NZ banking system stable despite dairy sector distress

New Zealand banking system stable despite dairy sector distress and higher household leverage

Sydney, August 01, 2016 -- Moody's Investors Service says that the outlook for New Zealand's banking system is stable over the next 12-18 months and reflects the system's robust capitalization and strong structural profitability; factors which will provide a solid buffer for the banks to withstand a potentially more challenging operating environment over the same period, as well as higher credit costs.

"Over the next 12-18 months, the banks' financial profiles will remain healthy on an absolute basis, and sound in relation to our expectations for their current ratings," says Daniel Yu, a Moody's Vice President and Senior Analyst.

"And, while asset quality and profitability are likely to weaken, the deterioration will be from a very strong base," adds Yu.

Moody's conclusions were contained in its just-released report on New Zealand banks titled, "Fundamentals Intact, Despite Dairy Sector Distress, Higher ousehold Leverage".

The stable outlook is based on Moody's assessment of five drivers:
Operating Environment (deteriorating); Asset Quality and Capital (deteriorating); Funding and Liquidity (stable); Profitability and Efficiency (deteriorating); and External Support (stable).

On the operating environment, Moody's baseline scenario assumes that New Zealand will achieve a steady headline economic growth of 2.6% in 2016 in real GDP terms and 2.5% in 2017. Moody's forecasts are lower than the 3.4% achieved in 2015 and reflect subsiding reconstruction activities in Christchurch - after the major earthquake in February 2011 - and a continued weak outlook for exports.

Domestic activities will nonetheless be supported by ongoing construction activity - particularly in Auckland - strong net migration and tourist inflows, as well as the central bank's still accommodative monetary policy stance.

But low dairy prices and rising leverage represent two key risks to the banks' operating environment. Moody's points out that the outlook is challenging for New Zealand's dairy producers, whose products account for 23% of total exports.

A key driver of New Zealand's high leverage has been the rebound in household borrowing which is supporting overall credit growth. Moody's says credit growth should stay strong relative to economic growth over the next 12-18 months, after growing 7.4% in 2015 compared to 4.6% in 2014.

As for asset quality, Moody's report says the banks' asset quality will weaken from a cyclical strong point. In particular, dairy sector exposures - which account for around 10% of the banks' loan books - will face higher delinquencies. The overall elevated level of household leverage will also weaken the ability of borrowers to withstand negative shocks.

Nevertheless, the deterioration in asset quality will be contained.
Housing loans - which make up the largest part of the banks' portfolios
- will continue to be supported by low interest rates and stable
employment conditions. In addition, the central banks' macroprudential
measures will support the performance of more recent loan vintages.

Bank capitalization will remain strong and provide an important buffer against any potential rise in credit costs. Moody's stress test results show the system's strong resilience to negative shocks, with the banks able to maintain a tangible common equity ratio of 9.6% in a distressed scenario.

On the issue of funding, Moody's says that the rise in credit growth will likely be sustained, limiting further improvements in the banks' funding positions. Nevertheless, tighter regulatory requirements will limit the banks' reliance on less stable funding sources and ensure that their funding positions will not deteriorate significantly. On the other hand, the banks' reliance on wholesale funding remains a key rating sensitivity.

With profitability and efficiency, Moody's says the banks' profitability will come under pressure from higher credit costs and margin compression.

Nonetheless, the system will remain broadly profitable, supported by the banks' strong overall pricing power and efficiency metrics.

On external support, Moody's assumptions for government support in New Zealand are low when compared to regional peers, reflecting the country's Open Bank resolution policy, which provides the government with a framework to impose selective losses on bank creditors.

Moody's rates eight of New Zealand's 15 locally incorporated banks. These eight banks cover 89% of total system loans.

Moody's has maintained a stable outlook on New Zealand's banking system since September 2010.

Subscribers can access the full report at
http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_PBC_1032965

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