The full-year flat cash earnings result produced by Westpac belies a more worrisome trend in Australia’s second largest bank - a significant deterioration in earnings in the second half of its financial year.
Higher funding costs and increased competition part explained why profits took a step down as the financial year rolled through - these are elements that could play into the results of each of the large banks in 2019.
Westpac’s consumer bank inked a 17 per cent deterioration in cash earnings in the second half. Much of the blame falls to the costs of fixing up the behavioural issues highlighted during the banking Royal Commission, but not all. It also experienced a lower margin and lower fees.
The good news is that the hefty costs of remediation and compensation for customers were primarily dealt with in 2018 and therefore should not be a significant drag going forward.
But the underlying performance of the banks - all which have all now reported - remains challenging.
Bank revenue is clearly under pressure thanks to slower loan growth particularly in the home mortgage area - which Westpac predicts will fall to around 4 per cent in the 2019 financial year.
Westpac’s chief executive Brian Hartzer notes that there are plenty of potential headwinds facing the industry - not the least of which is political uncertainty.
The banking industry is privately expressing concern about the prospect of a Labor government - more especially the threat of changes to negative gearing and capital gains tax.
But it is clear banks believe that now is not the time to pick a fight when there is a very real chance Labor will be in Government by May 2019. Any worsening of the toxicity could lead to even harsher outcomes - given the final report from Royal Commissioner Kenneth Hayne is due for release in February.
The banks’ unwillingness to support the Coalition is already frustrating the current government with treasurer Josh Frydenberg this week calling on business to become a more active lobby for its ‘lower taxing more fiscally responsible’ policies.
For the most part the major banks should not be too concerned if housing prices continue to fall in an ordered way - given that until a year ago prices in major cities like Sydney had risen up to 70 per cent over the previous five years and the bulk of customers are ahead of their payment schedules.
But there is a concern that if negative gearing and capital gains tax incentives were watered down the trajectory of the fall could steepen and along with it the size of the equity component in mortgaged homes.
Already banks have seen investors leaving the housing market partly offset by renewed interest from first home buyers.
Brian Hartzer was not heralding any disaster scenarios on Monday when he outlined the prospects for the Australian economy.
Westpac expects, ‘the outlook for the Australian economy remains positive, although there are likely to be economic headwinds in 2019, with GDP growth expected to moderate to around 2.7 per cent.’
Hartzer said consumers are likely to be more cautious in the face of flat wages growth and a soft housing market, while uncertainty ahead of a Federal election and a less favourable international backdrop are likely to weigh on business investment decisions.
But for all banks, including Westpac, challenging revenue conditions require a step up in cost cutting to mitigate further softening of profit. The bank has lifted its productivity target to $400 million next year.
During the 2018 financial year Westpac experienced a rise in its cost to income ratio - even though it remains best in class among the majors.
One of the banking industry tailwinds evident during this reporting season was the benign credit environment.
The employment market plays well into keeping consumer delinquencies low.
Having now wrapped up one salient feature is notable - it’s a tough market for the banks but none are prepared to cut dividends. For now at least, these are sacrosanct.