While Westpac’s third quarter numbers were slightly disfigured by an unexpected blip in its impairment charges, there was nothing in the update that challenged the view that conditions for the major banks are getting tougher.

Coming after Commonwealth Bank’s June-year results last week, which showed a definite slowdown in asset and income growth in the June half, Westpac’s update tends to confirm the view that the sector is almost flat-lining.

It did generate income growth, but only of 1.5%. Cash earnings were actually down 2%, although earnings excluding the impairment charges of about $300 million were up 2%.

While the higher impairments might appear disconcerting — and there was a modest increase in delinquencies within its retail banking businesses — Westpac said there was little change from the average of the first two quarters if economic overlay provisions were excluded.

It is an indication, however, that Gail Kelly and her board believe the tougher conditions aren’t a temporary phenomenon that the group, already at the efficient end of the industry league table, is planning a new round of cost-cutting and job-shedding to protect its bottom line and its returns to shareholders.

The problem for all the banks is the anxiety levels of consumers and businesses, which is translating into very weak demand for credit and therefore little volume growth. The volatility in global markets is also impacting the banks’ trading income.

The momentum provided by falling impairment charges (despite Westpac’s blip) is also fading fast — Westpac said yesterday all categories of stressed exposures declined in the quarter and the incidence of new impairments also continued to trend lower.

While the majors have been able to edge their net interest margins up — in Westpac’s case by four basis points to a still-skinny 2.12% — there is nothing in their environment that suggests a return to pre-crisis levels of earnings growth. Indeed Kelly cited the “new reality” of banking as justification for the cost-reduction program.

The banks are fortunate, so far at least, that the Reserve Bank, clearly torn between its desire to choke off incipient inflation and its concerns about the global instabilities and the implosion in business and consumer confidence, decided not to raise official interest rates at this month’s meeting.

The minutes of that meeting suggest that the decision was very finely balanced, with the decision to hold rates driven largely because of the violent instability offshore as Europe and the US wrestle with their sovereign debt problems.

A resumption of rate increases would hit lending volumes even more and could impact the more vulnerable segments of the banks’ consumer and small business loan books.

While Westpac said its first home buyer segment performed better than its total mortgage portfolio, CBA noted last week that loans written in 2008 and 2009 during the Rudd government’s crisis-induced increase in the first home buyers’ grant were experiencing some stress and producing some impairments. Westpac and CBA, as by far the biggest originators of those loans, wouldn’t want to further test the resilience of those households’ finances.

Indeed, with Westpac foreshadowing job losses, Qantas announcing 1000 jobs will go as a result of its new strategic plan and OneSteel saying it will lop more than 400 jobs — all announced yesterday — the weakness in the non-resource side of the economy is now flowing into large-scale job losses, which is good for neither the economy nor the banks.

Like CBA (and the other majors), at least Westpac is well-positioned for a downturn or, indeed, for another financial crisis, with a tier one capital ratio of 9.65%, $89 billion of liquid assets, much of its wholesale funding requirement already covered and customer deposit growth fully funding the modest asset growth.

That insurance against another external shock is very necessary, but in the absence of significant credit growth also makes it more difficult for the banks to generate the nominal returns shareholders have become accustomed to.

Bank shareholders by now — after the 2008 crisis — should in any event be more focused on risk-adjusted returns and on that basis the Australian banks are arguably the most attractive collection available anywhere in the world.

*This first appeared on Business Spectator.

Peter Fray

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