Shaky Isles shake up bank returns

Not unexpectedly, this latest reporting season for three of the four major Australian banks was typified by a hard slog on revenue, a grind on cost control and cyclically low bad and doubtful debt charges.

According to PwC’s review of the results (which included Commonwealth Bank’s December half along with ANZ, Westpac and National Australia Bank’s March halves) 60 per cent of the improvement in cash earnings was driven by reduced bad debt charges.

“Increased revenues from asset growth in housing and margin compression as asset price competition is only partially offset by declining funding costs,” PwC found. However net interest margins have contracted 19 basis points over the last two and a half years.

Of course, these were solid results: half year underlying cash earnings totalled $14.8 billion, a record, and an increase of 5.8 per cent compared with the prior half and 10.1 per cent compared with the prior comparable period.

Total revenue of $40.2 billion was 5.7 per cent higher than a year ago and aggregate returns on equity were 50 basis points higher at 15.2 per cent.

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Cash earnings - A$ million. Source: PwC.

But as Australia comes to terms with a future of much tougher fiscal discipline compared with the Federal budgets over the last decade, it is increasingly evident that returns beyond the pack are not going to come from the engine room of all the major banks, the Australian economy.

PwC noted as much saying “stronger performances from offshore operations, in New Zealand as the economy takes off, and Asia, where the banks are beginning to achieve critical mass delivering improved efficiencies and returns on investment” were stand outs.

This bank, ANZ, of course has the most pronounced skew to Asian growth but it is New Zealand, where the Big Four Aussie banks dominate, which looms as significant across the sector.

In short, New Zealand growth is accelerating and Australia’s remains moribund. And banks are leveraged plays on economies.

As PwC New Zealand’s Banking & Capital Markets leader Sam Shuttleworth says, "the major New Zealand banks have continued to put up strong results on the back of positive credit growth in a highly competitive market and historically low credit losses”.

Looking at ANZ, New Zealand contributed 18 per cent of operating income and 23 per cent of net profit after tax – a contribution not seen since the 2008 full year result, topping the previous half’s net profit contribution of 19 per cent and 18 per cent for the 2013 full year.

ANZ New Zealand’s cash profit of $NZ887 million was up 27 per cent from $NZ697 million in the previous corresponding half.

At NAB, New Zealand added $25 million to cash earnings while Australia subtracted $23 million. NAB’s New Zealand cash earnings were flat over the last half but at $NZ400 million they are more than 10 per cent up on the $NZ356 million of the September 2012 half.

For Westpac, the New Zealand improvement is even more pronounced: from cash earnings of $A282 million in the second half of 2012 to $A393 million in the latest half.

For all the banks, the New Zealand story is a good one and given recent economic data and the Australian Federal Budget, likely to continue to be relatively so compared with the island off to the west.

John Kensington, audit partner at KPMG New Zealand, doesn’t expect the major trends to be disrupted.

What he and other observers however note is the Kiwi housing market is the one structural challenge for the banks. Unlike almost nowhere else in the world, interest rates are rising in New Zealand.

That means Kiwi borrowers are shifting back to fixed rate mortgages, a lower margin product for the banks. As PwC’s Shuttleworth says “looking forward, it will be interesting to see how the continuing change in retail customer preferences towards fixed interest rate mortgages will impact the banks' results”.

Moreover, the Reserve Bank of New Zealand made a high profile decision last year to rein in what it saw as risky growth in mortgages by using macro-prudential tools, notably a restriction on the loan-to-valuation ratios lenders used.

Kensington reckons there may be “a slight further slowing in the property market due to overnight cash rate rises and the LVR restrictions although there is now talk of the LVR restrictions coming off later in this year or early next year and the OCR rises is slowing”.

Recent economic data, particularly weaker than expected employment,  have taken some wind out of Kiwi sails too although much focus will be what the RBNZ says about its policies – not just on macro-prudential measures but the strength of the Kiwi dollar which earlier this year had an extraordinary brush with parity to the Aussie.

Another wild card is politics. Despite the overwhelming support, particularly outside of the country, for the economic stewardship of the current government, recent polls have suggested a much closer election later this year, even a change of government. If nothing else, that uncertainty has helped the currency lower.

All that said though, and the land of the All Blacks is good at doing the hard yards, the economic story is still pretty good. The year on year growth employment, despite the latest headline “miss” on expectations, is 83,000 people – the largest annual growth in a decade.

Labour force participation is at an all time high and job creation of 3.7 per cent compares with a meagre 0.6 per cent in the years after the financial crisis.

With Australia remaining flat and all the banks grinding away at costs, it is the sometimes lower profile businesses which look like being the difference in performance in the medium term. That might, particularly in ANZ and CBA’s case, be Asia. It may – particularly for Westpac – be wealth. For NAB it might actually be the UK.

But for all the big four, New Zealand is becoming a more important story.

The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.

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