Banks emerging from recession gloom despite debt

UNDER EMBARGO UNTIL 6:00AM THURSDAY 4 FEBRUARY, 2010

Banks emerging from recession gloom despite bad debt pains

New Zealand’s five major banks (Westpac, ASB, ANZ National, BNZ and Kiwibank) are emerging from the gloom of the recession, maintaining core earnings and showing measured balance sheet growth despite a trebling in bad debt expenses and the accruing for costs associated with the conduit tax disputes with the Inland Revenue.

According to PricewaterhouseCoopers’ latest edition of New Zealand Banking Perspectives, the banks’ performance has been a story of two halves. For the first half of their respective 2009 financial years (1H09), New Zealand banks performed credibly with a modest decline of 1.8% in their aggregate statutory profits, compared to six months earlier.

However, the second half of the year (2H09) was a different story. The aggregated results of the major banks reported a statutory loss of $1.4 billion compared to a statutory profit of $1.3 billion for six months earlier. The combined 2009 full year results for the major banks represented a statutory loss of $76 million, compared to an overall statutory profit of $2,947 million reported in 2008.

PricewaterhouseCoopers Financial Services Partner Sam Shuttleworth said “The last six months will be remembered for the large provisions recognised in respect of the conduit tax cases between various banks and the Inland Revenue as well as public attention on residential mortgage interest rates. However, it should also be remembered for the resilient core earnings and sound capital bases the banks have maintained through careful efforts and well considered governance during a period of economic turmoil whilst combating escalating bad debt charges.”

Bad debts keep on rising

“Bad debt expenses for 2H09 lifted to $1,266 million, an increase of $450 million over the amount in the previous six months. Of the bad debt expenses in the second half of the year, approximately two thirds arose from the commercial sector – reflecting the impact of the domestic recession and global slow-down that occurred as a result of the global financial crisis. When examining bad debts expenses for the entire financial year, we note these had increased by $1.5 billion to $2.1 billion, a trebling in bad debt charges since 2008.”

“Looking forward, it is inevitable the major banks will incur further loan write-offs in the next financial year and we share the same caution expressed by the banks that 2010 will also be a tough year”, said Mr Shuttleworth.

Lower net interest income

Focusing on other aspects of the reported results for the major banks in the second half of the 2009 financial year, a lower interest rate environment resulted in a reduction in both headline interest income and interest expenses, with net interest income falling 5.5% or $177 million since the previous six months. “We also witnessed a number of the banks reporting that their net interest margins had deteriorated by over 20 basis points since 2008, which contrasts Australian experience, where net interest margins have increased by 15 basis points” said Mr Shuttleworth.

However, Mr Shuttleworth said it was equally important to remember the banks’ capital bases remained strong and well ahead of their Tier 1 and Total Capital requirements - there to enhance financial soundness of the banking system.

“We believe that the worst economic conditions are probably behind us and foresee low growth in the new financial year, with an expectation that banks are well set for a solid if unspectacular return to profit this year” Mr Shuttleworth said.

Funding

Mr Shuttleworth said: “Our banks are now more self-sufficient in funding their own business”. During the economic crisis, the major Australian banks (which included their New Zealand subsidiaries) appeared in the Global Finance “World’s 50 Safest Banks” list. Strong Australian banks were able to support their New Zealand subsidiaries which helped shelter our banks from the worst of the crisis fallout.

“While New Zealand banks have relied more on the wholesale markets than in the past to fund their operations and stretch their liquidity profiles, this impacted their overall financial results as this was relatively expensive funding. If they are to continue to attract international funding, New Zealand banks must maintain their credit ratings through strong, controlled financial performance that is supplemented by a confident New Zealand economy.“

The fierce deposit war between banks has continued with competitive targeting of retail deposits which has effectively kept interest rates on deposits higher than may have been expected simply based on the Official Cash Rate.

Lending

Growth in lending remained slow across the banks, reaching only 1% in 2H09. Two banks experienced a reduction in gross loans and advances to customers during that period.

Residential mortgage growth is still down from the 7.5% increase seen in 2H07, due largely to a focus on quality for new advances and tighter lending criteria.

Flat or even negative growth in corporate lending is expected to continue as banks continue to re-price these customers for risk while corporate customers are de-leveraging their businesses through focusing on debt prepayments, management of costs and capital expenditure requirements and retention of earnings.

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