Moody's: RBNZ's proposal on capital is credit positive for NZ banks

Moody's Investors Service says that the Reserve Bank of New Zealand's (RBNZ) proposal to raise the amount of capital that banks will need to hold against investment loans extended for residential properties is credit positive for these institutions.

"The proposal -- made on 29 May -- will strengthen the banks' capital buffers against such loans, in turn incentivizing them to either strengthen their loan underwriting criteria and/or to increase loan pricing, with positive implications for their risk-adjusted returns," says Daniel Yu, a Moody's Assistant Vice President and Analyst. "The requirements are also credit positive for New Zealand's covered bond programs, for which our assessments incorporate the quality of the issuing banks."

Yu was speaking on the release of a Moody's sector comment titled, "Banks: New Zealand Requirement that Banks Hold More Capital Against Investor Housing Loans Is Credit Positive"

The report notes that currently, both owner-occupied and investment property loans are included in a single-asset class definition and therefore the capital requirements for both types of loan are identical.

However, under the RBNZ's proposal, investment property loans -- defined as any loan for non-owner occupier purposes -- will be treated as a separate asset class with higher capital requirements relative to owner-occupied loans. These rules would add to the already strong capital buffers of New Zealand banks. As of December 2014, the Common Equity Tier 1 ratio of the banks averaged 10.8%, even after taking into account the RBNZ's conservative calculation methodology.

"These steps would particularly benefit New Zealand's four major banks, given their large residential mortgage portfolios which, on average, make up over half of their total loans," says Yu.

ASB Bank Limited (Aa3/Aa3 stable, a2 review for downgrade ), ANZ Bank New Zealand Limited (Aa3/Aa3 stable, a3), Bank of New Zealand (Aa3/Aa3 stable, a3) and Westpac New Zealand Limited (Aa3/Aa3 stable, a3) held approximately 86% of total system mortgages as of 31 December 2014. And for all banks, the RBNZ estimates that investment loans would make up approximately 25% of total loans, suggesting that such loans could comprise 10%-20% of the total loans of the four majors.

"The more stringent capital requirements being proposed will, as indicated, in turn incentivize banks to tighten their underwriting criteria, as the higher capital requirements will weaken the economics of lending to investors in residential property, who we view as being more risky than owner-occupied borrowers," says Yu.

Moody's also expects the higher capital requirements to increase the cost of mortgage lending and push up new mortgage rates for mortgage investor loans, helping reduce the threat of overheating in New Zealand's property market, given that house prices are at record highs.

Moody's further says that the RBNZ's proposal is also credit positive for New Zealand covered bonds because they incorporate the financial strength of the issuing banks, and the banks will benefit from having lower risk profiles. Furthermore, the new rules will improve the credit quality of cover pools because banks will have less and more conservatively underwritten investor loans to sell into these pools.

The RBNZ's proposal on investor loans reinforces another announcement on 13 May, which outlined restrictions on mortgage lending in Auckland -- New Zealand's most populated city -- to try and reduce risks in the housing market.

The RBNZ has proposed that the new classification and capital requirements will apply to new housing loans from 1 October 2015 onwards. Loans originated prior to that date will need to be reclassified under the new definition by 1 October 2016. The RBNZ will be accepting comments from the market until 19 June 2015.