FIPS Quarterly

Financial Institutions Perormance Survey

FINANCIAL SERVICES

A difficult quarter

Results from the Major Banks to 30 June 2009

Overview for the quarter

KPMG has continued to monitor the results of the major retail banks in NewZealand, with a particular emphasis on the big 5 banks (ANZ National, ASB Bank,BNZ, Kiwibank, and Westpac).For consistency, we have used the results of the New Zealand Banking Group’sto ensure consistency across the entities (as far as possible).

Entity disclosedIncludes

ANZ Banking Group –New Zealand BranchANZ Banking Group – New Zealand BranchANZ National Bank Limited GroupCBA – New Zealand BranchCBA Banking Group –New Zealand BranchASB Bank Limited GroupWestpac Banking Group –New Zealand BranchWestpac Banking Group –New Zealand BranchWestpac New Zealand LimitedBank of New Zealand GroupBank of New ZealandKiwibank LimitedKiwibank Limited

Results for the quarter

During the quarter ended 30 June 2009 the major banks have posted a loss aftertax of $348 million, driven by BNZ recognising the loss of the High Court casetaken by the IRD into certain structured finance transactions. If this was removedfrom the quarter, the profit after tax would have been $313 million, still lowerthan the $483 million of the prior quarter or the $722 million in the June 2008period.There are a number of drivers for the reduction in headline profitability butwhen we look at the normalised profit we see that underlying profit was $1,042million for the quarter (ie backing out tax, credit impairment and abnormals),compared to $1,409 million in the prior quarter and $1,139 million in the prioryear. This represents a 26% and 9% reduction from prior quarter and prior yearrespectively.The key events over the last quarter have been the continued significant increasein loan impairment charges and the tax conduit cases. However, it should benoted that there has been a further ‘hit’ to profitability for the quarter fromrevaluation losses on financial instruments.November 2009

Net interest margins have improvedslightly from the March quarter –improving to an average 2.07%,although this reflects some noise ininterest margins from the impacts ofprepayments of fixed rate mortgages inprior quarters, revaluations of hedgingand swaps and other associatedfactors. Significantly the cost of funds(interest expense over interest bearingliabilities) has increased faster than theassociated lending income reflectingthe tough competition in the market fordeposits.Costs have been well managed andhave tracked at a very flat level.Impaired asset expense increasedalthough only marginally over theMarch quarter - $609 million vs $582million but this is significantly morethan the prior year ($153 millionand $130 million respectively). Thiscontinues to reflect both lossesin mortgages but also commercialbusiness failures. However theselosses are also driving significantincreases in the level of collectiveprovision being held, with CPincreasing $113 million in the Junequarter (and a further $185 million inthe March quarter).So all told this has been a very toughquarter for the banking industry withtotal asset contraction, increasingcapital requirements, reducingprofitability and soaring bad debts.

Tax conduit cases

Obviously the major factor affectingNet Profit after Tax for the quarterwas the result of the New ZealandStructured Finance Transactions case(the so-called “Conduit Tax case”), witha judgement being reached by JusticeWild on 15 July 2009 against BNZon the majority of points of law. As aresult BNZ recorded additional incometax expense of $661 million, being$416 million of tax plus $245 million ofuse of money interest.BNZ have indicated publicly that theyintend to appeal against the judgementto the Court of Appeal but pending thisappeal (which could be several yearsin the hearing), BNZ decided to recordthe full amount of tax.BNZ’s approach was not followedby the other major banks as at 30June 2009 (Kiwibank excepted whois not subject to the conduit cases).However in early October 2009 theWestpac judgement was issued byJustice Harrison who also ruled againstWestpac. While the finer details ofthis judgement are still being workedthrough it appears likely that Westpacwill record an approximately $960million provision for this case and itwould appear likely that ASB and ANZNational will follow suit with exposuresstated as $282 million and $492 millionrespectively.

New bank registration

During the quarter, Baroda (NewZealand) has been listed as a newbank in New Zealand, taking thetotal number of registered banks to19. Baroda is a subsidiary of Bankof Baroda (India) and will operate inNew Zealand under the name Bankof Baroda (New Zealand). Bank ofBaroda has stated that it will offer awide range of banking services. Bankof Baroda is the third largest publicsector bank in India and operates in 25countries.

Economy and OCR

In the latest RBNZ monetary policyannouncement the central bank keptthe OCR at 2.5% and continuedsaying that the OCR will be kept at itscurrent rate or lower until late 2010.However, in contrast the Reserve Bankof Australia has recently increased itscash rate by 25 basis points to 3.25%.While there are signs of a recoveryin the New Zealand economy, thereremains significant risks to a fullrecovery ranging from the high NewZealand dollar, the level of Fonterramilk payout, and the property market.Therefore there is keen interest inthe economic data coming out andits implications on the RBNZ’s statedintention to hold the OCR at 2.5% forthe foreseeable future.

Funding and liquidity

It appears that the worst of the fundingand liquidity issues of the last yearare past, with the major New Zealandbanks finding the US commercialpaper markets easing back to moretraditional levels, and reducing theneed to utilise the Governmentswholesale deposit guarantee. Ascan be seen below issuance peakedin July 2009 and has in August andSeptember 2009 fallen away as theBanks have sourced funding offshoreat significantly reduced rates to thosebeing experienced earlier in the year.

Regulatory developments

The Government has acted early togive clarity on the future of the retaildeposit guarantee. Concerns had beenexpressed in a number of forums thatunless an extension had been providedto the 12 October 2010 maturity date anumber of entities, particularly financecompanies, may have found thecoming months a significant struggle.As such a revised version of thegovernments retail deposit guaranteescheme has been pushed throughParliament and will allow for depositsto be guaranteed through to the endof 2011, when it is hoped that theguarantees can end without any impacton financial markets. A significantfeature of the updated depositguarantee scheme is the requirementfor all entities to reapply for theguarantee, reductions in the level ofcoverage ($500,000 if with a bank or$250,000 with a finance company) andthe new requirements for entities tohold a credit rating equivalent to BBor better. Pricing has been introducedwhich will require entities to pay feesbased on their credit grading rising

from 15 basis points for AA rated to150 basis points for BB rated. Thisreflects general sentiment in theindustry that the Government (via theTreasury) was taking on a substantialliability which needed to be priced in.A further regulatory developmenthas been the fact that the RBNZ hasbeen conducting a Section 95 of theReserve Bank Act review of Westpacwith three stated objectives. Thereview encompasses a wide range ofobjectives including a review of thestructure of the operating model of theOverseas Banking Group’s businessin New Zealand; further the reviewwill cover a review of governance andcompliance with the conditions ofregistration. The results of this revieware not yet known, but point to a morehands on approach from the ReserveBank.While the worst of the impacts fromthe Global Credit Crunch appear tohave largely past, ongoing issuescontinue to arise and provide fuel tothe widespread “forest fire” which hasbeen raging in the international bankingsector. The latest such event beingthe news that the Latvian bankingsystem is on the edge of collapseas it has not met the spending cutsrequired to secure their next trancheof bail-out funds from the EU, Swedenand the International Monetary Fund.Should this occur, it could potentiallyspook the markets which have inrecent months begun to operate morenormally.While the full effect of the creditcrunch is coming to an end, regulatorshave been using this period to considerthe implications of the last two yearsand what the future of bank regulationmight hold. The UK Financial ServicesAuthority (FSA) has released proposedliquidity requirements which could costBritish banks as much £9.2 billion peryear, as the banks will be required tohold more liquid assets and which willconstrain the types of assets the bankscan hold. While these costs are likelyto be passed on to consumers, this isseen as preferable to the widespreadbloodshed which was experiencedin the UK banking system with theGovernment having to step in andprovide a £37 billion bailout to longestablished banks such as Royal Bankof Scotland, Lloyds TSB and HalifaxBank of Scotland, not to mention theNorthern Rock failure.In a New Zealand context the RBNZhas been working with the Banks tointroduce a revised Prudential LiquidityPolicy that will impose new liquiditymeasures on the New Zealand Banksand which it is speculated is likely tohave a flow on cost to consumers.Whether the RBNZ is likely to followthe path of the UK FSA is yet to beseen.Finally in New Zealand, the longrunning case between the CommerceCommission and Visa, MasterCard andthe credit card issuing banks in NewZealand appears to have reached asettlement with the banks. While notproviding any admission of liability, thissettlement will bring to a close theissues and allow the banks to moveforward under an amended set ofrules.