Brian Gaynor: Investors lose $1b company

The delisting of Westpac (NZ) Investments is an unwelcome development for New Zealand investors.

It means that the local bourse will lose a $1 billion company and New Zealanders will no longer be able to invest in the domestic banking sector through a tax-efficient NZX vehicle.

It also gives a clear signal that the other Australian-owned banks are unlikely to change their ways and pass on imputation credits to New Zealand investors.

The recent ANZ Bank and Westpac interim results and KPMG's Financial Institutions Performance Survey 2005 highlight the strong performance of our banking system.

Last week ANZ Bank announced net earnings of A$1.49 billion ($1.58 billion) for the six months to March 31, an increase of 13.7 per cent over the interim September 2004 year result.

In the latest period ANZ's New Zealand operations contributed A$306 million or 20.5 per cent of group earnings, compared with A$219 million or 16.7 per cent for the six months to March 31, 2004.

As the National Bank was included for only four months of the first half of the September 2004 year a more meaningful comparison is with the second half of that year. In that period New Zealand contributed A$291 million or 20.5 per cent of group net earnings.

According to the March 2005 half-year commentary, New Zealand earnings were adversely affected, when translated back into Australian dollars, by the strong New Zealand dollar. Mortgage margins were tighter because of the "mortgage price war" initiated by Bank of New Zealand.

Nevertheless ANZ reported that overall conditions were relatively favourable in New Zealand.

This week Westpac announced net earnings of A$1.32 billion for the six months to March 31, an 8.2 per cent rise over the same period in the September 2004 year. New Zealand banking contributed A$203 million, or 14.7 per cent of group cash earnings, compared with A$192 million (15.6 per cent) for the six months to March 2004 and A$214 million (16.1 per cent) in the six months to September 2004.

Westpac reported strong volume growth in New Zealand but margins decreased as the operating environment became more challenging.

Westpac's share of new housing growth slowed to 15 per cent, compared with 20 per cent for the six months to March 31, 2004. This followed a decision not to reduce interest rates during the "mortgage price war".

But the most important news as far as New Zealand investors are concerned is that the Australian parent is exercising its right to convert Westpac (NZ) shares into Westpac shares in July on a one for one basis.

According to Westpac, it has made this decision because of tax changes that will create Australian franking debits in relation to the NZ class shares from July 1.

Westpac NZ shareholders receive New Zealand imputation credits on dividends received but the conversion to Westpac shares will mean that all imputation credits earned by Australian-owned banks in New Zealand are worthless.

This is a strong incentive for these banks to reduce the tax paid in New Zealand.

The Westpac NZ/Westpac conversion is particularly annoying because the Australian parent has increased its interim dividend from 42Ac to 49Ac (Westpac NZ shareholders receive the parent company dividend converted to New Zealand dollars and including imputation credits).

The 49c dividend will be the last imputed dividend paid to New Zealand shareholders, although they will be able to participate in Westpac's dividend reinvestment scheme after conversion.

According to the comprehensive KPMG report, there are 17 registered banks in New Zealand with total assets of $221 billion and net earnings after tax of $2.7 billion.

Only two, Kiwibank and TSB Bank, are New Zealand-owned.

They represent only 1.5 per cent of total sector assets and 0.8 per cent of net profit after tax.

No other Western country is so dominated by overseas-owned banks.

Excluding Kiwibank and TSB Bank, the foreign-owned banks had net earnings of $2.65 billion in 2004 and from now on there will be no imputation credits available to NZ investors from these earnings.

The performance of the banking sector has been phenomenal. Since 1992 the combined earnings of the five large registered banks has risen nearly four-fold, from $523 million to $2.08 billion.

By comparison net earnings of the five largest NZX-listed companies have risen from $807 million to $1.66 billion over the same period. The 1992 figure included a $157 million loss by Fletcher Challenge and the latest an extraordinary profit of $387 million, mainly from the sale of forests, by Carter Holt Harvey.

Net earnings of our five largest banks have risen consistently and steadily, whereas the performance of our five largest listed companies has been far more volatile.

Based on KPMG's analysis a number of other observations can be made about the banking sector over the past decade. These include:* Branch numbers have fallen from 1512 to 1153.

* The sector now has 23,548 employees compared with the 26,373 of 10 years ago.

* There are now 2004 bank-owned ATMs compared with 1068 in 1994.

* Total assets have grown from $89 billion to $221 billion and net earnings from $800 million to $2.7 billion.

But the most important change is the composition of lending.

In 1994 the trading banks had 38 per cent of net loans and advances to residential mortgages compared with 54 per cent in 2004.

In rough figures this means that registered banks had $95 billion lent against residential property in 2004 compared with just $24 billion 10 years earlier. The aggressive lending has fuelled the housing market and substantially increased banking exposure to the residential property market.

According to KPMG, the acquisition of the National Bank by ANZ Bank has changed the industry. Before this the five main banks (ANZ, ASB, BNZ, National and Westpac) were fairly similar in size and had more than 85 per cent of total bank assets.

The ANZ-National group is significantly bigger than the other three and the amalgamation was seen as an opportunity by the other banks to take customers from the combined entity. This resulted in the "mortgage war", which has now abated but could resurface.

The final word goes to Andrew Dinsdale of KPMG. In the introduction to his firm's banking study Dinsdale is highly critical of any attempts to bring the New Zealand banks under Australian regulatory control.

He wrote that the Australian Prudential Regulatory Authority would not be responsible to the New Zealand Government.

He noted, with a sense of irony, that Australia had strict policies regarding bank ownership and foreign ownership of the ANZ, CBA, NAB and Westpac, the owners of more than 85 per cent of our banking assets, is strictly prohibited.

But the horse has bolted as far as the New Zealand banking sector is concerned.

We should not have sold ASB, Bank of New Zealand, Trust Bank and 25 per cent of ANZ New Zealand to the Australians.

The result is that after the Westpac conversion none of the main banks will be paying imputed dividends in New Zealand and there will be a strong incentive for them to transfer profits to Australia to have more franking credits available for their Australian shareholders.

* Disclosure of interests: Brian Gaynor is an executive director of Milford Asset Management.