Credit tsunami reshapes banking & finance sector

The SmartCompany Dun & Bradstreet Industry Growth List for the banking and finance sector shows the rampant volatility shaking global credit markets is fundamentally reshaping the landscape, leaving a trail of winners and losers. By MIKE PRESTON

 By Mike Preston

The rampant volatility shaking global credit markets is fundamentally reshaping the landscape, leaving a trail of winners and losers in its destructive wake.

The SmartCompany Dun & Bradstreet Industry Growth List for the banking and finance sector provides a snapshot of the incredible growth many businesses achieved in the 2007 financial year.

And, less than a year later, it highlights just how far the mighty have fallen, with several businesses in the list facing much slower growth in the current uncertain credit environment.

Foremost among the losers is high profile investment bank Allco Finance Group. At the end of the 2007 financial year it was riding high, with revenue topping $1 billion following an extraordinary 676% growth on the previous year.

But today Allco is being touted as the biggest Australian victim of the credit crunch, with some market watchers speculating that it may not survive the year.

Another business in the top 10, Firstmac, is one of a group of non-bank lenders specialising in mortgage securitisation that has seen its source of finance all but disappear in the current environment.

But while just about all businesses in the sector are likely to experience slower revenue growth this year than last, the Industry Growth List does point to some businesses well placed to weather the storm.

Industry superannuation funds in particular come out looking good, with the Australian Retirement Fund coming in third and two others taking a place in the top 10 of the SmartCompany Dun & Bradstreet Industry Growth List.

And the big banks? They rank around the middle of the list – but analysts say they could be big winners in the new financial services landscape.

Investment banks feel the pain

Allco Finance Group grew revenue massively in recent years by using the financial wizardry it had previously applied to plant and equipment leasing to a range of assets.

Allco’s revenue increased from $158 million in the 2006 financial year to more than $1.2 billion in 2007, an astounding 676% leap.

But then came the fall. High-profile troubles with Allco’s Rubicon property trust investments transformed into a general negative market sentiment as the credit crunch took hold, sending Allco shares spiralling and raising question marks over its future.

And lawyers have joined those circling over the investment bank – launching a class action on behalf of shareholders alleging Allco failed to disclose vital commercial information in the lead up to its crash.

Allco’s revenues for the first half of this financial year still topped $620 million, but most analysts now predict a dramatic fall from those levels in the year ahead.

Ian Rogers, editor of independent banking publication The Sheet, says while nobody is sure if Allco will see out the year, there are some signs its core business will see it pull through.

“The fact that they haven’t appointed administrators suggests that the directors and management team can see a way through – the message seems to be they are confident that the core leasing business remains viable and of long term value,” Rogers says.

“They are on thin ice, but if they restructure the rest of the business around leasing in a way that keeps bankers on-side they may survive.”

The other investment banks on the list, such as Macquarie Bank (rank 2 and 6) and Babcock & Brown (rank 13), are not doing as badly as Allco.

One banking analyst, who asked not to be named, says: “Size definitely comes into play – Babcock and Macquarie are much bigger the Allco – and their exposure to leverage as well.”

“Babcock has come under a fair bit of pressure, but it acted quickly and decisively to replace short term financing with long term [financing] and mitigate risk.

“And both Babcock and Macquarie has taken a decisive approach to confronting rumours in the market. It hasn’t been 100% successful, but it’s better than Allco’s tactic of saying nothing,” the analyst says.

Even so, the current squeeze on lending means most businesses in the investment banking sector are unlikely to see the mega-profits of recent years, The Sheet’s Rogers says.

“Their business models will be under review because various aspects of business won’t be earning the required returns,” he says, “so any financier in the area of high-end structured finance will be restructuring, asset growth will be slowing and they’ll be doing less.”

Funding drought hits non-bank lenders

Australians’ insatiable demand for property – and the finance to purchase it – helped several non-bank lenders achieve outstanding growth in recent years.

Non-banker lenders Firstmac (rank 7) and Bluestone Group (32) met the surging demand for finance by extensive mortgage securitisation – in effect, packaging mortgage debt and selling it on the markets.

Then the credit crunch hit, undermining market confidence in housing debt and quickly killing off any prospect of further mortgage securitisation in the short term.

According to Alan Blake, general manager advisory services with banking analyst East & Partners, this has left several previously strong businesses struggling to find a funding source.

“Non-bank lenders such Mobius, Macquarie, Bluestone don’t have a deposit base and relied on the asset-backed securitisation market. That market has basically gone out for very long lunch, and that has made funding extraordinarily expensive,” Blake says.

While that means a squeeze on new lending, the concern is now that some lenders might be unable to roll-over existing loans because of the liquidity crisis.

“How do you continue to fund a 25-year mortgage when finance paper is short dated – that’s exactly what happened with RAMS when they got overextended – and now everyone is pulling back on liquidity, everyone is concerned that they’ve got enough cash in the pot to look after existing obligations,” Blake says.

On 15 March Bluestone executive chairman Alistair Jeffery told The Australian newspaper he expected business volume to be down by 70% in 2008.

Big banks, little banks and brokers

But where there are losers there are usually winners – and in this case, the big banks are shaping as the business most likely to come out ahead.

The big four banks have done well in the financial boom of recent years, Commonwealth Bank ranked 22, ANZ Bank ranked 28 and National Australia Bank ranked 29 in the SmartCompany Dun & Bradstreet Industry Growth List for the banking and finance sector– significant growth given their massive revenue size.

And, in contrast with their competitors, the banks’ strong branding and solid deposit base means they are in a position to maintain growth despite the dwindling availability of credit.

“There is a gap in terms of the impact of the credit crunch in Australia between bank and non-bank lenders,” Blake at East & Partners says.

“The bank lenders generally have good asset exposure and good deposit bases – particularly the Commonwealth – and, unlike non-banks, still access to capital markets here and offshore, so really they are in a much stronger position.”

And, Blake says, the banks consolidate their market position in the medium term, despite the tough conditions for finance companies and the hammering they are taking on sharemarket.

“The banks are probably in a better competitive position now than seven or eight months ago,” he says. “Not only have they lost a prime competitive genre out of the mortgage market because securitised lenders are gone, but people are looking for confidence and they have faith in the big banks, so there will be a flight to quality there as well.”

For mid-size and smaller banks the outlook is mixed. While smaller regional banks with larger deposit bases such as Bank of Queensland (rank 20) and Bendigo Bank (30) are likely to continue to do reasonably well, Adelaide Bank (21) and Credit Union Australia (9) are already being hit by higher costs because of their smaller deposit holdings.

“Some credit unions and smaller banks with a smaller deposit base are withdrawing products from brokers or having their activities curtailed, and that will continue, especially those that have tried to grow through securitisation in recent years,” Blake says.

Blake also sees some trouble ahead for mortgage brokers, both those at the big end of the market such as Australian Finance Group (ranked 19) and Mortgage Choice (49) and the many thousands of smaller operations.

“Brokers have already seen the non-bank lender part of their panel wound back – that leaves the banks, and they are going to put pressure on to cut their fees,” Blake says. “Ralph Norris (CBA chief executive) has already said he is reviewing remuneration structures and I strongly suspect all the banks will be doing the same.”

And just in case it feels like everybody is suffering except the banks, several analysts, including The Sheet’s Ian Rogers, caution that the slowing Australian economy will almost certainly hit big banks’ bottom lines.

“In the next two years bad debts will go up, and that will take the shine off profits,” Rogers says.

“We are already seeing problem loans increase in several areas and that will get worse, especially in business banking in late 2008 as stress in the household sector increases.”

Steady as she goes for super funds

Massive in size but often operating on a non-profit basis, superannuation funds are the sleeping giants of the financial services sector.

The SmartCompany Dun & Bradstreet Industry Growth List for the banking and finance sector shows they achieve earnings that are the envy of the sector, with the Australian Retirement Fund (ranked 3), AGEST Super (rank 4), HEST Australia (8) and BUSS[Q] (14) all in the top 20.

The list also reveals the dominance of industry super funds over their retail competitors, with seven industry funds making the top 60.

Jeff Bresnahan, managing director of independent superannuation researcher SuperRatings, says the strong market position of industry funds is the result of groundwork laid in recent years.

“Australian Retirement Fund is the classic example. They sorted out their operations and marketing four or five years ago and the fruits of that is giving them massive momentum – a lot of it is the industry funds advertising campaign, which was controversial but has been successful,” Bresnahan says.

It’s not all smooth sailing for super funds – Bresnahan says they have taken a hefty 6% hit to their asset holdings in this calendar year alone – but there is one factor that will continue to underpin growth in the sector; compulsory employer contributions.

“It is a compulsory environment, so cashflows are very strong and will remain so,” he says. “That won’t offset investment losses in the current market, but it will go some way to offsetting the reduction in overall assets of the funds.”

The sun will continue to rise in the morning

There is no avoiding the doom and gloom plaguing the banking and financing industry, even if much of it is more a product of sharemarket nerves than shaky fundamentals.

The crisis on international financial markets almost certainly has further to run, and until a robust consensus emerges that the worst has passed, the sector will continue to be knocked around.

And at the end of it all? According to The Sheet’s Ian Rogers, a more concentrated sector with fewer, more profitable players is a likely outcome.

“It will almost certainly be more concentrated and quite possibly more profitable for that reason. At the moment business plans are under review, and lenders who depend heavily on wholesale debt may suffer slow growth or short term losses, but generally we’ll see the big guys get bigger,” Rogers says.

SmartCompany Dun & Bradstreet Banking & Finance Industry Growth List

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