The latest financial stability report from the RBA came out yesterday. Along with the Statement of Monetary policy ( SoMP ) I consider this to be one of the most important pieces of Australian financial documentation. The RBA does a very good job putting all of this data together, however as I have commented previously I find the analysis of the data somewhat lacking in the risk management department:
I have previously stated my concern about the RBA position on the financial stability of the private sector. My main issue is that in all of the recent literature produced by the RBA I cannot find suitable recognition of the fact that private sector debt issuance and private sector asset values are intrinsically linked. As far as I can tell much of the risk analysis performed by the RBA seems to ignore this point and at a time of historically low credit issuance this is a major concern.
The main crux of my concern is covered in the following paragraph in reference to the 2009 first home buyer cohort.
The issue I had with that analysis was that the RBA seemed to be saying that the cohort who took on “riskier loans” will not get into trouble because house prices will continue to rise. This may end up being the case in the long run, but what the RBA doesn’t seem to be taking into account is the “cause and effect” in their analysis. The reason house prices continued to rise was because of the demand of the first home buyers who took on those risky loans, that is, the risk mitigator mentioned by the RBA is intrinsically linked to the cause of that same risk
So once again let’s take a look:
The household sector has continued to consolidate its financial position. The household saving rate remains well above the levels recorded in the 1990s and early to mid 2000s and households have been actively shifting their portfolios towards more conservative assets such as deposits. The aggregate debt-to- income ratio has drifted down over the past year, with demand for new debt remaining low and many households choosing to repay their existing debt more quickly than required. Solid income growth is also helping to support households’ debt-servicing capacity. In aggregate, households are managing their debt levels well, though mortgage arrears rates are still a little higher than a few years ago.
The business sector has been experiencing mixed conditions: the mining and related sectors continue to benefit from the resources boom, while the retail, manufacturing, construction and tourism sectors are facing weaker conditions associated with subdued retail spending, the high exchange rate and, in some cases, tighter lending standards than average. Overall, profitability and conditions in the business sector are positive. However, banks’ non-performing business loans and failure rates are somewhat higher than average, reflecting the challenges some firms are facing as the Australian economy goes through a period of structural change. The business sector is in a better financial position than it was several years ago, having reduced leverage considerably and improved its liquidity position. Even so, demand for credit remains subdued.
Household Sector
Households’ more prudent approach to financing has persisted through the past few quarters. As one indicator of this, the household saving ratio has been around 91⁄2 per cent of disposable income for the past few years, significantly above the levels recorded in the 1990s and early to mid 2000s (Graph 3.1).
Part of the motivation for this higher rate of saving may have been a desire to bolster wealth, given the weakness in some asset markets in recent years. Real net worth per household is estimated to have fallen by 61⁄2 per cent over 2011, to be 111⁄2 per cent below its 2007 peak (Graph 3.2). This contrasts with the rapid trend expansion in this series over the decade to 2007 when average annual growth was 61⁄2 per cent. Recently, the weakness in household wealth has been driven by dwelling prices, which were down about 4 per cent on an average nationwide basis over the year to December 2011; prices declined in most cities over the year. Housing market conditions remain soft; preliminary data indicate that dwelling prices have fallen a little in early 2012. At the national level, the ratio of dwelling prices to income has fallen over the past year, and is below the average of the past decade, while rental yields have begun to pick up, assisted by stronger rental growth as well as lower prices.
A continuation of disleveraging and its flow-on effects. Interesting enough, but nothing particularly new for MacroBusiness readers (though it seems to be a surprise at The Australian today). Net wealth of households is falling, mostly due to falling house prices, which is ironically due to the private sectors desire to gain more wealth:
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Households have also displayed a less exuberant approach to taking on additional debt in recent years. Growth in household credit has remained at an annual pace of 41⁄2 per cent in the past year, well down on the 14 per cent average growth rate recorded between 2000 and 2010 (Graph 3.4). The reduced appetite for debt has been more pronounced for borrowing for investment purposes, with investor housing credit growing at a slightly slower pace than owner-occupier housing credit for much of the past few years, and the value of outstanding margin loans 30 continuing to fall; it is now down about two-thirds from its 2007 peak. Households’ use of credit cards has also been quite subdued over the past year, with aggregate balances increasing only slightly.
So again, we see the growth in demand for credit in the private sector slowing which is leading to a fall in asset prices. If the trend continues then Australia’s private sector will be deleveraging within 18 months. As we have documented continuously on MacroBusiness over the last year this dynamic is placing downward pressure on many areas of the economy, most notably consumption based service industries, housing and banking. Recent examples being Stockland , BoQ and David Jones.
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And this is where, once again, the FSR wanders off the path of what I consider to be adequate macro-prudential oversight . The slowing rate of credit issuance isn’t only driving down asset prices it is also lowering the potential for growing bank profits. In order to compensate for this lower demand banks have ..… well you can read it:
Housing loan approvals data point to continued modest growth in housing credit in the immediate period ahead. Although the value of monthly approvals increased a little over the six months to January, it remained well below the peaks seen in recent years. The increase was largely driven by a pick-up in approvals to first home buyers, partly reflecting some pull-forward of their demand ahead of the expiry of stamp duty exemptions in New South Wales on 31 December 2011.
Some first home buyers might have also been attracted into the market because lenders resumed offering loans with 95 per cent loan-to-valuation ratios (LVRs) last year. Consistent with this, the share of new owner-occupier housing loans with an LVR above 90 per cent has risen from a trough of 11 1⁄2 per cent in the June quarter 2010 to 17 per cent in the December quarter 2011 (Graph 3.6). The share of owner-occupier housing loans approved at fixed interest rates has also increased over this period, to about 11 1⁄2 per cent in December, a little above its long-run average. This increase likely reflects a narrowing in the spread between fixed-rate and variable-rate loans, though it may also be associated with recent uncertainty about lenders’ loan pricing related to volatility in their funding costs. The share of interest-only (including 100 per cent offset) loans was broadly steady in 2011, while low-doc and other non-standard loans continued to account for a very small share of the market.
In the face of a solid downtrend in local credit growth, a government aiming for surplus and a rather risky looking global outlook I find these numbers worrying. My long standing belief is that the RBA has consistently understated the risks created by high LVR lending, specifically the post-GFC lending environment. As we have recently heard from RPData, the number of houses worth less than the original purchase price is growing and once this occurs there is the much greater potential for financial stress. As I have stated previously:
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There is no way banks were going to see large increases in defaults in a rising market, anyone in financial trouble has been able to sell their property for a higher price, pay down their debt and move on with their lives. Even those who have recently been in financial trouble have been able to access hardship assistance which would have given them time to sell their house if need be. It is when the market begins to fall that the potential for trouble begins.
The FSR does, however, go on to state that households are generally coping well with their levels of debt, many are ahead on their loan repayments, have solid income growth, and have seen household interest payments to disposable income fall due to lower rates and higher incomes. Some analysis, however, seems quite dated and I am not so sure that comparisons between 2010 and 2012 are valid given the recent movements in household wealth:
Although the household sector as a whole is still quite indebted, it remains the case that there is only a small share of very highly geared borrowers, and households generally appear well placed to meet their debt obligations. Data from the latest HILDA Survey, for 2010, show that a declining fraction of indebted owner-occupiers met standard criteria for assessing vulnerability. Just under 3 per cent of indebted owner-occupier households (holding around 7 per cent of owner-occupier housing debt) had both high debt-servicing ratios (DSRs) and high LVRs in 2010, compared with 31⁄2 per cent in 2008. As well, less than 5 per cent of indebted owner-occupiers in 2010 were in the lowest 40 per cent of the income distrubition and had DSRs above 50 per cent. More than 90 per cent of owner-occupier households with mortgages in the 2010 survey had an LVR below 80 per cent and/or a DSR below 30 per cent of income. These households also account for the bulk of outstanding owner-occupier debt.
Consistent with these survey results, aggregate indicators of financial stress show that the household sector has been coping reasonably well with its debt level. While arrears rates on mortgages are still above average, they have eased a little recently, and remain low by international standards. The arrears rate for housing loans (on banks’ domestic books plus securitised housing loans) declined to 0.6 per cent in December, from 0.7 per cent in mid 2011 . The non-performing rate for credit cards has also improved, falling from 1.4 per cent in June 2011 to 1.2 per cent in December, while the rate for other personal loans has been broadly unchanged since mid 2011 at around 2 per cent.
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The information about arrears also seems a little at odds with the latest information from Fitch and Bank of Queensland but overall this is good news. However, in terms of risk management, I am still concerned.
I see very little in global or local trends to suggest that we are going to see a reversal of the current pressures facing the Australian economy. In fact I would suggest that the possibility of a terms of trade shock is greater now than it has been over the last number of years. However, even without some external event, it would appear that there has been a structural shift in the Australian private sector with household savings rates and therefore lower credit growth here to stay. That being the case I continue to see evidence that neither the RBA nor the Australian Treasury have adjusted their growth models to cope, and that is a concern in terms of macro-prudential risk management.
The full housing and business balance sheet section of the FSR is below.
