Local banks stand firm despite chaos

Fairfax

BANKS FIRM: Local investors, already gun-shy from the failure of a succession of finance companies, are now asking a question unthinkable just last year: could the big local banks fail?

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New Zealand depositors tracking the sharemarket fortunes of their banks' Australian owners can be forgiven for feeling a little edgy.

Over a few trading days last week National Australia Bank shed an astonishing 22 percent of its market capitalisation.

Shares in NAB, which owns the Bank of New Zealand, have plunged 56 percent from their recent peak. Australia and New Zealand Banking Group shares have more than halved while Commonwealth Bank Group (which owns ASB) and Westpac have fallen 36 percent and 30 percent respectively.

Local investors, already  gun-shy from the failure of a succession of finance companies, are now asking a question unthinkable just last year: could the big local banks fail?

Well, nothing's entirely without risk, say local experts and regulators, not even government bonds. But it's not time to start stuffing banknotes under the mattress just yet.

The punishment meted out to NAB and ANZ was mostly because of their exposure to US instruments linked to the US sub-prime mortgage market.

Citigroup estimates NAB will have to write down between A$500 million and A$1 billion of its A$15b in “conduit assets”.

ANZ has US$11.6b in credit default swaps, Citi reports, and is at substantial risk of having to declare a proportion of these assets impaired.

But these provisions are small change relative to the banks' size and overall asset quality. Both Reserve Bank governor Alan Bollard and his Australian counterpart, Glenn Stevens, have moved quickly to reassure the market the big banks are safe.

Stevens has pumped in A$3b  or yards, the term preferred by currency traders to differentiate billions from millions  into the settlement system. Bollard has so far had only to ease liquidity measures so the banks' New Zealand subsidiaries can more easily access that scarce commodity, cash.

The banks' plummeting share prices,  which suggest the market doesn't share the central bankers' comfort level, don't in themselves spell trouble.

David Tripe, head of banking studies at Massey University, says they will  become an issue only if one or several of the banks has to recapitalise, that is, go to the markets for more shareholder capital.

But ANZ et al don't need to recapitalise yet as their exposure to sub-prime assets is comparatively tiny and the books are in good health: total assets across the four are A$1.6 trillion and combined shareholders' funds are A$92b.

"Even if they were to lose A$10b  and there's no indication they're going to lose anything like that  it still won't cause any alarm," Tripe contends.

Credit ratings agencies Standard & Poor's and Moody's have reaffirmed the four's AA ratings and say the banks are well-placed to withstand the crisis.

Kiwibank chief executive Sam Knowles says the New Zealand and Australian banks aren't incentivised by byzantine tax systems to invest heavily in complex financial structures.

CDOs (collateralised debt obligations), CLOs (collateralised loan obligations) and the like always “have a tax component, particularly where you've got an ability to defer tax through timing and take the benefit of that,” Knowles said.

“It's largely thanks to the tax reforms of the 1980s and the learnings from the late 1980s [when BNZ went to the wall] that we haven't got these problems.”

But there's a fear the Australian parents will lean on their subsidiaries to bolster balance sheets hit by the global financial crisis. What would happen in the unlikely event an entity like ANZ fell over?

The assets of the New Zealand subsidiary are ring-fenced, Knowles reassures, and “New Zealand has some of the strictest rules in world” regarding debt to equity ratios.

“It effectively forces us to keep more capital against loans,” he said of the Reserve Bank's “most conservative” interpretation of Basel II, the international banking rules governing the amount of capital banks must hold.

Theoretically, Tripe added, these assets are ring-fenced. “But I'm not sure how things would work out in reality.

The subsidiaries owe substantial debt to their parents, he said, and “if one is placed in liquidation it will make demands on the New Zealand entity”.

Ring-fencing notwithstanding there's always a way to squirrel profits offshore, Tripe said.

But whether it could be done on a large scale was debatable: “They could probably rape and pillage but it's not in their best interests to do so.”

Knowles agreed: “Their best piece of asset is in New Zealand. I think it's remarkably robust,” he said of the trans-Tasman banking system.

“The banks learnt from the problems of the 1980s and haven't moved into highly leveraged lending.”

The biggest risk, he said, was the flow-on impact of the unravelling American financial sector on global economic growth.

That is a question, he added, that will not be answered until next year.

- © Fairfax NZ News