An artificial boost to bank profits from falling bad debts has almost run its course, as bank analysts warn rising unemployment and interest rates will have an impact on the ability of borrowers to repay their loans.
Three of the four big banks posted record results in the past year, posting a total of $45 billion in pre-tax profits.
But two-thirds of the 5 per cent rise in that profit came from the winding back of provisions for bad and doubtful borrowings. The resulting "release" of reserves put aside for bad debts goes straight to the banks' bottom lines.
The big four cut their assessments of bad and doubtful debts by almost a third in the past year to $3.5 billion, and are now at their lowest level compared to total loans in almost 20 years.
"It is hard to see bad debts continuing to fall by 30 per cent year-on-year," PwC finance head Hugh Harley said.
One bank analyst even called the 2014 results "weak". "They are lower quality earnings when you meet consensus forecasts because low debts fall."
Other observers point out that while total return on equity at an average of 16.1 per cent is healthy, that is going to be hard to maintain should the government accept any recommendations from the Murray inquiry to raise the majors' capital levels.
But good news came in the form of lending growth becoming a significant contributor to revenue for the first time in years, with total credit growth up 5.4 per cent in the year to September, the highest since 2009.
In recent years new loans written by banks have been so low that many have been able to fund them entirely from deposits. But since the beginning of this year, they have had to tap wholesale debt markets to fund them again.
Even demand for loans from businesses has shown signs of strong recovery, up 3.8 per cent across the majors to total $76 billion.
"The balance sheet tends to lead the P&L, so the stronger lending we have seen in the past three to six months is likely to flow through to FY15," Credit Suisse analyst Jarrod Martin said.
The business loan growth was at the expense of the biggest business bank, NAB.
Net profits at NAB fell almost 10 per cent to $5.8 billion and all its 12.9 per cent growth in underlying earnings per share was down to improvements in bad debts.
As well as muted growth in its business loans, NAB's results were dragged down by its poorly performing British and US businesses, which it is either selling or listing.
Margins on loans have been squeezed as banks have slashed rates amid fierce competition. Net interest margins were still down another 0.2 percentage points to 2.05 per cent across the majors, the lowest since 2008.
Cost growth has also been going up, rising 9.7 per cent, or $3.2 billion. Half of this was driven by NAB, according to PwC analysis. But technology costs rose 10.7 per cent due to big spending on major systems upgrades in previous years now hitting balance sheets.
Talk of targeted "macro-prudential" policies from the Reserve Bank and the Australian Prudential Regulation Authority and the inevitable rise of interest rates from their present lows put a question mark over house lending growth, given it is driven by investors – with loans in this category up 9.5 per cent for the year from 6 per cent growth last year – piling into property in Sydney and Melbourne in response to low rates.
But housing construction is up 9.1 per cent in the year to June, which may ease pressure on house prices and some of the Reserve Bank's concerns of a price correction. The Reserve is also worried about apartment oversupply in Sydney and Melbourne precipitating that fall as investors shy away from falling rental yields.
Andrew Dickinson, a financial services partner at KPMG, however, thinks that won't be a long-term situation. "I'd be surprised if that emerges as a long-term issue – really construction has been lagging long-term population growth, there is pent-up demand there."
As one analyst put it, however, the banks' actual numbers were not the main focus for the investment community even before they came out.
"It's all about Murray now," he said.
Most expect the Murray financial system inquiry to recommend the biggest banks hold more capital to bring them closer to the levels their smaller rivals must hold, and to ensure they have enough to cover losses in the event of a major downturn.
The chiefs of Westpac and ANZ have warned the price for a safer system will either be higher interest rates or reduced dividends to shareholders.
But experts say the big banks have built up enough capital from years of record profits to absorb the likely imposts.
"If Murray's capital changes impact the whole industry, it is more likely to be passed through to customers than if it just impacts one or two banks," one analyst said.
"The two items most spoken about are an additional charge on [domestic systemically important banks], which will impact all four majors, and a risk weight floor on mortgages, which again will impact all four majors, but more so the two biggest banks."Author: Shaun Drummond
Source: The Age