Regional banks chart a course through choppy waters

AMP Bank, Bank of Queensland, Bendigo and Adelaide Bank (BEN), Macquarie Bank and Suncorp can between them be relied on for substantial annual benchmark deal flow in particular in senior-unsecured and securitised – primarily residential mortgage-backed securities (RMBS) – format. This deal flow is typically supplemented by issuance from smaller listed banks, a handful of new market entrants and the larger names from the mutual bank sector.

In any given half-year in recent times, the nonmajor bank sector as a whole typically prints at least A$5 billion (US$3.2 billion) and as much as A$12 billion in the Australian wholesale capital market (see chart 1). Flow eased in the pandemic years as banks were able to take advantage of the Reserve Bank of Australia’s term funding facility (TFF), but it has rebounded since to revert to historically normal levels of supply since the second half of 2021.

The current year has brought an unusual level of headline attention to the smaller and regional bank sector globally. In March, volatility spiked across capital markets in the wake of the collapse of three substantial US second-tier banks: Silicon Valley Bank (SVB), Silvergate Bank and Signature Bank. While none was considered systemically important – a distinction that allowed their balance sheets to escape close regulatory scrutiny and which ultimately paved the way for their failure – they were large enough to represent the second, third and fourth largest bank failures in US history.

The nature of the US bank failures – the root cause was in all cases holdings of assets that were not marked to market but which dramatically lost value in the rising rates environment, leading to sudden and catastrophic loss of depositor confidence – has brought the asset books and regulatory status of smaller banks across the world under scrutiny. Australian investors have told KangaNews about immediate reappraisals of all their bank holdings in the wake of the US bank collapses, for instance.

At the same time, consolidation in the regional bank sector is back on the cards. In July 2022, ANZ Banking Group and Suncorp agreed an acquisition that valued the latter at A$4.9 billion. In August this year, the Australian Competition and Consumer Commission (ACCC) rejected the deal on the basis that it would “further entrench an oligopoly market structure that is concentrated, with the four major banks dominating”.

The deal is not dead, and the two banks are preparing an appeal to the Australian Competition Tribunal. The combination of the ACCC’s response and the situation with US regional banks suggests, however, that an Australian sector for these financial institutions will continue to exist – and it will do 14,000 so under ongoing investor scrutiny of its resilience, for the time 12,000 being at least.

The first piece of good news for these banks is that the collapse of SVB and its peers does not appear to have severely damaged access to wholesale funds. Australian nonmajor bank wholesale issuance fell behind its 2022 run rate in the wake of the US bank failures but this largely reflects a coincidental March issuance spike in 2022. By mid-year, the regionals were mapping last year’s funding path almost to the dollar (see chart 2). Bank funders generally say there was an uptick in investor enquiry following the demise of SVB but they characterise it as a due diligence effort rather than one that carried significant risk of a withdrawal of funding.

They emphasise regulatory regimes that differ to the extent that ‘smaller’ US banks – though SVB last reported an asset book of more than US$200 billion, or more than three times that of Suncorp, for instance – were able to have game-changing exposures to US Treasuries that were not marked to market even as cash rates climbed at an unprecedented rate, or even to ultra-volatile cryptocurrencies.

Australia’s second-tier banks do not fall under the highest scrutiny, domestic systemically important bank, regulatory regime. However, they insist the oversight of their liquid assets and funding ratios is a solid barrier against the type of fate that befell SVB and its peers. Their own balance-sheet conservatism only adds to their safety.

“Investors wanted to reaffirm their understanding of how our market works, particularly from a regulatory regime perspective, which they did by asking questions about liquidity and capital frameworks. Accounting policies were a particular focus – they wanted to know how we valued our assets,” reveals Jason Bounassif, AMP’s group treasurer and chief financial officer at AMP Bank in Sydney. “While there were a lot of questions, there was also a sense that most investors already knew the answers – it was about reaffirming their understanding.”

Luke Davidson, treasurer at BEN in Melbourne, tells KangaNews: “Differences between US regional banks and the situation in Australia are well understood by investors so we haven’t experienced much of an increase in inbound questions. There have been a few questions aimed at clarifying the framework for interest rate risk management and how fair-value movements in liquidity portfolios are recognised, but these conversations were pretty straightforward given the strong framework in Australia.”

Neither, apparently, does investor concern increase when it comes to smaller capital-markets-relevant banks. MyState Bank’s Melbourne-based treasurer, Ryan Sharp, says the bank received questions from just one existing investor in the wake of the SVB collapse. This investor was satisfied with the responses MyState provided, Sharp says, and the bank has not had any follow-up enquiry from elsewhere.

Overall, Bounassif believes, the situation with US banks has if anything improved sentiment on their Australian equivalents as it provided an opportunity to reaffirm the robustness of the Australian sector.

“We visit investors globally, especially throughout Asia and the UK, and a recurring theme is always the robustness of the Australian market and Australian banking sector,” he reveals. “In addition, investors view the product we issue – senior debt and RMBS – as high-quality, relative to other sectors. I would not say we have picked up new investors as a result – yet – but we hope and suspect the sentiment could lead toward this.”

On the other hand, bank funders acknowledges that market volatility in general picked up post-SVB and this has acted as a timely reminder of the consequences of event risk for issuers in capital markets.

There is also a focus on asset quality that applies to all lenders in all markets, given rapidly rising rates and economic weakness. Australian nonmajor banks report a similar asset performance profile to other domestic lenders: an uptick in arrears, but at the margin and from a historically low base.

Bounassif, for instance, notes higher 30-day arrears but a return to the previous profile in the 30-60 day arrears basket. He attributes this primarily to seasonality and customers adapting payments as they fall off fixed-rate loans, rather than to the emergence of significant credit issues – noting, for instance, that hardship rates have barely moved.

Judo Bank is a specialist lender to SMEs – including providing mortgages to SME owners. The bank’s Sydney-based treasurer, Michael Heath, says most of its loans are variable rate, with the result that most borrowers have been able to adapt to the hiking cycle as it has played out. “Our focus is to maintain our current strong geographic and industry diversification,” Heath comments. “We see opportunities in agribusiness and health though at this point we are a little more cautious on discretionary retail and commercial property.”

With this in mind, Australia’s nonmajor banks universally emphasise the majority role deposits play in their funding mix. While these banks are, in aggregate, a significant contributor to Australian wholesale capital markets supply, this is not their primary funding option nor are they beholden to it in the short term.

“The starting point for BEN is the strength of our customer deposit franchise, which results in lower and arguably more predictable wholesale funding requirements,” Davidson says. “When determining issuance strategy for wholesale debt, we take a conservative approach with the objectives of maximising issuance flexibility and staying ahead of funding requirements.”

In particular, nonmajor banks typically say they do not rely on capital markets to fund growth. Sharp comments: “Our growth strategy is retail deposit led and we supplement this focus on deposits with funding via the capital markets. Management of the maturity profile, investor appetite and diversity, as well as relative cost, all come into consideration when we need to approach wholesale markets.”

The factor with the greatest potential to change the landscape, in the medium term at least, is the TFF. Regional banks took advantage of this source of ultra-cheap funds during the pandemic era. In many cases, they drew more TFF funds in the “supplementary and additional” round, which tends to be due for maturity around June 2024, as opposed to the initial round that typically expires by September this year (see chart 3).

Judo Bank, for instance, drew only minimal volume in the first round of TFF funding but tapped the supplementary and additional round for A$2.8 billion – a volume Heath describes as “a significant amount for us at the time”.

Nonmajor banks describe a proactive approach to TFF repayment, which often involves active pre-funding and use of diverse options. But deposits remain the core funding type for these banks, even for a major external refinancing like the TFF. Heath comments: “Our expectation is that the primary source of TFF repayment will be via deposits, but we have also been very active in securing committed warehouses – now up to a A$3 billion level of commitment.”

Davidson acknowledges that TFF maturities “present a challenge at system level over the next 12 months” – one that BEN has endeavoured to prepare for by paving the way to diverse wholesale issuance in addition to its strong deposit funding base. “We feel well prepared – particularly given the establishment of a covered-bond programme in 2022,” Dvaidson continues. “This provides access to a much broader range of buyers of triple-A rated paper relative to our existing RMBS investor base.”

This is not to say that securitisation is falling off the nonmajor bank radar. Some market users have suggested conditions are falling into line for something of a bank RMBS issuance renaissance, and issuers affirm that the asset class is certainly still part of their funding mix – despite some complexity about whether or not deals can be relied on for ongoing capital relief (see box).

At the same time, the deposit market itself may present increasing challenges. While higher rates should increase the appeal of deposits at the margin, cost of living pressures and higher mortgage repayments are putting pressure on household savings and therefore retail deposits. Meanwhile, all banks – including the majors – are competing for deposit funding with the result that funders acknowledge that margins have started to creep upward.

“The deposit market is very competitive and we have seen deposit rates rise above RBA rate changes over the past 12 months,” Sharp confirms. “We continue to experience growth in our total retail deposits. But we have observed a shift by depositors to savings and term deposit accounts from zero or low interest deposit balances as the opportunity cost of holding the former has increased.”

Bounassif agrees that competition for deposits has stepped up but also notes that the environment has been even more challenging at various points in the past. He also says there is no obvious sign of pressure on household balance sheets squeezing assets out of the savings pool entirely. “I don’t think this trend has emerged yet – if anything, it feels more like everything has returned to normality. For instance, ee have not seen a significant shift out of offset accounts,” he reveals.

The motivation for nonmajor banks to issue in wholesale capital markets is clear. Issuers also say they are confident of receiving a positive investor response when they do. This applies to established and newer names, and for additional capital as well as senior and structured instruments.

For instance, Heath says Judo Bank has adopted an “additional layer of conservatism” in its approach to funding in response to the “temporary distortion” caused by TFF refinancing, including building significant contingency through committed securitisation warehouse platforms. The bank still expects to access wholesale term markets “if credit spreads remain supportive”.

Bounassif adds: “Whether it is the subordinated notes of an RMBS trade or a tier-two note, there is strong demand so long as we engage with investors early and price appropriately to give a sufficient return. From a pure credit risk perspective, I do not get any sense at all that there is concern about credit quality or going down the capital stack for RMBS trades, additional tier-one or tier-two notes.”