Potential for big fall in NZ property prices still concerns S&P

A sharp fall in property prices remains a key risk facing the New Zealand banking sector, Standard & Poor's says.

In its annual outlook for the NZ banking sector the credit rating agency does, however, say its base case expectation is for NZ banking system asset quality metrics to stay around their current cyclical low for the short to medium-term, backed by sound economic growth prospects. A relatively low level of credit losses should continue over the next two to three years underpinning the strong profitability of New Zealand's major banks, S&P says. Nonetheless downside risks are seen.

S&P also warned of the potential for, and damage from, a sharp drop in NZ house prices in 2014 and 2013.

"We believe that persistent house price inflation notwithstanding low credit growth could further heighten the risk of a sharp property price correction sometime in the future, particularly if there is an external shock to the economy that increases the risk of the banks incurring higher credit losses," says S&P.

"Consequently, we consider the stand-alone credit profiles of banks and credit unions in New Zealand as remaining subject to negative pressures, as reflected in a negative rating outlook on a number of these banks and credit unions. We are also of the view that the banking sector's high dependence on net offshore borrowings that fund about 30% of domestic customer loans, and limited support from core customer deposits, which fund only about 49% of domestic customer loans, remain key weaknesses for New Zealand's banking system."

S&P goes on to say a significant fall in property prices could be triggered by a weakening of NZ macro-economic factors.

"In our view such a scenario could include a large fall in terms of trade that weaken NZ's export earnings and business and consumer confidence, and which ultimately weighs on its labour market and household debt-servicing ability or the ability of NZ to access capital to fund growth."

Another risk S&P points to is stresses stemming from the dairy sector.

"We note that dairy prices are low, resulting in the forecast dairy payout being well below the payout levels achieved in the 2013-2014 season. We are also of the view that banks' exposures to dairy farmers are concentrated to a small number of large borrowers and that a sustained lower dairy payout ratio might especially harm borrowers who are highly leveraged. In our view the high level of the New Zealand dollar may also have an impact on those borrowers," says S&P.

The latest Reserve Bank sector credit figures show agricultural debt of $54.318 billion and total household debt of $212.599 billion. The latest Quotable Value figures show nationwide residential property values increased 6.4% in the year to February, with Auckland values up 13%.

S&P says the NZ banking system is well capitalised with regulatory common equity tier one capital ratios above the Reserve Bank mandated minimum requirement of 4.5% plus the 2.5% buffer required. Relative to international peer banks, the profitability level of the NZ banking system is "high," S&P adds.

S&P has AA- ratings with stable outlooks on ANZ NZ, ASB, BNZ and Westpac NZ, and an A+ rating with a negative outlook on Kiwibank. See credit ratings explained here. The primary credit analyst on S&P's NZ bank report is the Sydney-based Nico DeLange.

'There is unlikely to be a material correction in Australia's residential property market'

In its outlook on the Australian banking sector, S&P predicts Australia will remain one of the lowest risk banking systems among the 85 where it makes country risk assessments.

"We believe that key economic settings will remain supportive, particularly around economic growth and unemployment, and that there is unlikely to be a material correction in Australia's residential property market," says S&P.

"That said, we believe that potential changes in the regulatory, legislative, and policy landscape following the finalisation of the Australian Financial System Inquiry (FSI) recommendations could impact bank ratings, particularly those of the major Australian banks. Although the FSI is reviewing a large range of items that could impact the Australian banking system, potential changes with respect to creditor bail-in and regulatory capital requirements stand out as the developments most likely to impact the Australian banks' credit profiles from our stable base case setting," S&P says.

Although the credit rating agency doesn't expect a major drop in Australian residential property prices, it does say increases in credit losses, precipitated by a sharp drop in property prices, remains the most significant economic risk faced by Australia's banks.

"This risk is accentuated by the recent and expected build-up in property prices, in addition to Australia's significant dependence on continued access to external funding flows."

Given the Australian economy, and therefore the country's banks, are closely linked to China's economy, this is also a key factor to consider S&P says.

"We believe that the probability of an economic hard landing in China remains low although its resultant impact on Australian banks could be significant. Furthermore, we believe that a soft or medium China landing would likely have no or low impact on Australian financial institution ratings."

*The chart above comes from the S&P report on NZ.

This article was first published in our email for paid subscribers. See here for more details and to subscribe.