The credit environment has significantly tightened, especially in the housing arena, and of course this has flow-on implications for businesses reliant on lending secured by residential property. The house has been the implicit financing vehicle for many businesses. Tighter access to credit could make 2022 a crunch year for undercapitalised small-medium sized businesses that have hung on through COVID’s twists and turns, inflation, supply chain challenges and staffing difficulties.
Changes in the credit environment include:
- Tighter loan-to-value ratio (LVR) restrictions.
- Potential application of debt serviceability restriction such as a cap on debt as a multiple of income. Some banks are already applying them.
- Expanding bank margins. Borrowing rates have risen far more than what banks offer on the liability side of their balance sheet.
- Changing bank perception of risk. Deals outside the box, that could previously be squeezed into the bank lending box with some effort and thinking, are now rejected. According to the Reserve Bank Credit Conditions survey, the two key factors tightening credit availability are bank’s perception of risk and regulatory changes.
- The test interest rate used by banks sit well above actual borrowing rates and have started to increase after falling in prior years. This restricts borrowing capacity.
The final change has been the Credit Contracts and Consumer Finance Act (CCCFA) which took hold formally from December. Changes to the CCCFA mean lenders do more gathering and checking of detailed information from borrowers before they give approval. Banks need to be able to provide a clear evidentiary trail the borrowing is affordable.
Cue an invasion into what people spend money on. It is getting a lot of media attention. Words like fiasco are being thrown around to describe it. It is an example of well-intended legislation (aimed at loan sharks) having unintended and massive consequences as bankers and mortgage brokers trawl through bank statements eying spending patterns – the coffee count, subscriptions, takeaway habits, all in the interest of responsible lending. Banks are not in the business of irresponsible lending.
The legislation needs to be reworked. Focus too much though on the likes of the CCCFA and you risk missing the forest for the trees. Home lending has increased at an average rate of 8 percent per year since 1999, massively outpacing income growth. Home lending is up 11 percent in the past year. That cannot continue indefinitely. Outside of just after the global financial crisis, household debt has consistently risen faster than household income.
Household financial liabilities as a share of disposable income has risen from 100 percent in 1998 to 170 percent now. Falling interest rates meant borrowers have been able to service more debt. The household debt servicing ratio (interest costs to income) is below 6 percent. We are now in a rising interest rate environment and the household debt servicing burden will rise too.
Does it make sense that borrowers can sustain double digit credit growth, amidst 5-6 percent income growth, and especially in a rising interest rate environment? Of course not. The regulator (Reserve Bank) has stepped in. Banks are easing back.
The problem is that people have become conditioned to recent home lending trends where housing related lending (the net between new borrowing and repayments) grows by $2.5-3.5 billion or $33 billion in a year. When the brakes are applied you get an adverse reaction.
Let’s assume home borrowing converges to income growth of 5-6 percent over the coming years. Home lending is just under $330 billion, meaning home loan growth around $17-20 billion. That is a big step down from the past year(s).
This reality is welcome. Credit is one contributor to house price exuberance. New Zealand is not going to get wealthy selling more expensive houses to each other. The business sector needs to step up, and I suspect we are set to see major changes across the business lending landscape over the coming decade. Constrained home lending growth will be one factor driving change and alternatives.
Unfortunately, there will be side effects of slow home loan growth and consequences for those using the house as the funding mechanism for the business. More non-bank lenders are appearing to fill voids though they lack the overall scale to turn the dial significantly. But small steps are being taken.
What is needed though is a real shake-up and this includes businesses improving their financial fitness and “fundability” as opposed to banking on the house. The OECD, in their 2021 economic survey of Australia highlighted long-standing concerns about financing constraints for small and young businesses. They challenged banks to consider broader forms of security than residential property. You could rinse and repeat those comments in New Zealand.
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