According to Fitch Ratings, the operating profit of Australia’s four major banks is likely to come under further pressure in the next 12 months, as stress emanating from the mining and apartment-building sectors continues to undermine asset quality, says Fitch Ratings. However, Australian banks are still likely to remain highly profitable compared with their international peers, and are in a strong position to cope with capital pressures that might result from upcoming regulatory changes.
The four major banks – Australia and New Zealand Banking Group (ANZ), Commonwealth Bank of Australia (CBA), National Australia Bank (NAB) and Westpac Banking (WBC) – posted the first drop in their combined pre-tax profit in eight years in the financial year 2016 (FY16). Pre-tax profit fell to AUD41bn (USD32bn), 7% lower than FY15. Profit was hit by a 36% increase in loan-impairment charges – albeit from a cyclical low – which reflected problems in the resources sector and its knock-on effects for businesses and households in mining areas. CBA was the only one to report pre-tax profit growth, of 2%. ANZ’s pre-tax profit dropped the most, by 22%, largely owing to restructuring costs and valuation adjustments. Further restructuring costs are likely in FY17, as ANZ says it is refocusing on the Australia and New Zealand market, and its profitable Asian institutional business. Restructuring costs also weighed on NAB’s pre-tax profit, but the sale of its UK business and partial sale of its life insurance operations are now completed and will not affect FY17 results.
Fitch expects Australia’s banks to face a weak operating environment again in FY17. Net interest margins are likely to be squeezed further by higher wholesale funding costs, and tougher loan and deposit competition. Falling mining investment and weaker employment in the resources sector will continue to weigh on the performance of banks’ mining sector exposure, despite the recovery of some commodity prices this year. Increased technology expenses and compliance costs will undermine efforts at cost management.
Property developers may also soon start experiencing problems settling agreed apartment sales, which may feed through to banks over the next 18 months. The decision by the four major banks earlier this year to stop lending to non-resident property investors means the latter are now likely to find it harder to source finance to complete agreed purchases, and may back out of deals.
Australia’s major banks are in a good position to cope with the weaker conditions, in our view, as their balance sheets are robust. All banks have issued additional common equity in the last 18 months to boost capital buffers in response to regulatory changes. Even with a drop in profitability they have the flexibility to meet increases in capital requirements that might come with the introduction of Basel IV or changes to the Australian Prudential Regulation Authority’s guidelines.
Moreover, their direct exposure to the mining and property development sectors is relatively small and manageable. Asset quality is likely to remain relatively strong in the absence of broader problems in the mortgage market, which dominates banks’ balance sheets.
High underemployment appears to be creating stress for some mortgage borrowers – arrears have risen over the last year, albeit to a still-low 1.14% of total mortgages. Moreover, high debt levels make households vulnerable to a rise in interest rates or further deterioration in the labour market. However, Fitch does not expect the Reserve Bank of Australia to start raising its cash rate until 2018, and the unemployment rate is likely to remain stable. Improvements in banks’ underwriting standards since mid-2015 should also provide a cushion, especially since the sharp increase in property prices since then has boosted the equity of earlier home buyers.
