The cloud over this year's bank profits

Investors have become used to stellar profits from Australian banks. However, this year's headline figures, even if good, will need to be read more carefully.

Bank reporting season has been fairly predictable in recent years, with record profit after record profit. This year, however, things are a little different. Investors must look beyond the headline numbers and dig a little deeper -- those who do will see big changes.

National Australia Bank, ANZ Banking Group and Westpac Banking Group will all report full-year results in the next week, with NAB kicking off proceedings on Thursday.  Estimates put the combined cash earnings of the three banks at around the $20 billion-mark, with both ANZ and Westpac tipped to again report record profits.

Of the three results, NAB’s will be most interesting, since it should provide investors with some much-needed insight into the direction CEO Andrew Thorburn wants to take the group. He’s already set the wheels in motion, announcing almost $1.3 billion of new impairment charges earlier this month, including $964m for NAB's beleaguered British banking business.  

With most of the headline numbers already announced, the strategic update will be Thorburn’s chance to set the bank on the right course. Investors should watch out for an update on plans for its MLC wealth business and the timetable for a full exit from the UK, while there may also be news on its Great Western Bank business in the US. Indeed, Citibank analysts expect a new writedown could be on the way, since the $US1.044bn partial IPO was nearly $US500m lower than book value.

After NAB comes ANZ on Friday, followed by Westpac on November 3. CBA, which delivered its full-year result in August, will deliver a trading update on November 5.

Despite the impairments flagged already by NAB, the total cash profits of all four banks are expected to beat last year’s $27.2bn.

Any other year, investors and analysts would be cheering those sorts of numbers, but this year the Financial System Inquiry is a dark cloud over the season. And that means that instead of focusing on the numbers, analysts will be pouring over the releases looking for any scrap of commentary on capital buffers and the impact of increased regulation in the sector. Investors should also keep a close eye on the annoucements, as they could have huge implications for dividends and share prices.

When the Financial System Inquiry hands down its recommendations in late November, it’s all but guaranteed that Australian banks will be told they need to hold more capital. And that will bring disappointment for yield-focused investors hoping for ever-increasing dividends.

Right now our banks are reasonably well capitalised – as they keep telling us. Indeed, their capital levels are currently above average relative to their global peers.

That said, our global peers haven’t yet fully transitioned to Basel III, and are still in the process of increasing capital. So for Aussie banks to stand still now would mean they’d actually fall back down the ranking. Not only this, but because Australian banks are so dependent on foreign capital, and we have such a concentrated banking system, David Murray is sure to push for more arduous protection and say our banks need to have ratios that are in the top quartile of their peer group.

Ultimately, David Murray has been tasked with ensuring our financial system could withstand another global financial crisis. He’s not at all concerned with safeguarding your dividends or pushing share prices higher. Whether you like the banks as an investment or not, it would take a brave investor to make a call on buying shares right now. When asked if investors were likely to sit on the sidelines until the Murray Inquiry findings are published, Credit Suisse’s Jarrod Martin had just one thing to say: “Definitely.”