Brian Gaynor: Why Kiwibank is hungry for capital

Kiwibank has been able to rely on the New Zealand Post network. Photo / Richard Robinson

The banking system is back in the headlines with the suggestion that Kiwibank may offer shares to the public and the proposed formation of a new bank through the merger of Marac, CBS Canterbury and the Southern Cross Building Society.

Banking is a serious issue in most countries but particularly here because the four main banks are overseas owned.

The proposed sale of shares in Kiwibank has raised fears that it may also fall into foreign hands while there has been a favourable response to the planned Marac bank.

However bank licences are difficult to obtain and, if successful in this regard, the Marac bank will face far more competition than Kiwibank did when it was set up in 2001.

Of New Zealand's 19 registered banks the four main ones - ANZ National Bank, ASB Bank, Bank of New Zealand and Westpac - represent 92.1 per cent of total bank assets.

The three domestic-owned banks are relatively small as Kiwibank has a market share of 3.7 per cent, TSB Bank 1.3 per cent and Southland Building Society just 0.8 per cent.

Thus the 16 overseas banks have a 94.2 per cent market share, leaving the three domestic banks with just 5.8 per cent.

Kiwibank is owned by New Zealand Post, TSB Bank by the TSB Community Trust and the Southland Building Society is a mutual.

Kiwibank was incorporated on May 4, 2001, with only $4 million of capital. It became a registered bank six months later.

Kiwibank had a relatively easy start because the main Australian-owned banks considered it to be a bit of a joke and didn't take it seriously.

The new bank was also able to take advantage of New Zealand Post's 300-plus outlets and this reduced its start-up costs. This is because Kiwibank remunerates its parent company on a transaction basis only.

Most banks classify their customers into different categories which we will call gold, silver and bronze. Kiwibank has been particularly successful at attracting the bronze, or less affluent, clients and now has around 700,000 customers.

The accompanying table shows that the company has achieved phenomenal growth since 2001. As at March 31, 2010, it had assets of $12 billion and equity of $426 million.

Net profit for the June 2009 year was $63.6 million and the bank reported a net profit of $35.8 million for the first nine months of the June 2010 year, compared with $40.1 million for the same period in the June 2009 year.

However Reserve Bank capital adequacy requirements mean that fast-growing banks are capital hungry. Consequently the Crown, through New Zealand Post, has had to contribute new equity each year except in 2002-03.

Kiwibank has yet to pay a dividend because of its huge capital requirements.

Equity of $426 million as at March 31, 2010, comprised $310 million of share capital, $164 million of retained earnings and a negative $48 million, mainly from cashflow hedges.

Westpac, the smallest of the big four, is still 4.6 times larger than Kiwibank.

The big question now is, do the public want the bank to continue to grow and challenge the Australian-owned banks and, if so, who will fund this growth?

The obvious answers are yes to the first part and then the funding must come from either the Government or from some other source.

If the Government funds the growth then this will reduce its expenditure in other areas, including health, education and new infrastructure.

A better option would be to issue shares to the public on the basis that the Government would maintain majority control and foreign ownership would be restricted by legislation.

These restrictions would be essential because politicians made a hash of full privatisation in the 1980s and 1990s. In addition Kiwibank's marketing has had a heavy patriotic bias while most of its customers are in the bronze category and these are strong supporters of majority Government ownership.

Public ownership of between 20 per cent and 30 per cent, which would be through the issue of new shares and be widely distributed, would allow Kiwibank to raise the capital required to help it catch the Australian-owned banks.

This would also allow the Government to maintain control and enable it to focus on its social and non-commercial objectives.

This week it was announced that Marac, a fully owned subsidiary of Pyne Gould Group, listed CBS Canterbury and Southern Cross Building Society would merge to create a South Island-based banking entity.

The merged group would have starting assets of about $2.2 billion, compared with Kiwibank's $12.1 billion, TSB Bank's $4.3 billion and Southland Building Society's $2.7 billion.

The proposed bank faces two big hurdles:

* To obtain a banking licence from the Reserve Bank.

* To implement the merger and set up the systems needed to become a profitable bank.

The Reserve Bank looks at a large number of criteria before granting a banking licence.

These include:

* The incorporation and ownership of the applicant.

* The suitability of the directors and senior managers.

* The size and nature of the applicant's business.

* Capital, loan concentration, risk management and the "separation of the business from other interests of the owner".

The proposed bank has a great deal of work to do before it is granted a licence, particularly in regard to its credit rating.

The three existing companies have the following ratings: Marac BB-, CBS Canterbury BB+ (stable), and Southern Cross Building Society BB (stable).

This compares with AA for the four main Australian-owned banks, AA- for Kiwibank, BBB+ for TSB and BBB for the Southland Building Society.

It is reasonable to assume that the Marac group will have to achieve a BBB- or better rating before it is granted a banking licence.

The other big task is bringing together three different groups, an extremely difficult assignment for companies with a combined customer base of 70,000.

Technology will be a huge challenge, with a basic platform costing at least $10 million, and up to $50 million. The main Australian-owned banks have technology spends of up to $50 million a year.

The other tests will be management and board quality, distribution and competition.

Banks are different from finance companies and building societies and the Marac proposal will have to employ experienced bank staff.

Banking regulations are far greater than the existing Marac group management and board will be used to, particularly regarding money laundering, Basel 11 requirements and so on.

Distribution will also be demanding because the new bank will be based in the South Island, where there is far less growth than there is in Auckland, and the three existing companies have only 21 branches between them.

Finally the four main banks are unlikely to underestimate the potential of a New Zealand-owned bank as they did with Kiwibank.

The proposed Marac bank will face strong competition from the incumbents but if it has the right structure - including capital, a spread of assets, a high credit rating, world class technology, effective distribution and a strong management team - then it should give the existing banks a run for their money over the medium to longer term.

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