Squeeze on margins a real and present danger

Critics of the banking sector should try to grasp the interaction between both sides of the balance sheet.

Bendigo and Adelaide Bank boss Mike Hirst, in Melbourne yesterday, said there are no ‘systemic’ issues in the sector. Picture: David Geraghty.

Bendigo and Adelaide Bank’s annual profit, announced yesterday, is a window into the industry’s stresses and strains, which will only be reinforced when Commonwealth Bank reports its full-year numbers tomorrow.

The good news is that Bendigo’s 2016 cash earnings edged up 1.6 per cent to $439.3 million.

The bad news, which is all the stuff that Canberra doesn’t want to know about, is that half-on-half profit reversed in the six months to June by 3.6 per cent.

It’s far from calamitous, and chief executive Mike Hirst says the margin crunch in May when Bendigo passed on 20 basis points of the Reserve Bank’s rate cut will be mitigated by keeping 15 basis points of last week’s policy easing.

The industry will be hoping that Hirst is right, because there’s a worrying slide in yesterday’s investor pack that shows Bendigo’s monthly net interest margin falling off a cliff in June, down six basis points.

It’s unusual for a bank to break its margin down into monthly movements.

CBA, however, should seriously consider following Bendigo’s lead because the slide is the most effective counterargument to the nonsense sprouted by Canberra that there’s no excuse to hold back some of last Tuesday’s rate cut.

It could actually force some stakeholders to remove their blindfolds and unplug their ears.

Like with Bendigo, CBA’s result tomorrow will show its second-half profitability was protected to an extent because the pressure on its headline margin would have intensified only late in the second half.

That said, Credit Suisse analyst Jarrod Martin is still predicting that second-half cash profit will be lower than in the six months to December, down from $4.772 billion to $4.761bn.

“Earnings risk is skewed significantly to the downside,” Martin says. “Margins are under pressure, asset growth is slowing and bad debts are rising.”

With apologies to the PM, who says he understands the finance industry, the case for banks maintaining their profit margins at or near current levels so they can continue to fund the economy is a no-brainer. Over the years, the industry has explained ad nauseam why out-of-cycle rate increases have been necessary.

Banks, though, have not taken up the challenge to explain the new environment.

It’s more complex and multi­faceted than the post-GFC period, when the crisis was in everyone’s faces and there was a direct correlation with rising funding costs.

This time, an understanding is required of the interaction between both sides of the balance sheet.

Banks earn their profits from maturity transformation and credit risk.

They might pay a return to customers for a term deposit that’s repayable in months, but lend the funds to a borrower for up to 25 years while taking on the risk of default.

As interest rates dive ever lower, there comes a point where the deposit book starts to run down as customers hunt for a better return elsewhere.

Also, about 42 per cent of Bendigo’s retail deposits (equivalent to 82 per cent of the bank’s funding) are at call, with 27 per cent of that figure earning an interest rate below 25 basis points.

As the proportion of the deposit book earning no interest climbs, the pain of continuing official rate cuts gets worse because they can’t be passed on.

The banks also earn less on their own free funds.

Deposit-flight represents a real risk for the nation’s banks, which are under heavy regulatory pressure to maintain healthy deposit buffers ahead of the 2018 introduction of the net stable funding ratio.

The NSFR aims to minimise the banks’ exposure to more volatile, short-term wholesale funding markets.

It’s no surprise that interest rates on term deposits have started to creep up, with the majors paying retail investors as much for their “stickier” deposits as they do to wholesale investors.

Former federal treasurer Wayne Swan picked out last week’s Reserve Bank statement on monetary policy to say it “undermines claims by banks that the recent interest-rate gouge is justified by funding costs”.

In fact, the RBA was referring to wholesale funding only.

It said the cost of new issuance by banks of both short and long-term debt had recently been below the cost of outstanding debt.

Average wholesale funding costs might have declined.

Swan, though, overlooked the challenges in the deposit market, which is the source of a lot of the margin pressure.

Bendigo’s tier one capital ratio also declined, down from 8.24 per cent at the end of last year to 8.09 per cent at balance date.

Hirst says the bank has “ample” capital to grow its business organically, but the market has its doubts.

Despite a 4.3 per cent share price gain, UBS said the result was “soft” because it used revaluations, provision releases and one-offs to hit consensus forecasts.

Analyst Jon Mott said Bendigo’s “tight” capital position was still an issue for the lender.

Hirst is happy to appear before the annual Turnbull Inquisition of the banks, which will be conducted by a parliamentary committee, but draws the line at the Labor Party’s call for a royal commission.

As much as Labor cries that the industry’s acknowledged stuff-ups are “systemic”, the Bendigo chief says they are isolated, and mostly confined to a “number of financial planners in a single bank (CBA)”.

“If it was a systemic issue the problems would be occurring everywhere all the time,” he says.

“Clearly they are not.”

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