The window of opportunity: recovery sets stage for delivery with purposeful ambition - PwC Major Banks Analysis Half Year May 2021

• Earnings rebounded to $13.8b thanks to positive credit impacts and lower notable charges in the half
• Return on equity (ROE) rose to 10.4% as a result
• Credit impairment expenses fell to a $109m write-back, as provisions were adjusted to reflect improved economic economic outlook
• Provisions remained elevated at $22.2b, circa $5b higher than before crisis
• Notable items (pre tax) fell by $1.4b to $1.5b, but remain a significant feature of the results
• Net interest margin (NIM), at 1.87% remains at historical lows driven by the rate environment, but with an increase of 2bps hoh as a result of lower funding costs and deposits mix
• Non-interest income decreased to $8.2b, continuing a steady decline since 2018 and down by 6% hoh
• Lending grew 0.7%, predominantly driven by owner-occupied housing and some very early signs of business lending growth
• Capital adequacy (CET1) ratio rose to a record 12.44%

Australia’s major banks delivered dramatically improved financial results in the first half of the 2021 financial year, with FY21 starting out as an almost inverse to FY20. The remarkably rapid economic recovery has driven profits up with a net write-back of credit charges in the half as well as lower but persistent costs for remediation and restructuring. As a result, cash earnings were $13.8 billion, levels not seen since before the COVID-19 pandemic, and there are clear signs this could continue in the second half of the year. Industry return on equity (ROE) was 10.4%. While this is a favourable result given the environment and outlook, it is still lower than any half before 2019.

PwC Australia’s Major Banks Analysis Half Year 2021 indicated that the banks are stronger than they have been in a generation. Balance sheets, business architecture, and reputation, together with the macro outlook for continued global growth, all point to a positive trajectory and optimism. However, uncertainty and risk does remain as do many of the challenges facing the industry, including margins and fees, credit growth, changing customer preferences and a stubborn cost base.

Sam Garland, Banking and Capital Markets Leader at PwC Australia, said, “A rekindled fire in the economy and the banks own strengthening puts them in good shape as the country rapidly emerges from a difficult period stronger than expected. While there is justified confidence, there is also a need for determination and resolve, and to be conscious of the risks and challenges that remain for the industry.

“A number of long-term trends remain evident in the results and have been amplified by the pandemic, pointing to the need for the banks to maintain a laser-focus on delivery at a time of strength and optimism. This includes the completion of remediation and standards uplifts but also the simplification, cost and digitisation agendas that have been underway for some time.

“More broadly for the banks, this is a time of transition - between a post-GFC era coming to an end and a distinctly new age beginning. The social, political and economic environment calls for courage and ambition. Australians are showing new resolve as we emerge from the COVID-19 pandemic, and are looking to their institutions to respond to and address some of our most profound and longstanding challenges. The banking system has a critical role to play.”

Rapid rebound underway

Earnings recovered in the first half of 2021 as a result of much reduced credit charges and lower notable charges while cost growth was limited and balance sheet growth moderate. Margins, however, remain low, suppressed by low interest rates and a record volume of deposits. Constrained dividends, coupled with elevated profitability, have helped increase capital higher than ever.

“The pandemic credit loss experience to date for the major banks has been very limited and as economic forecasts have improved, the banks have updated their assumptions for estimated losses - resulting in some write-backs of provisions and a large swing in credit expenses for the half. Of course, a lot of uncertainty remains as to how the recovery will play out and the potential losses so the banks have been cautious in these adjustments,” said Mr Garland.

Notable items for the half, reduced by $1.4 billion half-on-half though at $1.5 billion, were still a notable feature in the results of some of the banks. With the remediation of past issues, sales of businesses and other ‘reshaping’ activity now nearing completion, it may be that these reduce further in the outlook.

Expenses were essentially flat for the half, which, combined with declining income led to a rise in expense-to-income of 37 basis points half-on-half to 46.8%, excluding notable costs. Given a challenging income-growth outlook driven by low net interest margins (1.87% for the half) and declining non-interest income, costs are likely to remain a significant focus for the years ahead.

Favourable outlook and need to respect uncertainty

Economies around the world have contracted less than expected during the COVID-19 crisis, due to ample and proactive government stimulus, particularly in Australia, where a vigorous recovery is already underway and the banks have started to feel the benefit.

Mr Garland said there is so much to be hopeful about in the current environment and it is also a time to invest in resilience. “The economic recovery, reputation boost, simpler businesses and significant balance sheet strength present a very positive position for the banks, but the pandemic has taught us all that relief can be short-lived.

“There still remain uncertainties about the health and economic recovery, the geopolitical environment and a number of more direct risks for the banks that have real focus for customers and regulators such as cybersecurity, fraud and the reliability of systems and processes.

A time for determined execution and purposeful ambition

The banks’ results, outlook, uncertainties and long-term challenges come at a time where the broader expectations of institutions and their societal impact is in transition. Traditional priorities of financial safety, fair treatment of customers and reliable processes will continue to be base expectations but more focus than ever is on the contribution made to societally important objectives. This will have profound implications for businesses, society and the banks.

“This is a unique window of opportunity because on the one-hand banks must deliver on the existing priorities to respond to the long-term trends we have highlighted for some time. But on top of this the changing expectations of banks mirror the changing expectations on institutions and leaders more broadly - they will be increasingly judged by their contributions to the great challenges of the day.

“Banks will, of course, have a choice on whether and where to lead on issues. These won't be easy decisions as there are many and varied views on what role banks have the right to play, as we have seen with recent discussions on ESG. But ultimately, like all businesses, these positions will contribute to what we call a bank’s ‘social capital’ which, though not quantifiable like financial capital, is arguably just as important,” concluded Mr Garland.