RBA: Debt high but households building a buffer

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By Leith van Onselen

The Reserve Bank of Australia (RBA) Financial Stability Review (FSR), released earlier today, contains some interesting data on household debt levels and household’s preferences on how they service this debt.

The FSR shows that overall debt levels, which are 148% of disposable incomes currently, remain near historical highs having barely moved since 2006, when they peaked at 153%. However, due to lower interest rates, this debt has become easier to service.

The more prudent approach to finances can also be seen in households’ reduced appetite for taking on additional debt since the financial crisis (Graph 3.12).

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Household credit growth has been slower in the past five years – at an average annual rate of around 5½ per cent – than in the 20 years prior, when it averaged around 13½ per cent. Within household credit, personal credit has declined over the past five years, with a large fall in margin loans partially offset by modest growth in credit card debt. Growth in housing credit has also slowed over this period, to a current annual rate of around 4½ per cent despite a moderate pick-up in the value of housing loan approvals in the past few years. The slower pace of credit growth has been outpaced by income growth in the past couple of years, resulting in the household debt-to-income ratio falling slightly, to 148 per cent, after peaking at 153 per cent in late 2006. Real household disposable income growth has recently slowed a little, however, to 2 per cent over the  year to the December quarter 2012. This modest growth in income, combined with the decline in interest rates and slower credit growth, has reduced the share of disposable income used to make interest payments to an estimated 9½ per cent in the March quarter 2013. Household indebtedness and gearing are still around historically high levels though, so from the perspective of their financial resilience it would be preferable if households maintained this more prudent behaviour.

The RBA also implictly explains why housing finance commitments have, until recently, been rising whilst mortgage credit growth continues to fall. The answer is in the fact that households with pre-existing mortgages are taking advantage of lower mortgage rates to pay down their debt (partly offsetting new mortgage creation). These accelerated repayments, in turn, are improving household’s own financial stability by increasing their mortgage buffers – i.e. the amount paid in excess of their minimum required repayments.

Contributing to the slower pace of credit growth is the fact that many households have been taking advantage of the lower interest rate  environment to pay down their debt faster than required. Mortgage buffers – balances in mortgage offset and redraw  facilities – are now estimated to be equivalent to around 14 per cent of the outstanding stock of housing loans (Graph 3.13).

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When interest rates fall, not all borrowers reduce their mortgage payments, resulting in an increase in prepayment rates. The increase in the rate of prepayment as a result of  the decline in mortgage lending rates since late 2011 is estimated to have reduced the growth rate of housing credit by around ½ percentage point over 2012.

Measured a different way, in aggregate, households’ mortgage buffers are equivalent to around 20 months of scheduled repayments (principal plus interest) at current interest rates. This provides considerable scope for many borrowers to continue to meet their loan repayments even during a temporary spell of unemployment or reduced income. As with housing loans, households have also been paying off credit card debt; net repayments on personal credit and charge cards have been above average in recent years and balances on personal credit cards have also slightly declined since mid 2012.

While the aggregate lift in mortgage buffers is a good thing, it provides only a limited assessment of default risks. Since risks are at the margin, we would need to know the breakdown at different loan-to-value ratio (LVR) levels in order to know whether there are a significant portion of high LVR mortgages potentially at risk in the event of a major economic downturn.

 

8 Responses to “ “RBA: Debt high but households building a buffer”

  1. StephenM says:

    One starting point for examining the distribution of high LVR mortgages is the data accompanying the Genworth accounts that are submitted to the SEC. Select the 2012Q4 spreadsheet from the link http://phx.corporate-ir.net/phoenix.zhtml?c=175970&p=irol-quarterlyreports for the data.

    It’s not perfect, but given that it is mostly high LVR insurance, the annual averages can be a reasonably good starting point for the higher risk component of a lenders (read bank) portfolio. It is also worthwile to note that WBC and ANZ self-insure – so the bulk of the Genworth should be CBA and NAB.

    I don’t beleive that the LVR numbers are dynamic (that is, adjusted for house price evolution) and make sure that the facevalue RIF numbers are used.

    • Deep T says:

      The LVRs you refer to Steve are a dynamic assessment. However, I’ve never thought they were of much use as they are averages anyway

  2. briefly says:

    Of course, households have been able to improve their financial position over the last few years because the public sector has been willing/able to run deficits and thereby accommodate the imbalance (deficit) in our external accounts.

    This was not a problem as long as aggregate debts grew less quickly than the economy and less quickly than the external deficit.

    As the terms of trade weaken and nominal (AUD) export income start to fall, aggregate debt (household + public sector debt) is now growing more quickly than the economy. This is a signal that the exchange rate ought to be falling, but of course, due to financial repression in the large economies, the currency is in fact appreciating.

    It is time we engineered a depreciation of the currency in order to maintain the relative positions of our export and import-competing sectors, and to encourage further investment in our capacity to supply these sectors.

    We should do this before economic contraction sets in and starts to make all these household debt ratios look a whole lot more troublesome than they already are.

    • Janet says:

      But doesn’t this just reinforce the point that it is ‘our job’ to run a higher exchange rate than otherwise would be the case? The USA and other QE nations have a vested interest in seeing tha their ‘new money’ come to us as debt. We are coerced into taking their debts away and talking them onto our balance sheets, both private and public. I doubt anything will change the value of the A$ downwards, whilst QE has a role to play anywhere. Until the USA etc. repudiates its policy of a weaker dollar and repatriates enough real work back to its own soil (to reduce the unemployment rates) I do not see the A$ falling.

      • briefly says:

        The US would certainly like to see things work this way. But as China re-orients its economy, we will have to re-orient ours too.

        We should actively manage the relative prices of our exports. Why not?

  3. barry says:

    “Since risks are at the margin, we would need to know the breakdown at different loan-to-value ratio (LVR) levels in order to know whether there are a significant portion of high LVR mortgages potentially at risk in the event of a major economic downturn.”

    And where is that data on this? Nowhere from what I can see. Neither the APRA, the RBA nor the ABS compile an accurate data set on First time buyer LVRs.

  4. Bobby Fischer says:

    “Contributing to the slower pace of credit growth is the fact that many households have been taking advantage of the lower interest rate environment to pay down their debt faster than required.

    When interest rates fall, not all borrowers reduce their mortgage payments, resulting in an increase in prepayment rates.”

    Right. So central banks rates have gone from 7+ % around the GFC period to multi-decade lows at 3% (danger Will Robinson!) & the sheeple have managed to pull ahead an extra 1 month per year in terms of their mortgage buffer -> going from a massive 15 months ahead in 2008 to 20 months ahead in 2013.

    That’s not exactly a lot of bang for the buck with cuts of over 4% centrally.

    Just imagine what we can achieve under ZIRP.

    • gonderb says:

      You have to remember that the 15 months – > 20 months repayment buffer is an aggregrate statistic. An improvement of over 33% of this measure *is* significant in this context.