ASB underlying profit falls 10% in Sept qtr; new CEO sees subdued growth ahead

By Bernard Hickey

Commonwealth Bank of Australia's New Zealand operation, ASB Bank, has reported a 10% fall in underlying profit in the September quarter as lending margins contracted and bad debt charges more than tripled. New ASB Chief Executive Charles Pink forecast a tough period for banks and the economy in the years ahead as individuals and companies 'hunkered down' to de-leverage in the wake of the Global Financial Crisis (GFC).

"I don't see when we're going to get back to double digit lending growth," Pink told Interest.co.nz in an interview. "I think the GFC has bought a significant change to the world and New Zealand. People are deleveraging rather than leveraging and companies are de-leveraging rather than leveraging. People in companies are hunkering down," he said.

"We probably will see low single digit lending growth going forward, which is not the world we've been used to in the last 10-20 years globally or in New Zealand." ASB's underlying profit in the three months to September 30 fell 10% to NZ$85 million from NZ$94 million in the same period a year ago, driven by a fall in its overall net interest margin from 180 basis points in mid 2008 to 160 basis points a year later and an increase in loan impairment charges, Pink said.

ASB's total impaired assets as at September 30 were NZ$418 million or 0.78% of total loans, which was up from NZ$352 million or 0.67% a year ago. ASB's profits had fallen less than the other big three Australian-owned banks, partly because its impairment charges were not as high relative to its peers, Pink said. ASB had been more conservative in the past and was now in a position to support customers because of that conservatism, Pink said.

"We have been very cautious about property lending. It's a very sensibly positioned book and we don't have big problems in property lending," Pink said. ASB had also held off relaxing its lending criteria in recent months, unlike some other banks, he said. "Some have banks have relaxed their criteria. We haven't. I don't think we're going to. As a general rule we don't lend more than 80% of value." Westpac has been the most aggressive of the big four in promoting its 80% plus loan to value ratios.

Tax provisions

ASB released its General Disclosure Statement for the three months to September 30 showing its pre-tax profit fell to NZ$120 million from NZ$127 million the previous year. ASB reported impairment losses more than trebled to NZ$77 million from NZ$19 million a year ago. Like the other big three banks, ASB also reported NZ$208 million in provisions for its structured finance transactions since 2001 in the wake of High Court decisions in favour of Inland Revenue Department rulings against the transactions.

This meant ASB reported a bottom line loss of NZ$124 million for the period, down from a NZ$94 million profit in the same period a year earlier. The GDS also showed ASB's retail banking division reported a net profit of NZ$64 million for the quarter, up from NZ$58 million in the same period a year earlier. Net profit from relationship or business banking fell to NZ$25 million from NZ$36 million, while ASB's Treasury and Financial Markets division made a loss of NZ$171 million (including the tax provisions), compared with a profit of NZ$42 million the previous year.

Dairy capital adequacy

Pink said ASB was still expanding its dairy lending as customers covered their losses.

"We are supporting our existing customers through difficult times and that's what causing our lending to rise because some of them have cash flow deficits at the moment," Pink said.

"Clearly the dairy sector is still stressed, although it's helped by the improved dairy payout forecast," he said. Pink said recent Reserve Bank moves to review capital requirements for bank lending to farming were likely to increase the amount of capital banks would have to put aside for rural lending.

"We're going to see increased capital requirements. Broadly it's not un-sensible because we have seen a rapid expansion, and this will manage that expansion, but we have to be careful around the timing and the phasing because the general effect of increased capital requirements is less lending or increased price because banks have to make acceptable returns on capital," Pink said. "The timing and phasing of the introduction of a sensible policy needs to be thought through carefully to ensure it's not abrupt in its impact on the sector," he said.

Core funding ratio

Pink said the Reserve Bank's moves towards a core funding ratio had helped drive even stronger competition for retail deposits, which was a factor in squeezing bank interest margins lower. ASB was in a better position to meet the Reserve Bank's targets for the core funding ratio than some others, he said.

The RBNZ is planning to bring in its new core funding ratio from April next year with a 'starter' level of 65%, rising to 75% within a couple of years. The core funding ratio forces the banks to have a certain proportion of their funding from local and long term sources, rather than from 'hot' wholesale markets internationally.

"We were conservatively managed so attaining the new ratios will be less of a stretch than it might have been if we had not been conservatively managed. Longer term there's a ratchet upwards. In many ways we are running ourselves in line with the policy anyway."

Production and distribution split

Pink assumed the CEO role this year after the retirement of Hugh Burrett and has appointed several new executives from outside ASB to new posts. He has also reorganised the functions of the bank somewhat around a separation of production and distribution.

Pink created "two very heavyweight roles" on risk control, including the appointment of former Royal Bank of Scotland executive Kevin McDonald as Chief Risk Officer from January 2010 and Jai Somaratne as Chief Internal Auditor from November 30.

Somaratne is a former colleague of Pink's at First Caribbean International Bank, a unit of Canada's CIBC. ASB was also splitting its 'production' and 'distribution' roles. The production role, which is named Customer, Markets and Products will be headed up by Catherine McGrath from February. McGrath is a New Zealander who has worked for BNZ and most recently worked in London at Lloyds TSB as Transaction Banking Director.

This role creates banking products, which are then distributed through the branch network, call centres and online outlets. "We've created a product management and marketing unit, which is the manufacturer of products for the organisation. We had manufacturing and distribution combined into single very big units before. We've now picked out the manufacturing because I want to have a manufacturing and distribution discipline within the company," Pink said.

Pink compared banking to car manufacturing, where cars were not built and sold in the same places. Car makers also looked to create a few platforms that could be tweaked for various customers at a relatively lower cost. "You do want manufacturing to be a separate unit. It's absolutely like building a car. Obviously in our case it's an intangible product, but the key thing is to have as few versions as possible to keep the costs down, but to be able to tweak them to meet customer needs," Pink said.

"We have not had a separate manufacturing function who are spending their whole time thinking about getting product to market. It was mixed in with our distribution units. They're different disciplines and they require different skills." Pink said ASB customers were likely to see more product innovation, more cost efficiency (which would flow on as lower prices where possible) and more product variations on a standard platform.

"We will make brave pricing moves when we can. We will pass on pricing advantage to the customer when we can," Pink said, referring to ASB's recent decision to cut its variable mortgage rate to 5.75%, which triggered a round of reductions by other banks.