Bank bosses scramble to deliver after shock results


Betting against the big banks, which make up more than a fifth of the ASX 200, is notoriously tough. Short-selling the banks, a strategy aimed at making a profit from a falling share price, has been known as a “widow-maker” trade, in part because of the huge popularity of these stocks among yield-hungry investors.

Lately, however, the more bearish observers of banks such as Cheruvu have been feeling vindicated.

Westpac and National Australia Bank shareholders will get a smaller dividend payment next month than they did this time last year, after both cut their final dividend this week. ANZ investors, meanwhile, will receive less in the way of franking credits.

Though the big four still made almost $27 billion in combined cash profit last financial year, this was the lowest since 2012, accounting firm PwC says. Return on equity, a key measure of profitability, fell to 11 per cent, the lowest since the 1990s.

Given the large role that banks play in many investors’ portfolios, these trends will put significant pressure on the major bank chief executives: ANZ’s Shayne Elliott, Westpac’s Brian Hartzer, Commonwealth Bank’s Matt Comyn and NAB’s Phil Chronican, soon to be replaced by Ross McEwan.

These bosses are scrambling to find ways to deliver the high returns shareholders have become accustomed to, while also dampening some of those lofty expectations.

If the bank profit results of the last week and a half are anything to go by, they will have their work cut out.

Self-inflicted pain

For a sign of the declining financial performance of banks, look no further than the executive bonuses being handed out this year, in a sector renowned for its lavish pay.

Westpac’s Hartzer gave up a $1.6 million bonus voluntarily, and the entire NAB senior executive team won’t be getting a short-term bonus – something that last happened at CBA following its money-laundering compliance scandal. Both NAB and Westpac are desperate to avoid incurring a second backlash on executive pay at their upcoming annual meetings.

The point isn’t to evoke sympathy, as each of the big four’s chiefs still collect enormous pay packets compared with the average wage. But it was telling that none of the big four CEOs were on a list of the 10 highest-paid chief executives in corporate Australia from the Australian Council of Superannuation Investors.

The key reasons for the (relative) moderation in CEO pay are the sector’s worsening financial returns, shareholder anger over past excesses, and the searing experience of the Hayne royal commission.

And many of these wounds are, of course, self-inflicted.

The biggest swing factor in this year’s decline in profits across the industry were massive provisions for compensation payments, which more than doubled to $5.7 billion, according to EY, after a run of scandals exposed at the royal commission.

Further damage to the big four’s bottom line came from the cutting or removal of fees that the lenders now admit were excessive or unnecessary. KPMG’s head of Australian banking, Ian Pollari, points out non-interest income (fees) fell $2.6 billion in the year.

NAB CEO Phil Chronican said this week that banks were being affected by two “cycles”: the sharp rise in remediation costs, at the same time as “extremely low credit growth and low interest rates”.Credit:Alex Ellinghausen

“Consumers tend to benefit from those fees being removed or reduced. Inevitably it has a financial impact as well,” Pollari says.

Higher compliance costs and the divestment of scandal-prone wealth businesses also battered this year’s results, and can be placed in the “self-inflicted” category.

Double whammy

The other key forces hitting the banks’ profits came from the economic and financial environment.

Housing credit is growing at slowest pace on record and ultra-low interest rates are starting to bite the banks. This is because it’s getting harder to offset lower lending rates by cutting rates on deposits. The result is a gradual crunch on net interest margins (NIM) – the difference between funding costs and lending rates – which is expected to intensify in 2020.

NIMs are at their lowest levels on record, falling by an average 8 basis points to 1.94 per cent, according KPMG.

As NAB’s Chronican put it this week, banks are being affected by two “cycles”: the sharp rise in remediation costs, at the same time as “extremely low credit growth and low interest rates”.

“Those two things coming together obviously have had a big negative effect on the profitability of banking. But one thing we know about our industry is that over time cycles change, and there will be a growth cycle at some point in the future and we’ll be positioned to take advantage of it,” he said.

“How long the current period goes on for is something that I don’t think any of us can be certain of.”

Where does this leave shareholders, then?

Most agree that eking out much in the way of profit growth will be a hard ask in the year ahead. The CEOs’ commentary on the outlook was full of phrases such as “tough,” “challenging,” and “difficult.”

Westpac’s Hartzer said the backdrop was “obviously challenging”, though he stressed some of the headwinds — such as higher compliance spending — would not continue indefinitely.

“I think we’re in a cyclical downturn for the economy where growth rates are low, credit demand is low and interest rates are very low at the same time as there’s a significant investment required in regulatory and compliance matters,” he told The Sydney Morning Herald and The Age this week.

While not giving precise profit guidance, ANZ’s Shayne Elliott said revenue growth would be “tough” for the bank. “Volume is going to be close to zero, very small, and margins continue to be under pressure … and fees continue to be under pressure as well,” he said.

NAB’s Chronican said whether the bank lifted profits would be a “fine line” and largely dependent on cost control and bad debts, given revenue growth would be “hard to achieve”.

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CBA, which uses a different financial year to its rivals and will deliver a quarterly trading update next week, reported its fall in profits back in August. But chief executive Matt Comyn this week pointed to the growing challenge banks face in trading off the interests of depositors and borrowers.

“I guess, we have 7 million customers who have deposits and save with us, and about 1.8, 1.9 million home loan customers,” Comyn said at a customer forum in Brisbane.

“So for those seven million customers, they are constantly asking about, ‘Well I am really worried about the deposit rate’,” he said.

Many of the forces that will drive the banks’ profitability are outside the lenders’ control – including interest rates, credit growth, competition, and regulatory decisions on capital.

What is in the banks’ control are their strategies and cost control, and the last fortnight has made it clear that each of the banks will seek to keep on cutting expenses, while investing more in technology.

Hartzer vowed to step up cost-cutting to $500 million in the year ahead. But as well as cutting, the bank was spruiking a new investment in a digital platform that it says will help it reach more customers, by working with fintech and other firms.

While it received less attention than the dividend cut, Westpac’s results also showed the extent of cost-cutting. Staff numbers were cut by more than 1700, it removed 349 ATMs and closed 61 branches.

Where to now?

More optimistic observers say the combination of cost-cutting and a likely fall in remediation costs can support the dividends that so many shareholders crave. The recovering housing market may also drive credit growth higher.

“You’re looking out to 2020, a lot of these costs that are factored into their earnings won’t be repeated,” says Hugh Dive, chief investment officer at Atlas Funds Management.

Andrew Martin, principal at $7 billion fund manager Alphinity, says even though the underlying business conditions look challenging, bank shares can still stack up as investments for those prepared to take the risk on the dividends.

“The market as a whole is in earnings downgrade mode. So at some point, from an investment point of view they do look OK, that’s kind of what you’re looking for,” says Martin.

Taking into account this week’s dividend cut, Westpac shares were still offering a yield of 5.5 per cent, compared with less than 1 per cent for a three-year government bond.

Whether the prospect of decent yields is enough to continue attracting income-hungry investors to the big four remains to be seen.

But based on their current trajectory, some observers believe the banks may not be quite the force they once were in the local sharemarket.

David Walker, senior analyst for large cap stocks at Clime Asset Management, points out the big four once accounted for about 27 per cent of the ASX 200.

That proportion has fallen to about 22 per cent this week, as investors seek out alternatives to the big four. “It’s probably headed for 20 per cent,” he says.

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