Fitch: New Zealand regional lenders to continue solid performance, despite economic challenges

Fitch Ratings says in a report, "Peer Review: New Zealand Regional Lenders - Solid Performances to Continue Despite Economic Challenges," that it expects the solid performance of New Zealand's Regional Lenders (Regionals) to continue over the next 12 to 24 months, despite some operating environment challenges.

Two banks - Southland Building Society (SBS, rated BBB) and The Co-operative Bank (Co-op, rated BBB-), were placed on Positive Outlook earlier in September 2015. The Positive Outlooks reflect the banks' change in strategic direction following the appointment of its new management over recent years. Fitch believes these changes are structural and are likely to have positive implications on the banks' ratings. In both cases, there are early signs of performance improvement and membership growth, although we expect the biggest benefits to their respective competitive positions to emerge over the next 18-24 months, without compromising their conservative risk appetite.

The Regionals' combined market share is small, making up less than 10% of New Zealand's mortgages and deposits at March 2015. However, we recognise the significant value these franchises gain from local ownership, which includes loyal and, at times, parochial community support.

Challenges for the New Zealand economy include moderating economic growth due to low commodity prices weighing on incomes and investment, and weaker global demand, resulting in reduced net exports. A sustained period of low commodity prices such as dairy and/or further weakening of the operating environment of its main trading partners - China and Australia, represent downside risks. This could lead to higher unemployment and potentially a sharp correction of the high property prices, particularly in Auckland. High household leverage and property prices remain risks to the financial system, although the impact on the Regionals may be more limited, relative to the major banks due to their lower exposure to the Auckland market.

The lenders' risk appetite is likely to remain conservative, reflected in tight underwriting standards which mitigate some weaknesses in risk control, such as, concentration risks. This conservatism has benefited their asset quality which we expect to remain stable in the financial year ending March 2016 (FY16), in the absence of a significant shock to the economy.

Fitch expects some earning pressure in FY16, driven by narrowing net interest margins due to the competition for mortgages and cuts in the official cash rate in 2015. However, the potential for a weaker economy in the medium-term could impact unemployment which could result in increasing arrears and impairment charges.

The Regionals' capital ratios and funding positions are strengths, relative to international peers. These act as buffers to offset the lenders' small absolute size and limited access to fresh common equity. The Regionals predominantly fund their loan books through customer deposits, making them less reliant on investor sentiment.