Sustained profits under pressure
Sustained profits under pressure from lending margins contracting and slower loan growth
New Zealand’s five major banks (ANZ, ASB, BNZ, Kiwibank and Westpac) net profit before tax has increased to $1,696 million during the third quarter of the 2015 calendar year (being 1 July 2015 to 30 September 2015, 3Q2015), however net interest margins have continued to decrease and lending growth is slowing down.
Net profit before tax has slightly increased by $11 million compared to the second quarter of 2015 to $1,696 million. Underneath this headline, there are some curious movements which may suggest this sustained period of earnings may be difficult to maintain.
Comparing to the second quarter of 2015, net interest income has increased by $20 million (0.9%) while impairment losses on loans have increased by $29 million (39.7%). However other operating income has increased by $94 million (13.4%) and operating expenses have increased by $74 million (6.9%) principally due to a one-off reclassification by a bank (between these items) during the second quarter of 2015. When normalising the impact of this reclassification, other operating income has increased by $28 million (3.7%) while operating expenses have increased by $8 million (0.7%).
The competitive lending environment we witnessed during the first two quarters of the 2015 calendar year has intensified into 3Q2015, with record low interest rates being offered by the banks to win market share, therefore straining lending margins with more customers moving to lower margin fixed rate mortgages. The banks’ net interest margin for 3Q2015 has decreased to 2.23% (from 2.26% in 2Q2015). This decrease has been driven by a fall in asset margins with interest income from average interest earning assets decreasing from 5.72% in 2Q2015 to 5.51% in 3Q2015. This has been partially cushioned by a fall in borrowing costs with interest expense on average interest bearing liabilities falling from 3.93% in 2Q2015 to 3.71% in 3Q2015 reflecting favourable funding conditions experienced by the banks.
With the pressure on net interest margins, net interest income growth was primarily driven by a fall in interest expense which has decreased by $108 million (3.3%) to $3.2 billion, driven by favourable funding conditions. Interest income has decreased by $88 million (1.6%) to $5.3 billion for the quarter despite growth in gross lending of $5.8 billion (1.7%) during 3Q2015 to $341 billion, with the impact of lower asset margins hitting the banks’ results greater than the increase in lending volumes.
On a normalised basis, other operating income has increased by $28 million to $793 million due to volatility in the gains/losses on financial instruments recognised at fair value for each individual bank. On a normalised basis, operating expenses have remained relatively constant, with a small increase compared to 2Q2015 by $8 million to $1.1 billion. With net interest margins under pressure, maintaining current profit levels may be through control of operating expenses by tightening expenditure on manual operations as the banks move to an increased focus on value-added digital technology with the efficiency gains and innovation these bring.
Impaired asset expenses (or bad debt expenses) have increased by $29 million to $102 million in 3Q2015 compared to $73 million in 2Q2015.
Lending growth is lower than the previous two quarters, up 1.73% in the third quarter of 2015 (up 2.27% in the second quarter of 2015). Total lending has increased to $340.5 billion in 3Q2015, compared to $334.7 billion at the end of the previous quarter. This slowdown has been predominantly driven by slower corporate lending growth which increased by 1.65% during 3Q2015 to $125.7 billion compared to 3.02% growth during 2Q2015. 3Q2015 is the lowest percentage growth in corporate lending in the last five quarters.
Interestingly, mortgage lending growth for the quarter was 1.94%, up from the previous quarter growth of 1.85% despite market speculation that the Auckland property market is cooling down. This is the first quarter since 1Q2014 where mortgage growth in percentage terms was higher than corporate lending growth. Total mortgage lending at the end of 3Q2015 is $201.2 billion, up from $197.3 billion at 2Q2015. With the new lending restrictions in place from 1 November 2015, it will be interesting to see how the next quarters growth pans out. This growth has been driven by the attractive record low short term fixed interest rates. Other retail lending remains largely static at about $13.6 billion.
The percentage of mortgages with an LVR in excess of 80% has continued to fall and is now at 12.9% of total mortgage lending in 3Q2015, compared to 13.8% of total mortgage lending in 2Q2015. The RBNZ has implemented new LVR restrictions which came into force on 1 November 2015 aimed at slowing the hot Auckland property market whilst easing restrictions for mortgage borrowers outside of Auckland where prices are not so heated.
During 3Q2015, the OCR was cut twice by the RBNZ from 3.25% at end of 2Q2015 to 2.75%. As a result, we are now seeing new record low short term rates in the low 4%s. Customers on floating rates are stable at 25.0% at the end of 3Q2015 as compared to 25.3% in 2Q2015. Customers with fixed rates maturing within the next two years have increased from 61.0% in 2Q2015 to 63.4% at the end of 3Q2015.
The stable level of customers on floating rates may be due to mortgage holders holding out for further interest rate cuts before fixing, as there was market speculation of further OCR cuts at the end of 3Q2015 which have eventuated with the OCR cut by a further 0.25% to 2.5% on 10 December 2015. We have observed further switching during the month of October 2015 for customers from floating rates to short term fixed rates, with customers on floating rates down to 24.8% and customers with fixed rates up to two years up to 64.1%.
Customer preference for fixed rate mortgages with terms above two years has continued to be less attractive to customers, falling from 13.6% in 2Q2015 to 11.5% in 3Q2015. The banks’ long term interest rates are influenced by the wholesale funding market and with the US Federal Reserve raising key interest rates by 0.25% (their first time rate hike since 2006) on 16 December 2015, this may increase the banks’ wholesale funding costs which could ultimately lead to higher lending interest rates.
Overall credit quality appears to be improving despite concerns over loans to the dairy sector, with total credit provisioning decreasing by $56 million since 2Q2015 to $1.8 billion at 3Q2015. This decrease has been driven by a fall in individually assessed provisions which have declined by $107 million or 19.8% since 2Q2015 to $433 million at 3Q2015. This has been partially offset by an increase in collectively assessed provisions of $51 million or 3.8% to $1.4 billion in 3Q2015.
Impaired assets have decreased during the quarter by $168 million or 11.3% to $1.3 billion at 3Q2015, following the decrease in individually assessed provisions. This decrease will be due to the work out of impaired assets during the third quarter of 2015, or write-off/release of individual provisions for impaired loans raised previously for certain large single named exposures for corporate loans. 90 day past due assets (not impaired) have decreased by $31 million or 4.9% to $597 million at 3Q2015.
Retail deposits grew by $5.7 billion or 2.4% since 2Q2015 to $247 billion, in line with the rise in gross lending during the same period of $5.8 billion.
The banks continue to be well above regulatory minimums for capital levels, with average total capital ratio hovering at 12.9% at 3Q2015, up from 12.5% in 2Q2015. The RBNZ has implemented the new asset class treatment for residential property investors that came into effect on 1 November 2015, which may partially reduce the current capital adequacy headroom.
Basic leverage ratio (eligible capital to total assets) increased from 6.94% at 2Q2015 to 7.25% at 3Q2015 which reflects the increase in eligible capital during the quarter.