Finance system sound as Auckland housing, dairy risks grow, RBNZ says

The household debt sector is one area the Reserve Bank will be analysing as part of its financial stability research. Photo / NZ Herald

New Zealand's banking system remains in good health, even as a heavily indebted dairy sector and continued heat in the Auckland property market pose greater risks to the nation's lenders, according to the Reserve Bank's six-monthly update.

This year's slump in dairy prices has increased stress on dairy farmers' balance sheets while Auckland's housing market has continued to accelerate in the face of regulatory curbs, increasing the risks facing bankers' loan books, the central bank's financial stability report says. That's been exacerbated by increased volatility in global financial markets and more downward pressure on commodity prices caused by fears about the strength of China's economy.

Still, New Zealand's banks have the wherewithal to cope with their current level of dairy debt if that sector sours further and are holding more capital than the regulatory minimums, while new curbs imposed on lending to residential property investors in Auckland are expected to moderate house price growth in the country's biggest city.

"Banks hold strong capital land liquidity buffers and have maintained their profitability with further reductions in cost-to-income ratios," deputy governor Grant Spencer said in a statement. "Lending growth to households and businesses has picked up and is being funded mainly through higher domestic deposits."

The Reserve Bank has been concerned about country's rapid house price appreciation for a couple of years as low interest rates, rising inbound migration, and a shortage of supply in Auckland and Christchurch drove activity in the nation's two biggest cities.

While that supply shortage in Christchurch has largely been addressed in the earthquake rebuild, Auckland is still missing as much as 20,000 houses and struggling to keep pace with population growth. That's seen house prices rise 27 percent in the year through September, more than three times the pace in the rest of the country, and prompted the central bank to impose new lending curbs on property investors specifically in the country's biggest city.

The bank expects that will reduce house price inflation by 2-to-4 percentage points over the coming year, though recent gains in prices in Hamilton and Tauranga have prompted it to watch potential spill-over into other regions.

About 40 percent of residential mortgages are issued at more than five-times a borrowers' gross income, compared to two-times during the 1980s, due to lower interest rates, while a lack of inflation means mortgage repayments remain a burden for longer.

"While there have not been substantial losses on mortgage loan books in New Zealand for many years, loans today are much larger relative to incomes," the report said. "In the current environment of low interest rates, rapidly rising house prices, and elevated household debt, lenders need to take particular care to maintain adequate testing of loan serviceability."
The central bank plans to keep watching the total-debt-to-income multiples, which it says will help assess its new loan-to-value ratio policies in strengthening lenders' balance sheets.

The bank also wants the country's five biggest lenders to the dairy sector - ASB Bank, ANZ Bank New Zealand, Bank of New Zealand, Westpac New Zealand and Rabobank New Zealand - to stress test their portfolios. It estimates a worst-case scenario where dairy prices remain low for the next couple of years will cause credit losses of as much as 18 percent of pre-tax profit, a level it says is manageable for the wider system.

While the country's banks are holding more capital than required the Reserve Bank plans to review those minimum capital requirements over the coming year, in part due to potential changes in the Basel capital adequacy framework and as Australia reviews its own requirements. The central bank also noticed private banks increasing their use of hybrid debt and preferred shares to meet those capital requirements.