HOLDING ON, BUT LOOKING FOR UPSIDE - BANKING MATTERS | MAJOR BANKS ANALYSIS - PWC AUSTRALIA
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Banking Matters | Major Banks Analysis
Holding on, but
looking for upside
June Quarter Snapshot 2018
August 2018
www.pwc.com.au
August 2018
Seeking catalysts for growth in
a sea of risk and remediation
Bank earnings (excluding special Turbulence emerging, but bank This is perhaps because the Australian
charges) continued holding on through performance hanging on and global economies are holding up,
the June quarter in the face of the In May we reported that we saw continuing to show surprisingly robust
considerable economic, competitive ‘turbulence emerging’ in bank half-year growth in the face of material economic
results, with the impact of economic, and geopolitical challenges. In fact,
and conduct challenges we have been
competitive and conduct challenges markets seem steadfastly optimistic, with
monitoring and writing about for
beginning to materialise in financials volatility back down and the Schiller PE
some time. Given the industry outlook Index2 nearing record levels, as shown
in place for so long, this is something (see our May report Turbulence
Emerging: Major Banks Half Year 2018). in Exhibit 1.
of an achievement. Nevertheless,
This has been on the radar for a while
signs of future stresses are beginning Risks to the downside
but had previously been staved off by
to flow through to financials – even fortuitous circumstances including the Unfortunately, it is hard to hang on
before considering the significant surprising durability of the synchronised forever, and we see risks to the downside
charges incurred for risk management global ‘Goldilocks economy’ described for both major bank financials as well as
and remediation dominating the in our December snapshot (Goldilocks the global economy. Like the banks, the
banking agenda. redux – for everyone but the banks). global economy is showing its own signs
of emerging turbulence, most recently
What’s more, as important as risk and The combination of margin challenges, in Turkey.
remediation may be, they are not really conduct, remediation and restructuring
going to drive significant long-term charges, compounded by a continued,
but gradual slide in asset growth, are
value creation. In this environment,
all well in train. They have conspired to
with the outlook continuing to deliver three consecutive quarters of flat
be unfavourable and risks to the or falling cash earnings relative to the
downside, it is more important than prior-year period1. Although diminished
ever for banks to identify and create relative to the record levels of the prior
catalysts for upside. In this report, we year, they have not fallen dramatically
highlight price and cost management as but have continued to track within the
two key opportunities, and drill down same broad quarterly band for the past
into the pricing opportunity in our Hot five and a half years. In short, bank
Topic: The Price is Right - What should earnings are hanging on.
we pay?.
Exhibit 1: Fear and greed: historical stock price volatility
100
90
80
70
60
50
40
30
20
10
0
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
VIX Schiller PE
Source: Bloomberg and Chicago Board Options Exchange. Data represented above ends 17 August 2018.
1.
Based on three banks’ reporting of quarterly earnings: CBA, NAB and ANZ. WBC does not report quarterly earnings and so is excluded from the earnings and
bad and doubtful debt expense analysis for our December and June-quarter updates.
2.
Schiller PE Index is the US share market price-to- trailing 10-year earnings ratio
PwC Banking Matters | 2
August 2018
For this reason, though we expect 1. Synchronised global Increasing trade tensions are especially
continued volatility in bank earnings, expansion benefiting Australia worrisome. Although the recent US
we should be cognisant of the risk to the threat to impose tariffs on up to $500bn
downside should the global environment Continued global growth in the of Chinese imports may seem like a
turn. Accordingly, margin and cost face of risks and headwinds bilateral issue, the disruption to global
remain paramount. As mentioned, The global economy continues to supply chains that such a move could
in this quarter’s Hot Topic we dig demonstrate healthy growth with the US entail would affect almost every part
deep into the first imperative, which perhaps even on the cusp of overheating of the global economy. What’s more,
is the pricing of standard financial and in the face of the challenges with the money supply in most markets
services and products. In the future, described in Exhibit 2 below. still much higher than it was before the
we shall address new products and GFC, such supply-chain disruption could
services (especially payments) and create just the inflationary spark needed
Exhibit 2: Challenges in the current
the promise of automation, data and to ignite fears that have long been latent.
environment
artificial intelligence (AI) to improve These events are occurring in the context
both revenue and cost. Accordingly, our of a global tightening of (advanced
analysis of the June quarter major banks economy) monetary policy as central
financial announcement3 focuses on the banks reverse ‘quantitative easing’ and
following relevant messages: interest rates recover from post-GFC
lows. In short, the scene is being set for
• Australia continues to benefit from
increasing interest rates and stronger
ongoing global expansion; Geopolitical turmoil
advanced-economy currencies to drive
• The decades-long reliance on credit- Continued geopolitical turmoil and down asset values globally and, as
led growth is being felt in the face of abandonment of longstanding norms of Turkey’s leadership is now discovering,
the global order in areas such as trade,
rapidly decelerating business lending, diplomacy and immigration potentially
hammer indebted emerging-market
slowing mortgage and consumer increasing existing inflationary pressures economies. None of this would be
spending, and some early signs of underpinning central bank tightening positive for Australia.
credit stress;
Australia continues to benefit
• The previous points, coupled with
Fortunately for Australia, until the
existing challenges on cost and
risks and headwinds described above
revenue, have driven earnings down
materialise in an economic slowdown
relative to 2017; and
Leverage or full-blown financial crisis, Australia
• The imperative for managing price continues to be a beneficiary of healthy
Global consumer and business leverage
and efficiency is greater than ever, global economic growth, confidence and
back at pre-GFC levels, with highly-
with a continued unfavourable leveraged emerging markets a special risk appetite.
outlook for most drivers of return. point of vulnerability (including China,
Australia’s trade deficit has swung to
Turkey and others with significant US
dollar-denominated debt) surplus thanks to surging resource
exports, its budget deficit closed, and its
domestic industry (especially exports)
supported by monetary policy that has
gone in relative terms from one of the
most conservative to among the most
accommodating of the major economies.
Market exuberance Accordingly, although Australian house
Ebullient asset valuation and credit prices have begun giving back the gains
underwriting around the world, with of recent years, there has been no ‘hard
the Schiller PE ratio nearing historic landing’ and Australian households,
levels (comparable levels only previously though stretched, are still spending and
reached in 1929 and between 1997 borrowing.
and 2002)
Stressed housing
House prices showing strain in specific
regional markets such as Australia,
Canada, New Zealand and global urban
centres such as London, Stockholm,
Oslo, Shanghai and Beijing
3.
CBA, NAB and ANZ only; for CBA ‘June quarter’ financials derived as the difference between full-year results and, where reported, half-year plus third-
quarter (March) results, and for NAB and ANZ as the difference between the third-quarter trading update and half-year results
PwC Banking Matters | 3
August 2018
2. Repercussions being felt
from multiple decades of Exhibit 3: Annual lending growth by category, seasonally adjusted
credit-led growth
Domestic credit growth: Annual % growth - 12 month rolling average
Regardless of the pace of economic
growth in the short term, Australians are 25
now reckoning with the consequences
of three decades of credit-led asset-
price growth and leverage. Mortgage 20
originations continue to slow, as they
must, to bring household leverage down
towards levels sustainable in different
interest rate environments. Fortunately 15
for the banks, the rate of this slowdown
has been gradual, especially for owner-
occupiers whose borrowing is holding
10
up reasonably well. Unfortunately for
the banks, this means that, without
a dramatic acceleration of nominal
income growth, the slowdown will have 5
to continue for a very long time. This is
illustrated in Exhibit 3.
0
Jan-2008
Jul-2008
Jan-2009
Jul-2009
Jan-2010
Jul-2010
Jan-2011
Jul-2011
Jan-2012
Jul-2012
Jan-2013
Jul-2013
Jan-2014
Jul-2014
Jan-2015
Jul-2015
Jan-2016
Jul-2016
Jan-2017
Jul-2017
Jan-2018
Jul-2018
-5
-10
Housing – Owner-occupier Housing – Investor Housing Personal Business
Annualised % growth - 3 month rolling average
10
8
6
4
2
0
Jun-2016
Jul-2016
Aug-2016
Sep-2016
Oct-2016
Nov-2016
Dec-2016
Jan-2017
Feb-2017
Mar-2017
Apr-2017
May-2017
Jun-2017
Jul-2017
Aug-2017
Sep-2017
Oct-2017
Nov-2017
Dec-2017
Jan-2018
Feb-2018
Mar-2018
Apr-2018
May-2018
Jun-2018
-2
-4
Housing – Owner-occupier Housing – Investor Housing Personal Business
Source: RBA
PwC Banking Matters | 4
August 2018
Exhibit 4: Business lending growth once again lower than nominal GDP
Business lending growth minus nominal GDP growth, Australia
20%
15%
10%
5%
0%
01/03/1988
01/03/1989
01/03/1990
01/03/1991
01/03/1992
01/03/1993
01/03/1994
01/03/h1995
01/03/1996
01/03/1997
01/03/1998
01/03/1999
01/03/2000
01/03/2001
01/03/2002
01/03/2003
01/03/2004
01/03/2005
01/03/2006
01/03/2007
01/03/2008
01/03/2009
01/03/2010
01/03/2011
01/03/2012
01/03/2013
01/03/2014
01/03/2015
01/03/2016
01/03/2017
01/03/2018
-5%
-10%
-15%
Source: RBA, ABS
By contrast, investor mortgage growth What’s more, as we’ve observed in the 3. Earnings down for a third
has fallen substantially, which is past, in this environment of slower quarter in a row
consistent with prudential intent, as has lending growth, non-majors continue In such an environment, it is no
business lending, which is not. In fact, to gain share as illustrated in Exhibit 5. surprise that quarterly earnings are
so far in 2018, business credit growth If it were possible to track loss of share under pressure, down 8 per cent on
has once again fallen below the growth to non-bank lenders, one would suspect the prior-comparable period (pcp)
in nominal GDP, something that has this picture to be starker still. and flat or down on pcp for three
happened only a few times in the past quarters in a row (see Exhibit 6). What’s
generally following major downturns as more, although reported earnings
shown in Exhibit 4. That it should have may be up in the quarter relative to
happened again so long after the last prior quarters, this is only due to the
financial crisis, and with employment non-repetition of significant itemised
and business conditions so healthy, is a charges in both December and March
testament to how much leverage remains for risk, remediation and restructuring.
to be worked out of the system and to Underlying profits excluding these
how the impact of regulator actions to charges show a downward trend since
dampen this leverage are working. October 2017.
Exhibit 5: Non-majors continuing to gain share
79.8% 25%
79.6%
20%
79.4%
15%
79.2%
10%
79.0%
5%
78.8%
0%
78.6%
78.4% -5%
01/06/2018
01/01/2017
01/02/2017
01/03/2017
01/04/2017
01/05/2017
01/06/2017
01/07/2017
01/08/2017
01/09/2017
01/10/2017
01/11/2017
01/12/2017
01/01/2018
01/02/2018
01/03/2018
01/04/2018
01/05/2018
Major banks market share of ADIs Major bank credit growth (annualised) ADI credit growth excluding majors (annualised)
Source: APRA
PwC Banking Matters | 5PwC
1,000
2,000
3,000
4,000
5,000
6,000
7,000
0
31/12/2012
31/03/2013
30/06/2013
30/09/2013
31/12/2013
31/03/2014
Source: Company statements and PwC analysis
30/06/2014
30/09/2014
31/12/2014
31/03/2015
30/06/2015
30/09/2015
31/12/2015
31/03/2016
Exhibit 6: Estimated underlying cash earnings for three of four major banks by quarter
30/06/2016
30/09/2016
31/12/2016
31/03/2017
30/06/2017
30/09/2017
31/12/2017
31/03/2018
30/06/2018
Banking Matters | 6
August 2018August 2018
In addition to slowing loan growth,
margins are being put under pressure Exhibit 7: Emerging pressure on short-term funding costs
by the rise in short-term funding costs. 2.30
1,3- and 6-month Bank Bill Swap Rates
(BBSW) are increasing as shown in
Exhibit 7, and competition for owner- 2.20
occupier mortgages is intensifying.
Balancing that, however, was the
2.10
opportunity to increase rates for interest-
only and investor mortgages consistent
with their greater perceived risk and the 2.00
prudential intent to reduce their share of
the Australian market. As the large wave
of interest-only loans written in 2014 1.90
and 2015 approach mandatory 5-year
rollover, into principal-and-interest,
this will be a headwind for margin but 1.80
also, in the case of borrowers unable to
service the increased payments, on loan
1.70
losses as well.
1.60
1.50
1.40
Jul-2016
Aug-2016
Sep-2016
Oct-2016
Nov-2016
Dec-2016
Jan-2017
Feb-2017
Mar-2017
Apr-2017
May-2017
Jun-2017
Jul-2017
Aug-2017
Sep-2017
Oct-2017
Nov-2017
Dec-2017
Jan-2018
Feb-2018
Mar-2018
Apr-2018
May-2018
Jun-2018
Jul-2018
Interbank Overnight Cash Rate 1-mth BBSW 3-mth BBSW 6-mth BBSW
Source: Company statements and PwC analysis
PwC Banking Matters | 7August 2018
To date, however, loan losses continue to decline, as shown in Exhibit 8, and are in fact down 3 percent from the cyclically high
March quarter. This is despite rising arrears and ongoing restraint in consumer spending. Should the trend of rising arrears
continue (especially among the wave of interest-only borrowers coming to the end of 5-year terms forced onto amortising loans),
this will become another headwind to bank earnings.
Exhibit 8: Consolidated bad and doubtful debt charges for three of four major banks by quarter
1,400
1,200
1,000
800
600
400
200
0
31/12/2012
31/03/2013
30/06/2013
30/09/2013
31/12/2013
31/03/2014
30/06/2014
30/09/2014
31/12/2014
31/03/2015
30/06/2015
30/09/2015
31/12/2015
31/03/2016
30/06/2016
30/09/2016
31/12/2016
31/03/2017
30/06/2017
30/09/2017
31/12/2017
31/03/2018
30/06/2018
Source: Company statements and PwC analysis
PwC Banking Matters | 8August 2018
Finally, notwithstanding the effort and 4. Imperative for managing
focus on cost reduction, digitisation and price and efficiency greater
productivity, the tangible progress to than ever
date on this agenda has been less than Unfortunately, given all that we have
compelling. With continued pressure on discussed above, the outlook for most
margins from competition and public drivers of future earnings remains
scrutiny, as well as the conduct and negative, consistent with the outlook
reputational challenges so poignantly we highlighted in the half as shown in
evident in the Royal Commission Exhibit 10. This makes current efforts to
hearings, the opportunities to roll reduce cost and maintain pricing more
out new products and services have imperative than ever.
been limited. Reflecting this reality,
Australian bank shares substantially
underperformed both local and global
markets. It is worth noting however that
they have recovered somewhat since the
end of the quarter in June, with a mini
‘bull run’ commencing in mid June and
continuing until the time of writing. This
is shown in Exhibit 9.
Exhibit 9: Australian bank shares vs global equities
1.4
1.2
1.0
0.8
0.6
0.4
0.2
0.0
01/01/17
01/02/17
01/03/17
01/04/17
01/05/17
01/06/17
01/07/17
01/08/17
01/09/17
01/10/17
01/11/17
01/12/17
01/01/18
01/02/18
01/03/18
01/04/18
01/05/18
01/06/18
01/07/18
MSCI Banks
Source: Company statements and PwC analysis
PwC Banking Matters | 9August 2018
Exhibit 10: Headwinds in all drivers – cost and pricing crucial
Future outlook
Increased scrutiny on pricing and competition including impact of
Net interest
? open banking.
2. Revenue
margin Possible scope for more risk-based pricing.
Non-interest Ongoing pressures augmented by Royal Commission
income ? transparency and sensitivity.
Itemised Likely but as-yet unquantifiable additional expenses to respond to
3. Expenses
charges conduct and other operational risks.
1. Earnings and returns
Significant investments in digitisation and automation balanced by
Cash
earnings
Expense-to-
income ratio ? increased requirements on compliance, oversight and control.
4. Asset quality
Capital Bad debt
expense
Asset quality has been very benign for many years.
Potential mortgage tightening may have second-order consequences.
Credit
provisions
5. Balance sheet
Common Major moves on capital largely complete.
equity Further divestments may even provide future flexibility.
tier 1 ratio
Clear regulatory intent to constrain mortgage growth over the
Credit medium term.
growth
Potential for accelerated business lending still unclear.
Cost reduction has been under way for Price, reflected in both interest and However, there is an opportunity to
some time. Every bank is engaged in non-interest margins, is a more improve what already exists today.
some form of restructuring but with complex discussion. To protect their Increased transparency and more
timing of benefits varied. Some have ability to generate attractive margins nuanced, risk-based pricing can more
already made fundamental choices and dull the kind of ‘commodity-trap’ closely align offer to customer needs
about business architecture and realised price competition we described in our while improving price realisation in
significant reductions in operating costs, September 2016 report: Escaping the existing products and services - even
while others are making substantial Commodity Trap: the future of banking those that are commodities. At the
upfront investments in digitisation in Australia, banks must introduce new, same time, it can also achieve a number
and productivity with the promise of differentiated and tailored services to of other social objectives including
substantial savings down the track. The become more deeply connected to their increased economic efficiency, enhanced
extent to which this has been successful customers. That report described a financial stability as well as fairness.
remains to be seen and opportunities number of organisational, operational We describe this opportunity in the
for cost reduction continue to emerge and strategic choices banks could make. attached Hot Topic: “The Price is Right -
through automation, data and AI. What should we pay?”
PwC Banking Matters | 10Contact us
Colin Heath Sam Garland
Banking and Capital Markets Leader Banking and Capital Markets Partner
Tel: +61 3 8603 0137 Tel: +61 2 8266 3029
colin.heath@pwc.com sam.garland@pwc.com
Jim Christodouleas Julie Coates
Banking and Capital Markets Director Financial Services Industry Leader, Australia
Tel: +61 448 431 121 Tel: +61 2 8266 2006
jim.christodouleas@pwc.com julie.coates@pwc.com
Hugh Harley
Banking and Capital Markets Partner
Tel: +61 2 8266 5746
hugh.harley@pwc.com
Acknowledgement
We would like to thank the following PwC team
members who have made a significant contribution
to the development of this publication:
• Mathew Kassar • Nat Bauman
• Will Dunn • Brooke Cashman
• Abe Alvarez
• Lauren Lopatko
© 2018 PricewaterhouseCoopers. All rights reserved.
This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
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