Positive outlook for Kiwi banks - S&P

Bank signs along Queen Street in Auckland City. Photograph by Dean Purcell.

New Zealand's banking sector is likely to face low credit losses over the next few years but remains at risk from persistent house price inflation and a sharp property price correction, according to Standard & Poor's.

The international credit rating agency released its latest outlook for the sector today.

Credit analyst Nico De Lange said his base case expectation was that the strong profitability performance of New Zealand's major banks would be underpinned by a relatively low level of credit losses over the next two to three years.

But a key downside risk was a sharp fall in property prices which could be triggered by an external shock to the New Zealand economy.

"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 said one example of an issue that could weaken the New Zealand economy was a large fall in terms of trade that would potentially damage export earnings, business and consumer confidence and ultimately the labour market and households.

"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.

"We note that China is New Zealand's second largest trading partner (after Australia), therefore, New Zealand has both a direct and indirect exposure (through Australia) to China.

"In our view New Zealand's direct exposure is primarily through soft commodity prices which could fall sharply in a hard landing scenario."

But De Lange said the introduction of the Reserve Bank's speed limits on home lending and pending interest rate rises could be enough to slow down house price inflation.

"We expect that the implementation of the "speed limits" and higher capital requirements for high loan to value ratio lending recently introduced by the RBNZ may be enough to contribute to a tightening of lending criteria, thereby slowing down of household credit growth, which in turn should help in ultimately containing the growth in house prices."

The analyst also remained concerned about New Zealand banks high reliance on external 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 per cent of system-wide domestic loans."

While dependence on offshore funding had reduced since 2010 increasing credit growth would likely increase it again, he 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."