Australian banks delivered solid full year earnings in contrast to many of their US and European peers. This was despite sizeable bad debt expenses, slowing credit growth and contracting margins.
According to PricewaterhouseCoopers ‘Major Banks Perspective’, the five majors achieved aggregate underlying cash earnings of $17.1 billion in FY08, down just 3 per cent over the prior year. This was against a backdrop of the most severe dislocation of global capital markets since the Great Depression.
Mike Codling, PricewaterhouseCoopers Banking and Capital Markets Leader said, "Australia’s majors have produced a good set of results overall. They have risen to the challenge and helped reinforce their reputation as being amongst the best general commercial banks in the world. Not of course that they have emerged completely without blemish, but certainly with their collective reputation enhanced not diminished, in overall terms.”
"In recent times, governments internationally have responded decisively to restore confidence and stability to the financial system. And the Australian Government is no exception, offering unprecedented guarantees on deposits and wholesale bank borrowings, and announcing a $10.4 billion economic stimulus package.”
"As markets normalise, our Government continues to face fundamental challenges, which include dealing with some of the unanticipated consequences of their recent decisions, stimulating renewed competition in the market, and helping the banks address their over-reliance on global capital markets for wholesale funding.”
"In the current environment, we can expect the banks to focus even more on cost control as a priority to offset sluggish revenue growth and increasing credit losses,” he said.
Net interest income maintained
Defying downward trends, net interest income remained strong, rising to $4.0 billion, a 12.2 per cent increase over the previous 12 months. The robustness of the net interest income book was driven by strong loan growth which continued well into FY08. During the year, gross loans rose by 14 per cent, slightly less than the 15.6 per cent achieved in FY07.
The banks were also disciplined in managing the spreads between lending and borrowing rates, which enabled them to limit the downside impact on net interest margins to 11 basis points.
Mike Codling said, "In prior years it has largely been competition that has driven down margins. This year, margins have been eroded by the turmoil, with higher funding costs and the dampening impact of holding more liquid assets.”
Funding and liquidity key
Much of the banks’ focus over the past year has been on funding and liquidity: building a strong lending mix and increasing their holdings of liquid assets.
"A big part of the story has been the war for customer deposits, which have become an increasingly important element of the funding mix,” said Mr Codling.
"A major impact of the market turmoil has been a flight to the quality of bank deposits by consumers and businesses. This has been ongoing since last year, but rose dramatically in October, first when market uncertainty spiked, and then when the Government guarantees were announced” added Mr Codling.
Asset quality
The dark spot was the significant increase in credit losses, rising 174 per cent to $6.6 billion for FY08. This represents 41 basis points of total loans, a statistic not seen since 1994.
Mr Codling said, "With the liquidity crunch and subsequent economic downturn, we’ve seen impaired assets more than double. However, business balance sheets generally have been prudently managed since the last recession, and the Government has signalled its intent to stimulate economic activity.”
"Nevertheless, genuine fears remain for the immediate future. If steps to unfreeze the lending pipes are unsuccessful, and credit rationing by the banks continues, there could be some real stress across businesses.”
Transformation and investment
Mr Codling said, "In the current environment cost reduction is very much back at the top of the agenda.”
"The institutions that can take out costs without compromising service quality or distribution reach will emerge in the best position.”
During FY08, aggregate costs rose by 5.1 per cent. This was driven largely by salary cost increases, reflecting the tight labour market conditions when salary decisions were last made, plus some full-time equivalent employee increases mainly in frontline roles.
In addition, the banks set aside more than $1 billion in costs below the cash earnings line, associated with restructuring and core systems replacements. A number of institutions are using the proceeds from the VISA International float to fund these initiatives.
"Several of the majors have already announced core systems replacements and large scale transformations, paving the way for improvements to customer service offerings and bank productivity. We may also see accelerated moves toward off-shoring arrangements as part of the banks’ response to lowering costs.”
"For institutions undertaking large-scale merger activities, a key challenge will be how they balance the requirements of integration versus meeting the process improvement needs of the broader organisation,” he said.
Challenging times for wealth management
Plunging equity and asset values saw the banks’ wealth management businesses post lower growth than recent years. Nevertheless, underlying cash earnings from wealth management were 12 per cent higher than last year.
"The banks’ have achieved a creditable result in wealth despite difficult market conditions. We’ve seen the ASX 300 lose more than a quarter of its value during the past nine months”.
The funds under management (FUM) market contracted 11 per cent between December 2007 and June 2008 as a result of lower asset prices and an 80 per cent reduction in net inflows. The funds under administration (FUA) market fell 10 per cent with a 25 per cent drop in annual inflows.
"The majors managed to fare better than their competitors, increasing their market share of FUM by 70 basis points and of FUA by 40 basis points in the six months to June,” said Mr Codling.
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