Aussie banks have just made record profits. What’s going on?

Sascha: [00:00:02] Welcome to the Dive, the podcast that asks who said business news needs to be all business. I'm your host, Sascha Kelly. Cost of living, inflation and interest rates. They've been the big economic stories of the past 18 months. People and businesses are doing it tough. You don't need me to tell you that. So when Australia's big four banks reported their latest results, there was a fair bit of anger. Commonwealth Bank's profit rose 5% to $10.2 billion. NAB's profit rose 9% to 7.7 billion. ANZ rose 14% to 7.4 billion. And Westpac's rose 26% to $7.2 billion. Today we want to look into these numbers and understand how bank profits are rising. It's Monday, the 20th of November, and today I want to know how Australia's big banks are making record profits in a cost of living crisis? To talk about this today, I have the pleasure of being joined by my colleague and the co-founder here at Equity Mates. It's Alec Renehan. Alec, welcome to the dive. 

Alec: [00:01:03] Sascha, good to be here. I'm sure this will be a controversial episode.

Sascha: [00:01:07] Yeah, absolutely. Alec.

Audio Clip: [00:01:08] Rising interest rates are delivering big bucks for the big four banks. Banks are making record profits off the back of people's pain. 

Sascha: [00:01:17] So I ran through some headlines just then, but can you give me a bit more information about the bank's results? 

Alec: [00:01:25] Yeah. So collectively, they made about $32 billion in profit over the past 12 months. The reason that it's in the headlines, it well, bank profits are always in the headlines, but the reason that it's captured people's attention is that up 8.2% across the four banks over the past year. So as you said, CBA up 5%, NAB up 9%, ANZ 14%, Westpac 26%. Everyone is feeling the pinch in different ways. A lot of businesses are feeling the cost of living crisis, not the banks.

Sascha: [00:01:57] So I want to know how they're making so much money because I know interest rates are going up, but that's the cash rate that the RBA is telling us. I would assume that that would have affected the banks just the same way it affects us. How are they still raking in these profits? [00:02:12][14.5]

Alec: [00:02:12] Yeah, so banking as a business is pretty simple. They take in money in deposits and then they lend that money out in loans. And the way that banks make money is the difference between the interest rate on what they pay and then what they get paid. It's called the net interest margin. And you're right, interest rates have gone up this year and it means that they're charging more for their loans like mortgages, and they're paying more on their deposits like savings accounts. But the difference, the gap between those two numbers has increased, according to an analysis from a Y. Across Australia's four big banks. The net interest margin is now 1.85%, which is up 11 basis points from the year before. So really, they're you know, when you say that they pass on the full interest rate increase to mortgages straight away and they maybe slowly pass on part of that increase to savers, that's their net interest margin increasing and it improves their profitability. 

Sascha: [00:03:18] So I guess like a bit of a loaded question then, like how are they able to make so much money once we understand that concept? 

Alec: [00:03:26] Yes. So this is, I guess, a gripe that a lot of people have with Australia's corporate landscape more generally. We live in the land of the oligopoly, you know, where there's a few big powerful companies on the top of every industry and you would think for major banks there would be enough competition there that they can't increase in net interest margin because their competitors are, you know, taking their business away, offering more to savers or offering better mortgage rates to borrowers. But it's not really been the case. Tim Harcourt, the chief economist at the University of Technology Sydney, has said that, quote, The banks sort of behave as a small pack. I think if you had more competition, they probably couldn't pass on the interest rates so easily. Now he's saying they behave as a small pack, not us, but you know, that's sort of the behaviour that I guess we're seeing in the market. 

Sascha: [00:04:25] What about other countries? Do they crack down on banks making high profits or do they just have more competition?

Alec: [00:04:30] Yes. So the rising rate environment has been good for banks all over the world. Like there's no getting around it. It's not just Australia where net interest margins are improving and profitability is increasing. We've seen a number of European countries, I guess, react to these rising profits in this current economic climate. In August, the Italian government proposed a one off 40% tax on bank profits from higher interest rates. 

Audio Clip: [00:05:00] Italy's prime minister said she took full responsibility for the shock decision to impose a one off bank tax. The announcement has been blamed for hurting the government's credibility with financial markets, but its Prime minister, George Maloney, was defiant and said she would do it again.

Alec: [00:05:17] Countries like Spain and Hungary have already imposed some windfall taxes on the sector. There's talk that others might follow suit. So, you know, I don't think that's going to happen in Australia. But lawmakers are responding to this in other countries.

Sascha: [00:05:32] Yeah, that's super interesting because obviously we have the conversation about windfall tax for miners. But, you know, banks kind of slipped through the crosshairs there. And this is all happening at the same time that mortgage holders, they're being squeezed. 

Alec: [00:05:46] Yeah, housing is the biggest cost for all Australians. And it's it's becoming a struggle. So to put the interest rate rises in context, we we pulled out a mortgage calculator. Let's say you had $750,000 borrowed as a mortgage at 2% interest, which is what you would have been getting about 18 months ago from a bank for 30 years. You'd be paying about $2,800 a month at 7% interest, which is what is close to what you're getting now for 30 years. You'd be paying $5,000 a month. So many mortgage holders have seen their monthly repayments close to double in less than two years. And that's a key driver of this cost of living crisis. And then renters, according to Cole Logic's latest data, they've seen the average rent rise 14% in the past year. So if you're a mortgage holder, if you're a renter, you're feeling this housing pinch, basically, unless you own a home without a mortgage. This has been a tough 12 to 18 months. 

Sascha: [00:06:50] Yeah, absolutely, Alec. But also the banks reporting their bumper profits feels like gaslighting. They said that the Australian consumer, they're going okay, I don't know how this went down. 

Alec: [00:07:02] I don't know if we can say the data is gaslighting. Like the data seems to be better than what you would expect. So maybe it's the media that's gaslighting us and the data is actually better than we think. 

Sascha: [00:07:13] Maybe we're part of the problem here. Yeah. 

Alec: [00:07:16] Yeah, yeah. So the bank's data show that whilst people are feeling the stress, it hasn't led to like the catastrophic situation at a scale that's really showing up in the numbers yet. So to go through some of the banks numbers and what they're telling us about their customers. According to CBA, the proportion of customers whose mortgages were in arrears by more than 90 days increased slightly, but the share remained relatively low at 0.47% of their mortgage book. They saw a slight uptick in late payments for credit cards, up 20 basis points. And then the home loan arrears was up three basis points. So not big increases in the amount of people falling behind on their loans, according to ANZ CEO Shayne Elliott of the banks, 1 million mortgage holders, only 2000 were currently in hardship. Now, I don't know how he defines hardship, but that's you know what, that's 0.2% of their mortgage book. ANZ 90 day mortgage delinquencies increased four basis points to 64 basis points, 0.64%. But the bank said that the ratio of people behind on their mortgages was well below pre-COVID levels of above 1%. So again, you know, a slight uptick. But the data is saying not too bad. Similar story from NAB. NAB's CEO Ross McEwan came out and said the bank's mortgage book was, quote, in good shape. And he actually said that NAB customers increased amounts in their offsets and redraw facilities during the year, which isn't really surprising because if you had money invested or you had money stashed away and your mortgage rate increases so much, you're going to put it in your offset account. But yeah, it's somewhat surprising because this data doesn't seem to align with what we're saying in the media. But I think the way that we square this is that more and more Australians are feeling housing stress and are having to put more and more of their disposable income in the take home pay into paying their mortgage or paying their rent. And so it's not showing up in the bank numbers yet because housing is the last thing people are going to get rid of. You know, they're going to stop going out and, you know, stop going to the gym or like they're going to cut all those other expenses to keep up with their mortgage. So from the bank's perspective, people are keeping up with the mortgage. But that data doesn't really reflect what people are giving up to keep up with their mortgage.

Sascha: [00:09:53] Yeah, there's more to the picture than just that data. But despite the bumper profits, the banks have all warned. About a mortgage war brewing, Sir Alec, let's talk about that and maybe some possible relief. But after the break, we'll. Welcome back to the dive. The banks are making record profits and borrowers and savers are paying for it. That seems to be the sentiment emerging from the recent reports of Australia's four major banks. But recently there's also been talk about a mortgage war brewing. Okay, first of all, what on earth is a moment of war? 

Alec: [00:10:33] Yeah. Mortgage war is the media term for banks cutting prices, I guess for, you know, giving cashback offers to move your mortgage across or reducing the rate that they charge on their mortgages. And, you know, some would call that competition in business. But in Australia, when the banks actually start competing with each other, we call that a mortgage war. 

Sascha: [00:10:55] And there's always someone who's leading the pack. The other banks are calling out ANZ in particular for starting the war. They got shot the first hour or whatever it might be. 

Alec: [00:11:06] Yeah, yeah. Well, in ANZ latest results they posted the fastest growth in the mortgage book of the four major banks and there was a pretty competitive period where a lot of them were offering, you know, cash back or cheaper home loans. ANZ net interest margins. So again, that's the difference between what they give to depositors like savers and then what they lend out that money to borrowers like mortgage holders. ANZ net interest margin dropped from 1.75% in the first half of the reporting year to 1.65% in the second half. So down ten basis points. Not a huge drop, but enough of a drop for people to claim they've started a war. 

Sascha: [00:11:52] And I think the start you had at the beginning was a 1.85, right? So yeah, they're well below what the average is across the other banks. 

Alec: [00:11:59] Yeah, that's right. And as those banking margins are reduced by this competition in home lending, Commonwealth banks say Matt Coleman has come out and said that some of his bank's peers experienced what could be, quote, the biggest negative margin erosion in banking history. 

Sascha: [00:12:19] Okay. Big call.

Alec: [00:12:20] Yeah, I don't know if anyone's feeling too sorry for Matt Coleman and Commonwealth Bank. Common went on to say some banks are chasing volume and trying to win back some of the volume or market share that they've lost. And clearly that's coming at a high cost. To be clear, he's saying it's coming at a high cost to the banks, not at a high cost to customers. So really, the second half of the year has been labelled as one of the most competitive times in the past two decades for home loan pricing. And the banks are, I guess, worried that that's going to affect these profit numbers going into next year.

Sascha: [00:12:56] And for people who, you know, spend their lives watching this kind of data, there's some that are arguing that this is irrational pricing by ANZ.

Alec: [00:13:05] Yeah, we read a few bits of analysis that started talking about irrationality in the mortgage market. There's one quote we have here. The UBS analyst John Story said that ANZ growth during a period of heightened competition reflected quite possibly irrational pricing. But Sascha, this is where I think finance starts to lose connection with reality. And I was trying to explain this in the office yesterday and I was getting absolute crickets. So I want you to tell me if I'm making sense here. 

Sascha: [00:13:35] Okay. That's what I'm here for. After all. 

Alec: [00:13:38] So ANZ net interest margin dropped from 1.75% to 1.65% because of their supposedly irrational mortgage pricing. But 1.65% is still higher than their net interest margin from the year before, which was 1.63%. And just comparing the half to from last year to half two of this year being the irrational pricing moment, ANZ profit was still up 8% from half to two half to. So it's just like how we calling their pricing strategy irrational when they still grow profit 8% and the net interest margin is still bigger than the year before. It's, you know, like it's still a profitable strategy. It's just the slightest hint of competition in this sector. And we shout irrationally.

Sascha: [00:14:33] That's what I was going to ask because I thought, yeah, if you're offering just a slightly lower rate. But by doing that, I'm getting hundreds of thousands of new home owners through your doors, then that's just good business, isn't it? 

Alec: [00:14:48] Yeah. You would say the pricing becomes irrational when you start onboarding customers that aren't profitable.

Sascha: [00:14:55] Yeah. When you've got a loss leader or something. Yeah. Yeah. 

Alec: [00:14:59] But we're not there yet. No, but look, Sascha, maybe I'm biassed in this. As someone who has recently taken on a mortgage with ANZ, I am all for the supposed irrational pricing. 

Sascha: [00:15:09] Well, we might leave it there. For today. Alec, I think you actually brought a fair bit of clarity to me with the banks. And I'm angrier than I was at the beginning of his episodes. And maybe that's backfired. We'll be back in your feeds for more dive on Wednesday. Thanks for joining us.