PORTFOLIO POINT: Small authorised deposit-taking institutions (ADIs) are in a good position to challenge the big banks in the wake of their grab for market share.
Cummins is a town on South Australia’s Eyre Peninsula with a population of 705 and a single bank branch – a community bank operated in partnership with Bendigo & Adelaide Bank.
The chief executive of ME Bank, Jamie McPhee, a former CEO of Adelaide Bank, cites the Cummins Community Bank as an example of the sustainable competitive advantage that Bendigo & Adelaide Bank has in the Australian banking marketplace.
The Cummins bank is sharing profits with the local community and it would be difficult for any of the major banks to return to the community, having caused a great deal of dislocation through their departure from the region a couple of decades ago.
As head of the industry fund-owned ME Bank, McPhee is now focused on what sustainable competitive advantage each of the niche banking franchises offers Australian consumers relative to the majors.
It’s an important issue for investors, because a number of small authorised deposit-taking institutions (ADIs) are likely to come to the market in the next year or so, claiming to create value for shareholders by taking market share off the majors.
McPhee readily acknowledges the disadvantages of the smaller players, and says the main challenges are inferior credit ratings, a need to adhere to the more onerous 'standardised’ model for calculating regulatory capital, and a lack of economy of scale.
But he says the opportunity for a challenger brand looms large, following a grab for market share by the majors over the past four years. McPhee compares the current opportunity to the early '90s, when customer satisfaction levels with the major banks was in the low '40s.
McPhee’s ME Bank is looking to exploit its unique access to workplaces by virtue of being owned by 32 industry funds. There are 5.5 million members of industry funds and 2 million union members who are members of union funds who are potential ME customers. ME’s proposition is that it wants to be seen as the fairest and most accessible bank for workers.
Among the listed players, McPhee is complimentary about the BEN strategy, but he is less certain about the offering of Bank of Queensland, which recently completed a $450 million capital raising by its new chief executive, Stuart Grimshaw.
McPhee sees the owner-managed branch (OMB) concept as an innovative remuneration structure that can be replicated by the major banks if they choose. BOQ is going to have to work harder to enunciate its competitive advantage.
BOQ’s Grimshaw, like McPhee, is an experienced banking executive. He has already flagged further 'refinements’ to the OMB model under his watch. But he is backing the OMB model, saying it can offer customers a unique experience and will drive growth for BOQ.
BOQ recently reported an underlying loss of about $72 million following the booking of a $160 million collective provision overlay charge, which is aimed at quarantining the bank from further falls in commercial property prices in its home state.
Grimshaw is well qualified to note that there has been little differentiation between the listed banking players to date. He maintains BOQ has an opportunity to do something different.
Investors are clearly backing Grimshaw in wanting to develop a challenger to the major banks, based on innovative products and pricing and branding.
The retail component of the recent BOQ offering raised about $162 million, which followed a $288 million institutional placement.
This is despite the fact that in recent years, BOQ has underperformed its peers.
Following the capital raising, BOQ is now trading at a clear premium to BEN.
Relative price performance of regional and major banks over the past five years.
Forward P/E of BEN vs BOQ
We believe it is right for investors to focus on the prospects of the smaller ADIs over the next few years as they play a role in the inevitable consolidation of the sector.
It is worth remembering that the best-performing listed ADI over the past year was not ANZ, but rather Rock Building Society, which was taken over by Mystate last August in a $68.3 million deal.
Investorfirst has a buy recommendation on Mystate and a Speculative Buy recommendation on IMB, which maintains a market in its own shares.
Hugh Robertson is a Melbourne-based stockbroker and an executive director of Investorfirst Securities.