Financial Stability Review – March 2009 Household and Business Balance Sheets

Over the past year the household sector, in aggregate, has faced the conflicting forces of continued strength in incomes and a significant fall in measured wealth. The effect of the latter, combined with increased uncertainty regarding the macroeconomic outlook, has seen households take a more conservative approach to their finances. A number of indicators point to a marked decline in households' appetite for borrowing, although housing credit continues to grow at a reasonable pace. Over the past year there have been some signs of increased household financial difficulties, although loan arrears rates remain relatively low.

Similarly, businesses have recently become more risk averse, with many companies seeking to de-risk their balance sheets by repaying debt, or by delaying further borrowing and investment decisions in the face of an uncertain economic outlook. Nonetheless, many businesses' balance sheets remain well placed to deal with the current difficulties, after a long period of strong profit growth. While credit conditions have tightened and competition for business lending has diminished, credit is still generally available, although risk margins and collateral requirements have been tightened.

Household Sector

Household disposable income grew strongly over the year to the December quarter 2008, increasing by 14 per cent in nominal terms (before interest payments). Even after allowing for the effects of inflation, household income increased by almost 10 per cent, well above the historical average (Table 9). An important factor underpinning this outcome was a large increase in government transfer payments, which grew by nearly 40 per cent over the year, contributing around 5 percentage points to the increase in aggregate income over that period. Disposable incomes have also been boosted by tax cuts that came into effect in the second half of 2008, with total tax payable by the household sector declining by 3 per cent over the past year. In contrast, growth in employment income slowed over the course of 2008, to be slightly below its longer-run average.

The finances of some households have also been strengthened recently by a large decline in interest payments. At the aggregate level, the ratio of interest payments to household disposable income is likely to fall from its peak of over 15 per cent to around 11 per cent in the March quarter 2009; a further decline should occur in the June quarter as the full effect of earlier falls in interest rates flows through (Graph 61). This will bring the interest-payment ratio back to levels last seen around 2003/04. Many households' real disposable incomes have also recently been boosted by falling petrol prices.

In contrast to the robust growth in household income over 2008, household net worth is estimated to have fallen by around 10 per cent, the largest annual decline in several decades. After peaking at more than 6½ times household disposable income in late 2007, net worth is now closer to 5 times income, around the same as in 2000 (Graph 62). The decline in the value of households' financial and housing assets has resulted in aggregate household gearing ratios moving higher over the year, despite credit growth slowing considerably.

Overall, the Australian housing market has held up better than those in many other countries over the past year. Nationwide indices show a decline in house prices in Australia of around 4 per cent since their peak in March 2008, compared with declines from their peaks of around 10 to 25 per cent in the United States (depending on the measure used) and almost 20 per cent in the United Kingdom. In Australia, the recent weakness has been most evident at the top end of the market, with prices in less expensive suburbs broadly unchanged over the latter part of 2008, after having declined over the previous year (Graph 63).

While further softness in the Australian housing market is possible, the market does not appear to have the same vulnerabilities that have been evident in some other countries. Importantly, the adjustment in the housing market – after a number of years of very large price gains – started at the end of 2003 and thus was well advanced before the onset of the current financial crisis. Reflecting this, the ratio of house prices to household income has declined noticeably from its peak in late 2003. While this ratio remains higher than was the case in previous decades, this is at least partly explained by a number of structural factors, including the transition to an environment of lower inflation and thus lower nominal interest rates. In addition, Australia did not see the very marked decline in mortgage lending standards that occurred in other countries, particularly the United States, and the related negative impact on house prices resulting from a surge in loan foreclosures and a large amount of housing stock coming onto the market. Also differentiating the housing market in Australia from that of the United States is that the demand for new housing in Australia has outstripped net new additions to the housing stock over much of the past decade, suggesting there is substantial underlying excess demand for housing. Finally, housing affordability has increased considerably over recent months as interest rates have fallen, with the cost of borrowing now similar to rental payments in some situations, after many years when renting was much cheaper than buying.

While the value of the household sector's housing assets has declined only slightly over the past year, the value of financial assets has fallen significantly, mainly due to sharp falls in equity prices – which are currently around 50 per cent lower than their peak in November 2007. According to HILDA data for 2006 (the most recent data available), the wealthiest 20 per cent of households held around two thirds of aggregate household financial assets, with these households consequently the most directly affected by the decline in the equity market (Graph 64). The majority of these high net-worth households were still in the workforce, and so are likely to have other sources of income to offset the decline in the value of their financial assets. A little under 25 per cent were retirees, however, of whom around 60 per cent were not receiving any benefits or pensions from the government in 2006. For this group, the decline in wealth has likely resulted in a large fall in available income.

As has been the case globally, declines in household wealth and increased uncertainty about the economy have dented consumer confidence, although the decline in confidence in Australia is less than that in a number of other countries. Households are less optimistic about their personal finances than they have been for most of the past decade or so, and sentiment about general economic conditions over the year ahead has deteriorated significantly (Graph 65).

This marked change in sentiment has seen the household sector take a more conservative approach to its finances over the past year. This is illustrated by the fact that the proportion of households who nominate paying down debt as the wisest use of savings has reached its highest level for over 10 years (Graph 66). Similarly, spending on credit cards has slowed sharply, to be up only 1 per cent over the year to January 2009. In contrast, spending on debit cards was up by more than 15 per cent over the same period (Graph 67).

Partly reflecting this change in attitudes, there was a substantial increase in household saving in the December quarter, with the ratio of net saving to disposable income at 8.5 per cent, compared with almost no net saving a year earlier (Graph 68). Although the most recent outcome was influenced by the large increase in government transfer payments, it is nonetheless a marked change in household behaviour, particularly from that of the first half of this decade, when the household saving rate was negative. Further, since June 2008, households have returned to their longer-run behaviour of net injections of housing equity, whereas they had been withdrawing equity from their homes in the period between late 2001 and mid 2008.

Households' more conservative approach to their finances has seen a substantial slowdown in the pace of household credit growth. After many years of growth in household credit significantly outpacing nominal income growth, it is now running at a slower pace than nominal income, with outstanding credit increasing at an annualised pace of around 4 per cent over the six months to January (Graph 69).

This slowdown in credit growth has been less marked for housing credit than for other types of credit, with the outstanding value of housing loans increasing at an annualised pace of 6.4 per cent over the six months to January. In recent months there has been a pick-up in new loan approvals, as households respond to lower interest rates and increased government support to first-home buyers. Countering this, many households have increased their principal repayments as required interest payments have declined with lower mortgage rates. In contrast to housing credit, there has been a marked reduction in the stock of margin loans outstanding, reflecting both the poor performance of the stock market and the desire by households to de-risk their balance sheets. As at December 2008, total margin debt outstanding was $21 billion – equivalent to around 2 per cent of household credit – down 44 per cent from a year ago.

Overall, arrears rates on housing loans remain relatively low, although they have increased from the unusually low levels of the middle part of this decade. For housing loans on banks' domestic books (which account for more than three quarters of housing credit), the proportion of loans that were non performing in December 2008 was 0.48 per cent, up 16 basis points over the previous 12 months (Graph 70). Arrears rates on prime securitised loans have also increased over the year, to stand at 0.73 per cent in December 2008. These figures are much lower than in a number of other countries for which comparable data are available, although the Australian experience is broadly equivalent to that in Canada (Graph 71).

The arrears rate on securitised low-documentation loans (where borrowers can provide less evidence of debt-servicing ability than normal) has increased noticeably over the past year, up 126 basis points to be 2.0 per cent in December (Graph 72).[2] For non-conforming loans – made to borrowers with impaired credit histories or who do not otherwise meet the credit standards of traditional lenders – the arrears rate was 9.86 per cent in December, having increased by more than 3 percentage points over the past year. It is important to note, however, that non-conforming loans account for only around 0.5 per cent of the total value of outstanding housing loans in Australia, with this share having declined from around 1 per cent over the past couple of years.

Across all housing loans in Australia, it is estimated that around 20,000 borrowers were 90 or more days behind on their mortgage repayments in December 2008, compared with an estimate of 13,000 the previous December.

As well as differences in arrears rates across loan types, arrears rates also reflect differences in credit standards across lenders. For example, the arrears rate of full-documentation loans originated by non-bank lenders is higher and has increased by more than that for equivalent loans originated by banks and other ADIs (Graph 73).

The emergence of non-traditional lenders and the availability of loans on more generous terms are illustrations of the significant structural changes that took place in the Australian housing finance market over the past decade. These changes have meant that for any given set of economic and financial conditions, the arrears rate is likely to be somewhat higher than once would have been the case. In addition to these effects, the recent increases in arrears also reflect cyclical elements. Declines in house prices in some locations in the past few years and softer labour market conditions have contributed to higher arrears rates, as have earlier increases in interest rates, though interest rates have subsequently fallen.

In contrast to housing loans, the arrears rate on credit cards has been little changed over 2008, at around 1.1 per cent, though it has drifted slightly higher over recent years. Arrears on other personal loans, however, have increased notably, up by 54 basis points over the year to December 2008 to stand at 1.34 per cent (Graph 74). This increase is, in part, due to pressures on households with margin loans following the very large declines in equity prices, with the number of margin calls having increased sharply in the December quarter.

Households with particularly large housing loans, or those with high loan-to-valuation ratios, are, on average, more likely to be experiencing difficulties (Table 10). This is consistent with the fact that the arrears rate for investor loans now exceeds that for owner-occupier loans; available evidence indicates that investor loans tend to have higher gearing, and be for larger amounts, than owner-occupier loans (Graph 75).

Loan arrears have increased in all states over the past year, though they remain much higher in NSW than elsewhere, and particularly in regions in western Sydney (Graph 76). Whereas the arrears rate in Western Australia had been markedly lower than the rest of the country for a number of years, since the end of 2007 the number of households in arrears has increased substantially, to be currently around that of most other states. Recent developments in Western Australia have some parallels with those seen in western Sydney earlier in the decade. In both episodes, rapidly rising housing prices induced home buyers to borrow more and, increasingly, to use low-doc and other non-standard loan products to do so, with a relatively high share of the lending undertaken by non-bank lenders. As prices subsequently declined, borrowers who bought near the top of the cycle have seen their home equity erode, although the incidence of negative equity remains fairly limited.

In line with the deterioration in loan performance in Western Australia, the number of applications for property possessions in this state increased noticeably over 2008 (Graph 77). Possession applications have also increased in Queensland in the past year, but are broadly unchanged in New South Wales and Victoria, after substantial increases between 2004 and 2006. Similarly, the number of applications for the early release of superannuation benefits has been little changed over the past year, although the number of personal administrations (including bankruptcies) increased by 12 per cent over the year to December.

Business Sector

Like the household sector, the Australian business sector has responded to the more difficult financial and macroeconomic environment by taking a more cautious approach to finances. For some firms, the increase in risk aversion has led them to reduce leverage by repaying debt and raising equity, while others are reassessing their spending plans, particularly as growth in profitability slows. The desire to reduce leverage is also being influenced by concerns that, at some point in the future, financial conditions may become tougher still, making it more difficult to rollover maturing debt. This is occurring despite the fact that Australian banks are generally continuing to provide credit to good quality borrowers, and that balance sheets in large parts of the business sector have been in good shape over recent years.

The long-run expansion of the Australian economy has seen profits account for a historically high share of GDP for much of the past decade, with both mining and non-mining sectors experiencing consistent profit growth (Graph 78). However, as the economy has slowed over the course of 2008, profits in the non-mining sector (excluding the farm sector) have weakened, to be 12 per cent lower in the year to December. For mining companies, in contrast, profits remained very strong for most of 2008, though growth slowed in the December quarter in response to substantial declines in income from commodity sales. Although some parts of the mining sector are currently hedged against commodity price falls through fixed-price contracts lasting into the first half of this year, these firms will also become exposed to lower prices as contracts come up for renegotiation.

The changed conditions for both mining and non-mining firms were reflected in profit results in the most recent corporate reporting season. While resource firms' underlying earnings in the December 2008 half were up by around 15 per cent on the December 2007 half, this compared with average growth of 38 per cent between 2003 and 2007. For non-resource firms, underlying profits declined 13 per cent, compared with average growth of 16 per cent over the longer period. Forward earnings expectations have also been revised down substantially in recent months. Forecasts for mining company profits for the 2008/09 financial year are currently around 30 per cent lower than those made in June 2008, while those for the 2009/10 financial year are 50 per cent lower (Graph 79). For non-mining companies, full-year earnings are expected to be lower than last year, though a resumption of profit growth is currently forecast in subsequent years.

On top of the slowdown in underlying earnings, many companies' headline profits have been negatively affected by downward asset revaluations and investment losses. These write-downs, together with uncertainty regarding the economic environment, have seen many businesses seeking to deleverage their balance sheets. However, for a small number of particularly highly geared companies, attempts to wind back debt have not been sufficient to offset write-downs in the book value of their equity, which has resulted in increases in gearing ratios; infrastructure and utility firms are particularly prevalent among this group. The effect of this has been a further slight widening in the distribution of gearing among large listed firms – these unintentional increases are in contrast to the deliberate increases in gearing of some parts of the corporate sector over recent years (Graph 80).

For companies outside this most highly geared group, asset write-downs have been largely offset by a scaling back in debt and/or new equity raisings, with the result that gearing levels for these companies have increased only slightly. Overall, the aggregate measure of gearing of listed companies is little changed in the past six months (Graph 81).

Both before and after the announcement of their financial results, a number of companies undertook equity raisings to bolster their balance sheets. Despite falling equity prices, more than $8 billion of new equity has been raised by the non-financial sector over the past three months, compared with a quarterly average over the past four years of $5.5 billion (Graph 82). Further, because companies are seeking to preserve capital at present, buyback activity has been subdued.

Some companies have also sought to build capital by scaling back dividend payments, with around half of the recently reporting ASX 200 companies having announced a cut in dividends; one quarter of all firms announced a cut of more than 50 per cent. However, these companies are mostly relatively small, and the aggregate value of dividends to be paid following the December 2008 reporting season is estimated to be 3 per cent higher than for December 2007. In part, the corporate sector's ability, in aggregate, to leave dividend payments unchanged is a reflection of the sector's relatively conservative dividend payout policy between 2003 and 2007. Although earnings for ASX listed companies grew strongly for much of this period, this was not fully matched by growth in dividends, and the dividend payout ratio declined from around 75 per cent to 60 per cent in the four years to end 2007. The last few months have again seen the dividend payout ratio increase as companies have sought to minimise dividend reductions while profits have slowed (Graph 83).

The changed environment has seen a slowing in business credit growth; in the six months to January business credit grew by 5.7 per cent in annualised terms (Graph 84). With business confidence having fallen to around its lowest levels for nearly 20 years, much of the slowdown in business borrowing is due to firms looking to deleverage their balance sheets in the current period of uncertainty (Graph 85). Reflecting this, liaison with lenders suggests that there has been a large decline in the number of new business loan applications over recent months. However, as discussed in the chapter on The Australian Financial System, credit conditions have also tightened with lenders increasing risk margins. Notwithstanding this, most borrowers have still been able to refinance maturing debt as needed. As an illustration, large borrowers in the commercial property sector – a sector that has reportedly found it particularly difficult to source funds – have had $5.3 billion of new syndicated loans approved since end-June 2008, more than offsetting the $3.4 billion of maturities over that period.

One factor that has mitigated lenders' increased risk margins is the recent substantial easing of monetary policy. Average interest rates on outstanding loans are estimated to have fallen by around 230 basis points for small businesses and 370 basis points for large businesses since their peak in mid-2008, and are currently at their the lowest rates for many years (Graph 86).

Despite this easing in business interest rates, the slowdown in business earnings over the past year has strained some firms' cashflows. This has contributed to an increase in the share of business loans on banks' balance sheets that are classified as non-performing (Graph 87). To date, however, there has been only a modest increase in the extent of more severe corporate distress, with business failures as a share of the number of all incorporated businesses increasing by only 4 basis points over the year to January, to stand at 0.16 per cent.

Within the business sector, impairment rates on commercial property loans have increased much more than for business loans in general. While economic conditions have clearly been behind some of this deterioration, it is also the case that some firms' business models left them more exposed to a downturn.

Until recently, strong demand for space and a lack of vacant supply had led to several years of rapid growth in commercial property construction, especially in the office markets in Perth and Brisbane. This combination of additional supply and decreased occupancy demand due to a slowing economy has recently resulted in a softening in rents and valuations in these two cities, with this turnaround likely to continue as projects under construction are completed and demand from tenants slows further (Graph 88). Prices have also softened in other markets, although the earlier run-up in prices and construction was much less than in Brisbane and Perth. The uncertainties regarding rental incomes and asset valuations have contributed to the slowdown in growth in bank lending for commercial property, after a number of years where this grew much faster than business lending in general.

One notable characteristic of the current episode is the increase in leverage of some property trusts. For listed property trusts (LPTs) – also known as Australian Real Estate Investment Trusts (A-REITs) – the ratio of aggregate debt to assets has more than doubled over the past 10 years, and the gearing of unlisted property trusts has also increased over this period (Graph 89). The risks of this model have come into focus in recent months, with property trusts facing a period of reduced rental incomes and downward property revaluations – this saw LPTs write off a little over $12 billion in the second half of 2008. Not surprisingly in the current environment, LPTs have been actively seeking to restructure their balance sheets, with around $9 billion of new equity raised since October 2008.


Part of the recent increase in the arrears rate for securitised loans is due to technical factors. The arrears rate on these loans in earlier years is likely to have been held down by strong growth of such loans, as only mortgages not in arrears are securitised. With new securitisations having all but dried up recently, this effect has reversed. [2]