economics@1

Presentation toPresentation toBank for International Settlements Bank for International Settlements

Markets CommitteeMarkets Committee

Housing finance in AustraliaHousing finance in AustraliaHousing finance in Australia

Saul EslakeSaul EslakeChief EconomistChief EconomistANZANZ

SydneySydney1919thth November 2006November 2006

www.anz/com/go/economicswww.anz/com/go/economicswww.anz/com/go/economics

economics@2

Housing is the most important form of wealth Housing is the most important form of wealth for most Australian householdsfor most Australian households

Land

Dwellings

Life insurance & pension funds

Shares

Other financialassets

Composition of household wealth, 2006

Other ‘real’ assets

Ownedoutright

Ownedwith

mortgage

Privaterental

State rental

Australian housing tenure, 2005

Source: Australian Bureau of Statistics.

economics@3

Investment in housing has traditionally been favoured by government policiesInvestment in housing has traditionally been Investment in housing has traditionally been favoured by government policiesfavoured by government policies

Interest payments on borrowings for owner-occupied housing are not tax-deductible, but neither capital gains on owner-occupied housing nor ‘imputed rent’ are taxed

Owner-occupied housing is typically exempt from land tax, and excluded from ‘assets tests’ used to determine eligibility for social security benefits and concessions

Most first home buyers are eligible for government grants and/or stamp duty concessions or exemptions

Historically, State housing authorities have constructed housingfor sale to eligible individuals, or have been willing to sell rental housing to tenants, upon favourable terms

Interest on borrowings to acquire investment properties (and other income-producing assets) is tax-deductible (including against other non-investment income – so-called ‘negative gearing’), property investors can claim tax deductions for ‘depreciation’, while (since 1999) capital gains on assets held for more than 12 months have been taxed at half the rate applicable to other types of income

economics@4

House prices have risen 141% in nominal terms, House prices have risen 141% in nominal terms, and 87% in real terms, since the midand 87% in real terms, since the mid--1990s1990s

Established house prices – State and Territory capital cities

-20

-10

0

10

20

30

40

66 71 76 81 86 91 96 01 06

% change from year earlier

Nominal

Real

Note: From 1966 through 1978, figures are for Sydney and Melbourne only; includes Brisbane from 1978 onwards; Perth, Adelaide and Canberra from 1980 onwards; Hobart from 1984 onwards; and Darwin from 1986 onwards. ‘Real’ house prices are nominal prices deflated by the RBA’s ‘trimmed mean’ CPI series or, prior to 1976, All Groups CPI. Sources: ABS; Real Estate Institute of Australia; RBA; Economics@ANZ.

economics@5

Real house price gains over the past decade have substantially outpaced those of previous decades Real house price gains over the past decade have Real house price gains over the past decade have substantially outpaced those of previous decades substantially outpaced those of previous decades

Australian capital city established house prices

0

50

100

150

200

250

1965-1975 1975-1985 1985-1995 1995-2005

Nominal

Real

% change

Note: See footnotes to slide 3.Sources: As for slide 3.

economics@6

Australian house prices have risen more rapidly than in many other comparable countriesAustralian house prices have risen more rapidly Australian house prices have risen more rapidly than in many other comparable countriesthan in many other comparable countries

Established house prices

75

100

125

150

175

200

225

250

275

300

90 94 98 02 06

1990 = 100

UK

Australia

New Zealand

US

50

75

100

125

150

175

200

225

250

275

300

325

350

90 94 98 02 06

1990 = 100

Japan

Singapore

Hong Kong

Sources: National statistical or regulatory agencies; Thomson FinancialDatastream; Economics@ANZ.

economics@7

The stock of housing has grown substantially over The stock of housing has grown substantially over the past 15 years ….the past 15 years ….

Housing completions

100

110

120

130

140

150

160

170

180

190

71 76 81 86 91 96 01 06

'000 units (annual rate)

Decadeaverages

Sources: ABS; Economics@ANZ.

economics@8

… but so has the number of households requiring … but so has the number of households requiring accommodationaccommodation

Sources of population growth

2.45

2.50

2.55

2.60

2.65

2.70

2.75

2.80

2.85

90 92 94 96 98 00 02 04 06

Number

(series break)

Falling householdsize has resultedin the creation of

over 500 000 morehouseholds than

suggested by 'raw'population growth

Average number of persons per household

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

90 92 94 96 98 00 02 04 06

Contribution to population growth(% pts per annum)

Natural increase

Net immigration

Sources: ABS; Economics@ANZ.

economics@9

Thus the supply of housing has barely kept pace Thus the supply of housing has barely kept pace with the increase in underlying demandwith the increase in underlying demand

Number of households and number of dwellings

Note: Dwelling stock estimates for 1991, 1996 and 2001 based on census figures; other years interpolated using completions data. Sources: RBA; ABS; Economics@ANZ.

Over the ten years to June 2005, the stock of housing increased by 1.26 million or 18%

– 1.44 mn new dwellings were completed during this period, but around 172,000 old dwellings were demolished

Over the same period, the number of households rose by 1.33 million or 20%

– faster than the increase in population (12.5%) because of falling average household size

In effect, the increase in the supply of housing was more than absorbed by increased demand

6.0

6.5

7.0

7.5

8.0

8.5

95 96 97 98 99 00 01 02 03 04 05

Number of dwellings

Number of households

Mn

economics@10

Since the early 1990s mortgage rates have halvedSince the early 1990s mortgage rates have halvedwhile real incomes have grown by 11½%while real incomes have grown by 11½%

Standard variablemortgage rate

0

2

4

6

8

10

12

14

16

18

82 85 88 91 94 97 00 03 06

% per annum

Nominal terms

Real terms

Average weekly earnings

-4

-2

0

2

4

6

8

10

12

14

16

82 85 88 91 94 97 00 03 06

% change from year earlier

Nominal terms

Real terms

Note: dotted lines show averages 1982-1992 and 1996-2006. Sources: RBA; Commonwealth Treasury; Economics@ANZ.

economics@11

‘Borrowing capacity’ for a ‘typical’ household has ‘Borrowing capacity’ for a ‘typical’ household has risen by at least 125%risen by at least 125%

Note: data are for the June quarter each year.Sources: ABS; Economics@ANZ.

Maximum borrowing by couple earning average male and female

earnings, repayments capped at 25% of gross income and 20% deposit

50

100

150

200

250

300

350

85 90 95 00 05

$'000

Since the early 1990s, average earnings have risen by over 60% while the standard variable mortgage rate has halvedThis has increased the maximum amount which a ‘typical couple’ can afford to borrow under standard lenders’ rules from around $135 000 in 1992 to $305 000 in 2006In practice the rates actually paid by borrowers have fallen by more than the standard variable rate, while the traditional ‘rules’ are much less rigorously applied

economics@12

Innovations in Australian housing finance since the early 1990sInnovations in Australian housing finance since Innovations in Australian housing finance since the early 1990sthe early 1990s

Entry of new types of lenders– in particular, mortgage brokers and originators, whose loans

are funded by wholesale lenders via securitization

Heightened competition among lenders– enhanced by reductions in transaction costs (eg abolition of

stamp duty on mortgages) and improved technology

Greater flexibility in the management of loans– new features such as flexible repayment schedules, interest-

only loans, ‘re-draw’ facilities, home equity loans, ‘offset accounts’ (allowing interest on deposits to be offset against mortgage interest), split (part fixed, part floating) loans

Wider availability of mortgage finance– higher loan-to-valuation ratio (LVR) loans, ‘low-doc’ loans

(requiring less disclosure of servicing capacity), ‘sub-prime’ lending, ‘shared equity’ loans

Easier terms for lending to property investors– elimination of interest rate premium on investment loans,

introduction of split-purpose loans

economics@13

Entry of mortgage originators and brokers has Entry of mortgage originators and brokers has heightened competition in the mortgage marketheightened competition in the mortgage market

Note: ‘other lenders’ include credit unions, life and general insurance companies and government agencies. Sources: ABS; Economics@ANZ.

Share of new housing finance commitments

0

10

20

30

40

50

60

70

80

90

100

81 86 91 96 01 06

% of total (by value;12-mth moving total)

Banks

Building societies

Mortgageoriginators

Other

Securitizations as apc of total mortgage credit

0

5

10

15

20

25

88 90 92 94 96 98 00 02 04 06

% of total mortgage credit

economics@14

Competition among lenders has resulted in a Competition among lenders has resulted in a further lowering of effective mortgage ratesfurther lowering of effective mortgage rates

Standard variable mortgage rate vs cash rate

Mortgage lenders’margins

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

92 94 96 98 00 02 04 06

% points

Standard variablemortgage rateover cash

Effective mortgagerate over cash

0

2

4

6

8

10

12

14

16

18

20

82 85 88 91 94 97 00 03 06

% per annum

Standard variablemortgage rate

RBAcash rate

Mortgage ratesubject to regulatory ceiling

Sources: RBA; Economics@ANZ.

economics@15

Australian households are repaying mortgage Australian households are repaying mortgage principal more slowlyprincipal more slowly

Mortgage repayment rate

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

92 93 94 95 96 97 98 99 00 01 02 03 04 05 06

% of principal outstanding (4-qtr moving average)

Sources: ABS; Economics@ANZ.

economics@16

As in the US, mortgage market innovations have As in the US, mortgage market innovations have allowed Australians to ‘tap’ their real estate wealthallowed Australians to ‘tap’ their real estate wealth

Mortgage equity withdrawal – US and Australia

-8

-6

-4

-2

0

2

4

6

8

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06

% of annual personal disposable Australia

United States

Sources: RBA; ABS; US Federal Reserve; Bureau of Economic Analysis; Economics@ANZ.

economics@17

The tax system has encouraged investment in rental property especially after 1999The tax system has encouraged investment in The tax system has encouraged investment in rental property especially after 1999rental property especially after 1999

Taxpayers with rental income Net rental income

Note: Data are for fiscal years ended 30 June.Sources: Australian Taxation Office; Economics@ANZ .

9

10

11

12

13

14

94 95 96 97 98 99 00 01 02 03 04

% of total no. of personaltaxpayers

Interest paid by property investors

2

4

6

8

10

12

94 95 96 97 98 99 00 01 02 03 04

$bn

-3.0

-2.0

-1.0

0.0

1.0

94 95 96 97 98 99 00 01 02 03 04

$bn

5052545658606264

94 95 96 97 98 99 00 01 02 03 04

% of total

Loss-making property investors

Capital gains taxrate halved

Capital gains taxrate halved

Capital gains taxrate halved

Capital gains taxrate halved

economics@18

Investment property lending grew rapidly Investment property lending grew rapidly especially after the 1999 tax changesespecially after the 1999 tax changes

Finance commitments to owner-occupiers & investors

Loans to investors as a pc of total commitments

10

15

20

25

30

35

40

45

50

90 92 94 96 98 00 02 04 06

% (trend)

0

2

4

6

8

10

12

90 92 94 96 98 00 02 04 06

A$ bn (trend)

Investors

Owner-occupiers(excl. refinancing)

Source: ABS.

economics@19

Borrowing for housing has grown rapidly over the Borrowing for housing has grown rapidly over the past fifteen yearspast fifteen years

Mortgage credit to households

-5

0

5

10

15

20

25

76 81 86 91 96 01 06

% change from year earlier

'Real'

Nominal

0

50

100

150

200

250

81 86 91 96 01 06

A$000 (trend estimate)

Average newmortgage

Note: ‘Real’ mortgage credit is nominal credit deflated by the ‘trimmed mean’ CPI. Sources: RBA; Economics@ANZ.

economics@20

As a result, both debt and interest payments have risen substantially relative to household incomeAs a result, both debt and interest payments have As a result, both debt and interest payments have risen substantially relative to household incomerisen substantially relative to household income

Household debt to income

0

25

50

75

100

125

150

175

76 81 86 91 96 01 06

% of annual disposable income

Interest payments to income

0

2

4

6

8

10

12

76 81 86 91 96 01 06

% of annual disposable income

Housing

Total

Sources: Australian Bureau of Statistics; Reserve Bank of Australia; Economics@ANZ.

economics@21

Australian households now have relatively high debt-income ratios by international standardsAustralian households now have relatively high Australian households now have relatively high debtdebt--income ratios by international standardsincome ratios by international standards

50

75

100

125

150

175

90 92 94 96 98 00 02 04 06

% of annual disposable income

Australia

New Zealand

Canada

UK

US

Household ‘debt to income’ ratio

Sources: ABS, Thomson Financial Datastream.

economics@22

On the other hand, the value of household assets has also risen substantiallyOn the other hand, the value of household assets On the other hand, the value of household assets has also risen substantiallyhas also risen substantially

Household debt to assets

0

5

10

15

20

25

30

76 81 86 91 96 01 06

% of assets

Housing debt tohousing assets

Total debt tototal assets

Household gross and net assets

300

350

400

450

500

550

600

650

700

750

800

76 81 86 91 96 01 06

% of annual disposable income

Gross assets

Net worth

Sources: Australian Bureau of Statistics; Reserve Bank of Australia; Economics@ANZ.

economics@23

High levels of household debt are concentrated High levels of household debt are concentrated among households who can service itamong households who can service it

Source: Bruce Heady & Mark Wooden, Income, Wealth and Joblessness: Insights from the HILDA Survey, Paper presented to “Sustaining Prosperity”Conference, 31 March 2005.

55% of households have a debt-income ratio of less than 50%

The median level of debt among the least wealthy 20% of households is just $2,000

– and they account for just 4% of total household debt

Only 9% of households have a debt-income ratio of over 400%

– about half of these purchased their home within the past five years

– no evidence (in 2002) that these households were reporting above-average levels of financial stress

Only 2.4% of households had debt-service ratios over 50%, and only 4.2% had gearing ratios over 75%

– only 0.4% exceeded both

0

5

10

15

20

25

30

35

0 1 -50

51 -100

101-200

201-300

301- 400

400+

% of households

Household debt to income ratios, 2002

Debt to income ratios (%)

economics@24

High levels of household debt are concentrated High levels of household debt are concentrated among households who can service itamong households who can service it

Note: Figures in parentheses show average weekly household disposable income for eachquintile. Source: ABS; Economics@ANZ.

0

2

4

6

8

10

12

14

Lowest 2nd 3rd 4th Highest Average

Interest (principal residence) Principal (principal residence)

Interest (other property)

% of disposable income

($263) ($518) ($790) ($1,125) ($1,886) ($915)

Interest and principal repayments as a p.c. of disposable incomes, by income quintiles 2003-04

economics@25

Two thirds of Australian households have little or Two thirds of Australian households have little or no debtno debt

Debt service ratio by age of household head, 2003-04

Source: ABS (unpublished data from Household Expenditure Survey; Economics@ANZ.

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

0 0 -<4

4 -<8

8 -<12

12 -<16

16 -<20

20 -<24

24 -<28

28 -<32

> 32

Household head aged < 55 Household head aged 55+

Million households

Debt-servicing ratio

economics@26

Total loan delinquencies and write-offs remain at extremely low levels Total loan delinquencies and writeTotal loan delinquencies and write--offs remain at offs remain at extremely low levels extremely low levels

Impaired assets and write-offs: banks

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

2.0

95 96 97 98 99 00 01 02 03 04 05 060.10

0.15

0.20

0.25

0.30

0.35

0.40

0.45

0.50% of total assets

Total impaired assets(left scale) Write-offs

(right scale)

% of total assetsannual

Source: RBA

economics@27

Rising loan delinquencies largely confined to mortgage originatorsRising loan delinquencies largely confined to Rising loan delinquencies largely confined to mortgage originatorsmortgage originators

Major banks

Non-bank originators

Regional banks

Other banks

Source: S&P

economics@28

Despite the increase in ‘buyDespite the increase in ‘buy--toto--let’ housing let’ housing investment, rental markets remain tightinvestment, rental markets remain tight

Rental vacancy rate Median rents

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

86 90 94 98 02 06

% (4 qtr moving average)

150

175

200

225

250

275

99 00 01 02 03 04 05 06

$ per week (4 qtr movingaverage)

3-br houses

2-br units

Note: data are weighted average of eight capital cities.Source: Real Estate Institute of Australia.

economics@29

FixedFixed--rate mortgages remain relatively unpopular rate mortgages remain relatively unpopular in Australiain Australia

Fixed and floating mortgage rates

Fixed-rate loans asa pc of total new loans

4

6

8

10

12

14

16

90 92 94 96 98 00 02 04 06

% pa

Standardvariable

3-year fixed

0

5

10

15

20

25

90 92 94 96 98 00 02 04 06

% of total (12-mth moving average)

Sources: RBA; ABS; Economics@ANZ.

economics@

The proportion of mortgages at floating rates in Australia is high by international standardsThe proportion of mortgages at floating rates in The proportion of mortgages at floating rates in Australia is high by international standardsAustralia is high by international standards

0

20

40

60

80

100

120

Neth-erlands

France US Swe-den

Can-ada

NZ Italy Ire-land

UK Ger-many

Aust-ralia

Spain Fin-land

% of total

Variable interest rate loans as % of all loans, 2004

Source: OECD

economics@31

What goes up doesn’t necessarily have to come down ….What goes up doesn’t necessarily have to come What goes up doesn’t necessarily have to come down ….down ….

Some observers point to the fact that Australian house prices are now at record highs relative to incomes or rents

– and argue that, just as falls in share prices are often precededby periods in which price-earnings ratios have been unusually high, high ratios of house prices to incomes or rents mean that house prices must ‘inevitably’ fall sharply

This line of reasoning ignores a fundamental difference between the share and residential property markets

– no-one has a ‘natural long’ position in the share market– but in cultures where home ownership is strongly preferred

(such as Australia), the household sector does have a ‘natural long’ position in the residential property market

So long as interest rates remain at reasonable levels (and unemployment remains low) – so that currently marginal owners do not become forced sellers – people will not sell their own houses simply because they appear ‘over-valued’However the ‘structural’ price gains of the past 15 years are most unlikely to be repeatedAnd the increased presence of investors in Australian housing markets could induce greater price volatility