Some heavily indebted dairy farmers are barely covering their interest payments despite relatively strong prices for several seasons, Westpac NZ chief executive David McLean says.
"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 says.
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"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 Sept. 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 says it's only the dairy sector that remains stressed because other farmers "are doing quite nicely."
Fonterra's payout fell to just $3.90 a kilogram of milk solids 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 last 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 says some farmers need 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," he says.
Agribusiness loans grew from $9.2 billion to $9.5 billion in the year ended September, accounting for 8.1 per cent of total capital employed.
Westpac New Zealand lifted annual net profit 3 per cent to $964 million, boosted by a net $10 million write-back of charges against profit for bad debts and the $40 million gain from selling its Paymark stake.
The bank says its core earnings for the year were down 1 per cent amid strong competition and rising costs.
"We think we've delivered a balanced result in a challenging environment," McLean says.
Westpac's operating costs rose 7 per cent in the year to $993 million while net interest income was nearly flat at $1.97 billion and non-interest income rose 10 per cent to $448 million – the latter reflected the Paymark profit which helped offset the bank removing or reducing 13 fees in the year and removing five products from service or sale.
The fee reductions followed the joint review of conduct and culture by the Reserve Bank and the Financial Markets Authority which was sparked by the Australian royal commission into financial services.
Westpac's chief financial officer, Ian Hankins, says 2 per cent of the costs increase related to that review, another 2 per cent related to other regulatory changes including RBNZ's policy restricting outsourcing and the bank's remediation work on its internal models for calculating capital.
In late 2017, RBNZ had announced that Westpac had failed to get approval to use nearly half the internal models it had been using since it was accredited to do so in 2008.
The only New Zealand banks allowed to use internal models are the four Australian owned banks which account for about 88 per cent of the NZ banking system, giving them a strong competitive advantage. All the other banks have to use standardised models.
While Westpac worked to get the necessary approvals, RBNZ had ordered the bank to hold about $1 billion of additional capital, a two-percentage-point overlay above its minimum required capital. RBNZ will lift that impost from Dec. 31.
Hankins says Westpac NZ's capital position at Sept. 30 was little changed from June 30 when it had common equity of 12 per cent, total tier 1 capital of 14.7 per cent and total capital including tier 2 capital of 16.7 per cent.
That compares with ASB Bank's total capital of 14 per cent, ANZ Bank's 13.5 per cent and Bank of New Zealand's 13.7 per cent.
The regulatory minimum tier 1 capital is currently 8.5 per cent but RBNZ has proposed raising that to 16 per cent for the major banks and requiring it all to be common equity – the current rules allow 2 per cent to be made up of hybrid securities which cost about a fifth of equity.
The RBNZ proposals also include restricting the advantage the Australian-owned banks get from using internal models, which will push up the actual amount of capital they will need.
In February, RBNZ revealed that ANZ Bank held slightly more than half the capital to support every $100 of mortgages than the government-owned Kiwibank had to hold.
RBNZ, which has estimated the banks would need to raise another $20 billion in capital to meet the proposed requirements, has said the major banks could meet the new requirements by withholding 70 per cent of the dividends they currently pay their Australian parents over a five-year period.
RBNZ is scheduled to announce its final decisions in early December. Observers expect it may increase the phase-in period from the proposed five years.
McLean says Westpac hasn't yet made any decisions on whether the New Zealand subsidiary will return some capital to its parent and nor has it made any decisions on dividends.
But the parent bank, which reported a 16 per cent fall in annual net profit to A$6.78 billion, is about to be flush with capital after its current A$2.5 billion capital raising.
Ahead of the capital raising, the parent's common equity tier 1 ratio at Sept. 30 was 10.67 percent, just above the Australian Prudential Regulatory Authority's 10.5 per cent minimum "unquestionably strong" benchmark. The capital raising will lift that ratio to 11.25 per cent.