Westpac's new normal?

Westpac's result provides the clearest insight yet into the chilly environment around the big four, and neither its cost-cutting nor sales strategies have yet been able to offset pressure on margins.

Westpac’s first-half result provides perhaps the clearest contemporary insight into what’s happening within the domestic banking system. It is a rather bleak and grinding environment for the banks.

Westpac, almost a purely domestic financial services business, doesn’t have National Australia Bank’s UK baggage nor ANZ’s Asian growth to distract from the performance of its core businesses, so the flat-lining in its performance provides a clear view into the system.

That the group was able to produce even the slightest of increases in cash earnings was attributable to a respectable performance on costs, a rebound in markets-related income in the second quarter and a very solid increase in its New Zealand earnings. The core Australian businesses, both banking and wealth management, are struggling to generate any growth.

Net interest income, while up 4 per cent of the March half of last year, was marginally lower than in the September half and Westpac’s net interest margin was down four basis points in the half relative to the September half (five basis points if treasury and markets income is excluded). In fact, the group’s net interest margin excluding treasury and markets ended the half at 2.02 per cent, or 10 basis points lower than where it started.

That’s consistent with what we saw in ANZ’s results, indeed slightly better (ANZ’s net interest margin was down 13 basis points). But it provides further justification, if any were needed, for the NAB and Commonwealth Bank decisions to hang onto some of this week’s Reserve Bank 50 basis points reduction in official rates.

The banks are being squeezed by the contest for deposits and the absence of significant volume growth – Westpac’s lending grew five per cent but its customer deposits grew 11 per cent.

The new banking environment is focused on funding rather than lending, partly as a result of subdued demand for credit but more particularly because the major banks are trying to manage down their exposures and reduce their vulnerability to the volatile offshore wholesaling funding markets.

The evolving new regulatory regime, which requires them to hold more capital and liquidity, is also a factor.

The banks are trying to defend their core earnings by reconfiguring their cost bases – shedding jobs and adding technology – to reflect the abrupt shift in what had been, until the financial crisis erupted, a high-growth system. Those halcyon decades for banking are over for the foreseeable future.

Westpac has a good record on costs – it prides itself on being the most efficient of the majors – and during the half its cost-to-income ratio was lowered another 10 basis points to 41.1 per cent. It has also placed greater emphasis on cross-selling its banking and wealth management products and continues to make progress with that strategy. But neither the cost cutting nor the cross-selling have yet been able to offset the absence of credit growth and the pressure on margins.

Nowhere was that more evident than in the St George brand, where earnings were down 7 per cent from those generated in the September half. St George is primarily a retail bank and therefore is heavily exposed to the new defensiveness among households and the deposit wars. The BT wealth management business was also, unsurprisingly, adversely affected by the market conditions.

Of some concern is the emergence of new indications of stress within the small and medium-sized business segments of the major banks’ portfolios, with Westpac saying the dollar and weak discretionary spending were hurting some sections of its portfolio.

While not unexpected – business failures are becoming a staple of the daily news bulletins – the banks have been benefitting from falling impairments. And adding a new surge in loan losses to the pressures they are already experiencing would add to the sense the banks are likely to remain ex-growth for some time to come.