EY’s analysis shows profits hit hard as banks brace for more uncertainty

Australian banks have been hit hard by the unprecedented economic impact of the COVID-19 pandemic, with their reported half-year results painting a vivid picture of a sector bracing for even more uncertainty ahead.

According to EY analysis of the major banks’ 2020 half-year results, overall combined headline cash earnings decreased to about $5.3 billion (AUD 8.3 billion) this half – down by 42.6% from the same time last year – largely driven by a steep rise in impairment charges through the collective credit provision.

Analysis this period is made more difficult, given the Commonwealth Bank of Australia’s (CBA) half-year ended on 31 December 2019, before the impact of the pandemic started to be felt in the local market, making it an outlier for this reporting cycle.

For the three banks with 31 March half-year closes (ANZ, NAB and Westpac), however, the economic impact of the pandemic has already had a major impact on their results, despite only hitting during the tail end of the reporting period. Expected credit losses saw total impairment charges across the banks rise significantly to about $3.7 billion (AUD 5.73 billion) before tax, up by about $2.6 billion (AUD 3.98 billion) from the 2019 half-year. 

“Impairment charges have increased dramatically, driven by collective provisions, as the banks review potential future loan losses in the face of anticipated deteriorating conditions and a highly uncertain – and potentially bleak – economic outlook,” EY Oceania’s banking and capital markets leader Tim Dring said. “We are still in an interim period where the banks are not yet aware what the full extent of these losses will be. Many customers have taken advantage of repayment holidays, which makes determining the true scale of potential delinquencies hard to predict.”

Dring added, “But, with the cash rate set to remain at historical lows for a prolonged period and the economy in a sharp and possibly protracted decline, there is no doubt that the major banks face substantial earnings headwinds in an environment of unprecedented uncertainty.”

More pressure on revenue, capital and dividends

Net interest margins held up relatively well in the current reporting cycle, decreasing by an average of just 2 basis points from the 2019 half-year results, to 1.93%. An improvement in margin, however, is anticipated as banks reprice credit risk and start to see a potential easing of competition in both deposits and loans.

“Ultra-low interest rates and continuing uncertainty over the credit growth outlook point to the banks facing ongoing revenue compression,” Dring stated. “We’ve also seen lower earnings in recent periods putting pressure on capital generation and the banks’ ability to sustain elevated payout ratios. The banks are engaged in a delicate balancing act between the needs of shareholders – particularly retirees who may rely on dividend income – and maintaining capital.”

Dring also shared that the half-year cycle has seen a “combination of reduced and deferred dividends and issuance of capital” as banks prepare for the changing climate ahead.

Economic outlook remains uncertain

The world is in the middle of the biggest economic shock since the Great Depression. The global economy is projected to contract by 3% in 2020 and around 90% of economies are expected to record a fall in gross domestic product per capita growth. 

Locally, the Australian economy is expected to contract by 4% to 6% in 2020, and while growth is expected to bounce back next year, a U-shaped recovery is the most likely path.

“Australia may have avoided the last global recession, but we are unlikely to be so lucky this time. Unemployment is set to rise significantly, and we are likely to see a significant downturn in property prices in both the commercial and residential sectors through the remainder of 2020 and into 2021,” Dring said.

Adding, “Although the hit to the economy will be substantial, Australia does benefit from having strong balance sheets in the banking sector and the government, with the major banks remaining unquestionably strong. Still, the economic outlook – and therefore the pace and timing of economic recovery – remains highly uncertain and much will depend on when, and how, travel restrictions and social distancing are eased.”

Support for retail customers and SMEs

“Government and the banks are playing a critical role in supporting the local economy through the current crisis, both as a conduit for credit and liquidity flows to small-to-medium enterprises and in managing loan repayment deferral programs to mortgage holders and small businesses,” Dring shared.

According to the banking and capital markets leader, this is an “opportunity for the sector to redress at least some of the reputational damage of recent years.” It also brings risk, and banks face a “substantial challenge” in balancing the competing needs of their customers.

“Confronted with unprecedented conditions generated by the pandemic, they will have to make some difficult choices on credit decisioning and managing credit losses over the coming months,” Dring said.“Not all of the bank’s customers will recover from this crisis – driven by the surge in unemployment and reduced consumption – and the banks will be further tested on the trust equation based on how they work through defaulted loans and access collateral.”

Looking beyond the pandemic

Dring also said that Australia’s financial system is “resilient” with a well-capitalised banking system and with a strong liquidity position. “However, the outlook is more uncertain than ever and there is little doubt that the economic downturn, ultra-low interest rate environment and the likelihood of a rapid deterioration in asset quality will put further pressure on future revenues, profits and returns for the banks,” he said.

The major banks, according to Dring, responded well to the pandemic, saying, “In pivoting to remote work, banks have already discovered change can be implemented more quickly than imagined. As we look ahead, beyond the current pandemic, there are opportunities for banks to apply these learnings more broadly to help them transform for the next wave of banking, with a focus on greater operational resilience and agility, sustained productivity, and accelerated automation and digitisation.”

Re-disseminated by The Asian Banker

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