Banks are battling the same headwinds

NAB’s Andrew Thorburn has been singing from the same song sheet as his major banks peers when explaining the bank’s approach to the RBA rate cut. (Tomohiro Ohsumi/Bloomberg)

Within the flurry of bank reports over the past week there has been a consistent and somewhat disconcerting narrative.

The themes within the results were echoed in National Australia Bank’s third quarter trading update today: bad and doubtful debts are picking up; funding costs are edging up and margins are tightening.

NAB, after reporting a solid earnings uplift for the six months to March, when cash earnings rose 6.5 per cent, said today that third-quarter earnings were $1.6 billion. That is about three per cent lower than the quarterly average in the March half and three per cent lower than the corresponding period last year.

While revenue was stable, the group’s net interest margin was slightly lower due to the higher funding costs and the charge for bad and doubtful debts rose 21 per cent, to $228m.

Across the major banks the story has been the same. After solid first halves, the major banks’ earnings have turned down.

Commonwealth Bank, reporting for the year to June last week, experienced a three per cent decline in second-half earnings. ANZ and Westpac both reported an increase in bad and doubtful debts in their third quarters as well as increased funding costs.

The sharp rise in bad debts isn’t surprising, although it might be regarded as surprising that it has taken so long to flow through to the banks’ numbers.

The banks had been experiencing historically low levels of impaired assets/historically high asset quality and that was most unlikely to be sustainable over the longer term.

We are now seeing the downturn in the resources sector that started some years ago, and the more recent troubles within the dairy sector across Australia and New Zealand, starting to show up in the banks’ results. The credit cycle has turned and is now gradually normalising.

It isn’t just the agricultural and resource sectors where pressure has emerged. There are some indicators of consumer stress showing up in personal loan statistics as well as some large individual corporate exposures that have soured.

At this point, given how low the starting point was, there isn’t any great concern about the rise in bad and doubtful debts. It is something, however, that the banks and those who observe them will be monitoring closely given the apparent fragility of business and consumer confidence and of the economic conditions more broadly.

With little volume growth — demand for credit across all sectors is weak by historical standards — the rise in bad debt charges and the squeeze on margins can only really be offset by what the banks do on costs.

NAB said its expenses fell one per cent.

The controversies around the banks’ responses to this month’s Reserve Bank rate cut (all of them, not just the majors) reflect the margin compression they are experiencing as funding costs have edged up.

The repricing of deposits that was part of their response to the RBA’s move (the more controversial part was their collective decision not to pass on the full 25 basis points to home loans) is an element of those increased funding costs. They have to at least maintain their existing deposit bases to comply with looming prudential requirements for stable funding.

The cost of raising wholesale funds in offshore debt markets and hedging them back into Australian dollars has also been creeping up.

NAB’s Andrew Thorburn is singing off the same song sheet as his major banks peers when explaining NAB’s approach to the RBA rate cut, saying the decision reflected the responsibility the bank had to balance the needs of all its stakeholders, which he said included borrowers, depositors and 584,000 shareholders.

Despite the banks making a much bigger and better effort to try to explain the context in which they are operating and the decisions they have made, the notion that banks have constituencies other than home loan borrowers to satisfy — including their regulators — appears to be continuing to fall in deaf ears in Canberra.

NAB itself remains a work-in-progress, given that it only shed its troublesome UK banking operations earlier this year and is still finalising the sale of 80 per cent of its low-returning and capital-intensive life insurance business to Japan’s Nippon Life. That deal is scheduled for completion before the end of the year.

A recent management restructure created a leaner and simpler organisational model with a sharper customer focus, while NAB has also been more aggressive in defending its core business franchise.

There is a cost to margins in winning share in an environment where demand for business credit is anaemic but all the banks are competing for the available volumes now that the relative appeal of home lending has been diminished by the Australian Prudential Regulation Authority’s introduction of a floor under mortgage risk-weightings and its crackdown on investment property lending.