Australia’s rising household debt and should we worry? HSBC's Paul Bloxham

Australia’s rising household debt and should we worry? HSBC's Paul Bloxham
Australia’s rising household debt and should we worry? HSBC's Paul Bloxham

GUEST OBSERVER

Following the end of the mining boom, Australia’s growth has been rebalancing towards housing and the services sectors. The first part of the rebalancing act involved a significant rise in housing prices and housing construction.

Housing prices have risen by 30 percent since mid-2012, led by Sydney and Melbourne. Most of the rampup in building has been apartments in the major cities.

The housing market is now cooling, as a result of tighter prudential settings and the boost to housing supply.

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Australia’s rising household debt and should we worry? HSBC's Paul Bloxham 

Although the housing upswing has been a necessary part of the rebalancing act, it also drove a rise in household debt. The household debt-to-income ratio has risen from 167 percent in 2011 to 186 percent in 2015. Australian household debt levels are among the highest in the world. However, high household debt is not, in itself, a problem, as long as the debt is held by households that can service it. In Australia, the distribution is fairly favourable, with high income earners holding most of the debt.

Institutional features also matter. In Australia’s case, all mortgages are full recourse, significantly reducing the incentive to default. Australia does not have sub-prime mortgages. Australian households also use their mortgage to save, given the tax benefits available for doing so. This has meant that the average mortgage is currently more than 2.5 years pre-paid, leaving households with a significant equity buffer to draw down, if needed. The prudential regulator has also been tightening lending standards over the past 18 months, particularly for investors, reducing the risks involved with the new lending. Loan-to-valuation ratios on new loans have fallen.

We expect housing price growth to remain subdued in coming quarters. We see some risk that apartment prices could fall, given signs of over-supply of apartments, particularly in Melbourne and Brisbane. However, we view these apartment markets as somewhat segmented from the detached housing market. Significant foreign investment in new apartments also limits domestic financial system exposure.

Overall, we see mortgage debt as generally well distributed to households that can  afford to continue to service it and see the financial stability risks as moderate.

Australia’s housing market is cooling 

National housing prices have been broadly steady over the past six months, following strong growth over recent years (Chart 1).

The slowdown has been most vivid in Sydney and Melbourne, where housing prices have been flat since October, following annual average growth of 10 percent and 6 percent over the previous four years (Chart 2). Housing price growth has been much more modest in the rest of the country at around 3 percent a year over the same period.

Apartment prices have generally risen by less than detached housing prices in recent years, and are slowing down by more than detached housing prices in some of the major markets.

The slowdown reflects a range of factors, including tighter prudential settings, particularly for investors, and rising housing supply. We expect these factors to continue to constrain housing price growth in coming quarters and forecast that national housing price growth will run at low single-digit rates this year and into 2017, following growth of around 10% in 2015 (see Downunder Digest: Australia’s housing market cools, 11 December 2015).

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Australia’s rising household debt and should we worry? HSBC's Paul Bloxham

Household debt has risen, but it’s the distribution that matters

The housing price boom has led to rising household debt. The household debt-to-income ratio has increased from 167% in 2011 to 186% in 2015, mostly led by a pick-up in lending to investors (Chart 3 and 4). This makes Australian household debt levels amongst the highest in the developed world (Chart 5). Of course, given the rise in housing prices, the household debt-to-asset ratio has been more subdued: it has actually fallen from 24% in 2011 to 22% in 2015.

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Australia’s rising household debt and should we worry? HSBC's Paul Bloxham

High household debt levels can make an economy more vulnerable in the face of a shock.

However, it is unusual for the high debt levels, in themselves, to be the driver of a downturn. The US sub-prime crisis was a rare example of this situation. Importantly though, even in the US, it was not the level of aggregate debt that mattered most, but the distribution of debt. In Australia’s case, most of the debt is held by higher income households. Numbers for 2010 showed that, at that time, around 72% of the household debt was held by the top 40% of income earners (Chart 6). Less than 4% of the debt attributed to the lowest 20% of earners.

Australia’s financial system also has institutional features that help to reduce the risk that household debt could become concerning. For a start, all mortgages are full recourse.

Australia’s tax system also favours paying down mortgages ahead of schedule as interest payments and expenses on owner-occupied properties are not tax-deductible.

The latest numbers suggest that the average mortgage in Australia is currently over 2.5 years pre-paid, leaving households with a significant buffer in the face of the risk of rising unemployment.

Lending standards were tightened as investor borrowing rose

Despite these factors, the strong rise in lending to housing investors through 2013-15 raised concerns that the new lending could increase the risk to the overall mortgage book. Concerns increased partly because the ramp-up in debt was quite geographically concentrated in New South Wales and, to a lesser degree, Victoria, and because the strong investor interest was helping to fuel double-digit housing price growth in these markets (Chart 7).

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Australia’s rising household debt and should we worry? HSBC's Paul Bloxham

As a result of these concerns, the authorities tightened prudential settings. This included: requiring the banks to test new borrowers for a higher mortgage rate than offered; requiring the banks to slow the growth in their lending to investors to below 10% y-o-y; and, requiring the banks to hold more capital (which saw effective mortgage rates rise). Tighter prudential settings have seen a clear pullback in lending to investors (see Chart 7). There has also been a fall in the proportion of lending at loan-to-valuation ratios of over 90% and a decline in ‘interest only’ loans (Chart 8). This should help to reduce the risks associated with recent new lending.

Apartment over-supply presents a risk

To the extent that there are risks, the key focus is on the apartment markets in the major cities. Apartment building has picked up substantially in the major cities (Chart 9). Importantly, our view remains that the national detached housing market is not over-supplied, which means the overall housing market is not yet showing signs of being over-supplied (see Downunder Digest: Australia’s housing supply ramp-up, 9 September 2015). As Chart 9 shows, there has only been a modest rise in construction of detached dwellings in recent years.

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Australia’s rising household debt and should we worry? HSBC's Paul Bloxham

The risk of a potential over-supply of apartments is largest in Melbourne and Brisbane, where apartment building has been at record highs as a share of the existing stock (Chart 10). There is also some risk of over-supply in Perth, where apartment building has been strong.

To some degree, the detached and apartment markets are segmented, given the lack of perfect substitutability. For example, buyers of detached dwellings in the suburbs tend to be quite different from buyers of inner-city apartments. So a possible decline in apartment prices, due to over-supply, would not necessarily translate into a matching fall in detached housing prices.

This is particularly the case, given that there has only been a limited pick-up in detached home building in recent years. The tightening of prudential settings and falls in loan-to-valuation ratios also help protect the financial system from any decline in apartment prices as new borrowers would need to see larger price declines before they fell into negative equity.

Strong foreign investor involvement in the major city apartment markets, particularly from China, may also limit the exposure of the domestic financial system to the impact of any falls in apartment prices in these markets. Government approval numbers show that there has been a strong rise in foreign purchases of new dwellings in Australia over the past year (Chart 11).

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Australia’s rising household debt and should we worry? HSBC's Paul Bloxham

Many of these purchases are off-the-plan apartments, partly because foreigners are restricted to purchasing newly constructed dwellings.

In its recent semi-annual financial stability review, the Reserve Bank of Australia (RBA) noted that ‘the Australian banking system has little direct exposure to Chinese investors’. Foreign buyers may also have different motivations for purchasing, with some looking to invest in property as a store of value, rather than for speculation. This could limit the willingness of foreign investors to divest, even in the event of some capital losses.

Falling apartment prices could also put pressure on developers’ balance sheets, with many of the apartments having been sold ‘Off the plan’. Again, the RBA recently noted that its liaison suggested that ‘settlement failures have, to date, remained uncommon and are generally expected to increase significantly only if housing prices fall substantially’.

Related risk in commercial property

Global demand for commercial property assets has also somewhat displaced Australia’s commercial property market. Commercial property prices have risen well ahead of rents in recent years, as global investors ‘search for yield’ pushes Australian yields down to global levels, which are around historical lows. The ramp-up in commercial property prices (and fall in yields) has come despite office vacancy rates that remain elevated, with particularly sharp increases in Brisbane and Perth.

This could have a bearing on the domestic apartment market as there may be some substitutability between office and apartment buildings. A retreat in commercial property prices could put some downward pressure on apartment prices. However, much like the apartment market, foreign investor involvement in the commercial property sector has been significant, which could limit the risks to the domestic financial system.

Mortgage loan arrears are still falling

Finally, it is worth noting that mortgage loan arrears have continued to fall since their peak in 2011 and are at very low levels (Chart 12). What is most interesting is that arrears continued to decline despite the rise in the unemployment rate over recent years. This is likely to reflect the support from falling interest rates over that period. The recent decline in the unemployment rate should help to support loan servicing and potentially limit concerns about household debt levels.

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Australia’s rising household debt and should we worry? HSBC's Paul Bloxham

Paul Bloxham is chief economist (ANZ) for HSBC . Daniel Smith is economist. They can be contacted here.

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Bubble Housing Prices

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