As of July 31 a total of $73.7 billion of bank loans were receiving some form of COVID-19 related relief. Gareth Vaughan speculates on what might happen to banks' non-performing loan ratios when the deferral scheme eventually ends

As of July 31 borrowers holding $73.7 billion worth of bank loans were receiving COVID-19 related repayment relief.

The loan repayment deferrals were introduced for six months in March at the onset of the COVID-19 crisis. The Reserve Bank agreed last month that banks can extend these deferrals for up to another six months, to March 2021.

Banks aren't required to treat this lending as non-performing. Thus the latest figures from the Reserve Bank's Bank Financial Strength Dashboard show total non-performing loans across the sector of $3.488 billion at June 30. That's equivalent to 0.76% of total bank loans of $457.772 billion.

Reserve Bank guidance issued in March said banks should treat loans where borrowers are taking advantage of COVID-19  deferrals as performing and not in arrears for capital purposes. If a loan is recorded as being in arrears, normally this significantly increases the amount of capital the bank lender needs to hold against that loan compared to when it's treated as a performing loan. Under accounting rules banks are, however, required to consider future expectations in their loan provisioning when reporting financial results. This includes a future loss model with the bank's view of the outlook for economic conditions driven by the likes of unemployment, Gross Domestic Product and house price movements. As of June 30, New Zealand banks' total loan provisions stood at $3.143 billion.

Now, we don't know what percentage or value of the deferred loans will need to be treated as non-performing when the scheme is ultimately ended, whether that be March or further into the future. But here are a couple of calculations speculating on where banks' non-performing loans might end up. Remembering that non-performing loans are the combination of loans classified as impaired, and loans at least 90 days past due.

If, say, 10% of that $73.7 billion needed to be treated as non-performing, that's $7.37 billion worth of loans. Add that to the just under $3.5 billion of non-performing bank loans at June 30 and you'd be at $10.86 billion of non-performing loans. That would be equivalent to 2.4% of total bank loans at June 30. For some context in March 2011, after the Global Financial Crisis and just post the big Christchurch earthquake, non-performing loans were at 2.1% of total loans.

In a worse case scenario if 25% of the deferred loans end up as non-performing loans, that'd be $18.425 billion. Throwing those in with the June 30 non-performing loans gives you $21.9 billion worth. That's 4.8% of total bank loans, as of June 30.

In something of a statement of the obvious a paper from the Bank for International Settlements (BIS), the central banks' bank, pointed out in June that whilst an "indispensable lifeline" to borrowers impacted by COVID-19, loan deferrals increase future risks to both borrowers and banks because the missed payments are not forgiven and must be repaid.

The BIS paper said the financial stability implications of payment deferral programmes will be driven by the extent to which borrowers will be able and willing to repay their debt obligations once the payment holidays expire, especially in the absence of a government guarantee.

"The famous American investor, Warren Buffett, once said 'It’s only when the tide goes out that you learn who has been swimming naked.' The cumulative impact of COVID-19 and payment deferral programmes on bank balance sheets depends on many factors and will only become apparent over time. Therefore, the timely classification and measurement of credit risk is critical for banks to provide confidence to supervisors and their stakeholders on their financial health. Delaying loss recognition until the tide goes out may leave banks and supervisors with fewer options for dealing with the repercussions," BIS said.

The deferred loan figures come from the New Zealand Bankers' Association (NZBA). For consumer lending these show 88,558 customers making reduced loan repayments on loans valued at $27.5 billion. Another 61,063 customers had deferred payments on all loans to the value of $20.9 billion. These consumer lending figures, as of July 31, cover home loans, personal lending, credit cards and arranged overdrafts.

NZBA figures for business lending show 14,511 customers making reduced loan repayments on $16.3 billion of loans. A further 3,383 customers have deferred all loan repayments on $1.2 billion of loans. Another 3,533 customers have restructured $7.8 billion of loans due to COVID-19. The business lending figures include temporary or term business/corporate lending, stock or equipment finance and arranged overdrafts.

The vast majority of deferred lending will be secured lending. Home loans, for example, are secured by the bank against the property the loan is provided to the homeowner for.

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