National Australia Bank's BNZ has reported a flat annual operating profit as a squeeze in interest margins because of higher funding costs offset a fall in bad loan charges due to a strong local economy and fewer mortgage arrears.Chief executive Anthony Healy told Banking Day in an interview that competition for term deposits had intensified and overseas funding costs had increased over the last year, reducing BNZ's net interest margin by 19 basis points to 2.25 per cent. That reduced net interest earnings by NZ$7 million to NZ$1.6 billion for the year, despite a 7.6 per cent rise in gross loans to NZ$70.8 billion, which was solidly in line with market system lending growth.Meanwhile, the bad and doubtful debt charge fell to NZ$125 million for the year from NZ$134 million the previous year, due largely to better conditions in housing and business lending reducing arrears for mortgages. This more than offset higher collective provisions because of an increase in bad debts in dairy lending.The end result was a flat underlying profit of NZ$1.3 billion, up 0.9 per cent from a year ago.Healy said the worst appeared to be over for the dairy sector now that a higher milk payout at profitable payout levels had been forecast. BNZ was the first major bank to increase its bad debt provisions for dairy lending. It reported NZ$823 million in dairy loans had been categorised as impaired but not in default as at September 30, up from NZ$579 million six months ago.BNZ also noted that it had issued NZ$900 million of tier one capital notes to National Australia Bank in October, which increased its tier one capital ratio by 1.48 per cent and strengthened its capital position. This followed the redemption of NZ$785 million of Basel II capital instruments before the September 30 balance date, which had effectively reduced BNZ's tier one capital ratio to 10.2 per cent from 10.7 per cent a year earlier.Meanwhile, Healy confirmed a restructure would result in the net loss of 100 full time equivalent positions.