Credit rating agency Standard & Poor's is again warning rising New Zealand house prices could heighten the risk of a sharp drop, especially if there's an external economic shock.
In its 2014 outlook for the New Zealand banking sector, S&P is projecting a relatively low level of credit losses over the next two-to-three years, underpinning the strong profitability of this country's major banks.
“Nevertheless, we note that a key downside risk to our base case scenario is that persistent house price inflation 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,” said S&P credit analyst Nico De Lange.
“Consequently, we consider the stand-alone credit profiles of all 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," De Lange added. See credit ratings explained here.
The latest data from government valuer Quotable Value shows an annual increase in residential property values in the year to January of 9.6%, with a rise of 14.5% in Auckland. Residential property loans account for about 60% of total lending by the New Zealand banking sector.
The S&P report comes after ASB yesterday posted record interim net profit after tax of $416 million, a rise of 14%, with loan impairments down $7 million, or 25%, to $21 million.
This time last year S&P caused a stir with a warning that New Zealand and its banks were vulnerable to a sharp correction in property prices.
LVR restrictions & higher bank capital requirements encouraging
The credit rating agency said a sharp correction in property prices could happen if New Zealand's economy weakens through, for example, a large fall in terms of trade that weaken the country's export earnings and business and consumer confidence, with this weighing on labour market and household debt-servicing ability.
"We are of the view that a hard landing in China could potentially have a material impact on the New Zealand banking system; that said we consider the probability of a hard landing to be low," S&P said. "In our view New Zealand's direct exposure is primarily through soft commodity prices which could fall sharply in a hard landing scenario."
S&P said the introduction by the Reserve Bank of "speed limits" on banks' high loan-to-value ratio (LVR) residential mortgages, and higher capital requirements for high LVR lending, may be enough to contribute to a tightening of bank lending criteria, thereby slowing down household credit growth and containing house price growth.
Reliance on offshore funding still a weakness
Nonetheless they raised the old chestnut of the major New Zealand banks' dependence on offshore funding.
"We hold that a high reliance on external funding is a key weakness of the New Zealand banking system, with net banking sector external debt funding about 32% of system-wide domestic loans. Banks' dependence on offshore borrowing has reduced since 2010, reflecting lower credit growth and a strong inflow of customer deposits. We expect that increasing credit growth would likely increase dependence on offshore borrowing," S&P said.
"In our view, any disruption in the offshore wholesale funding markets might be to the detriment of the cost and availability of funding for banks. A potential scenario includes a euro zone crisis that causes a dislocation in international funding markets."
"In particular, we consider the New Zealand banking system's sensitivity to a disruption in external funding as possibly being more pronounced during a period of rapidly depreciating currency, falling property prices, or increased credit losses. Nevertheless, we believe that the major banks are likely to benefit from their parents' support in normal as well as most stress scenarios," S&P added.
S&P said its base case forecasts banks' nonperforming loan levels and credit losses will remain flat after peaking at about 2.1% and 0.8%, respectively, in 2009-2010.
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