Analysis: Bank profits on interest rates are falling, not rising

Posted in News April 16, 2009 - 12:00pm, Bernard Hickey

By Bernard Hickey It is the biggest free kick in New Zealand's political and business scene right now. Everyone is kicking the big four Australian-owned banks because, it's assumed, they're profiteering on interest rates at the expense of farmers, homeowners, small businesses and big businesses. The big four are padding their profits by not passing on rate cuts, the argument goes. The other assumption is that the only 'good' bank is Kiwibank, which has sacrificed profits by cutting interest rates. The trouble is the free kickers are wrong on both counts. Our analysis of bank General Disclosure Statements (GDS) to the end of December show the net interest margins earned by the big four fell fast in the second half of 2008. Banks actually sacrificed NZ$396 million of profit from interest rates or 12 basis points on total assets of NZ$329.5 billion. Surprisingly, the big four's bank fees also fell, both in total and as a percentage of assets. The only reason bottom line profits didn't fall as much is the big four banks stripped out around 8 basis points or NZ$250 million of costs in the second half of 2008. Our analysis also shows Kiwibank had the highest net interest margin in the second half of 2008 and was the only bank not to see a contraction in its margin. The only thing making its net profit look less buoyant than the big four is that its operating costs (salaries, rents, advertising) are more than double those of its big four competitors as a proportion of total assets. These figures don't take into account what has happened in the last 3 months and it's possible the latest moves have reversed the falling profits, but it's unlikely given the sheer size of the bank balance sheets and the fact that the cost of the NZ$100 billion or so of foreign debt is just as high as it was late last year. So it's a little surprising that all and sundry are lining up to take the free kick. Federated Farmers has accused the banks of "profit gouging", Reserve Bank Governor Alan Bollard has called on banks to 'play their part' in passing on lower interest rates and Finance Minister Bill English has told banks to accept lower profits because they are guaranteed by the government. It turns out the big four have already done what Bollard and English asked of them. The assumption is that banks have not passed on cuts in the Official Cash Rate to borrowers and have cut term deposit rates much deeper than they needed to, thus widening their interest rate margins to more than offset expected increases in bad debts. Many customers, unions and consumer advocates are also angry at big fees to break fixed rate mortgages. Again, the kneejerk reaction is to say banks are gouging profits and turning down loan requests at a time when businesses and homeowners need lower interest costs and savers need higher term deposit rates. But are these assumption true?

A quick look at some data collected from the Reserve Bank seemed to suggest they were. These first two charts were ominous. This Reserve Bank sourced 'Bank funding spread' chart (above left) going back to 1990 shows the average difference between the funding costs the banks pay and the interest they receive has spiked up in the last year. However, this data has a major flaw. It doesn't take into account the foreign funding costs faced by the banks. The Credit Crunch has increased these costs by anything from 150-250 basis points, say the banks. Cross checking these claims is difficult. Another way to look at what banks are paying versus what they are charging for interest rates is to look at the premium between the variable mortgage rate and the 90 day bill rate. That also shows margins apparently rising, but again it doesn't take into account the higher funding costs from around NZ$100 billion of foreign funding. Follow the money The best way to understand what is happening to interest margins and bank profits is to look at their General Disclosure Statements, which detail their net interest income, expenses, fee incomes, bad debt charges and ultimately, net profit. The key number is net interest income, which nets off all interest receipts and all interest payments. This effectively calculates the profit from interest on mortgages, credit cards, business loans and consumer loans minus the cost of everything in funding melting pot, including term deposits, long bonds, interbank funding locally and foreign short term funding. Simply looking at the bottom line net profit numbers is misleading because they include all sorts of factors, including non-interest fee income, trading gains, cost reductions, bad debt charges and tax changes. It's also best to compare Apples with Apples by measuring everything as a percentage of assets to make sure the numbers aren't skewed by size. It's worth going through the banks one by one so readers can understand where we got the numbers from and to see how your bank is doing. ASB's net interest margin down 15% (13 bps) ASB reported in its results for the six months to December 31 in its GDS, that its net interest income fell to NZ$483 million from NZ$494 million, which meant its net interest as a percentage of assets fell 15% to 74 basis points from 87.2 basis points in the same period a year ago. This is no doubt why CBA CEO Ralph Norris, who is very familiar with the mortgage market here, said in February that he saw more rational pricing soon in the New Zealand market. If ASB had maintained its 2007 net interest margins in 2008 on its NZ$65.343 billion of assets it would have booked a NZ$568 million profit, rather than the NZ$483 million profit it did book, implying a profit reduction for the six months of NZ$85 million because of those lower margins. This wasn't the end of the story for ASB. Its bad debt charges rose to NZ$67 million from NZ$5 million in the previous comparable half year. Operating expenses (salaries, rents, advertising) also rose to NZ$336 million from NZ$296 million, offsetting some of the increase in 'other income' (fees and trading gains) to NZ$244 million from NZ$189 million. The end result was that ASB's net profit fell to NZ$238 million from NZ$267 million. Hard to call that gouging. ASB's Key Information Summary (KIS) showed its net profit as a percentage of total assets fell to 0.8% in the year to December 31 from 1.0% the previous year. Westpac's net interest margin down 8% (4.7 bps) Westpac reported in its results for the three months to December 31 in its GDS that its net interest income rose to NZ$307 million from NZ$285 million in the same period a year ago, but its net interest margin as a percentage of total assets of NZ$55.951 billion fell 8% to 54 basis points from 58.7 basis points. If Westpac had maintained its 2007 margins in 2008 it would have made a NZ$328 million net interest margin, implying a profit reduction of NZ$21.4 million because of those lower margins. This isn't strictly comparable with the ASB profit sacrifice because it is for 3 months rather than 6 months. One crude measure would be to double Westpac's number to NZ$42.8 million. Westpac, however, managed to claw back some of the pain by keeping its costs under control and picking up some extra money from hedging gains. Income from fees and other trading gains rose to NZ$119 million from NZ$88 million. All of that came from hedging gains. Fees and commissions actually fell to NZ$88 million from NZ$89 million. Bad debt charges rose to NZ$91 million from NZ$22 million, while operating expenses fell to NZ$169 million or 30 basis points as a proportion of total assets from NZ$171 million or 35 basis points. The end result was that net profit fell to NZ$115 million from NZ$119 million. Doesn't look like gouging to me. The net profit as a percentage of assets in the year to December 31 was 1.1%, unchanged from the previous year, Westpac's KIS shows. ANZ National's net interest margin down 13% (7 bps) ANZ National reported in its results for the three months to December 31 in its GDS that its net interest income rose to NZ$601 million from NZ$570 million, but that its net interest to assets fell to 45 basis points from 52 basis points because of a jump in its assets over the period to NZ$132.127 billion from NZ$109.468 billion. If ANZ National had maintained its 2007 profit margin in 2008 then it would have made NZ$687 million, not the NZ$601 million it booked, implying a profit sacrifice of NZ$86 million. Again crudely, to make it comparative to the ASB 6 month result, this would imply NZ$172 million of lost profit in the second half of 2008. ANZ National's results actually got worse after it took into account bad debt charges tripled to NZ$94 million and other operating income, which includes fees, halved to NZ$93 million. Expenses also rose to NZ$380 million from NZ$350 million, although expenses as a percentage of assets dropped to 29 basis points from 32 basis points because of the 21% rise in assets. The net result was an after tax profit for the three months of NZ$210 million, down from NZ$310 million in the same period a year ago. Doesn't look like gouging to me. ANZ National's net profit as a percentage of assets for the 3 months to December 31 fell to 0.9% from 1.1% a year ago, ANZ National's KIS shows. BNZ net interest margin down 10% (6 bps) BNZ reported in its results for the three months to December 31 in its GDS that its net interest income rose to NZ$385 million from NZ$337 million a year ago. But once the 28% increase in its assets to NZ$76.086 billion is taken into account, that meant its net interest/assets fell 10% to 51 basis points from 57 basis points a year ago. Applying that 2007 margin to its assets at the end of December 2008 meant it would have made net interest income of NZ$433 million rather than the NZ$385 million it did make. Again using the crude method, this suggests profits sacrificed in the second half of 2008 was NZ$96 million. Like Westpac, BNZ managed to make up for the interest margin losses in other areas. Its other operating income, including fees, rose to NZ$100 million from NZ$96 million. Gains on financial trading produced the big bonus, increasing to NZ$111 million from NZ$28 million. Expenses were also virtually flat at NZ$192 million from NZ$189 million a year ago, meaning its expenses/assets fell to 25 basis points in the three months from 32 basis points a year ago. These helped offset a rise in bad debt charges to NZ$35 million from NZ$12 million a year ago. The end result of all of this was BNZ's net profit rose to NZ$260 million from NZ$171 million. This does look like gouging, but as I've shown, this was due to trading gains rather than expanding net interest margins. BNZ's net profit as a percentage of total assets rose to 1.29% for the year to December 31 from 1.21% the previous year, BNZ's KIS shows. Kiwibank net interest margin unchanged The great irony in this analysis is that the one bank that appeared to have 'gouged the most' through its net interest margin in the last 6 months was Kiwibank. Despite all its cut-rate mortgage offers, Kiwibank reported in its results for the six months to December 31 in its GDS that its net interest income rose to NZ$79.74 million from NZ$53.46 million the previous year. Taking into account the 50% rise in its assets to NZ$9.43 billion, Kiwibank's net interest margin was actually steady at 85 basis points. This meant Kiwibank's net interest margin was actually higher than ASB's for the half year. ASB was the only other bank to report its results as half year results. This relatively high net interest margin is due almost wholly to Kiwibank's near complete reliance on retail domestic savings for its funding rather than wholesale foreign funding. This meant Kiwibank has missed out on the higher foreign funding costs because of the credit crunch and has been able to take advantage of the big fall in term deposit rates in tandem with the slump in the Official Cash Rate over the last six months. The other thing worth noting from Kiwibank's results was its relatively high 'other income,' which included fees from customers and fees charged to New Zealand Post for running its payment services network. This other income rose to NZ$71.74 million from NZ$63.98 million. This meant Kiwibank's fees as a proportion of income fell to 80 basis points from 85 basis points the previous, but this is more than double the fees charged by ASB as a percentage of assets. ASB's much larger scale has no doubt created some economies of scale, but the large cross subsidy from NZ Post is evident here. It is Kiwibank's expenses line which transforms its healthy looking profit before expenses into something not so healthy. Expenses rose to NZ$110.3 million from NZ$88.51 million the previous year. This meant its expenses to assets percentage dropped to 118 basis points from 140 the previous year. But this ratio compares very unfavourably with the ASB's 51 basis points for a comparable period. This means Kiwibank is the one bank which hasn't seen margin contraction and is the bank with double the fees and double the cost base of the other banks. The end result disclosed in Kiwibank's Key Information Statement is that its net profit to asset ratio fell to 0.3% or 30 basis points in the 12 months to December 31 from 0.7% or 70 basis points the previous year. The conclusion? Politicians and business lobby groups are just plain wrong when they suggest the big four banks are gouging profits. They are also wrong when they suggest Kiwibank is sacrificing profits to help its customers more than the big Aussie banks. All this suggests that the big four banks will be very reluctant to pass on much of the expected cut in the Official Cash Rate later this month. It also means fixed mortgage interest rates have almost certainly bottomed out because the banks will be unable to tolerate much more margin contraction, particularly now they are having to fight very hard for local term deposits with retail rates that are now at least 100 basis points above wholesale rates. * This article was first published yesterday in our daily email subscription newsletter for the banking and finance industries. The email costs NZ$365 per annum and carries exclusive news and analysis for New Zealand banking and finance industry executives, regulators and investors. Sign up for a free trial here. Your thoughts? Comments below please.

Wow detailed analysis. Thanks for

Wow detailed analysis. Thanks for the breakdown. Looking forward to some rebuttals from the proponents of the "Profit Gouging" theory.

by Rupie | 16 Apr 09, 12:58pm

As a relatively new kiwibank

As a relatively new kiwibank mortgage customer, and purely in my own best interests, I don't care about their profit margins or funding structures. They (usually) offer the best mortgage rates which is helping me get debt free quicker. If they can make a profit at the same time then good on them.

by Stephen Judd | 16 Apr 09, 1:10pm

Can you explain more thoroughly

Can you explain more thoroughly why you are dividing margins by assets? Margins are already a size-neutral measure. At first blush this seems like an egregious step whose main purpose is to make Kiwibank look bad.

by EdgeRider g | 16 Apr 09, 1:12pm

It would be interesting to

It would be interesting to see this updated with discussion around the difference between the floating rate and LIBOR rates. Has the cost of overseas funding been dropping steadily since October 2007?

by Bernard Hickey | 16 Apr 09, 1:33pm

Stephen Judd, Margins as a

Stephen Judd,

Margins as a proportion of assets is the only way to compare apples with apples. Not to do that would be to say Air New Zealand is more profitable than TradeMe because it produces more profit in nominal terms, whereas TradeMe, for example, is vastly more profitable as a percentage of sales, assets and people employed.
Net interest margin in NZ$ terms is not size neutral. The banks don't publish their margins, but the cleanest way to measure it is net interest in NZ$ terms as a proportion of assets in NZ$ terms.

EdgeRider,
Overseas funding costs, as a margin to swap rates, have risen sharply through 2008. If you meant October 2008, they have probably fallen back from those peaks, but are still around 150-200 points above their pre-Crunch levels.

cheers
Bernard

by Stephen Judd | 16 Apr 09, 1:59pm

Sorry Bernard - I'm used

Sorry Bernard - I'm used to thinking of margin as shorthand for profit margin, ie profit/revenue as a percentage. This misled me.

by Kieran | 16 Apr 09, 2:15pm

The fact that Kiwi bank

The fact that Kiwi bank has a smaller asset base and doesn't rely on foreign lending like the australian banks means its not comparing apples with apples anyway. Why should Kiwi banks margins be compared unfavourably with the Australian banks just because they haven't suffered from increased foreign lending costs, good on Kiwi bank for not dipping its head in the same trough, they can now offer lower interest rates and get better profit margins, thats called good management not profit gauging

by EdgeRider | 16 Apr 09, 2:46pm

Thanks Bernard. Yes I did

Thanks Bernard. Yes I did mean 2008, my apologies.

by Bullitt | 16 Apr 09, 3:54pm

Kieran are you suggesting that

Kieran are you suggesting that all the Australian banks should follow Kiwibank's example and raise their funding from NZ depositors? Itd have some limited benefits to me as a first home buyer but I dont see any way this would be possible without all 4 banks stopping lending completley until they had vastly reduced the size of their balance sheets.

by Philsiebob | 16 Apr 09, 4:20pm

Kiwibank are gov't owned and

Kiwibank are gov't owned and do not have a requirement of profit! Therefore kiwibank can float around the profitable areas of banking, undercutting the Aussies (and keeping them honest) and not really have to worry about being efficient.

The money raised via term deposits and then onlent is cheaper than money borrowed from o/seas (no risk margin built in). The problem would be if all New Zealanders went to Kiwibank to get a mortgage, they would have to access the same more expensive funding.

Should govt be involved in banking? Why not petrol, or food (supermarkets make profits - surely a non-profit distributor would reduce prices)

by Kieran | 16 Apr 09, 5:55pm

Bullitt if the Australian banks

Bullitt if the Australian banks had followed kiwi banks example and not taken advantage of all the easy money created by wall street our housing bubble wouldn't be so big and we wouldn't be risking a credit rating downgrade. The government would have better economic stimulation ammunition up their sleeve rather than the bows and arrows they are forced to use now. The ozzy banks are now reliant on getting expensive overseas funding just to service the loans already made, if this means lower margins, operational cost cutting and lower profits then tough bickies.

Philsiebob Kiwi bank is required to operate profitably and they are doing a much better job at it than their Australian counterparts. Should govt be involved in banking? of course they should our economy depends on it. If we put all our banking in the hands of the Australians we will come off second best.

by IndianKiwi | 16 Apr 09, 6:14pm

"Should govt be involved in

"Should govt be involved in banking? of course they should our economy depends on it. If we put all our banking in the hands of the Australians we will come off second best."

Just a off topic question

Can anyone explain why the government accounts are still with Westpac? Why don't they shift to Kiwibank?

by Kate | 16 Apr 09, 7:54pm

IndianKiwi - I think the

IndianKiwi - I think the Govt tenders for its retail banking services - not sure how often, but unlikely that Kiwibank were around when that exercise was last done.

by Chris_J | 16 Apr 09, 8:46pm

Bernard What about the interest

Bernard

What about the interest earned on the Bank's capital??

This is included in their net interest income - isn't it? Therefore it makes sense that net interest income has fallen in tandem with falling interest rates.

For example: If we look at the numbers for you're sponsor ASB:

(Firstly the reference to a 74bps margin is misleading. $483m net interest income for six months on $65b is 148bps (when you're talking interest rates doesn't 1bps generally refer to 0.01%PA?? Note the per annum)).

Now for the 6 months to 30 June 2008 ASB had a floating rate of 10.75% so their $3.2b shareholder equity would have earned them $172m out of a total $494m net interest earnings. So their margin on money ASB was on-lending would have been 115bps.

For the 6 months to 31 December 2008 the time weighted floating rate was about 9.5%, so their $2.693b (reported shareholder equity) earned $127m out of $483m. Hence their margin on money that was on-lent was about 114bps.

That's virtually unchanged - not the 15% decline that you reported Bernard!

I haven't looked at the others but since the ASB reported the biggest decline, it's conceivable that some of the other banks actually increased their margins.

It's also worth noting that most of the big falls in interest rates were in December and would have had little effect on the overall interest income for the whole period. In fact 285bps were cut from floating rates during this period versus a 325bps OCR cut. Since January only 140bps out of 200bps OCR cuts have been passed on. I think that it's this more recent failure to pass on OCR cuts that people are complaining about!

Intuitively you would've expected reduced interest income for the banks due to such an enormous number of fixed term loans being broken during this period. At banks where break fees are calculated based on the comparative fixed at the time, savvy mortgage holders were breaking their fixed term loans a few days before OCR announcements with the bank having no hope of re-lending the money at the same interest rate prior to the rates cut.

In spite of the losses that banks would have incurred from this activity their margins were still about the same, so they were probably "gouging" the remaining unsophisticated mortgagors!

It would be more interesting to compare bank's margins prior to 2008. From 1999 to 2007 the floating rate averaged about 2% above the OCR. For the first half of 08 it was closer to 2.5% higher and the second half of the year was towards 3% above.

With the floating rates now 350bps above the OCR, I don't think your analysis, Bernard, proves that they aren't "price gouging".

by Chris_J | 16 Apr 09, 9:10pm

Bernard The "Big Profit Squeeze"

Bernard

The "Big Profit Squeeze" table would have looked a lot more sensible if all the margins were annualised.

But I guess that would show that ANZ National, Westpac and BNZ were all making about a 200bps margin (or in the case of Westpac in December 2007 nearly 240bps!!) which wouldn't necessarily fit with the hypothesis of the bank's not "price gouging".

Based on your numbers in the table Westpac were making a 30% mark up between the wholesale and retail interest rates in 2007 - little wonder they were giving away money to anyone who could offer a certificate of title as collateral!

by alastair thompson | 16 Apr 09, 9:48pm

Bernard, This may be misunderstanding

Bernard,

This may be misunderstanding things but looking at bank margins overall isn't necessarily the issue. Even if it were true that they were not earning more profit on interest (and that seems far from clear) they could still be gouging particular sectors - the floating raters being the most obvious because their is no long term high interest rate funding element at the short end.

For what its worth I am not completely sympathetic to the high overseas cost of credit argument either because of the issue of transfer pricing. It happens with Aluminium ore - why not bank funding. I.E. is the bank really obtaining the cheapest funding that it can - or is it getting some of its credit from related parties.

For my money the gross profit figures of the major aussie banks. Their apparent desire not to pay tax and the mismatch between the way they treat their NZ vs their Aussie customers tends to put me in the camp with Bollard and the Feds. And surely if anyone would know whats going on it would be Bollard.

Anyway. Fascinating apologia but I am yet to be convinced that our aussie money lenders have our interests and not their own at the center of their decision making processes.

by sam.p | 16 Apr 09, 10:17pm

Comparison of bank margins relative

Comparison of bank margins relative to assets is misleading for the following reasons:

1. Banks assets are often excessively overvalued. It is not hard to capitalise the incomes and show a low return on assets. Banks are good at this.

2. Commonsense should guide that no industry or service sector really operates at a low return level of about 1% for a long period of time. Banks claim to do so. Can we trust their financial summaries? I would not.

3. The operating profits before tax & depreciation matters too. Whether this profit level has increased or not is one good indicator.

by rbot | 16 Apr 09, 10:51pm

Kiwibank sucks. Bought to you

Kiwibank sucks. Bought to you in association with ASB

by Bernard Hickey | 16 Apr 09, 10:56pm

Chris J Many thanks. Banks

Chris J
Many thanks.
Banks don't earn interest on their equity. Net interest to assets is the best measure of profits on interest margins.

Sam.p
Many thanks
Not sure how to answer your query. You're essentially saying we shouldn't believe the bank valuations. I'll be the Reserve looks over these numbers like a hawk and wouldn't accept any shonkiness. I believe these numbers.

Alastair Thompson
Many thanks. You may be right about gouging some sectors and not others. The numbers I refer to for the whole of the banks. I believe, for example, that banks have increased their margins sharply for business loans but have left them reasonably low for mortgage lending, creating a cross subsidy.
On the transfer pricing issue, I doubt the banks' Aussie parents are 'overcharging' their NZ units for funding. IRD and the RBNZ watch this closely. On Bollard knowing what is happening and still criticising: He has actually been very careful in the last couple of months not to criticise the banks for overcharging. He's asked them to 'play their part' and has said wholesale (not retail rates) have risen too much, but he hasn't gone as far as Federated Farmers, Finsec or Bill English. I think the RBNZ has already done a similar analysis to mine and reached a similar conclusion. We'll know more next month when the bank releases its Financial Stability Report.

cheers
Bernard

by waymad | 17 Apr 09, 9:26am

's lonely being a data-driven

's lonely being a data-driven Troofer, eh, Bernard. Lots of yappy detractors with good soundbites, nipping at your heels.

Nil carborundum illegitimi. And keep up the real, solid analysis. Well done.

And to the rest of the crew who apparently think that businesses shouldn't exist solely to earn a profit, how's aboot reading a leetle Adam Smith. He figgered things like this out in the late 1700's.

by Alistair | 17 Apr 09, 9:42am

Hi Bernard, really like your

Hi Bernard, really like your site and mostly I think your views and comments are really helpful. However, I am disappointed you think it appropriate to post videos with ASB plastered all over them. You say the banks aren't profit gauging, but lots of other people say they are. You're sponsored by the big banks, those who say banks are profit gauging and need to pass on savings to customers are not sponsored by the big banks. Who do we believe? Unfortunately it is hard to believe you when ASB is one of your big sponsors - you just come off looking like a mouthpiece for the banks.
Can't you find another sponsor for the videos? I'm not saying you shouldn't allow banks to advertise on your site, but you definitely shouldn't confuse advertising with independent editorial - which is what I believe you are doing.
I don't mean to be overly critical, but a lot of this stuff is quite hard for the Average Joe to comprehend and getting unbiased, independent advice is nearly impossible.

by Bernard Hickey | 17 Apr 09, 10:41am

Alistair, Many thanks for your

Alistair,
Many thanks for your comments and voicing something others may be thinking. I'm glad you like our site and I'm disappointed you're disappointed. Let me try to un-disappoint you if there is such a word.

I thought this question might come up over this story so I'm happy to address it directly. This is a tough question to answer as it all depends on perceptions, but I can show you how I/we operate and what I've commented on previously to prove the independence of this site.

All I can do is assure you that I'm not in the pocket of the banks. I've been a financial journalist for 18 years and have never written a story or skewed a story at the request of an advertiser. For me this is a fundamental principle. It's one of the reasons I enjoyed coming to work each day for 18 years. I could be making a lot more money than I am now by writing PR for companies. But I like being independent and useful.

We have a clear separation of advertising and editorial at interest.co.nz. The owner and publisher of interest.co.nz, David Chaston, handles the advertising. I handle the news and opinion. I don't get involved in negotiating advertising deals or handling queries from advertisers.

To give you an idea of how I'm not in the pocket of the banks. Here's story from earlier this month detailing 5 reasons to thank the banks and 5 reasons to spank the banks.

The 5 spanks are quite large.
1. They are not offering enough interest rate relief to businesses, particularly medium to large ones.
2. They are lending too much and too fast to farmers.
3. They borrowed too much overseas on short terms.
4. They pumped up the housing bubble with too much high LVR (Loan to Value Ratio) lending.
5. They cut their term deposit rates too fast and too far.

http://www.interest.co.nz/ratesblog/index.php/2009/04/02/opinion-5-reaso...

I would love to have discovered the banks had gouged profits. It would have made for a more popular story. But I spent hours poring over the GDSes and the analysis above is the consistent theme that came out.

I'd also suggest you contact the bank PR people to ask if they think I'm a mouthpiece for the banks. I think you'll find they respect and watch what we do, but I don't think they're in love with us. We publish good news and bad. In particular, we publish whenever they increase mortgage rates, which can cause friction.

Finally, I'd say that anyone wondering about this sort of sponsorship arrangement should look at the example of National Bank sponsoring One News on TVNZ. I doubt anyone would suggest National Bank is treated differently because of that sponsorship. I would say the same about ASB and any of the other banks that sponsor us or advertise on this site.

Many thanks and I hope we can win you back.

cheers
Bernard

by Chris_J | 17 Apr 09, 11:46am

Bernard Youâ€™ve totally missed the

Bernard

You've totally missed the point I was trying to make.

Banks have more assets than liabilities (at least NZ ones do!), therefore you can't use your overly simplistic calculation to work out their margin.

Banks also have cash on hand, property assets (office chairs and computers etc!), goodwill etc. etc. which produce no income along with things like RBNZ deposits and interbank lending which don't earn them a retail margin.

You seem to be approximating a circle with a square!

The calculations I gave in my previous comment were still really back of the envelope calculations. But a slightly better approximation "“ maybe an octagon!

I've looked through ASB's General Disclosure Statement again (someone else can do the other banks if they are interested!) and there is enough detailed information to work out the banks margin near enough exactly.

For the six months to December 2008 ASB earned $2.29b interest from $52.119b advanced to customers. They paid $2.091b to service $55.525b borrowings (including borrowings for other assets "“ securities, derivatives etc). So they received an 8.98%PA return on money they loaned out and paid 7.67%PA on money they borrowed.

That's a 131bps margin (and it's probably as accurate a number as you are going to get).

Do the same for 2005, 2006 and 2007 and you get 129bps, 128bps and 127bps respectively.

So ASB's margin is actually fairly consistent (as you might expect), however it's actually up by nearly 3% from 2007 to 2008. The 2008 margin is also over 2% higher than the average for the previous three years. Definitely NOT down the 15% that you quoted!!

Given the arguments I made in my first comment about why you might intuitively expect that their margin should have reduced during the second half of 2008. I think that there is more evidence for "price gouging" than against it. Although 4bps probably doesn't equate to gouging, it's noteworthy that ASB were offering the lowest rates amongst the major banks as interest rates fell during the second half of last year (they reversed that this year!) yet still increased their margin, so you may find some of the other banks were making a bit more than 4bps more!

So in summary:

ASB'S MARGIN WAS UP 3% FROM 2007 TO 2008 NOT DOWN THE 15% YOU REPORTED BERNARD!!

THAT'S A DISCREPENCY OF 18% POINTS "“ MORE THAN ENOUGH TO CONCLUDE THAT YOUR APPROXIMATIONS ARE INVALID!!

Plenty of dubious statistics get passed around the inter-web (more than a few from this site!) but this one is a pretty egregious example that is easily disproved.

With analysis like this going on it's little wonder how the Financial Crisis developed!!

Take a look at the numbers Bernard! I think the headline needs to be changed!

by Bernard Hickey | 17 Apr 09, 12:15pm

Chris J Many thanks for

Chris J

Many thanks for your exclamation marks and capital letters. That's one way to reinforce your arguments.

However, you're wrong using your own figures. How can you possibly get a per annum figure with 6 month figures? Good luck with the back of that envelope.

Let's stick to the 6 month figures. Even using your method of working out the margin by measure interest income as a percentage of advances to customers and setting it against the interest expense as a percentage of liabilities, it shows that ASB's net interest margin fell 5% to 15.9 basis points in the second half of 2008 from 16.7 basis points in the second half of 2007, according to this GDS. http://reports.asb.co.nz/report/article/2691/16/0/general-disclosure-dec...
I invite all readers to have a good look at the numbers. It is beyond me how anyone can conclude that someone's profit margin on interest actually rose when its reported net interest income fell from NZ$494 million to NZ$484 million at the same time as lending to customers rose to NZ$52.119 bln from NZ$44.93 bln.

Also, your approach also fails to take account of the very real cost of capital, which my analysis does.

Kind regards (sans exclamation marks...)
Bernard

by Chris_J | 17 Apr 09, 3:36pm

Bernard No offence intended by

Bernard

No offence intended by the punctuation.

I must admit that I am a little staggered that you don't see the need to annualise figures especially for a man who likes his apples with apples.

Who would quote their monthly mortgage rate as 48.6bps rather than 6%PA?

It seems nonsensical to be working out margins on interest rates in anything other than annualised terms.

Enough of that, so back to the main argument. It seems that you couldn't keep up with my calculation so I will take you through it a little more slowly.

Firstly, I'll review your calculation.

You take the net interest income from the Income Statement (Pg 6 of the GPS) and divide it by the total assets from the Balance Sheet (Pg 8 of the GPS). This for 2008 gives 483/65,343 = 0.739% and for 2007 494/56,175 = 0.879%. You call these numbers the profit margins (note these are not annualised so the percentage isn't actually comparable to a margin on an interest rate "“ annualised numbers would be 1.48% and 1.77% respectively "“ ie a 148bps and 177bps margin).

This is a nonsense calculation for reasons that I have already given.

My calculation is as follows:

First take the total advances to customers from the Balance Sheet (Pg 8 GPS). Then find the interest earned from these advances to customers from the Interest Income section of the Notes to the Financial Statements (Pg 18 GPS). Divide the two and you will get the effective interest rate that the ASB earned on their advances.

For 2008 we get 2,290/52,119 = 4.39% or 8.98%PA. For 2007 we get 1,845/44,926 = 4.11% or 8.38%PA.

For the average interest rate that the bank paid for funding, take the total interest and discount bearing liabilities from the Balance Sheet (Pg8 GPS), then find the total interest expenses from Interest Expenses section of the Notes to the Financial Statements (Pg 18 GPS). Divide the two and you will get the effective interest rate that ASB was paying for its funding.

For 2008 we get 2,091/55,525 = 3.77% or 7.67%PA. For 2007 we get 1,729/49,485 = 3.49% or 7.11%PA.

Hence we can conclude that ASB had an effective 131bps margin for the six months to 31 December 2008 and a 127bps margin for the six months to 31 December 2007.

This is as I said before. These are ASB's numbers not mine.

ASB's margin was up nearly 3% not down the 15% you suggest.

To your point about not including the cost of capital, I make the following comment based on 2008 numbers.

ASB's remaining Assets (just the total assets excluding advances to customers) was $13.224b at the end of 2008. Their remaining interest bearing liabilities were $3.406b which cost $128m to service. ASB's income on the remaining assets before impairment losses on advances was $528m, giving a $400m net return on the remaining assets which is an 8.3%PA return.

The size of the impairment losses at $67m admittedly is a big number versus ASB's income. Something you didn't pick up on was that 6.33% of ASB mortgages (1 in 15.8) were overdue in December 2008 and nearly 0.6% of loans (by value) were more than 90 days past due "“ a four-fold increase on December 2007.

The $67m impairment losses ($21m from residential mortgages) from the second half of 2008 together with $35m from the first half of the year if spread over the whole portfolio would have cut 19.5bps off their margin. This compares with a cost of about 2bps in 2007. This demonstrates how much impact impairment losses have on the banks income statement. (Note that the annualised rate of losses for the second half of 2008 amounted to 26bps).

Bernard, you should know that numbers are not always what they seem. That is why there is a profession of people called Investment Analysts. What I've pointed out is pretty basic stuff really you certainly don't need to be a mathemagician to come around to my way of thinking! (Excuse the exclamation)

Just as an aside I was previously an Investment Analyst at a multi-national Fund Manager. But note this hasn't been peer reviewed and it's just my informal personal (sometimes humorous) observations on what is a pretty straight forward calculation "“ I certainly didn't need to muster a Maths degree to crunch these numbers.

So Bernard you better start crunching the apples, while I return to some more profitable activities.

by Miguel Sanchez | 17 Apr 09, 5:02pm

No Bernard's approach is basically

No Bernard's approach is basically right. Dividing interest income by assets, then dividing interest expense by liabilities, is nonsense because it glosses over any changes in the mix of funding. In the case of ASB, interest-bearing liabilities fell from 88% of assets in 2007 to 85% in 2008 - they became less leveraged, which would reduce their interest expenses and widen their net interest margin, all else equal.

If you're having trouble following this, let me give an extreme example: if ASB was entirely equity-funded, its interest expense would be zero and its net interest margin in 2008 would have been 8.98% - 0.00% = 8.98%. Would that mean they are 'gouging'? Not necessarily, since while they wouldn't be paying any interest, their shaeholders would expect a whopping dividend to make it worth their while.

by Fred | 17 Apr 09, 8:15pm

OK exactly what assets are

OK exactly what assets are we talking about here? And what of these are needed by a bank to earn income? Staff (outsourced to India), computers/applications (rented from head office in Australia), Vaults with gold in them (no bank let alone country does that anymore), Branches/buildings (could be leased or in the case of ANZ/National 1/2 of them are worth nothing), Skill? (the ability to borrow money at a lower interest than you) hmmm then why hang on the the pronouncements of the RB about the latest OCR. So . . . that leaves deposits less loans and that's just a measure of leverage and the aim of any bank is to gear up to the level that the regulator will allow. Start here http://www.debtdeflation.com/blogs/2009/01/31/therovingcavaliersofcredit/ There should be a clear distinction between retail banking (a commodity/transaction service) and investment banking.

by sam.p | 17 Apr 09, 8:24pm

Thanks for the reply Barnard.

Let me clarify my basic concern. The bank financial figures are correct under the assumed accounting model. The flaw lies with the model and not with your inference.

Bank assets are increasing in value disproportionately when compared to the increase in profits. This cannot happen unless clever accounting helps to capitalise the incomes. This leads to a s smaller proportion of profits in relation to the asset value. NZ banks borrowing at a higher rate from overseas will have to face some reduction in profits but this is the price they pay for their excessive past lending practices based on short term borrowing. Nevertheless this action is necessary for the banks to keep their assets valued high and liquid.

by Miguel Sanchez | 17 Apr 09, 10:11pm

"Bank assets are increasing in

"Bank assets are increasing in value disproportionately when compared to the increase in profits. This cannot happen unless clever accounting helps to capitalise the incomes."

It can also happen when banks make more loans (which is where the asset growth comes from) but at smaller margins. Which is kinda the point that Bernard is making.

As for banks supposedly capitalising their interest income - do you really think that the Reserve Bank and the IRD aren't wise to the potential for such an obvious tax dodge? For starters, putting the income onto the asset side of the balance sheet would require an offsetting entry on the other side - specifically, banks would end up creating a whole lot of new equity out of nowhere. And the Reserve Bank, for one, pays a lot of attention to how much equity the banks hold and what it's made up of.

by sam.p | 17 Apr 09, 10:53pm

Miguel, I was not suggesting

Miguel, I was not suggesting a tax dodging but commenting the way the accounting model works.

Have a look at the bank asset growth data at the RBNZ site

rbnz.govt.nz/statistics/banksys/g1/hg1.xls

For example, total assets (NZ$m) of BNZ is 64,209 as of Sep 08 which grew from 22,800 during Mar 96.

There is no point is arguing that banks make only < 1% return on assets when assets values nks are adjusted excessively upward.

by Miguel Sanchez | 18 Apr 09, 10:15am

If not a tax dodge,

If not a tax dodge, why else would they bother? Banks try to make their balance sheets look smaller, not bigger, so that their regulatory capital requirements are lower.

And a return on assets of 1% or less is standard in the banking industry. 1% return on assets combined with 20x leverage = 20% return on equity, which is the ratio that matters.

by Chris_J | 18 Apr 09, 4:48pm

Miguel Sanchez I think youâ€™ve

Miguel Sanchez

I think you've got a little befuddled.

How can you compare interest bearing liabilities with total assets in order to establish what leveraging ASB had?

You need to compare apples with apples (it's a similar problem to that of Bernard's). ASB's debt to asset ratio went 94% in 2007 to 95.9% in 2008. So ASB increased their leveraging in 2008. They certainly didn't deleverage!

It should have been pretty obvious that ASB couldn't possibly become less leveraged when shareholder equity fell and their loan book increased!

My calculation uses the total interest bearing liabilities to calculate the cost of funding I not sure how you think that glosses over "any changes in the mix of funding".

Take your example of an entirely equity funded bank who is lending money at 8.98%. My calculation would say they weren't charging a margin on their financing (mathematically it would be undefined, since my calculation would have you dividing by zero liabilities). Bernard's calculation would give the banks margin at 8.98%, which is a nonsense result since they are not charging a margin on financing at all!

This is possibly better illustrated by an example where the bank was 50% equity funded. Same lending rate as above but say a financing rate of 7%.

My calculation would give the margin as 1.98%. Bernard's calculation would give the bank's margin at 5.48%. When you consider that a margin is the difference between the price that you pay for something and the price that you sell it for, I'm not sure that I can make the point any clearer than in this example that Bernard's calculation is nonsense!!

Bernard

One of the reasons you are getting such a large decline in 2008 margin from you're calculation is that non interest bearing derivative assets listed on the balance sheet were up four-fold, correspondingly derivative liabilities were up five-fold. This gives a relatively neutral change to the bank's financial position, but if you use the total assets number to calculate their margin then since total assets are way up on last year there margin is way down.

Another reason is as illustrated to Miguel above re shareholder equity.

But the main reason why you are getting a negative number is that you are working out the margin that the bank is making over its whole portfolio including its cash and fixed interest investments that the bank has to provide solvency and meet their capital adequacy requirements. You can't expect them to be earning a big margin on these mainly short-term investments "“ the banks pay more in interest to depositors in savings accounts than they earn on having these investments.

The amount of money that the bank has in each as asset class (other than mortgage advances) is very fluid so trying to do a proper attribution analysis for each of the assets is impossible unless you have all of the daily cash-flow data.

However we can see that ASB earned significantly less from their cash and fixed interest investments in 2008 because of the lower OCR and consequently lower wholesale interest rates. This is why their net interest income actually reduced when the amount of mortgage lending increased.

I've taken another quick look through the ASB's GDS and the only change that I would make to my calculation is to add deposits from non interest bearing customer accounts to the liabilities number I used (I hadn't noticed that this was excluded initially). Once this is done their 2008 margin was 154bps and the 2007 margin was 153bps.

It's worth noting that the margins between what the bank was earning on its interest and what they were paying for financing are largely constant over the last four years.

When you consider operating expenses, other revenue, the return from cash etc. and impairment losses etc. you can't say the banks are making more money in 2008. But you can establish that they are charging no less a margin on their mortgage lending than they have in previous years.

by Miguel Sanchez | 18 Apr 09, 10:21pm

"Take your example of an

"Take your example of an entirely equity funded bank who is lending money at 8.98%. My calculation would say they weren't charging a margin on their financing (mathematically it would be undefined, since my calculation would have you dividing by zero liabilities)."

Just my point - a measure that can give you an undefined result is clearly flawed.

I used interest-bearing liabilities because they are the relevant measure for the very specific question of interest rate margins. Non-interest bearing liabilities will include the likes of deferred tax payments and mark-to-market losses on derivatives - neither of which I would consider "leverage".

"a margin is the difference between the price that you pay for something and the price that you sell it for"

Which means that the margin is the dollar value of interest income, less the dollar value of interest expenses. If you want to express that as a ratio, then you need to use a common denominator, as Bernard has correctly done. But whatever, it's not up to me to tell you how to do your former job properly.

by sam.p | 18 Apr 09, 11:02pm

I doubt whether there is

I doubt whether there is any common denominator for the bank profitability. Income less expenses is expressed in NZ$, but we borrow from overseas a lot (which are actually in other currencies). So there is no common denominator.

The current accounting model has its own flaws. We make an inference on profitability assuming that this model is correct. I would say this method of conclusion is short sighted. It is not surprising to see an economist supporting the GDP measurement method, which is rubbished by a sociologist. I guess Miguel has academic qualifications in a banking related subject. So I am not surprised with the way you interpret and justify. The total amount of cash held with banks and RBNZ is also part of the total assets. Cash held has considerably increased (due to regulatory and other reasons) which is not taxed. It is also easy to see that bank profitability has increased considerably in absolute terms.

My argument is just based on common sense. When assets are overvalued, the "˜profitability' as a proportion of total assets will appear small. The contributing factors such as the expensive overseas borrowing, weaker NZ$, reduced lending etc contribute to lower "˜profitability' (in the way it is currently measured). This measure of profitability is just notional.

The fact remains that the savers who earn little more than the current OCR have to pay tax on the interest earned and their real value of the saving becomes negative after adjusting for the inflation. So the loss to saving public is much more than the little notional reduction of profitability to banks under the current accounting practice. It is also a fact that these banks were to blame for the excessive lending on housing assets. Banks were making profits selling debt rather than encouraging saving. Once their debt sale strategy to increase "˜profitability' becomes risky, savers are punished by negative returns for no fault of theirs. As a saving public, I have little sympathy for banks.

by Les Rudd | 19 Apr 09, 9:10am

In Bernard's input at April

In Bernard's input at April 16th, 2009 at 10:56 pm

http://www.interest.co.nz/ratesblog/index.php/2009/04/16/analysis-bank-p...

In responding to points made by Alastair Thompson, Bernard says:

"You may be right about gouging some sectors and not others. The numbers I refer to for the whole of the banks. I believe, for example, that banks have increased their margins sharply for business loans but have left them reasonably low for mortgage lending, creating a cross subsidy."

I've asked Bernard on a companion blog to this article if he could look into where gouging by sector maybe occurring, but I appreciate it might be difficult to ascertain anything more useful on that. However, given some of the expertise displayed here I'd like to ask for comment on the second sentence in quotes above please.

Given there would usually be a difference in treatment between business loans and mortgage lending anyway, can anyone give views on the degree of "cross subsidy" that seems to be happening now and how that compares with the situation before the credit crisis please? (Am thinking it can't just be as simple as the difference between stated rates.)

Thanks, Les Rudd.

by Bernard Hickey | 20 Apr 09, 10:44am

Chris J Many thanks for

Chris J
Many thanks for your responses.You've taken a lot of time to make a point. I appreciate the effort you've made.
I love a good debate.
But in this case I think we'll have to agree to disagree.
Many thanks to the others who contributed too.

cheers
Bernard

by Michael | 03 May 09, 9:11am

Indiankiwi: "Can anyone explain why

Indiankiwi:
"Can anyone explain why the government accounts are still with Westpac? Why don't they shift to Kiwibank?"

The Government tenders for banking services every few years, and believe it was most recently done last year. Westpac has a substantial institutional & government banking service in Australiasia (along with plenty of experience) that Kiwibank does not. Kiwibank targets primarily personal customers, and in the last two years small-medium business operations. They do not have the expertise, infrastructure or manpower to provide the government banking services. To transfer baning services to a government associated entity regardless of the costs, benefits would be of ideological only.

In this section

Offers for readers

Follow the news from interest

The comment stream

Recent comments

Editors choice

Finance sector jobs

The news stream

Latest news

Most commented

Most viewed

Reader poll

Analysis: Bank profits on interest rates are falling, not rising

Related Topics

interest.co.nz, Helping you make financial decisions

Text Size: