Copying and distributing are prohibited without permission of KangaNews. Please contact [email protected]

 

Mutual sector consolidation to bring opportunities for capital markets

New analysis from S&P Global Ratings (S&P) predicts further consolidation within the mutual sector. This consolidation should see greater capital-markets activity from the sector thanks to greater entity scale and expansion of the range of funding tools available to mutual banks.

On 23 June, S&P published a report Larger, well-managed Australian mutuals will prevail as market consolidates which argues that Australia’s mutual banks will remain competitive even though consolidation in the sector is inevitable. The report expects larger mutuals to strengthen their positions as the number of players in the sector reduces.

The mutuals sector is at a critical juncture in funding and capital markets – as also discussed at the first-ever KangaNews Mutual Sector Wholesale Funding Seminar in Sydney in February. Delegates at the event heard that the competitive environment presents an opportunity for mutuals but that to take advantage many need to improve their funding and capital strategies.

“The mutuals currently generate ROE of around 5.5 per cent on average. Despite a one-off boost to capital bases, the economic viability of MCIs would depend on the ability of mutuals to improve their profitability.”

Strong capitalisation

S&P calls out the growth in the mutuals sector as being particularly noteworthy compared with the Australian banking system as a whole. Mutuals have around a 2.5 per cent market combined share of the Australian banking industry. S&P does not expect this to change substantially in the near term but argues that consolidation is fuelling long-term prospects.

In a 3 July webinar, Lisa Barrett, associate director, financial institutions at S&P in Melbourne, said there were more than 180 mutuals across Australia 15 years ago compared with around 70 in 2019 and with a handful more intrasector mergers underway – for example the proposed merger between G&C Mutual Bank and Unity Bank. Barrett predicts the number of Australian-wide mutual institutions to be less than 70 by the end of the year.

Australian Prudential Regulation Authority (APRA) restrictions on investor and interest-only lending opened the door to greater market share for the mutuals. “The impact of APRA restrictions has been more pronounced on the major banks than on smaller lending institutions, particularly the mutual sector. The mutual sector is working within the confines that APRA has set but has continued to grow over the last couple of years – which is a trend we expect to continue,” Barrett commented.

S&P points out that the mutual banks are among the most highly capitalised in the Australian banking system. The rating agency recognises this as a sectoral strength and Barrett says it is not something which S&P expects to change in the medium term.

However, there changes are underway which at the margin could further solidify mutuals’ capital strength. The Treasury Laws Amendment (Mutual Entities) Act 2018: Tranche 2, which passed in April, introduces a new bespoke capital instrument in the Corporations Act 2001 for all eligible mutual entities and permits the use of mutual capital instruments (MCIs) for mutuals across Australia.

“This offers the mutuals another option to put in their capital toolkit,” Barrett comments. “We expect many entities will put in place programmes to issue MCIs. Doing so will require them to make changes to their constitutions, however they have three years from the introduction of the legislation to complete this.”

The value of MCIs may be marginal, though. Barrett suggests a 7-8 per cent coupon may be required by investors in such instruments, and says most mutuals would face material challenges in generating incremental return on equity (ROE) sufficient to meet this level of coupon.

She continues: “The mutuals currently generate ROE of around 5.5 per cent on average. Despite a one-off boost to capital bases, the economic viability of MCIs would depend on the ability of mutuals to improve their profitability. In addition, pricing and market take up could pose further challenges. It is therefore unlikely in our view that MCIs would be capital-accretive on an ongoing basis in the foreseeable future.

Funding choices

On access to funding more broadly, the KangaNews seminar in February heard that mutuals were foundationally funded by member deposits and have tended to diversify their funding as they grow.

Some of the larger institutions have already transitioned their funding profiles from issuing wholesale term deposits and then negotiable certificates of deposit to now being active in capital markets.

“As mutuals continued to grow in scale, they started issuing MTNs in larger clips and for longer tenors, and they have begun to use RMBS [residential mortgage-backed securities] as capital-relief and funding-only mechanisms,” Barrett said.

Mutual-sector bond and securitisation issuance has so far been limited to a handful of names. However, as the industry continues to consolidate the mutuals will naturally grow in size and Barrett says more institutions will naturally become relevant to RMBS and vanilla bond markets.

Mark Symes, Melbourne-based analyst at S&P, adds that the rating agency expects retail deposits to remain the dominant funding source – at least for now. But he adds: “With current technological innovation of product, we expect increased pressure on retail deposits for the mutual sector. Securitisation and other wholesale funding mechanisms will continue to offer alternatives – certainly for the larger mutuals.”

The content on www.kanganews.com is for information only. Please read our Terms & Conditions and Privacy Policy before using the site. All material subject to strictly enforced copyright laws. © BondNews Limited