Australia’s love for residential housing and the unprecedented borrowing to fulfill that dream is well documented, despite warnings from regulators flying thick and fast.
A note by Macquarie Group — aptly titled “A zero-sum game”, on how much more mortgage repricing households can absorb — shines more light on rising home loan rates and the impact on disposable income and consumer spending.
Macquarie’s thesis adds to concerns about whether Australia would be able to engineer a soft landing for the housing sector in order to extend the more than a quarter century of unbroken economic growth.
The Reserve Bank of Australia has repeatedly warned about the financial stability risk from housing and banking regulator the Australian Prudential Regulation Authority recently took further steps to curb risky lending.
This paragraph from Macquarie reveals the extent of the risk:
Based on our estimates, a 1% increase in owner occupier interest rates reduces households’ overall disposable income by $11 billion per year (i.e., ~3% of overall discretionary consumer spending), while a 1% increase in investor interest rates reduces disposable income by $3.4 billion.
The bank’s analysts add that while, from afar, it appears Australians can absorb higher interest rates, a closer examination reveals that’s not the case.
They cite two main reasons (our emphasis in bold):
1. While the RBA’s cash rate is at a record low of 1.5% – about 60% below the 10-year average rate of 4% – the buffer for households isn’t material thanks to high leverage and existing mortgage rate increases by the banks.
Lenders have increased their home loan spread over the RBA cash rate by 200 basis points since 2007. As a result average mortgage rates are currently only 25% below their 10-year average of 6%, it said.
2. About 30% of households have no debt and 40% have relatively small amount of debt or just two times their annual income. That means that only 30% of households are responsible for 85% of debt of $1.5 trillion. Further, Macquarie estimates that the most indebted 10% of households have 45% of overall debt.
These charts reveal the spread and household debt demographic
“The most indebted 10% of households are at most risk from rate increases,” the analysts said. “The interest burden for those households is material. We estimate the interest servicing cost alone accounts for 40-60% of total household disposable income.”
That isn’t great news for either consumption and an economy struggling to reinvigorate wages and investment or for the central bank, which has very little of its interest rate ammunition left.
It’s quite possible that all the regulatory warnings in recent weeks have provoked Australians to reassess their prospects and come to grips with the fact that the debt taken on in order to get into the property market will need to be repaid.
There are already tentative signs that a consumer retreat might be underway. For example, February’s negative growth in retail spending. Car sales have also been looking a little weak.
This month Morgan Stanley analysts said the banking regulator’s intervention to apply the brakes on speculative housing activity by limiting the flow of interest-only lending could directly strip billions of dollars out of household consumption. It blamed bank moves to reprice mortgages and the clampdown for forcing investors to wade into principal and interest repayments, rather than just servicing the interest-only component.
Macquarie analysts estimates the 30% cap on interest-only mortgages could reduce household income by $6.5 billion or 1.5% or consumer spending. Currently 40% of new loans are interest only.
It sums up the risk in this table
“A 1% increase in interest rates has a 12-31% impact on disposable income of highly indebted households. The impact is far more material if we assume these households switch from interest-only to principal and interest seeing a 34-76% reduction in disposable income,” Macquarie’s analysts say.