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RBA says negative equity possible, but big jump unlikely

Nicki Bourlioufas  |  23 Apr 2019Text size  Decrease  Increase  |  
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The RBA warns some homeowners could face negative equity this year, which could further cut into household consumption and burden the economy – but falling interest rates will cushion the blow to the big banks.

The prevalence of negative housing equity is low, but substantially larger price falls would see a large share of households’ housing equity eroded or even turn negative, the RBA said in its recent Financial Stability Review.

“If large falls in housing prices were to weigh on economic growth, this could impact employment and wages growth, making it harder for some households and businesses to service their debt,” the RBA said.

“This would increase the risk of costly defaults for lenders if unemployment were to rise. Further price falls could also increase lenders’ perceptions of the riskiness of housing lending, compounding the somewhat tighter availability of credit seen to date. Greatly reduced credit supply would be detrimental to the economy and so financial stability,” the RBA said.

However, David Ellis, senior equity analyst at Morningstar, says negative equity is no real threat at this stage to the big banks.

“You would need to have a sustained fall in house prices. And as long as interest rates don’t go up, this isn’t likely, with the very low level of interest rates still supporting house prices,” said Ellis.

“The average loan-to-value (LVR) ratio on the big banks’ lending books is around 50 per cent. The average across new loans written in the last two years is around 70 to 80 per cent. Even for loans over 80 per cent, these require mortgage insurance which protects the banks in the case of a default.

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“Only if the unemployment rate jumped, which might happen during a recession, would negative equity become any real threat.”

Indeed, the RBA still see house price declines as "orderly" and "the risks continue to be manageable given the benign economic environment".

Increased defaults are “unlikely if the unemployment rate remains low, particularly given the improvements in loan serviceability standards over recent years,” the RBA said.

Big banks bear brunt of slowdown

Slowing credit growth is a problem for the big banks, whereas non-bank lenders are enjoying strong growth in housing credit.

“The decline in housing credit growth over the past six months reflects a slowdown in lending by authorised deposit-taking institutions (ADIs), particularly the major banks. In liaison, banks reported that they had received significantly fewer loan applications over the past year,” the RBA said.

While the RBA estimates only a small share of borrowers are experiencing negative equity, about 2.75 per cent, they caution that "if there were further large housing price falls, the share of borrowers in negative equity would increase significantly".

At the moment, the RBA says almost 60 per cent of loans in negative equity are in Western Australia or the Northern Territory, where a fall in property prices after the end of the mining boom has left some homeowners with mortgages worth more than their homes.

“Rates of negative equity in other states remain very low,” says the RBA.

The big banks’ profitability is being dragged down by slower credit growth, though this is not the main drag, according to Ellis.

“Lower net interest margins and or higher bad debts have a bigger impact on bank profitability. The availability of credit is very important, and we are seeing tighter home loan underwriting criteria as part of the reason for the credit slowdown,” he said.

Rates likely to drop soon

Several economists are forecasting a cut in interest rates given the slowing Australian economy, and this is likely to put a floor under house prices. Westpac economists forecast an interest rate cut in August or September this year, with a likely second cut by mid next year.

Economists at UBS expect a rate cut even sooner in July. “Overall, the FSR maintains the RBA's recent stance that the housing downturn is ‘orderly’ and ‘does not raise material financial stability concerns’. However, they did take the step of highlighting potential sources risk if the downturn were to continue, or if the ‘benign’ economic environment deteriorated,” said George Tharenou, Carlos Cacho and Jim Xu in a recent research note.

“For now, we still expect May's meeting to add an easing bias (given likely downgrades to the growth outlook), ahead of cutting 25 basis points in both July … and August”.

 On the positive side, housing is becoming more affordable, which will attract buyers. The Westpac Melbourne Institute Time to Buy a Dwelling index rose a further 2.4 per cent to 119.4 in April, a four-year high. The index has now risen 33 per cent from its mid-2017 low and is back around its long run average of 120.

 

is a Morningstar contributor.

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