Something will have to give. Interest rate cuts, like we got yesterday from the Reserve Bank can only work so far in boosting bank incomes. Our big banks are starting to run into headwinds and investors have been warned – by the head of the ANZ no less.
In fact after yesterday’s rate cut, it would be foolish for banks and shareholders to factor in any further reductions. The wording of the RBA statement makes that clear.
Despite the uncertain outlook, the ANZ chief Mike Smith says the bank will meet its commitment to significantly lift shareholder returns over the next 18 months, in spite of admitting that the outlook for banking is looking tougher than it has for years.
Mr Smith said in the earnings announcement yesterday morning that for the foreseeable future, the bank “will be operating in a lower growth environment in which there will continue to be occasional volatility and shocks."
“Nevertheless, the outlook for credit quality remains relatively benign supported by low interest rates, the stimulus of a low oil price and an appreciating US dollar."
And yet he was quoted on the bank’s Blue Notes website as saying that the bank will continue to try and boost return on equity and maintain payouts to shareholders at the high end of the range of 65% to 70% of earnings.
The ANZ has a target return on equity figure of 16% by the 2016 results – but it fell by 0.80 of a percentage point to 14.7%, from 15.5% a year ago (too many comparisons were made by the banks and business media with the final half of 2013-14 (not the first quarter, which is the more accurate basis for comparison).
On Monday Westpac (WBC) saw reported ROE of 15.8%, down 67 points (or 0.67 of a percentage point).
The ANZ’s cash net interest margin fell to 2.04%, from 2.15% and its cost to income ratio rose to 45.1% from 44.3%. Westpac by the way saw a fall in its cash net interest margin to 2.05% from 2.11% and a worsening in its cost to income ratio, which rose to 41.5% from 40.0%.
The ANZ’s Mr Smith yesterday conceded the 2016 target, which he announced in 2013, had become harder to hit because of the lower growth outlook.
Cuts on official interest rates will help (they will lower impaired assets and help stressed borrowers), but that help is getting to the end of its usefulness and it could be that any lending splurge triggered in housing (for example) results in a rise in bad debts and impaired assets over time.
The net interest margins are being driven lower by rising competition in home lending, and falling interest rates. The weaker Australian dollar though has added to the cost of wholesale funds raised offshore (around 0.5% according to Mr Smith).
As well, the big banks will be forced to raise more capital and leave it on their balance sheet (lowering their leverage), hence the decisions by both Westpac and the ANZ to restart discounted dividend reinvestment plans this week. They are aimed at raising more capital ahead of regulators telling the banks to do so.
Mr Smith indicated the bank would sell assets and focus on businesses that are less capital intensive and more fee based, such as cash management or foreign exchange.
"Businesses that are not core to strategy we are looking to sell. And some of those will happen during the year," he said.
On Monday ANZ confirmed it planned to sell $8.3 billion of assets in its Esanda Dealer Finance unit, and last month it was reported the bank had resumed talks to sell its 39% holding in Indonesian lender Panin Bank.
On top of this watch for cost cutting in the bank’s back offices and technology and a consolidation of branches and processing operations.
And Westpac’s poor profit result on Monday saw Goldman Sachs and Morgan Stanley downgrading the bank, and casting doubt on the future profitability of the sector.
Credit Suisse maintained its underperform rating but added that Westpac’s result – coupled with ANZ’s flat result on Tuesday – could lead to the entire banking sector being re-rated.
Goldman Sachs downgraded Westpac from buy to neutral and Morgan Stanley from equal-weight to underweight on the back of the interim result in which Westpac announced a flat cash profit of $3.78 billion in the six months to March 31.
