Bernard Hickey: Free kicks miss mark

It is the biggest free kick in New Zealand's political and business scene at present.

Everyone is kicking the big four Australian-owned banks because, it's assumed, they're profiteering on interest rates at the expense of farmers, homeowners, and businesses.

The big four are padding their profits by not passing on rate cuts, the argument goes. The other assumption is that the only "good" bank is Kiwibank, which is sacrificing profits by cutting rates.

The trouble is the free kickers are wrong on both counts. Our analysis of bank general disclosure statements (GDSs) to the end of December shows the net interest margins earned by the big four fell fast in the second half of last year.

Banks actually sacrificed $396 million of profit from interest rates on total assets of $329.5 billion.

Surprisingly, the big fours' bank fees also fell, in total and as a percentage of assets. The only reason bottom-line profits didn't fall as much is banks stripped out around $250 million of costs in the second half of last year.

Our analysis also shows Kiwibank had the highest net interest margin in the second half of last year, compared to the only other bank reporting a six-month figure, which was ASB.

It's hard to compare with the other banks, which reported three-month figures, but Kiwibank was the only bank not to see a contraction in its margin in the second half. The only thing making its net profit look less buoyant than the big four is that its operating costs (salaries, rents, advertising) are more than double those of its big four competitors as a proportion of total assets.

These figures don't take into account what has happened in the past three months and it's possible the latest moves have reversed the falling profits, but it's unlikely, given the sheer size of the bank balance sheets and the fact that the cost of the $100 billion or so of foreign debt is as high as it was late last year.

Federated Farmers has accused the banks of profit gouging, Reserve Bank Governor Alan Bollard has called on banks to "play their part" in passing on lower interest rates and Finance Minister Bill English has told banks to accept lower profits because they are guaranteed by the Government.

It turns out the big four have already done what Bollard and English asked of them. The assumption is that banks have not passed on cuts in the official cash rate to borrowers and have cut term deposit rates much more deeply than they needed to, thus widening their interest rate margins to more than offset expected increases in bad debts.

Many customers, unions and consumer advocates are also angry at big fees to break fixed-rate mortgages.

However, it's worth doing the analysis before criticising the banks. The best way to understand what is happening to interest margins and bank profits is to look at their GDSs, which detail their net interest income, expenses, fee incomes, bad debt charges and, ultimately, net profit.

The key number is net interest income, which nets off all interest receipts and all interest payments. This effectively calculates the profit from interest on mortgages, credit cards, business loans and consumer loans, minus the cost of everything in the funding melting pot, including term deposits, long bonds, interbank funding locally and foreign short-term funding.

Simply looking at the bottom-line net profit numbers is misleading because they include all sorts of factors, including non-interest fee income, trading gains, cost reductions, bad debt charges and tax changes. It's also best to compare apples with apples by measuring everything as a percentage of assets to make sure the numbers aren't skewed by size.

All this suggests that the big four banks will be reluctant to pass on much of the expected cut in the official cash rate later this month. It also means fixed mortgage interest rates have almost certainly bottomed out because the banks will be unable to tolerate much more margin contraction.

* Bernard Hickey is the managing editor of www.interest.co.nz, a website for investors and borrowers wanting free and independent news and information about interest rates, banks, finance companies and the economy.