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Combined cash profits from Australia's big four banks increased 6.5 per cent to $28.5 billion in FY22, delivering a bumper year ahead of a looming deterioration in economic conditions.

Australia’s big four banks delivered bumper earnings in fiscal year 2022, buoyed by a booming property market and strong credit demand. However, conditions are set to deteriorate as the economy grapples with inflation pressures and absorbs seven consecutive interest rate increases.

Analysis by KPMG concluded that combined cash profits from Westpac, ANZ, Commonwealth Bank of Australia and National Australia Bank increased 6.5 per cent to $28.5 billion in FY22, reflecting strong housing credit growth and improved asset quality.

Shareholders subsequently benefitted from a 9.5 per cent boost to dividend payments. Payout ratios across the four banks remained at 71 per cent, leaving some wiggle room to adjust future distributions. This is in addition to the $15.4 billion in bonus buybacks returned by the big four.

The strong profit results come amidst cost inflation amongst the wider industry, particularly in wages, as banks look to accelerate technology adoption. All four signalled that previously announced cost targets would be either adjusted or abandoned.

The multiyear trend of falling net interest margins (NIMs) − the difference between what banks pay for deposits and the interest received on loans − continued, with a 10-basis-point reduction in FY22 due to competition and refinancing activity.

Doubled-edged sword

Positively, NIMs picked up in the second half of FY22 as cash rate increases began to flow through to borrowers. This drops straight to the bottom line of the big four, however, and is somewhat of a double-edged sword.

By raising the cash rate to 2.85 per cent, the Reserve Bank of Australia has pulled the handbrake hard on the local economy. Consumer sentiment is at crisis levels, while signs of a slowdown are appearing in certain spending categories.

Higher interest rates have already instigated a retracement in credit as borrowers reassess their capacity to service larger repayments. Housing looks particularly vulnerable, with listings and dwelling values falling. This is especially unfavourable for the big banks given the lion’s share of earnings is tied to mortgages.

“Current market conditions are trending well below expectations, particularly in inner metro areas,” Domain chief executive Jason Pellegrino told shareholders at the property listing company’s first-quarter update. “The rapid pace of interest rate increases has impacted on market sentiment and listing volumes, with a noticeable deterioration since September.”

CoreLogic’s home value index fell another 1.2 per cent in October, with national house prices down 6 per cent since the highs of April. Research director Tim Lawless said it is likely too early to say if the worst of the decline phase is over.

“There is a genuine risk we could see the rate of decline re-accelerate as interest rates rise further and household balance sheets become more thinly stretched.”

Provisioning called into question

There is also the potential for an increase in bad debts as existing borrowers are slugged with rising interest costs in addition to inflation-induced cost-of-living pressures. This is despite the banks releasing most of the COVID-19 provisions in FY22. Notably, CBA and ANZ now have lower relative provision balances than in FY19.

In a speech to the financial services professional body FINSIA, outgoing Australian Prudential Regulation Authority Chairman Wayne Byres cautioned banks on reducing buffers prematurely.

“Capital is illusory unless balance sheets are fairly marked and assets are provisioned accordingly,” Byers said. “At present, with a deteriorating economic outlook, the release of provisions from bank balance sheets is perplexing and warrants particular scrutiny.”

Intense competition

With lending anticipated to slow, competition amongst the big four will intensify. This will be further exacerbated when the majority of fixed-rate loans roll off in 2023. Additionally, the Term Funding Facility, which allowed the big four to borrow on ultra-low fixed rates of 0.10-0.25 per cent for three years, will need to be repaid.

NAB chief executive Ross McEwan said in an earnings call he is avoiding the intense competition in residential lending, instead favouring opportunities in the business and institutional bank. 

“There are players that want this more than we do, at a price that we think is probably not worth being in the market [for],” he said. 

Uneven impacts

Despite the increasingly clouded outlook, the big four have so far been sanguine in their assessment of the economy. All have highlighted the extremely low number of loans in distress in addition to the relative strength of households resulting from high levels of savings and employment.

Where the big banks could run into trouble is regarding new borrowers. The RBA has highlighted this cohort as particularly vulnerable given it has been stress-tested at historically low levels, with less time to accumulate home equity and build repayment buffers.

Westpac chief executive Peter King told investors most customers are in decent shape but admitted the impact of higher interest rates will be felt disproportionately. “If there is a slowdown, the effects will be uneven.”