BNZ's 1 bln euro covered bond issue hits its net interest margin with lending growth weak; wants to lend more to reluctant customers

By Gareth Vaughan

The Bank of New Zealand (BNZ) says one of the main reasons for its flat first-half year margins is because the bulk of the NZ$1.75 billion it raised in a European covered bond issue last November is being held in cash and earning lower returns than what it cost the bank to raise the money.

BNZ's financial results for the six months to March 31, out yesterday, showed its net interest margin unchanged from the first-half year at 2.24% with net interest income up just 0.3% to NZ$640 million.

The bank's CEO Andrew Thorburn said one factor in this was the cost associated with securing NZ$1.6 billion worth of retail deposit money during the half in a "competitive" market for retail funding. BNZ chief financial officer Ken Christie said the 1 billion euro, seven-year covered bond issue had also weighed on margins given weak lending growth meant BNZ was sitting on most of that money.

"We're holding that NZ$1.7 billion essentially in cash and therefore the returns we get are substantially lower than what it cost us to pay for that," Christie told interest.co.nz.

The bank grew its gross loans in the half by just 0.7% to NZ$55.4 billion. Thorburn said deleveraging had been a major factor.

"Our business book has grown NZ$400 million in the half, but we lent NZ$1.2 billion of new money to business clients in that same period. So you can see the deleveraging that has occurred to bring it back to (a) NZ$400 million net (increase)," Thorburn said.

Bringing the money home 'not cheap'

Christie said issuance costs and the cost of converting the covered bond money into New Zealand dollars - from euros to the US dollar and then the kiwi - was not cheap.

"It was about 110 basis points of additional funding costs just to do those swap transactions to bring it back from euros to kiwi dollars," said Christie.

The seven-year issue, sold to European institutional investors, was priced at a spread of 62 basis points per annum over the Euro mid swap rate.  BNZ is paying a fixed interest rate of 3.125% per annum to the investors'.

Despite the costs of the big covered bond issue, Christie said BNZ had wanted to strengthen its balance sheet ahead of 2012 and 2013 when it expects increased lending growth.

"And we didn't want to be in a position where we hadn't pre-funded our balance sheet," Christie added.

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.” Popular in Europe, they are usually issued for terms of between five and 10 years. 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.

Overall BNZ is "certainly cashed up," Christie said, with cash and liquid securities well in excess of NZ$8 billion.

'Deleveraging necessary but it's now time to borrow again'

Meanwhile, Thorburn said the deleveraging of the past couple of years had been necessary, but now was the time to start borrowing again. Most New Zealand businesses were in good shape and there was strong demand for our products and services in key overseas markets like Asia, Australia and the US.

"I think we should be stepping out more confidently because there's no way New Zealand is going to achieve its potential as an economy if we don't have businesses growing, creating exports, creating profits, creating jobs," said Thorburn. "And I think that's something we as a country need to be a lot more supportive of."

BNZ economists are forecasting 2012 Gross Domestic Product growth of 3.6% and systems lending growth for housing and personal credit of about 3%.

"That's more positive than where we've been and is a good start," Thorburn said. "(But) what I'm saying is it could be better than that if businesses back themselves, start to invest, start to leverage their balance sheets sensibly. We as a bank certainly want to support that."

BNZ's forecast growth could be exceeded but this would require businesses being confident in investing. "And in the long run as a nation us really being a lot more pro-business and business oriented," Thorburn said.

Thorburn's comments echo those from his Westpac counterpart George Frazis this week. Frazis said after 18 months of deleveraging by both households and businesses, New Zealand now needed to move from "caution to confidence" and Westpac was "match fit and ready to help."

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