High household debt could ‘amplify’ impact of housing downturn

In a recently released report, ratings agency Moody’s has said that while APRA’s latest measures are likely to “weigh on demand for property at the margins”, household debt is likely to grow in aggregate as low interest rates and expectations of continuing rises in house prices encourage purchases.

As part of its announcement last month, APRA introduced a cap on interest-only mortgages at 30 per cent of new residential mortgage lending, compared to almost 40 per cent of the outstanding stock. Lenders will have to strictly limit interest-only lending at LVR ratios above 80 per cent, and provide justification for ratios above 90 per cent on such loans.

The regulator also instructed lenders to ensure that growth in housing investment loans remains comfortably below the 10 per cent guideline limit that it introduced in December 2014.

Moody’s said that the new measures will raise recurring costs for some households by imposing a more spread-out repayment of mortgages, which will potentially deter demand and dampen appetite for mortgages from buyers who would have relied on capital gains to pay off their debt.

“To the extent that the new mortgage rules implemented by the Australian Prudential Regulation Authority (APRA) cool growth in household debt and reduce mortgage risks, the measures are supportive of the sovereign's credit profile,” Moody’s said.

“Nevertheless, household leverage in Australia will continue to rise from already elevated levels. We do not expect the build-up in household leverage to reverse. High household debt, only buffered by limited liquid assets, would amplify the economic impact of a housing downturn.”

The ratings agency stressed that Australia’s household debt is the second highest in the world after Switzerland according to the Bank for International Settlements.

The nation’s household debt is also “very high” as a proportion of disposable incomes at just under 200 per cent, according to Moody’s.

“It is also by far the highest percentage in Asia Pacific, above New Zealand’s 94.4 per cent and Korea's 91.6 per cent,” it said.

“While household debt does not pose a direct or immediate risk to the government's balance sheet, in the event of an economic downturn, highly leveraged households would likely cut back on consumption spending more sharply than less leveraged borrowers, crimping economic growth and fiscal revenues.

Moody’s added that a simultaneous slump in house prices would “aggravate” the hit to consumption, as homeowners would feel less well-off than previously.

“Given that household debt is also high compared to households' liquid financial assets, the latter would provide a relatively limited cushion to domestic demand. Overall, GDP growth would likely slow substantially in the event of a negative shock that involved a housing downturn.”

Further, Moody’s highlighted that Australian banks are largely exposed to the property sector, with around two-thirds of banking lending going to households.

“Nevertheless, the banks’ strong capitalisation and generally high financial strength significantly reduce the risks of a banking crisis and any related costs to the government,” it conceded.

[Related: Regulatory measures won’t halt pressure on house prices: Moody’s]