Fitch: Australian Regional Bank Mergers Are Credit Neutral

Thu May 22, 2014 7:00pm EDT

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(The following statement was released by the rating agency) SYDNEY/SINGAPORE, May 22 (Fitch) The recently announced acquisitions in Australian regional banks are credit neutral, and highlight the ongoing challenges facing smaller lenders in boosting profitability and expanding loan books organically, Fitch Ratings says. We expect the need for increased scale to be an important driver of further merger activity, with the operational environment remaining tough for regional banks. The acquisitions of Rural Finance Corporation's (RFC) assets by Bendigo & Adelaide (BEN); and Investec Bank (Australia) Limited's (IBAL) professional finance, asset finance and leasing businesses by Bank of Queensland (BOQ); are not expected to significantly alter the risk profiles of the acquirers. As we highlighted in April, the acquisition of IBAL's business will be financed through a fully underwritten AUD400m capital placement, thereby limiting its impact on BOQ's regulatory capital ratios. Furthermore, the purchase - comprising primarily low-risk professional finance loans - diversifies BOQ's asset base away from Queensland while adding to assets and earnings. BEN's acquisition of RFC's assets is financed through a fully underwritten AUD230m capital placement. However, it has also been raising wholesale and deposit funding as BEN has only acquired RFC's assets. BEN's capital and liquidity positions are unlikely to weaken substantially following the merger. The acquisitions reflect an increasingly difficult operating environment for Australia's mid- and small-tier banks, which have struggled to build loan books organically and improve operating profitability amid intensifying competitive pressures. The Australian banking sector remains dominated by four major players, which significantly reduces the price-setting power and business generation capabilities of the regional lenders. As a result, net interest margins for smaller banks are lower than for their large counterparts, and they have had to compete principally on customer satisfaction and by targeting under-serviced areas such as rural finance. The weaker financial position of the regional banks relative to the Big 4 has been particularly noted amid the wider slowdown in credit growth over the last two to three years. We forecast Australia's GDP growth as remaining stable, and therefore the structural constraints to growth faced by the regional lenders should remain. As such, the pressures for acquisitions between the smaller and mid-sized banks are likely to continue. Greater scale via mergers will help to improve the regional lenders' franchises, and facilitate faster revenue growth and better cost efficiency. However, key risks to be monitored include how these deals are financed, and any major changes in funding profile and asset quality. Regional lenders' wholesale funding has been stabilising. However, they remain reliant on capital markets, and are more susceptible to investor sentiment and changes in funding costs due to their smaller franchises. Operational challenges inherent in mergers - such as management distraction related to integrating processes - could also add to risks. Contacts: Andrea Jaehne Director Financial Institutions +61 2 8256 0343 Fitch Australia PTY Limited Level 15, 77 King Street Sydney, NSW Australia Justin Patrie Senior Director Fitch Wire +65 6796 7232 Media Relations: Leslie Tan, Singapore, Tel: +65 67 96 7234, Email: leslie.tan@fitchratings.com; Leni Vu, Sydney, Tel: +61 2 8256 0325, Email: Leni.Vu@fitchratings.com; Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: wailun.wan@fitchratings.com. The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings. Applicable Criteria and Related Research: 2014 Outlook: Australian Banks here Bank of Queensland here Bendigo and Adelaide Bank Limited here

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