Investors
P: 1800 658 404
View full details
Financial advisers
Contact your state account manager or our client services.
View full details
Shopping Centres
For leasing, casual leasing and brand solutions enquiries
Contact Us
Connect with us to stay up to date with news and updates.

LinkedIn

Is this the end of record profits for ‘big 4’ banks?

Australian banks may have seen the end of record profits and dividends as the world recovers and Australian growth moderates.

Recently bank share prices have been volatile as the pace of profit expansion wanes

Since their recent reporting season, all our major banks have run into a volatile patch with the sector giving back much of its year-to-date gains. The market has been underwhelmed by the financial results delivered by the banks in May and this could signal the end of their record profits and dividends. This watershed moment may have seen valuations, relative to the global peer group, peak with our banking sector losing some of its advantage as the world recovers and Australian growth moderates. Offsetting this is the Reserve Bank of Australia (RBA), now with a record low cash rate of 2%, which may still ease further and should support debt affordability and asset quality. The sector will also benefit from the valuation support given to stocks with such high dividends in a yield-starved world. Overall, investors need to acknowledge the changed environment and ‘right size’ their positions to the sector. The banks represent a large proportion of retail direct equity holdings so clients need to be more prudent about the extent of their holdings in these names and take profits by trimming back oversized positions.

Bank shares have given back some of their large gains

Source: AMP Capital and Bloomberg

Their pace of profit expansion seems set to slow

Source: AMP Capital and Bloomberg

Life’s tough at the top: Some profit growth drivers in the sector turn flat, but not yet down

The ’big four’ banks have been top global performers (in local currency terms) and a very large driver of our stock market rally particularly since the Euro-crisis days of 2012. All four major banks have outperformed the index. For the past three years the environment could not have been more ideal for profits in the banking sector. With the mix of rates at all-time lows and growth around trend, the banks were able to grow their mortgage books at the same time as problem loans dissipated. As a result, the profits of the ’big four’ have doubled from 2008 levels as we can see in the chart above. This has led to a sustained, steady rise in stock prices, bank profits and a growing stream of dividends.

But many of the drivers of that growth in profitability and earnings are now slowing and this will lead to some contraction in valuations. One driver has been cost reduction. Banks have kept a keen eye on costs over this period by capping the growth in the number of employees and implementing productivity and cost-out initiatives. This has led to what the banks call ’positive jaws’, which basically means an increase in profit margins. But cost pressures are re-asserting themselves, meaning this area of margin expansion may be more difficult to achieve going forward. Another big driver of profits has been the release of balance sheet provisions for bad and doubtful debts. These are reserves the banks hold against loans that are in arrears or at risk of impairment. As interest rates plummeted to all-time lows, these problems loans started to improve to such an extent that the banks are obliged by accounting standards to release those reserves to profits. But with the provisioning for these loans now below pre-GFC levels, they represent a one-off profit driver which may reverse if the cycle weakens. So while profits should still grow this year, some of the factors that were driving these profits are starting to run their course.

Banks have grown profits and kept a lid on costs

Source: AMP Capital and Bloomberg

Their pace of profits expansion are set to slow

Source: AMP Capital and Bloomberg

About the author
Dermot Ryan, Portfolio Manager, Public Markets Solutions
Taking your SMSF to the next level
Download free ebook

Sign up to our newsletter!

Receive regular insights and marketing communications including a weekly update of trending news and market insights that are tailored for SMSF trustees and investors.
AMP's Australian operations are bound by the current Australian privacy legislation which outlines how organisations should manage and use personal information collected and held about their customers. AMP Privacy Policy
Sign me up Not right now. Thanks

Sign up to our newsletter!

Receive regular insights and marketing communications including a weekly update of tending news and market insights that are tailored for SMSF trustees and investors.
AMP's Australian operations are bound by the current Australian privacy legislation which outlines how organisations should manage and use personal information collected and held about their customers. AMP Privacy Policy
Sign me up