Mutuals escaping ‘vicious cycle’ in merger mania: S&P

There has already been a developing, long-term trend of consolidation among mutual banks, but S&P Global believes the newly announced deals stand out and reflect an overarching change in banking.

Newcastle Permanent, which holds a $9.1 billion loan book, and Greater Bank, with its $5.5 billion, would overtake Great Southern Bank’s $13.5 billion as the mutual with the largest market share, with a combined $14.6 billion.

People’s Choice on the other hand, is currently the second-largest mutual lender behind Great Southern Bank, holding $8.1 billion in loans.

S&P associate of financial institution ratings Riley Michel explained there have been few deals of similar scale in the sector, which shows that among other factors, margin headwinds are likely to persist amid rising costs for technology maintenance and regulation.

“For the large majority of mutuals, their higher costs translate into lower returns,” Mr Michel said.

“For mutuals with high cost bases, we see mergers as being a really compelling proposition and realising efficiency through scale would help mutuals create room for more investment in product service and ultimately, further operating efficiencies.”

S&P has forecast that the consolidation wave will accelerate over the next two years.

Mergers are expected to present the most benefit to mutual banks, plagued by high costs that cut into their profits. With more profitability comes more flexibility around pricing and the ability to invest more into offerings and services, Mr Michel said.

“We see scale as one important way that mutuals can avoid… the vicious cycle of weak earnings, lagging investment and ultimately avoid a product or service that loses appeal with the member base,” he said.

Similarly, Mark Symes, associate for Financial Institutions Ratings added the costs of operating high-cost structures and updating outdated legacy core banking systems will require many players to consider whether they invest in new technology or seek an already tooled up partner.

For a bank looking to invest in its own technology, the process can not only be expensive, but also “increase operating risks”, Mr Symes warned.

“Under the second scenario, the merger becomes a technology play rather than based purely on size and scale,” he said.

Greater Bank chief executive Scott Morgan has also warned that the future viability of mutual banks is under threat given the growing costs of technology.

APRA also previously told mutual banks that they may need to prepare to merge, should they face severe financial stress.

Further, S&P associates believe the two recent mergers show a shift in thinking from leadership teams.

“The boards and management teams of mutuals now have… greater skills and are more commercially focused than in the past,” S&P associate for financial institution ratings, Nico De Lange said.

“And because of this, they… have a more forward looking mindset compared to historical considerations, such as relinquishing control. That is becoming less of an immediate barrier to mergers.”

While such deals will shape the mutual subsector, they are unlikely to boost the lenders’ competitive position against that of regional or major banks, Mr De Lange noted.

“The banking landscape is dominated by the Australian major banks. Their competitive position is extremely strong, their business positions are strong, their market share of residential mortgage lending activities is nexus,” he said.

“Within this landscape, the mutual banks… even a merged entity, will still remain a small player. Also compared to, for instance, regional banks, there is still a bit of a steep change that needs to happen for a mutual or a merged entity to get to the strength or the competitive position of a regional bank.”

The Adviser explored the wave of mergers washing through mutual lenders in its August issue.

Pulse Credit Union and Teachers Mutual Bank Ltd also recently signalled they were edging closer to joining forces, after gaining approval from APRA.

[Related: Broker, big 4 dynamics shift benefits smaller banks: Auswide]