and exploring new technology such as AI, digital ID and developments in payments.
3. Diversification revisited: In response to a more simple, narrower base of earnings, there will be an inevitable review of the services and business lines that make up the bank – potentially leading to acquisitions and a renewed focus on innovation.
4. Resilience and reputation tests: From how the banks deliver for customers in need, through to investment in protecting customer’s data, against scams, cyber threats and a renewed regulatory focus following the events overseas, and new leadership in domestic regulators.

Mr Garland said these strategic themes arise in the context of a strong banking system and continued uncertainty, meaning decisions will be carefully taken.

“Overall, Australia’s major banks remain in terrific balance sheet and business model shape, with regulatory metrics well in the top quartile of international banks and businesses simple and focused. While this has led to a narrower base of earnings, it has also put our banks in a far stronger position to absorb volatility and explore new opportunities. The banks are likely to be extremely discerning of the risk/reward trade off in these decisions,” concluded Mr Garland.

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Sam Garland

Key points

• Cash earnings returned to pre-pandemic levels at $26.8b (from $17.4b last year), return on equity recovered to 9.9%.
• Adjustments to credit provisions provided a net benefit of $0.8b in FY21, a $12b improvement relative to last year ($11.2b expense).
• Credit provisions were $20.4b, down $2.9b yoy but still $4.1b higher than FY19.
• Notable items charge (pre-tax) fell to $3.4b for the year, down from $6.6b yoy.
• Net interest margin (NIM) decreased to 1.86% down 3bps.
• Non-interest income continued to decline, hitting $16.1b (down $1.0b yoy), its lowest level in over a decade.
• Expense-to-income excluding notable items rose to 48%, the highest in more than a decade, average FTE across the majors increased by over 6,000 (4.3%) to c.152,000 for the year.
• Lending grew by 3.8%, less than domestic system growth as non-majors increased share.
• Common equity Tier 1 (CET1) rose again to 12.6% (pre-dividends and buy-backs).

Cash earnings of Australia’s major banks rebounded to pre-pandemic levels in the full year 2021, as economic confidence continued to build with vaccination progress and reopenings. The stark reduction in uncertainty since a year ago reduced credit expense by $12 billion while expenses for remediation and restructuring, which have dominated bank results since 2018, reduced significantly, though not completely. This was despite a rise in operating expenses (excluding notables) as the banks added more than 6,000 additional people in the year to provide support through the pandemic, deal with increased lending volumes and bolster risk management.

As a result, cash earnings were $26.8 billion, up 53.7% and at a level almost identical to FY19 before the pandemic struck. This lifted industry return on equity to 9.9%. Due to these returns, as well as significantly increased levels of capital and provisions on their balance sheets, the banks were able to commit to returning $32.2 billion to shareholders ($18.7b dividends and $13.5b share buy backs).

Sam Garland, Banking and Capital Markets Leader at PwC Australia, said, “2020 was the year of uncertainty and concern, with credit provisions and capital built up to protect the balance sheet at significant cost to the results. In 2021, we’ve seen much of that reversed or adjusted as the impact of government support, economic improvement and vaccinations reduce uncertainty for now and return results to a more normal level.”

PwC Australia’s Major Banks Analysis Full Year 2021 revealed that as Australia begins to open up and look ahead, the banks are emerging strong into an environment of significant opportunity and profound change. Reputations and balance sheets have been reinforced as the banks supported their customers through uncertainty and they have continued to progress on customer experiences, remediation, simplification and technology transformations despite the circumstances of the pandemic. However, challenges remain as long-term pressures continue in the core business and the same trends presenting significant opportunities create profound threats.

Mr Garland said, “The big movements in bank results over the past few years have been driven by large charges for notable items like regulatory remediation and business divestment and, in 2020 and 2021, credit. Looking through all that reveals businesses that have delivered steady profitability, even as they have invested in strengthening their balance sheets, profoundly simplifying their businesses, supporting customers, transforming technology and addressing a large number of regulatory and reputational issues.

“However the combination of long-term headwinds in core business earnings, intensifying and broader competition and accelerating changes in the external environment means that the transformation can not stop there. It is a tremendously exciting but challenging period ahead for the banks.”

Shifting sands set stage for further transformation

While earnings rebounded significantly during the year, most of this was due to the $12 billion swing in credit costs and over $2.5 billion (post-tax) reduction in notable items charge, with several indicators of core business performance remaining lower relative to the past.

Mr Garland said that these long-term trends in results demonstrate why the banks have been investing so much in simplification and transformation. “The trends we’ve seen in core results for many years around margins, subdued lending growth and non-interest income continued through 2021 and competition is intensifying. This really reiterates why investments in technology and new services to transform customer experience is critical and why we’ve seen a flurry of announcements of acquisitions, new products and partnerships over the last year.

“Non-majors grew mortgage lending faster in absolute terms than three of the majors in 2021, we’ve recently seen a multi-billion dollar bank IPO and a buy-now-pay-later company is the subject of the largest acquisition in Australian history, by an international player with growth ambitions. The banks remain in an extremely strong position, but the market is changing.”

Given these pressures, costs are critical to maintaining sustainable results and the capacity to invest. Expense-to-income rose to 48% in FY21 (ex notables), the highest in over a decade, indicating the challenge ahead for the banks on the cost base.

Adding to the opportunity and challenge for the banks are significant changes in the economy, society and the industry that were gathering momentum before the pandemic and are now moving quickly – the shifting sands. These have huge business and purpose implications and present the impetus for the next phase of transformation for the banks.

Mr Garland said, “The banks will need to adapt to maximise the vast economic change and investment required for decarbonisation, the implications for them and their customers of the future of work and the mainstream adoption of digital currencies, decentralised finance and serious digital competitors. They’ll also need to help customers operate across increasingly fractured geopolitical relationships and consider carefully the societal implications of a k-shaped recovery and housing affordability on their customers.

“Taken individually, any one of these factors has significant implications for banks. Taken together at the same time is enormous, challenging but could be hugely rewarding.”

The measures agreed at COP26 alone will be the foundation for an expected $1-2 trillion worldwide in incremental global investment each and every year, at least to 2030 and likely beyond, according to the United Nations Climate Action report.^[1] The implications for banks in supporting this transition are clear and will require much more than just writing loans.

PwC Australia’s recent report^[2], What Workers Want: Winning the war for talent, showed that the balance of power has shifted from employer to employee. With greater bargaining power, workers are more readily changing jobs for better pay, benefits, and conditions. This has deep implications for the employee value proposition (EVP) for the banks themselves, as well as their customers’ workforces and cost structures.

Finally, the extent of technological change building in the financial system itself could have profound implications for how business is conducted and the position of banks in the system. Mr Garland added, “The potential of digital currency and decentralised infrastructure to transform the financial system and disintermediate incumbents is significant. While it is far from a fait accompli, it warrants close and open minded attention.”

Balance between rigour and speed

The majors are hard at work on priorities expected such as: technology simplification and transformation: rolling out new services; customer intimacy; uplifting culture; risk management practices and controls; compliance; customer outcomes; productivity; ESG; and, the balance sheet.

Mr Garland said, “Banks are complex things. It’s not just because of legacy systems and processes. It’s due to the very nature of who they are: institutions that sit at the heart of capitalism, intermediating between so many, and often, competing stakeholders, interests and objectives. Transforming such an enterprise, while simultaneously satisfying such a wide range of operational, regulatory, legal, and commercial requirements has never been easy.

“There is no bank not working hard on all of this now. The big question, of course, is whether they will move fast enough – and carefully enough – and how much of the opportunity will be seized by others while they work through this balance.

In the coming months and years, we will be paying attention to the way the major banks balance ambition, rigour and speed,” concluded Mr Garland.

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[1] https://www.un.org/en/climatechange/raising-ambition/climate-finance
[2] https://www.pwc.com.au/important-problems/future-of-work-design-for-the-future/what-workers-want-winning-the-war-for-talent.html

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