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Sean Aylmer: Welcome to the Fear and Greed Daily Interview, I'm Sean Aylmer.

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Sean Aylmer: We've talked a lot about the banks in recent days

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Sean Aylmer: with the last of the big four reporting full year

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Sean Aylmer: earnings this week. EY has just completed their analysis of

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Sean Aylmer: the 2021 results. Overall there was a rebound in earnings

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Sean Aylmer: on the previous year as the impact of the pandemic

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Sean Aylmer: wore off. But broadly the sector remains under pressure from

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Sean Aylmer: subdued revenue growth, low interest rates and huge competition. Tim

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Sean Aylmer: Dring is Oceania Banking and Capital Markets Leader at EY. Tim,

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Sean Aylmer: welcome back to Fear and Greed.

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Tim Dring: Great  to  be  with  you, Sean.

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Sean Aylmer: Tim, it just feels like the banks are at a bit

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Sean Aylmer: of a turning point. They've been incredibly solid institutions, and

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Sean Aylmer: COVID hit and this isn't really a reflection on COVID,

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Sean Aylmer: it's a reflection on technology. That just, in this last

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Sean Aylmer: couple of years, there's so many new players biting at their heels.

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Tim Dring: I think you're right. It probably is an inflection point

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Tim Dring: for a number of reasons. I think for many many years,

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Tim Dring: even coming out of the GFC, their earnings held up

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Tim Dring: pretty well with very strong returns on equity, 14, 15%

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Tim Dring: certainly was the norm right across the board for the banks.

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Tim Dring: We're now seeing that ROE get slightly depressed through COVID, starting to rebound but

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Tim Dring: it's still south of 10%. They are at inflection point,

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Tim Dring: you're right. And then in some ways, some of their

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Tim Dring: weaknesses have been exposed through COVID. You've seen new entrants

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Tim Dring: being able to migrate quickly to digital, and some of

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Tim Dring: the processing issues that some of the majors have faced in processing

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Tim Dring: mortgages and so forth, has really been evident.

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Sean Aylmer: It seems to me that the technology players that have come in,

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Sean Aylmer: particularly in the payment system area, but also the speed

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Sean Aylmer: of service. Some of those new guys are just better

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Sean Aylmer: than the banks at speed of service. You mentioned mortgages,

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Sean Aylmer: but it's almost across the board I'd say.

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Tim Dring: Absolutely. I mean, I think whether you look at payments

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Tim Dring: or traditional products of deposits and mortgages, or even just

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Tim Dring: account opening processes, they benefit from one thing and that

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Tim Dring: is technology. They're working off more contemporary systems. Generally, it's

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Tim Dring: only just one or two systems versus perhaps, the significant

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Tim Dring: number of legacy systems that major banks face, just to

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Tim Dring: process a mortgage, may go through more than a dozen

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Tim Dring: systems through a bank. And I think, those sorts of

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Tim Dring: infrastructure set ups, hav really sort of been a hindrance

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Tim Dring: to process and to costs.

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Sean Aylmer: I mean, this is in no way any investment advice

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Sean Aylmer: here because that's not what we're talking about. But the

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Sean Aylmer: better technology banks look like they've got arosier future in some aspects.

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Sean Aylmer: And as I just repeat, this is not an investment show. We're

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Sean Aylmer: just talking about earnings.

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Tim Dring: No look, I think there's no doubt about it. Their cost to income is down,

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Tim Dring: relative to the majors they can act more nimbly. One

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Tim Dring: thing they don't have, they don't have scale and they don't have market share.

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Tim Dring: And when I look at the majors, they're still writing

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Tim Dring: more than sort of 80% of mortgages across the market

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Tim Dring: and that's significant. But having said that, others are biting

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Tim Dring: at their heels, trying to get into that space as well.

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Sean Aylmer: Okay. So,  if  you  look  at  the  last  year,  almost  27 

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Sean Aylmer: billion  in  cash  earnings,  and  that's  up  about  55%,  I 

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Sean Aylmer: suppose  that's  off  a  lower  base  though.

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Tim Dring: Yeah. It was off a low base, the base last

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Tim Dring: year really had the full impact of those COVID provisions

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Tim Dring: that went through. The CBA went through at 30 June and then

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Tim Dring: obviously the banks, the other three at 30 September last year. So,

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Tim Dring: that was a big impact on the 2020 results. We've

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Tim Dring: seen a number of those provisions reverse. So, we've actually seen

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Tim Dring: that again to impairment charges as some of those provisions have

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Tim Dring: reversed out during this year. But they're still at a level

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Tim Dring: that is higher than pre- COVID that's for sure.

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Sean Aylmer: Okay. So, just explain to the listener exactly what you're talking about with these impairment charges,

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Sean Aylmer: how the banks have to take a charge if they

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Sean Aylmer: expect loan defaults to be higher. Is that right?

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Tim Dring: That's right. So, one of the key areas of the accounts is

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Tim Dring: provisioning for loan loss, and some of that is the

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Tim Dring: future loan loss. Particularly, making a determination whether there is going

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Tim Dring: to be a significant increase in credit risk. Now, COVID 19

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Tim Dring: was one of those factors and therefore they needed to

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Tim Dring: look right through the cycle, take into account forward looking adjustments.

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Tim Dring: And I think at the time, if I go back

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Tim Dring: to last year, there was so much uncertainty around COVID 19.

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Tim Dring: We did not know how long this pandemic was going

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Tim Dring: to go for. And perhaps we still don't know in

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Tim Dring: some ways, or be it there is some light at the end of

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Tim Dring: the tunnel. We didn't know whether there was going to

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Tim Dring: be a vaccine. We didn't know how deep this would

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Tim Dring: cut into a number of impacted sectors, particularly retail, particularly

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Tim Dring: travel and entertainment and so forth. So, there was a lot

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Tim Dring: of judgment made back then. And obviously the 12 months on,

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Tim Dring: we know a little bit more about where COVID is heading,

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Tim Dring: but we still don't know all the facts. So, as

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Tim Dring: a result, they've been, I think, pretty cautious. There's still

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Tim Dring: some sectors in the economy showing that, are yet to rebound.

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Tim Dring: And some of them may not fully rebound.

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Sean Aylmer: We've seen a lot of loan deferrals now they're coming

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Sean Aylmer: off now, how will they play out? Because I mean,

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Sean Aylmer: unlike the big malls, for example, the shopping centres, people

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Sean Aylmer: actually got rent relief. They won't have to repay what

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Sean Aylmer: they didn't pay. That's not the case with the banks.

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Sean Aylmer: If you had your loan deferred, you will still have

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Sean Aylmer: to pay that loan back and the interest on that period.

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Tim Dring: Yeah. That's right. Those loan deferrals is really arrangement between

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Tim Dring: the institution and the borrower and effectively allowing those borrowers

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Tim Dring: to effectively go into hardship. And there's some certain provisions

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Tim Dring: in there, that enable them to work a little bit

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Tim Dring: more effectively with their institution in relation to fees and

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Tim Dring: repayment terms. And the ability to restructure the loan. APRA

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Tim Dring: (Australian Prudential and Regulatory Authority) has provided a number of concessions for banks in respect of those loans. So,

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Tim Dring: effectively not treating them as impaired and holding additional capital

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Tim Dring: against them in the short term. So, I think that

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Tim Dring: has certainly helped the sector. It's helped the banks, really

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Tim Dring: buy time with their customers and try and work through

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Tim Dring: some arrangements and in particular customers to work through their

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Tim Dring: own circumstances, whether it be rent relief if you're a

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Tim Dring: business customer with your landlords and so forth. Or if

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Tim Dring: you are a retail customer with a mortgage, those separate

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Tim Dring: arrangements you may have with that institution.

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Sean Aylmer: Stay  with  me  Tim,  we'll  be  back  in  a  minute. 

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Sean Aylmer: My  guest  today  is  Tim  Dring,  Oceanian  your  Banking  and 

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Sean Aylmer: Capital  Markets  Leader  at  EY.  Okay.  So,  we've  spoken  about 

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Sean Aylmer: credit  and  payment  charges.  You  mentioned  return  on  equity  has 

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Sean Aylmer: come  down  over  a  number  of  years.  The  other  big 

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Sean Aylmer: one,  which  banks  talk  about  are  average  net  interest  margins. 

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Sean Aylmer: What  are  they?  And  what's  happening  there?

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Tim Dring: Yeah. Well, net interest margin is really the difference between what

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Tim Dring: a bank lends money for and the cost that it

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Tim Dring: pays to deposit holders for using that money. That margin

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Tim Dring: we've seen over the last decade, Sean, just on a gradual decline.

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Tim Dring: We've been tracking the bank results now for more than

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Tim Dring: a decade. And at the start of that period margins were

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Tim Dring: well above 2%. We're now down to 1. 86% and

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Tim Dring: that's a fall of three basis points from this time

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Tim Dring: last year. What has driven that? There's probably a couple

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Tim Dring: of things. So, I guess there's some positive aspects on that.

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Tim Dring: The banks have been able to access pretty cheap funding,

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Tim Dring: through the term funding facilities set up by the RBA.

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Tim Dring: Which enabled them to sort of utilise funding at 10

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Tim Dring: basis points. Which is very cheap funding, in addition to

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Tim Dring: the funding from deposit rates which has certainly been favourable

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Tim Dring: to the bank's deposit rates. So, very close to that

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Tim Dring: if not zero for some products. But on the other

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Tim Dring: side of the fence, we've seen intense competition right across

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Tim Dring: the market, particularly in respect of residential mortgages probably hasn't

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Tim Dring: been as intense, that competition. We've seen institutions offering sort

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Tim Dring: of cash backs, for refinancing with their institution. We've seen

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Tim Dring: honeymoon rates, we've seen low fixed interest rates, and all

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Tim Dring: of those things have really chipped away at margin. It's

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Tim Dring: actually been quite astonishing, actually right across the board. And

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Tim Dring: not only that, the heavy bias towards fixed rate loans.

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Tim Dring: We've probably seen a great tendency of that through COVID,

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Tim Dring: than probably what we saw pre- COVID where there was

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Tim Dring: more of bias towards variable interest only, and also lending

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Tim Dring: to investors as well.

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Sean Aylmer: If we look at the three that have reported in the

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Sean Aylmer: last three weeks. Westpac's result was disappointing, full stop. And

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Sean Aylmer: this is based on the share market reaction to it and

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Sean Aylmer: I think no one's arguing that. ANZ's cash profit was

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Sean Aylmer: up 65% but the CEO, Shayne Elliott said, they had missed

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Sean Aylmer: the home lending boom, which given what's gone on in

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Sean Aylmer: the housing market, is significant. National Australia bank seemed to

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Sean Aylmer: be more solid, although its institutional business didn't do so well.

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Sean Aylmer: It must be very hard to run a bank and

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Sean Aylmer: get every part of it, every division working.

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Tim Dring: I think that look, there's a lot of levers to pull in bank.

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Tim Dring: You try and grow loan volume, through incentives that puts

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Tim Dring: the pressure on back office, and particularly through COVID where

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Tim Dring: you may have some of those functions being performed by

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Tim Dring: a third party or even offshore. Can put pressure on, on turnaround

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Tim Dring: times and time to yes. And once again, systems that

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Tim Dring: in some ways, are very much reliant on legacy. So,

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Tim Dring: that time to yes can be based very much around manual processing

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Tim Dring: as well. You've then got the margin lever and you compete

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Tim Dring: on price or you're trying to compete on volume. Then

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Tim Dring: you've also got the mix of business and you're between retail mortgages,

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Tim Dring: business banking and institutional lending. You've then got the markets

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Tim Dring: business and then overlaying all of that, you've then got

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Tim Dring: sort of cost levers and how much do you invest

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Tim Dring: in technology? How much do you invest in sort of

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Tim Dring: operational improvement? And there's so much to continue to invest in

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Tim Dring: just bank resilience, whether it be, complying with legislation, building

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Tim Dring: out better risk management processes, all of those things add

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Tim Dring: to the cost basis of an institution as well. So,

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Tim Dring: there's a lot of levers to pull and as I said,

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Tim Dring: trying to get all of them right at the right time,

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Tim Dring: can be a challenge.

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Sean Aylmer: Dividends are back, Tim.

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Tim Dring: They are back and they're back with a vengeance. So, sure we

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Tim Dring: have seen a number of the banks really increase their

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Tim Dring: dividend payout ratios. I think, cognitive of a few things,

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Tim Dring: one is the return to earnings, which is good. So,

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Tim Dring: it's going to help shareholders. But I think the other

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Tim Dring: thing too, is the capital base right across the banks,

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Tim Dring: I mean the capital position across the market is very

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Tim Dring: strong and, we've certainly seen a number of the banks

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Tim Dring: if not all of them at some point in time,

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Tim Dring: start to announce and work through share buybacks simply because

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Tim Dring: they are sitting on a lot of capital. Capital returns. So,

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Tim Dring: their return on equity is down. Perhaps hand it back to shareholders.

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Sean Aylmer: Yep, fair enough. Environmental, social and governance factors, ESG. The banks,

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Sean Aylmer: certainly more, talking about it more. Though it was interesting

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Sean Aylmer: National Australia Bank deliberately said, it would lend for gas

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Sean Aylmer: at least because that was a transition fossil fuel is

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Sean Aylmer: how they put it. Is it a bigger part of

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Sean Aylmer: their thinking, do you think?

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Tim Dring: It certainly has really come to prominence. So, I think

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Tim Dring: in the last 12 to 18 months and probably could

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Tim Dring: say even with COP26, it's even risen to the service

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Tim Dring: a lot faster and more prominent than perhaps we would've thought.

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Tim Dring: But it's fair to say that there is a lot

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Tim Dring: to be done, and we did a big sort of

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Tim Dring: risk survey right across the director base of global banks,

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Tim Dring: including Australian banks in that sample and (Chief Revenue Officers). And there's

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Tim Dring: no doubt ESG in particular, the E is rising to prominence.

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Tim Dring: Last time we did the survey was sort of about

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Tim Dring: number seven or eight on the list. It's now up

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Tim Dring: to number one and two, depending on what you look at.

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Tim Dring: But we're also seeing that play out across institutional investors

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Tim Dring: and proxy advisors that the significant focus on that ESG

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Tim Dring: agenda and through COP. And I think through what, the

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Tim Dring: announcement from our banks. They've got a pretty critical role

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Tim Dring: to play in that, how they support their customers through this

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Tim Dring: transition phase. I think is going to be really important. A number have

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Tim Dring: come out and said, they're taking pretty firm stances in,

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Tim Dring: who their bank going forward, but that transition play is

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Tim Dring: going to be really important over the next decade as we,

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Tim Dring: start to transition to net zero. But there's a lot

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Tim Dring: to be done. There is a lot of dynamics that

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Tim Dring: play here, Sean. It's not only about the, perhaps it's the

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Tim Dring: large institutional customer that is the borrower. But behind those

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Tim Dring: institutional customers shareholders, there are employees and many of those

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Tim Dring: have bank products and mortgages. So, there's a lot of

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Tim Dring: dynamics to work through here. And that is why I

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Tim Dring: think we're probably going to see how bank support corporates

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Tim Dring: transition is going to be probably the most critical thing over

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Tim Dring: the next decade.

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Sean Aylmer: Tim,  thank  you  for  talking  to  Fear  and  Greed.

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Tim Dring: You're  welcome  Sean.  Thank  You.

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Sean Aylmer: That was Tim Dring, Oceania Banking and Capital Markets Leader

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Sean Aylmer: at EY. This is the Fear and Greed Daily Interview.

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Sean Aylmer: Join me every morning for the full Fear and Greed

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Sean Aylmer: podcast with all the business news you need to know.

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Sean Aylmer: I'm Sean Aylmer. Enjoy your day.