|Summary: Regional banks and smaller lenders are taking advantage of improved wholesale funding conditions to prise market share from the major banks. Bank of Queensland and Bendigo and Adelaide Bank have improved their margins, and analysts are tipping further share price growth.|
|Key take-out: Improved financial conditions have narrowed the funding gap between the major and regional banks, presenting new opportunities to the smaller lenders.|
|Key beneficiaries: General investors. Category: Growth.|
The clouds finally appear to be lifting for regional banks.
In the past few months, they’ve piggybacked the big four’s spectacular stock price rises. But there’s more to it than simply being sucked along in the slipstream. A sudden resurgence in wholesale funding markets has fundamentally shifted the banking landscape that could return the regionals and non-bank operators to the halcyon days of a decade ago.
Put simply, the regionals will find it easier to raise cash at competitive prices.
The two big ones to watch are Bendigo and Adelaide Bank and the Bank of Queensland, the latter of which appears to have much greater scope for growth after a horror 2012 that obliterated earnings following a series of self-inflicted wounds and mounting bad debts.
Further down the chain are a host of smaller players including Wide Bay Building Society, Mystate, Heritage Bank and Yellow Brick Road.
Newspaper reports in the past few days have homed in on the possibility of imminent out of cycle interest rate cuts from the major banks, apparently because they’ll be shamed into it during an election year.
Don’t believe a word of it. There’s no doubt the big four will capitulate a portion of the generous interest margins they recently unveiled – in Commonwealth bank’s half-year earnings and quarterly updates from ANZ and NAB . But shame and politics don’t even enter the equation.
It is all about protecting market share from the renaissance of regional banks and non-bank lenders, all of which are poised to benefit from the recent recovery in wholesale lending markets, and in particular, the residential mortgage-backed securities market.
The two big ones to watch are the Bank of Queensland and Bendigo and Adelaide Bank. Further down the chain are a host of smaller players, including Wide Bay Building Society, Mystate, Heritage Bank and Yellow Brick Road.
Bendigo’s recent half-year result told the story. Cash earnings were in line with most analyst expectations. But the margin expansion of nine basis points in the past half year, along with expectations that it is likely to increase this half, provided a taste of what’s to come.
Ever since the crisis, the regionals and the non-bank lenders have had a tough time of it. Less attractive credit ratings made it almost impossible to compete with the majors on wholesale markets.
Even the Commonwealth government guarantee came at a premium. Fees charged to the major banks to access the sovereign AAA credit rating were skinnier than those charged to smaller rivals, which paid a premium for a lower rating and, hence, had increased risk.
That competitive advantage is narrowing. In recent months, all the banks have been refinancing their expensive government guaranteed debt which, at its 2010 peak, reached around $140 billion. But a sudden rush of buybacks has seen that total drop to $60 billion. (The guarantee was a money spinner for the Federal Government, which has netted about $4 billion in fees so far.)
Bendigo and Adelaide recently took advantage of the more benign funding markets to issue $850 million worth of residential mortgage-backed securities (a collection of home loans sliced up into marketable parcels). And its recent half-year results provided a pleasant surprise to analysts when it delivered almost 3% more in cash earnings than most expected.
The RMBS issue is just 100 basis points above the 90-day bank bill swap rate. Westpac is in the process of doing the same, with a $1 billion issue, at an even slimmer margin. While the big banks may still have the financing edge over the regionals, where was once there was daylight between them now there is merely a shard of light.
Bendigo is a conservatively run organisation that is more cyclical than most realise. In addition to its cheaper funding options, it has a sizeable margin lending operation, its Homesafe equity release scheme along with a wealth management business.
On the downside, UBS analysts point out that Bendigo and Adelaide has only a skinny balance for provisioning for any rise in bad and doubtful debts. Should conditions deteriorate, those losses would flow straight through to the bottom line.
Despite its improved outlook, many analysts rate Bendigo as neutral or a hold. That’s because, like most banks, it has gone on an enormous run in recent months. From $7.50 last September, Bendigo and Adelaide breached $10.50 last week, before settling back this week at just below $10.
With a net dividend yield of a touch under 6% and a price earnings multiple of 12 times forward-year earnings, Bendigo and Adelaide represents cheaper buying than its big four cousins.
The recent better earnings results from Bendigo prompted Credit Suisse analysts to cast their eye over Bank of Queensland, which they concluded was ripe for further price appreciation.
Like its regional counterpart, Bank of Queensland has enjoyed a huge share price run in recent months, bouncing off a $6.85 nadir in November and pushing through $9.25 this month before settling back around $9 in recent days.
The northern-based bank was beset with problems last year as bad debts obliterated earnings. But that situation is stabilising and it has restocked its balance sheet to put it back on a firm footing.
Its first-half earnings are not due until late April, but at current estimates BoQ is trading on a multiple of just 10 times forward earnings. That equates to a 17% discount to the majors and a much greater than average discount to Bendigo and Adelaide.
That potential for greater reward comes with associated risk. It is heavily exposed to southern Queensland real estate, which has performed poorly in the past few years although is now showing signs of stabilising.
It also has a relatively high degree of impaired assets. But those reservations are priced into the stock.
On the upside, Credit Suisse predicts solid growth in net interest income from $656 million last year to a forecast $675 million this year and $718 million next year.
Given the write-downs and disasters that befell the group last year, earnings per share are forecast to rise from 7c a share to 83c a share this year and 91c in 2014. In terms of earnings growth, that represents a whopping 1023.7% this year before resuming to a more normal, but still impressive, trajectory of 9.1% next year.
The playing field upon which our banks compete has begun shifting rapidly as risk-on sentiment sweeps through funding markets. Once heavily tilted in favour of the big four, the more amenable conditions – while benefitting the majors as well – are likely to open up new opportunities for the smaller players.