Realm Investments: Low Rates & the Changing Landscape in Australian Banking

By Realm Investments


It would be an understatement to call the year 2019 a “challenging” one for our banking system, with the Royal Commission, the prospect of an unfriendly Labour government and a tsunami of negative public opinion.

Despite the myriad of travails, perhaps the greatest challenge to rear its head was the belated arrival of the spectre of low interest rates.


Low rates change the status quo

Over the last decade we have looked on as global bank returns on equity plunged into single digits, just as our own banks made hay, delivering mid teen returns on core equity by doing little more than writing mortgages.

The chart below taken form a BIS working paper focused on the effect of low interest rates on banking. The story is simple, as rates drop interest margins on lending plummet.

Source BIS


While this is a new dynamic in Australian banking, it is symptomatic of a very well-worn global path.

So how have banks countered this dynamic overseas and what can this teach us around our likely trajectory here in Australia?

What is observable overseas is that banks pivot towards increasing non-interest income to offset plummeting interest rate margins. The chart below illustrates how important fee and trading income becomes for these foreign banks as rates approach and then pass through zero.

According to the BIS, fees and trading income rises to as high as 35 to 40% of total income. This becomes essential for maintaining return on assets. This is one of the key reasons why many believe that some form of QE in Australia is inevitable as rates approach zero.

Source BIS


Where to from here?

Where does that leave our banks? Simply, the regulatory regime our banks operate under means that it will be difficult to supplement returns with trading revenue. Our banks are simpler (some would say one dimensional) businesses, which while meaning that they are less exposed to the travails of global financial markets, it means that they have less flexibility in dealing with this kind of environment.

Furthermore, the global experience clearly illustrates that maintaining system lending and portfolio risk becomes challenging as rates decline. The chart below from the BIS again illustrates this dynamic. It illustrates risk weights (a measure for bank risk) declining as rates drop.

Put simply, our banks are constrained by both regulation and the environment. This means that to improve their performance the focus needs to be on improving overall efficiency by seeking to maximise the return on their capital and in attacking costs.

Source BIS


In the midst of chaos there is also opportunity

Later this year, APRA is due to release a revised framework on bank capital treatment, this will likely see increases to capital requirements for certain kinds of mortgages, cards and other lending.

This new regulation in combination with the current low rate environment will only heighten the need for banks to focus on getting more out of their capital base.

We believe this will lead to a rise in proactivity, driving banks to seek ways of improving the efficiency of their own lending books. In mortgage lending for example, we believe it is likely that banks will utilise additional security measures through bespoke/sector focused RMBS to offset rising capital requirements, while in asset backed markets we feel that banks may be more aggressive still.

This will lead to a range of new opportunities which will provide experienced debt investors with the requisite skill set unique opportunity.

Another area that we think will be a primary beneficiary of this developing environment is wholesale banking.

This is an area within banks that provides wholesale funding to other retail money lenders and broader funding programs. This ranges from emerging fintech’s, to well established non-bank and regional lenders, as well as other unique, secured corporate funding programs, which finance everything from equipment receivables for large corporations, invoice financing for multi-nationals and even lending facilities to fast food franchises.

For investors, gaining access to this market has been difficult, if not impossible. Frankly, in days gone by the banks haven’t needed to share the economic surplus on these assets. However, this is now changing.

What the current environment and increasing risk weights will result in is a focus on driving risk transformation. This is the process whereby banks introduce external investment capital onto their balance sheets for the purpose of protecting their lending position, while simultaneously increasing the credit quality of these loans (and consequently reducing capital requirements).

In the process the banks will create a range of high quality, high yield opportunities for investors who maintain market access and the skill to assess the risk.

Realm launched a fund in 2018 to take advantage of this developing trend. The key features of the strategy was to monetise the complexity, liquidity and aversion premium that existed in this capital funding markets. The strategy was raised as a closed end fund on this basis with final applications having closed in June 2019.

The strategy has performed strongly since inception, exceeding our expectations.

At the time of launch we felt the total opportunity would provide us the ability to raise a smaller opportunistic strategy, however through our contact with banks and issuers we have begun to appreciate that the requirement for funding is bigger and broader than even we may have initially appreciated.

Due to a strong client led response a decision was made to re-launch and broaden the strategy. The Realm Strategic Income Fund Enduring unit class has been launched in response to this demand as at the 31st of January 2020. Incidentally Powerwrap is the first platform to make it available.

The new strategy will be open ended, providing limited liquidity on a monthly basis and will seek to deliver the same return objectives and a very similar investor profile to the original capital series, more specifically we are targeting a net of fees return of 4.75% over the cash rate (5.5% at current rates).

The approach this strategy takes to generating yield is unique. Rather than speculating on individual high yield bonds, the strategy will provide investors with exposure to well diversified system risk. The underlying facilities that the fund invests in are backed by thousands of loans providing valuable diversity.

While this type of investment is new and likely unfamiliar to Australian financial advisers, these types of assets are a big part of the system. For years these assets have been primarily funded by larger insurance and annuity providers as well as the larger industry funds, who have benefited greatly from the aversion, complexity and illiquidity of these assets,

Our belief is that the Realm Strategic Income Fund will provide Australian financial advisers and their clients with access to a unique strategy allowing them to benefit off an attractive structural opportunity within the Australian Banking system.

Those interested in learning more should contact realm directly or feel free to contact our client service team at, or visit our website at