Challenging landscape fails to dampen the New Zealand's major banks' results

New Zealand’s five major banks (ANZ National, ASB, Bank of New Zealand, Kiwibank and Westpac) have revealed a 2% increase in core earnings in the first half of their 2011 financial years (1H11), which is a respectable result considering the difficult conditions the banks are operating in.

According to PwC’s latest edition of New Zealand Banking Perspectives, an analysis of the five majors’ financial performance, the banks’ combined core earnings in 1H11 was $2.3billion (bn), up from $2.2bn for the second six months of their 2010 financial years (2H10). This was driven by increasing net interest income and growth in other operating income, offset by a rise in operating expenses. The impact of the Christchurch earthquakes has halted the decline in bad debt expenses seen since 2H09. Overall, this has left the profit before tax largely unchanged at $1.9bn when comparing 2H10 to 1H11.

PwC Financial Services Partner, Sam Shuttleworth says “There have been no major movements in the key drivers of profitability since 2H10. In fact, this reflects the lowest level of movement seen period on period in the last two years. In the face of a sluggish economy and with the impact of the Christchurch earthquake, the results for 1H11, and its comparison to the previous six months is not surprising given it has been widely acknowledged by many as a difficult six months, not only for the banking sector but for New Zealand as a whole.”

Low interest rates have meant that bank customers are continuing to hold increasing levels of floating rate debt, relative to fixed rate debt. “This translated into net interest income for the period only increasing $44 million (1.3%) to $3.4bn for the period” says Mr Shuttleworth.

The Christchurch earthquake in February and its aftermath has had an unfavourable impact on the bad debt expense of the banks, keeping them flat period-on-period ($355 million for 1H11 versus $364 million for 2H10) and wiping out an estimated underlying 35% to 40% drop in the bad debt expense.

“As well as higher than expected bad debt expenses as a result of the earthquake, many of the banks have offered relief packages to support Christchurch businesses and households through lower interest rates or adjusted repayment terms, which have all had an adverse impact on profitability.” adds Mr Shuttleworth.

Weaknesses in some of the major overseas economies, have recently pushed the New Zealand dollar to all-time highs against the United States dollar. This strength has provided some volatility in the foreign exchange market helping increase customer flows and hence trading income.

With all four Australian owned New Zealand banks being downgraded by Moody’s in May due in large part to their reliance on overseas funding, increased pressures are being put on interest margins. There are real concerns the impending reviews by Standard & Poor’s may lead to a further credit rating downgrade as well.

Mr Shuttleworth warns “Any impact that does arise from these downgrades will put further pressure on the banks’ net interest income. This pressure would be especially unwelcome with balance sheet growth stalled and the re-pricing of loans onto wider spreads post-GFC arguably coming to an end.

“This leaves the New Zealand major banks in a difficult situation. With returns on equity decreasing by four percentage points in the last three years, there is likely to be increasing pressure from the shareholders to start increasing these returns.”

The most obvious controllable area is costs. Yet, many banks need to replace key systems in order to remain competitive in the technology-driven modern banking marketplace, whilst regulatory and compliance requirements continue to increase. It is worth noting the rise in the GST rate has contributed to the increased operating expenses in the current period.

“The challenge for the banks will be how they reignite growth in their balance sheet.” adds Mr Shuttleworth.