Mortgage Duopoly Emerges

This story features WESTPAC BANKING CORPORATION, and other companies.
For more info SHARE ANALYSIS: WBC
The company is included in ASX20, ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

 By Greg Peel

Last night in the US, the Federal Reserve posted its October monetary policy statement. While reiterating its intention to leave its cash rate near zero for a long time, the Fed also reconfirmed its intention to continue supporting the local mortgage securitisation market until April next year.

The Fed has been supporting mortgage securitisation since the GFC killed off the market. The packaging-up of residential mortgages into parcels and on-selling them to investors had become the mainstay of mortgage loan generation in the US, allowing competition and cheaper mortgage rates. Unfortunately it all went awry when fierce competition and cheap money led to the sub-prime debacle and the CDO rort.

If not rorted, mortgage securitisation is a sensible means of matching investors and borrowers via the conduit of a bank. It is also a way in which smaller banks can compete for funding with bigger banks, and such competition leads to more affordable mortgages for homeowners. To prevent an ongoing surge in both US mortgage foreclosures and small bank bankruptcies, the Fed stepped into ensure the mortgage securitisation market still functioned.

The idea is not lost on the Rudd government. Securitisation was also the funding mainstay of Australia’s small banks and non-bank lenders, but as was the case in the US the Australian market froze in the GFC and has not yet thawed. Smaller banks cannot compete realistically now with the Big Four, and thus have lost market share. In order to encourage competition, and to keep mortgage rates down to reasonable levels, the federal government contemplated introducing what has been coined “Ruddbank”. Ruddbank’s role would be the same of that of the Fed in supporting securitisation.

We all know that Treasurers put on a song and dance for the cameras every time an Australian bank raises its mortgage rate. It’s all good politics to scream “unAustralian!”, but the pollies know full well banks run on tight margins and still rely on offshore funding. There’s not a lot the banks can do, but at least competition keeps them honest.

Or does it?

The Big Four banks have seen credit demand as a whole diminish post GFC but they have seen their own share of the smaller pie increase as smaller lenders fall by the wayside and as Australians rush back to the safety of the big names. The result is a net gain. This is what Rudd is concerned about – that even having four banks fighting it out is not enough to provide consumer choice – a choice that was once prolific when everyone from Aussie to RAMS to Wizard and the smaller regional banks were in the game. And justification for that concern has been confirmed.

Westpac ((WBC)) and Commonwealth ((CBA)) now share a total of 48.9% of all outstanding Australian mortgages (as at end-September calculations according to CoreData). CBA, which picked up BankWest, leads with 25.5%, while Westpac, which picked up St George, is close behind on 23.4%. Throw in National ((NAB)) on 12.8% and ANZ ((ANZ)) on 12.5% and the Big Four control 74.2% of all mortgages.

Not a lot of competition there. Fifth place goes to ING all the way down at 3.3%, followed by Suncorp-Metway ((SUN)) on 2.7%, Bendigo & Adelaide ((BDG)) on 1.9% and Macquarie ((MQG)) on 1.5%. As CoreData puts it, “Tier 2 Banking is dead”.

In the meantime, Westpac posted its full-year result yesterday and it was slightly better than consensus expectation. Indeed, most analysts agreed it was the outstanding result among the three similar results recently (NAB and ANZ reported last week). Profits were up, and the dividend was better than expected as well.

And of the three banks, Westpac’s management was the most bullish in its accompanying commentary. Management suggested impairment charges (bad and doubtful debts) had “likely” peaked. Last week ANZ suggested they had “stabilised” while NAB was playing it safe and not ready to call any peak just yet. Westpac also noted that even if they haven’t quite peaked the bank is very well provisioned, as is the case with the other two.

The bad news in Westpac’s result was mostly that it was trading profits in a volatile market which helped earnings beat expectations, and that at 8.1% Westpac’s tier one ratio is the lowest of the Big Four. Such volatility is sure to wane and trading opportunities thus diminish, while at 8.1% Westpac is looking tight against CBA’s 8.5%, NAB’s 9.0% and ANZ’s 9.5%.

For the banking sector as a whole, risks currently surround wealth management divisions given the current government review of fund management fees and other practices. Meanwhile, the government is also yet to decide, in the wake of the GFC, whether Australian banks should have their minimum tier one ratio requirements increased and deposit guarantees watered down.

And what about this competition problem? Surely it is a signal that Ruddbank will be back on the agenda, although in theory the Big Four can still access the securitisation market just as easily as smaller banks. Might the government come up with some other ploy?

This is not something bank analysts mulled over yesterday as they reassessed their Westpac recommendations. Once again, analysts were split on whether the Big Four as a whole, and Westpac in particular, are now fairly priced for an FY11 revival or are still leaving room for share price upside.

Macquarie was the only broker to change its recommendation – up from Neutral to Outperform in the wake of the result. Macquarie joins UBS as the only Buy-rating equivalents, while all other brokers in the FNArena database bar Credit Suisse are on a Hold-rating equivalent. This school believes it’s all been priced in.

Credit Suisse (Underperform) notes that at 14x FY10 forecast earnings, Westpac is already trading at the Big Four average PE. Australia may not have suffered a major recession, but are things really back to normal already? That’s what Credit Suisse is worried about.

Despite their general indecision, most analysts raised their FY10 and FY11 earnings expectations on the back of the Westpac result, sending the average target price up from $26.08 to $26.85.

As for the competition, or lack thereof, question, we’ll have to wait and see.

Click to view our Glossary of Financial Terms