Analysis: Margin squeeze forcing consolidation

In the past six months, Australia’s smaller banks have largely maintained market-leading home loan offerings.

Their sharp rates have driven significant volumes through the third-party channel – but at what cost?

In a market dominated by the big four banks, the smaller ADIs and non-bank lenders have resorted to heavy price discounting to woo brokers and their clients.

But the fight for market share looks increasingly futile as the smaller players take a hit to their margins in the hunt for volume growth.

Queensland-based Heritage Bank unveiled a variable rate of 4.39 per cent in November, which led to a 380 per cent surge in volumes in a single month through mortgage aggregator AFG.

RateCity spokesperson Peter Arnold said the bank’s discount rate was one of the most popular products during the quarter.

But a closer look at Heritage Bank’s half-yearly results paints a more complex picture.

Margin squeeze

Heritage posted a profit after tax of $16.2 million for the six months to 31 December – down 9.5 per cent on the corresponding prior period.

Loan approvals increased 20.7 per cent over the period on the back of the bank’s rate cutting while its net interest income remained unchanged.

Chairman Kerry Betros attributed the result to increased investment in technology and process improvements, as well as continued jobs growth.

Non-bank lender Homeloans Limited suffered a 1 per cent fall in net interest income over the same period.

The group announced a half-yearly profit of $2.6 million, up 7.1 per cent from the corresponding period in 2013.

Meanwhile, MyState Bank saw its net interest margin slip 9 basis points from 2.45 per cent at 31 December 13 to 2.36 per cent at 31 December 2014.

The Tasmania-based lender is experiencing strong growth through the broker channel but chief executive Melos Sulicich admits margin squeeze is pressuring small lenders to merge.

Following the release of its half-yearly results, Mr Sulicich told Fairfax Media that as the cash rate has come down, smaller banks particularly are finding it increasing difficult to compete as interest margins are squeezed.

“We're keen to explore any other M&A opportunity – we have got a strong capital adequacy position," he said. "We are actively looking around the market."

Joining forces

The acquisition of Barnes Home Loans by Homeloans last month is indicative of the type of partnership smaller lenders like MyState are hungry for.

On 17 February, non-bank lender Homeloans Ltd entered into a binding agreement to acquire Barnes Mortgage Management for a consideration of $2,450,000.

Barnes Home Loans executive director Janelle Rayner has urged non-bank lenders to join forces to combat the strength of the big four.

Ms Rayner told Mortgage Business she expects to see “a lot more consolidation” among non-banks in the future.

“The bigger lenders do have a lot of strength and as smaller lenders we need to get together and strengthen our position because there need to be alternative lenders out there,” she said. “You can’t just have the big four.”

Mergers and acquisitions

A research report by Morningstar last year named Yellow Brick Road, Wide Bay Australia, Mystate and Bank of Sydney as potential acquisition targets for the regionals.

“Distribution is crucial, and while Bank of Queensland purchased Virgin Money to penetrate online channels, the acquisition of Yellow Brick Road, which offers lending and accounting and tax services, would be a new customer channel,” according to the Morningstar report.

“Macquarie Group’s 15 per cent shareholding would make a deal difficult, given Macquarie would potentially lose the banking, wealth management and mortgage funding services it currently provides Yellow Brick Road,” it said.

The Morningstar report, Australian Regional Banks: The Not-So-Ugly Ducklings, analysed the position of the regionals in Australia’s major bank-dominated mortgage space, in which Bendigo and Adelaide Bank, Bank of Queensland and Suncorp each account for two to three per cent of the market.

The report noted that while the regional lenders offer lower standard variable rates than the majors, the big four have maintained a stable market share of 83 per cent.

The average rate for a major bank variable home loan is 5.1 per cent, 30 basis points higher than the average regional lender’s 4.8 per cent, the July 2014 report found.

“While we don’t believe the regionals take on higher-risk residential loans, they do need to price more aggressively,” the report said.

“It also pushes the regionals to acquisitions in order to achieve growth,” it said.

Looking at other lenders, the report highlighted the successful growth strategies of ING Direct and Macquarie in the residential mortgage market.

“ING Direct has been extremely successful during the past 15 years, as it targeted customers happy to bank online, while Macquarie has capitalised on partnerships with adviser and broker businesses such as Yellow Brick Road,” the report said.

Morningstar analysts concluded that while M&A will be central to the regionals growth, moving forward, the next logical step will be diversifying into wealth management.