Bank of New Zealand boss Angie Mentis has warned that "capital will get scarcer" as it prepares itself for new capital requirements by the Reserve Bank (RBNZ).
Early next month, RBNZ is due to announce its final decision on proposals to increase the capital which banks have to hold.
Its proposals include a near doubling of the minimum common equity banks should hold from 8.5 per cent currently to 16 per cent for the big four banks and are designed to ensure there is less chance of a bank failing.
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BNZ parent National Australia Bank revealed as part of its results announcements yesterday that under the proposals it would need $4 billion to $5 billion in capital or a decrease in its balance sheet to meet the requirements.
It also said management actions to reduce the impact on the bank could include repricing and/or reducing lending.
Banks have already warned the capital increases could push up mortgage interest rates for home-loan borrowers, although the Reserve Bank has downplayed this issue saying any change is likely to be small.
Speaking after the results announcement yesterday, BNZ chief financial officer Peter MacGillivray said there was not a lot it could talk about its plans until the proposals were finalised.
"We do need around about $4 billion and that can come from a variety of different ways - we can get an injection from our parent, we can look at how we structure and shape our balance sheet, and depending on what the proposal looks like we might be able to issue capital ourselves using a tier 1 instrument.
"So really, until we get the final proposal, it is difficult to say what combination of those things will be. My guess is probably all three we will work through."
BNZ chief executive Angie Mentis gave more of a clue on where it could look to shape its loan book, saying it had moved its strategy a year ago to focus on consumer lending and small- to medium-business lending.
Asked if that meant scaling back on its loans to the big end of business, Mentis said: " I think capital will be scarcer."
She said that meant the bank would be focused on deploying its capital to those segments that were part of its strategy.
Its business lending rose in value by 6.5 per cent from $41.5b to $42.9b between March 2018 and September 2019 but its share of the business lending market was nearly flat, rising from 23.5 per cent to 23.6 per cent.
That compares to its retail lending, which rose 12.2 per cent from $39.5b to $44.3b. Its share of the home lending market has risen from 15.6 per cent to 16 per cent.
While mortgages make up 49 per cent of its $87.2b loan book, the second largest area is agriculture, forestry and fishing, which is 19 per cent.
That's an area where the BNZ has seen a rise in its credit impairments.
Its lending to the dairy industry was one of four areas highlighted by NAB as "asset quality areas of interest".
The bank noted that 6 per cent - equating to loans to the value of $471 million of its dairy book - was now impaired compared to 2 per cent in March 2019.
Mentis said it had seen a small number of exposures that it had moved to impaired.
"We are seeing an increase in headwinds in pressure for some of our agri customers, more at the bigger end.
"The increasing farm costs, there has been deferred maintenance that has happened during 14/15 and 15/16. We know there is increased compliance costs, tighter foreign ownership rules - we know there has been stress on cashflows."
But she said for the majority of its dairy lending book were loans to "solid mum and dad, family intergenerational farms".
"They are well run and they are well-placed to handle the challenges. We have just been prudent and impaired a handful of larger exposures."
Mentis said it didn't anticipate increasing the impairments further but said there were some other loans it needed to work on.
"There are a number of clients that had alternative uses for their land over the last year or so and we have got to work with them because that is not an overnight thing to change your farm from dairy to sheep and beef or to horticulture.
"I just think the industry is in a transition period. We have got to support our clients as they move through that."
MacGillivray said while there were challenges for the sector, the dairy price was forecast to be over $7 per kg of milk solids for the next year, which would help cashflows.
BNZ is not the only bank to have concerns over its dairy lending.
Earlier this week, Westpac New Zealand chief executive David McLean said some heavily indebted dairy farmers were barely covering their interest payments despite relatively strong prices for several seasons.
"The ones who've got more leverage, most of those are still covering their cost of production but some of them are close to the edge," he said.
"Their interest cover isn't that great – there are a lot of farmers who are doing it tough and there's not a lot of buffer."
That's why although only 0.32 per cent of Westpac's agribusiness portfolio was actually impaired at September 30, down from 0.42 per cent a year earlier, loans classed as "stressed" rose from 9.7 per cent to 10 per cent of the portfolio.
McLean said it was only the dairy sector that remained stressed and other farmers "are doing quite nicely".
Fonterra's payout fell to just $3.90/kgMS in the 2015/16 season from a still-poor $4.40 the previous season. At that time, the average dairy farmer needed a payout above $5 to break even.
Rising costs pushed the 2017/18 season's average break-even point to $5.88/kgMS, although the Reserve Bank has estimated the most indebted farmers need a payout above $6.20.
That was still above the $6.12/kgMS Fonterra paid in the 2016/17 season, but the past two years have been higher at $6.69 and $6.35 respectively.
This year is also shaping up well, with Fonterra's advance payout at $7.05/kgMS, the mid-point of its current $6.55-$7.55 forecast.
But McLean said some farmers needed prices to remain high for longer to fully recover.
"We need the dairy payout to stay at these levels or higher for quite a sustained period."
-additional reporting Businessdesk.