Housing market and farm debt still a risk to financial systems, Reserve Bank says

Reserve Bank Governor Graeme Wheeler says the economy continues to face risks. Photo / Mark Mitchell

New Zealand's financial system is sound but continues to face risks in the form of high farm debt and from inflated house prices, the Reserve Bank said in its latest six-monthly financial stability report.

Reserve Bank Governor Graeme Wheeler said global economic growth had been subdued despite extremely accommodative monetary policy in a number of countries. Wheeler said in a statement financial markets have remained volatile due to heightened political uncertainty.

He noted dairy prices have recovered in recent months and the average dairy farm is now expected to return to profitability this season.

"However, indebtedness in the sector has increased as farms have had to borrow to absorb losses over the past two seasons, leaving the sector vulnerable to future shocks. Some farms remain under pressure and problem loans are likely to continue to increase for a time," he said.

Wheeler said house price inflation in Auckland had softened in recent months but remained uncertain as to whether this will be sustained. The bank said "vulnerabilities" in the housing market have increased in the past six months.

Despite some recent softening, house price growth in Auckland remains high at 9.3 per cent in the year to October and Auckland's house price-to-income ratio, at 9.6, is among the highest in the world, it said.

House price pressures continue to spread to the rest of the country, with most cities experiencing annual house price growth above 10 per cent. Credit to the household sector is growing rapidly, and the household debt-to-disposable income ratio now stands at 165 per cent, a record high.

Rising house prices continued to reflect low interest rates, steady income growth, and an imbalance between population growth and the rate of house building. "There is a risk that a reversal of any of these factors could cause a significant market correction," the bank said.

"House price to income ratios in the region remain among the highest in the world and prices are continuing to rise rapidly in the rest of the country," he said.

"There is a significant risk of further upward pressure on house prices so long as the imbalance between housing demand and supply remains."

Deputy governor Grant Spencer said new restrictions on lending to property investors with high loan to value ratios (LVRs), which came into force on 1 October, were increasing the resilience of bank balance sheets to a downturn in the housing market.

"However, the share of bank mortgage lending to customers with high debt to income ratios has been increasing and this could increase the rate of loan defaults during a housing downturn," he said.

In its comment on the dairy sector, the Reserve Bank said low milk prices have caused the average dairy farm to suffer operating losses for the past two seasons. However, auction prices for whole milk powder have increased by 69 percent since July this year, due in part to a reduction in European production and projected falls in New Zealand supply.

The bank noted that Fonterra had raised its farmgate milk price for 2016-17 season to $6 per kilogram of milk solids, which would return the average dairy farm to profitability, but it said parts of the dairy sector remained under significant pressure.

Dairy farms have reduced their costs, but there was significant variation in cost structures across farms, it said.

"Even with the improvement in dairy payouts, some farms may struggle to achieve profitability - especially given that 20 per cent of farms account for around 50 per cent of overall dairy debt," it said.

Debt levels have been stretched further as dairy farms have borrowed working capital to absorb operating losses over the past two seasons. "High debt levels leave the sector vulnerable to any future weakness in dairy prices," the bank said.

The bank said it was assesssing the impact of the 7.8 magnitude Kaikoura earthquake on November 14. "While it is too early to estimate the cost to insurers, the sector is well positioned in terms of catastrophe reinsurance cover and capital buffers."

Read the rull report here: