Back in March, Standard and Poors (S&P) released a report warning about the increasing risk of a New Zealand property crash and noting that Australia’s Big Four banks, which own New Zealand’s Big Four, would be on the hook in the event that they needed to be bailed-out (my emphasis):
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In our base case scenario we expect that strong asset quality ratios are likely to be maintained at levels supportive of banks’ current ratings.
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Potential risks to the banking sector include a sharp correction in property prices and a disruption in funding access.
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Should economic risk buildup and the Economic Risk score be lowered to ’4′ from ’3′ the ratings on New Zealand banks could be lowered.
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The issuer credit ratings and outlooks on the major banks remain linked to those on their parents.
The outlooks on the four major banks remain linked to those on their respective parents. Potential triggers for a downward rating action on the four major banks could be a significant weakening in the rating on their respective Australian parents, or our assessment that their support to the New Zealand banking subsidiaries has significantly weakened.
We consider that the SACPs on all the New Zealand banks remain exposed to the risk of a sharp correction in property prices as a result of a weakening of New Zealand’s macro-economic factors. In our view such a scenario could include a deterioration in the terms of trade or a widening in the current account deficit from its current cyclical low. Should such a scenario materialize it could lead us to assign a higher risk score for economic imbalances, which could put pressure on our economic risk score under our BICRA assessment.
We are also of the opinion that there remains a significant risk of disruption in the banking sector’s access to funding, given the sector’s material dependence on external borrowings. In particular, we consider the New Zealand banking system’s sensitivity to a disruption in external funding could be more pronounced during a period of rapidly depreciating currency, falling property prices, or increased credit losses. Nevertheless, we consider that the major banks are likely to benefit from their parents’ support in normal as well as most stress scenarios.
Overnight, S&P downgraded eight New Zealand banks to a negative outlook from stable. However, the Big Four’s outlook was kept unchanged at stable, reflecting their implicit support from their Australian parents (my emphasis):
We believe New Zealand’s economic vulnerabilities, including a material dependence on external borrowings, persistent current account deficits, and recent strong growth in house prices, could escalate. In our view, this increases the risk of a deterioration in New Zealand banks’ credit qualities.
As a result, we are revising our outlooks on eight New Zealand banks to negative from stable…
Our outlooks on seven other banks: ANZ Bank New Zealand Ltd., ASB Bank Ltd., Bank of New Zealand, Westpac New Zealand Ltd., Bank of India (New Zealand) Ltd., Rabobank New Zealand Ltd., and Kiwibank Ltd. remain unchanged reflecting support from their respective parents…
We may lower the ratings on the eight New Zealand banks that are on negative outlook by one-to-two-notches within the next two years if economic vulnerabilities worsen, in our view. We consider that this risk is heightened by New Zealand’s material dependence on external borrowings and persistent current account deficits, in the backdrop of an uncertain short-to-medium term outlook for the global economic recovery. Furthermore, we note recent strong growth in house prices (particularly in Auckland).
Consequently, we consider that there is an increasing risk that a sharp correction in property prices could occur if there is a weakening in the country’s macroeconomic factors. For example, should there be a further widening in current account deficit, or a weakening in terms of trade, this could heighten the risk of a sharp depreciation in currency, which may affect confidence in the housing market, particularly if accompanied by a significant rise in unemployment. If these were to occur, banks’ credit losses could rise materially, given that there was a build-up in housing prices and domestic credit over the period preceding the global financial crisis. We consider that such a scenario would have a high impact on the banking sector and financial strength of the balance sheets of New Zealand banks…
For the banks that benefit from group support, we are of the view that the ratings of these institutions would remain equalized with that of the parent…
Through a chain of implicit guarantees – Australian government > major banks > NZ subsidiaries – it appears the Australian tax-payer is ultimately on the hook for New Zealand’s growing property bubble, in addition to our own. In the event that New Zealand’s property bubble burst, there is also the outside chance that a downgrade in the subsidiary rating could move up the chain to the Australian majors.
