Banks worry ratings agency
Standard & Poor's has warned it could cut the credit ratings of New Zealand's smaller banks and credit unions if economic risk continues to build.
The ratings agency's 2014 outlook for the New Zealand banking sector raises further concerns about the overheated property market.
It warns that a sharp drop in house prices combined with an external shock to the economy could increase bad loans, which are currently at or near cyclical lows.
Such a shock could come in the form of a large fall in terms of trade, or a "hard landing" of the Chinese economy. China recently became New Zealand's largest trading partner.
The report's primary credit analyst, Nico De Lange, said the risk was reflected in the negative rating outlooks on a number of smaller local banks and credit unions, including state-owed Kiwibank, TSB and the First Credit Union.
The major Australian-owned banks - ASB Bank, ANZ, Bank of New Zealand and Westpac - do not face the prospect of a rate cut.
That was because Standard & Poor's considered them core subsidiaries of their much larger parents, with ratings held at the same level.
The report said the Reserve Bank's restrictions on low equity home loans and higher capital requirements "may just be enough" to slow down house price inflation.
"In addition we expect that rising mortgage interest rates and a pickup in housing construction may also reduce pressure building in the New Zealand housing market," De Lange said.
Another key weakness of New Zealand's banking system was its high reliance on external debt, which still funded about a third of domestic loans.
"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."
On the bright side, Standard & Poor's "base case" was that the banks would continue to perform strongly, with return on assets returning to pre-financial crisis levels of about 1 per cent.
Banks were well capitalised, and low levels of credit losses were expected to continue over the next two to three years.
Earlier this week ASB Bank reported a record interim profit of $416 million, partly driven by falling impairment charges on bad debts.
The lender's return on assets rose from 1.1 per cent to 1.2 per cent, and it also grew its net interest margin, which is the key metric of profitability.