KPMG analysis finds that the Australian major banks (‘the Majors’) have reported a significant decline in financial performance for the full financial year 2020.
As the impact of the COVID-19 pandemic continues to evolve, the Majors have maintained a strong focus on supporting their staff and customers, as they demonstrated resilient operations and continued lending.
While they have significantly increased their loan loss provisions and allowed customers to defer loan repayments, to date their actual loss experience has been minimal. The open question is to what extent loan losses will materialise in 2021, as the Commonwealth Government unwinds its economic support measures.
FY2020 has also been the year when interest margins have continued their downward trajectory (in a record low interest rate environment), costs have remained stubbornly high and significant extraordinary items (customer remediation and regulatory charges) heavily influenced the full year results.
Ian Pollari, KPMG Australia’s Head of Banking commented: “Despite the substantial challenges, the Majors have proven resilient in the last year and through the strength of their balance sheets, played a critical role as shock absorbers for the economic downturn.”
As the focus shifts to recovery, the Majors will need to tread carefully in extending liquidity or deferral measures to customers and remain vigilant in assessing the solvency of borrowers.
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Pollari added: “They have a big job ahead of them to play their role in Australia’s recovery and improve their financial performance, while progressing with a number of large and complex remediation, regulatory change and technology programs.”
In the face of more customers migrating to digital channels and the significant cost opportunity in automating processes, the Majors will need to create financial and operational capacity to invest in the digitisation of their operations.
“The cost transformation challenge for the Majors requires them to accelerate the digitisation and automation of end-to-end processes, notwithstanding the persistently high levels of risk and compliance spend,” said Pollari.
Hessel Verbeek, KPMG’s Banking Strategy Lead, said: “As the global and local banking industry enters a period of economic and digital disruption, the Majors remain focused on supporting customers, protecting their balance sheets and investing in the future.
“Whilst their profitability has fallen considerably in the past year, in part due to notable items, their returns continue to be above that of many global peers.”
The Majors face strong competition from focused challengers, in payments, mortgages, consumer credit, business lending and merchant acquiring that appeal to an increasing number of customers. Many of these competitors offer digital channels and products, supported by efficient processes.
Verbeek added: “The Majors are increasingly turning to fintech partnerships to digitise processes, launch new products and build new business models. This leapfrog approach can overcome many of the transformation challenges posed by their legacy systems and environments.”
Key highlights of the results are as follows:
- Total operating income (cash basis) declined 1.7% to $79.3 billion, reflecting subdued lending conditions and an ongoing decline in margins. The Majors grew their mortgage books by a combined 1.6% in FY2020, with non-housing lending contracting by 3.4%.
- The Majors reported a cash profit after tax from continuing operations of $17.4 billion, down 36.6 percent compared to FY2019. This decrease is a consistent trend across the Majors and reflects downwards pressure on margins, high loan loss provisions and significant remediation and regulatory costs.
- Cost-to-income ratios have increased from an average of 47.2% to 53.2%, in large part driven by customer remediation and higher IT related expenses, which included increased costs associated with mobilising the workforce for remote working conditions and higher software amortisation charges. In addition, one of the Majors also reported significant extraordinary items relating to regulatory matters.
- Credit quality has deteriorated as a result of the COVID-19 pandemic and continued uncertainty in the economic outlook, leading to an increase of 28 basis points in impairment charges as a percentage of gross loans and advances. As of yearend, the total Expected Credit Loss provision is $24.8 billion, and aggregated loan impairment expense has increased by 201% to $11.2 billion. This reflected both the impact of COVID-19, as well as a broader credit deterioration.
- The average Common Equity Tier 1 (CET1) capital ratio increased 59 basis points to 11.4%, driven by capital management initiatives including divestment of non-core businesses, dividend reinvestment plans, prudent dividend management as well as capital raisings by two of the Majors.
- The major banks recorded an average net interest margin of 189 basis points (cash basis), down 5 basis points compared to the FY2019, largely driven by repricing of both deposits and mortgage and business lending assets, amidst RBA rate cuts and increased competition in the market.
- Rising bad and doubtful debts, increasing capital and subdued growth sees return on equity (ROE) continue to fall, decreasing by 458 basis points to an average of 6.7%. Mounting risks will continue to keep pressure on returns.
For FY2021, important performance indicators to watch include loan loss performance as Government support unwinds, credit growth (especially in mortgages and business lending), the rate of interest margin decline and cost-income ratios.
The Majors will need to continue to balance between operational resilience, shareholders looking for dividends, the required investment in growth, and cost transformation. The banks that manage to quickly transition to more efficient operating models and are able to execute at scale will be rewarded.
The full report is available on the KPMG website.