HSBC: Australian households have a lot of debt, but that's not a concern


Concerns over mounting household debt in Australia have grown in recent months, coinciding with the elevation of Philip Lowe to RBA governor in September last year.

Given his emphasis on financial stability when evaluating monetary policy, coupled with prior rampant house price rises in Australia’s largest cities, Sydney and Melbourne, it’s all but ensured there’s been increased focus on the indebtedness of households.

As this chart from HSBC shows, there’s a good reason why that’s occurred, especially amid concern over what high levels of indebtedness could do to the broader Australian economy should another economic shock arrive.

It shows the debt-to-nominal GDP ratio — the amount of outstanding debt compared to annual economic output — for a variety of different nations, both developed and developing.

It also breaks down the debt by different sectors with household debt shown in black.

Source: HSBC

While Australia’s total indebtedness sits in the middle of the pack based on data presented by the Bank of International Settlements back in 2015, it’s clear that household debt levels are high.

They sit well above the levels of other comparable advanced economies such as Japan, the UK, US and New Zealand.

It’s little wonder why concerns over household indebtedness are rising.

However, HSBC’s chief Australia and New Zealand economist Paul Bloxham, says rather than focusing on the size of the debt levels, it should be about who is holding it.

And on that score he thinks things look a lot more comforting than the headline figure suggests, at least based on 2014 data.

He explains:

The survey shows that the bulk of the household debt is held by high-income earners, with 74% of the debt held by the top 40% of income earners. The survey also shows that most of Australia’s highly-indebted households — those with debt-to-income ratios in the top 10th percentile of debt holders — are also high-income earners.

Australia’s financial regulatory environment is also strong. All mortgages are full recourse and there is no sub-prime lending. Australians also have an incentive to pay down their mortgages ahead of schedule, as they cannot deduct the expenses associated with their owner-occupied housing, such as mortgage interest, against their other taxable income. As a result, the average mortgage holder is around 2.5 years ahead on their mortgage payments when offset accounts and redraw facilities are included. This means that the average borrower has a significant buffer on which to draw in the event of job loss or some other negative income shock.

However, given the data is dated, and indebtedness increased further in the past two years, Bloxham says there’s still need for caution.

First, the information on the distribution of debt is from 2014 and we know that household debt has risen since then. We do not know much about the distribution of the new debt, although we do know that the bulk of it has been for property investors. On the positive side, historically, investors have been less likely to default on mortgages than first home buyers as investors tend to have equity in an owner-occupied property, and tend to be older and higher-income households with a loan repayment history. On the negative side, we do not know much about the new investors in recent years, although we know that the prudential regulator has been tightening its settings since late 2014 to prevent an excessive build-up of risk.

Second, although the average mortgage holder has a significant buffer, it is not the average borrower that typically defaults. At the riskier end of the spectrum of borrowers there is evidence of mortgage holders with only slim buffers against a negative income shock.

However, Bloxham says that given that lending standards have been tightened by Australia’s banking regulator, APRA, and that risky loans are still only a small share of total loans, “a large enough rise in loan defaults to shake the overall financial system is unlikely”.

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