The strategist credited with picking the sub-prime Credit Crunch, Christopher Wood, has warned in a research note that depositers in New Zealand banks could become worried about their health because of their exposures to the slumping property market and their heavy reliance on international wholesale markets for funding. He has recommended depositers should put their money with the government-owned Kiwibank. The chief strategist for Hong Kong-based broker CLSA Asia Pacific issues a regular report titled Greed and Fear. He was credited by the Wall St Journal as being the first to pick the Credit Crunch when he warned in October 2005 that investors should dump any securities linked to American mortgages. Wood wrote of the risk that collapses in the finance company and mortgage trust sector could spread into the banking sector. "The New Zealand situation is deteriorating at a pace that could precipitate depositor concerns about the health of the New Zealand banks," Wood said in its August 7 edition of Greed and Fear. On this point, there are a few key points to understand," he said. "First, the loan-deposit ratio of the New Zealand banking system is 175%, resulting in massive dependence on wholesale funding. Second, there is no deposit insurance system in place in New Zealand. Third, most of the major New Zealand banks are wholly-owned subsidiaries of Australian banks."
Wood said this meant a financial crisis in New Zealand would directly ricochet into Australia. "This New Zealand exposure is one important reason why reed & fear continues to recommend a zero weighting in Australian banks," Wood said. CLSA's head of regional banks research Daniel Tabbush had already highlighted that ANZ has 25% of its lending in New Zealand and other major Australian banks around 15%, he said. "Certainly, a depositor panic in New Zealand will present these Australian banks with a major problem," Wood said. "It is certainly the case that if the New Zealand government decides, Northern Rock style, to guarantee all deposits, it will certainly want ownership of its banking sector back," he said. "Note that the only non-Australian owned major bank in New Zealand is the government-owned Kiwibank, an institution which Greed & Fear now recommends all depositors with New Zealand dollars to transfer their savings to immediately." Wood went on to warn that the problems in New Zealand were a lead indicator of what might happen in Australia. "For like New Zealand, there has been a consumer debt driven bubble of massive excesses in Australia further fuelled by the following wind from the commodity boom," he said. "Thus, Australia still has a current account deficit of 7% of GDP despite the massively positive terms of trade shock stemming from the commodity boom. The problem now is that the domestic economy is unwinding just as the oil-led commodity complex is showing growing evidence of cracking," he said. "Like their New Zealand subsidiaries, the Australian banks also have a high loan-deposit ratio of 135%. This again translates into what is likely to prove an increasingly costly, and therefore reckless, dependence on wholesale funding. "As has been noted by Daniel Tabbush, the issue for banks in both New Zealand and Australia is that the rapidly weakening economies means that they will be forced to lower lending rates as both the Australia and New Zealand central banks start cutting rates aggressively in coming months. "But the problem will be that deposit rates will not come down nearly as quickly. One reason why is that the Australian and New Zealand currency bubbles have finally begun to bust. The New Zealand central bank has already cut once but a lot more rate cuts are coming since short term rates are still 8%. As for Australia, the central bank faces a problem of a two tier economy, in the sense of the strong commodity driven economy in the West and the weakening housing market in the East of the country. Wood, a former journalist for The Economist, saw an opportunity for macro investors to bet aggressively on falling interest rates and falling currencies for Australia and New Zealand. "But both trends will not be bullish for Australian banks which absolute-return investors should remain short of as for relative-return investors in Asia Pacific, the increasing likelihood of significant Australian dollar weakness over the next 12 months or more is another reason to run a massive underweight in Australia," he said. "This should be funded by an overweight in Japanese domestic stocks given the massive potential for yen appreciation against both the Australian dollar and the New Zealand dollar." Wood said another likely result of the coming financial crisis in Australia and New Zealand was the withdrawal of Japanese investors from Uridashi bonds. "The Japanese enthusiasm for the high yield on offer "Down Under" and the willingness to ignore the obvious currency risks have been well documented," he said. "Still a new report by CLSA's Head of Japan Research Jolyon Montague highlights the extent of this exposure. Thus, to quote one example, the Japanese investment trust industry has invested Y2.9 trillion in Australian bonds and another Y511bn in New Zealand bonds as at the end of June 2008, accounting for 16.7% of its total foreign bond holdings." "This same report notes that the flows into Aussie and Kiwi dollar instruments from the Japanese have already begun to slow. But there has as yet been no panicky withdrawal of funds. But that stampede for the exit will inevitably come if events turn out as Greed and Fear expects." Wood said the financial excesses of the credit bubble were not just confined to America. "This is a global phenomenon where the greatest excesses have been where the Anglo-Saxon free market model has been most vigorously practised. As noted here before by Greed and Fear, this is not an indictment of the free market model per se. But the model has been fatally compromised by the only too evident view of the relevant financial service sectors that the relevant governments and central banks will always bail them out of a problem," Wood said. "While this story is becoming increasingly understood in the financial markets, it is also going to become common knowledge on Main Street during the next 12 months. In the meantime, returning to the Australasian theme, while the initial vulnerability lies, as with Northern Rock, in terms of excessive dependence on wholesale funding, the long-term problem will be rising NPLs," he said. "These have barely begun rising. The NPL ratio for Australian banks is now only 0.4%, compared with a peak of 9.1% in 1992. Likewise, New Zealand banks' impaired assets to lending ratio have declined from 9.2% in 1991 to 0.1%." My view (for what it's worth). Christopher Wood paints an even gloomier picture than I do (and that's saying something) about the potential for contagion to spread from finance companies to banks. However, I don't think he's right that our banks are precarious or in any way vulnerable to a run. Our banks are very well capitalised. They are diversified across small business, medium business and corporates for lending, albeit with a bigger than usual exposure to home mortgages. However, they are heavily exposed to international markets for wholesale funding. But the banks are telling me they have no problem getting this funding at the moment. It simply costs more. One factor Wood may have missed from Hong Kong is that the Finance Companies and Mortgage Trusts that have collapsed were virtually unregulated. They were not forced to keep capital aside and they were involved in very risky lending at the fringe to Bentley-driving property developers. Most were also completely exposed to capitalising loans to developers and investors that required highly liquid real estate markets with rising prices to survive. Our banks are heavily regulated by the Reserve Bank, which forced them months ago to keep aside extra capital in case house prices fell 30%. The banks here also raised over NZ$2 billion through perpetual bond issues and other pseudo equity in March, April and May. I do, however, agree that the lack of a deposit insurance scheme is an issue that should be addressed to add another protection against a run on a bank. If I had to rank the banks in the same way as I did for the finance companies, our 4 banks would get all the ticks in our 5 Survivability Factors. They are diversified in their lending and their borrowing (certainly much, much more than for finance companies. They have AA credit ratings. They have very strong corporate backers in that they are owned by Australian pension funds with A$1 trillion in savings. At the last resort, neither the New Zealand nor the Australian government (and Reserve Banks) would allow any one of these banks to fail. If any one of them got into trouble, a merger would be forced or some bailout organised. At the very last resort the government would bail out any struggling bank and nationalise it. Your money is much safer in the bank in New Zealand than in any finance company and it is safer than in any bank in Britain or America, where there are genuine concerns about exposures to reckless securitised mortgage lending in America. Our banks hold their mortgages on their own balance sheets and control their own lending processes and standards.