A$20 billion in total assets is emerging as the new scale to be competitive in the Australian retail banking market. If this is the new ante to play, the magic number for Australian mutual lenders could be less than 10. That means that about 40 mutual banks will disappear in the coming years as consolidation continues to accelerate.

Merging provides smaller lenders greater economies of scale and eliminates material duplication costs. This should make them more efficient and able to price competitively.

Large Mutuals Will Merge With Each Other

Mergers between larger mutual lenders will deliver a bigger bang for your buck by eliminating the disruption and costs associated with integrating many small institutions. Historically most mutual mergers involved large mutuals gobbling up smaller players. This has changed since mid-2021. In August of that year, the Newcastle-based Greater Bank Ltd. and Newcastle Permanent Building Society Ltd. announced their intention to merge, creating what was to be the largest mutual lender at the time. This was quickly followed by People's Choice Credit Union Ltd. and Heritage Bank Ltd. announcing their proposed merger just a few weeks later. Both mergers were completed on March 1, 2023, creating Newcastle Greater Mutual Group Ltd. (total resident assets of A$24.4 billion as of June 30, 2024) and Heritage and People's Choice Ltd. (trading as People First Bank; A$26.9 billion).

However, the mergers under way (see table 1) are essentially mergers of equals. This demonstrates the increasing need for scale in a competitive retail lending and deposit-taking environment. The ongoing requirement to invest in technology to keep up with customer expectations and industry trends adds further fuel to the merger fire. With A$20 billion shaping up as the new benchmark for participation in the Australian retail banking market, up to 40 mutual lenders may face consolidation and potentially disappear due to ongoing mergers.

Differences in mutual common bonds are no longer the hurdle they were for consolidation. Many mutuals in recent years have loosened historical common bonds to facilitate mergers or generate lending growth. This is because boards have become more pragmatic about the compelling rationale for mergers. Mutual customers have become less concerned with any watering down of traditional common bonds and more interested in the pricing benefits and service capability mergers can deliver. Two current mergers exemplify this. G&C Mutual Bank Ltd. has its roots in providing banking services to New South Wales state government employees while Unity Bank Ltd.'s history largely encompasses maritime, mining, and power unions. Similarly, Bank Australia Ltd., has for many years focused on sustainability and the environment whereas Qudos Bank Ltd. started as the credit union to staff of the national carrier, Qantas.

Table 1

Mutual Banks Remain Price Takers

As small players in the Australian banking sector, mutuals are price takers on both sides of the balance sheet. Personalized customer service through branch networks are no longer the strong drivers of business generation. As such, mutuals focus on defending and growing market share through sustained competitive pricing. The pricing dynamics in the market, particularly for mortgages and deposits--mutuals' core products--have resulted in the net interest margin (NIM) of Australian mutual lenders falling to about 2% as of March 31, 2024, from about 3% in 2004.

Mutuals' balance sheet and the mutual structure allow 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. Nevertheless, their profitability has suffered. Mutuals' return on assets has fallen to 0.4% in 2024 from 0.8% 20 years earlier. This compares with the return on assets of the Australian major banks, which has only moved to 0.7% from 1.0% across the same period. Ultimately, the absence of shareholder return obligations may not suffice to fund the pricing required to win business. As such, the sector needs to seek cost economies. The most obvious and fastest way to do this is through consolidation.

Margin Pressure Therefore Likely To Remain

Margin pressure is likely to remain for Australian mutual lenders. This will be more evident for those mutuals that chose to increase lending via brokers. The use of brokers can reduce the return on a mortgage by as much as 40 basis points. In general, mutual lenders rely less on brokers than the major Australian banks. As of March 31, 2024, mutuals originated an average of 47% of lending via brokers, up from 25% in 2019. This compares with 57% for the Australian major banks.

Costs Likely To Stay High

Furthermore, mutual lenders' costs will remain high. We will see continued investment in technology, both to better service members and manage risks, such as cyber. The acceleration to digital banking adds a new dimension to the retail banking landscape in Australia. Mutuals have fewer resources than larger banks to lead the market in developing an effective end-to-end digital mortgage loan offering. In time, a fully digital mortgage will become a customer requirement in the Australian banking market. Australian mutuals will need to invest to keep up.

Consolidation in the mutual lending sector has continued unabated over the past 20 years. The total number of mutual authorized deposit-taking institutions fell to the mid-50s as of March 31, 2024, from about 185 in 2004. Despite this, however, the cost-to-income ratio of Australian mutuals has remained high, averaging 75.8%. This compares with an average of 47.8% for the major banks over the past 20 years. Particularly in the years immediately following a merger, merger-related costs could outweigh potential cost savings in relation to labor, property, marketing, technology, and compliance.

Fundamentally, we see mutual mergers as credit positive, but this may not translate to higher ratings immediately or in all instances, given even the largest mutuals in the country are much smaller than the Australian major and regionals banks. Time will tell if 10 or less is the magic number.

Appendix

Table 2

Editor: Lex Hall

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