Christine St Anne: A recent Morningstar report looks at whether banks are able to sustain their dividends. Today, I'm joined by the reportï¿½s author David Ellis to give us an overview of some of the key findings.
David Ellis: It's pleasure, Christine.
St Anne: David, the banks reported relatively moderate earnings in the last reporting season. Are they on track to sustain their dividends of the past?
Ellis: We believe so, yes. Despite moderate earnings growth the banks, in absolute dollar terms, are very profitable and lending growth is moderate, so the demands on their capital levels - their capital ratios are under control and so they're continuing to build surplus capital. As long as the general economy doesn't enter a sustained and deep downturn, we believe that the key drivers are in place to support moderate earnings growth and importantly dividend sustainability.
St Anne: David, on that point of the lending business, housing credit continues to remain weak. Is that going to have a real impact on their earnings?
Ellis: Not necessarily, certainly housing credit growth has been declining ï¿½ the rate of growth has been declining for nearly eight years now. It's running at a roundabout - for the system, is running about 5% but the banks themselves are taking market share from non-bank lenders and the major banks are doing pretty well. So, overall system credit growth is declining for housing, but to offset that - partially offset that is business credit growth is increasing from, it's still at low levels, but the rate of growth is increasing, it has been for the last 18 months or so.
So, ones partially offsetting the other and whilst housing finance - housing credit for the banks, is a large part of their loan books, it's not necessarily a large component of their profit. The banks generates just as much profit from their deposit books.
They obviously have quite profitable business banking and commercial banking, markets business and personal lending, credit cards, transaction so on and so forth. So, whilst housing credit is important, I think it's overstated - that importance is overstated. As far as the bottom line profits are concerned, it doesn't have as much of an impact as a lot of people would think.
St Anne: Global markets, of course, remain in turmoil. David, will funding costs remain a key issue for banks?
Ellis: It certainly is an issue. Wholesale funding costs are - across their funding portfolios are gradually increasing and will probably increase for the next 18 months of so, 12 months. But the rate of increase seems to be easing a bit. Obtaining the funding is not a problem for the four major banks. They have high credit ratings and quite very, very profitable businesses.
So, funding costs are an issue, they are increasing. However, the big advantage of an investment in four major banks is that they have pricing power. So whilst funding costs have been increasing and will likely to continue to increase, the banks have the ability to increase their loan rates and they do, do it. The banks have the ability to increase their lending rates, to maintain their margins and over time, the banks have and will maintain their interest rate margins.
St Anne: David, what would be the key issues that banks will have to grapple within the future in order to sustain their earnings and maintain those margins?
Ellis: Well, over the last four or five years, the focus of the banks has been on ensuring they have enough capital and ensuring that their bad debts were managed, so their credit quality was improved. Looking forward, we see the next four or five years focus will be on technology and on cost control.
So, in a low credit growth environment, which we expect will continue for several years, that means low revenue growth, the focus on reducing cost or reducing the rate of growth in cost is becoming much more important and we'll expect to see more of that over the next few years.
Technology is a big issue, of course, for the big banks. It's a big issue for most businesses globally, it's not just an issue for the four major Australian banks. So, the focus is on particularly the shift from over-the-counter branch transactions to mobile devices.
So, the rate of take up or of banking transactions through smartphones and tablets and mobile devices has been rapid and of course, we expect that rate to continue. So, significant amount of management time and investment in improving technology to ensure that the banks do not lose a large part of their business to the global tech companies.
St Anne: David, thanks so much for your time today.
Ellis: It's pleasure, Christine.
St Anne: Premium subscribers could get a better understanding of some of the key drivers that David spoke about by going to the morningstar.com.au website, clicking on the Special Reports tab and then clicking on the link below.