ANZ is playing it safe in a dangerous world
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Looking at the ANZ Bank result for the year to September you could be forgiven for thinking the world is in a pretty good place right now.
Cash earnings up 65 per cent; a net $567 million release of provisions for loan losses from COVID-19 amid a very modest bad debt experience; an 82 per cent increase in dividends and big increases in returns on assets and equity would suggest a benign, even quite buoyant, external environment.
ANZ’s numbers show a high level of caution as uncertainty swirls in the banking sector.Credit:Sam Mooy
Look a little more closely, however, and a bank that’s carrying $6 billion of surplus capital and more than $4 billion of collective provisioning for potential loan losses is one that is signalling a high level of cautiousness and risk-aversion.
That’s not surprising given the actual nature of the external environment.
The pandemic and its after-effects remain a threat. Most of ANZ’s release of its provisions occurred in the first half, before the Delta outbreaks that forced the latest, prolonged, lockdowns in NSW and Victoria. It essentially preserved its still-heavy levels of provisioning in the second half.
While the pandemic, contrary to expectations, hasn’t scarred bank balance sheets – probably because of the extent of federal and state governments’ support for businesses and individuals – and the ANZ’s 90-day past due loan levels are falling and repayment deferrals are almost non-existent, the attritional effects of the series of lockdowns in the major capitals on smaller businesses could still emerge.
ANZ’s ultra-conservative balance sheet settings provide insurance against any delayed after-shocks from the pandemics, albeit at a significant cost.
The bank’s return on equity did increase from a paltry and shareholder-wealth eroding 6.2 per cent in the 2019-20 financial year to 9.9 per cent, more than covering a cost of capital estimated at about 8.5 per cent, but the excess capital is weighing heavily on the returns.
If ANZ were to buy back that excess capital, or profitably deploy it, while preserving the “unquestionably strong” capital levels required by the Australian Prudential Regulation Authority, it would add at least a full percentage point to its returns on equity.
The bank has clearly decided to adopt a safety-first stance, given the unpredictable course of the pandemic but, in the absences of some destructive new development, will be under increasing pressure next year to do something more structural than the $1.5 billion buyback it launched mid-year.
It has been apparent for some time that the banks, which had loaded up their provisioning dramatically in expectation of waves of pandemic-driven business failures, soaring unemployment and heavy losses in their home loan portfolios, have had a far better than expected pandemic.
The potential for something other than the pandemic to impact banks shouldn’t be discounted.
There is a global energy crisis, a global supply-chain crisis, major and dislocative policy shifts in China and the increased tensions between China and the West, and with Australia and the US in particular.
There’s also apparently entrenched inflation, rising market interest rates and the prospect of increases in central bank rates next year.
Longer-term issues are the intensifying global focus on carbon emissions, which has significant implications – threats and opportunities – for the banks trying to transition away from lending to carbon-intensive sectors and towards greener finance as well as the intensifying disruption by technology-driven non-banks.
For ANZ, with its regional institutional banking acidities as the major point of difference with its peers, within those threats lie some opportunities.
The extraordinary surges in house prices and the stretched, by historical standards, debt-to-income ratios they have generated mean that the core of the domestic banking system – mortgage lending – would be vulnerable to rising unemployment and interest rates. Credit:Peter Rae
Income from its institutional banking activities was down substantially, particularly in the second half (which suffered by comparison with a bumper corresponding period in the previous year). That’s because there was little volatility to drive income from markets activity.
With greater volatility emerging, and yield curves starting to steepen even without central bank rate rises, the settings for banks to profit from trading activity and, more fundamentally, from borrowing short and lending long – in an environment that’s shifting from one where rates across the board were historically low and yield curves almost flat to one that proffers profit for maturity transformation – will be more bank-friendly.
Those changes, however, aren’t without risk. The extraordinary surges in house prices and the stretched, by historical standards, debt-to-income ratios they have generated mean that the core of the domestic banking system – mortgage lending – would be vulnerable to any delayed, pandemic-related rise in unemployment or an unexpectedly rapid and large run-up in global interest rates.
ANZ, which had some issues with its processing of home loans in the second half, has inadvertently added another tinge of conservatism to its position through its inability to grab its share of the volume growth that poured through the system.
It does appear to have resolved those issues but, given the frothy state of the housing markets this year, perhaps missing out on some volume isn’t as damaging as it might be in more conventional market circumstances.
ANZ is the first of the major banks to report for the year to September but it has been apparent for some time that the banks, which had loaded up their provisioning dramatically in expectation of waves of pandemic-driven business failures, soaring unemployment and heavy losses in their home loan portfolios, have had a far better than expected pandemic.
They prepared for the worst, as prudent banks should do, but experienced few material adverse effects.
The housing price boom, and the intense competition to lend, however, does expose the vulnerability of banks that have, thanks to the Royal Commission, retreated to their core banking activities, shedding their wealth management and insurance operations and leveraging their exposures to an overheated housing market.
ANZ at least has its regional institutional business and the smaller but de-risked exposures to trade flows and cross-border financing and markets-related activity to provide some diversification and blunt what appears likely to be more restrictive “macro-prudential” measures from APRA if housing market activity continues to be as fevered as it has been this year.
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