Commercial banks face formidable challenges

But positive signals energise prospects

A PricewaterhouseCoopers Analysis

New Zealand’s five major banks reported core earnings of $3480 million in the first half of their 2015 financial years (1H15), up from $3281 million for the previous six months (2H14). This was driven by increases in net interest income (up by $184 million) and a reduction in operating expenses (down by $49 million), while other operating income decreased by $34 million.

Following an increase in bad debt expenses (up by $54 million), profit before tax was up 5% (or $145 million) to $3299 million and profit after tax was up 4% (or $92 million) to $2372 million.

Strong performance

For Web-Commerical banks face- Profits GraphThe results show another strong performance by our major banks on the back of good lending growth to both the household and non-household sectors.

The lift in lending by circa $10 billion over the past six months, combined with the $7 billion for six months earlier has generated the lift in net interest income growth of around $184 million.

The demand for credit over this twelve month period has been very strong when compared to recent times. The reduction in operating expenses also aided the lift in profitability for the period.

Higher costs

However, this was more a story of higher costs in 2H14 due to one-off charges.

Interestingly, the banks’ operating expenses for the first half of their 2015 financial years was up against the comparable period twelve months ago.

The previous positive lift in other operating income has now slightly reversed which reflects our comments in our previous report – this is a quality income story but more reflective of gains and losses being recognised on financial instruments held at fair value.

As we have previously said, this is effectively a zero-sum game from period-to-period and the swings in the fair value of financial instruments have contributed to the earnings volatility of our major banks.

Bad debts cost

For Web-Commerical banks face-Income TableOne continuing trend from six months ago is further bad debt expenses being recognised when compared to the previous six months.

When looking at the underlying asset quality of the lending portfolios, there has been a gradual deterioration in stressed loans as well as those assets that are 90-days past due (an early indicator for stressed loans). Looking forward, it will be a question of whether this performance can be sustained.

The strong economic conditions experienced over the past two years are predicted to slow in the short to medium term, but nevertheless comparably positive on a global scale. This combined with a hot property market in Auckland and difficult trading conditions for our rural community and those that service it, we are about to embark on an interesting journey.

OCR Changes

This journey will be further enhanced by forecasted changes to the official cash rate (OCR) which will be of some benefit to New Zealand borrowers but, equally, it will be of little comfort to depositors should they experience falling deposit rates.

This, combined with volatility in the wholesale funding markets means the lending market will remain competitive but the inherent value of customer deposits will remain.

The technology race will continue to evolve. It is a game changer to the global banking sector which, if harnessed correctly, will drive better customer experiences and outcomes.

Fin Tech explosion

This evolving technological world has already resulted in the explosion of financial technology (FinTech) entities in various regions around the world. It also means a global bank could potentially enter our local market without the need to invest in bricks and mortar.

Instead, a global bank could leverage its brand and establish a presence through an online branch targeting a niche segment of our market.

Long Term impact

Against the backdrop of technological enhancement, while any possible changes to the market will not be extensive in the short-term, it will have an impact across the New Zealand market in the longer term.

In any sector or organisation, technology can be seen as a challenging disruptor or viewed as the key to unlock future value. From the perspective of New Zealand’s major banks, which side of coin will be face up when this finally lands?

When looking at the underlying asset quality of the lending portfolios, there has been a gradual deterioration in stressed loans as well as those assets that are 90-days past due.

This Analysis has focused on the performance of major banks (ANZ Bank New Zealand, ASB, Bank of New Zealand, Kiwibank and Westpac) performance for the first half of their 2015 financial years with reference to the previous six months.

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