As expected the COVID-19 pandemic, lockdowns, and the surge in unemployment and business problems whacked every measure at Australia’s big four banks in the year to September 30.
But because of the campaign by regulators, led by APRA and the Reserve bank over recent years for the banks to hold more capital via so-called ‘buffers’ the impact so far of the pandemic, higher loan losses and provisions and tightening interest margins, has been muted (see separate story on the NAB).
Reports on the big four’s 2019-20 performance from several leading analysts confirm the damage done.
KPMG’s Major Australian Banks Full Year Analysis Report 2020 found the big four reported a combined cash profit after tax from continuing operations of $17.4 billion, down a massive 36.6% on the previous year.
The 2019 total of $26.9 billion was down 7.8% on 2018.
The 2018-19 performance was all about the damage the revelations from the Hayne Royal Commission and the multi-billion dollar cost of fixing those and starting a remediation payment process for aggrieved customers – that continued into 2019-20.
The cost of those and the strength of the revelations saw the banks accelerate asset divestment plans for insurance, funds management, advisory and associated businesses that had started in 2016 and 2017. Billions of dollars were raised or were to come from staged sales.
So as the big banks started raising their eyes to a more distant future in the first two months of 2020 (and some analysts started talking about capital management moves, with the Commonwealth widely tipped to lead off with some sort of capital management plan) the COVID-19 pandemic hit and banking (and the Australian society and economy0 have been changed forever.
The pandemic and its fall out saw the banks significantly increased their loan loss provisions, while allowing customers to defer loan repayments Encouraged by regulators). So far their actual loss experience has been minimal.
KPMG asked the question in its survey yesterday “The open question is to what extent loan losses will materialise in 2021, as the Commonwealth Government unwinds its economic support measures.
The year to September FY2020 saw interest margins continue to tighten after the Reserve Bank cut the cash rate to 0.25%. That has now been cut to 0.10%, which will further crimp margins this financial year.
KPMG says “costs have remained stubbornly high and significant extraordinary items (customer remediation and regulatory charges) heavily influenced the full-year results.”
But the big banks have survived, as Ian Pollari, KPMG Australia’s Head of Banking commented in his firm’s report:
“Despite the substantial challenges, the Majors have proven resilient in the last year and through the strength of their balance sheets, played a critical role as shock absorbers for the economic downturn.”
He says that as the focus shifts to recovery, the banks will need tread carefully in extending liquidity or deferral measures to customers and remain vigilant in assessing the solvency of borrowers.
He also says that in the face of more customers migrating to digital channels (which has accelerated with the pandemic) and the significant cost opportunity in automating processes, the Majors will need to create financial and operational capacity to invest in the digitisation of their operations.
“The cost transformation challenge for the Majors requires them to accelerate the digitisation and automation of end-to-end processes, notwithstanding the persistently high levels of risk and compliance spend, “said Pollari.
KPMG said that despite the impact of the pandemic the banks total operating income (on a cash basis) fell 1.7% to $79.3 billion, “reflecting subdued lending conditions and an ongoing decline in margins. The Majors grew their mortgage books by a combined 1.6% in FY2020, with non-housing lending contracting by 3.4%.”
Cost-to-income ratios rose from an average of 47.2% to 53.2%, “in large part driven by customer remediation and higher IT-related expenses, which included increased costs associated with mobilising the workforce for remote working conditions and higher software amortisation charges. In addition, one of the Majors also reported significant extraordinary items relating to regulatory matters.”
“Credit quality has deteriorated as a result of the COVID-19 pandemic and continued uncertainty in the economic outlook, leading to an increase of 28 basis points in impairment charges as a percentage of gross loans and advances.
“As of year-end, the total Expected Credit Loss provision is $24.8 billion, and aggregated loan impairment expense has increased by 201% to $11.2 billion. This reflected both the impact of COVID-19, as well as a broader credit deterioration.”
In its report, EY said “The banks are already starting to see early signs of portfolio distress, but the full impact of the economic downturn on asset quality is yet to play out. Its scale will not be revealed until forbearance programs and income support measures which are planned to draw to a close in the first quarter of calendar 2021.”
But the banks are well capitalised – KPMG said the average Common Equity Tier 1 (CET1) capital ratio increased 59 basis points to 11.4%, driven by capital management initiatives including divestment of non-core businesses, dividend reinvestment plans, prudent dividend management as well as capital raisings by two of the Majors.
The major banks recorded an average net interest margin of 189 basis points (cash basis), down 5 basis points compared to the FY2019, “largely driven by repricing of both deposits and mortgage and business lending assets, amidst RBA rate cuts and increased competition in the market.”
And rising bad and doubtful debts, increasing capital and subdued growth saw their return on equity (ROE) continue to fall, decreasing by 458 basis points to an average of 6.7%.
“Mounting risks will continue to keep pressure on returns,” KPMG warned.
And EY said that in 2021 “In the face of the highly uncertain economic outlook, the banks’ top priorities are managing credit risk and continuing the journey of process simplification and digitisation as a mechanism for controlling costs.”
