Mutuals face uncertain future in a complex mortgage market

While measures by the prudential regulator to restrict investor housing loans are credit positive for asset quality in the broader financial system, they will raise competition in the owner-occupied market that the mutual sector is more focused on, according to a Moody’s report.

The report found that, on average, owner-occupied loans make up 79 per cent of total housing loans among mutuals, compared to 61 per cent for all financial institutions.

Released this week, the report entitled Australia's Mutual Financial Institutions: Rising Competition to Challenge Growth found, on a positive note, the competitive disadvantage of the mutuals relative to the major banks will be somewhat narrowed by APRA’s recent decision to raise the amount of capital required for residential mortgages at banks using the internal ratings-based (IRB) approach to calculate regulatory capital.

The report noted slowing economic growth, weakening labour market conditions and rising house prices are significant risks to Australia's residential mortgage market – a key lending focus for the mutual sector.

"On a fundamental level, mutuals are facing increasing competition in their core franchise of home mortgage lending from Australia's four major banks, whose large economies of scale and superior access to wholesale funding put them at a competitive advantage," Moody's vice president and senior analyst Daniel Yu said.

“Specifically, the proliferation of online and third-party banking channels, as well as the use of multi-brand strategies by the major banks, directly threaten mutuals' traditional relevance and appeal as community-based niche players.” 

The report found that structural challenges faced by mutuals have been the driving force behind ongoing consolidation within the sector, which has been shrinking by an average of eight entities per year over the past 10 years.

In addition, pressure on profitability is exacerbated by the RBA’s monetary easing, which has lowered mutuals' loan rates more than their deposit rates, given that deposits include transaction accounts that earn almost zero interest.

“However, these pressures are moderated by the absence of a shareholder structure, enabling management to fully reinvest profits back into the business,” it said.

“Moody's views this as a key support for the mutual sector's credit profile, as it provides mutuals with the flexibility to forego growth in order to convert capital when operating conditions turn volatile.”

Mr Yu said that while most mutuals will continue to generate sufficient capital internally to maintain their existing capital levels, those with weaker franchises or a smaller scale will be affected by price competition and higher operating costs – factors that will likely continue the sector's long-standing consolidation trend into 2016.