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Battle of the banks – regionals vs big four

Are the regionals fully priced?

You have to feel for the Australian regional banks. They have good niche businesses, strong brands and customer loyalty, they are profitable and they pay nice, attractive dividend yields.

They’re just not as profitable as the big four.

The playing field

To be fair to Suncorp, Bendigo & Adelaide Bank and Bank of Queensland, while they compete vigorously with the big four in the markets they contest, they are not on a level playing field with the four kahunas.

The big four have stronger pricing power, which stems from their dominant market positions within a limited – and regulated – market. The big four have stronger balance sheets and higher credit ratings: they have greater access to wholesale funding and rely less on household deposits. Thus they enjoy at least a 50 basis point funding cost advantage over the regionals.

The big banks charge more for loans and pay less for deposits than smaller banks, hence their average interest margin is 2.2%, compared with the 1.8% margin of the regional banks.

Worse – from the point of view of the regionals – is that the big four banks are allowed by the Australian Prudential Regulation Authority (APRA) to apply lower risk weightings to their home loan assets than the regional banks, because they are “systemically” more important, and under more intense regulator supervision.

Thus, the big four have to hold far less capital against their home loans: they assign an average 16.4% risk weighting to their home loan portfolios, less than half the 35% to 40% that other Australian banks must apply. In other words, holding half the risk buffer, the big four can leverage their capital base twice as much.

Hence they have much higher return on equity (ROE) and return on assets (ROA) than the regional banks.

Adoption of – and compliance with – the new Basel III banking rules will cost the regional banks more than the big four.

The good news

The regional banks can match – or even better – the dividend yields on offer from the big banks, they just do so less reliably.

Listed Banks: the tale of the tape



Like the big four, the regionals have slightly different business models, and aspects that make them unique.

Suncorp (SUN) is a true 'bancassurance' business, a combination of banking and insurance, with a portfolio of national insurance brands and Suncorp Bank. Suncorp has experienced a profound turnaround over the past four years, under chief executive Patrick Snowball, and has been a star performer, particularly in the last 12 months, over which it has delivered a return (including dividends) of 44%.

But while Suncorp offers the highest dividend yield of the Australian banking sector, it has cruised to an altitude that runs higher than the analysts’ consensus target price. Principally, it needs a resurgence in the housing market in south-east Queensland to justify its price.

The same applies even more to Bank of Queensland (BOQ), which has expanded out of its Queensland base into Victoria, New South Wales and Western Australia through its owner-managed branch (OMB) distribution model (however, Queensland still generates almost 60% of the business). The balance sheet is still heavily weighted towards home loans, but BOQ did see strong business loan growth in its FY13 results.

This month, BOQ flagged the closure of some branches – expected to be ones it runs itself, rather than OMBs – as it tries to lower costs and improve the performance of its retail banking arm. The bank is also trying to extend its reach by using mortgage brokers and its Virgin Money business, which it bought from Richard Branson for $40 million in April. Again, this is a high-yielding stock, but over-valued according to the analysts’ consensus.

What makes Bendigo & Adelaide Bank (BEN) unique, is its community branch distribution model, which focuses on a community banking network in locations that the majors have neglected, or vacated; in a relationship that sees the local communities and Bendigo Bank share the profits.

This symbiotic focus has allowed Bendigo to grow its branch network at a much greater rate than the big four, and even with most bank transactions moving online, the network has been a strong driver of Bendigo’s profits. (That said, Bendigo was the only bank to experience rising bad and doubtful debts (BDDs) in FY13, on the back of its agribusiness exposures.) Bendigo, too, is an attractive stock on yield grounds – particularly for SMSFs – but appears significantly over-valued at the current price.

Broker Goldman Sachs rates the three regionals as ‘neutral,’ the same rating it applies to ANZ Bank. That ranks their attractiveness as somewhere in between Westpac and CBA – both of which Goldman Sachs rates a ‘sell’ – and NAB, which is its only ‘buy’ at present. And where the banking analysts as a group still see small upside from present levels for Westpac, NAB and ANZ, like CBA, they see quite a bit of room on the downside for the three regionals – buttressed somewhat on yield grounds. 

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

Published on: Wednesday, November 20, 2013

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