Brian Fallow: Shrewd banks have kept us stable

A robust banking system is no comfort to families forced to sell their homes. Photo / Paul Estcourt

The number of mortgagee sales has jumped lately but this is not the onset of the same kind of economic frostbite which has hobbled the American economy over the past year or so.

Terralink, which monitors such things, reports that the 150 mortgagee sales in January was 121 per cent higher than in January last year. Since September, mortgagee sales have been running at rates higher than the previous peak in 2001.

But Reserve Bank research, reported in last November's Financial Stability Report and then the bank's March Bulletin, should assuage fears that we are staring down the barrel of a US-style epidemic of foreclosures ravaging the property market.

That is despite the fact that our housing boom was stronger than those in the United States, Australia or Britain.

Between 2001 and 2007, house prices increased by two-thirds in real terms, but the incomes out of which mortgages and rents have to be paid rose much more slowly.

That has pushed traditional metrics of housing affordability into uncharted territory: house prices relative to incomes, household debt levels relative to incomes and debt servicing costs as a share of incomes.

Even with lower interest rates, ANZ National Bank estimates the debt servicing burden relative to income remains around 14.3 per cent, half as high again as its historic average.

And remember that is an average across the household sector as a whole, diluted by the fact that only a third of households are owner-occupiers with a mortgage.

But we can take comfort in three important differences between the US and New Zealand.

One is the fact that, whether from natural prudence or shrewd regulation, our banks have generally not securitised and on-sold the mortgages they write, thus maintaining the incentive to lend to creditworthy borrowers.

Local banks did not mimic the phenomenon of lending to "sub-prime" borrowers with poor credit histories and little or no documentation to back the income they claimed to have.

Thirdly, in many US states if a borrower defaults and the mortgagee sale fails to cover the outstanding loan that is the bank's problem. Borrowers can walk away, slate clean.

Here the banks will pursue them to the grave for the balance. That increases the incentive for borrowers to pay the mortgage come what may.

The Reserve Bank has looked at data from Statistics New Zealand's triennial household economic survey to assess households' financial vulnerability.

The most recent survey was in 2007 so it gives a picture of the starting point, before the housing market crashed and the economy tipped into recession.

But it also allows them to stress test the mortgage book, estimating the impact of a combination of lower house prices, higher unemployment and higher interest rates.

The first point is that mortgage debt is quite highly concentrated.

Of the 35 per cent of all households which have a mortgage on their homes, over 40 per cent were less than $100,000 and another 40 per cent between $100,000 and $200,000. Only about 4 per cent were larger than $400,000. (An important caveat is that this survey is not good at capturing mortgages secured against investment properties).

Most of the debt was held by higher income households - over 70 per cent by the highest 40 per cent of households ranked by income.

Loan-to-value ratios (LVR) in 2007 were significantly lower than in the 2001 survey, indicating that house prices during the boom rose faster than debt.

Highly geared households (with LVRs over 80 per cent) tended to be those with high incomes.

High LVRs expose the borrower to the risk of negative equity. But a loan that is "under water" is only a problem if the borrower's income drops below the level at which he or she can handle the mortgage payments.

So the other key indicator of vulnerability is the debt service ratio - interest and principal payments relative to household disposable income.

In contrast to LVRs, high debt service ratios were concentrated among low- to middle-income households.

Hardly any households - just one in 1000 in the survey sample - fell into the overlap between these two sources of vulnerability, an LVR of more than 80 per cent and a debt service ratio over 55 per cent.

But that was then and this is now. What happens if households are hit by a combination of tumbling house prices, rising unemployment and high interest rates?

It depends, of course, on the extent of those shocks.

Reserve Bank modelling found that under a relatively mild combination of a 15 per cent fall in house prices, 6 per cent unemployment and 100 basis points increase in interest rates, only 0.9 per cent of households would face the perilous combination of high LVR and debt service ratios.

If house prices fell 30 per cent, unemployment hit 9 per cent and interest rates climbed 300 basis points that could rise to 3.6 per cent.

Now clearly, as the bank acknowledges, it is arbitrary to define vulnerability as the combination of a loan-to-value ratio over 80 per cent and a debt service ratio over 55 per cent. For many households, the threshold of distress would be lower than that.
The central bank is looking at this from a standpoint of assessing the soundness of the banking system. A relatively clean bill of health there is no solace to families who lose their homes in a mortgagee sales.

But it should provide some comfort to the rest of us, and our international creditors, about the economy's seaworthiness in these stormy times.

That is not to say complacency is appropriate about the state of households' finances overall. Problems come in the chronic variety as well as the acute.

By 2007, the ratio of household debt to disposable income had climbed to 160 per cent compared with 140 per cent in the United States and just over 100 per cent at the start of the decade.

That run-up in household debt was reflected in a rise in New Zealand's net external debt to an internationally conspicuous 93 per cent of GDP.

People have clearly concluded that this is not sustainable. Households have for the past year reined in their borrowing and spending.

Household debt grew just 3.1 per cent in the year to February, much the weakest rate since at least the early 1990s.

And household consumption shrank in each of the the first three quarters of 2008. In the fourth quarter it was flat, despite the combined stimulus of the October tax cuts, 300 basis points off the official cash rate and 50c a litre off the price of petrol.

Looking ahead, the Reserve Bank forecasts only feeble growth in household consumption over the next three years, to the point that by 2012 in per capita terms consumption will be below where it is now.

This is part of a rebalancing of the economy, a shift towards a more sustainable split between spending and saving, between consumption and investment, and between importing and exporting. It needs to happen.

But for firms in the business of choosing the consumer's dollar, it will be a long, slow grind.