KPMG analysis finds 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 percent 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 percent 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 percent 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 percent from 10.4 percent 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 percent on 2H21, growing to $1,812 billion. At the same time, business lending grew 4.8 percent 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 percent. 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 percent to $4.9 billion. As a result, the average cost-to-income ratio decreased from 2021 by 73 basis points to 49.6 percent.
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 percent 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.
- Cost-to-income ratios decreased modestly from an average of 50.3 percent in HY21 to 49.6 percent. The Majors reported a decrease in operating costs of 1 percent 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 percent 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 percent.
- Dividend pay-out ratios increased to 66.0 percent from 63.2 percent in the prior comparative period.
- Higher earnings have seen Returns on equity (ROE) increase by 21 basis points from the PCP to 10.6 percent, 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.
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