Lending a key driver of growth
Profits across the four major banks are improving despite pressure on interest margins, a new report has found.
In its Major Australian Banks First Half-year Analysis Report 2022 analysis released on Monday, KPMG said cash profit after tax from continuing operations across the big four banks totalled $14.4 billion in the first half of FY22 – up 5.1% compared to the first half of 2021.
Cash profits after tax were down just 0.4% compared to three years’ ago, signalling a “relatively flat medium-term growth path,” the audit, tax and advisory service said.
On a cash basis, operating income across the majors was up 0.8% on the first half of 2021, rising from $39.6 billion to $39.9 billion. Return on equity rose from 10.4% in the 2021 financial year, to 10.6%.
Strong volumes in mortgage and business lending were the underlying drivers of growth in operating income, both areas continuing to experience high demand in the first half of 2022.
At $1.812 billion, the total value of mortgage loans was up 2.5% on the second-half of 2021, KPMG said. Business lending grew 4.8% in the last half year, to $1.077 billion.
KPMG Australia head of banking and capital markets Steve Jackson (pictured) said recovery of the Australian economy and strong housing market performance provided a springboard for delivery of improved financial results.
“With returns on equity in the sector now again restored to double digits but with uncertainty ahead, it will be interesting to see how they maintain their current momentum,” Jackson said.
KPMG banking strategy lead Hessel Verbeek said the 2.5% growth in mortgage lending was driven by a very competitive market, with low interest rates.
As a result, the net interest margin fell from 188 basis points to 175 basis points.
“One major component has been that in recent times, the share of lower margin fixed interest mortgages has been higher (in many cases, these fixed rate mortgages represented about half of the total new mortgages being written),” Verbeek said.
“While the mortgage market has continued to perform strongly, the profitability of the market for all lenders is under pressure.”
Given continued low interest rates, net interest margins (NIM) have continued to fall, weighing on financial performance.
“The market dynamic has been dominated by the NIM decrease resulting from low lending rates in a very competitive market and strong demand for low-margin fixed rate mortgages,” Verbeek said.
“This downward pressure has only partially been offset by lower funding costs from near-zero deposit rates. The impacts of an extended period of low interest rates are deeply baked into net interest margins.”
Amid a backdrop of COVID-19 recovery and higher inflation, loan loss provisions of $218m were released, bringing overall provisioning closer to pre-COVID levels due to the strong performance of the economy, KMPG said.
Balance sheet strength has decreased, the average CET1 ratio declining by 90 basis points to 11.8%.
Key highlights of the KPMG report were:
- Combined cash profit after tax from continuing operations across the four major banks was $14.4 billion, up 5.1 % from the prior comparative period (PCP). The result reflected strong growth in lending and reductions in large one-off notables including remediation/regulatory and impairment expenses.
- Average net interest margin (cash basis) decreased 13 basis points from the first half of 2021 to 175 basis points. Declining margins were driven by low lending rates, a shift in the housing lending mix towards lower margin fixed rate lending and higher holdings of low-yielding treasury assets.
- Cost-to-income ratios decreased from an average of 50.3% in the first half of 2021, to 49.6%. The four majors reported a decrease in operating costs of 1%, to $19.7 billion. The result reflected reductions in notable items, offset by higher staffing expenses in response to increased lending volumes, wage inflation, and increased investment in growth and productivity.
- Aggregate loan impairment expenses of $218 million were driven by continued improvements in the economic outlook and strengthened asset quality. As the provision was lower in the first half of 2022 than in the second half of 2021, the impairment expense was a release of $218m, resulting in income for the major banks.
- The common equity tier 1 (CET1) ratio decreased by 90 basis points to 11.8%, as all four banks completed share buy-backs over the half-year, KPMG said. Lending growth drove higher credit risk weighted asset usage. The CET1 ratio remained comfortably above the APRA benchmark of 10.5%.
- Dividend pay-out ratios increased to 66% from 63.2%.
- Returns on equity rose by 21 basis points to 10.6%, returning to “double-digit standards” prior to the COVID-19 pandemic.
As the 25-basis point increase to the official cash rate (to 0.35%) in May signalled the end of record-low interest rates, KPMG said there was a general expectation bank NIMs would recover.
However, strong competition, falling fixed rate loan volumes and the unwinding of the term funding facility are expected to weigh on margins.
Higher interest rates and high household debt levels were also expected to increase mortgage impairments over time.