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KPMG Financial Institutions Performance Survey

2 May 2000

Summary Paper

2000 New Zealand Financial Institutions Performance Survey

Banking and Finance Group
KPMG

Contents

Page
Introduction 3
Industry overview 3
eBusiness – major opportunity or serious threat? 4
Globalisation 5
Informationalism and Consumerism 5
Customer satisfaction 6
The ‘People’s Bank’ 7
Industry alliances 9
Competition 10
The mortgage lending market 11
Treasury activities 12
Funds Management 12
Interest Margins 13
Electronic Banking 13
Branch Network 14
Finance Companies 14
Savings Institutions 15
Performance Analysis
Registered Banks 15
Branch Banks 16
Finance Companies 17
Savings Institutions 17
Outlook 17

Introduction

The 14th edition of KPMG’s annual survey of New Zealand financial institutions follows past practice of providing information on New Zealand registered banks, major finance companies and other financial institutions with total assets in excess of $30 million.

As in the past, information comes from publicly available annual reports, disclosure statements and prospectuses. It is supplemented by lending analyses, branch, employee and ATM numbers, some off-balance sheet and managed fund figures as well as other information obtained from survey participants.

Industry changes noted this year include:

 Deutsche Bank’s takeover of Bankers Trust in June 1999 and the subsequent relinquishing of the BT banking licence.

 The creation of Rabobank New Zealand Limited and the issuing of a new bank licence after Rabobank gave up the licence for its subsidiary, Primary Industry Bank of Australia

 The inclusion in the survey of six additional finance companies

Industry overview

Positive environment

New Zealand’s financial institutions begin the new millennium having achieved record profitability as an industry in 1999. On virtually all measures of financial performance the industry is performing strongly, with New Zealand’s five major registered banks performing particularly well. Asset growth has continued unabated and while interest margins have shrunk further, earnings have moved ahead strongly. This reflects growth in non interest income and tight control of operating expenses. The industry’s doubtful debt experience continues to be very good.

An important factor is the New Zealand economy, which grew strongly over the second half of 1999. All major components of GDP showed increases. In particular, household consumption and exports recorded a strong surge in the third quarter of 1999. And more recent signs suggest the pickup has continued since then.

1999 was a year of record profitability for New Zealand’s registered bank sector with improvements achieved for most of the key drivers of profitability. Unlike 1998 the significant improvements in underlying performance were reflected in overall net profit after tax for the sector, increasing from $1.2 billion to $1.6 billion.

Whether the industry’s strong performance can be maintained, and the improving economy capitalised on, depends on how New Zealand’s financial institutions address the following industry issues:

 Financial services specialists have successfully eroded market share in mortgages and investment products from traditional competitors

 Retention of top profit customers has become more elusive while least profitable customers continue to erode the overall portfolio value

 Contact with customers has not improved sufficiently, and may have in fact deteriorated in quality due to cost-cutting and channel proliferation

 Capturing the “trapped value” of a customer base has proved difficult due to organisational, technological and cultural barriers.

These issues have prompted the following responses from financial institutions:

 Encouraged them to broaden their product range
 Introduce or extend customer management strategies
 Extend eBusiness strategies
 Investigate and/or initiate outsourcing/alliances with specialist skills
 Introduction of change programs to improve flexibility

eBusiness - major opportunity or serious threat?

The last few years have presented the global financial services industry with a significant number of challenges, including:

 Globalisation
 Increased competition from both traditional and non-traditional players
 Commoditisation of traditional financial services products
 Increased customer power

One of the most significant contributors to the changing financial services environment is the Internet, whose unprecedented speed of adoption by the mainstream marketplace has given rise to a new ‘digital economy’. The emergence of the digital economy presents a new set of competitive pressures and opportunities for organisations, including new distribution channels, eCommerce, financial services convergence, and the need for more focused customer management strategies.

KPMG’s perspective is that there are a number of industry imperatives framing the digital economy that financial services organisations must accept, embrace and respond to in order to remain competitive. A key tenet of these industry imperatives is that the opportunities they present are no longer relevant only to long cycles of economic progress. What used to be the principles of long-term growth are now beginning to govern the dynamics of day-to-day business. Organisations must now operate in ‘Internet time’ where the dynamics of growth become the dynamics of short-term competitive advantage.

Globalisation

More than any other medium the Internet has fuelled the advent of global ‘borderlessness’ – a phenomenon which New Zealand is not immune to. In the financial services industry alone, international players such as Charles Schwab, E*Trade, Merrill Lynch and Quicken have announced their intentions to establish themselves more substantially on New Zealand’s virtual shores.

There is clearly an opportunity in the New Zealand marketplace for an organisation to take the high ground and establish themselves as the destination site for online financial services. An elite few, such as ASB Bank, BankDirect and AMP General Insurance, have enjoyed the limelight for the last couple of years with minimal competition, however their market position is now poised for attack as global organisations realise the complacency of New Zealand’s financial services institutions in the online space.

Informationalism and Consumerism
The Internet has facilitated the move into the ‘knowledge economy’, where customers have access to extensive amounts of information about products and services, which in turn gives them knowledge and most importantly – choice. The emergence of ‘knowledge consumers’ has shifted the power in relationships from the supplier to the buyer.
New Zealand’s financial services marketplace is no exception to this market phenomenon. Research and surveys conducted by KPMG show that New Zealand’s online financial services marketplace is two to three years behind its international counterparts.
In cases where New Zealand financial services organisations have embraced the Internet, they typically offer only commodity products and services. Excepting ASB Bank, New Zealand banks have only recently rolled out online banking, whereas internationally financial institutions are offering a myriad of value-added products and services.
Financial institutions can no longer provide a suite of average performing products and expect to be successful. The value chain is shifting from the vertically integrated model, best demonstrated by the traditional bank and branch network of the past, to a virtually integrated “value web” based model. In the value web, ‘providers’ produce commodity financial products, while portals provide navigation services to best-of-breed products and services.
The adoption of a ‘clicks and bricks’ strategy is imperative for today’s financial services organisations – not merely to compete, but to exist in the 21st century. A ‘bank’, an ‘insurance company’ or a ‘share broker’ are becoming less relevant concepts as we witness the development of strategic partnerships and alliances between both online and traditional organisations – all in the name of adding value to the customer relationship.
The real risk exists that New Zealand’s financial institutions may underestimate the significance of the Internet. Already 54 percent of New Zealand’s population have access to the Internet, and currently 34 percent use the Internet on a regular basis. It is not surprising, however, that the majority of the traffic generated by these consumers leaves New Zealand’s shores. Consumers are getting impatient for organisations to offer localised and tailored products and services online, and it is this demand that is fuelling the emerging competition from non-traditional and global players.

Customer satisfaction

The Customer Contact Experience

If we take the view that customer power is growing and will continue to do so, through technology providing better information, we would expect that the number of customers switching banks will increase. If this is the likely future then it becomes critically important for banks to understand their customers’ current and projected future level of satisfaction and the factors influencing that level of satisfaction.

While each of the banks use their own independent means to survey their customers and the marketplace, the Residential and Business Customer Survey conducted by the University of Auckland is well regarded by the industry. The most recent survey was undertaken between June and September 1999 by Mark Colgate and Bodo Lang of the Marketing Department of the University.

Similar overall results were noted across both residential and business customers. Of the five large banks, ASB and National Bank were the top performers, BNZ formed a middle group by itself and WestpacTrust and ANZ formed the bottom group. Of the smaller banks, TSB clearly outperforms all other banks mentioned in this study across all the generic performance measures used.

The study also investigated the components of banks' performance. The results suggest that banks perform well in some aspects such as the friendliness of their staff and their willingness to help customers. However, in general customers seem somewhat unhappy and frustrated.

Consumers feel particularly disappointed about the monetary component of their banks' performance. That is, they are dissatisfied about fees, interest rates (savings and borrowing) and the value-for-money they are getting from their bank. Availability of staff also seems to be a problem at times for business customers.

The study showed very clearly that residential customers consider switching banks because they are driven away from their current bank, rather than being attracted by another bank. Twenty-two percent of bank customers have seriously considered switching in the last year but did not do so because of the perceived possible negative consequences.

Research firm ACNielsen have determined the overall satisfaction of rural customers with their main bank. The results are very similar to the results recorded by the Auckland University survey of residential and business customers with ASB Bank and National Bank featuring as having the highest levels of customer satisfaction. Also in this group is Rabobank who, with a market share of slightly less than 10%, have the least number of dissatisfied customers and a comparatively high level of overall customer satisfaction.

This analysis points to the market leader (National Bank) and smaller banks offering more targeted offerings having the best customer satisfaction ratings. This raises issues for ANZ and WestpacTrust and, to a lesser extent, Bank of New Zealand as, based on this survey information, they appear to be the banks that are most likely to be affected by customers switching banks.

Our conclusion based on these survey findings is that financial institutions need to focus again on each interface they have with their customers. There has been considerable media attention during the last twelve months on banks as they have sought to introduce new fee structures that better reflect the costs of the services they provide. This has meant banks have had to make greater efforts to clearly communicate the rationale for changes in fee structures and to provide more guidance on how customers can manage the cost of their services.

The ‘People’s Bank’

In early March 2000 the Deputy Prime Minister and Economic Development Minister, Jim Anderton announced the possible creation of a “people’s bank” providing banking services through an extensive branch network.

The vehicle proposed is New Zealand Post, possibly in conjunction with an overseas partner, while the Public Trust plays a secondary role following a liberalisation of its legislation to allow it to expand its financial services.

The announcement followed numerous public statements preceding and after the General Election in November 1999. Targets have regularly been fee levels, branch closures and the repatriation of profits to foreign owners. Mr Anderton’s particular concern has been what he views as a reduction in services provided to provincial New Zealand.

At the time of preparation of the Survey, Mr Anderton’s officials were still working on details of what would constitute a “people’s bank” and exactly which perceived problems it would seek to address.

The Deputy Prime Minister’s initiative has been widely discussed. The banking industry’s reaction is best summarised by the comments of ANZ Managing Director, Dr Murray Horn who suggested that a people’s bank would struggle to provide a cheaper service than what is currently available, unless it was subsidised.

It is certainly timely to reflect on the fact that New Zealand has one of the most competitive banking environments in the world. Over the last ten years, customers have been given a wide choice of institutions, a vast array of flexible products, multiple service delivery channels as well as low and competitive pricing. In this respect, we are unusual but the rest of the world is starting to catch up.

Does the argument for a “people’s bank” come down to the question of fees and the cost of doing banking in New Zealand? As Dr Horn pointed out, each of the major banks provides “low cost options” for each and every customer. However, a large number of customers choose to use services that are expensive to provide, and are simply not satisfied with being restricted to a single, low cost, product range.

The erosion of bank branches is one of the arguments most frequently raised by advocates. In the last ten years there has clearly been a reduction in branch outlets but a far greater increase in alternative service delivery channels. In fact for many people, the local garage, dairy or supermarket has become a quasi bank. It has to be conceded that they cannot take deposits, but they are certainly a convenient source of cash.

The New Zealand Government may be inclined to rethink its strategy of putting pressure on banks to ensure adequate services to provincial New Zealand, in the light of a recommendation arising from a major review of banking in Britain, The Review of Banking Services in the UK, published in March 2000.

Banking in the United Kingdom is not as sophisticated or as competitive as banking in Australasia. But according to the review, chaired by a former UK telecommunications industry regulator, Don Cruickshank, there should be no need for government to intervene in the provision of basic banking services.

He added that any intervention should seek to bring competition gains and not distort competition by engineering permanent cross-subsidies. It should also avoid attempting to negotiate with banks to deliver a free service, a move regarded as unhelpful to consumers.

These are factors that Mr Anderton will undoubtedly be considering as he ponders the objectives and likely structure of a “people’s bank”. It would be unfair to pass judgement on the concept until we know more about it.

But if it is intended to provide full service banking facilities, which will come at a cost to the taxpayer, the debate will quickly focus on the extent to which the Government’s investment will be seen as the appropriate use of taxpayers money.

The appointment of a Labour-led coalition Government is clearly going to have an impact on the financial services sector. Along with the “people’s bank” proposal there have been rumours of an enquiry into the banking industry similar to those held in Australia over recent years. The benefits that would arise from such an enquiry are again debatable. What we do know from the Australian experience is that enquiries are time consuming, expensive and ultimately of dubious benefit to the general customer. However, they can have a cathartic effect by giving different viewpoints an airing.

Industry alliances

Revenue growth

During the year we have seen a number of strategic alliances formed in the financial services industry. These alliances have been driven by the need to have best-in-class products and processes to compete effectively in the market.

One such alliance is GlobalPlus – a three way grouping of Bank of New Zealand, Air New Zealand and Telecom. The partnership was brought together in 1998 to launch the GlobalPlus MasterCard. The cardholder is able to earn Air Points whenever they “talk, shop or fly”.

In early 2000 Bank of New Zealand launched the next GlobalPlus initiative – the GlobalPlus Home Loan. This innovative product enables the homeowner to earn Air Points based on the amount of their mortgage outstanding.

Other examples include ASB Bank and AGC Finance. ASB Bank have entered into an alliance with Vodafone to utilise WAP technology which will enable ASB Bank customers to do on-line banking using their Vodafone mobile phones.

AGC Finance have a joint venture with the Automobile Association - AA Financial Services - which has over 9,000 members. AGC Finance also has alliances with Carter Holt, Fintel, GE Capital and Macquarie Bank.

Most recently, alliances that will provide financial services organisations with greater access to new customers have been negotiated with New Zealand retailers such as The Warehouse and Farmers Trading Company.

Such alliances provide access to a bigger network of places where customers can talk to bank representatives without the costs associated with the traditional bricks and mortar style branches and their associated staff.

Another variation on alliances is the arrangement ANZ Bank has with BP and WestpacTrust has with Caltex to site ATMs at their service stations.

Cost minimisation

Perhaps the greatest potential for alliances to deliver real cost savings lies in the processing of customer transactions. The back office processing of customers transactions can be performed by a third party without the customer’s knowledge.

It was reported in February 2000 that Commonwealth Bank and Westpac in Australia were finalising a joint venture to combine their key back office functions. The joint venture, known as Trident, would process cheques for the banks. In New Zealand the majority of the banks have an alliance with EDS to provide processing services.

During 1999 the Reserve Bank was in discussions with the commercial banks with a view to improving the efficiency of cash handling and processing. Following these discussions the Reserve Bank announced its intention to effectively remove itself from its current role in facilitating daily bank note processing and distribution. This decision was made concurrently with the progressive introduction of the new polymer bank notes during 1999.

This comes at a time when non-traditional players such as Brambles and Armaguard are getting involved in the provision of automatic teller services in Australia. They are seeking to roll out ATMs in low volume locations in urban and regional parts of the country. The banks are outsourcing services as the profitability of ATMs has declined in the last five years due to greater use of EFTPOS services for making cash withdrawals.


Competition

New entrants

The financial services industry has become still more competitive during 1999 and the first three months of 2000 with a number of new players in the market.

Farmers Trading Company has announced plans to offer home loans from AMP, The National Bank, Sovereign and WestpacTrust through a new subsidiary, Farmers Home Loan Services. Farmers will initially offer home loans in South East Auckland with an area-by-area rollout in response to customer demand. Farmers are essentially positioning themselves as mortgage brokers utilising the strength of their brand and customer base to obtain incremental earnings.

Another large retailer – The Warehouse – has been looking at providing selected banking services. With a significant nationwide presence, the discount retailer is understood to be in discussion with ANZ Bank on setting up a joint venture in which services could be marketed under The Warehouse name. Already The Warehouse has three bank outlets co-sited in their stores. The Warehouse also offers two types of insurance, as well as its own store card, and accordingly providing further financial services appears a natural progression.

The interest from retailers in utilising their brand and customer base in the financial services arena follows developments overseas including the partnership between Woolworths and Commonwealth Bank in Australia.

In terms of the Australian mortgage players, Wizard Financial Services Group joined Australian Mortgage Securities, Interstar and Resi Home Loans in having a New Zealand presence in the last twelve months. They come from a country where some 20% of the market is now held by non-banks.

Wizard announced in December 1999 it would commence operations in Auckland in early 2000 and open a nationwide network of service centres providing a complete range of financial services products.

Resi Home Loans has been here since November 1998 and is said to be rapidly expanding through selling retail franchises and is considering setting up another processing centre in Wellington in addition to its operations in Sydney. In Australia, it has a $3 billion loan portfolio and a AAA rating on its products from Standard & Poor’s, well above the main banks’ ratings.

In April 2000 Craig Heatley, Chairman of eVentures, announced that E-Loan, an online lending service, will be launched in New Zealand within the next few months. eVentures is a joint venture between Mr Heatley (20%), Epartners, a subsidiary of News Corporation (40%) and Japan’s Internet investor, Softbank (40%), set up to provide investment and development services to new and established Internet businesses.

Convergence

Convergence between the traditional suppliers of financial services - banks, insurance companies, funds managers, superannuation companies, stock brokers and financial planners - has also fuelled industry rationalisation. Many of Australia’s banks, and by virtue of their ownership New Zealand’s banks, have adopted bancassurance or “allfinanz” strategies to diversify their income stream to counter reduced interest margins flowing from increased competition. This is vividly demonstrated, at the time of writing, by Commonwealth’s friendly takeover of Colonial (itself a bancassurer) and National Australia Bank’s friendly takeover of fund manager MLC. Clearly, banks are evolving into providers of all financial services.

The mortgage lending market

The mortgage lending market is perhaps the most competitive market. Of the home-grown mortgage wholesalers, Sovereign Financial Services continues to grow as part of the ASB Group, but the mortgage book of AMP/ERGO Mortgage and Savings Limited has now been assumed by AMP Banking.

Overall, mortgage brokers continue to grow in popularity, primarily because they are seen as independent, professional, reputable, friendly and approachable.

As competition bites the banks have looked to sell additional products, particularly insurance, to compensate for the loss in interest and fee income.

There are 29 different mortgage providers quoted in the New Zealand Herald each week, so financial service providers have had to turn to greater product innovation to maintain and grow market share. There are currently two prime examples: Bank of New Zealand’s GlobalPlus Home Loan and ASB Bank’s low variable rate mortgage which charges monthly fees.

Treasury activities

We have analysed the disclosure statements of the registered banks to compare their on and off balance sheet treasury activity. The analysis indicates that six banks have significant treasury activities.

The main trends show that all of the six banks, except BNZ, have experienced a fall in trading gains compared to 1998. The largest single reason for this is the replacement of the Monetary Conditions Index with the Official Cash Rate as the Reserve Bank’s mechanism for implementing monetary policy, in March 1999.

The introduction of the OCR has significantly reduced the volatility in short term interest rates, reducing trading opportunities and customer volumes.

It would not be wise to draw too many conclusions from these figures, particularly as they are at a certain point in time and may not be indicative of overall activity.

However they do confirm:

 the relatively small market in New Zealand

 that there are only six registered banks that could be considered “market-makers” in foreign exchange and five that could be considered “market-makers” in interest rate contracts

 WestpacTrust and BNZ have the greatest volume of foreign exchange related contracts

 ANZ has become the most active bank in trading currency options and

 foreign exchange forwards and interest rate swaps are clearly the highest volume products in their respective categories of foreign exchange and interest rate products.

Funds Management

We have again surveyed the funds management activities of registered banks. However, we have been unable to distinguish between wholesale and retail funds management. The key information we have sought to obtain is the scale of activity and therefore an indication of the contribution this activity makes to the banks’ financial performance.

Of most significance was the sale of BT Funds Management to The Principal Financial Group following Deutsche Bank’s takeover of Bankers Trust during 1999. This moved $2.1 billion of funds out of the total for the bank sector, compounded by Citibank’s decision to move out of NZ$ managed funds as the Group’s fund management operations were centralised in Melbourne.

Offsetting this was strong growth in funds under management recorded by ANZ Bank, ASB Bank, Bank of New Zealand and Westpac Trust.

Interest Margins

The management of interest margins is a key driver of bank profitability and average interest margin across the registered banks has fallen for the fourth straight year. All of the major banks experienced decreased margins in 1999 except the National Bank.

The continuing decline is the result of the intensely competitive banking environment. Banks have been competing aggressively for new business while being forced to keep deposit rates at levels attractive to depositors. This combination has kept the squeeze on overall interest margins.

1999 was a year of low and very stable interest rates. Since interest rates are now rising, it will be interesting to see to what extent banks will be able to pass on increased funding costs to borrowers and the impact that this will have on margins reported in 2000.

Electronic Banking

Technology continues to attract an increasing amount of investment and is changing the way banks operate and the way they interact with their customers. EFTPOS, ATMs and telephone banking are well-entrenched and Internet banking is now becoming a focus for the major banks.

EFTPOS transaction volumes first surpassed cheques and paper deposits in 1997. The total number of EFTPOS transactions carried out in 1999 reached 450.3 million, up from 401.3 million in 1998.

While the number of available ATM machines increased last year, the volume of ATM transactions remained almost identical to that recorded in 1998, down from the peak year of 1997. WestpacTrust’s decision to impose fees on customers who use competitor’s machines has been followed by ANZ and if other banks adopt this fee, ATM transactions may be inhibited.

Telephone banking is increasingly popular for routine transactions. Banks report that between 20 and 50 percent of their retail customers now use phone banking services and we expect this to increase.

As we have predicted in previous Surveys, Internet banking is beginning to make some headway. ANZ, BNZ and National have all joined market leaders, ASB in offering Internet banking servies. WestpacTrust is trialling its Internet service and is expected to go to a full launch shortly.

Currently a relatively low proportion of banks’ retail customers currently use this service, but as more than 50 percent of New Zealanders have access to the Internet, the potential is obvious. As New Zealanders become more comfortable with the concept of Internet banking, its use is likely to grow rapidly.

Current numbers of Internet banking customers reported by the major banks are set out below:

ANZ Bank 26,985
ASB Bank 52,000
Bank of New Zealand 17,500
The National Bank 22,500
Total 118,985

Branch Network

The role of the branch network has been under challenge from ATMs, telephone banking, EFTPOS, mobile banking officers and Internet banking.

As a result, the branch networks continue to shrink. Since 1993, 676 branches have closed. In 1999, the total number of bank branches decreased by 12 percent, compared to a 10 percent decrease in 1998. The largest decrease in branch numbers was recorded by the National Bank which closed 61 branches as it continues to rationalise its branch network following the acquisition of Countrywide Bank in 1998.

WestpacTrust closed 45 branches but still maintains the largest branch network in New Zealand with 225 branches.

In contrast, the number of ATMs in New Zealand continues to grow. WestpacTrust added an additional 74 machines this year. This brings their total to 485, the largest ATM Network. ANZ has the second largest ATM Network with 353 machines. BNZ added 10 new machines this year, but still has the smallest ATM network of the major banks.

As branch numbers fall, staff numbers continue to decrease, though the rate of decline has slowed from the previous year. Total staff numbers fell by 4.7 percent in 1999, compared to a 7.6 percent decrease in 1998.

While technology-based channels may be more effective in meeting customers’ routine banking needs, there is still a high value placed on quality financial advice and personal service.

The traditional bank branch changed little throughout the 20th century, but in future, we expect banks to package their branches as “financial stores” offering the personal service that customers continue to expect from banks. Innovative use of the branch network is one means banks may use to differentiate themselves from the competition.

Finance Companies

This year’s survey included 24 finance companies, compared to 19 in last year’s survey. All of the 19 from last year are analysed again this year except Primus Financial Services Limited (formerly Ford Motor Credit Company) for which information was not available. In addition, six companies have been added to the survey. They are Farmers Mutual Finance, Frontline Finance Holdings, ORIX New Zealand, Pacific Retail Finance, Scottish Pacific Business Finance and S.H. Lock (NZ).

Lending activity in this sector grew for the first time since 1996. This was further evidence of the recovery of the New Zealand economy as economic activity rebounded from the mild recession experienced in 1998.

Despite the significant increase in total assets, growth in industry profitability was only 3.6 percent based on mixed results. The following factors impacted industry profitability in 1999:

 falling interest margins for the majority of companies
 increasing costs
 increasing impaired asset expense and
 increasing diversification of income streams.

Savings Institutions

The same eight savings institutions that were included in last year’s survey were again included this year. This group consists entirely of building and investment societies which are predominately focussed on a local region, providing housing mortgages and personal lending funded by retail deposits.

Total assets in this sector grew for the fourth year in succession, but at 5.2%, the rate was the lowest achieved in the last four years. At 9.1%, growth in underlying lending was higher than the growth rate for total assets

Sector profitability was down 20.1% in 1999, almost entirely due to non-recurring gains recorded by the PSIS in 1998. Efficiency measures remained at levels similar to those reported last year.

Performance Analysis

As in previous years, we have presented eight measures against which we have ranked the banks, finance companies and savings institutions. We have also presented an overall ranking of the major banks, though it is worth noting that this simple ranking doesn’t necessarily give a perspective of how close the banks are to each other.

Registered Banks

1999 was a year of record profitability for New Zealand’s registered banks. Continuing the trend of recent years, solid asset growth was also maintained.

While operating income for the sector increased by 6%, operating expenses only increased by 2%. As a result the sector’s cost-income ratio has fallen from 62% to 57%. Such a large decrease points to the effectiveness of the banks’ cost reduction and efficiency programmes.

As a sector the registered banks recorded a 10% improvement in underlying performance.

Net interest income for the sector increased by $170 million despite an overall contraction in the weighted average interest margin of 13 basis points. The weighted average interest margin of 2.45% is at the lowest level since we began tracking interest margins in the Survey and is evidence of the highly competitive market in which New Zealand banks operate.

The decline in the interest margins continues the trend of the last four years. The registered banks have acknowledged that the pressure on interest margins means there is less ability to subsidise the cost of other services provided to the banks’ customers. Accordingly we might expect that lower interest margins will be accompanied by higher fees to recover the cost of the services provided.

However, this trend is not evident from the sector totals for Net Interest Income and Other Income. The ratio of Net Interest Income to Other Income has been steady at 63:37 for the last two years. As noted above, interest margins have fallen 13 basis points year on year. Therefore it has been the growth in interest earning assets that has preserved the relative contribution of Net Interest Income to Operating Income.

As in previous years we have sought to benchmark the performance of New Zealand’s major banks against the four largest Australian banks utilising the key measures used in our performance rankings.
Both Australian and New Zealand banks reported increased profitability in 1999. Total net profit after tax for the Australian majors was up 31%, however, the New Zealand banks, whose combined profits were up 35%, surpassed this result. As in previous years, both sets of banks achieved the same return on total assets, up from 0.9% in 1998 to 1.1% in 1999. The ratio of net interest income to total assets was also very similar. However, the return on net assets of the New Zealand banks (24.5%) remained superior to their Australian counterparts (17.3%).

BNZ regains the top ranking this year after being displaced by WestpacTrust in 1998, although the gap between the two is small. ANZ improves one place to third and National Bank is fourth. ASB has fallen to fifth place after placing third in the past two years.

Branch Banks

New Zealand’s branch banks were successful in lifting their profitability during 1999.

Following its acquisition of Bankers Trust, Deutsche Bank has become the largest branch bank operating in New Zealand, excluding WestpacTrust. The Hongkong and Shanghai Banking Corporation is now second, with AMP Bank now the third largest branch bank in New Zealand.

In general, performance was strong across the branch banks and most achieved significant asset growth.

Finance Companies

The four largest finance companies remain the same as last year’s rankings, with UDC still the largest. Motor Trade Finances was again the most profitable finance company and has also achieved the second lowest ratio of operating expenses to operating income.

Of the 24 finance companies surveyed, 15 achieved higher net profits in 1999, while nine saw their profits decrease. Overall, the industry-wide ratios of net profit to average total and net assets declined slightly in 1999.

Savings Institutions

Savings institutions remain dominated by Southland Building Society, Public Sector Investment Society and Southern Cross Building Society, who together account for 82.5 percent of total savings institutions assets.

Outlook

It is expected that economic growth will continue to rise during 2000 before easing slightly over the following two years. However, business confidence sagged in the March 2000 quarter. The proportion of firms expecting an improvement in the general business situation in New Zealand during the next six months was only slightly higher than the proportion expecting a deterioration. The manufacturing and merchant sectors remain positive about the future, but the building and service sectors have become pessimistic.

Despite the fall in overall confidence, firms are positive about their own performance. Trading activity is expected to lift again in the coming quarter following a strong increase from December 1999. This expectation is underpinned by the outlook for exports, given the low level of the New Zealand dollar. In the first quarter of the year manufacturers reported strong growth in exports and expect similar growth in the next quarter.

The Reserve Bank has signalled an intention to continue tightening monetary policy through interest rate rises. Accordingly, with the expectation of higher interest rates over the next 12 months together with the higher costs from imported goods, business confidence has fallen. However, business recovery will continue over the next 12 months driven by strong export growth.

Accordingly, the prospect exists for further asset growth for New Zealand’s financial institutions during 2000.

One constraint in maintaining the exceptional asset growth New Zealand’s financial institutions have experienced over the last five years is individual borrowers’ ability to take on more debt. A key statistic that can be used to measure an economy’s capacity for more debt is the ratio of household debt to disposable income. Since December 1996 New Zealand’s ratio has deteriorated from 84.3% to 100.0% for the quarter ended 30 September 1999. At 100.0% New Zealand now has a very similar ratio to the United States which is seen as having relatively high debt levels per household. Accordingly, if economic growth leads to further asset growth, economists would be concerned if there is no commensurate increase in disposable income.

The forecast increase in interest rates as the Reserve Bank implements monetary policy through the mechanism of the Official Cash Rate may provide an opportunity for an improvement in banks’ earnings (due to the increased return on free funds).

However, the financial sector continues to be extremely competitive as evidenced by the increasing number of participants particularly in the non-bank sector and the further contraction in interest margins. Whether the growth in lending assets will be sufficient to offset any further fall in margins will ultimately be dependent upon business and consumer confidence.

As noted last year we believe that there will continue to be a greater emphasis on fee generated income given the industry’s desire to appropriately price for services delivered. Operating costs have continued to fall and the industry is now experiencing the benefits of a permanent reduction in costs. Whether further costs can be driven out of the sector will to a large degree depend on future technology investments, not only to enhance revenue but also to bring further efficiencies.

The New Zealand market continues to be subject to change. The Australian Federal Government has steadfastly refused to release its “four pillars” policy thus preventing any one of the four major Australian banks to takeover or merge with one of the other three. This, however, has not prevented Commonwealth Bank of Australia’s friendly takeover of Colonial, which will have some impact on the New Zealand market. It is when the Australian policy on bank mergers is relaxed that the impact on the New Zealand major banks will be significant.

Undoubtedly, 2000 will be another year of challenges and change for New Zealand’s financial institutions.

Contacts


For further information please contact:

KPMG

Andrew Dinsdale, Wellington
Email adinsdale@kpmg.co.nz
Phone (04) 802-1214
Godfrey Boyce, Wellington
Email gboyce@kpmg.co.nz
Phone (04) 802 1278

Jan Dawson, Auckland
Email jadawson@kpmg.co.nz
Phone (09) 367 5820


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