Big banks’ retail divisions run out of steam

The Australian 12:00am May 9, 2017

Richard Gluyas

The post-crisis boom in retail banking is over.

That’s the big theme to come out of the major banks profit reporting season, and it means the sector’s four chief executives will be desperately hoping Scott Morrison can pull something out of the bag — anything — to make businesses dust off their long-dormant investment plans.

On past experience the CEOs shouldn’t hold their breath.

The March half-year profit ­results demonstrated yet again how much the banks rely on their retail divisions, particularly home lending.

On PricewaterhouseCoopers numbers, residential mortgages now account for two-thirds of the major banks’ gross lending, up from 59 per cent in 2009.

Home lending also contributed 80 per cent of the sector’s loan growth for the most recent half.

While Commonwealth Bank’s retail division delivered an outstanding result for the six months to December, there was further proof in Westpac’s interim result that retail banking’s salad days are mostly over. Consumer banking revenue barely moved, up $2 million to $4.055 billion, with cash profit falling $28m, or two per cent, from the prior period to $1.511bn.

There was some volume growth and mortgage margins actually expanded.

But this was more than offset by higher funding and deposit costs and the perennial lead in every bank’s saddle bag — massive regulatory and compliance expenses, which will persist for some time to come.

The contrast with the last 20 years or so, when retail banking was pretty much money for jam, could not be more stark.

Enormous value was created for shareholders over that period through a combination of lean balance sheets and strong asset growth — overwhelmingly from residential lending.

That’s now a thing of the past, as regulators demand ever-deeper capital buffers to withstand the next crisis.

As for asset growth, there’s zero chance over the next decade that the banks will again be allowed to treble the size of their mortgage portfolios, even in the extremely unlikely scenario that the growth is there in the first place.

The fact is that the double-digit growth of yesteryear is long gone, with Westpac chief executive Brian Hartzer predicting it will taper from the current level of 6.5 per cent to 5.5 per cent over the next year or so.

Business lending will grow in a range of 4.5 per cent to 5 per cent. The medium-term outlook is even more problematic.

Macquarie Research analyst Victor German reckons the recent tightening in credit standards, along with the vulnerability to rising interest rates of heavily indebted households, translates to earnings challenges for the banks.

Repricing opportunities will also be more limited in a hostile political environment.

And as the backlog of new housing stock — particularly in the apartment market — begins to clear, volume growth will slow to a rate that’s below the nominal GDP growth rate, according to German.

Needless to say, Hartzer sees a very different picture.

He concedes the model is changing, but argues that attractive growth will still be there for the taking.

The Westpac boss’s starting point is 5-6 per cent underlying credit growth, with housing at the middle-to-upper end of that range.

Competition for term deposits due to introduction of the net stable funding ratio will abate, and the recent trend towards more nuanced pricing for mortgages will mean more — not fewer — opportunities for repricing.

“We’ll also see significant productivity benefits from our digital agenda, with more revenue dropping straight to the bottom line,” according to Hartzer.

“So there are other factors that will contribute to the earnings outlook.” The digital and associated productivity agendas of the banks are assuming huge importance in a constrained revenue environment.

By pulling on the cost lever, the sector’s cost-to-income ratio fell by 160 points to an average of 43.4 per cent.

Westpac reported flat costs and a CTI of 41.7 per cent after extracting $118m in efficiency gains from changes in operating models in the business and institutional banks, as well as the digitisation of manual processes.

Among the latter was the implementation of mobile personal loan applications, and extending the automation of term deposit rollovers to business customers.

There was also a net reduction of 45 branches in Australia and New Zealand over the half year, with group-wide ATM numbers down 15 and smart ATMs up three per cent.

Smart ATMs now represent ­almost 40 per cent of the ATM network.

Similar gains will have to be locked in for future results as the bank strives to get its CTI below 40 per cent.

Overall, the major banks managed to lift headline cash earnings by 6.2 per cent to $15.6bn compared with the previous corresponding period.

Underlying cash earnings, excluding one-offs like asset sales and restructures, were up 2.3 per cent.

It was heavy going and it’s not going to get any easier.