Most mortgage holders managing repayments, but ‘servicing stress’ growing

The central bank says the vast majority of mortgage holders have been able to manage higher repayments, although the share of mortgage arrears had increased.
Photo: 123RF

The Reserve Bank (RBNZ) says the country’s financial system remains strong as it adjusts to higher interest rates, but warns a greater share of households will feel more pressure.

In its half-yearly financial stability report (FSR), the central bank said the vast majority of households had been able to manage higher mortgage repayments, although the share of mortgage arrears had increased from low levels.

It expected an increasing share of borrowers would face “significant debt servicing stress” as they moved on to higher interest rates.

“Pockets of stress are likely to grow in the medium-term as highly-indebted households continue to be tested by higher debt servicing burdens,” the report said.

A significant deterioration in the labour market remained a major risk to financial stability.

The report said key global risks in the near term included the possibility of further rate hikes, unexpected impacts from previous rate rises, potential spillovers from the slowdown in the Chinese property market and escalation of conflict in the Middle East.

The RBNZ said weakening global demand, particularly in China, had contributed to lower commodity prices for New Zealand, which would impact farmers.

A lower milk payout and increased costs would likely see some dairy farmers make a loss in the current season, with highly indebted farmers more exposed.

“A single season of low payouts is unlikely to lead to widespread financial distress across the industry. However, a prolonged downturn in dairy prices could see a material pickup in loan losses for banks.”

The country’s banking system remained in good shape to handle external shocks and an economic downturn.

“Banks’ liquidity positions are strong and capital ratios are well progressed towards meeting the higher requirements being phased in by 2028.”

Households keeping up with repayments

The FSR said higher interest rates meant more pressure on indebted households’ budgets, but the majority had been able to meet repayments. More borrowers would feel the pain of higher interest rates, it warned.

“We expect an increasing share of borrowers will face significant debt servicing stress. 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.”

Households that borrowed at high debt-to-income (DTI) ratios over the period remained at risk, it said. The average share of their disposable income going to interest payments was expected to rise from a low of 9 percent in 2021 to about 18 percent by mid-2024.

Loan arrears have steadily increased over the past year, but remained well below levels seen following the Global Financial Crisis in 2008.

Work ongoing on DTI restrictions

The RBNZ said work on developing a framework for imposing restrictions on high debt-to-income mortgage lending was ongoing.

“Banks are developing reporting and management systems so that DTI restrictions could practically be implemented by April 2024,” the report said.

“We are currently assessing how a DTI tool could be calibrated alongside LVRs (loan to value restrictions) and intend to consult publicly on potential DTI settings in early 2024.”

Financial institutions show resilience, but some face challenges

The RBNZ said the country’s financial institutions continued to show resilience despite the recent headwinds.

“Banks remain profitable and have strong capital and liquidity positions, with the sector well placed to manage the possible emergence of more severe financial stress and weaker economic conditions,” it said.

However, the non-bank sector faced challenges – building societies, credit unions and deposit-taking finance companies – with total lending of about $2.2 billion.

The RBNZ said there had been a broad slowdown of new lending by non-bank deposit takers (NBDTs) over the past year, driven by higher interest rates and the uncertain economic outlook.

“The resilience of New Zealand’s NBDTs varies across the sector. While the NBDT sector as a whole continues to build capital buffers and improve operational efficiency, some NBDTs face ongoing challenges, largely due to a lack of scale.”

The central bank said insurers had also felt the impact of higher reinsurance costs, severe weather events and investment losses due to rising interest rates, but solvency positions remained robust.

“Despite profitability declining, aggregate solvency positions remain well above regulatory requirements for the three main types of insurance, highlighting the ability of insurers to withstand shocks.”

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