By Gareth Vaughan
A downgrade to the Co-operative Bank's BBB- credit rating wouldn't have a material impact on the bank, CEO Bruce McLachlan says, but he would expect a "major response" from New Zealand authorities if Standard & Poor's followed through on a threat to downgrade eight New Zealand banks and credit unions due to macro-economic factors.
In May S&P revised the outlook on Co-operative Bank's BBB- credit rating to negative from stable and said it might lower the rating by one or two notches within two years. A BBB- rating is S&P's lowest investment grade rating. The credit rating agency also changed the outlook on the ratings of TSB Bank, Heartland Bank and five credit unions* to negative from stable, but said the negative outlook didn't reflect deterioration in its assessment of bank-specific credit factors.
Rather, S&P said its action was due to a belief that New Zealand’s economic vulnerabilities, including a material dependence on external borrowings (ironically through the big four Australian owned banks whose AA- credit ratings retained their stable outlooks), persistent current account deficits, and recent strong growth in house prices, could escalate.
"In our view, this increases the risk of a deterioration in New Zealand banks’ credit qualities," S&P said in May. "The negative outlook does not reflect deterioration in our assessment of bank-specific credit factors."
"We may lower the ratings on the eight New Zealand banks that are on negative outlook by one-to-two-notches within the next two years if economic vulnerabilities worsen, in our view," S&P said.
S&P's warning came after it issued a report in February warning New Zealand and its banks were vulnerable to a sharp correction in property prices. Other major credirt rating agencies have raised similar concerns. In a report on New Zealand banks' operating environment, Fitch Ratings warned in April that strong asset growth and fierce price competition were potentially leading to asset bubbles. And, also in April, Moody's Investors Service said New Zealand banks faced a number of risks and it was starting to see more evidence of these risks "coming through the banking system."
'Hundreds of banks have BB ratings'
McLachlan told interest.co.nz that a downgrade would clearly not be positive news.
"But I don't think it's material to us," said McLachlan. "There are hundreds and hundreds of banks around the world that are at BB (in terms of their credit rating). New Zealand actually has one of the highest standards in terms of setting BBB as the standard for banks."
Banks need a credit rating of at least BBB- to obtain banking registration from the Reserve Bank. However, asked by interest.co.nz in May if a bank's rating was cut below investment grade whether this would place its bank status in jeopardy, a Reserve Bank spokesman said; "A credit rating is only one of a number of criteria that we have regard to when considering bank registration. We do not comment on individual banks."
Registered banks are required by the Reserve Bank to have a credit rating. See credit ratings explained here.
McLachlan said a downgrade to a speculative, or "junk", rating would be an issue for entities reliant on wholesale funding, but the Co-operative Bank wasn't one of these, rather relying on retail funding. In its annual results issued on Friday, the bank revealed a core funding ratio of 105.6% versus the Reserve Bank mandated minimum of 75%, and a total capital adequacy ratio of 16.9% versus the mandated minimum of 8%.
'Major response expected'
If S&P ultimately followed through with its threats to downgrade the eight institutions, McLachlan said the reaction of the Government and regulators would be important.
"Because I think it wouldn't be about any one institution. It's about the system and I think you'd see quite a major response from them in reaction to any change in outlook for a system," said McLachlan.
"If there were multiple downgrades concurrently - due to macro-economics factors beyond any entity's control - and in some instances by multiple notches, there is danger of system wide impacts which would have negative long-term impacts on the economy," said McLachlan.
"Therefore, it is most likely that you will see authorities doing whatever is required to restore system confidence. What that action is will be determined by the circumstances that exist at the time."
"I think we have already seen with the Government's supply commitment to build 39,000 (Auckland) homes in the next three years, and the Reserve Bank's pre-positioning for LVR (loan-to-value) speed limits, that you are already seeing a swift and decisive action ahead of the problem," McLachlan added.
TSB Bank CEO Kevin Murphy, whose bank had the outlook on its BBB+ S&P rating revised to negative from stable, recently told interest.co.nz that New Zealanders needed a better understanding of just what credit ratings are.
"Pre-global financial crisis there were a number of financial institutions worldwide that had A (credit) ratings that no longer exist," Murphy said." So a (credit) rating is not necessarily a definitive view on the financial performance of an organisation."
Brand push looms, credit card coming
Meanwhile, the Co-operative Bank, which announced plans to pay out $1 million to customer-members through rebates on Friday, is also aiming to build awareness of its brand. McLachlan said; "You are going to hear a lot about us in coming weeks."
The bank is also revamping its online and mobile banking services, opening a second call centre in Wellington - alongside its existing one in Levin - and is preparing to launch a credit card. McLachlan said Co-operative Bank had a partnership in place "with one of the schemes" for its credit card, although he wouldn't say who. Launching a credit card was a big project for the bank, with details likely nearer the end of the year.
As for the call centre plans, this would extend the hours of operation, see new staff coming on board, although these wouldn't be big numbers, and some "redistribution" of staff as well.
Currently with 31 branches, the Co-operative Bank plans to open another three in September with two to be in Auckland and one in Christchurch. The bank currently has seven branches in Auckland and wants about 10 more with these to come progressively, McLachlan said.
"We're reasonably well represented in parts (of Auckland) but clearly short centrally, out east and in the north."
He said about 20% of the Co-operative Bank's mortgage book was sourced from Auckland, with about 15% of its customers from the city. The bank's July 25 annual general meeting will be held in Auckland.
"We know we've got big investments to make, not just this year but in future years, so that will be ongoing," McLachlan said.
Net interest margin falls
The annual results showed the Co-operative Bank's net interest margins down to 2.63% for the year to March 31 from 2.75% the previous year. Despite the drop that's well above the average of about 2.25% across New Zealand's big four banks. McLachlan said this was because Co-operative Bank holds more capital than other banks. The year-on-year net interest margin drop was attributed to the $1.77 million sale of a fixed interest portfolio (FIP) investment.
Separately, McLachlan said the Co-operative Bank's cost to income ratio had fallen to 83% from 87%. This is well above the major banks, whose cost to income ratios are in the 40% range. McLachlan attributed his bank's high cost to income ratio to its small size.
Year-on-year, total assets rose $70.69 million to $1.5 billion, with provisioning put at 0.16% of total assets. The bank's total liabilities increased by $65.55 million to $1.387 billion.
* The credit unions impacted were Credit Union Baywide (BB), Credit Union South (BB-), First Credit Union (BB), New Zealand Association of Credit Unions (BB+), and Police and Families Credit Union (BB+).
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