Reserve Bank figures are showing rising levels of non-performing housing loans. What we all want to know is whether we are now seeing the full extent of the pressure caused by high interest rates - or whether the problems may be just starting

By David Hargreaves, Interest.co.nz

So, it's the big question. What are we seeing?

Does the sharp rise in non-performing mortgage loans now being witnessed tell us that the full extent of stress from the high interest rates is emerging and becoming fully visible?

Or is there much more - and worse - to follow?

Historical perspective is always valuable and so it should be stated at the outset that in the years after the Global Financial Crisis (2009-11) we saw the ratio of non-performing housing loans hit 1.2%, while the overall ratio of non-performing loans of all types topped out at 2.1%.

Our figures now are coming off a very low base, but are currently climbing swiftly, so, that as of January 2024 the ratio of non-performing housing loans has hit 0.5%, while the system-wide total of non-performing loans is up to just under 0.7%.

There's nothing in the developments to date that's any worse than the Reserve Bank (RBNZ) and the country's commercial banks have been expecting. But it's a very fluid situation.

For the sake of context the 'problem' here is that the RBNZ has raised the Official Cash Rate from just 0.25% as of the start of October 2021 to a current level of 5.50%.

Mortgage interest rates had been, in a historic sense, virtually non-existent. The banks pre-empted the RBNZ from the middle of 2021 and started rapid fire increases. So, rising interest rates have been a key story since July 2021 onwards.

Based on RBNZ-compiled figures detailing the 'special' rates banks offer on new mortgages, the low point in the super-low interest rate cycle was June 2021. At that time the average one-year fixed mortgage rate was just 2.2%. The average two-year fixed was 2.6%.

Trying to be as up to date as possible, I report that the most recently updated rate among the major banks at time of writing has been by BNZ. As of this week it is currently offering 7.24% for one year and 6.79% for two years - both of these are 'specials'. The one and two-year rates are used as examples because they are always among the popular options.

So, what's been happening with mortgage customers? What have they faced?

If we imagine a new mortgage applicant taking up a one-year term in June 2021, well then (assuming they subsequently renewed for the same term), their rate would have gone up from a 2.2% starting point to 5.1% in June 2022 and 6.9% in June 2023. Right now they could be looking at something with a '7' in front of it when they refix in June this year.

A person taking up a two-year rate in June 2021 would have seen their rate increase to 6.5% as of June 2023. What will they be refixing at in June 2025? Oh, that's a good question!

But what this quick example does tell you is that while people are rolling over on to new terms all the time, the point from the above is that the BIG increases should have kicked in for most people by now. The pain isn't getting worse, as such. But is it becoming cumulative in its damage?

For the record, RBNZ figures as of January 2024 show us that the mortgage pile was $355.7 billion as of the end of that month. Of this, $38 billion was 'floating', while $317.7 billion was on fixed rates. And of that latter total, just over a third of it - $107.8 billion - was due for refixing by July 2024. Right at the moment it looks unlikely that any of those people refixing within six months will get a lower rate than they were on. But as I say, most of the eye-watering jumps in interest rate sizes seem to be behind us.

That doesn't mean, at all, that the problems are behind us.

In its most recent, six-monthly, Financial Stability Report (FSR) issued in November 2023 the RBNZ, not unnaturally, (mortgages being a BIG financial stability issue), devoted a lot of attention to the current situation regarding the impact of much higher interest rates.

The RBNZ made the point that for many households that borrowed in 2020 and 2021, current interest rates exceed the 'test rates' used by banks to assess affordability, and "some may be particularly vulnerable to debt servicing stresses".

"While household incomes have grown strongly in recent years, further increases in interest rates may result in a larger rise in loan defaults. Banks report that the arrears which have occurred to date have largely been associated with unexpected individual events, such as illness or job loss, rather than hardship due to higher interest rates alone," the RBNZ said.

"However, there is a portion of lending still to reprice to higher interest rates and this will create more financial difficulties for some borrowers."

It's worth looking at that 2020-21 period, because it was nuts, and it may yet come back to bite us harder than we currently hope. It is our Achilles heel, I believe.

According to the RBNZ-compiled monthly new mortgage figures, in the two years spanning 2020-21 a grand total of $175.4 billion worth of new mortgages were issued.

To give some perspective on how nutty that was, the average monthly amount of new mortgages across those two years was a touch over $7.3 billion - which is actually a HIGHER figure than the previous record for ANY month prior to September 2020. As I say, NUTS!

In the previous two years, 2018-19 there was a total of just $132.5 billion worth of new mortgages, for an average of $5.5 billion a month.

In terms of growth of the overall mortgage pile, the outstanding mortgage stock grew by a whopping $52.4 billion (to $325.9 billion) in the two years ending December 2021.

In the two prior years it grew by just $31.94 billion.

Oh, and I know what you will say - "but mortgage sizes got bigger, so that's the difference, that's why the figures grew so much". Well, exactly! And that is the nub of the issue. Low interest rates fuelled our ability to take out mortgages of breathtaking size. I thought at the time many mortgages being taken out were just 'too big', regardless of the fact that the historically low interest rates was making them then 'affordable'.

I had a dig back through some of the statistics earlier this year, which made for interesting reading.

One thing to emerge from that was the fact that the average size of new mortgage in New Zealand increased from $230,000 in 2018 to $345,000 in 2021; an exactly 50% increase and all made possible by super-low interest rates.

That was the big binge. So, what of the post-spree hangover?

That November 2023 Financial Stability Report from the RBNZ contained projections from the big five New Zealand banks of likely rates of non-performing loans.

Alongside this (and utilising those same big bank projections) there was some RBNZ modelling on possible non-performing loan rates, which factored in the expected rate of unemployment as per the forecasts the RBNZ had made in its August Monetary Policy Statement (MPS) last year.

Not unsurprisingly, the RBNZ makes much of the link between rates of unemployment and difficulty paying the mortgage. So, what happens with unemployment is vital.

What did the big banks forecast then? Well, they forecast that the ratio of non-performing housing loans would hit 0.5% by December 2023, rising to 0.6% in June 2024 and 0.7% in March 2025. As of January 2024 the actual non-performing housing loan ratio IS 0.5%.

In terms of overall provisions for the entire bank book, IE including business loans etc, the big five banks projected that this ratio would hit 0.6% in December 2023, 0.7% in March 2024, 0.8% in September 2024 and 0.9% in March 2025. As of January 2024 the overall non-performing loans ratio IS already at 0.7%, IE the figure forecast to be reached in March 2024. So, actual results are tracking the forecasts.

The RBNZ's modelling in that November Financial Stability Report, including those unemployment forecasts, was for a slightly higher overall non-performing loan ratio, reaching 0.6% in December 2023, but then hitting 1.0% by the end of this year, 1.1% by March of next year and continuing to slowly rise to 1.3% by the end of the forecast window in September 2026.

What's very important to note about the RBNZ modelling though is that the RBNZ has subsequently revised down its forecasts for unemployment. It now sees peak unemployment (as per its February MPS) of 5.1% by June next year, versus a previous forecast (August MPS) of 5.3% by December of 2025.

This is important because the actual rate of unemployment is undershooting forecasts.

And yet, although it is early days, the rates of non-performing loans are actually going up pretty much in line with those earlier forecasts - in which unemployment was expected to be higher.

That's right, fewer people than expected have lost jobs - but the stressed loan ratios are going up at pretty much the same rate as was forecast with a worse unemployment position.

So, does this mean that despite not losing jobs, people are still in any case beginning to lose the battle to service the mortgage every month?

Remember, the pandemic period allowed a lot of us to build up good 'buffers' with savings. But it's possible these buffers are now wearing thin for some people. And in any case, it may be okay to meet higher payments for a while, whilst perhaps putting off things like dentist visits etc, but everything has a habit of catching up. Cumulative pressure.

Is it possible the sheer size of the loans is catching up with people regardless of whether they lose their jobs or not?

Another point worth raising at this stage is, what of people running their own business, but struggling?

I was most interested in a section of the latest monthly report from credit bureau Centrix, in which Centrix managing director Keith McLaughlin noted: "We’ve also observed an upswing in mortgage stress for a sole proprietor [of a business], with many needing to leverage their home equity to continue funding their businesses – a concerning trend that could spell trouble for these owners in the long term."

One of the, for me, more worrying aspects of the latest RBNZ non-performing loans figures is the very strong rise in the non-performing loan ratios of small-to-medium-sized businesses (SMEs).

In the period from January 2023 to January 2024 the non-performing loan ratio of SMEs has shot up from 0.5% to 1.1%.

But it's a bit worse even than that suggests - because it all effectively happened in the last six months of that period.

As of January 2023 there was $416 million of non-performing SME loans. By July 2023 that figure was $422 million.

Then, in the six months to January 2024 that figure shot up by 92.7% to $813 million. What are the potential ramifications of such an increase?

It's difficult sometimes to establish cause and effect convincingly. But we do know the housing market has got off to a very sluggish start this year and there's been a flood of houses listed for sale.

It is dangerous to make blanket assumptions about why people may put properties up for sale. And if people are under stress with their payments, or simply just getting cheesed off with the struggle and so want out, well, they are unlikely to say that's the reason. People are private. People are proud.

But you do wonder.

The RBNZ in its February MPS reduced its forecast of house price growth for the 2024 calendar to just 3.4%, down from a forecast of 5.2% in the November 2023 Monetary Policy Statement. Some bank economists have started trimming their forecasts too.

What do you think? I don't think it is looking great. We will have to see what happens.

Mortgage relief is not expected any time soon. The wholesale interest rate markets are currently pricing in about a two-thirds chance the first cut to the Official Cash Rate will be in August. But, okay, even if mortgage rates do start to decline in the second half of the year - how much will they decline by?

Someone who's gone from paying 2.2% for their mortgage in 2021 to maybe over 7% this year is not going to see it go back to 2.2% overnight are they?

Indeed, it's fair to assume that whenever the mortgage rates do start to come down, it will be slowly and rates may well ultimately settle at levels significantly higher (say maybe 4% to 5%?) than those historic levels we saw.

In the meantime, people need to carry on as best they can.

The situation is going to be well worth keeping an eye on. We need to see what happens to the level of housing listings - versus how many are sold and at what prices. And we need to see how the non-performing loans figures track in coming months.

And then there's those unemployment figures. If those do suddenly take a marked turn for the worst, well, not good.

So, there are many moving parts to this story and it is by no means clear which way it is all going to go.

This story was originally published on Interest.co.nz and has been republished here with permission.