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CBA shareholders having nothing to fear from neobanks, says Morningstar

Emma Rapaport  |  25 Sep 2019Text size  Decrease  Increase  |  
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Online “neobanks” have been touted as a disruptive force in the banking landscape, but traditional lenders can keep them at bay, says Morningstar.

These digital-only banks hope to have cut through with user-friendly mobile apps with fast and simple sign-ups. They've aggressively gone after new customers with high interest rates, zero-fee accounts, helpful budgeting features and the promise of a new way of easy, independent and fun banking.

You may have heard of a few:

  • Xinja – whose bright pink glow-in-the-dark cards are hard to miss and recently gained an authorised deposit-taking institution licence from Australian Prudential Regulation Authority;
  • Up – a collaboration between software development company Ferocia and Bendigo and Adelaide Bank, promising no monthly fees, spending analysis and an unmissable “welcome experience”; and
  • 86,400 – (representing the number of seconds in a day) Australian's newest “smartbank” run by former chief of ANZ Japan Robert Bell and backed by payments company Cuscal;

Morningstar banking analyst Nathan Zaia says it's easy to be enticed into thinking that these new banks will annex the market share from their legacy, branch laden peers. Customer satisfaction with the big four banks took a hit during the royal commission, research from Roy Morgan shows, down 3.6 percentage points between January and September 2018.

But Zaia believes the biggest of the big four can defend its turf.

"History has shown it can be extremely difficult to build the required scale to run a profitable and sustainable bank," he says in a Prem Icon research note, which reconfirmed the Commonwealth Bank's wide economic moat rating.

"We confirm our view about the competitive advantages of Commonwealth Bank, and while not all challengers will be failures, we do not believe they will be the source of an industry shake-up that some expect."

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Zaia says even though some digital banks are growing and reporting large percentage growth rates in their loan books, that this had had a "limited" effect on the banking landscape so far – and history shows us this is unlikely to change.

Taking ING Bank Australia as an example, which has held a banking licence in Australia since 1994, he says while the bank owned by ING Group has managed to steadily grow its loan book, its share of the mortgage market has remained at about 3 per cent for the last five years.

"We believe small challenger banks – without the balance sheet and opportunity to leverage technology spend – will struggle to be as disruptive, or more so, than ING," he says.

"Even at this scale in Australia, we estimate ING is generating a return on equity below the group target of 11 per cent."

Zaia says neobanks will likely appeal to small parts of the market who are ultra-price sensitive or see the appeal of new app features. However, he thinks these benefits will be short-lived, and doesn't foresee big four customers switching en masse.

"Ultimately I don't see these banks having much of a point of difference," he says. "Yes, they can offer introductory bonus rates, but if their loan books don't grow fast enough, they won't need extra deposits.

"It's not hard to image the major banks being able to easily incorporate features which resonate with customers.

"It pushes the big banks to keep innovating, which is good for customers and competition."

Challenger banks face challenges of their own

Additionally, Zaia believes the market is underestimating the "significant risks" challenger banks may face, many of which are loss-making businesses. Notable is the risk that chasing growth in lending can come at the expense of credit quality, he says, and in a downturn, "spectacular growth can quickly give way to mounting bad debts".

He is also concerned that tailwinds for challenger banks such as heightened regulatory scrutiny on the big four and price pressure in the mortgage and business bank markets – a function of the low-cash-rate environment reducing the importance of low-cost deposit funding – is unlikely to last.

"The improvement in their relative funding cost positions is likely to be cyclical and the disparity in lending standards between major banks and smaller lenders will be temporary," he says.

"Rising cash rates or global liquidity events can quickly alter the pricing competitiveness of challenger banks, a downturn in economic conditions will test their credit decision capabilities, and regulatory oversight and compliance costs will only rise as/if their loan books grow.

"The larger some of these competitors become, the more likely regulators will take greater interest."


No changes to moat rating

Zaia has reaffirmed the wide-economic moat rating for CBA – set by his predecessor former Morningstar banking analyst David Ellis - due to the bank’s sustainable cost advantage and switching costs.

"Its cost advantage is the most important source of the bank's wide economic moat and is supported by a low-cost deposit base, operating efficiency, and conservative underwriting relative to its peers," Zaia says.

"Given the commoditised nature of the industry, and competition for loans and deposits, low costs are the key to achieving excess returns."

The bank is currently trading on par with Zaia's $80 fair value estimate – it is down 0.52 per cent at $81.97 in early trading on Wednesday.

Outlook: growing, but slower

But just because the Commonwealth Bank (ASX: CBA) is unlikely to be caught out by the digital revolution, doesn't mean the bank is in the clear.

Zaia says aside from severe reputational damage, the bank successfully navigated the Hayne royal commission with dominant market positions undiminished, pricing power in place, and its wide economic moat intact.

However, he says storm clouds gathering over the global and Australian economy will weigh on the bank's ability deliver earnings growth.

"We've got low economic growth, anemic wages growth, high asset prices, a lack of business and consumer confidence. Really, population growth is the only thing that's supportive of loan growth in meaningful numbers," Zaia says.

"Australians already have high levels of household debt and there isn't room for them to lever up like we have in the previous cycle."

Zaia puts annual loan growth at 3 to 4 per cent for the next five years.

With CBA becoming increasingly focused on their core banking operations, having completed the sales of Colonial First State Global Asset Management, Sovereign life insurance in New Zealand, TymeDigital and Count Financial, Zaia says deposits and lending is where the banks strengths will come from.

Zaia also says the lowering of interest rates could hurt profitability as CBA will find it difficult to reduce the rates they pay on term deposits as fast as the interest rates they charge lenders.

"Deposit funding is cheap – people buy a 12-month term deposit at 1.5 per cent. But the bank also has a lot of funds where they pay little to no interest – like people's transaction account," he says.

"A big part of their funding is already free, so as the lending rates fall, you can't offset that with your funding costs. You can't reduce your funding costs by the same amount you reduce your lending costs, so the net impact is negative on your margins."

Additionally, he says banks could hit a point where they can't keep lowering rates on term deposits in line with the cash rate, as investors needing income could start looking elsewhere for higher return, such as higher risk alternatives like equities or hybrids.

Zaia notes that in countries where rates have gone negative like Sweden, Germany and Japan, savings rates actually increased. He puts this down to people realising they're not going to get as much of a return on their money, so they need to save more.

"There's two ways for retirees to go in this circumstance. They could either switch their investments or start saving more," he says.

He says CBA could support underlying earnings growth by making operational cuts - stripping costs out with improved productivity and digital processes.

Dividend sustainable

Zaia believes the bank's strong capital position and banking franchise make the $4.31 per share dividend sustainable in fiscal 2020.

And in this low-cash rate environment, a fully franked dividend yield above 5 per cent is attractive, he says.

"Our view on banking when it comes to lending growth, margins, and EPS growth dictates our view on dividends per share," he says.

"If we do have a recession and unemployment starts to rise, earnings forecast will weaken as bad debts rise, as do dividends. CBA is ultimately a cyclical business."

is the editorial manager for Morningstar Australia. Connect with Emma on Twitter @rap_reports. You can email Morningstar's editorial team editorialAU[at]morningstar[dot]com

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