05 May 2023
We are at an economic inflexion point and it is one many in financial markets – and indeed in business and households – have either never seen or not seen for decades.
We are experiencing stubbornly high inflation, higher interest rates, geopolitical instability and, typically as a consequence, a rise in financial distress – for both business and households.
"Right across ANZ we are seeing the benefits of seven years of simplification, of greater focus on specific businesses and a broader campaign of reducing higher risk and increasing lower risk segments and businesses."
Yet, and notably here at ANZ, we are not seeing tangible evidence of a deterioration in credit quality or a rising number of delinquencies. But we are hardly complacent.
In this result we have taken a Collective Provision (CP) charge of $163 million, lifting our CP balance to just over $4 billion. However, increased Individual Provision (IP) charges were fully offset by writebacks and recoveries, resulting in an IP release for the half which means our total Credit Impairment Charge was $133 million in this result.
These are measured responses to the environment, informed by data, accounting standards and the use of discretionary overlays to counter the uncertainty. The CP balance is $2.2 billion above our base case scenario and $800 million higher than our downside scenario which I’ll detail below.
Over the course of the last 12 to 18 months, we have seen interest rates go from effectively zero to 3.85 per cent and 5.25 per cent in Australia and New Zealand respectively.
It is challenging to see how that scale of tightening will not result in some casualties. There is clearly more turmoil to come. We are going to see ongoing stress in global markets, commercial property, construction and in small business and retail. With over $4 billion in credit provisions we are, however, prudently providing for any such future stress.
Moreover, corporates and retail customers used the last couple of years to get themselves into really good shape. During COVID, people and business weren’t able to spend the money they would have normally and they also became more cautious. They built up considerable buffers. Higher priced debt has been paid down, credit card balances have fallen.
For ANZ’s part, we have been consistently simplifying and de-risking since 2016. We’ve sold or exited over 30 businesses. Today our book is shaped to support a lower future loss profile reflecting the fact ANZ is a much less risky and more prudently managed and more diversified bank.
We have substantially grown those segments of our book that have historically represented lower historical IP outcomes. So for example, mortgages, sovereigns and banks have historically represented 5 per cent of our individual provisions and we have grown those by $229 billion from 59 per cent to 64 per cent of our Exposures at Default (EAD), from 2016 to today.
The other 95 per cent of our individual provisions have historically come from unsecured retail (personal loans and credit cards) and corporate lending. We have reduced unsecured retail from 7 per cent to 3 per cent of EAD and we have also reduced non-investment grade lending by approximately one third, more than halving the amount of that lending partially secured or unsecured. That now comprises about 4 per cent of EAD.
At the same time, we have grown the higher quality investment grade component of our corporate lending by 70 per cent.
Nevertheless, we must expect with cost-of-living pressures, the credit cycle will deteriorate. So we are well prepared. And corporates and households – in general – are well prepared.
Considerable thought, rigour and discipline goes into determining our provision levels. On the face of it, an increase for the half of $163 million may appear low but our provision balance level is higher today than at any time pre-COVID. We also began to bolster our provisions before last year’s full-year result because we believed conditions may deteriorate.
We assessed a range of scenarios, including the base case and downside case where, in Australia, unemployment would go from about 3.5 per cent to 6.9 per cent, house prices would fall almost 30 per cent and there was a recession.
For this half, we used a similar downside scenario. The collective provision balance is $2.2 billion above our base case scenario and $800 million higher than our downside scenario.
Now that downside scenario is pretty dire and moreover, to comply with accounting standards, we must assume that would happen in one year. Could unemployment go from 3.3 to 6.9 per cent in a year? It has happened, in the 1980s notably, but with a vastly different economy and starting point.
Again, under accounting standards, individual provisions can only be recognised once they have occurred and when we consider early indicators such as loans 30, 60 and 90 days past due, there are some signs of customer stress starting to emerge.
However, these indicators are lower than this time last year and about half of what they were pre-COVID. In addition, while calls to the hardship line have increased, they are also still lower than this time last year.
In March we saw the most severe stress on the banking system since 2008 with failures including Silicon Valley and First Republic banks in the US and the forced merger of Credit Suisse into UBS in Switzerland. Anxiety around the soundness of the banking system in some jurisdictions continues.
Notably, Australia is not one of those jurisdictions and the operational flaws, regulatory lapses and loss of trust are not present here. Each of the highest profile failures had notable vulnerabilities which would not be allowed in Australia or New Zealand.
Australian banks are also very highly capitalised and ANZ, in some surveys, is the most highly capitalised bank in the world. The banks here are safely in the prudential supervisor’s “unquestionably strong” category. Most tellingly, interest rate risk in Australia is hedged and all securities are marked to realistic values which are then reflected in our capital position. That is a fundamental difference.
Nevertheless, anxiety persists and ANZ is taking the situation extremely seriously. Indeed, we have reinstituted a COVID-tested response system.
We focus on four points: Protect, Adapt, Engage and Prepare.
Protect concerns securing our positions, monitoring limits and exposures and in some cases reducing risk. With Adapt we look at our own liquidity and funding strategy. That means monitoring data even more frequently. Engagement is about communication across the group and with our customers.
Communication also includes our regulators, industry bodies such as the Australian Bankers Association and other important stakeholders including our shareholders.
All these factors play into how we assess our risk appetite settings and provision levels and, more significantly, how quickly we act when we see issues emerging.
We are continuing to watch for early signs of customers getting into financial difficulty. Our investments in systems and people are helping us identify those early warning signals, proactively engage with customers and reduce early-stage delinquencies.
Right across ANZ we are seeing the benefits of seven years of simplification, of greater focus on specific businesses and a broader campaign of reducing higher risk and increasing lower risk segments and businesses.
Our largest corporate customers are predominately diversified global businesses. If we compare our book with the time of the global financial crisis in 2008, our top 30 corporate customers are on average five times larger in market capitalisation in current dollar terms with an average S&P rating of A and an average tenor of less than 12 months.
We also have no commercial property exposures in our top 30 corporates whereas in 2008 three of our top 10 were commercial property clients.
More importantly, we have experienced lower actual loss with our Individual Provision Charge to Gross Lending Assets reducing from 33 basis points in 2016 to 1 bp in 2022. This means we have gone from being the bank with the highest IP coverage and actual dollar amount compared with our peers to now being the lowest.
Kevin Corbally is Group Chief Risk Officer at ANZ
The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.
05 May 2023
05 May 2023