The issue is indeed the outlook.
It’s worth breaking down each of these elements.
In essence, banks are a leveraged play on economic growth. If an economy is growing at 2 per cent to 3 per cent, bank revenue can probably manage 5 per cent or 6 per cent. But typically that comes from credit growth in the economy – borrowing by companies and individuals. It is that appetite for borrowing which is constrained with individuals already highly leveraged and companies still cautious.
As EY noted in its review of the results, “softening housing credit growth (the major driver of the banks’ lending), competitive pressures, higher capital requirements, and regulatory and policy impacts on volumes and costs point to constrained earnings growth for the banks”.
That captures both the demand and supply side and while EY saw signs of a more aggressive desire to lend in the sector, bank chief executives cautioned in their commentary that tighter scrutiny of borrowers, responsible lending measures and more intense supervisory attention would inevitably slow credit provision – even if only at the margin.
While there are signs of more lending appetite and price competition in the sector, that then raises the question of the quality of the revenue generated: will it be robust during a period of slower economic growth/disruption/higher interest rates?
Capital was a good story. Following the financial crisis and waves of new regulation, the banking sector has had to ramp up core capital - essentially its equity base - lowering leverage. In Australia ittook the form of a demand the banks’ capital base be 'unquestionably strong' – core tier 1 equity of at least 10.5 per cent.
The signal from regulators such as the Australian Prudential Regulation Authority is the heavy lifting has been done but fine turning remains, notably on specifically how much capital needs to be set against certain kinds of loans.
In EY’s view “capital ratios remain strong, supported by sound organic capital generation. All the banks remain well-positioned on CET1 ratios."
"Now that APRA has provided greater certainty on capital requirements for residential mortgage lending, it appears there will be no increase in absolute capital, although risk-weighted assets may go up. In response, business models and product lines will require review”.
However EY fingered a critical chapter in the capital story.
“Strategies and pricing models will need to address the changing capital requirements across different portfolios to ensure appropriate returns on equity,” the group said.
This is a crucial point: with revenue flat, margins tight, costs under scrutiny and business transformations under way, investors will be rightly focussed on how banks can manage their balance sheets to still deliver shareholder returns and growth in earnings per share.
That means an assiduous focus on capital allocation for returns – something which is at initial stages – boards looking at how any excess capital can be managed – for example, capital returns via share buybacks or dividends – or internal investment.
It’s easy to forget just 12 months ago the discussion was around how much more capital banks needed to raise.
In its research note on the results season Citi wrote “capital returns to shareholders now in the frame - after many years of continuing to build capital levels to APRA's expectations, the sector is now on the verge of a sustained period of capital returns to shareholders."
“ANZ has announced a buyback during 1H18 with an announcement this week of a potential extension to its program following the completion of a reinsurance deal with Zurich.”
With the multiple challenges facing the sector, operational efficiency becomes crucial. For example, business simplification is something several executive spoke about and asset sales – particular in the wealth sector – continue to be announced.