Tuesday, 26 October 2021

Sector repositions for recovery as pandemic constrains profitability and asset growth

Challenging operating conditions dampen consumer sentiment and business confidence contributing to anaemic loan advances and record low return on equity

Australia’s gross domestic product (GDP) is estimated to contract to -4% in 2020 as lockdown measures stymied both consumer spending and business investment in integral service-based sectors of the economy including hospitality, recreation and tourism. Varying trading restrictions and interstate travel bans applied throughout the year dampened both consumer sentiment and business confidence particularly within the retail segment as government initiatives such as JobKeeper and JobSeeker struggled to offset lost income. GDP is expected to recover marginally with a 3% growth forecasted in 2021 assuming pandemic-induced restrictions are relaxed, active virus cases remain controlled and broad vaccination programmes completed by the third quarter (Q3) to facilitate pent-up demand.

Consumer prices remained stable in 2020 registering an uptick of 0.7% as a wage growth of 1.4% ensured preservation of consumer purchasing power and household discretionary spending. The country’s unemployment rate has breached 7% and in response the budget deficit expanded to 11% in 2020 due to applied fiscal stimulus leaving relatively few policy options to reverse the ongoing recessionary effects. The Reserve Bank of Australia (RBA) was equally aggressive in cutting its benchmark cash rate target three times in 2020 as part of broader quantitative easing programmes to enable faster job creation and provide housing price support.

The Australian Prudential Regulatory Authority’s (APRA) approach during the pandemic was centred on ensuring financial stability through a risk-based approach. Planned supervisory activities and policy reforms were put on hold for six months as resources were re-directed towards ensuring financial and operational resilience measures. These initiatives included adjusted capital and provision requirements for loan deferrals, support customers facing loan repayment difficulties while reviewing its impact on the industry’s broader credit portfolio and developing a single pandemic data collection platform in collaboration with other agencies.

Given the challenging pandemicinduced operating environment, the impact on the Australian banking sector has been relatively mixed as total assets increasedby 4.9% over the year to September 2020 although Q3 registered reductions in derivative instruments over the quarter. Industrywide gross loans and advances managed negligible growth at 0.7% over the year, the lowest since 2010, driven by weak personal loan and business credit demand. While ANZ remains the largest player in terms of total assets, CBA secured the highest return on assets (ROA), ROE and net profit at 1.3%, 17.5% and $4.2 billion respectively.

The year 2020 saw industrywide ROE decline to a historical low of 6.2% (Q3), due in part to weak net profit as allowances of $10.4 billion for bad or doubtful debts were made as well as expanded shareholders’ equity. Net interest income remained constrained rising by 0.8% only as both interest income and interest expenses contracted in line with the Reserve Bank of Australia (RBA) cash rate reductions. Similarly, cost income ratio (CIR) rose to 57% as one-off regulatory fines were paid off and fee and commission-based income receded.

There has been a sustained build-up of total capital and common equity tier 1 capital ratios reaching 16.9% and 11.8% respectively in Q3 of 2020. This reflects prudent capital management activities such as lower dividend pay-out ratios and increased equity capital raisings with Macquarie Bank a stand-out among its peers with a capital adequacy ratio (CAR) of 18.9%. Likewise, industry non-performing loan (NPL) ratio advanced to 1.1 per as at Q3 2020 and could have risen higher had repayment deferrals and income support measures not been in place.

The coming year will likely remain a challenging one for the industry as we expect to see a resumption of key Royal Commission recommendations being applied on violating entities. Asset quality is also likely to deteriorate in the medium term as loan repayment deferrals are set to expire and government support programmes are phased out. While industry stability will be maintained finding new sources of income amid a low interest rate environment, constrained fee business should have a knock-on effect on industry profitability and asset growth.

Diary of Activities
Transaction Finance and Risk Dialogue and Awards Ceremony
23 November 2021