Financial Stability Review – September 2007 Household and Business Balance Sheets

As discussed in the most recent Statement on Monetary Policy, the Australian economy is continuing to grow at a strong pace, which is contributing to favourable conditions in the household and business sectors. Overall, household and business balance sheets remain in good shape. While the share of households experiencing difficulties meeting their debt obligations has risen over recent years, this share remains relatively low. Moreover, a number of indicators suggest that the rate of increase in households experiencing difficulties has slowed in the past year or so, which is consistent with the continuing strong growth in employment and firmer housing markets in many parts of the country. While leverage among businesses has increased over the past couple of years, debt-servicing requirements and arrears rates remain low, in part due to the ongoing strength in profitability.

Household Sector

As has been discussed in previous Reviews, household balance sheets in Australia have expanded significantly since the early 1990s, with a substantial rise in the value of both debt and assets relative to household disposable income (Graph 44). Over this period, the net worth of the household sector has also risen significantly, from the equivalent of about 4½ times annual income to a little over 6½ times income.

The strong growth in household balance sheets has continued in recent years, with debt rising by around 13 per cent and assets by 11 per cent over each of the past two years. Moreover, the fact that the value of assets significantly exceeds the value of liabilities means that, despite the latter growing more quickly, household net worth has increased at an average rate of 11 per cent over these two years, slightly above the long-run average rate of increase. Aggregate gearing of the household sector – the ratio of debt to assets – has also continued to rise, to stand at 17½ per cent at the end of March 2007, an increase of 5½ percentage points over the past decade. Despite this increase, household gearing remains lower than in many comparable countries.

Over the year to March 2007, the latest period for which relevant data are available, the value of households' holdings of financial assets increased by 13 per cent, compared with an increase of 18 per cent in the previous year (Table 6). Growth continued to be underpinned by valuation gains resulting from generally buoyant equity markets, with the ASX 200 increasing by about 40 per cent over the past two years. There have also been significant inflows into financial assets, with net inflows into superannuation up by 22 per cent in the year to March. This increase is consistent with survey data which show a sharp rise over the past couple of years in the proportion of households that view superannuation as the preferred place for their saving (Graph 45). Although official data are not yet available, the superannuation industry has reported that there was a surge in contributions in the June quarter, as households took advantage of the one-off opportunity to make superannuation contributions of up to $1 million before lower limits on concessionally-taxed contributions were introduced. As well as switching from other financial assets, such as deposits, this increase in superannuation contributions appears to have been partly funded by increased borrowing, as discussed below.

After having been subdued for a couple of years, growth in the value of households' non-financial assets – mainly housing – has picked up recently, in line with the firmer tone in the housing market. Average nationwide house prices rose by 9 per cent over the year to the June quarter, double the average rate of growth over the previous two years (Table 7). Divergences in the rate of house price growth across the capital cities have also narrowed, with prices levelling out in Perth and picking up in most other cities. Most notably, average house prices rose by 3 per cent in Sydney over the past year, after falling over the previous two years. Disaggregated data indicate that the increases in Sydney are concentrated in the upper end of the market, where auction activity has strengthened recently, while house prices are still flat or declining in less expensive suburbs, particularly in the outer metropolitan area.

As noted above, on the liabilities side of the balance sheet, household debt also continues to grow solidly. Borrowing for housing, which accounts for the bulk of household debt, increased by 13 per cent over the year to July 2007, around the same as in the previous year. Growth in housing debt had slowed in the latter part of 2006 and into early 2007 but has since lifted, largely due to a pick-up in the demand for credit by investors (Graph 46). In six-month-ended annualised terms, growth in investor and owner-occupier housing credit is now broadly similar, following a couple of years in which growth in investor housing credit had been lower.

For much of the past year, demand for fixed-rate housing loans was relatively high, with almost one fifth of new owner-occupier housing loans in the year to July taken out at fixed interest rates, compared with 14 per cent in the previous year and a decade average of 11 per cent (Graph 47). While the stronger demand for fixed-rate loans reflects, in part, some borrowers' expectations about future movements in interest rates, it also reflects increased competition among lenders, with spreads to funding costs having narrowed. While the most common term for fixed-rate housing loans is still only three years, some lenders have reported increased demand for longer terms, including up to 10 years.

Growth in personal credit had been fairly steady for much of the past year before picking up sharply around the middle of the year. Part of the recent pick-up is likely to have reflected borrowing to fund superannuation contributions ahead of the rule changes that took effect on 1 July. Over the year to July, personal credit increased by 15 per cent, up from growth of 10 per cent in the previous year.

Within personal credit, growth in margin lending for the purchase of shares and managed funds has been especially strong, at 46 per cent over the year to June, up from 39 per cent in the previous year. Strong demand for margin loans was associated with strength in the equity market throughout much of the period, which also contributed to a relatively low frequency of margin calls. Typically, margin loans are well collateralised by the underlying securities, with an average loan-to-valuation ratio of just over 40 per cent. Partial data for the September quarter show a marked rise in the number of margin calls as a result of the increase in share market volatility.

Credit cards are one component of personal credit for which growth has moderated in the past year. Outstanding credit card balances grew by 11 per cent over the year to July, down from average annual growth of around 13 per cent in the previous two years. This reflects a combination of slower growth in the number of accounts and a tendency for cardholders to repay their balances more quickly than in the past.

Continued growth in the ratio of household debt to income over recent years, together with higher interest rates, has seen the ratio of aggregate household interest payments to disposable income continue to increase. In the June quarter 2007, interest payments on household debt were equivalent to 12 per cent of household disposable income, up by around one percentage point from a year ago, and well above the previous peak (Graph 48). The bulk of the rise in this ratio over the past decade has been due to an increase in interest payments on housing loans, with the aggregate interest-payments ratio for owner-occupier loans increasing from 3½ per cent to 6½ per cent, and that on investor loans increasing from 1 per cent to 3 per cent. With the average interest rate on outstanding housing loans roughly the same in the June quarter 2007 as it was in mid 1997, the increase in the overall housing interest-payments ratio over the decade is mostly attributable to the increase in the ratio of housing debt to income – from 62 per cent to 138 per cent.

As noted in previous Reviews, there are three main factors that underlie this increase in the ratio of housing debt to income. First, there has been a substantial increase in the ratio of house prices to income, with the median dwelling price rising from the equivalent of 3.5 times annual household disposable income in mid 1997, to 5.7 times currently (Graph 49). This increase means that, for a given loan-to-valuation ratio, borrowers have had to take on a larger amount of debt relative to their income to purchase a median-priced house. Second, there has been an increase in the proportion of households with owner-occupier mortgage debt. According to the latest Census, 35½ per cent of households were paying off an owner-occupier loan in 2006, up from 27½ per cent in 1996, with the increase in the indebted ownership rate most evident for households in the older age groups (Graph 50). Third, there has been an increase in investor activity in the housing market, with data from the Australian Taxation Office showing a rise in the share of taxpayers with investor housing debt, from about 8 per cent in the mid 1990s to 10½ per cent in 2004/05 (the latest available data).

The increase in the share of households with debt means that the rise in the aggregate debt-servicing ratio overstates the rise in the average ratio for households with debt. According to estimates based on Census data, the median owner-occupier debt-servicing ratio of indebted households (calculated as interest and principal repayments – including any excess repayments – on owner-occupier debt as a share of gross household income) increased from 20 per cent in 1996 to 21½ per cent in 2006, which is less than the increase in the aggregate owner-occupier interest-payments ratio over the same period (Graph 51).

This rise in debt-servicing ratios over the past decade is not surprising given the favourable macroeconomic environment, including the strength in the labour market, over this period. In particular, the reduction in the unemployment rate to the lowest level in about 30 years, the associated growth in real incomes and the moderation in macroeconomic volatility since the 1980s has given households the confidence to take on larger debt-servicing commitments relative to their incomes. Even allowing for the increase in interest payments, real disposable income averaged across all households has grown at an average annual rate of 2 per cent over the past decade, which means the average household now has a higher absolute amount of income remaining after allowing for both inflation and interest payments than was the case a decade ago (Graph 52). Consistent with this, estimates from Census data indicate that the median gross income of indebted owner-occupier households after debt payments increased by 19 per cent in real terms between 1996 and 2006. Moreover, the rate of growth was more pronounced for households in the bottom two income quintiles than for those in the top three quintiles, in part reflecting the reduction in the unemployment rate over this period.

The willingness of households to take on larger debt-servicing commitments is also reflected in an increasing share of households with debt-servicing ratios that have historically been considered high. At the time of the 2006 Census, 29 per cent of indebted owner-occupier households are estimated to have had debt-servicing ratios above 30 per cent, compared with 23 per cent a decade earlier. Most of this increase is accounted for by higher-income households, which accords with survey data showing that the bulk of the increase in housing debt over this period has been taken on by higher-income households, who should have the greatest capacity to repay it. There has also been a slight increase (from 62 per cent to 64 per cent) in the share of indebted households in the bottom two income quintiles with owner-occupier debt-servicing ratios over 30 per cent – a commonly used measure of ‘housing stress’. However, as relatively few households in the bottom two quintiles have housing debt, only about 3 per cent of all households in Australia were in this situation in 2006.

Notwithstanding the increase in average debt-servicing ratios, only a small share of households are experiencing difficulties meeting their debt repayment obligations, although this share has increased over recent years. As at end June 2007, the ratio of the value of non-performing housing loans to total housing loans on banks' domestic balance sheets stood at 0.41 per cent, a rise of about 0.2 of a percentage point since mid 2003, when this ratio was at extremely low levels (Graph 53). Over the past couple of years, the share of these loans that are not well covered by collateral has risen. This reflects the general increase in loan-to-valuation ratios on new loans, as well as the weakness in residential property prices in some parts of the country.

The 90-day arrears rate on securitised prime housing loans was also 0.41 per cent in June, and has been broadly unchanged since the beginning of 2006, after increasing in 2004 and 2005. This levelling out in the arrears rate is reflected in the data on the repayment record of loans by year of origination. Securitised full-doc loans made in 2005 and 2006 are currently showing a somewhat better repayment record than loans that were made in 2004 (Graph 54).

The securitisation data also show that borrowers who have taken out non-conforming loans and low-doc loans are more likely to be experiencing repayment difficulties than borrowers with standard loans (Graph 55). Non-conforming loans are the closest equivalent to sub-prime loans in the United States and represent only about 1 per cent of housing loans in Australia, compared with the 15 per cent sub-prime share in the United States. While the 90-day arrears rate on securitised non-conforming loans has risen consistently over the past couple of years – and is currently around 7 per cent – it is still considerably lower than the equivalent arrears rate on sub-prime loans in the United States. For low-doc loans – which account for around 7 per cent of housing loans outstanding in Australia – the arrears rate is much lower than that on non‑conforming loans, at 0.95 per cent, and has increased only slightly over the past year.

Despite the increase in non-performing housing loans over the past few years, the arrears rate remains low by international standards. Moreover, the recent increase is not unexpected, particularly given the strong competition in lending markets over the past decade or so, which has made housing finance available to a broader range of borrowers. The general easing of credit standards over this period has meant that the marginal borrower over recent years has been riskier than was the case a decade ago and, as a consequence, the arrears rate for a given level of interest rates and unemployment is likely to be higher than was the case in the past.

A modest increase in arrears rates over recent years is also apparent for banks' personal loans and on credit card debt. As at June 2007, the non-performing rate for credit cards was 1.2 per cent, up from 1.1 per cent a year earlier (Graph 56). For banks' personal loans, the equivalent figure was a little under 1 per cent in June 2007 and broadly unchanged over the year. As with housing loans, both of these rates remain low by international standards. In addition, the rate of growth of credit card cash advances, another possible indicator of financial distress, has slowed markedly over the past year.

The number of court applications for property repossession has also risen over recent years, although less so in 2007 (Graph 57). Over the year to August, there were 5,605 such applications in New South Wales and 2,775 in Victoria, although these figures overstate the number of housing repossessions that eventually occur, as borrowers can choose to sell their property or refinance the loan before the lender goes through all the remaining legal steps to take possession (see Box B). Liaison suggests that some of the newer, non-bank, entrants to the housing loan market are quicker than traditional lenders to seek repossession.

Another measure of the financial condition of the household sector is the number of applications to the Australian Prudential Regulation Authority (APRA) for early release of superannuation benefits in order to overcome financial stress, either resulting from mortgage payments or medical expenses. In 2006, 13,871 such applications were approved for a total release of $135 million of superannuation benefits, compared with 10,459 approvals for the release of $77 million in the previous year (Graph 58). Part of this increase is likely to reflect a change in behaviour, with some lenders promoting access to superannuation as one way for borrowers in difficulty to get up to date on their mortgage obligations.

While the various indicators show some increase in the share of households experiencing financial difficulties over recent years, the vast bulk of borrowers are still meeting their debt repayment obligations. Moreover, many borrowers are making excess principal repayments on their housing loans. Liaison with banks indicates that about one quarter of owner-occupier borrowers are more than a year ahead on their mortgage repayments, and around one half are ahead by more than a month. Data on a sample of securitised housing loans suggest that the rate of net excess principal repayments (i.e. net of redraws of excess principal previously paid) averaged around 0.3 per cent of outstanding loan balances per month during 2006 – equivalent to 3½ per cent at an annual rate (Graph 59).[1] While this is a lower rate than earlier in the decade, it has picked up a little since late 2005 reflecting, in part, a desire by some borrowers to repay their loans more quickly given robust real income growth and increases in interest rates. Surveys of consumer sentiment also suggest that households remain reasonably positive about their personal finances.

Even though the picture is reasonably benign at the aggregate level, disaggregated data do show there are some pockets of difficulty. These are most noticeable in New South Wales, where the mortgage arrears rate has been higher than in the other states for some time (Graph 60). Within New South Wales, higher arrears rates appear to be concentrated in western Sydney. This is consistent with other indicators which suggest that this area is experiencing more financial difficulties than many other areas. Court data suggest that the number of writs of possession have been highest in western Sydney, and Census data show that the share of households in this part of Sydney with a (owner-occupier) debt-servicing ratio above 30 per cent is considerably higher than in other parts of the country (Graphs 61 and 62). The unemployment rate in western Sydney has also risen slightly and property prices have been under downward pressure. In addition, a disproportionately large number of borrowers in this part of Sydney took out investment housing loans around the peak of the house price cycle.

Over the past couple of years, there has also been a disproportionately large increase in the number of personal administrations (mainly personal debt agreements and bankruptcies) in New South Wales compared with the other States. At the national level, it is also notable that there has been an increase in the proportion of people nominating ‘excessive use of credit’ as the primary cause of their bankruptcy – about one quarter nominated this in 2005/06, up from 10 per cent in the late 1990s – but this share is still well below that in the late 1980s when excessive use of credit was nominated as the primary cause of about one half of all personal bankruptcies.

Business Sector

The strong expansion of the Australian and global economies has continued to underpin favourable conditions in the business sector. In aggregate, business finances are in good shape, with profit growth continuing at a strong pace and debt-servicing ratios remaining at low levels. Notwithstanding the ready availability of internal funding, strong growth in investment over recent years has been associated with an increase in external fund raising, mainly intermediated debt, which has recently been growing at its fastest pace since the late 1980s. This has resulted in an increase in overall gearing, although business balance sheets remain in sound condition, with business loan arrears rates at low levels. While six months ago it looked as if the period of conservative gearing in the business sector might be coming to an end – with the boom in leveraged buyouts being the clearest sign of this – the recent turbulence in global credit markets makes it less clear how this will play out in the period ahead.

Profits of the non-financial business sector – as measured by the gross operating surplus of private non-financial corporations and gross mixed income of unincorporated enterprises – increased by 8 per cent over the year to the June quarter 2007, broadly in line with average growth over the past decade. (These figures are adjusted for the reclassification of Telstra from the public to the private sector in the March quarter 2007.) Profits have increased as a share of GDP since earlier in the decade, with this ratio currently around historically high levels (Graph 63).

There has been a marked change in the composition of aggregate profit growth over the past year, with profit growth of the mining sector slowing, offset by a pick-up in profit growth of the non-mining sector. The notable exception to this is the farm sector, where profits have weakened considerably owing to drought conditions. For the business sector as a whole, the profit outlook is positive, with surveys indicating that firms' expectations of profitability are at, or above, long-run average levels and equity analysts continuing to forecast fairly solid earnings growth for listed non-financial companies over the next few years.

Strong corporate profitability in recent years has been reflected in share price gains through much of the period. Notwithstanding the recent falls, the ASX 200 is 26 per cent higher than a year ago, and has roughly doubled since mid 2003 (Graph 64). This is above the increases seen in major overseas share markets over the same period. In aggregate, the share price increases of the past few years have been well supported by earnings growth, so there has been relatively little change in the price/earnings (P/E) ratio. Currently, the P/E ratio for Australian companies stands at about 17, around the average of the past two decades.

As noted in the most recent Statement on Monetary Policy, the favourable macroeconomic environment has been associated with a strong rise in business investment, from 12½ per cent of GDP in mid 2002 to 16 per cent in the June quarter of 2007 (Graph 65). While strong profit growth has enabled businesses to finance part of this expenditure out of internally generated funds, external fund raising has also picked up significantly over the past few years. Over the year to June 2007, external funding represented 63 per cent of new business finance and was equivalent to about 13 per cent of GDP, up from 5½ per cent in 2003. Total business funding in the past couple of years has exceeded firms' fixed investment spending, with the excess being used to accumulate financial assets, mainly deposits and offshore equity.

The bulk of the increase in external funding in recent years has been in the form of intermediated credit, which has recently been growing at annual rates of around 19 per cent, the fastest pace since the late 1980s (Graph 66). APRA data also indicate that the strong growth in business credit is being driven by larger businesses, with the outstanding value of bank loans greater than $2 million rising by 31 per cent over the year to June 2007 (Table 8). This is partly due to the strong growth in syndicated lending, for which approvals have been at record levels in recent years. In the year to June 2007, $124 billion of syndicated loans were approved, up from $84 billion in the previous year.

The recent strength in syndicated lending partly reflected the boom in leveraged buyout (LBO) activity that was particularly prominent in 2006 but has moderated in 2007. In the six months to June, the total value of LBO deals completed was around $2 billion, down from $9 billion in the second half of 2006, with a number of major proposed buyouts not proceeding. While there are a variety of reasons for these deals not going ahead, a less receptive funding environment is one factor that is likely to limit LBO activity in the period ahead. The recent volatility in global credit markets has closed the gap between the cost of debt and the return on equity that was one of the main drivers of LBO activity in 2006 (Graph 67). Investors still prepared to fund LBOs are now demanding more covenant protection, effectively ending the trend toward so-called covenant-lite loans. Even though LBO activity has fallen, there is still a large value of other merger and acquisition deals in the pipeline (Graph 68).

Unlike intermediated debt, net non-intermediated capital raisings by non-financial companies have been broadly steady as a share of GDP over recent years. Within the total, annual net equity raisings rose from $10 billion in 2004/05 to $22 billion in 2006/07, while net debt issuance in 2006/07 was $8 billion lower than the peak of $22½ billion reached in 2004/05, mainly owing to reduced offshore bond issuance (Graph 69). Looking over a longer period, non-intermediated debt has become a more important source of funding for private non-financial corporations, comprising 19 per cent of their outstanding debt in March 2007 compared with around 11 per cent in the mid 1990s (Graph 70). There has also been a greater tendency for these companies to issue longer-term debt securities and to issue more of these securities within Australia rather than offshore.

In terms of overall balance sheets, business leverage has tended to increase over recent years. For listed non-financial corporations, the debt-to-equity ratio has risen by 12½ percentage points since December 2004, to stand at 68 per cent (Graph 71). This is close to its post-1980 average, but well below the level in the late 1980s, when it exceeded 100 per cent. Underlying this increase have been some divergent trends at the sectoral level. The very strong profitability of resource companies has allowed these companies to finance their investment out of earnings without increasing their debt levels, while the gearing of companies outside the resources sector has tended to rise, albeit for a relatively small number of companies and from quite low levels in most cases.[2] For all non-financial businesses, the ratio of debt to profits has risen over recent years, but interest-servicing requirements remain at a relatively low level owing to the strength of profitability and the compression in lending margins (Graph 72).

In line with low debt-servicing requirements, arrears rates on banks' business loans are lower than a few years ago (see The Australian Financial System chapter). In addition, there has been no default on a (rated) corporate bond since 2004. One area where there has been a number of recent high-profile corporate failures is residential property development. In part, this reflects soft conditions in the residential property market in recent years, but also appears to be due to a number of company-specific factors, including high borrowing costs and overheads, and high-risk business models. The chapter on Developments in the Financial System Infrastructure contains a discussion of some of the regulatory issues associated with these collapses.

The positive business environment continues to be reflected in most business surveys, financial market pricing and credit ratings. According to a range of business surveys, actual and expected business conditions have strengthened recently and are well above long-run average levels. Non-financial corporate bond spreads and credit default swap (CDS) premia remain lower than earlier in the decade, though they have widened in the past few months, in line with developments in corporate debt markets internationally (Graph 73). The recent increases in CDS premia have occurred across the corporate sector, in contrast to the increases earlier in the year, which were largely confined to a subset of companies that were takeover targets in leveraged buyout deals. As has been the case in recent years, ratings actions of credit rating agencies are consistent with positive business conditions, with Standard & Poor's making more rating upgrades than downgrades for Australian companies in the past year.

One particular area of interest is the commercial property market, given the role that this market has played in financial stresses in the past. Commercial property lending, which accounts for about one quarter of banks' business credit and about 10 per cent of their total credit, has been growing rapidly over the past few years. Lending for offices – which accounts for around one quarter of banks' total commercial property lending – increased by 27 per cent over the year to March 2007, and lending for industrial property grew by 31 per cent (Table 9). Competitive pressures in this segment of the business lending market have strengthened in recent years, with downward pressure on margins on commercial property loans and pressure to ease other terms and conditions on such loans. Nonetheless, as discussed in The Australian Financial System chapter, the share of banks' commercial property exposures that is impaired is very low and has declined in recent years. This reflects buoyant conditions, particularly in the office property market, where prices and rents are growing strongly and vacancy rates are low (Graph 74). In part, this is the result of some supply shortages, with office construction as a share of GDP being well below the levels of the late 1980s, although the tightening in office property markets has prompted a noticeable pick-up in planned construction.


See Reserve Bank of Australia (2007), ‘Loan Approvals, Repayments and Housing Credit Growth’, Bulletin, July. [1]

See Reserve Bank of Australia (2007), ‘Box D: Recent Developments in Corporate Gearing in Australia’, Statement on Monetary Policy, August. [2]