Would banks be at risk from a 40-50% drop in Auckland house prices?

by Pattrick Smellie / 05 September, 2016
Economist Arthur Grimes has called for a 40% fall in Auckland house prices, and a Greens co-leader says they need to drop by 50%.
Cartoon/Chris Slane
Cartoon/Chris Slane


New Zealanders have home mortgage borrowings totalling almost $228 billion, according to the latest KPMG Financial Institution Performance Survey, published in late July. That’s close to two-thirds of the total lending by New Zealand-registered banks, which KPMG put at $364 billion.

Clearly, if the housing market went south in a big way, it would be reasonable to expect that would be a big problem for the banking system.

Yet for all the hand-wringing about the risk to the financial system of absurdly high house prices, a house-price slump – even a sudden, savage one – would not be particularly dangerous at all.

It would be certain to badly hurt highly indebted individual home owners, whether investors or owner-occupiers, but the banking system would cope fine, according to “stress tests” conducted by the Reserve Bank at the end of last year.

Source/Michael Reddell and QV
Source/Michael Reddell and QV


As part of its task of guarding against financial crises, the Reserve Bank routinely applies an apocalyptic economic recession in which house prices nationally fall 40%, with a 55% fall in Auckland.

That is far more dramatic than the steady 40% house-price fall over several years provocatively proposed by economist and former Reserve Bank chairman Arthur Grimes, which Prime Minister John Key dismissed as “crazy”.

Yet even then, the Reserve Bank concluded such a big house-price slump was unlikely to have any impact on banks’ profits – they would just widen their loan margins – and that the rate of losses on home lending was likely to be low, at around 2%. Mortgage lending would still account for about 30% of all losses under this meltdown scenario, but losses on lending to businesses and other sectors would be closer to 5%.

Source/Massey University
Source/Massey University


“The tendency of New Zealanders is to continue to pay a mortgage and stay in your own house” during tough economic times, says New Zealand Bankers Association chief executive Karen Scott-Howman, who “cannot imagine such an extreme situation” emerging unless there is a huge global economic shock.

However, Grimes’ scenario not only is for a slow-motion house-price decline, but assumes the opposite of a recession. He believes the Government should adopt house-building targets as it has in other policy areas and engineer a sustained building boom.

The biggest problem under that scenario may be finding enough people to quickly build so many houses.

Source/Productivity Commission analysis of Corelogic data
Source/Productivity Commission analysis of Corelogic data


Bear in mind, too, that a 40% fall in Auckland house prices would only take them back to 2012 prices. Still, as shown in the table below, almost 40% of total outstanding mortgage lending occurred in Auckland in the four full years from January 2012 to December 2015.

Close to 117,000 borrowers would be affected by such a reduction, which would be felt as a reduced sense of household wealth. On the upside, first-home buyers would find getting into a home that much easier. There were 26,637 of them in the past four years, all buying into an ever-rising market.

Grimes agrees such a price fall would dent household confidence, although it’s not clear how badly. “There’s not much data on that. There’s some evidence that when equity [in a house] goes up, people spend more, and if it goes down, they spend a bit less. But most people are only making an unrealised loss.”

Unless they sell when the market has plunged, it’s no more than a paper loss.

All the same, a slump in house prices was the unmaking of many Americans’ dreams in the 2008 financial crisis, so why wouldn’t it threaten the financial system here?

* Houses sold more than once during this period are counted only once in these statistics ** Counting only property transactions involving a mortgage Total home lending = $228bn  Total bank lending = $364.5bnSource: KPMG FIPS, July 2016
* Houses sold more than once during this period are counted only once in these statistics
** Counting only property transactions involving a mortgage
Total home lending = $228bn  Total bank lending = $364.5bn Source: KPMG FIPS, July 2016


The answer is mainly that New Zealand’s banking system was far better regulated than America’s. There is no equivalent here to the sub-prime mortgage market, which collapsed when widely marketed bundles of low-quality mortgages were unmasked as a toxic mess.

Also, since 2008, banks everywhere have been required to buffer their balance sheets with extra capital against the potential for just such a meltdown. New Zealand’s banks were already well capitalised at the time of the global financial crisis. Today, they are even more so.

And finally, the Reserve Bank’s loan-to-value ratio restrictions have sharply cut banks’ exposure to the housing market, and the main trading banks have all voluntarily stopped lending to non-resident foreign buyers. By requiring investors to have at least 40% equity and most owner-occupiers to have 20%, banks are well placed for a downturn.

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