Lateral Partner's view on the current lending environment

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By Ben Pauley

Residential Lending Market

The residential lending market caught an almighty slap towards the end of the last calendar year. We had inflation figures reported upwards of 6% (the highest in decades), rising interest rates, cuts on over 80% lending with all banks, and the introduction of the much-maligned CCCFA legislation.

On top of this, Auckland was cautiously venturing out of a lockdown, New Zealand was thoroughly invested in a much-needed Christmas break, and the spectre of Omicron was looming over the nation.

All of this led to a significant fall in lending activity in the residential sector. We have seen auction clearance rates fall, approvals at banks become harder to ascertain, the cost of debt double, and at the least a plateau in property prices.

This has caused some very jittery nerves with borrowers and prospective property purchasers. What has happened since then hasn’t done a lot to ease the nerves, but there are some positives on the horizon.

The government has all but admitted that it made an error with the CCCFA legislation, and has officially began unwinding the brashness of the legislation with some easing of policies, official from June onwards. The banks have begun to adopt this in principle and we are seeing a softer approach when reviewing expenses, with approvals picking back up. We expect that this will continue in the coming months.

Omicron seems to have peaked, and the government has retrenched on lockdowns, mandates and border closures. We should all see some normality resuming to our daily lives.

There remains some headwinds regarding surety in off plan purchases, with a lack of 12 month approvals available in the market, however, with good advice purchasers are continuing to buy the right product. If you’re unsure which product is right for you, get in touch with us- we’d be happy to help.

Changes to Inflation and Rising Interest Rates

Perhaps the most persistent change and most intriguing to watch is inflation and interest rates. We have seen inflation figures reported at levels unseen in NZ for 30+ years and the corresponding lifting in interest rates in an effort to begin combating this. The trouble the Reserve Bank has is that to effectively combat inflation, interest rates must lift above the rate of inflation, this would mean rates approaching 10%.

To be frank, this is not going to happen. Persistent low rates and stimulus in NZ has led to a binge on credit and lifting interest rates that far would cripple the nation. The current OCR lift and corresponding forward rate increases seen in residential rates has more than doubled the cost of debt for a number of people. Many borrowers opted to fix some or a portion of their loan last year for 1 year, as the rhetoric from the RBNZ was that rates would persist at a low level for the foreseeable future (they may need some better eyeware) and this was a record low interest rate. This now means, however, a number of borrowers are moving from a 2% fixed rate to something with a 4 if not a 5 in front of it.

In effect, this is doubling the cost of their debt and we would not be surprised to see an economic downturn on its heels, with people spending less on discretionary activities as they plow more of their income into their mortgages.

To be clear, we don’t expect inflation to fall, wages are rising rapidly and costs will continue to escalate. People will just be able to afford less for their dollar. The cost of production isn’t falling and therefore prices won’t.

The RBNZ is then going to be faced with a bit of a dilemma, do they stimulate and encourage a rebound in the economy OR do they continue to fight inflation? We think they will cede to inflation and go about some easing of monetary policy in an effort to get things moving again. If we had to pick timing, we would say that it will likely be in the last quarter of this year or first half of next. Certainly before the election.

Development Lending Market

The development lending market has been in a bit of a credit crunch over the last 6 months which has been caused by a few things.

The first is the main banks sliding back down the risk curve. In a market where their margins have been squeezed and capital ratios increased, the banks have required a reduction in risk to maintain their returns. This has seen their lending appetite fall. It isn’t an issue of liquidity with the banks, but rather margin preservation.

Because of this, the demand for non-bank lending has increased significantly. I have written on the boom in this sector previously and would expect it will continue for the foreseeable future.

Coupled with this demand for capital in the non-bank lending space, has been cost escalations and time delays. These 3 factors have led to most lenders in this space fully leveraging their balance sheets and suffering from a lack of liquidity. Quite simply, they have expended their available capital and are not able to recycle it with the same frequency they had previously because of construction and council delays.

The knock-on effect of this has been a fall in the risk profile of these lenders. This has resulted in suffering for prospective projects with many being delayed or cancelled as they are unable to attract capital to get them underway. This is exacerbated by the residential lending market stalling and the lack of pre-sales further slowing projects.

What is going to change?

A couple things.

Firstly, we expect that with the current fall in activity we expect in the last quarter of this year and first half of next year we should return to a more normal construction cycle, with less supply and liquidity constraints. With fewer projects the demand for supplies should fall and therefore we would expect that this will ease the delays in materials and thus the delays in programme.

Secondly, we would expect that the current projects on lenders’ books will begin to settle, and they will recycle their capital which will bring further liquidity back to the market.

Thirdly, the major banks that support the non-bank lending market are likely to have their capital limits extended for non-bank wholesale lines for their new financial year (June year end) and thus, greater available funds for the non-bank lenders to lend.

Lastly, if as we predict above, the RBNZ moves to ease monetary policy, we should see a second wind blow into the property market with returning pre-sales and asset price inflation.

So, what can we make of all of this?

Times are tough, with plenty of headwinds and hurdles for both residential and development borrowers. We do, however, expect this will ease significantly towards the end of this year and think that those who are patient and manage their capital and projects well will be in a position to capitalise.

If you’re wondering about your specific situation and where you’re sitting in light of current market changes, get in touch now, we’d love to help.

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