18 November 2019
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Time to bank on the small fry?

Tim Boreham
13 February 2019

Royal Commissioner Kenneth Madison Haynes’ final report on bank atrocities was never going to make pretty reading after the tome landed on the desk of salivating reporters.

Having said that, the entrails weren’t quite as gory as expected and the heads-on-a-pike stuff was largely reserved for the upcoming finale of Game of Thrones — save for the National Australia Bank’s chairman and CEO of course.

While the inquiry was never formally aimed at the Four Pillars, as it happened the Big Four (as well as AMP and IOOF) were guilty of the multitude of sins, ranging from charging dead customers fees to shoddy lending practices.

As more big bank execs prepare either to spend more time with their families - or to work out who to blame - the smaller banks have emerged with their reputations largely intact.

For the juniors, there’s no better time to woo customers based on their more wholesome image, consistently reflected in surveys showing they are trusted more than the majors.

Should investors make the switch as well? While we can’t see the majors losing their oligopoly status in a hurry, the smaller regional banks can steal valuable market share, if they play their cards right by using digital technology to negate the disadvantages of being small and regional based.

And as my fourth grade teacher said: if you’ve done nothing wrong, you’ve got nothing to fear.

Most investors would be aware of the three remaining ‘super regional’ banks: Bendigo and Adelaide Bank (BEN), Bank of Queensland (BOQ) and bank/insurer/wealth manager Suncorp (SUN).  With market valuations of $5.2bn, $4.1bn and $17bn respectively. they’re not exactly minnows. The trio didn’t exactly escape the wrath of Hayne, either, having been forced to front the Commission over some unsavoury customer case studies.

Reporting her bank’s (disappointing) half year results, Bendigo CEO Marnie Baker noted trust in the banks “was and still is at an all-time low” and this played to the strength of Bendigo’s product offerings and “market leading customer service.”

With a mere $420m market cap, MyState (MYS) resulted from the merger of Tasmania’s Trust Bank and Tasmanian Perpetual Trustees with the Rockhampton based The Rock building society.

MyState is benefiting from the surprise resurgence of Tasmania’s economy, but also has been growing strongly outside of its traditional Tassie and Queensland heartland. Notably, MyState has a wealth management division, last year growing funds under management or advice by 6% to $1.153bn. With all the Big Four except for Westpac retreating from advice and with AMP in disarray, it’s a nice business to emphasise.

Meanwhile, the Bundaberg-based Auswide Bank (ABA) calls out the “Severe Reputational Damage of the Big Banks” (their capitals) and the associated internal investments they will need to make in improving their culture and systems.

“The environment represents an opportunity for Auswide, the only listed Queensland bank that calls regional Queensland home,” the bank says.

While the banking minnows sniff opportunity, they stand to be relatively more affected by the Commission’s unprecedented proposals to rein in the mortgage broking sector by abolishing trail commissions (and then  banishing lender-paid commissions altogether).

Haynes largely dismissed concerns that as the smaller banks are relatively more reliant on brokers to source loans, they would be disadvantaged.

Under the current system, he argues, lenders are competing not on offering the best product at the best price, but on who can offer the highest commissions to the brokers and aggregators (parties that sit between the lenders and the brokers).

Given the timing and uncertainties involved with the broker reforms, any impact on the competitive position of the small fry won’t play out for years.

However, the reforms will have a more immediate and direct effect on Goldfields Money (GMY), which is both a Kalgoorlie-based 'virtual’ bank and a mortgage aggregator (having acquired the business of Finsure last year).

Notably, Goldfields shares were marked down when the rest of the banking sector rallied post the Hayne Report.

On the banking side, Goldfields looks to be doing right, having increased its total loan settlements by 20% to $12bn during the year. In the September quarter, core banking loan settlements grew to $217m, compared with $68.7m a year previously.

Despite their reputational advantage, the small banks also continue to contend with a capital disadvantage, in that the Big Four are perceived as ‘too big to fail’ – or too big to be allowed to fail – and enjoy a higher credit rating.

Arguably, the regional small fry are better placed in a housing downturn because non capital city properties did not rise as much in the first place.

Global capital regulators also require smaller banks to hold more capital to support their lending. But this uneven playing field was partly levelled out in 2017, when then Treasurer Scott Morrison imposed a $6b deposit tax on the majors.

The Hayne pain is not the only obstacle threatening to derail the banks from the golden prosperous run they have enjoyed for the past decade.

Fuelled by the millennials' disdain for traditional banking, fintech rivals are chipping away at most aspects of the banks’ activities.

ASX-listed examples are the crowd funders Domacom (DCL) and Wisr (WZR), rewards card intermediary EML Payments (EML), investing app Raiz Invest (RZI). Of course, there are also the ‘buy now pay later’ conduits, Afterpay (APT) and Zip Co (Z1P), which face their own potential regulatory crackdown.

The obscure Novatti (NOV) has applied for a limited banking licence under APRA’s liberalised regime, targeting the 220,000 underbanked migrants who arrive annually.

The fintechs’ market penetration will be helped by the pending introduction of Open Banking, which will compel the banks to provide customer data to these would-be rivals at the customer’s request.

Or is the peak banking/death of the Four Pillars overplayed? This month’s half-year report from the Commonwealth Bank -- the only one of the Big Four with a June 30 balance date – didn’t exactly scare the pundits. Still, it’s too early to gauge the impact of the Hayne fallout and the housing slump.

It’s likely that devoid of their wealth practices, the Big Four will emerge as stronger institutions as they focus on core retail banking and a business strategy that doesn’t rely so much on screwing customers.

Interestingly, the minnows have fared little better than the majors, share price wise. Over the last 12 months, the Big Four declines range from a very modest 3% for the CBA to -14% for the NAB. Bank of Queensland shares have tumbled 17%, Bendigo shares are down 8%, while Suncorp shares have gained 4%.

MyState shares have fallen 6%, while Auswide stock has treaded water. Shares in Goldfields Money, a special case because of the bank’s aggregator role, have tumbled 50%.

We wouldn’t advise wholesale abandonment of the Four Pillars in their hour of need. But given the ASX banking milieu now strays far beyond the major, now’s the time for investors to mull some much-needed diversification of their banking portfolio.


Disclaimer: The companies covered in this article (unless disclosed) are not current clients of Independent Investment Research (IIR). Under no circumstances have there been any inducements or like made by the company mentioned to either IIR or the author. The views here are independent and have no nexus to IIR’s core research offering. The views here are not recommendations and should not be considered as general advice in terms of stock recommendations in the ordinary sense.

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