Bank profits to stay strong but risks seen, S&P says

A resurgence in property prices means loan to value ratio ‘speed limits’ are like to stay, Standard & Poor’s says in a report that predicts banks will continue to post strong earnings growth while trading in the shadow of a ‘heightened risk’ of a future property crash.

“The relatively low level of credit losses over the next two to three years will continue, underpinning the strong profitability performance metrics of the New Zealand major banks,” the credit rating company says in a New Zealand banking sector outlook report.

The report notes stresses in the dairy sector from low prices and from a lower forecast payout to farmers and says banks’ exposure to dairy farmers is concentrated in a small number of large borrowers.

The report focuses on the property market and the risks that banks face in lending to that market.

“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,” S&P says.

“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.”

The report says house price inflation is Auckland-driven, reflecting net migration inflow and demand that exceeds supply.

The increase in New Zealand median house prices as at the end of January was higher than S&P expected.

The Reserve Bank intends to ease, or remove, LVR restrictions when house price inflation moderates but S&P doesn’t see it happening any time soon.

“It is our view that the removal of the LVR speed limit restrictions over the short term is unlikely, particularly in light of the increase in overall New Zealand house price inflation post September 2014,” S&P says.

It notes the RBNZ is investigating increasing capital requirements for investor mortgages by establishing a new assets sub-class within the existing retail asset class but does not comment further on it.

The long-held view that New Zealand banks get too much funding from offshore is repeated in the report but on the other side of the balance sheet the quality of bank assets is strong and is likely to remain so, supported by strong economic growth prospects.

“We note that the asset-quality metrics improved across all asset classes for the banking system during 2014.”

The New Zealand banking system remains well capitalised, S&P says.

Regulatory ratios have strengthened since 2009, largely due to retained earnings increasing, S&P says, while taking a swipe at New Zealand’s capital requirements.

“In our view the RBNZ capital requirements are also more onerous compared to international minimum standards,” the report says.

The major banks’ risk adjusted capital ratios are adequate-to-strong and they are likely to be maintained at their current levels in the short-to-medium term.

“We believe that relative to international peer banks, the level of profitability of the New Zealand banking systems is high,” the report says.

The outlook on the four major banks’ ratings remains stable, reflecting those of their respective parents, S&P said.