Kiwibank - success or something less

By Fiona Rotherham

Friday 1st November 2002

West Coast farmer Arnold Nolan opened 17 bank accounts - one for each of his grandchildren - the day Kiwibank opened its doors in Hokitika in April this year. He wanted to mirror the Post Office Savings Bank accounts opened for him as a child and provide an incentive for his grandchildren to save. Nolan also opened a savings account for himself and his wife, Margaret. He thinks Kiwibank will succeed; still, he's retained his accounts with his existing bank.

His case illustrates one of Kiwibank's main problems. The bank is on track with customer numbers. It has 60,000 to date - some 10,000 ahead of target - and says it is signing up on average 500 customers a day. It says it needs 100,000 customers within three years to break even and 150,000 to be profitable. But that's not quite true. It's not quantity of customers that will make the bank profitable, it's quality. As a non-business-focused bank with low transaction fees, it will make the majority of its money in a single area: interest payments on loans. To be able to get them, it needs two sorts of customers - big savers (so there's money in the bank to lend out) and people wanting big loans, typically to buy a house. Trouble is, most of the customers Kiwibank are attracting aren't doing either with the bank.

The philosophy behind Kiwibank is to offer ordinary New Zealanders a cheaper, more accessible, locally owned banking alternative while giving its state-owned enterprise owner, NZ Post, a new source of revenue as its core mail business declines. If it works, New Zealanders win. If it doesn't, taxpayers lose, possibly big time.

Opened in February, Kiwibank is targeted to make losses for the first three years before becoming profitable. Even then, its anticipated tax-paid return on capital of 11.7% is less than half that generated by the other banks. It's difficult to tell at this stage whether Kiwibank will need bailing out but there are early warning signs.

For a start, its mortgage business has been slower than expected. To the end of the June 2002 financial year, Kiwibank had $86.1 million in customer deposits and $43 million lent in mortgages. It won't say what it expected, but mortgage broker Cairns Lockie says if the average mortgage size is around $120,000 (the national average), that is just over 350 mortgages in the five months Kiwibank's been operating. Considering the bank has 260 branches (it wants 290-300 by Christmas), this equates to each branch originating just over one mortgage. The broker estimates some branches at other banks will have originated over 150 mortgages in the same period.

To be fair, Kiwibank's deposits have doubled to $160 million and the home loan book grown substantially to $110 million since June. But that's still only an average of three mortgages per branch.

Does it matter? Kiwibank is realistic about only ever being a small player - aiming for around 6% to 7% of the overall retail banking market and 5% of the highly competitive home lending market. But when it put forward its original revenue targets, NZ Post assumed the bank would attract roughly equal numbers of two main sorts of customer: "basic", who typically are of low value and only interested in simple transaction-based banking services, and "money manager", who are typically wealthier and use the full range of banking services. Due to its low-fee structure, the bank doesn't make money on transactional accounts. It needs savings and loans business to meet its target returns. Instead, it's got customers like the Nolans at Whataroa. Kiwibank won't reveal precise details on its customer mix to date but concedes it has more children and superannuitant accounts than planned.

There's no problem with superannuitants but many of them have simply opened one account rather than switching all their banking.

The bank's average customer deposit is $2800 - half the $6000 it hoped to achieve. "The real risk that creates is they are not going to generate the substantial revenues they need to make the bank sustainable," says David Tripe, senior lecturer in banking studies at Massey University.

These problems were predicted early on in a report by external assessor Cameron & Co. It said Kiwibank would attract a greater-than-expected number of lower value customers because the survey data, upon which NZ Post's estimates were based, was overly optimistic. The data failed to take into account respondents' reaction to the cost of switching banks and competitors' response. Only 4% of New Zealand bank customers switch banks each year, despite surveys showing high levels of customer dissatisfaction. Kiwibank is the top alternative for unhappy bank customers, according to a University of Auckland annual survey, but the number of people who said they would leave their old bank and switch to Kiwibank fell this year to 13% compared with 16% in 2001 and 40% in 2000.

Cameron & Co also criticised NZ Post's prediction that some 16,000 superannuitants and high-balance customers would come over to the bank, providing a significant chunk of its overall value. These two demographic groups are often conservative, the report said, and show high degrees of inertia to switching or are unlikely to be attracted to Kiwibank's market position.

Staunch Kiwibank critic ACT MP Rodney Hide reckons Jim Anderton should come clean on the impact of Kiwibank's low level of deposits on the bank's projected profitability. NZ Post is, after all, playing with taxpayers' money. SOE Minister Mark Burton rates Kiwibank's results to date as "promising".

Despite the high risk, the Labour-led government agreed to contribute $78.2 million of taxpayers' money towards start-up costs: $72.2 million in a capital injection and $6 million more coming from a lower NZ Post dividend to the state. Finance Minister Michael Cullen warned that was the limit of the government's initial investment. But he didn't rule out NZ Post coming back for more money if it failed to meet its financial targets in three years. Moreover, any profit shortfall from Kiwibank is likely to mean reduced dividends to the government from NZ Post. The SOE pays 60% of its net profit after tax each year to the government - more than half a billion dollars since it was set up in 1987.

Kiwibank spin-doctor Bruce Thompson says the customer mix is starting to change to include more high-value customers. The bank's home lending has also picked up pace: in September it launched a guarantee for the next six years that Kiwibank would refund the difference if a home loan customer would have been better off taking a mortgage with another bank.

Since Kiwibank came on board, the major banks have increased their range of products and services but its aggressive undercutting hasn't sparked a sustained drop in mortgage rates. The big five (see "What the big five competitors say") have actually increased their margins and interest income on home loans.

It's not all bad for Kiwibank. The company announced a $10.2 million loss in the year to June - about $1 million better than budget. It hasn't said exactly how much of the agency income that formerly went to NZ Post is now on Kiwibank's books, but the postal giant reported a 4.2% net profit rise in the year to June despite the bank development costs. Operating expenses rose 2% to $913 million and earnings before interest and tax dropped $9.7 million to $46 million, mainly because of Kiwibank. For example, NZ Post was forced to meet the $25,000 per outlet refurbishment costs.

Undaunted by the hitches, Anderton wants the bank to extend its retail banking to small business accounts (companies employing fewer than 20 people) once the branch rollout is completed at the end of the year. Under the terms of the government approval, the bank is not allowed to enter corporate banking (remember the BNZ and DFC bailouts due to commercial investment loans?) and corporate banking is out of Kiwibank's league anyway. The next step will be to launch a credit card early next year - a move designed to attract the higher value customers it needs.

The jury is still out on whether these new moves will work, although Cairns Lockie is sceptical. "If a NZ Post employee threw $10 notes off the roof of parliament for eight hours a day at the rate of 20 per minute for the 23 weeks Kiwibank has been operating, they could not throw away as much money as Kiwibank has lost. We think this suggestion would bring more tangible benefits, particularly for those who picked up the $10 notes."

What the big five competitors say

WestpacTrust:

What impact has Kiwibank had?

We watch with interest what Kiwibank does but not with as much interest as we watch our major competitors. It is a very small player.

What competitive response have you made?

The week before Kiwibank launched we cut our Eftpos transaction fee to 15 cents, giving up $1 million a year in income to boost Eftpos use, but this wasn't in response to Kiwibank's 30-cent transaction fee.

ANZ:

What impact has Kiwibank had?

A very small impact on a big market. It has 60,000 customers while we have 1.1 million and we have gained customers since it started.

What competitive response have you made?

We launched a new fee and account structure in July, but this was a long-planned transtasman move in response to customer demand, nothing to do with Kiwibank.

ASB:

What impact has Kiwibank had?

It has put some focus on the banking market from the media and the public but we don't view them as a major competitive threat.

What competitive response have you made?

We lowered our mortgage rate to match theirs purely as a tactical move for the first two weeks after it started, but since then our tracking tells us we're not losing customers to them.

BNZ:

Makes no comment on its competitors.

National Bank:

What impact has Kiwibank had?

We think they have had an impact on the market but not on our business. We do take them seriously.

What competitive response have you made?

We haven't had to refocus our strategy to date.

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