International credit ratings agency Standard & Poor's is warning that New Zealand and its banks are vulnerable to a sharp correction in property prices.
In a report on the New Zealand banking outlook S&P says its "base case scenario" sees real estate prices continuing to stabilise at current levels over the medium term, and such an occurrence having a stabilising effect on asset-quality ratios, especially as residential mortgage loans account for approximately 60% of the total banking sector loans.
"That said, given the uncertain short-to-medium term outlook for the global economy, we are of the opinion that there remains a significant risk of a sharp correction in property prices," S&P said.
"We believe that a scenario that may lead to such a weakening of New Zealand's macro-economic factors is a deterioration in the terms of trade or a widening in the current account deficit from its current cyclical low, which could heighten the risk of a sharp depreciation in currency and a sharp fall in property prices.
"In our view, such a scenario, in conjunction with a rise in unemployment, could increase the risk of a significant rise in banks' credit losses, on the back of a build-up in housing prices and domestic credit over the period that preceded the global financial crisis.
"We are of the opinion that such a scenario would have a material impact on the financial strength of the balance sheets of New Zealand banks."
The warning salvo from the ratings agency comes amid a stream of news suggesting more and more heat in the property sector. Statistics New Zealand figures for January showed that construction consents for new houses (excluding apartments) were up a seasonally-adjusted 9.6%. Reserve Bank sector credit figures for January showed a NZ$952 million rise in home lending during the month - the most in dollar terms for nearly five years and the biggest annual rate of increase in four years. Real Estate Institute figures for January showed that the annual median house price was up 4.2%, while the number of houses sold hit a five-year high for the month.
S&P said it had noted the recent increases in property prices in regions such as Auckland and Christchurch and considered that a continued rise in house prices could amplify the credit losses if there was a subsequent sharp correction in property prices.
"We are also of the opinion that the current subdued credit growth environment may also lead to an increase in competition between banks that could increase the risk appetite of New Zealand banks, especially in light of modest earnings outlooks relative to historical levels."
S&P rates countries' economic risk from 1-10, with 1 being the least risky. New Zealand currently has an Economic Risk Score of '3' . Should the economic risk buildup and the Economic Risk score be lowered to '4' from '3' the ratings on New Zealand banks could be lowered, the ratings agency said.
"We are of the opinion that such a change in the Economic Risk score would have a direct impact on the stand-alone credit profile of all New Zealand incorporated banks and the issuer credit ratings of banks that do not benefit from group support. A change in the Economic Risk score could also impact our capital and earnings assessment especially in instances where risk adjusted capital ratios are close to our threshold levels."
S&P said it was also of the opinion that there remained a significant risk of disruption in the banking sector's access to funding, given the sector's material dependence (37%) on external borrowings.
"In particular, we consider the New Zealand banking system's sensitivity to a disruption in external funding could be more pronounced during a period of rapidly depreciating currency, falling property prices, or increased credit losses. Nevertheless, we consider that the major banks are likely to benefit from their parents' support in normal as well as most stress scenarios."