Moody's affirms NZ banks' credit ratings with stable outlooks, sees 'strong buffer' to withstand stresses from a potentially more challenging operating environment

Here's Moody's release

Moody's Investors Service has today affirmed the baseline credit assessments (BCA), adjusted BCAs, counterparty risk assessments (CR assessments), and all the ratings of five New Zealand banks at their current levels.

The rating outlook for each bank remains stable.

The banks affected are ANZ Bank New Zealand Limited, ASB Bank Limited, Bank of New Zealand, Westpac New Zealand Limited - all of which are rated at Aa3, stable and a3 -- and Kiwibank Limited, at Aa3, stable and baa2.

The rating action reflects the strong financial profiles of the five banks.

Bank asset quality is currently very strong, profitability has improved, and capital remains robust. 

These favorable characteristics provide the banks with a strong buffer to withstand the stresses arising from a potentially more challenging operating environment during 2016-17. 

Moody's expects credit conditions for these banks to weaken as credit growth and household leverage continue to rise, increasing sensitivity to shocks, and against a backdrop of weaker economic growth and rising stress in the dairy sector.

This more challenging operating environment has been reflected in Moody's downward revision of New Zealand's Macro Profile to "Strong+" from "Very Strong-".

MACRO PROFILE CHANGE

The change in Moody's assessment of New Zealand's Macro Profile to "Strong+" from "Very Strong-" reflects a weakening operating environment for the country's banks. 

In particular, this change reflects the continued weakness in the dairy sector -- New Zealand's largest export sector -- and a renewed increase in private sector debt. 

Milk prices have fallen around 54% from their peak in 2014, and are likely to remain low, placing pressure on bank asset quality as many farmers face a second consecutive season of prices which are below breakeven.

As the same time, credit growth has also started to accelerate, raising the potential for the high level of private sector debt and, in particular, housing sector debt, to amplify negative shocks. 

At end-2015, private sector credit to nominal GDP was 153%, an increase of 6 percentage points from an already high 147% at end-2012.

We expect credit growth to continue to outpace GDP growth and place further pressure on this metric.

RATINGS RATIONALE 

The affirmation of the five banks' ratings reflects the fact that they have traditionally operated with sufficiently strong balance sheets to accommodate much of the volatility inherent in a small, open economy such as New Zealand. 

The banks' strong asset quality metrics, as well as their healthy profitability, have improved over recent years. However, we expect them to come under some pressure, given the challenges faced by the dairy sector which accounts for, on average, 10% of bank portfolios. 

Despite these stresses, overall bank asset quality will remain healthy. Moreover, any deterioration will come off a very strong base; at end-September 2015, non-performing loans made up, on average, 0.59% of gross loans.

Furthermore, the quality of housing loans, which comprise the largest proportion of bank portfolios at 52% of total loans, continues to benefit from low interest rates and stable employment conditions. 

At the same time, underwriting standards for bank mortgages will continue to improve as a result of the Reserve Bank of New Zealand's (RBNZ) macro-prudential policies to limit bank exposures to high (greater than 80%) loan-to value (LTV) lending. 

In addition, the banks' capital levels remain robust, providing a strong buffer against any losses arising from challenges within the dairy sector.  

We expect the banks to maintain their organic capital generation levels due to their healthy profitability. Furthermore, if required, the four major banks have the flexibility to reduce dividends to their Australian parents to conserve capital. 

Profitability will likely be pressured by the rising credit costs associated with a weaker level of agricultural asset quality. However, overall levels of profitability are likely to stay healthy relative to global peers, reflecting the concentrated structure of New Zealand's banking system.

The country's banks also have very strong efficiency metrics, reflecting their relatively simple-to-deliver housing loan businesses, as well as the benefits of their investments in technology. 

The stable rating outlook reflects our expectation that while a more challenging operating environment will pressure the banks' metrics, any weakening in their fundamentals will be off a very strong base.

Furthermore, we expect the banks' financial profiles to remain healthy on an absolute basis and sound in relation to expectations for their ratings.

BANKING SYSTEM OUTLOOK 

Reflecting the challenges in the operating environment and expectations for increased asset quality stress in the dairy sector, Moody's has revised to deteriorating from stable the Asset Risk sub-factor of its Banking System Outlook for New Zealand.  

However, the overall outlook remains stable, reflecting the strong buffers in the banks' financial profiles, namely their healthy capitalization, strong profitability and strong asset quality. 

WHAT COULD CHANGE THE RATINGS UP/DOWN 

Negative ratings pressure could arise if the banks' fundamentals weaken, as evidenced by the development of an even more challenging operating environment, and/or deterioration in their financial metrics.

Upward ratings pressure is not considered likely in light of the operating environment's potential to become more challenging.

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1 Comments

Reflecting the challenges in the operating environment and expectations for increased asset quality stress in the dairy sector, Moody's has revised to deteriorating from stable the Asset Risk sub-factor of its Banking System Outlook for New Zealand.

However, the overall outlook remains stable, reflecting the strong buffers in the banks' financial profiles, namely their healthy capitalization, strong profitability and strong asset quality.

Yeah right - pull the other one.