Regional banks rely on covered bonds to stay competitive

The ability of the regional banks to access alternative sources of funding such as the recently opened covered bonds market is key to these lenders being able to compete with the major banks on mortgages and other lending products, according to a new report by KPMG.

Australia’s regional banks comprise Bendigo Bank, Adelaide Bank, Members Equity (ME) Bank, Suncorp and Bank of Queensland.

According to KPMG’s Regional Banks: 2011 Financial Institutions Performance Survey, these four banks remain a “viable alternative to the major banks” in the core markets of retail deposits and home and consumer lending, “producing strong numbers in terms of market share while also managing to increase profit before tax by 16.1%”.

“Market share has been strong and margins have remained tight, rising just three basis points to 1.64%,” says KPMG banking partner Martin McGrath.

However, McGrath says the major challenge for regionals remains accessing funding at a competitive price.

“The regionals have shown that they are a competitive force in the retail deposit market.  However, they are at a competitive disadvantage in wholesale markets, which impacts their interest margin.”

Regional along with non-bank lenders have been impacted by the demise of the once thriving residential mortgage-backed securities (RMBS) market, which provided a cheap source of wholesale funding before the advent of the GFC.

Covered bonds – prohibited in Australia until the government changed the legislation in October in a bid to help banks diversify their funding bases and increase competition in the retail banking market – offer a potentially positive alternative to retail deposits.

The debt securities reside on the balance sheet of the lender and are cheaper than RMBS because they have a higher credit rating.

“It remains to be seen how much uptake there will be by the regionals of covered bonds.  It is clear that the scale of the major banks gives them an advantage, but the advent of covered bonds opens a welcome alternative source of wholesale funding.” McGrath says.

ANZ is expected to raise up to $970 million through a covered bond issue in the US due to be finalised this week, while the other major banks are all holding investor roadshows in Europe and the US.

According to the KPMG report, a concern for shareholders in regional banks is the return on equity for the sector of 6.7% generated over the 2011 financial year.

The strongest performer in this regard was Bendigo and Adelaide banks, with a return on equity of 9%. Bank of Queensland is returning 8% and Members Equity 6.4%. Suncorp returned 3.2% in the 2011 financial year, but this result included non-core business divisions. Suncorp’s core banking unit return on equity would have been 15.6%.

Suncorp has the biggest mortgage book of the four regional banks at close to $30 billion.