Uncertainty remains despite big banks' solid earnings – EY Australia

by Mina Martin10 May 2022

Australia’s major banks have delivered a solid performance in their 2022 half year results, driven by robust asset growth and quality, capital returns, and careful expense management, but margins continue to constrain earnings, according to fresh analysis from Ernst & Young, Australia.

The EY Australia report said the big-four banks delivered $14.4 billion in combined headline cash earnings for the 2022 half year, up 5.1% from the same time last year.

Asset quality also generally improved, moderated by impairment risks as businesses reopen, border restrictions ease, and the local economy continues to recover. This positive outcome, however, was mitigated by ongoing economic uncertainties, particularly inflationary pressures. Household balance sheets, meanwhile, are generally in good shape, with many households having built up substantial buffers on their mortgages – this despite the increased level of high debt-to-income lending, the EY Australia report said.

Other pressures remain, with net interest margins (NIM) declining across all the banks to a 1.75% average, driven by a low-interest-rate environment and exacerbated by intense competition and an unfavourable mix of fixed-rate mortgage loans. EY Australia expects these headwinds to continue into the second half of the year, but also noted that the outlook is a little brighter in light of the recent cash-rate rise.

“While margin compression is likely to continue in the short term, the rising interest rate cycle should ease NIM pressures and lead to improved profitability for the banks over the medium term,” said Tim Dring, EY region banking and capital markets leader Oceania. “However, ongoing economic risks point to continued uncertainty for the banking sector’s outlook. Last week’s higher-than-expected rise in the official cash rate by the RBA, and future expected rises, offer top-line revenue growth opportunities and earnings upside. On the flip side though, rate rises coupled with strong inflation could also put pressure on asset quality and slow credit growth, and continued mortgage competition may also reduce margin upside for the banks. In the current economic environment, the only real certainty for the sector is uncertainty.”

In the face of ongoing profitability pressures, EY Australia said banks will continue to focus on managing margins for some time yet.

“The half-year results show the banks have continued to execute well on their expense management initiatives, although costs remain elevated due to ongoing compliance, regulatory, and technology programs, with the need for additional resources to meet loan demand and to address cybersecurity and financial crime risks,” Dring said. “Reducing the cost base remains a challenging task, given traditional operations silos, complex legacy systems, and the need to respond to ever-evolving regulatory requirements. This is contributing to the banks’ struggle to transform their banking operations with an integrated, holistic approach that leverages data and analytics to inform risk management and, perhaps most importantly, enable the banks to form a forward-looking view of risks and opportunities.”

Another significant challenge faced by banks is around acquiring and retaining talent, with shortages for critical in-demand skills such as data and engineering.

“On the war for talent, salaries aren’t the only factor,” Dring said. “To remain attractive, banks will need to focus more on their people experience, with a clear business purpose and an engaging employee value proposition.”

The EY Australia report also noted that institutional build-to-rent developments are starting to gain greater traction in Australia, with state governments implementing various schemes and incentives to attract investors and address housing shortages looming across several states.

“Build-to-rent is a particularly attractive option for institutions, such as large superannuation funds and property investment companies, seeking reliable, steady returns,” Dring said. “While institutional build-to-rent will only represent a small portion of the overall residential asset class, the sector will be dominated by institutional platforms, which will be an important source of lending growth for all the Australian major banks. Financiers will need to better understand the dynamics of this asset class in order to compete with the overseas financial institutions that currently dominate the financing of these projects.”

Moving forward, the banking sector is expected to face continued uncertainty, despite the expectation of cash rate hikes aimed to help ease the pressure on margins and boost the banks’ profitability.

“The highlights that banks cannot afford to take their foot off the accelerator when it comes to their strategic cost management and operations transformation,” Dring said. “The banking sector is moving from an era of large multi-year transformation programmes, to one of building capabilities to manage continual change and create more sustainable future-ready organisations. In this environment, following through on simplification, innovation, and digitalization strategies will be key to the banks boosting their efficiency, improving customer experience and remaining competitive against disruptive new players.”