Westpac 'relaxed' about household debt

  • By Christian Edwards

Australia and its banking system are sufficiently flexible and strong enough to endure the slings and arrows of outrageous household debt that largely occupy the Reserve Bank of Australia’s latest Financial Stability Review.

This, in a nutshell, was Westpac's response to the review in which the RBA described an Australia beset by household debt and populated by vulnerable Australian families and investors. According to Westpac’s Bill Evans, the risks around household balance sheets are “macroeconomic in nature” rather than directly threatening the nation’s financial institutions.

JP Morgan economist, Sally Auld, agreed with Evans that the RBA sees the banks as “well placed", with "tightening of lending standards in recent years (evidenced by the decline in high LVR lending)", providing some offset to the current environment.

The key dynamic, according to Evans, is what the bank described as “a highly-indebted household sector that is likely to be more sensitive to declines in income and wealth and may respond by reducing consumption sharply”.

The RBA noted that a full third of Australian bank customers, “have either no accrued buffer or a buffer of less than one month's payments".

Get used to it

According to Evans, while Westpac is “reasonably relaxed” about the risks, the RBA may have little recourse other than to get used to the discomfort.

“For our part, we remain reasonably relaxed about these risks, not because of the distribution of the debt, but because we see that Australia has sufficient flexibility around policy; its exchange rate and strong banking system to ameliorate the impact of shocks,” Evans declared.

“All the (Reserve) Bank can really do is focus on slowing the rise in household debt without really having much comfort about the risks they face."

Since the RBA’s last Review, household indebtedness in Australia has crept forward primarily due to rising levels of housing debt and weak income growth.

According to the central bank, “aggregate mortgage buffers are high, at around 17 per cent of outstanding loan balances or around two-and-a-half years of scheduled repayments at current rates", however "those with minimal buffers tend to have newer mortgages, or to be lower-income or lower-wealth households".

For the vulnerable “highly indebted households”, only 40 per cent hold any kind of buffer at all.

“Presumably as new lending lifts this ratio will continue to rise since minimal buffers are dominated by newer mortgages or lower income or lower wealth households. This ratio strongly debunks the assertion that the 'buffer' is an important source of stability,” Evans said.

“However, in previous Reviews a much more relaxed Bank (RBA) has emphasised the point that those borrowers with the high leverage tend to be the high-income earners who can best manage debt.”

Vulnerable borrowers

While the volume of vulnerable borrowers with limited buffers appears to be growing, Evans said that the higher risk aspects of interest only (IO) loans “may be exacerbating” that issue. Debt, the RBA noted, has increased “substantially” while income growth remains "weak".

“Some types of higher-risk mortgage lending, such as IO loans, also remain prevalent and have increased of late,” the report continued.

While the RBA expressed concern at emboldened investor activity, it noted regulatory action and independently-initiated bank rate hikes have eased some of the velocity the central bank is witnessing in household indebtedness.

“Of most interest is the investor,” Evans said. “Only around 23 per cent of owner occupier loans are interest only whereas 64 per cent of investor loans are interest only. IO loans have a higher average indebtedness over the loan than principal and interest; while after the IO period expires (typically 5-10 years) repayments are considerably higher.

“While the (Reserve) Bank recognises that arrears data shows that investors have historically performed better than owner occupiers, this observation has not been tested in a severe downturn,” he added.

And according to JP Morgan, the RBA and its regulators are already watching this space.

 “But as we have seen in recent weeks, this area is clearly a work in process for regulators, and the RBA states that there is scope to do more on this front if necessary,” Auld added.