The earnings of Australia’s four major banks are likely to fall further in the near term due to slowing credit growth, especially in the residential mortgage segment, and further remediation and compliance costs associated with inquiries into the financial sector, including the Royal Commission, says Fitch Ratings. The banks reported an aggregate decline in profitability in their latest full-year results.
Slower growth puts pressure on the banks to increase lending margins to maintain profitability. However, intense regulatory and public scrutiny of the sector, as well as strong competition, may make it difficult for the banks to reprice loans and pass on the recent increase in wholesale funding costs, as evidenced from the latest financial results. Net interest margins are therefore unlikely to improve in the short term.
The major banks made provisions for client remediation costs during the last financial year in response to the initial findings from the Royal Commission. Fitch expects some remediation costs to flow into the 2019 financial year as the banks continue to investigate previous behaviour. Meanwhile, compliance and regulatory costs to address shortcomings are likely to rise, despite the banks simplifying their business and product offerings. The banks also remain susceptible to fines and class actions as a result of the banking system inquiries.
The four major banks – Australia and New Zealand Banking Group (ANZ, AA-/Stable/aa-), Commonwealth Bank of Australia (CBA, AA-/Negative/aa-), National Australia Bank (NAB, AA-/Stable/aa-) and Westpac Banking Corporation (Westpac, AA-/Stable/aa-) – reported aggregated statutory full-year profit of AUD29.4 billion, a decrease of 0.8% from a year earlier, while cash net profit was down by 6.5%. CBA’s financial year ended June 2018, while ANZ’s, NAB’s and Westpac’s ended September 2018. The drop in aggregate profit was driven by slower lending growth, customer remediation charges and higher funding costs, especially in the second half of the financial year, as expected by Fitch. These pressures were partly offset by a benign operating environment that limited impairment expenses across the board.
All four banks reported lower or steady loan impairment charges during the reporting period. However, 90-day-plus past-due loans increased slightly, reflective of pressure on household finances from sluggish wage growth. Impairments are likely to rise from current historical lows due to the cooling housing market and high household leverage, which make households more susceptible to shocks from higher interest rates and unemployment. The ongoing tightening of banks’ risk appetites and underwriting standards should, however, support asset quality in the long term.
Common equity Tier 1 (CET1) ratios are broadly in line with the 10.5% threshold that regulators define as “unquestionably strong”. Banks have to achieve this level by 1 January 2020. ANZ reported a CET1 ratio of 11.4%, the highest of the major banks. ANZ is undertaking a share buyback and is likely to announce further capital management plans once it has received proceeds from recent divestments and asset sales. Westpac recorded a CET1 ratio of 10.6% and therefore already meets the new minimum requirement ahead of the deadline.
CBA reported a CET1 ratio of 10.1% at June 2018, which incorporates the AUD1 billion additional operational risk charge put in place following an independent prudential inquiry published in May 2018. However, this will translate to a pro forma CET1 ratio of 10.7% after already-announced divestments. NAB’s CET1 ratio is 10.2%, but we expect it to meet the 2020 deadline, with its capital position likely to be supported by an announced discounted dividend reinvestment plan and the potential sale of its MLC wealth-management business.
