Moody’s warns on mutuals sector

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Adding to the poor Bendigo Bank result today (which Macro Investor subscribers will be enjoying) comes a warning from Moody’s:

Sydney, August 20, 2012 — Moody’s Investors Service says that Australia’s mutual financial institutions have strong balance sheets, as reflected in their asset quality and funding profiles, but slower credit growth and strong competition from banks for deposits will put pressure on the sector’s profitability in 2012 and 2013.

Moody’s detailed its latest analysis of the industry — which includes credit unions, mutual building societies and mutual banks — in a report titled “Australia’s Mutual Financial Institutions: Balance Sheets Strong But Challenges Apparent.”

“The main issues for the sector are lower growth due to reduced demand for residential mortgages, and higher funding costs because of competition from banks for deposits. Both factors are putting pressure on the sector’s profitability which we expect to continue to drive consolidation. The mutuals are also exposed to sudden and localized shocks because of their narrow focus on their local markets or targeted employer groups,” says Daniel Yu, a Moody’s Analyst and author of the report.

“Mutuals generally maintain strong franchises due their strong ties with a particular region or employer group. However, Moody’s believes the industry will not be able to significantly increase its market share despite government moves to promote competition, because of the structural constraints mutuals face in their distribution networks and access to cost-effective funding,” adds Yu.

Except for 2011, housing loan growth for the mutual sector has lagged overall financial system growth since 2008, reducing the sector’s share of system housing loans from around 5.9% in June 2007 to 5.3% in March 2012.

“Because of their smaller size, as compared to the banks, the mutuals are essentially price-takers with high cost structures, making them particularly vulnerable to the slow economic growth environment,” says Yu.

The downside risks for the sector also include any sharp downturn in the housing market and exposure to any deterioration in the local economies and industries in which each individual mutual is concentrated. Australian house prices have not experienced the same sharp declines as compared with other developed countries, but the situation may change if there is an external shock, such as a dramatic fall in the demand for minerals that could trigger a correction which is greater than expected.

Nevertheless, the overall asset quality of the mutual sector remains strong and is supported by its concentration on prime residential mortgages. The latter comprise 88% of the mutuals’ total loans and they continue to perform well. Non-performing loans — defined as impaired loans plus 90-day past due loans — remain below 0.8% of gross loans, which is also well below Moody’s-rated banking sector average of 1.8% (banks are experiencing higher delinquencies in their proportionately larger non-housing loan books).

Moody’s notes that the mutuals have made increasing efforts to support growth over the years by accepting customers outside their targeted regions or employer groups and relying on brokers to grow outside of their home markets. However, these efforts have had mixed success.

Growth and profitability challenges, intensified by rising compliance and IT costs, will continue to drive consolidation in the market, especially amongst the smaller mutuals.

About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.