It's tough being a small fish in a big pond. The commoditized nature of Australian banking makes it difficult for mutuals to stand out from the crowd. Winning and keeping business hinges on four main factors: pricing; efficiency; end-to-end processing; and product and service features. Loyalty, a traditional strength that mutual lenders have leveraged, has eroded significantly. Nevertheless the ownership structure of mutual lenders helps. This is because the high proportion of funding via common equity and full retention of profits partly offsets limitations from their high cost base.

Technology is a key driver for customer and broker satisfaction. Many mutuals continue to upgrade their core banking and loan origination and approvals systems to drive efficiencies.

Mergers remain compelling for mutuals lenders. Brand strength and customer loyalty continue to evaporate such that price becomes a key determinant of customer acquisition. Merging provides smaller lenders greater economies of scale. This makes them more efficient and able to price competitively. Mutuals will over time become acquirers or consolidation targets. We believe the banking landscape will settle with a small number of larger mutual players.

Mutual Banks Are Price Takers In A Commoditized Market

Mutuals remain at a competitive disadvantage relative to the larger banks. Competition for mortgages and deposits--a mutual's two key products--is intense, driven by the commoditized nature of banking products. As price takers, mutuals focus on defending and growing market share through sustained competitive pricing. Their balance sheet structure allows them to play in this market. They have higher capital levels on which they do not need to pay returns compared with publicly listed banks. Profitability is nevertheless crucial. Good earnings will support the ability of Australian mutual lenders to invest in products and services, technology, and operating efficiencies.

Ongoing Digital Investment Required

To remain relevant to the changing needs of existing and new members, mutuals will need to continually invest in digital products. Lenders seek to grow their portfolios by attracting younger members as older members roll off. Younger, tech-savvy members are likely to value price and turnaround speed over branches and personalized service. Brand loyalty is all but gone. As such, Australian mutuals need to ensure they continue to invest in their digital products and remain fast followers in technology adoption and product development.

Branches Are Expensive

Customers want to bank how and when they want, usually on a mobile device. Only about one in 1,000 transactions occur in a branch today. However, as of June 30, 2022, about 18% of bank branches in Australia belonged to mutuals compared with their market share of less than 3%.

Branches are expensive. Rationalization would enhance the ability of mutuals to compete. Rent, personnel, and the underlying running costs of a branch remain high relative to the cost of serving customers online. This is notwithstanding the shift across the industry for reduced operating hours and the use of idle branch staff to conduct other back-office bank functions to optimize staff costs.

In addition, mutuals could reinvest the savings made through branch rationalization into digital enhancements.

End-To-End Processing Important For Broker Relationships

Brokers are a key origination channel for banks in Australia. Brokers originate about 60% of mortgages in the system. Brokers largely determine which bank a customer chooses. Many mutuals have recognized this in the past four years. During that time, the average percentage of lending mutuals have originated via brokers has increased to about 45% from about 30% in 2019. While most rated mutual lenders originate a portion of new lending through brokers, this can vary anywhere from 0% to more than 80% of flow depending on the institution. Some mutuals do not use brokers.

Some initial technological investment is necessary to enter the broker channel. Many mutuals are looking to increase the amount of lending originated via brokers and investing in the appropriate systems to achieve this. Today, many mutuals are seeking to streamline their loan-origination systems to reduce their approval times, a key consideration for brokers and customers. While we anticipate all lenders will eventually settle at similar approval times, those that have the resources to invest quickly will benefit from a first-mover advantage. Furthermore, mutuals need to continue to leverage their relationships with their core banking system providers and keep up with technology to maintain or grow their market share.

Mergers Remain Compelling

To remain competitive Australia's mutual lending sector will continue to consolidate over the next two years. This is unlikely to result in higher ratings or materially change the industry's competitive dynamics. Mergers allow mutuals to achieve greater economies of scale, reduce their cost base and invest in technology. In the banking industry, scale usually means efficiency and underpins through-the-cycle returns. This is clear when comparing Australian mutual lenders with midsize regional peers, and again when comparing midsize lenders with the major banks (see charts 1 and 2). Furthermore, larger players that have greater scope to invest will be the first to benefit from artificial intelligence and other technological advances.

Chart 1

Chart 2

Investment in digitization including open banking, lending origination and cyber security will continue to drive technology spending for mutuals. A larger organization will be better able to absorb the costs of these investments.

We have a positive outlook on most of the rated mutual lenders, reflecting a positive trend for Australian banking system risks.

Appendix

Table 1

Editor: Lex Hall, Jasper Moiseiwitsch

Related Research

• Australian Banks Can Ride Out Market Jitters, March 23, 2023