Australia’s Major Banks Face Earnings Pressure in FY18

Fitch Ratings expects Australia’s four major banks to face earnings pressure from higher impairment charges and lower revenue growth in their 2018 financial year, with cost control to remain an important focus. This follows the banks’ solid results for the 2017 financial year, supported by robust net interest margins and strong asset quality.

Australia and New Zealand Banking Group Limited (AA-/Stable), Commonwealth Bank of Australia (AA-/Stable), National Australia Bank Limited (AA-/Stable) and Westpac Banking Corporation (AA-/Stable) reported total statutory net profit after tax of AUD29.6 billion in FYE17 (up 30.3% compared with FYE16, which included National Australia Bank’s one-off losses on the sale and demerger of subsidiaries, or 6.4% higher based on cash net profit after tax).

Net interest margins held up well during the year despite strong competition for both retail deposits and loans. The major banks benefitted from asset repricing in the second half of the year largely in response to the Australian Prudential Regulation Authority’s (APRA) announced additional macro-prudential limits on mortgages in March 2017 (for more details, see Fitch: Further Regulatory Tightening Possible in Australia, dated 31 March 2017). Volume growth held up reasonably well during the year, which supported revenue growth, although this is likely to slow through the next financial year.

All four major banks reported lower impairment charges and a reduction in impaired assets (apart from a small uptick for Commonwealth Bank of Australia) relative to recent years, which also supported operating profits. Fitch expects the current impairment levels to be close to the peak of the asset quality cycle, with impairments likely to increase in FY18. Mortgage arrears have increased modestly from low bases in most markets – Western Australia has had more noticeable deterioration – and we expect this trend to continue in FY18 due in part to continued low wage growth and an increase in interest rates for some types of mortgages. However, interest rates in general are likely to remain low and we do not think unemployment will increase so any increase in mortgage arrears is likely to be modest and manageable.

The banks highlighted an ongoing focus on cost management, efficiency improvements, and investment, including in their IT systems and digital distribution, and regulatory changes in their FY17 results announcements. National Australia Bank especially flagged a significant increase in digital investment of AUD1.5 billion over three years to enhance its technology and customer experience. Rising investments and a focus on cost reduction to improve profitability will be a challenge for the major banks in the coming years. The banks are likely to face pressure on their profitability in the short term, although in the longer term these measures should improve efficiency. Conduct related charges may also have a negative impact on future costs.

Common equity Tier 1 (CET1) ratios are broadly at the regulator’s definition of “unquestionably strong” levels well ahead of the 2020 deadline. The CET1 ratios of National Australia Bank and Commonwealth Bank of Australia lag the other two major banks, but Fitch expects both to get to the minimum levels through internal capital generation, and, in the case of Commonwealth Bank of Australia, the sale of its life insurance business. Fitch is awaiting further clarification from APRA on how the “unquestionably strong” capital levels will be implemented, with the regulator likely to provide details by the end of this calendar year.

Author: Martin North

Martin North is the Principal of Digital Finance Analytics

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