Pandemic recovery – is the economy in the clear yet?

We may be patting ourselves on the back for how well New Zealand has come through the Covid-19 pandemic to date, but the Reserve Bank still holds some concerns for our economy and financial system.

In its latest Financial Stability Report, released last month, the Bank says that while we have pulled through better than initially feared, border restrictions, supply chain disruptions and social distancing have taken their toll on parts of our economy like tourism and education, leaving some businesses still vulnerable.

The successful health measures and financial support put in place by the government meant we did avoid many business failures and high unemployment levels.

“However, New Zealand’s economic prospects ultimately depend on the global containment of the pandemic and on the recovery of trading-partner economies,” the Reserve Bank says.

Business revenue has improved strongly in sectors linked to household durable goods consumption and construction. But the ongoing border restrictions and periodic ramp-ups in alert levels here have weighed on transport, tourism, and leisure-related industries.

Why the Reserve Bank is worried about housing

A particular focus in the Reserve Bank’s report is the housing market, as the low interest rates around the world, put in place to support economic recovery, have also caused higher asset prices as people take on more risk. In New Zealand this has translated into soaring house prices.

“A high proportion of new lending has had high debt-to-income and loan-to-value ratios (LVR),” Deputy Governor Geoff Bascand says.

“This makes recent borrowers more vulnerable to a rise in mortgage rates and exposes households and the financial system to a decline in house prices,” he says.  

The Reserve Bank figures show that the share of new investor lending with a debt-to-income ratio above five rose to 69 percent in the three months to March 2021, from 55 percent a year earlier. This was driven by loans with LVRs above 70. The share of new owner-occupier lending (your typical home owner) with debt-to-income ratios above five has also increased.

A debt-to-income ratio of five means a borrower earning $100,000 a year, has borrowed $500,000.  With an LVR, the higher the deposit paid, the lower the ratio. If you borrowed $700,000 on a $1 million house, the loan-to-value ratio would be 70 percent, for instance.   

The Reserve Bank is hopeful the recent tightening in LVR requirements it introduced, particularly for investor lending, will help mitigate some of these risks and support more sustainable house prices. The government has also introduced changes aimed at slowing the property market.

“We will be watching how market conditions respond to the government’s recent policy changes. If required, we are prepared to further tighten lending conditions for housing using LVR requirements or additional tools that we are assessing,” Bascand says.

It warns that the financial system can suffer large losses if many households default on their mortgages. This is because household credit represents 60 percent of bank lending to the private sector, and residential mortgages account for 97 percent of household credit.

But the good news is the relative strength of the employment market and higher house prices currently means people’s equity in their homes has risen, putting them in a stronger position. It is those new borrowers that are most at risk, as they have likely paid down less of their mortgages and have a bigger debt to service.