The profit margins of the Aussie banks who dominate the New Zealand banking market seems to be the major topic of discussion in the financial and economic media at the moment. How dare those institutions make increased profits when everyone else is struggling to make a buck? It pays to look behind the numbers before accusing the banks of being rapacious scrooges screwing the rest us. A good part of the increased profitability was the write back of excessive provisions made the year before for doubtful debts (bad loans) that did not eventuate as bad as first feared. Secondly, the artificial, unique and unsustainable situation of short-term interest rates remaining at “emergency stimulus” levels of 2.5% for two and half years has encouraged mortgage borrowers to naturally go for the lowest rate, floating rate mortgages. Thank-you, thank you say the banks to that as their lending margins above their cost of funds is greater for floating rates than fixed rate terms.
Whilst the banks have had these two favourable winds to boost their net interest margins and thus profits over the past 12 months, a look ahead is not so rosy for them on the profitability front:-
§ Write backs of over-providing for bad loans are one-off boosts to profits that do not repeat.
§ New lending growth is very slow (if not zero), thus net interest margins will decrease going forward as new deposits taken in by the banks are invested in liquid market securities instead of higher margin earning corporate and retail loans.
§ Whilst continually delayed, eventually market interest rates will increase and mortgage borrowers will all rush back to fixed rate terms, thus the more intense competition reducing bank lending margins (compared to floating rate margins).
§ Upcoming potential credit rating downgrades and Basel III banking regulatory requirements will again lift their own borrowing margins on longer term debt.
§ Competition (pricing and term) from domestic corporate bond and international debt markets will keep big corporate borrowing demand from banks at a low level. The establishment of the Local Governing Funding Agency will reduce borrowing demand on banks from that sector.
§ The Aussie banks here have all tapped the “Covered Bond” market to help reduce their overall borrowing costs, however they can only issue covered bonds up to maximum percentage of their total debt and most are already at that limit.
§ Banks with a strong Asian network (such as HSBC) are more likely to capture new banking business related to international trade as NZ importers and exporters rely more heavily on that part of the world.
§ Increased volatility in financial markets will be restricting bank trading and position taking limits and activity.
At the end of the day the competitive market will rule. If enough borrowers think that their bank lender is taking too big a margin off them, they will limit their borrowing or go elsewhere. If their bank lender shafted them when the going became tough in 2009, that will also be remembered when it comes to refinancing time. New Zealand borrowers and investors are not held hostage by the Aussie banks operating here and should not act as though they are. There are plenty of alternatives if you do not like the behaviour of the big four Aussie banks.
NEW ZEALAND DOLLAR MARKET COMMENTARY
Kiwi dollar forecast to fall before it rises again in 2012
The volatility of day-to-day movements in the NZD/USD exchange rate remains very high with daily news headlines coming out of the European debt fiasco dictating direction. Currency markets sentiment for the NZD remains unchanged in that the “risk on” mode from global investors (sharemarkets and commodity prices rising) pushes the Kiwi dollar up, and bouts of “risk off” mode sends the Kiwi down. The financial and investment markets are swinging abruptly from one mode to the other, creating confusion and uncertainty along the way. The G20 leader’s summit in France last week failed to reach any firm agreement on how Europe solves its debt and deficit problems. The Chinese, Japanese and Brazilians are not investing in any European bail-out bonds until they see a workable workout plan from the Europeans.
The NZD/USD rate continues to track both AUD/USD and EUR/USD movements, with the NZD appreciating from 0.7500 to 0.8200 in late October as market confidence grew that the European political leaders would agree a “grand plan” to bail Greece out once gain and build a firewall to prevent market contagion engulfing Portugal, Spain and Italy. The agreement to have the European banks take a voluntary 50% haircut on their holdings of Greek Government bonds, the recapitalisation of the banks and the role of the EFSF bail-out fund created short-lived euphoria in the markets. However, market confidence was soon lost as it emerged the detail would be harder to execute in practice and the Greek PM called for a national referendum to decide on the EU bail-out. It seems hard to comprehend that internal Greek political ructions is almost dictating global market sentiment and hence short-term NZ dollar direction.
Cuts in official interest rates in both Australia and Europe over this last week indicate the reduction in global inflation pressures, lower GDP growth forecasts and general concern about what the European debt problems mean for the global economy. These changes are broadly negative for the AUD and EUR currencies respectively, although neither has suffered immediate significant sell-offs. Further interest rate cuts are likely in both Australia and Europe before Christmas. Latest domestic economic data for inflation, employment and business confidence also point to New Zealand’s interest rate remaining lower for longer into the first half of 2012.
Looking ahead at the outlook and likely behaviour of NZD/USD movements over the next 12 months, the following two-stage scenario is seen as being more probable that other scenarios:-
Next six months horizon: NZD trending lower to the mid to low 0.7000’s
- Ongoing European debt/economic problems weakening the EUR/USD exchange rate to $1.3000/$1.2500 and the NZD/USD following.
- Lower global commodity prices due to weaker economic data out of China and the commodity currency, the AUD weakening as a result. Kiwi dollar following suit.
- Global investment funds favouring the USD as a safe-haven currency as the Swiss have dissuaded buying of their currency and the Japanese are intervening to sell the Yen.
Six to 12 months horizon: NZD appreciation on rising NZ interest rates
- On the proviso that the global economy does not fall into a double-dip recession, improving NZ economic growth during 2012 must ultimately lead to the RBNZ removing the 2.5% OCR emergency stimulus interest rates currently in place.
- The foreign exchange markets are always likely to build-in, or price-in, this scenario well before it actually happens.
- New Zealand may well be the only country increasing official interest rates in the second half of 2012, and thus the NZ dollar will stand out as a “buy” for global currency traders and speculators.
- The long-term economic fundamentals for New Zealand remain positive as a exporter of food to expanding Asian cities. New Zealand has come through the 2008/2009 GFC and the current fall-out from European debt problems much better than most, so it is very difficult to see the NZD depreciating relative to other economies with greater problems. Only a global recession in 2012 with both the US and Chinese economic turning sharply down would send the NZD/USD rate below 0.7000. The greater risk is that the NZD/USD returns to levels above 0.8000 in 2012.
USD exporters therefore may have a prime opportunity to enter longer-term currency hedging against the risks of 2012 over coming weeks and months.