Financial Stability Review – September 2009 Household and Business Balance Sheets

Developments in financial markets and the macroeconomy since 2007 have seen the Australian household sector experience a sharp fall in net worth and a rise in unemployment, though in a number of respects, conditions have recently begun to improve. Policy measures have helped to support household finances, thereby limiting the increase in household financial distress, and confidence has increased in recent months.

As with households, the business sector has faced a challenging economic environment since 2007, though signs of improving conditions are emerging. Difficulties in credit markets appear to be easing somewhat, and funds have generally been available for good quality borrowers. Borrowing conditions, however, remain tighter than in recent years. While financial stresses have increased in some areas, particularly for commercial property, firms across the business sector have actively consolidated their balance sheets over the past six months. Listed companies have been able to raise a record amount of equity capital; investors have supported this issuance, as share prices have recovered somewhat and confidence about business prospects has improved.

Household Sector

In the period since 2007, the household sector has experienced a significant decline, followed by a partial recovery, in net worth (Graph 62). The decline was largely driven by falls in the value of share portfolios: the ASX 200 price index is still around 30 per cent below its November 2007 peak. There had also been some softening in nationwide dwelling prices during 2008, though this price decline has since been retraced. Overall, preliminary estimates suggest that more than half of the peak-to-trough contraction in the household sector's net worth has been reversed over recent months.

At the same time as the negative effects of earlier asset price falls have been unwinding, household sector finances have benefited from various policy stimulus measures. Monetary policy has been eased substantially since late 2008, which has greatly reduced the ratio of interest payments to disposable income, from over 15 per cent in June 2008 to around 10 per cent at present (Graph 63). While the household sector's interest payment burden remains fairly high by historical standards, this reduction has been more rapid than in the early 1990s, and has substantially boosted household disposable income. Further supporting disposable income have been tax cuts and other government economic stimulus efforts, in the form of one-off payments to households: average real disposable income per household increased by 4 per cent over the year to the June quarter 2009. The support of these measures has helped offset the effect of the economic downturn on wage income – typically the main driver of household incomes. Compensation of employees per household declined 3 per cent in real terms over the year to the June quarter, reflecting the combination of a higher unemployment rate, slowing wage growth, and declines in employee working hours (Graph 64).

Although financial conditions have stabilised recently, for some households the effects of earlier developments have been relatively severe. The declines in equity values have had a larger effect on the assets of wealthier households and retirees: based on HILDA survey data, direct and indirect equity holdings comprise over 20 per cent of total assets for these households, compared to an average of 12 per cent for households outside these groups. Retirees' incomes have also been reduced by declining dividend and interest receipts. For many wealthier households, balance sheets have been further affected by the greater-than-average declines in prices of homes in the most expensive suburbs, which in the June quarter remained around 6½ per cent below their early 2008 peak. However, wealthier households tend to have lower gearing than average, limiting the sensitivity of their overall financial position to these asset price declines.

As asset values fell and economic conditions weakened, households' sentiment regarding their current circumstances deteriorated significantly (Graph 65). But both sentiment and confidence about the year ahead have rebounded in recent months, consistent with the more positive developments in housing and financial markets, the boosts to incomes households have experienced, and other signs of an improving economic outlook. This has seen some winding back of the very conservative financial attitudes of earlier in the year: while households still nominate deposits and debt repayment as the wisest options for savings, more recently interest in equities and property has picked up somewhat (Graph 66).

Households reduced the growth of their indebtedness significantly during 2008, though this has subsequently picked up. The reduced appetite for debt has been most pronounced for investment purposes. Over the six months to July 2009, borrowing for investor housing barely grew and margin loans continued to fall, though at a more moderate pace than earlier in the year (Graph 67). Households' use of credit cards has also been cautious, with little change in aggregate balances over the past six months (Graph 68). Overall, however, growth in household debt has edged up since the start of the year, supported by a pick-up in borrowing demand by owner-occupiers. Over the six months to July, owner-occupier housing credit grew at an annualised rate of 9.8 per cent, up from 8.4 per cent in January 2009.

A significant driver of owner-occupier housing loan demand has been first-home buyers looking to take advantage of recently enhanced government grants. Since late 2008 first-home buyers' share of total owner-occupier loan approvals, currently at 35 per cent, has been around 10 percentage points higher than its average over the previous 15 years (Graph 69). On top of the large increase in the volume of first-home buyer loans, the average value of these loans has moved sharply higher since late 2008, and indeed has exceeded that of other owner-occupier loans in some months – an unusual outcome by historical standards, in that first-home buyers' loans have traditionally been smaller than those of other home buyers. More recently, there are signs that first-home buyer demand has eased.

Loan demand by both first-home buyers and established owner-occupiers has also been supported by a substantial lowering in borrowing costs. Reflecting the significant cash rate reductions over the past 12 months, variable housing interest rates are currently around their lowest level for several decades, though it is notable that despite the historically low interest rates, affordability is still only slightly above its long-run average (Graph 70).

The household sector generally has significant buffers against adverse movements in housing prices and interest rates. Based on the most recent HILDA survey data available, in 2007 only 1 per cent of households with owner-occupier loans both had a loan-to-valuation ratio (LVR) of 90 per cent or more and spent more than 50 per cent of their disposable incomes on mortgage repayments (Graph 71). Although this share of more vulnerable households has edged higher in recent years, it was still the case that more than 90 per cent of owner-occupier households with mortgages had an LVR below 75 per cent and/or a debt-servicing ratio (DSR) below 30 per cent of income. The share of households with negative equity is estimated to be very low, with available data suggesting it is currently no more than 1 per cent of all households with owner-occupier mortgages.

The underlying condition of household balance sheets in Australia has helped limit the incidence of severe household financial difficulties during the current economic downturn. By loan value, the share of non-performing housing loans on banks' balance sheets was around 0.6 per cent in June, and around 0.9 per cent for securitised loans (Graph 72). Although these rates are higher than the low points seen in the earlier part of this decade, they are still low relative to international experience, despite some difficulties in making cross-country comparisons (as discussed in Box B).

While measurement differences also complicate comparisons between on-balance sheet and securitised loans, the higher arrears rate for the latter group is mainly due to a greater share of low-documentation and non-conforming loans. The arrears rate on securitised low-documentation loans (for which a more relaxed standard of proof of borrowers' debt-servicing ability applies) was 2.2 per cent in May, having been fairly stable since the end of 2008, but one percentage point higher than a year ago (Graph 73). For non-conforming loans, which were made from outside the banking sector, the arrears rate was significantly higher: 9.4 per cent in May, up from 7.9 per cent a year earlier. In aggregate, it is estimated that currently around 25,000 households are 90 or more days in arrears on their housing loans, compared with a (revised) estimate of around 23,000 at the end of 2008.

Changes in the housing finance market over the past 10–20 years, such as the increased availability of low-documentation and non-conforming loans, and a wider range of lenders, have meant that a greater amount of credit has been more readily available to households. As well, there has been an increase in the share of households borrowing for a longer duration, or for investment and other purposes, compared with earlier periods. The increase in the share of households in arrears over the last few years partly reflects these higher debt levels. Arrears rates are also likely to have been affected by movements in interest rates. The arrears rate on (securitised) variable-rate loans increased 35 basis points over the 12 months to December 2008, and has since declined by 20 basis points; this compares to an increase of 10 basis points for fixed-rate loan arrears over the same period, with no subsequent decline. More recently the slowing labour market has contributed to higher arrears rates, with liaison with lenders suggesting that reductions in overtime and working hours have caused difficulties for some borrowers.

Across other types of household borrowings, arrears rates on credit cards have been little changed in net terms over the past couple of years (Graph 74). In contrast, there has been a sharp increase in arrears on other personal loans, partly due to non-performing margin loans. This in turn has resulted from the financial pressure arising from the steep decline in share prices over the past 18 months, and the consequent sharp decrease in loan collateral values and increase in margin calls.

Housing loan arrears remain more prevalent in New South Wales than in the rest of the country, though recently there appears to have been some improvement in this state. In comparison, arrears rates in Western Australia have increased further while in Queensland they have been little changed, whereas the other states have seen some improvement. In general, non-metropolitan regions have seen a slightly greater deterioration than capital cities; within metropolitan regions, areas in western Sydney remain among the worst performing (Graph 75).

Developments in state-wide arrears rates have been reflected in recent increases in the rate of property possession applications in Western Australia and Queensland, as well as in increases in bankruptcies and other personal administrations (Graph 76). In contrast, these indicators have either stabilised or improved for households in other states. Overall, though, the number of households whose financial difficulties have deteriorated to the extremes of bankruptcy or lender property possession is very low in absolute terms.

Business Sector

After many years of strong profit growth, the slowing economy and challenging financial conditions of the past 12 months have resulted in a substantial fall in business profits. Over the year to the June quarter 2009, aggregate business sector profits – measured by the national accounts – declined 6½ per cent, the largest annual fall since the 12 per cent decline to June 1991. Mining profits fell particularly sharply, reflecting a downturn in commodity prices. More recently, signs of an improving outlook for the business sector have emerged: share market analysts' earnings forecasts have been revised upwards, and firms' perceptions about current conditions and confidence for the upcoming period have recovered from their troughs – their lowest levels since 1991 – to be a little above their long-run averages (Graph 77).

Surveys of firms' experience in obtaining finance indicate that this had become a more difficult task in the second half of 2008, before easing in the first half of 2009 (Graph 77). Finance availability remains a concern, though in recent months the share of firms reporting increased difficulties in sourcing finance has stabilised, and more firms are reporting an easing. Part of the reported tightening in credit availability is likely to have reflected lenders taking a more stringent approach to collateral requirements and loan conditions. Interest spreads have also increased since June 2008 – by 100–200 basis points for new large business variable-rate loans, and around 135 basis points for new small business variable-rate loans. Reflecting the easing in monetary policy, though, there has been a large decline in the average actual interest rate being paid on all outstanding debt (both fixed and variable) – around 345 basis points for large businesses and 230 basis points for small businesses since June 2008 – and this is likely to have influenced perceptions of finance availability reported in the surveys.

Conditions in wholesale credit markets have also eased recently, after a period where they were effectively closed to Australian borrowers. Large non-financial companies have issued around $23 billion of corporate bonds since the start of 2009, compared with only around $2 billion in the second half of 2008. While most of this issuance has been in offshore markets, investor appetite in the domestic market has increased in recent months.

Although firms, in aggregate, appear able to refinance as needed (albeit on tighter terms), the uncertain economic outlook has reduced their demand for credit. Firms have been looking to pay back loans and have been reluctant to increase gearing, even though debt finance is now cheaper. The net result of lower demand and tighter lending conditions is that business credit has been contracting, with the three-month annualised growth rate recently reaching its lowest point since the early 1990s (Graph 78).

Reflecting these developments, the share of overall business funding coming from debt finance over the past two years has fallen almost as much as in the early 1990s episode. In the first half of 2009 there was a net repayment of debt equivalent to around 1 per cent of GDP, compared with net new debt finance equivalent to nearly 14 per cent of GDP in the first half of 2007, when debt had been providing over half of total new business funding (Graph 79).

A distinguishing feature of the current episode, however, has been the success of listed companies in sourcing new funds through the equity market: the amount raised in the first half of 2009 was equivalent to around 6 per cent of GDP, more than double the average rate of the preceding 15 years. In comparison, in the early 1990s the reduction in debt finance was not offset to the same extent by a pick-up in equity raisings, and businesses, in aggregate, had considerably less capacity to fund their activities.

In total, listed non-financial and real estate companies have raised a record $63 billion of new equity since the start of 2009 – see Box C for further discussion. Reflecting the business sector's caution and a desire to reduce leverage, a large amount of these funds has been used to repay debt. Liaison with lenders and businesses has also indicated that banks have required some customers to raise additional equity, as a prerequisite for the continued availability of loan finance. Some of these raisings have also been by businesses looking to repair balance sheets following asset write-downs. While there have also been some raisings to fund ongoing business expansion, raisings for newly listed non-financial and real estate companies have been very weak. In the eight months to August there was only around $71 million of funds raised through initial public offerings, compared with an annual average of $5.4 billion since the start of the decade. An increase in offerings is likely over coming months, though, given the improving share market conditions since mid 2009. This improvement has also influenced other corporate financing decisions: a number of previously announced merger and acquisition deals have been cancelled, since the firms involved have now been able to raise equity on more attractive terms, instead of selling themselves or some of their assets.

The large amount of equity raisings undertaken this year has led to a fall in overall business-sector gearing. The aggregate gearing ratio for listed non-resource companies fell from around 95 per cent in December 2008 to around 82 per cent in June, while resource companies' gearing has declined slightly from around 60 per cent to 57 per cent, with further falls likely given recent large raisings (Graph 80). Equity raisings by more highly geared firms have narrowed the distribution of gearing ratios among large listed companies (Graph 81). Around two thirds of less geared firms have not raised equity, while the rest have only raised fairly small amounts.

Firms have also been strengthening their financial position by increasing cash holdings, with business deposits at banks having increased 17 per cent in the year to July 2009, compared to an annual average growth rate of 13 per cent in the preceding five years. The increase in cash holdings is likely to reflect both precautionary holdings, given concerns about the availability of finance, and a transitory unwillingness to commit to new investment expenditure. The declines in both debt and business interest rates have seen a substantial fall in interest payments as a share of profits.

Although there has been some de-risking of firms' balance sheets of late – through the decline in gearing and an improvement in liquidity and interest coverage positions – the difficult economic and financial conditions of the past year have seen business loan delinquency rates increase. Non-performing business loans comprised 3½ per cent of banks' total business loans in June 2009, up from around 1 per cent in June 2008 (Graph 82). The deterioration over the past year has been evident for both small unincorporated enterprises and larger corporates. Similarly, the rate of failure of incorporated businesses has increased over the past year; it has steadied in recent months, but at an historically high level. This is in contrast to the failure rate among unincorporated businesses, which has remained broadly unchanged at levels below those experienced during the 1990s.

Commercial Property

Conditions in the commercial property market have continued to weaken, with both declining white-collar employment and additional supply of office space contributing to increasing vacancy rates in the office property market. In line with this, national office capital values and rents have to date fallen by around 20 per cent from their recent peaks (Graph 83). This remains well below the 50 per cent peak-to-trough decline in capital values recorded in the early 1990s, partly due to a more moderate nationwide increase in new supply in the current episode (Graph 84). Brisbane and Perth, however, did see a strong supply response to the very tight vacancy rates and rapidly increasing rents experienced in the years running up to 2007. The build-up in supply has weighed on valuations, and both cities have recorded capital value declines of around 30 per cent.

Uncertainty about valuations and future demand, for both office and multi-unit residential property, has contributed to the difficulties experienced by some developers in obtaining finance for new projects. As discussed in the chapter on The Australian Financial System, there has been a tightening in overall lending standards for commercial property (including construction of multi-unit residential property). Reflecting this, and also a fall in borrowing demand, aggregate commercial property lending contracted by 3 per cent over the six months to June 2009. Foreign-owned banks reduced their lending by more than the industry average, with liaison suggesting most of them are maintaining their existing client base, but are not looking to originate new deals.

Although bank lending has tightened over the past year, larger real estate businesses have generally been able to retain access to debt finance, with listed real estate investment trusts (REITs) having successfully refinanced $24 billion of debt since January 2009. Recent bond issues suggest that large real estate companies still have good access to domestic and offshore non-intermediated debt markets. Commercial mortgage-backed securities markets, which traditionally provided some diversification in funding for real estate companies, have remained all but closed, though real estate firms have generally been able to replace this financing, mainly through bank loans.

As with non-financial businesses, some real estate firms' access to bank finance has been partly contingent on their being able to raise additional equity capital. Reflecting this, listed REITs raised around $10 billion of new equity in the first half of the year, equivalent to around 7 per cent of their assets as at the start of the period, with additional amounts raised in the months since then (Graph 85). Recent equity raisings have also been used to repair balance sheets after downward asset revaluations, which have been equivalent to 11 per cent of total assets in each of the half years to December 2008 and to June 2009 – a notable contrast to a few years earlier when upward revaluations were a significant component of balance sheet expansion. An increase in retained earnings in the most recent period has also added to funding, but the combination of this and equity raisings has not offset the effect of asset revaluations and debt maturities.