What If A Bank Put Its Customers Ahead Of Its Shareholders?
By Mike SeccombeFebruary 22, 2012
One small player in Australia’s banking industry is keeping its interest rates down ... will its shareholders revolt, or be glad to be part of an alternative to the Big Four?
When Australia's big four banks, one after another, jacked up their home mortgage rates this month, one of their most immediate and harshest critics was Jamie McPhee.
He hopped right into them, for favoring shareholders over customers, for seeking to protect swollen profits, for planning to sack staff, and for generally not showing signs of caring about social equity.
McPhee sounded, and continues to sound, like he's reading from the same script as Treasurer Wayne Swan, or the consumer groups, or the myriad other critics of big bank greed.
Yet McPhee is himself a bank CEO, and if you've been listening to Wayne Swan, as he encourages bank customers to vote with their feet by changing banks, you will likely have heard McPhee's bank mentioned by name.
It is ME Bank, and it's probably Australia's most interesting bank.
Unlike others, it is not owned by private shareholders. Its owners are 32 industry superannuation funds. This is both its great strength and, as we shall see, its great dilemma.
But first, let McPhee talk his book a bit, for he has some right. As he boasts, ME Bank "has had the lowest standard variable rate in the country since becoming a bank in 2001."
It now offers home loans at a hugely cheaper rate than the big four. Its current standard variable rate is 6.74 per cent, more than half a per cent below the cheapest of the major banks. (In descending order, the comparable rates are: Westpac, 7.46; Commonwealth, 7.41; ANZ, 7.36; NAB, 7.31).
The catch is that to get that rate, you have to be a union member or member of an Industry SuperFund.
"There are about 5.5 million members of Industry SuperFunds; it's not like we're dealing with a small group," says McPhee.
"It's a large part of the community, and we want to offer value to that part of the community."
To keep things simpler and cheaper, the bank offers a limited range of services compared with the majors.
"There's five key product categories: home loans, personal loans, cards, savings accounts and transaction accounts," he says.
"Over 90 per cent of our balance sheet is mortgages.
"There is also a smaller business banking capability. We want to bank the employer groups of the industry funds.
"But we don't offer margin lending or foreign exchange. If you're someone who wants to move your gold bullion out of your Swiss bank account into a margin loan that you're leveraging against your shares, then ME bank is probably not the most suitable for you. I believe the products we offer would satisfy the needs of 98 per cent of our target market," he says.
Like we said at the top, ME Bank grew out of the Industry SuperFund movement, which consistently outperforms private super funds. The idea was that ME Bank would do something similar - delivering its benefits to members/customers rather than to agents/shareholders.
But where the industry funds are now huge, controlling hundreds of billions of dollars in assets, ME Bank remains at this stage a relative minnow.
"We've got about $18 billion in assets," says McPhee. "Compare that to the Commonwealth, which has about $600 billion.
"We have about one per cent market share, so there's plenty of room for growth."
So, to his criticisms of the big banks. First came the press release, accusing the big banks of "looking to place the full financial burden of the higher cost of funding onto their customers", when a "fairer outcome" was "to share the impact between customers and shareholders".
It went on to highlight job cuts, and allege that the big banks had taken advantage of customers through "hidden fees and conditions, 'honeymoon' fees and complex products".
He repeats the dose when talking to The Global Mail about unsolicited credit cards, automatic credit limit rises, and other practices the banks had got up to in the past.
But the real fighting words come when he gets onto the subject of the Big Four banks' profitability.
When the big banks decided to raise their mortgage rates, even though the Reserve Bank had left official rates on hold, McPhee's bank decided not to follow suit. It was a decision about market positioning, for sure, but it was also a matter of philosophy.
"Our funding costs are exactly the same as everyone else's," he says. "It all comes down to a couple of critical questions.
"The first is what is the right balance between the value accruing to customers and the value accruing to shareholders.
"There has to be an economic return, otherwise you won't attract capital."
But he suggests that the returns on equity of the big banks (ROE is a measure of company profit, expressed as a percentage of shareholder's equity investment), they look pretty fat.
"Is it right to have a return on earnings of 19 per cent? Is 15 per cent the right ROE?"
He compares Australia's banks, with their steady and safe income streams and government guarantees against failure, with other exceptionally safe investments, such as utilities.
"If banks are becoming more like utilities, should they get returns more like utilities?" he asks. "I think that is a good debate to have."
If you look at the ROEs for different types of businesses, as Jessica Irvine did in the Sydney Morning Herald recently, you'll see utilities earn about seven per cent - less than half the average return of the big four banks.
The argument that Australian banks are comparable to utility companies is, therefore, a pretty incendiary one to raise. It is also, by the way, bolstered if you look at what they lend money for: In 2009 residential real estate loans were 59 per cent of all bank loans. Commercial real estate was 11.7 per cent.
That's an extremely high proportion by international standards and hardly a very risky or challenging way of making money. Those loans are literally as safe as houses. And before you say "but look what happened in the United States", bear in mind that the situation in Australia today is not at all analogous to America five years ago. There's no pending problem with sub-prime loans here, no "liar's loans", no bankruptcy laws which allow mortgage holders to just walk away. So the big banks are making big returns on not much risk.
It's not that McPhee is advocating a particular level of return as being a fair thing; he wants to see ME's own ROE lift from its current level, which is pretty much in line with that of a utility company.
"It's in the mid-sixes now, " he says, "but it's increasing quite rapidly.
"We want to get our return on equity into double digits."
Now, that ambition might seem to be at odds with McPhee's suggestion that banks be compared to utilities. And indeed it goes to the heart of the ME dilemma.
The big banks are raising rates because they prefer their shareholders to their customers. But in ME bank's case, the shareholders are the customers.
When the bank gives a cheap loan to a member of an Industry SuperFund, it cuts the return it gives back to the superfunds overall.
It is, if you will, be robbing Peter to pay Peter.
Those Industry SuperFunds invest in other enterprises as well. They could use the money to buy shares in the Commonwealth Bank, and get an inflated return.
Thus McPhee would like to see the bank's returns on equity go down, and ME bank's ROE come up to something closer to an equilibrium.
"It is a question of building a business for long-term growth [versus] short-term return. And that becomes the critical question," he says.
"What we're trying to do is put a genuine alternative banking proposition out there. We do believe the way we conduct our business is different from the major banks.
"Our shareholders … while capital is not patient, in that it's looking for an economic return, it is prepared to take a longer term view than the six-month view some analysts take."
Clearly, he feels the pressure.
But his owners are prepared to be patient.
Gerard Noonan, president of the Australian Institute of Superannuation Trustees, which represents the $450 billion not-for-profit superannuation sector, says they are thinking about more than the short-term bottom line.
"The not-for-profit super funds which own ME Bank are obviously always interested in maximising value on behalf of our members. But ME Bank plays a number of roles, other than simply being an investment," Noonan says.
"ME Bank was originally set up by the funds as an alternative bank to the increasingly concentrated banking system in Australia. It provided cheaper home loans because its infrastructure was much less elaborate and less costly."
The global financial crisis, he noted, only increased the market domination of the big four, by causing many smaller alternative lenders to become uncompetitive, resulting in them either falling over or being absorbed by the big banks.
"The recent action by the big four banks in all raising their mortgage rates in the space of a couple of days, without any move by the Reserve Bank on rates, looks and smells like the actions of a group of businesses acting a bit like a cartel," says Noonan.
"On behalf of our members, we invest in many listed (and unlisted) companies in Australia, and want the best possible returns on our investments. But the returns have to be fairly won," says Noonan.
"ME Bank can act as a drag on such behaviour - it's a bit like that old slogan used years ago by Don Chipp and the Australian Democrats: They're there to keep the bastards honest."