Reality of high interest rates has set in, bank lending data shows

High interest rates will make for a subdued Christmas for many.

Christmas will be a subdued event for many this year, with the latest bank lending data showing high interest rates are biting.

Small to medium-sized enterprises (SMEs) and commercial property owners are doing it particularly tough.

Meanwhile, mortgage holders are generally keeping their heads above water, as they need to look hard for signs of the market picking up.

“You don’t get rid of inflation without inflicting some economic harm,” Cameron Bagrie of Bagrie Economics said.

“We are now starting to head into the reality zone.”

While wholesale interest rates are falling as financial markets are heartened by inflation dropping in the United States, the impact of a rapid rise in rates over the past two years is well and truly being felt in New Zealand.

The banking sector as a whole is doing okay. The percentage of all bank loans deemed non-performing hit 0.6 per cent in November, according to the Reserve Bank.

While this was a rise from 0.4 per cent a year earlier, the ratio was well below post-2008 Global Financial Crisis levels when it hit 2.2 per cent.

Bagrie believed 2024 will continue to be tough, as high interest rates filter through the economy.

Nonetheless, the banking sector entered this part of the economic cycle from a solid starting point.

Looking at specific sectors, SMEs are taking the biggest hit, with banks’ non-performing loans to SMEs reaching 0.8 per cent in November - the highest ratio since at least 2018 when the data series began.

Only 0.3 per cent of bank loans to large businesses, with turnovers of above $50 million, were non-performing in November. This was well down from the Covid period.

Bagrie noted SMEs don’t have the benefit of scale, so aren’t as well placed as large businesses to absorb rising costs.

Large businesses also tend to have more pricing power, so can pass higher costs on more easily than SMEs.

While much is made of consumer inflation, Bagrie characterised business inflation as “ruthless”, noting profits had taken a significant hit.

Indeed, the Crown’s corporate tax take in the four months to October was 9.3 per cent below what it was during the same period last year.

Bagrie noted SMEs continued to struggle to access bank credit, as banks have to hold more capital for business loans than mortgages.

He said it was a perpetuatual problem that keeps directing Kiwis towards investing in property.

The value of banks’ stock of loans to SMEs fell by 1.9 per cent in the year to November, while loans to large businesses rose by 2.4 per cent.

Turning to the other pain point in the system, 0.7 per cent of commercial property loans were non-performing in November. Pre-Covid, this ratio sat at around 0.2 or 0.3 per cent.

Bagrie said commercial property owners were facing much higher refinancing costs on the back of lower capitalisation rates.

There is also tenant risk, as the retail sector struggles and demand for office space is up in the air with more people still working from home.

On the upside, industrial property is enjoying a tailwind.

Nonetheless, commercial and industrial property owners will need to brace themselves to start paying more than a half a billion dollars more tax a year collectively, as the Government is going to remove the ability for them to write off depreciation as an expense.

Residential property investors have regained a sliver of confidence, with the Government planning to allow them to once again deduct interest as an expense, and bringing the bright-line test back to two years.

The 8 per cent annual uptick in the value of new mortgages banks issued in November was driven by investors, who borrowed 18.9 per cent more than they did in November 2022.

High interest rates, tough loan-to-value ratio restrictions and property taxes are among the factors that dampened investors’ demand for residential property through much of 2022 and 2023.

While pockets of mortgage holders are feeling the squeeze from higher rates, only 0.4 per cent of bank loans to residential property owners were non-performing in November.

While this was above the 0.2 per cent level non-performing loans sat at in recent years, the ratio was well below the 1.2 per cent post-GFC peak.

The Reserve Bank expects this rate to pick up, as borrowers continue to roll onto higher interest rates.

Bank lending data suggests the property market remained flat in November.

The value of new mortgages written during the month was below that of November 2019, 2020 and 2021.

Jenée Tibshraeny is the Herald’s Wellington business editor, based in the Parliamentary press gallery. She specialises in government and Reserve Bank policymaking, economics and banking.