KGB: Bendigo Bank's Mike Hirst

Bendigo and Adelaide Bank Ltd chief executive Mike Hirst tells Business Spectator's Alan Kohler, Robert Gottliebsen and Stephen Bartholomeusz:

• If the housing market does decline, it will be orderly at a rate of 2-3 per cent

• Bendigo is considering following ANZ in decoupling from the RBA official cash rate decision cycle

• The strategies of the four major banks have never been so different

• Bank of Melbourne has not yet taken market share from Bendigo, but he treats it as a serious challenge

• The world has changed in term deposit pricing, and the existing community bank model must change with it

Alan Kohler: The Big Four are talking about the increased funding costs from the tighter credit market, particularly as a result of Europe. How are you finding the wholesale funding markets at the moment?

Mike Hirst: Look, wholesale markets aren't a big concern for us. One of the decisions that we took during the early stage of the GFC, or stage one whichever way you want to look at it, was to rely only on ourselves to get through. So, we wound our business down a little bit during that period. We were the only bank in Australia not to use the government guarantee for wholesale debt and we're predominantly retail funded, so we're about 80-odd per cent retail funded. The rest is in securitisation and short term wholesale.

AK: So, that's a good decision I guess?

MH: I think it was.

AK: Reflecting on it, the way things are going now.

MH: And, you know, if you have a look at markets now, I don't think they're at 2008 levels yet. The costs have certainly increased significantly. If you have a look at the recent covered bond issues that have been done, that's certainly priced higher than where I would have expected and it's pushed out unsecured, so there's no doubt funding costs are increasing. The likely impact for us will be any focus from the majors on deposit markets.

Robert Gottliebsen: Mike, let's just assume you're a big bank for the moment and you were borrowing on the wholesale market. Is what you pay in the overseas wholesale market a greater rate of interest than you pay on term deposits? Is the current rate higher overseas than within your local term deposits?

MH: By the time you've swapped it back into Australian dollars, overseas funding would be higher than term deposits marginally I think, so term deposits are probably running at about 200 over bills at the moment. Those issues that have been done overseas are around the 200 to 225 mark over bills.

RG: Ok, so if the wholesale market rates rise further, then they'd be very economic to push the deposit rates up to get the money?

MH: Well, only if you can reprice on the asset side. And I guess the thing about funding that maybe a lot of people don't understand is it's the impact it has on the margin, not so much the absolute level of rates themselves, and that's where this whole debate about repricing of home loans and other assets comes into its own.

Stephen Bartholomeusz: Mike, you refer to the majors' interest in deposits and they are no doubt scrambling for deposits to reduce the rise in the wholesale markets. After February the deposit guarantee drops from a million dollars to $250,000 and there's likely to be quite the scramble again to get hold of those big deposits. Is that likely to affect you? Because you are almost entirely deposit funded?

MH: I don't think so. The truth of the matter is when the government guarantee for deposits first came in, it actually impacted upon us negatively. So, we were going along quite fine on our own. The guarantee came in. It had a pricing differential depending on what you were rated and we weren't prepared to pay the cost of the guarantee. So, we lost about $800 million in funds from semi-professionals, councils, etcetera, who wanted the government guarantee but weren't prepared to pay for it themselves, so it was cheaper for them to go to the majors who only charged them 70 basis points – or Macquarie who charged them nothing. So no, I don't think it will have an impact on us at all. In fact, we lost $800 million to that sector of the market, but we almost picked exactly that up from the high net worth area of the market who then looked to spread their funds across different banks.

AK: Or were they looking for rates that were higher and were squeezing your margins?

MH: No. I think they were looking to get the government guarantee. You were covered for a million dollars at any institution, but if you put it through six institutions, you got six million dollars' worth of cover.

SB: If there is competition that pushes the price of deposits up, you will pay them lower margins than the majors. How do you respond to that? Is there an ability to reprice?

MH: Look, I think there is. I think that's going to occur at some stage this year. It has to. You know, in terms of margin, we aren't all that different from the majors. Our margin before we share it with our community bank partners is about the same as what the majors' margin is, so we're under pretty much the same pressure that they might be under. When you move into a much lower interest rate cycle that we're in now, you actually get pressure also from the low cost deposits because they can't be moved down at all, so as loans come down, the section that's funded by low cost deposits or capital gets squeezed. And in this particular market because of the funding issues, you know you're also getting squeezed on the other term deposits. So, there's no doubt bank margins have fallen, probably 10 basis points in the last six months.

AK: Mike, leaving aside the margins and the specifics of what's going on there, what we saw in 2008 was the market change completely. It previously had been quite competitive, a lot of securitisation, a lot of smaller players, and all of a sudden it went to 90 per cent Big Four with you and the Bank of Queensland trying to hang on and maintain your position. Where do you think the competition is going to come from in the future? I mean when you look forward five years, is it going to stay the same or will there be some return to securitisation or some other form of competition?

MH: I actually think things are pretty competitive at the moment anyway, and have been for some time. The difference between now and 2008 is that in 2008 there was a lack of funding, but plenty of demand for credit. Today there's a lack of funding and not any demand for credit. So, the pressures that were perhaps being seen previously in 2008 aren't there, so everyone is competing hard now for growth. Previously where you couldn't compete because you didn't have the funding, I think Gail Kelly said they grew 10 years' worth of growth in one year at that point in time, that was because of the funding advantage they had. That's not an issue now because you compete on the asset side and that's about service and those sorts of things.

SB: The bankers don't seem to be especially interested in balance sheet growth at the moment. What's your positioning?

MH: Well, if you have a look at the last twelve months and growth over the last twelve months, we're second only to the NAB. The NAB's done that on price, by their own admission. We haven't. We've done it on service and our value proposition. Our experience has been that over time we do pretty well during tough times because we've got the same value proposition and the same service coming through. It's when the markets are growing hand over fist that we probably fall down towards the bottom place because in those markets it's all about price.

RG: Bank competition in the future is going to be a lot about systems. The Commonwealth invested heavily in the front-end system. The NAB is investing heavily across the line. I'm not sure about Westpac and ANZ. Where do you stand? Are you revamping your entire system? Can you stay as you are?

MH: Well, we approved about a $60 million system investment two years ago that gives us a one view of customer, so it's a front end system for our customers. Our back end systems are all very good. The bit that counts the interest and who owes what, etcetera, we can keep that going for a long time I'm sure. It's the front end, the engagement piece with the customer, that's the important piece and a lot of our system spend goes in to that area and that will be more important.

RG: Are you as good as the Commonwealth [Bank] in that area?

MH: Well, I don't bank at the Commonwealth, so I can't tell you completely, but I actually worked with a few of the guys who did some of that stuff at the Commonwealth and the State Bank of New South Wales and from what they've been telling me, they've got a pretty good system.

RG: And does yours match it?

MH: I think it matches it in terms of what our customers are looking for. I think that in three to five years' time I'd like to be in a situation – and maybe that's a bit aggressive, maybe ten years' time – where a lot of your customer-facing systems are actually operated by the customer.

RG: The community bank model has been very successful. In these times of tighter margins in the total banking area, is it going to be economic? I'm a shareholder in community banking, incredibly profitable and I think of all this enormous money that's coming out of this community bank. Can you afford all that in a tighter margin structure?

MH: Look, one of the things that we did with the community bank model when we started it, and that was 13 years ago now, we thought ‘well if we get 10 of those, this will be fantastic'. Today we've got 270 or 280, but the systems that we put in place 13 years ago were systems that were operating up until the GFC and by and large they did the job. The deal is we get 50 per cent of the margin and the community gets 50 per cent of the margin, and fees, etcetera, get split on a reward-for-effort basis. But with the change to the term deposit pricing, it did show up a flaw in the systems and that was because we didn't have the funds transfer pricing system 13 years ago fixed-rate loans and deposits were done on a trail basis – so we paid 50 basis points for deposits and 50 basis points for loans. When term deposits went from bills-less-50 to bills-plus-200, the community suffered no margin share and we suffered the complete amount of margin share. In February or March last year we went and saw all of our community bank partners, explained the situation to them – the world's changed in terms of pricing for deposits and we're going to have to move away from a trail on fixed-rate to margin share on fixed-rate. Now, that entails us putting in a funds transfer pricing system which we've done, so we can count on an individual branch basis the margin on anything that's fixed rate. We moved from a 50 basis point trail to a 37.5 basis point trail for the next two-year period and then at that point in time we'll move to margin share assuming that the world's in the shape that we expect it should be.

SB: Just to get back to that deposit pricing issue for a moment, all the pressure upon the banks, and you included, is to reprice – raise – rates at a time when the RBA appears to be in a downward cycle. If there's another official rate reduction, can Bendigo pass that on?

MH: Well, we aim to be competitive, so you know it will be a matter of where are we at, at that point in time, and in terms of our competitive position. And right now, I think we're above the NAB, equal with I think it's CBA and below Westpac and ANZ or equally with ANZ and below Westpac and CBA.

AK: Is this on deposits or loans?

MH: This is on loans. We know that we can probably be about ten basis points higher than them and still grow our book because of our service proposition and community proposition. So, we've got room to move in respect of that pricing. However, we need to take into consideration the impact that it has on our customers and also the impact that it has on our profitability, and all of those things are weighed up at a point in time. One of the things that the industry hasn't been good at is explaining to the public that the official cash rate that gets on the front page of the Herald every Wednesday morning after the Reserve Bank's board met really doesn't have a huge impact on the price of funding that banks pay, and that all of the margin squeeze that's going on at the moment is around credit spread, not around official interest rates. And I applaud Mike Smith for the approach he's taking to say right we're just going to set our rates every third Friday.

AK: Mike Smith of ANZ?

MH: Mike Smith of ANZ. And, you know, I think that will go a long way to educating the public about how the price of their loans gets set.

SB: Have you thought about doing that too?

MH: Yeah, well, when we made our last announcement we said to everybody: look this really doesn't really reflect the cost of funds to us and it really doesn't reflect how transparent we want to be in our pricing with our customers. And so at some stage we will be moving away from this approach.

RG: Mike, where are you in terms of demand for funds around for loans, how do you see the retail sector? You have small retail businesses. How that's faring and can you see some bad debts there?

MH: We aren't seeing a lot of bad debts come through… a lot of that business is secured by housing and so those businesses are very focused on making sure that they're running a tight ship. Now, I'm not for a moment saying that it's easy, that it's a breeze out there, because it clearly isn't.

RG: So, you're saying that the shopkeeper has put his house on the line or her house on the line?

MH: Yeah. And they're working hard to make sure that their businesses are able to work their way through this and, you know, you've seen the increase in the savings rate just in terms of the amount of term deposits and that are flowing on banks equalling the amount of debt that's ahead of its repayment schedule and it's really significant.

RG: What about the actual funding of the shop itself, because those shops are going to go down in value? Does that worry you, commercial property? I'm thinking of retail shops though.

MH: We do have a smattering of retail shopping and, yes, values have been impacted at the moment. I think the question is whether or not people can see the long-term value in those properties and maintain their positions in them, and right now we haven't seen anyone who is not looking to do that. The change in valuations is a bit of a rollercoaster over the last few years to tell you the truth. If online takes hold and retail, with it, failed miserably, well clearly there's going to be an issue. Anybody can see that. But, listening one of Alan's shows on an aeroplane one day, they had a guy on talking who made a lot of sense to me, that said those companies that are successful in a digital world are those that have got clicks and bricks strategies and having either can leave yourself open to issues.

SB: You are fundamentally a mortgage lender. There's been, as you would be aware of this highly heated and polarised discussion about whether or not our market in Australia is above value.

MH: Yeah. It's mainly on your website.

SB: You presumably have a view on that?

MH: The view I hold is that if there is going to be a decline in property prices, it'll be orderly and it'll be two per cent here, three per cent there. And the reason that I hold that is because housing in Australia is majority held by owner occupiers and people have to live somewhere. Historically if property prices are beginning to fall, people just pull their properties off the market and don't sell. I think it's a great truism that the value of property in Australia is absolutely tied to employment. If people can afford to pay their loans, they will, regardless of what it's worth, because they've got to live somewhere.

AK: Which of the Big Four bankers do you admire or fear the most?

MH: That's an unfair question, Alan. Well, actually I was a bit of a fan of Ralph Norris. Ralph and I actually went on a course in Seattle in the early ‘90s when he was MD at ASB and he was then talking about the systems revolution that you could put through banking which is what you alluded to earlier, Robert, and I think he has carried that out well at CBA. You know, I know all of them well and they've all got their strengths and they're all nice people.

AK: Now come on, Mike, who do you reckon is at the top of the tree then?

MH: No. I honestly think they've all got their strengths and if you have a look at the –

AK: You're like a good mother, aren't you? You love them all equally.

MH: Yeah well, like any good mother when I'm alone with each of them I say they're my favourite. I think the interesting thing about Australian banking at the moment is the strategies at each of the majors have have never been so different. Mike Smith at ANZ is pursuing an Asian strategy and I think that's a really interesting strategy and probably appropriate for them, although it is a little bit of dj vu if you think back to Grindlays and those sorts of things. Cameron has come into NAB and pursued his break up campaign which is, again, an interesting campaign. I think when it all boils down to it, it's a price led campaign at the moment. Whether or not it can convert into something more than that, only time will tell, but it's certainly a different strategy and well worth a try. CBA very much are into customer service systems, development, etcetera. And I think Westpac are in a situation where they've had a number of reasonable sized mergers if you think about BT and St George and that, over time, often that does take a bit out of you. But again they seem to be doing a reasonable job.

RG: Mike, are Bank of Melbourne affecting you from Westpac?

MH: We haven't seen that as yet.

RG: They haven't taken market share from you?

MH: No. But even Bank of Melbourne's rhetoric is that they will take share off the major banks, not the regional banks.

AK: Yeah. I love their ads, you know: "If you're sick of the Big Four, come to us.”

MH: I mean, it is an interesting strategy and we'll wait and see how it works. My ‘man in the street' litmus test says to me everyone is saying they're just Westpac. But, you know, it's not a strategy that they wouldn't have thought through well. They're very smart people. They would have done all the research. They've been very successful using different brands in South Australia, and I guess the experience with St George is telling them that this will work. So, I don't for a moment, take it in an offhanded way. It's a serious challenge.

SB: Mike, APRA is moving in terms of Basel III ahead of most of the rest of the world in relation to capital requirements. Are you comfortable with the pace at which you're going to be required to hold more capital? Have you got the plans to get that capital in place itself?

MH: I think APRA will tell you that most of the Australian banks – and we did a $150 million capital raising the other day to purchase the Bank of Cyprus in Australia – are all ready probably to meet the requirements they need to around Basel III. So, I'm not concerned about meeting Basel III and complying with it. I think if there is a nagging thought at the back of my mind, it's in the overseas countries they need to get more credit and better credit into their economies to be able to reinflate them and get them out of the recession they're in. I don't see how putting more capital requirements on banks is actually going to allow that to happen because credit will become more expensive and there will be less of it. So, there's a real conflict in that between getting the economies up and running and what bank regulators want. And I do, as I said, have a nagging doubt that perhaps in those economies they'll go: ‘oh well, actually we'll put this aside and we'll do it sometime later when it makes more sense for us'. And being an early adopter you run the risk of being left out there on your own.

SB: You don't see a potential for a weaker version of that same sort of paradigm in Australia?

MH: There is no doubt if you require banks to hold more capital, there is less credit and it's more expensive.

SB: If I remember a conversation we had with your predecessor, Rob Hunt, in 2009, he talked about the extra capital you had to hold on residential mortgages because I think at the time you were using a standardised approach to risk weighting. Is that still the case and how big an issue is that for you going forward?

MH: That is still the case and we hold, on average, our housing are risk loaded at 40 per cent and the majors are somewhere between 15 and 20, so we're holding twice as much capital against our housing loans as the major banks are. However, under the advanced model you have to hold capital in a whole lot of other areas where we don't and so APRA would say that on a like-for-like basis everybody is probably holding the same amount of capital. We are going to go down the advanced model route and we're doing that because it gives you new sets of skills and systems, etcetera that make your business more robust, so we're doing it from that point of view. If there are capital benefits flowing out of that, then great, and I expect there will be.

AK: Thanks very much, Mike.

MH: Thanks, guys.

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