In mid- 2021, Newcastle Permanent Building Society (NPBS) and Greater Bank, as well as, Heritage Bank and People’s Choice Credit Union (PCCU) announced their intention to merge. The merger between Heritage Bank and PCCU would create Australia’s largest mutual bank with around $22b in assets. The NPBS / Greater Bank merged entity would have a similar scale with combined assets of around $20b.
The two merged mutual banks will rank alongside HSBC Bank Australia, AMP Bank, Rabobank and Members Equity Bank (which is now part of Bank of Queensland). This could be the first in a fresh wave of consolidation in the mutual banking sector. The chart below shows the distribution of banks ranked by total loans and investments for the largest banks outside the Major Banks and Macquarie Bank.
In this article Finity’s banking and finance team look at some of the forces driving this trend and how mutual banks may benefit from the scale that comes in a merger.
Source: APRA Statistics
Recent wave of bank mergers
These mergers are part of a broader wave of M&A activity in both the mutual and non-mutual banking sectors taking place in 2021. For example, Teacher Mutual Bank’s merger with Pulse Credit Union recently received 98% of the Pulse Credit Union’s member vote to proceed. Teacher Mutual Bank (with $9b in assets) has previously merged with smaller ADIs including University Credit Society and Fire Brigades Employee Credit Union. Outside the mutual banking sector, NAB also announced its acquisition of Citibank’s Australian consumer business which will add a further $12.2b to its portfolio. NAB also recently acquired nonbank 86 400 and its 85,000 customers. Bank of Queensland also completed its acquisition of ME Bank which will take its combined assets to over $88b.
Have we reached a tipping point for mutual bank mergers?
Banks involved in the recent merger announcements cite the increased ability to invest in technology as well as gaining scale as reasons for merging. The bar for technological and operational capabilities continues to rise for banks, as customers and members become accustomed to banking seamlessly across different platforms and channels. Banks need significant IT investments to develop this capability. Digital capability also needs to be supported with data and analytics to service customers effectively, again requiring significant investment. Technology also enables automation which can reduce service times, improve service quality while lowering costs and risks in the long run. Financial services regulation has continued to grow in complexity. The GFC is partly to blame with regulators now prepared to intervene through more rules-based standards. Banks have had to implement and manage several complex regulatory and compliance processes.
While there has been an ongoing history of consolidation in the mutual banking sector, now it is being driven by requirements around technology and digital capability. A merger with another mutual bank may be a necessary step to acquire the capability or be able to invest in capability.
The advantage of scale
Mergers can bring economies of scale. Beyond typical benefits such as synergies across shared processes and functions, merged entities can benefit from leveraging each other's existing capabilities, geographic diversification, and access to new distribution channels. When investing in new technology, this is leveraged across a larger member base and balance sheet. Inorganic growth (via mergers) however is not without challenges and achieving synergies is not guaranteed.
Mutual banks also have the option to issue Mutual Capital Instruments (MCIs) to raise capital. The MCI proceeds can then be used to invest in new technologies or capabilities. In 2020, Australian Unity became the first mutual to raise $100m via an MCI issue. Many mutual organisations have made changes in their constitutions to allow them to raise MCIs. The ability to raise long term capital from MCIs means that mutual banks can access equity without necessarily having to pursue a merger or having to demutualise.
Cost effectiveness and scale becomes important even for mutual banks whose main objective is not to maximise profit or return on equity. Strong profitability is a financial advantage that opens more options to invest or grow. A merger or acquisition provides an option to achieve the scale that facilitates this.
What will a new merged mutual banks look like?
After the merger, the two new mutual ADI groups will be of a similar scale to HSBC Bank, AMP Bank and ME Bank currently. While these banks are similar in scale they are not mutual banks. This distinction is important. The merged entities will have a higher NIM than HSBC, AMP or ME banks. This is in line with the broader mutual bank sector having better NIM relative to other banks.
Source: Bank annual reports, Finity analysis
Source: Bank annual reports, Finity analysis
However, the cost to income ratio is higher for the merged mutual bank entities with 72% for NPBS / Greater Bank and 78% for PCCU / Heritage Bank calculated using a simple weighted average. This compares to 50%, 63% and 62% for AMP Bank, ME Bank and HSBC Bank respectively. At a first glance, this seems to suggest scale could provide cost efficiency. Achieving scale and efficiency after a merger is not easy and potentially there will be significant integration expenses with an uncertain payoff in the form of future synergy benefits. Synergies will be easier to achieve where both banks use the same core banking platform, and this can be a key criterion in deciding whether to merge.
If after the merger, NPBS / Greater Bank and PCCU / Heritage were able to generate synergies over time such as through using automation then a benchmark cost to income ratio of 50% to 60% may be achievable, from the current 70% to 80%. There are a couple of caveats. Mutual banks have member value and link to communities that they serve as the primary focus rather than profitability for its own sake. The four mutual banks have an established physical bank branch network while, ME Bank and AMP Bank are digital only banks. The physical branch network can be an important channel for a mutual bank to maintain the service to its member base and community, this will alter the cost structure and make comparisons to ME Bank and AMP Bank difficult.
Source APRA statistics
Merging for continued success
Recently banks have entered into merger discussions with the goal of gaining scale and with it the ability to make transformational IT investments. The mergers between NPBS and Greater Bank, and between PCCU and Heritage Bank will create the largest two mutual banks in Australia. Their size should help them develop capabilities in data and digital, and compete effectively in a high regulation, low interest rate environment. While scale and potential for technological transformation are important, for mutual banks, mergers should preserve the member’s common bond and support member value. Smaller mutual banks may increasingly find it difficult to make the transformational investments unless they are able to merge or pursue other options such as raising capital through MCIs.
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