Greg Hammond is perhaps still best known to Australian debt-market participants for his former role as a partner at King & Wood Mallesons (KWM). More recently, Hammond has become a key player in the mutual space, including as a director at G&C Mutual Bank and as the author of a report into the sector that has sparked much discussion on issues including capital and mutual entities. Hammond spoke to KangaNews shortly after the KangaNews Mutual Sector Wholesale Funding Seminar.
Your report – Reforms for Cooperatives, Mutuals and Member-owned Firms – was published in July 2017. How did you come to take the position of independent facilitator for this report?
Shortly after I retired, a few mutual ADIs asked if I would consider sitting on their boards. I opted to join the board of a small one: G&C Mutual Bank. I have been on the board for more than five years. One reason I joined was because G&C has a reputation for trying innovative things to develop its business model. Capital forms an important part of this strategy.
It was through my role at G&C that the federal government asked me to undertake the review. The government reached out to COBA [the Customer Owned Banking Association] and the BCCM [Business Council of Cooperatives and Mutuals] for people who might be able to conduct a review of the barriers that impede mutuals from accessing capital. They put my name forward.
How have you engaged with the report’s issues and recommendations?
Since then, I have continued my involvement with COBA and BCCM on what mutuals need to do to take advantage of the new regime and educating the sector, investors and other interested parties on what the legislation enables and what it doesn’t.
What are your observations on how the legislation has been taken up? We are yet to see the issuance of a mutual capital instrument (MCI), for instance.
It wouldn’t surprise me if the first few MCI issues came from non-ADI mutuals, partly because they would have a quicker process. They would not have to go to as many regulators for sign-off – and we know from experience that novel capital instruments take some time to get through APRA. The regulator’s processes are thorough for all types of ADI.
On the other hand, I don’t think the early issuance will necessarily be the same type of instrument mutual ADIs will end up using.
The MCI was designed to take the place of ordinary shares. With ordinary shares, the issuer’s business management and governance are as important as the terms of the shares. This means it will be, I think, a different type of investor that is looking out for the MCI product. A fixed-income type investor might look at MCIs as a hybrid-like instrument that provides a predictable return. The other end of the spectrum is people interested in impact investing: the issuer’s impact on the community, what it is going to do with the money and so forth.
ESG [environmental, social and governance] investors appear to have some interest in the MCI product. The MCI could be more of an ESG investment play than anything else in three to four years.
There has been some issuance of pooled capital instruments by mutual ADIs in Australia, albeit not for several years. Why did this market fizzle and what does the MCI add that this type of issuance did not offer?
Neither of those issues was a common equity tier-one (CET1) transaction. The problem that has confronted the mutual ADI sector, and still confronts it, is that regulators increasingly put higher value on CET1 capital. Deductions come off CET1 and banks have to maintain a relatively high proportion of total capital as CET1.
Quite a few mutuals have executed tier-two deals and I expect this to continue, in the same way the majors have continued to issue tier-two paper. But there is a limit to how much tier-two, and AT1 for that matter, a mutual ADI can issue – not to mention a limit to how much it helps them.
There are other capital-relief methods, such as securitisation. There are about 25 mutual ADIs with current securitisation programmes but they don’t use them much – because they don’t need to. Again, I think there is a limit to how much capital-relief activity a mutual ADI would want focused in that area.
Then there is the issue of ratings. S&P Global Ratings rates about 15 mutual banks. Moody’s Investors Service and Fitch Ratings each probably rate a similar number – with crossover, of course. Many mutual ADIs have not felt compelled to go through the rating process.
I also don’t think the MCI will end up being an investment-grade product, given the current triple-B band ratings of mutual ADIs. As such, it wouldn’t necessarily require going through a rating process – although a successful MCI issue could enhance corporate credit ratings.
“ESG investors appear to have some interest in the MCI product. The MCI could be more of an ESG investment play than anything else in three to four years.”
This would suggest the MCI may be a purely retail product. Does this seem likely?
Issuing to existing members is a possibility. People immediately think this takes mutuals to retail, and that is probably the ultimate goal. But many mutuals, particularly those that are regional or closely aligned to their communities, have high-net-worth individuals and local corporate members that qualify as wholesale investors. This may be a completely different investor market, outside the existing one, for the MCI.
A small regional building society in the UK issued £15 million (US$18.5 million) of the local equivalent of MCIs and placed it entirely with the local council’s superannuation fund. The purpose was to enhance the issuer’s ability to lend on mortgages in the local area, which the local council wanted. This is a completely different market and issuance strategy.
There are also discussions about creating an open-ended fund to invest in MCIs. Whether there are patient investors that are willing to go into an open-ended fund is uncertain. But it is not uncommon to create a fund with the expectation that there will be only a cash-type return for the first 12 months while the portfolio builds – and then a better return over time. It might be in the mutuals’ interest to arrange this type of fund.
The biggest buyers of AT1 and tier-two deals from ADIs in the wholesale market are often other ADIs. Mutual ADIs have invested in this type of product as well and they could consider redirecting their interest to supporting other mutuals.
Are you disappointed at the pace of development of the MCI market?
There was concern that members would not understand the product and would block the changes. Some amendments are quite small and some are more significant. My understanding is that six mutuals have now made the necessary changes and these approvals have gone through with 80-95 per cent of members voting in favour.
All credit to the mutuals that took it to their AGMs. This is high support from members, which should encourage other mutuals to amend their constitutions. The pool of potential issuers should grow as a result. There has not been a large pool of potential issuers to date.
Bringing a new instrument to market can be a double-edged sword. An issuer will probably pay more for being first than if it is in the third or fourth round of transactions. On the other hand, there will be some PR benefit to moving early and a few mutuals may be happy to issue first, even knowing it will cost slightly more.
Overseas, issuers have paid more for the first issuance while the second and third tranches have been a better economic proposition.
The motivation for the review was that it would be beneficial for the sector to have access to more capital. This rationale seems only to have increased with the challenges to mutual-sector profitability and thus the ability to generate capital. How much more important is externally issued capital in today’s business environment?
Perhaps unsurprisingly, the banking royal commission and similar factors have helped the mutuals. The mutual ADIs’ growth in its traditional product, home mortgages, is above system growth. There is leakage from the majors to mutual ADIs.
Expanding portfolios requires capital. The challenge of the digital space has also opened up potential cost. Mutuals are increasingly looking at investing in online platforms and, for mutual ADIs, this involves a deduction from CET1. It would be much easier if mutual ADIs were able to raise capital for that purpose.
Quite a few mutuals are equity investors in digital financial institutions such as Society One and 86 400. I wouldn’t be surprised to discover there are mutual equity investors in several other entities of this type. Again, the lack of ability to raise CET1 hinders mutuals’ capacity to take on these investments.
“The biggest buyers of AT1 and tier-two deals from ADIs in the wholesale market are often other ADIs. Mutual ADIs have invested in this type of product as well and they could consider redirecting their interest to supporting other mutuals.”
Will mutual ADIs be able to undergo digital transformation without prejudicing the mutual value proposition? Having a regional branch network is still important for many mutual bank customers.
There is a range of other considerations, though. The federal government’s First Home Loan Deposit Scheme has 25 mutuals on the panel, which is guaranteed half of the 10,000 support places the government has made available. First home buyers are the younger generation – there won’t be many older people who meet the criteria. This will open new ways for mutuals to gain a foothold with younger generations.
Younger people also have less loyalty than older ones when it comes to financial institutions. It is a great opportunity to attract someone to a new offering – and it is also a challenge to keep them.
The nonbank sector has been performing well in Australia in the past few years and has been taking market share away from the major banks, for the most part. How similar is the opportunity set for mutual ADIs?
Most borrowers require a competitive price – they are not going to move to another bank otherwise. But it comes back to the mutual sector’s value proposition of being community oriented. Institutions invest in their community and transfer their financial benefits to members.
ESG concerns resonate with the younger generation more than they did with mine. If one of the majors succeeds in breaking the mould around trust, that is probably the biggest threat to the mutual sector.
Most mutuals are sponsors of events in their communities and this generates goodwill. It would not surprise me if Heritage Bank, for instance – which is heavily embedded in its local community – encountered investment wealth in its home area that would be prepared to invest if the bank issued an MCI.
This would not be unique. There are strong mutuals in regional Australia, and the major banks do not have a good name in regional Australia. They are closing branches. I know of one regional mutual that has mortgage pricing at the high end of the mutual sector but growth among the highest. This is because it has been generating loyalty in the communities it serves.