Bank results: what lurks beneath?

Shaded by the Royal Commission into financial services and some institution-specific matters, the latest Australian major bank reporting season was nevertheless not a thrilling session for investors and the industry.

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Even stepping back from the headlines, the outlook for the sector is tough – something acknowledged in the presentations from executives.

The results portend a hard slog on revenue generation and continued focus on absolute cost cutting at a time when more investment in technology and business transformation is necessary - all against a backdrop of new regulation.

"Appetite for borrowing is constrained with individuals already highly leveraged and companies still cautious.”

The sector analysts were hardly effusive.

Jonathan Mott from UBS called his report Tougher Times, beginning with “Standing in front of a train? 1H18 results were disappointing. Across the sector all line items weakened with the exception of credit impairment charges. Further, the outlook is getting tougher and the long shadow of the Royal Commission is hanging over the sector.”

Actually, the results themselves were solid – in particular margins were stable, bad debt charges benign and capital generation strong – but as Macquarie’s Victor German said “with rising funding costs, slowing volume growth and elevated regulatory costs, the outlook for 2H18 appears soft”.

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.

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Source: EY

Leaving any regulatory and legal developments aside, the Royal Commission is already a cost line for banks – over $A200 million in total – and a large commitment of management time. It also plays into the investment perspective for the sector although not, at this stage, dramatically.

Ratings agency S&P Global Ratings released a note on its view explaining commission findings would play into the assessment of the risk appetite of Australian banks, the effectiveness of regulatory controls and corporate governance standards. That then impacts S&P’s Banking Industry Country Risk Assessment (BICRA) score.

At the moment S&P rates Australia very low risk, one of only four out of 90 countries at that level. At present S&P doesn’t see any immediate reason to change and even a shift to “low” from “very low” risk would not be material – but it would limit potential upside for the sector.

S&P’s view is also predicated on the quality of Australian financial system regulation and supervision and that regime too is under scrutiny in the commission. The key points from the agency were flags on tighter lending requirements, potential legal action down the track and a review of regulatory measures.

Stepping back then, the bank reporting season gave us a picture of a robust economy, little sign of deterioration in credit quality, concerted moves on operating efficiency and simplicity and an intense focus on capital discipline – framed in a view of excess rather than insufficient capital.

That’s actually quite steady as she goes. But it’s the external uncertainties, whether that be a trade war or a Royal Commission, which create uncertainty.

Shayne Elliott, the chief executive of this bank ANZ, summed it up when I asked him after the result whether there were any tailwinds with all the discussion of headwinds:

“Surprisingly there are," Elliott said. "The economy is still doing pretty well. There is still strong business formation in Australia and New Zealand. More and more Australians and New Zealanders are setting up small businesses."

“Despite a lot of the rhetoric around trade wars etcetera, trade volumes are actually on the rise particularly in our part of the world in the Asia area. So we’ve seen a little bit of a tail wind from there. And of course perversely, because of global growth and optimism interest rates are rising in other parts of the world. As a general rule that tends to be of a mild positive for somebody like ANZ.

“So there are a few tail winds, not too many. It’s not going to be easy but it’s not all doom and gloom.”

Andrew Cornell is managing editor at bluenotes

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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