In this uncertain environment it is important to emphasise the huge difference between finance companies and banks, particularly in New Zealand.
The failure of more than 20 finance companies, which is a dreadful reflection on the poor governance and lack of regulation of this sector, doesn’t signal that any of the country’s 17 banks are in trouble.
Our banks are subject to Reserve Bank supervision and are required to have a high level of disclosure, whereas there is no effective supervision of finance companies and their disclosure has been woeful.
Banks are subject to scrutiny by the major international credit rating agencies whereas there has been no requirement for finance companies to be rated.
There are a huge number of banks around the world, including more than 7100 in the United States, and Standard & Poor’s rates more than 2000 of these.
The good news for New Zealand depositors is that the four largest domestic banks – ANZ National, ASB Bank, Bank of New Zealand and Westpac – are in an elite group of only 28 banks, out of the 2000 plus, that are rated AA or better.
As the accompanying table shows seven of these 28 banks are based in Switzerland, five in the United Kingdom, four each in Australia and the United States, three in Spain, two in The Netherlands and one each in Luxembourg, France and Belgium.
There are only five AAA rated banks – three Swiss private banks, Rabobank and Wells Fargo Bank. Rabobank, which is based in Utrecht, is the only AAA rated bank operating in New Zealand. None of the five banks with an AA+ rating, which is also New Zealand’s sovereign rating, operate in this country.
Six of the eighteen banks with an AA rating have New Zealand activities, the four largest Australian banks, Hongkong and Shanghai Bank and Citibank.
New Zealand’s major banks are given the same rating as their Australian parent because it is assumed that the parent will stand by them in case of distress although there are no formal guarantees that this will happen.
The New Zealand operations could be given a lower rating than their Australian parents if Standard & Poor’s decided the latter were no longer in a position to support their NZ operations.
UDC Finance is the only other NZ financial institution with an AA rating because it is a fully owned subsidiary of ANZ National Bank.
In simple terms an AAA rating means the highest rating and quality whereas AA indicates highest quality and a very strong capacity to meet financial commitments. The two other investment grades, A and BBB, signal favourable quality but with the potential for problems in adverse economic conditions. Ratings BB and below are non-investment grade and of speculative quality.
A “positive” attachment means that Standard & Poor’s is looking to upgrade a rating whereas a “negative” indicates the possibility of a downgrade.
Kiwibank has an AA-, which was changed from negative watch to stable on Wednesday following an upgrade of its parent NZ Post from AA- negative to AA- stable. TSB bank, the only other domestic owned bank, had its rating raised from BBB to BBB+ in March.
Another feature of Australasian banking is that bank failures, where depositors lose money, are extremely rare.
The last retail bank failures in New Zealand were in the 1860s when the Oriental Bank Corporation, Commercial Banking Company of New Zealand, Bank of Otago and Bank of Auckland failed. The latter collapsed after the general manager made ill-advised loans but he was nabbed as he tried to leave the country on a mail boat. Since the 1860s banking problems, including the Bank of New Zealand nearly 20 years ago, have been resolved without loss to depositors. This hasn’t been the situation with non-bank financial institutions.
The last retail bank failure across the Tasman was the Primary Producers Bank of Australia in 1931. Depositors lost a minimal amount in this collapse.
There are a number of additional reasons why our banks are in a far stronger position than the failed finance companies. These include;
* Banks are far better capitalised.
* They have much better governance structures and minimal loans to directors, employees and their related parties.
* Banks have diversified lending books and limited exposure to property developers.
* They have much wider funding capabilities.
* Australasian banks do not appear to have material exposure to sub-prime and other collateralised debt obligations (CDOs).
A major weakness of Australasian banking has turned out to be a positive in this environment.
One of the problems faced by Australian and New Zealand banks is that they don’t have a large enough domestic deposit base to fund their activities and, as a result, have to borrow overseas.
The positive side effect of this is that they didn’t have surplus cash to invest in CDOs but the negative is that they now have much higher overseas funding costs. This will have a negative impact on margins and profitability but Australasian banks should have limited CDO writeoffs.
Depositors must be careful to distinguish between profit downgrades and the risk of bank failures.
A number of finance companies were reporting large profits just weeks before they failed or announced proposed moratoriums – mainly because of unrealistic or shonky accounting standards – whereas banks’ earnings could come under pressure but there is no risk of collapse.
The biggest negative as far as the major retail New Zealand banks are concerned is their exposure to the distressed housing market. These exposures are;
* ANZ National with 47 per cent of its total assets in residential mortgages.
* ASB Bank with 61 per cent.
* Bank of New Zealand with 40 per cent.
* Kiwibank with 73 per cent.
* Westpac with 62 per cent.
A further deterioration in the housing market will impact New Zealand earnings but the more important consideration is the strength of their Australian parents. In this regard the news is much better across the Tasman because the housing market is more buoyant and the four major banks have a total sharemarket value of nearly A$155 billion ($189.5 billion) even after their recent share price weaknesses.
Another important point to note is that bank failures in the United States are more common – and do not signal a similar development here – because of the US Government’s deposit insurance scheme.
All deposits held by an individual with each bank are insured up to US$100,000 ($139,000) by the Federal Deposit Insurance Corporation. FDIC is funded through levies from banks and savings institutions.
The deposit insurance scheme encourages the establishment of banks because individuals have a strong incentive to diversify their banking exposure once their deposit exceeds US$100,000 and they don’t have to worry about the stability of a bank if they have US$100,000 or less on deposit.
A total of 7181 US banks are covered by this deposit insurance scheme with 35 new FDIC insured institutions established since April 1, 102 merged or closed while six collapsed.
An unusually large number of US banks fail because depositor insurance does not encourage best practice corporate governance.
This is reflected in Standard & Poor’s ratings as five of the 17 NZ banks, which represent over 90 per cent of all domestic deposits, have an AA or better rating while only four of the 7181 FDIC insured US banks have achieved this standard.
Top ranking Standard & Poor’s banks– Australasian banks are highly rated
|AAA Stable||Aargauische Kantonalbank||Switzerland|
|Wells Fargo Bank||United States|
|AA+ Positive||Basler Kantonalbank||Switzerland|
|AA+ Stable||Banque et Caisse d’Epargne de l’Etat||Luxembourg|
|AA+ Negative||Bank of America, USA||United States|
|AA Positive||Luzerner Kantonalbank||Switzerland|
|AA Stable||Australia & New Zealand Banking Group||Australia & ANZ National in NZ|
|Banco Bilbao Vizcaya||Spain|
|Commonwealth Bank of Australia||Australia & ASB Bank in NZ|
|Hongkong and Shanghai Bank||United Kingdom|
|Lloyds TSB Bank||United Kingdom|
|Westpac Banking Corp||Australia & Westpac in NZ|
|AA Negative||Banco Popular Espanol||Spain|
|Bank of Scotland||United Kingdom|
|Barclays Bank||United Kingdom|
|JP Morgan Chase Bank||United States|
|National Australia Bank||Australia & BNZ in NZ|
|Royal Bank of Scotland||United Kingdom|