Last week, Kiwibank’s owner Kiwi Group Capital announced that it invested $225 million into Kiwibank. The purpose of this investment is to accelerate growth. The infusion, a year after the government bailed out the largest New Zealand-owned bank, should be seen as an “expression of confidence”.
I have written often about the bank, non of it was encouraging. Unfortunately, last week’s announcement did not change my thinking about the bank very much. Its main capital ratio has flatlined after a steady decline, while other NZ banks managed to grow their CET1 ratios significantly. The government’s motivation for the bailout was to create a disruptor bank. However, as reported by Jenée Tibshraeny last week, Finance Minister Grant Robertson admitted that the disruptor story had not materialized: “Sometimes it’s played that role, sometimes it hasn’t. But there is scope there”.
More eggs in one basket
Against this background, what should we expect from this equity infusion of $225 million?
To answer that question, I will explain the transaction in more detail, taking the point of view of the parent holding company: Kiwi Group Capital. This is the ultimate parent and holding company of the group that includes Kiwibank and New Zealand Home Loans.
Before last week’s transaction, and ignoring New Zealand Home Loans, the balance sheet of the Kiwi Group Capital looked something like this:
This balance sheet structure is characteristic of bank holding companies. Dominant assets are equity investments in subsidiaries of the group, and receivables, which represent funds owed by subsidiaries to the parent. Likewise, the liabilities side generally features equity or own funds of the holding company and long-term debt.
I assume that the equity infusion involved $225mn cash, obtained from the sale of Kiwi Wealth to Fisher funds, about which I wrote earlier.
Now, as you can see, the Kiwi Group Capital could have used the cash, which is an asset with zero risk, to repay any long-term debt outstanding, or pay it to the government. In that case, some of the proceeds of the sale of Kiwi Wealth would be returned to … taxpayers.
However, it looks like Kiwi Group Capital decided to buy shares in the bank that it already owns:
The resulting balance sheet shows that risk-free cash has been invested into risky bank shares that are a not necessarily a better investment than the one in strong-preforming Kiwi Wealth. Moreover, with more eggs in one basket, the group has become less diversified.
The holding company has an increased risk exposure. Now, if Kiwi Group Capital had debt in issue, as the above pictures suggest and in the absence of the parent’s financial accounts, then this would constitute a case of double leverage: a firm that borrows to buy risky equity shares. From a prudential point of view, this is not desirable, because there is the risk that the combined assets of the holding company are insufficient to cover the long term debt. Some may say that the probability of such a scenario is small. Perhaps, but please note that Kiwibank has a feeble capital ratio, and double leverage was an existential problem for ING, a Dutch bank-insurance company that had to be rescued during the Global Financial Crisis. And there is little the parent can do in case it has to redeem debt. Sell the subsidiary? Sell the receivable that in practice is a permanent investment in the subsidiary?
(For the bank nerdy folks, it should be noted that supervision generally occurs at the consolidated level. However, given that this transaction is within the group, it is invisible at that level.)
Is this money well spent?
According to the press release, “This capital injection will enable Kiwibank to continue to deliver on its growth ambitions by supporting Kiwi with their home ownership aspirations and backing local businesses to thrive.”
From this statement, it appears as though the primary focus is on the aspirations of homeowners, which does not necessarily dovetail with the notion of a disruptor bank. According to the Herald´s Tibshraeny, Kiwibank estimates proceeds from the sale of Kiwi Wealth could enable it to increase its lending by up to $4 billion. This implies safe lending, with an implied effective capital ratio of 5.625% ($225mn/$4bn), which is significantly lower than the word disruptor implies.