The Reserve Bank says financial stress is building from very low levels with particular pressure on the commercial property sector

The Reserve Bank (RBNZ) says the number of people and businesses defaulting on their loans is rising but remains at relatively low levels. 

Retail banks told the central bank they expect the proportion of non-performing home loans to rise to 0.7% by the end of the year, half what was seen after the Global Financial Crisis (GFC), and up from 0.5% now. 

The RBNZ said in its May Financial Stability Report that the impacts of high interest rates have been contained so far and if anything have been less severe than anticipated.

Most residential mortgage borrowers have repriced onto much higher interest rates, with the average now 85% of its projected peak. While the vast majority are coping with this stress, some are not. 

Loan arrears and non-performing loans are around the levels experienced during the Covid crisis and are well below what was seen following the GFC in 2007/08. 

RBNZ data shows $1.76 billion of banks' $352.4 billion worth of housing loans outstanding at the end of March was non-performing. That's 0.5% compared to 1.7% of agricultural loans and just over 1% of commercial property loans considered to be non-performing. 

The RBNZ data also shows just 300 housing loans were impaired as of March 31.

Banks expect mortgage stress to increase as the economy slows and interest rates remain high. However, how bad it gets depends on economic activity and labour market conditions.

The RBNZ said it was “encouraging” the increase in borrower stress had not accelerated.

Business failures, which have been unusually rare in recent years, have begun to pick up in interest rate sensitive sectors — such as the construction sector. 

Commercial property is another sector that has been under pressure, with debt service costs suddenly much higher, and demand for both office and retail space much weaker.

Higher milk prices have helped ease pressure on the dairy sector, although it remains heavily indebted, while the sheep and beef industry is struggling with falling meat prices. 

Businesses and households are generally borrowing less money. This means aggregate debt levels as a percentage of the economy are falling, helping to improve resilience. 

Stable for now

Average mortgage rates have risen from 2.8% in 2021 to 6% today, and will continue to rise to about 6.5% at the end of this year. 

Only about 10% of mortgage lending remains at fixed rates below 4%, likely those who chose the longest fixed rate terms during the pandemic years.

Borrowers appear to have cut discretionary spending and, in some cases, slowed the rate at which they are repaying the principal on their loan.

These actions have not been enough for about half a percent of all borrowers, who have fallen 90 days behind on repayments and have been classified as non-performing loans. 

The share of lending that is 30 days past due, which is a leading indicator, has climbed to almost 1%. It is now above the 2020 peak and higher than it has been since 2013.

Banks expect the proportion of non-performing loans to peak at about 0.7% at the end of this year before easing. This figure got as high as 1.2% in the years following the GFC.

Job losses are often the cause of non-performing loans and the number of arrears will likely increase as the unemployment rate continues to climb.

This will impact bank profitability but is unlikely to threaten their stability, the RBNZ said. 

“Very few households are in a position of negative equity and banks would likely face relatively small losses in the event of an increase in borrowers defaulting”. 

While residential mortgages are looking relatively resilient, commercial property loans are on much shakier ground. This sector makes up about 8% of NZ bank lending. 

The RBNZ said remote working and online shopping trends had caused an increase in vacancies for office and retail properties. Now, the slowing economy could worsen the problem.

The central bank also said the Government’s plan to remove depreciation tax deductions for commercial property could also add to existing cash flow pressures.

If cash flow stress gets too severe, some property owners might attempt to sell up. However, that may be difficult as the market has become much less liquid. 

“A global commercial property slowdown could further exacerbate this as it could weaken foreign investors’ appetite for property in New Zealand. This would further reduce the pool of potential buyers,” the RBNZ said.

*The charts below come from the RBNZ's Financial Stability Report.