Regional banks—courage under fire: despite a turbulent corporate climate and the downturn in the global economy in 2001, Australia's regional financial institutions achieved stolid growth in operating profit, but things may not be quite as rosy in the year ahead. KPMG's annual survey of the sector provides a detailed analysis of the past year

Australian Banking & Finance, August 16, 2002

THE 2001 FINANCIAL YEAR SAW A number of corporate collapses and the downturn in the global economy. Whilst the effects of these events were felt across the financial services industry the Regional Financial Institutions sector ("the Regionals") appeared to emerge relatively unscathed. During 2001, operating profit after tax increased by 8.42% to $1.04 billion.

The Regionals have maintained a steady growth in operating revenue on the back of:

* continued revenue diversification efforts, in particular by Suncorp Metway through its allfinanz strategy and St. George through SEALCORP, its wealth management entity;

* strong net interest income growth in consumer markets stemming from asset growth associated with the continued low interest rate environment and the Government's commitment to the First Home Owners' Grant;

* continued focus on core lending competencies in the secured markets such as home and personal lending; and

* continued focus on cost control.

This increase in revenue however has been partially offset by:

* increased fees and commissions paid to mortgage originators and brokers;

* some increased provisioning for doubtful loans and loan write-offs; and

* continued margin pressure resulting from increased competition in the secured lending market.

COST TO INCOME

The past two years have seen an increased focus on cost management by the Regionals that has met with mixed success. Focus on head count and inefficient processes, coupled with expansion of more efficient electronic delivery channels such as internet and telephone banking, have been some of the key initiatives. As a result the Regionals have been able to stabilise their cost to income ratio at around 68%.

However, there are a number of factors which continue to impact the industry's cost to income ratio keeping it above that experienced by the Majors and the overseas banks:

* maintenance of a significant branch structure, and in the case of HSBC Bank Australia and the Bank of Queensland, opening additional, branches;

* a relatively lesser capacity to successfully implement and manage the process, technology and cultural, change required to achieve substantial cost savings;

* higher wholesale funding costs compared to the Majors, who have the ability to access a broader retail funding base and cheaper wholesale funds; and

* increased fees and commissions paid to mortgage brokers. This service has increased in popularity as it enables the Regionals to expand their traditionally local base.

INTEREST MARGINS

During the past few years the interest margins of the Regionals have been declining, in line with those across the entire financial. services industry. The 2001 financial year saw the Reserve Bank continue to cut interest rates with official, rates falling by 125 basis points between 1 January 2001 and 31 December 2001.

Similar to the positive financial impact this created for the Majors, the Regionals were able to reprice their liabilities ahead of the changes in official, interest rates.

As a result the decline in the average interest margin of the Regionals was not as significant as what may have originally been anticipated, with the average margin falling from 2.57% to 2.45% during the past 12 month period.

Industry analysis would suggest that, despite the global economic slowdown, interest rates will not reduce further. It remains to be seen whether competition for market share, especially as the Majors look to increase their share in the more secure consumer market, will result in further margin squeezes. Any increase in interest rates could also be expected to negatively impact margins.

INCOME DIVERSIFICATION

Combined non-interest income for the Regionals in 2001 totalled $3.4 billion, an increase of 9.4%. This is the result of the focus of the Regionals on income diversification and continues the trend established in 2000 and the strategy of the Majors and the global, financial. services industry. St. George and Suncorp Metway have been particularly focused on this area of their revenue through their wealth management and allfinanz strategies respectively.

The focus on income diversification remains important, particularly whilst downward pressure on margins remains.

Over the past two years the Majors have either acquired, or entered into joint ventures with, wealth management organisations, which will continue to improve their non interest income.

One of the challenges facing the Regionals is whether to follow the approach taken by the Majors, or the approach currently being pursued by Bendigo Bank which has indicated it will provide an online portal for customers to access a wide range of third party financial products.

ASSET GROWTH

Combined total assets for the Regionals increased by 10.1% (majors: 8.4%) to $128.5 billion for the 2001 financial year. This growth can be attributed to:

* the increase in popularity of broker originated lending which has enabled Regionals such as Adelaide Bank and Bank of Queensland to tap into other states around Australia;

* the sustained low interest rate environment which continues to stimulate the personal and home lending markets;