'Structurally challenged' banks with subdued revenue opportunities tipped to turn to cost cutting including laying off staff

By Gareth Vaughan

The days of laying off staff and closing branches could return to the country's big banks as opportunities to grow revenue dwindle against a backdrop of anemic lending growth and global financial market turmoil, analysts at UBS say.

Sydney-based UBS banking analysts Jonathan Mott, Chris Williams and Adam Lee say revenue opportunities for the big Australian banks, including their New Zealand subsidiaries, are now challenged with the tailwinds of a leveraging economy driving strong balance sheet growth, readily available funding, fee hikes and rallying markets, all looking like they've run their course. On top of this, both consumer and business confidence is likely to be subdued as the world deleverages and instability is to the fore.

"As a result we believe bank management are becoming increasingly focused on improving efficiency to deliver improvements in pre-provision profit," the UBS analysts say. "We believe the banks are structurally challenged given subdued revenue opportunities. This makes process re-engineering and structural cost reduction an imperative."

They see four areas where the banks are likely to turn to for cost cutting; Staff which account for 58% of the big Australian banks' expenses, product, processing and procurement, reprioritising investment expenditure, and reducing branch numbers.

'NZ subsidiaries one and same as Aussie parents'

Asked where the New Zealand subsidiaries of the major Australian banks - ANZ, ASB, BNZ and Westpac - fitted into their analysis, Mott told interest.co.nz that the New Zealand divisions are considered as part of their parent's group.

Mott says since 1995 the big four Aussie banks - ASB's parent Commonwealth Bank of Australia, BNZ's parent National Australia Bank, the ANZ Banking Group which owns New Zealand's ANZ and National banks, and Westpac Group the owner of Westpac New Zealand, have grown costs - excluding acquisitions - at a 5.5% compound annual growth rate (CAGR). Efficiency improvements, meanwhile, have been driven by a "seemingly unsustainable" 7.6% revenue CAGR.

"Given the combined A$32 billion cost base of the four major banks, we believe the banks should be able to take out around 10% of costs over the next few years," the UBS analysts say.

They estimate that for every 1% in lost revenue the banks must cut expenses by about 2.5% just to stand still. As the biggest part of group expenditure, staffing is an area that will "need" to be targeted. 

In the Westpac Group's recent June quarterly trading update CEO Gail Kelly hinted at job cuts over the next two years saying: "Net-net I would say staff (numbers) will come down somewhat over the year that we're in and will come down somewhat again next year. But there are quite a few moving pieces." A spokesman for Westpac NZ told interest.co.nz Kelly's comments related to Australia. New Zealand was run separately and continued to invest for growth, the spokesman said.

The New Zealand arms of the big Australian banks have been growing staff numbers, wage bills and broader costs. This year's KPMG annual Financial Institutions Performance Survey noted overall bank employee numbers had increased by 849 at the country's registered banks to 25,686. And earlier this year ASB disclosed a NZ$44 million year-on-year rise in its wage bill as it added 346 staff.

And, in the June quarter, seven of the country's main eight retail banks recorded a rise in operating expenses, with four in double digits and five increases of 8% or more, as they splash out on information technology upgrades, prepare for new regulation such as the Reserve Bank's open bank resolution policy, try to secure business in a deleveraging environment, and absorb last October's GST hike.

This comes against a backdrop of lending growth that's weak at best. Reserve Bank sector credit data shows, as of July, agriculture debt down 0.9% year-on-year to NZ$47.316 billion, business debt up 0.9% to NZ$71.841 billion, and total household claims up 1.2% to NZ$184.234 billion.

Profits rising

But the big banks are still managing to increase their profits. For the year to June ASB recorded record annual net profit after tax of NZ$568 million with its return on equity up 1.9% to 17.2% and ANZ NZ is on track to post record annual underlying profit. This comes as the banks' impairment losses on loans tumble and they benefit from customers switching from fixed-term mortgages to higher margin floating, or variable, rate mortgages. See more here.

Meanwhile, the UBS analysts note Australia's major and regional banks employed 166,000 full time staff in 1996. This dropped to 141,000 in 2002 but has now risen to 174,000. And although staff expenses grew at 2.7% CAGR between 1996 and 2002, since 2002 they've grown at 8% CAGR. Meanwhile, since 1994 Australian banks' wage rates have risen by 5.4% CAGR to A$104,000 per full time employee. This compares with an average 3.8% rise in average weekly earnings across Australia and 2.7% average consumer price index.

The UBS analysts are picking the big banks will look to cull middle management roles to reduce costs.

"Targeting middle management provides a substantial cost out opportunity, not only due to the higher wages that are paid for such roles, but also due to the additional expenses such as offices, technology and travel expenses that are usually associated with these positions. Many of these positions are also non-client facing and are less likely to be disruptive to revenues."

They also suggest the banks will look to cut sales jobs given a subdued revenue outlook.

'No justification for job cuts in NZ'

Not surprisingly, Andrew Casidy, general secretary of bank workers' union Finsec, says there's no justification for staffing cuts in New Zealand.

"From our perspective  there are of course concerns that the industry in New Zealand might go down that path once again," Cassidy, whose union represents about 5,000 bank staff, said.

"We're in pretty constant dialogue with our employers here about our view which is frankly that's not justified. The New Zealand industry is in pretty good shape and profitability has returned. Whilst the near-term future is looking relatively stable as opposed  to the high growth projectories we might have seen pre-Global Financial Crisis, from our perspective they're not over staffed."

Finsec is set to amalgamate with the National Distribution Union in October to form FIRST Union.

'Too many branches'

Meanwhile, Mott, Williams and Lee say the scale of branch networks must be brought into question with the ongoing reduction in the number of transactions done through branches and the expense of running branches. They note that cheques comprised 28% of Australian transactions in 1999 and just 4% today. Branch and over the counter transactions have declined from 9% in 1999 to 3% today. And over the same time period EFTPOS has gone from 18% to 32% and the internet from 1% to 25%.

"Branches are very expensive to run given wages, rents, utilities and other overheads," the UBS analysts say. " With few customers using branches, why are the banks continuing to expand their footprints?"

"We believe that the banks should continue to downsize branches, and move to kiosk formats."

In New Zealand, although the big banks have been refurbishing branches and opening some new ones - ASB added nine in the year to June for example - KPMG's last annual Financial Institutions Performance Survey noted overall branch numbers down by 10 to 1,217 after Kiwibank closed nine branches during 2010.

The UBS analysts also suggest bank management will reinvestigate the opportunities for cost cutting by shifting processing overseas to India and other countries.