New Zealand's rapidly rising house prices are cranking up the economic risks for the financial institutions operating in the country, S&P Global Ratings said in a report.
S&P said that if a sharp correction in property prices were to occur, the impact on financial institutions would be amplified by New Zealand's external weaknesses -- its persistent current account deficits and high levels of external debt.
Residential property prices nationally have increased in excess of 10 per cent in the past year.
Following strong growth during 2011-2013, house price growth abated in 2014.
Subsequently, S&P's "base-case" expectation was that house prices would slow in the second half of 2015 and 2016. Since then, the growth in house prices have instead accelerated.
"And while property prices in regions outside Auckland were relatively muted in the past, they have increased robustly nationwide in the past year," the report said.
"At the same time, private sector credit has also grown to about 157 per cent of gross domestic product so far in 2016 from about 152 per cent in 2015," it said.
S&P said renewed house price momentum in New Zealand, accompanied by record household debt, was again raising risks for the system.
The report comes as the Reserve Bank of New Zealand (RBNZ) prepares for a third round of macroprudential limits in an attempt to again curtail growing housing imbalances.
"And while some indicators of financial stability have improved since the RBNZ embarked on macroprudential intervention in 2013, their effect has been narrow as housing-related imbalances continue to build, highlighting the challenge facing the regulator as numerous cyclical and structural impediments, most outside of its control, remain unaddressed," the report said.
"We believe a stabilisation in economic imbalances will help to avert the possibility of further negative rating actions on New Zealand's financial institutions," it said.
S&P said a significant widening of the current account deficit to about 4.3 per cent of GDP in fiscal 2017 from its cyclical low of about 2.4 per cent of GDP in 2014 would heighten the risk of a sudden shift in foreign investors' willingness to fund New Zealand's external borrowing.
"In such a scenario, the cost of external borrowings would rise, domestic credit conditions would tighten, the currency may depreciate sharply, and economic growth would slow markedly," it said.
"These would ultimately result in lower income levels and a potential plunge in house prices.
But S&P said a burst in the asset price bubble appeared unlikely.
"Our base-case expectation remains that the heightened economic imbalances in New Zealand will unwind in an orderly manner - without a material rise in credit losses for the lending institutions," it said.
"This has generally been the case over past property cycles, and the New Zealand economic outlook remains relatively benign by global standards.
"However, other things being equal, a rapid rise in asset prices would signal a higher risk of a sharp unwinding--particularly if the rises were accompanied by strong growth in debt funding for such assets," it said.
S&P said that in a scenario of rapidly falling house prices, almost all New Zealand financial institutions would be exposed to a drop in operating earnings and a significant rise in credit losses.
"A sharp decline in house prices in any country is generally accompanied by a weakening of other key macroeconomic factors, such as unemployment, household expenditure, corporate investments, and total economic activity," it said.
"In New Zealand's case, its external weaknesses could amplify the impact."