High dairy sector debt a worry: banks

DAIRY HERD: The national dairy herd increased at a much slower rate in the year to June than in the preceding two years.

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High debt levels in the New Zealand dairy industry remain one of the greatest concerns for the banking sector, despite historically high prices for agricultural exports and a dramatic slowdown in lending to the rural sector in 2010, says KPMG.

While some farmers are enjoying a profit bounceback, "a number are only keeping up with interest and principal payments, as a result of being highly leveraged from growth through the boom of 2006 to 2008," the accounting firm says in its latest Financial Institutions Performance Survey

The Reserve Bank of New Zealand's proposal to impose a new "capital overlay" requirement on banks lending to farms would "ultimately increase lending costs for farmers and act as a brake on growth in the rural economy, one of the central planks to economic growth in an otherwise uncertain economic landscape," the report says.

KPMG says some of the "big five" banks drew back from rural lending over 2010, reflecting these concerns.

Specialist agricultural lender Rabobank stepping into the breach, although its lending growth was low by recent standards, and total rural sector debt was stable at around $47 billion, after double digit growth for most of the last decade.

In the meantime, banks are "managing their distressed rural assets rather than forcing a sale because of lessons learned during previous recessions, when individual banks lost market share, and the on-the-ground reality of a depressed rural property market.

The same approach is apparent across the whole of the banks' lending, with gross impaired debt and past due assets leaping from under $2 billion in 2008 to more than $6 billion in 2010, while total provisioning for both classes of loans fell over the period, reflecting expectations of economic recovery.

"Within gross impaired loans, ANZ has the largest book of non-performing loans, of just over $2 billion, representing 43 per cent of the sector's $4.8 billion liability," said KPMG, while a rise in bad debts at Deutsche Bank of $76 million put 44 per cent of its book in the non-performing category.

However, ANZ also showed the strongest margin growth in net interest margins among the major banks, in a year when a deposit interest rate "war" saw most banks shave margins in pursuit of local funds to shore up their capital adequacy ratios, as required by the RBNZ after the global financial crisis.

ANZ gained 9 basis points on net interest margins, climbing to 2.43 per cent last year, followed by ASB, which grew margins by 4 basis points to 1.68 per cent.

Most out of the money was Kiwibank, which lost 69 basis points on its net interest margins, which stood at a "slim" 1.19 per cent in 2010. 

Kiwibank was ahead of the market for a significant portion of 2010, offering higher than average deposit rates, according to the KPMG report. 

Kiwibank also continued to maintain a much higher cost base than other bank, with a cost-to-income ratio of 71.1 per cent, against a sector average of 45.7 per cent.

A combination of higher regulatory compliance needs, more active management of under-performing loans and a greater marketing effort for managed funds and deposit products also saw the sector add 849 jobs during 2010.

The banking sector as a whole also experienced a major bounceback in collective profitability, with return on equity jumping from 1.3 per cent in 2009 to 13.3 per cent in 2010.

The 2009 result had a double whammy from the global and local recessions, and the $2.2 billion settlement of tax avoidance cases.

Many banks were now restoring margins on lending to close to historical levels by clawing back margin as borrowers swap from mainly fixed interest rate mortgages to floating rates.

Commenting on the decimated finance company sector, KPMG said it believed finance companies seeking retail deposits would need financial assets of at least $100 million in the future, if they were to meet new regulatory, capital adequacy, and market competition requirements.

- BusinessDesk