Royal Bank of Scotland analysts predict revenue growth at Kiwi subsidiary banks to outperform Aussie parents

By Gareth Vaughan

Royal Bank of Scotland's Sydney-based banking analysts say the New Zealand subsidiaries of the big four Australian banks have an improving outlook, after a period of "mediocre economic and banking conditions," with their revenue growth likely to outperform that of their parents by about 1% per annum over an 18 month period.

In a recent research report entitled Backing the All Blacks, Royal Bank of Scotland (RBS) analysts Andrew Lyons, Ashley Dalziell and John Buonaccorsi say the New Zealand economy was hit particularly hard by the global financial crisis, which created a long period of "mediocre" economic and banking conditions. Furthermore an initial recovery was derailed by the Christchurch earthquakes.

"However, helped by fiscal and monetary support over recent months, consumer and business confidence has rebounded sharply and we believe the outlook for New Zealand’s economy over the short to medium term is now brighter," the analysts say.

Their report was released before last week's turbulence on global financial markets but comes at a time when the big Australian owned banks - ANZ, ASB, BNZ and Westpac - are already recording strong profit growth, despite anemic lending growth, highlighted by ASB's record annual net profit after tax of NZ$568 million with home loan margins wider than they were during the mid-noughties credit boom.

Theme emerges

The upbeat RBS view of the New Zealand banking sector follows a prediction late last year from Sydney-based UBS banking analysts that the New Zealand subsidiaries would be important profit drivers for their Australian parents for the first time in a decade as fixed-term mortgage customers flock to floating, or variable, rate loans. It also comes after Westpac New Zealand CEO George Frazis said New Zealanders were now more positive than their Australian counterparts about the economic outlook, with credit due to "solid and consultative political leadership" from Prime Minister John Key.

And the Westpac Banking Corporation's third quarter trading update today revealed that its New Zealand subsidiary delivered 2% lending growth in the June quarter, double the group's 1%.

The RBS analysts point out that the four Australian owned banks, combined, are sitting on 89% of total loans in the New Zealand banking market, which contributed between 6% (Westpac) and 16% (ANZ) of their parent's total group first-half year cash earnings.

"We forecast 8.1% annualised growth in net interest income over the next 18 months, driven by 10 basis points of margin expansion and 4.4% growth in average interest earning assets," the RBS analysts say.

"We assume 6.6% annualised growth in product net interest income, which is approximately one percent higher than our Australian product net interest income over this period. Total system (credit) growth is currently running at 0.5% and so we do assume a recovery over the next 18 months to 4.5% (annualised)."

Housing market 'has turned corner'

Of the housing market the analysts' say arrears have performed relatively well and the housing market "appears to have turned" with both house prices and sales increasing recently. They also note a recovery in mortgage approvals saying this highlights that housing demand should remain solid.

The Reserve Bank's latest housing loan approval data shows that at 5,983, the volume of home loans approved in the week to August 5 was the highest since 6,076 approvals in the week to April 1. The NZ$897 million value of home loans approved in the week to August 5 was the highest since NZ$904 million worth of approvals in the week to November 20, 2009.

The analysts say the housing market outlook was "further buoyed" by the government's offer to buy 5,000 of the worst earthquake affected homes in Christchurch based on their 2007 valuations.

"Asset quality in relatively good shape, with further improvements expected. On balance, we expect that earthquake-related losses should be minimal for the majors. This is largely due to the insurance arrangements that were in place, but also the substantial government assistance," Lyons, Dalziell and Buonaccorsi say.

"Across the housing book, arrears have performed relatively well and the housing market appears to have turned. We expect that business asset quality issues will be manageable over the coming years as the New Zealand economic recovery builds momentum and record soft commodity prices dampen some of the stress currently being experienced across the agricultural sector."

Although all four banks recorded an increase in total mortgage delinquencies through the first-half of their 2011 financial year, an aging analysis gives confidence the bulk of total mortgage delinquencies is concentrated in the 1 to 30 day arrears zone which appears to have held relatively steady, with the majority of these loans returning to performing status reasonably quickly, the analysts say.  

"We believe the short- to medium-term outlook for the New Zealand subsidiaries of the major banks is improving. Coupled with product spreads, which suggest margins may rise by another 10 basis points over the next 18 months, we expect top-line growth to outperform Australia by circa 1% pa over the next 18 months."

Disaster rebuild and rugby party expected to boost economy

They note that the Reserve Bank predicts the post-earthquake rebuild of Christchurch will add about 2% to Gross Domestic Product (GDP) in 2012 and that the September-October Rugby World Cup should also assist activity.

"A recovery in loan growth is likely to gain traction through the back end of this year and we would highlight the improvement in housing finance approvals and the recovery in consumer and business sentiment," the RBS analysts say.

They note of the Australian banks, the ANZ Banking Group which owns both the ANZ and National Bank making it New Zealand's biggest bank, is the best placed to benefit from a New Zealand pick up.

"We also expect that its move to a single New Zealand banking technology platform should provide significant medium-term cost benefits - subject of course to execution."

Lyons, Dalziell and Buonaccorsi say RBS expects GDP to recover through the back end of 2011, and then average 4.9% through 2012. They expect the first Official Cash Rate hike to occur in the fourth quarter of this year, with 50 basis points through the quarter, and then for the OCR to rise through 2012, with a total of about 200 basis points added to its current 2.5% over 18 months.

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