Big banks under more pressure on their overseas funding reliance from credit rating agencies than the RBNZ, KPMG says

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By Gareth Vaughan

The country's major banks are ready for the Reserve Bank's planned January Core Funding Ratio (CFR) increase, according to KPMG's Head of Financial Services John Kensington, and are now under more pressure over their reliance on overseas funding from credit ratings agencies than their prudential regulator.

In a Double Shot interview on KPMG's annual Financial Institutions Performance Survey (FIPS), Kensington told interest.co.nz the big banks' look in good health for the CFR increase to 75% from 70%, which is scheduled for January 1, 2013.

"Yes, I think they are ready for that," Kensington said.

"It's something the banks have managed well. It's going to be something the banks need to continue to manage well because of the increase, but also because the (credit) ratings agencies have made it clear that while they (the banks) have made some progress, they still feel the banks are very reliant on overseas funding and should problems occur in those markets, it would be problematic for the banks."

Introduced in April 2010 as a move to reduce New Zealand banks' reliance on short-term overseas borrowing, the CFR sets out that banks must secure at least 70% of their funding from either retail deposits, or wholesale sources such as bonds with durations of at least a year. The central bank lifted the ratio to 70% from 65% on July 1 last year.

Kensington added there was probably more pressure on the banks' overseas funding now from the credit rating agencies - Standard & Poor's, Moody's and Fitch - than from the Reserve Bank. All three of the major international credit ratings have downgraded their ratings on the big four banks - ANZ NZ, ASB, BNZ and Westpac NZ - over the past year.

'Susceptible to dislocation'

Fitch, the most recent to do so, estimated wholesale funding comprised about 40% of total funding (excluding derivatives), for the banks with the offshore share of the wholesale funding about 60% of the total.

 "This funding profile leaves the banks susceptible to dislocation in international wholesale funding markets," Fitch said adding: "Fitch expects the banks will continue to improve this mix, with a greater focus on deposit-gathering, a reduced reliance on short-term wholesale funding, particularly from offshore sources, and a continued increase in the duration of wholesale funding." See more here.

Fitch currently has AA- ratings on the big four, in line with S&P, while Moody's has them at Aa3.

Credit ratings matter for the banks because they effect their borrowing costs. A higher rating generally means lower borrowing costs and vice versa.

ANZ the biggest offshore borrower; NZ$3.4 bln borrowed through covered bonds so far this year

The FIPS report shows ANZ sourcing the largest percentage of its funding from overseas during 2011 at 41%, down from 44% in 2010. Next was Westpac at 40%, ASB, including its parent Commonwealth Bank of Australia's New Zealand operations, at 39% down from 46%, BNZ at 26% up from 25%, and Kiwibank at 8%, up from 5%.

The FIPS report notes the big four banks plus Kiwibank recorded a funding increase of NZ$5.680 billion in 2011 with a NZ$10.960 billion domestic funding boost more than offsetting a NZ$5.28 billion drop in overseas funding. At the same time gross loans and advances across the banking sector rose just 1.2% to NZ$300.791 billion.

Almost all the big four's overseas funding so far in 2012 has come through their issuance of covered bonds. They've borrowed NZ$3.4 billion through covered bonds, denominated in Swiss francs, the euro and New Zealand dollar, at terms ranging from three to seven years. Domestically the bank funding highlight has been a NZ$750 million, three-year bond issue by Westpac in March.

Covered bonds are senior debt instruments backed by a dedicated group of home loans assigned to provide security for the debt known as a “cover pool.”  The way they're structured means if the issuing bank defaults, the assets in the cover pool are carved off - or ring fenced - from the bank issuer’s other assets solely for the benefit of the covered bondholders.

The Reserve Bank has been consulting on proposed covered bond legislation, with submissions having closed on March 16. New Zealand banks started issuing covered bonds in 2010. The Reserve Bank has imposed, as a condition of bank registration, that banks can't encumber (use as collateral) more than 10% of their total assets to support covered bond issuance.

OCR increase coming after delay

Last November the Reserve Bank said it was delaying a planned CFR increase to 75% from 70% until January 1, 2013 from July 1 this year. Reserve Bank Deputy Governor Grant Spencer said then the delay, as Eurozone sovereign debt crisis woes mounted, was designed to give banks more flexibility if financial markets deteriorated further.

The Reserve Bank's November Financial Stability Report showed about NZ$15 billion of longer term bank funding, which then qualified for the CFR, was due to move to shorter terms over the subsequent 12 months.

*KPMG's audit clients include ANZ NZ, HSBC NZ, TSB Bank, SBS Bank, and Heartland NZ.