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Record bank earnings but margins near all-time low

Record bank earnings but margins near all-time low

Margins near record low, costs on the rise
Stronger credit growth, but slowing deposits
Low bad debts critical to higher cash earnings
Return on equity, up 50bps to 16.2 per cent.

Australia’s four major banks delivered combined underlying cash earnings of $14.8 billion for the first half - up 6 per cent on the previous half and up 10 per cent on the same time last year - according to PwC’s biannual Major Banks analysis.

PwC Australia’s Financial Services leader Hugh Harley said the result came despite margins shrinking 5 bps to 2.08 per cent, close to the all-time low of 2.05 per cent in 2008, with further falls likely as banks increase competition for business.

However, strong lending volumes helped overcome the fall in margins with credit growth hitting a five-year high, up 4.4 per cent to $2.2 trillion for the year to March.

“After years of very weak credit growth the slight pulse detected in last year’s second half has grown stronger, despite continued caution by business to invest,” Mr Harley said.

In addition, bad debts at $1.9 billion remain extremely low, reflecting low interest rates and solid business conditions. Roughly 60 per cent of the improvement in cash earnings has been driven by reduced bad debt, both for the half-year and full-year.

Operating costs rose by 7.5 per cent over the year, well ahead of inflation, reflecting strong salaries growth (up 6.7 per cent) and continued investment in critical areas such as technology (up 9.6 per cent) and distribution.

Other income streams such as wealth management also put in a markedly stronger performance, the best for many years, reflecting confidence in equity markets and lower life office claims and lapse rates. The contribution from Wealth Management is up more than 10 per cent for the year.

Growth Outlook
Mr Harley said the banks’ cautious optimism for the future was justified, given recent stability in the global economy, while Australian business appeared to be adjusting to a lower-growth environment.

“We are on the cusp of further potential change, not only to Australia’s banking landscape but to the broader financial services industry,” Mr Harley said, noting that “the Federal Government’s Financial System Inquiry will gather serious momentum in the next six months ahead of a host of key regulatory changes associated with the global Basel III banking rules”.

Credit – Where’s the growth?
“Credit growth from business is stronger than a year ago but still very sluggish at 2.6 per cent for the year to March. Hopefully, it has now bottomed,” Mr Harley said.

“The question will be how fast it picks up or whether it will continue to bounce along the bottom.
“The growth in credit is being driven largely by existing home owners, and investors most of all, with first home owners struggling to enter many markets,” Mr Harley said.

“Historically low interest rates are clearly assisting credit demand and bad debt expense but eventually they will need to return to more normal levels.”

Safe as houses?
Home loans represent the biggest share of total lending –accounting for 60 per cent of all loans – the most since the Hawke Government deregulated the financial sector in the mid-1980s.

Overall housing credit grew 5.9 per cent for the year to March, up from 4.4 per cent a year ago, its strongest growth in more than two years.

This growth helped offset weaker margins, which eroded 5 bps to 2.08 per cent over the past six months, with net interest income up 3.1 per cent for the half.

Mr Harley said it was likely margins would erode further amid competition for lending and deposits and subdued appetite for new lending.

Stronger growth in housing credit is being driven by strong growth in investor loans. Property investors were the biggest source of credit growth in the half.

“Investor housing has grown from 5.4 per cent to almost 8 per cent year on year,” Mr Harley said.

The flip-side of this is that first home buyers are down to record lows, being just one-in-eight of all owner-occupier loan commitments”, Mr Harley said.

Deposits’ Super Drop
Overall bank deposit growth has slowed sharply in the past year, from 9.9 per cent annually a year ago to 7.3 per cent for the year to March. - the low end of the 7-10 per cent long-term average.

However, households and business remain cautious, with both groups growing their deposit holdings more quickly. Household deposits were up 8.9 per cent year-on-year while business deposits grew from 2.8 per cent a year ago to 3.5 per cent.

A drop in deposits from superannuation funds caused the slower growth.

Since the Global Financial Crisis, deposits held by superfunds – including SMSFs – averaged growth of 12 per cent annually.

“Better equity markets seem to be the main reason why this growth has slowed to 9 per cent over the past year. In turn, this has slowed overall deposit growth,” Mr Harley said.

“The combination of stronger lending growth and slower deposit growth suggests that banks’ reliance on the wholesale markets is about to increase after a prolonged period where deposit growth covered all new lending. The markets seem quite relaxed about this for the moment.”

Costs – Is the lid off?
Expense growth has been higher than recent years – up 3.9 per cent for the half and 7.5 per cent for the year. This reflects continued investments, including in technology, as well as rising staff costs.

Staff numbers have remained steady at around 172,000 for the past two years but employee costs are up 4.9. per cent for the half and 6.7 per cent compared with the same period last year, reflecting higher salaries.


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