S&P Global Ratings says the economic risks facing financial institutions operating in New Zealand are increasing because of soaring house prices, viewing the economic risk trend as negative

• Economic risks facing financial institutions operating in New Zealand are increasing because of soaring house prices.
• We now view the economic risk trend as negative, reflecting a one-in-three possibility that in the next two years New Zealand financial institutions could face greater risk of a sharp fall in house prices, which could potentially result in higher credit losses, particularly if the growth continues unabated.
• If the current trend persists, we expect to assess our economic risk score for the New Zealand banking industry as having worsened. Nevertheless, we expect to keep our issuer credit ratings on the six rated New Zealand banks and two rated nonbank financial institutions unchanged in that scenario, primarily reflecting the support of more highly rated parents.
• In our base case, New Zealand financial institutions' credit losses are set to return to pre-COVID-19 levels on the back of a strong economic recovery.

S&P Global Ratings today (Friday, June 25, 2021) said that the economic risk trend for banks operating in New Zealand has turned negative, reflecting a one-in-three possibility that in the next two years New Zealand financial institutions could face greater risk of a disorderly correction in house prices if the sharp growth persists and prices continue to build (see snapshot below). This could result in higher credit losses for New Zealand financial institutions in the longer term. If the current trend persists, we expect to assess our economic risk score within our Banking Industry Country Risk Assessment (BICRA) for New Zealand to have worsened by one category.

This buildup of risks could lead us to lower our stand-alone credit profile (SACP) of some banks. Nevertheless, our issuer credit ratings on the six rated New Zealand banks and two rated nonbank financial institutions will likely remain unchanged due to strong parent support. We expect to keep our ratings on the four major New Zealand banks equalized with those on their Australian parents.

Unprecedent house price growth of more than 30% in the past 12 months is exposing financial institutions in New Zealand to rising economic risks, in our view. While the government and the regulator have taken various actions to mitigate the risks to financial system stability from the resurgent house prices, these initiatives have so far been less effective in restraining house price inflation than we previously anticipated. We now see a heightened risk that property price growth continues unabated.

Heightened Risk That House Price Growth Continues Unabated

In our base case, we expect that the Reserve Bank of New Zealand's (RBNZ) reinstatement of its loan-to-value restrictions from March 1, 2021, and subsequent tightening from May 1, 2021, will support an orderly slowdown of house price growth. Prices have soared in recent months on the back of improving economic activity, low retail interest rates, and persistent supply and demand imbalances.

We believe that the New Zealand government's housing policy package will also support a slowdown in property price growth. The package includes: extending the bright-line test (tax rules aimed at curbing speculation) to 10 years from five years, removing the ability of property investors to offset interest expense against rental income for tax purposes, and lifting the price and income caps on first-home buyer grants and loans.

We also anticipate that the recent agreement between the government and the RBNZ to add debt serviceability restrictions--such as a debt-to-income (DTI) limit or an interest rate floor--to the macroprudential regulatory toolkit will assist in slowing house price growth in the country. However, any decision on applying a DTI limit will be preceded by a full public consultation process and a regulatory impact assessment. Consequently, implementation of such measures and their impact on house prices could take many months.

Nonetheless, downside risks are increasing, in our view, particularly if policy support measures are unsuccessful in curbing property price growth.

Credit Losses To Return To Pre-COVID-19 Levels

In our base case, we forecast that the New Zealand banks' credit losses will return to pre-COVID levels in the next one to two years. This reflects the New Zealand economy's faster recovery from the effects of the COVID-19 pandemic than most advanced economies, supported by the government's fiscal stimulus. Despite the fiscal stimulus winding down and the end of the moratorium on mortgage lending and lending to small and midsize enterprises on March 31, 2021, we expect that credit losses over the next two years at New Zealand banks will return to about 5 basis points of gross loans and advances. Credit losses could rise well above our base case if house prices were to unwind in a disorderly manner or there was a material recurrence of a COVID-19 outbreak and containment restrictions, resulting in a deep and prolonged recession.

Issuer Credit Ratings On Six Rated New Zealand Banks And Two Nonbank Financial Institutions Should Remain Unchanged

If we assess the economic risk score within our BICRA for New Zealand as having worsened, we would apply higher risk weights in our capital analysis, which would result in a weakening in our capital ratios for all banks and nonbank financial institutions in New Zealand. We estimate that in that scenario, our issuer credit ratings on the six rated banks: ANZ Bank New Zealand Ltd., ASB Bank Ltd., Bank of New Zealand, Westpac New Zealand Ltd., Rabobank New Zealand Ltd., and Kiwibank Ltd.; and two rated nonbank financial institutions-- Avanti Finance Ltd. (Avanti), and Liberty Financial Ltd. (LFL)--should remain unchanged.

At the same time, the SACP for some of the New Zealand banks may weaken in such a scenario. Nevertheless, increased uplift above their SACPs due to parent (New Zealand government for Kiwibank) support should offset the impact of a one-notch weaker SACP on our bank issuer credit ratings. Even under our higher risk settings, we expect our risk-adjusted capital ratios on LFL and Avanti to remain above 15%, consistent with our current capital assessment. Furthermore, we continue to equalize the ratings on LFL with those on its parent, Liberty Financial Pty Ltd. (Liberty), reflecting Liberty's unconditional and irrevocable guarantee of LFL's obligations.

S&P Global Ratings believes there remains high, albeit moderating, uncertainty about the evolution of the coronavirus pandemic and its economic effects. Vaccine production is ramping up and rollouts are gathering pace around the world. Widespread immunization, which will help pave the way for a return to more normal levels of social and economic activity, looks to be achievable by most developed economies by the end of the third quarter. However, some emerging markets may only be able to achieve widespread immunization by year-end or later. We use these assumptions about vaccine timing in assessing the economic and credit implications associated with the pandemic (see our research here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.

This report does not constitute a rating action.

This is a press release received from S&P Global Ratings.