First-home buyers are often borrowing many times their annual income. Photo / 123RF
COMMENT:
The Reserve Bank has started releasing figures for the debt-to-income ratios of new borrowing by owner-occupiers.
The glass-half-full view would be that the trend is improving. The glass-half-empty view would be that the level — the proportion of borrowers getting up to their nostrils in debt — remains concerningly high in a world where interest rates are unsustainably low and in a country where employment rates are exceptionally high.
The risk is not to the solvency of banks, or to taxpayers if a systemically important bank needs to be bailed out. Loan-to-value ratio curbs and the proposed increases in bank capital requirements address those issues.
The risk is upstream of that, both to individual borrowers who might struggle to meet their obligations, and to the wider economy if people's fear of finding themselves in that predicament leads them cut back on spending.
The risk, in short, is that high debt-to-income (DTI) borrowing widens and deepens one of the channels though which a shock to the economy would spread.
The DTI ratio divides borrowers' total debt (the lion's share of which is likely to be a mortgage) by their gross, or pre-tax, income.
The series is monthly but extends back only two years. Beyond that, the Reserve Bank does not consider banks' information on borrowers' income comprehensive enough. And it only covers owner-occupiers, not investors.
But the measure is still a useful indicator of the risk that borrowers will find themselves unable to service their loans. It divides borrowing into buckets, ranging from a DTI ratio of below three through to more than six.
While there is no hard threshold for when a DTI is "high", the bank says, it keeps a "particularly close watch" on new mortgage lending with a DTI over five times.
Last June, 31 per cent of new borrowing to owner-occupiers was at a DTI or more than five. That was down from 37 per cent in June 2017.
For first-home buyers in Auckland, the ratio is of course higher: 49 per cent was at more than five times income, albeit down from 56 per cent two years earlier.
Mortgage rates are low by historical standards but even so, at a typical 18-month fixed rate of 4.5 per cent, borrowers on a DTI ratio of five or higher are committing at least 23 per cent of their pre-tax income to just paying the interest on their loans, never mind paying down any principal.
That might sound supportable — so long as the income side of the ratio holds up.
But it is clear from the dollar values of the incomes in the Reserve Bank's data that they are overwhelmingly the combined income of a couple.
In June the average gross income of first-home buyers was $116,000, and for other owner-occupiers (excluding investors) the figure was $132,000.
Among first-home buyers, nearly half were on an income of between $90,000 and $140,000, while among other owner-occupiers it was just under a third.
Some 55 per cent of first-home buyers were in the DTI range greater than four and less than six; among other owner-occupiers it was 39 per cent.
Incomes data from the latest household labour force survey released by Statistics NZ on Wednesday confirms that we are talking about couples here.
Average household income from all sources for couples was $112,300 for those with no children, for example, and $127,000 for those with two.
The obvious question is what happens when some economic shock hits and turns some of these two-income households into one-income households?
What happens when their DTI multiple suddenly climbs from, say, five to nine and their mortgage interest bill requires not less than a quarter of their pre-tax income but more than 40 per cent?
The risks of that are mounting. The news flow from the rest of the world is not reassuring.
It is not hard to compile a list of potential flashpoints which could trigger a crisis in a world economy rendered brittle by a prolonged period of cheap money with its side effects of high debt levels, compressed risk margins and inflated asset prices.
And underlying those cyclical concerns are structural changes to the demand for labour, as more and more work becomes globally contestable or at risk of being done more cheaply by some clever algorithm.
In the long run, one might hope that these trends deliver higher incomes and more leisure for everyone, but here and now the distribution of the benefits and costs is extremely unequal.
So it would be unsafe to just assume that New Zealand's current high employment rate will continue. As of the latest June quarter, Statistics NZ tells us, the proportion of New Zealanders aged between 15 and 64 who were employed was 77.8 per cent, which by the way compares with 71.1 per cent in the United States, where they are celebrating the lowest unemployment rate for 50 years.
As for the debt side of the DTI ratio, there is a risk that house price inflation, which has subsided somewhat, especially in Auckland, will be reignited as the lagged effect of lower fixed rate mortgages flows through and is boosted by the Reserve Bank's own current easing cycle, 75 basis points so far.
As it is, the decline in the share of new lending at a DTI of more than five, from 37 per cent two years ago to 31 per cent now, has tended to flatten off; it has ranged between 29 and 31 per cent since October last year.
And the bank itself says the decline was "driven primarily by a reduction in the volume of high-DTI Auckland lending, although the share of high-DTI lending in Auckland continues to be much higher than the national average." Until the city's housing shortage is relieved, the threat of a revival of house price inflation to ever more eye-watering levels will remain.
It is also unsafe to assume that retail interest rates will just keep on falling. That they are as low as they are reflects a global trend for the custodians of trillions of dollars of other people's money to pile into the safe haven of government debt, even though the mooring fees, so to speak, in the form of negative real, or even nominal, yields have become exorbitant.
It is not a cheerful comment on how those professional investors see the prospects for the global economy.
And you have to wonder how long it can last. While the equilibrium interest rate, which balances willingness to save with desire to invest, has undoubtedly fallen, it is unlikely to have fallen as far as market rates have.
There comes a point where deposit interest rates, for example, become incompressible. Depositors were already facing pretty meagre returns after tax and inflation before the Reserve Bank's official cash rate cut his month.
As David Chaston at interest.co.nz points out, banks have split the benefit of the OCR cut between lower mortgage rates and sparing savers the full effect of a 50-point cut in deposit interest rates.
"So far the answer seems to be that a bit more than half the benefits have accrued to borrowers and a bit less than half have been held back for savers," he said.
The S&P/NZX 50 Index closed down 0.10%, falling to 12,627.32.