Economic recovery will be ‘unpredictable and uneven’ RBA warns as it models 50pc property price fall
More Australians could go into “negative equity”, where the value of their property falls below the outstanding balance on their mortgage, if the pandemic-led recession leads to a big fall in house prices, according to the Reserve Bank (RBA).
In a speech about major risks to Australia’s financial stability on Tuesday evening, RBA assistant governor Michele Bullock warned more businesses would go under and this would have a negative impact on bank balance sheets.
Ms Bullock said the economic recovery from the recession would be “unpredictable and uneven”.
“There will be rising business insolvencies and problems for some households in servicing their debts,” she said.
The recession has raised the possibility some households will be unable to meet their repayments because their incomes have fallen.
This would see the banks face an increase in non-performing loans, Ms Bullock said.
She warned that while the share of loans currently in negative equity was low, this could change if there was a substantial fall in house prices.
With population growth forecast to remain weak for the next year at least, it is possible the housing market could further weaken, especially across major capital cities.
“Price falls could be exacerbated by housing investors who, seeing vacancy rates rising and rents falling, decide to sell,” Ms Bullock said.
More households could face ‘difficult circumstances’
While households’ cash flow has been underpinned by government income-support policies, loan repayment deferrals, and low interest rates, and some Australians have been saving and paying down their debt or building deposits, many others are vulnerable.
“Not all households will have been able to increase saving and will find themselves in difficult circumstances,” Ms Bullock said.
At the peak in June, about 8 per cent of housing loans were on deferred payments.
“Many of these deferrals ended in September and October and payments have recommenced,” she said.
“There is still, however, a significant minority of households that are seeking to remain on deferred repayments.
“Many of these loans are higher risk, in that they tend to have higher loan-to-valuation ratios or are held by people who work in industries particularly at risk from the current health crisis.
“Non-performing loans to households, which had already risen over the past couple of years, are therefore expected to continue to rise over the coming months.”
She said banks had increased their reserves for future losses.
However, this position could change. The Reserve Bank carried out hypothetical modelling to show what could happen to banks’ balance sheets if something unusual and unexpected happened.
“As an example, one scenario that would see a major bank’s capital ratio fall below 6 per cent — that is well into its capital-conservation buffer — would be a fall in property prices of 50 per cent, GDP declining by 20 per cent and unemployment rising to 20 per cent,” Ms Bullock said.
“A downturn of this magnitude has not been observed since the Great Depression and, even then, capital ratios remained about prudential minimums.
“This confirms that the likelihood of a major bank failing is very low. But there are vulnerabilities.”
Business failures to impact bank balance sheets
Aside from the risk from households, small businesses have been hit particularly hard during the recession, with revenue falling in aggregate by close to 15 per cent since March.
“In industries such as arts and recreation, and accommodation and food services, the declines in sales have been even bigger,” Ms Bullock said.
She said as stimulus measures were wound back, business failures would increase, and this would happen even as the economy started to recover.
“Survey evidence suggests that around a quarter of small businesses that are currently receiving income support would close if support were removed now and trading conditions had not improved,” she said.
“While not all business failures will result in losses for the banks, it will have an impact on banks’ balance sheets.
The area of particular concern is commercial property, with retail vacancies on the rise.
“This has accelerated with the onset of the pandemic, particularly in CBD retail,” Ms Bullock said.
She said there was uncertainty about prospects for rental demand for CBD office property, particularly in Sydney and Melbourne.
“In both cities, there is substantial new supply coming onto the market, and vacancy rates have already started to rise,” she said.
“Commercial property prices could experience sharp falls in this environment, putting pressure on investors that had borrowed to invest in such property.
“While banks do not have a large direct exposure to commercial property, impairment rates are likely to rise.”
Ms Bullock said there were also still big international risks that could spill over into Australia.
“High corporate debt in some countries, high sovereign debt in Europe and low profitability of banks in some countries all pose a risk to financial stability,” she said.
“The current recession is likely to exacerbate these issues and potentially impact the financial system’s ability to cushion the shock.”
Victorian drag on economy won’t be so bad: RBA deputy
Earlier in the day, Reserve Bank deputy governor Guy Debelle was more positive about Australia’s recovery from the coronavirus-driven recession.
He told Senate Budget Estimates Australia’s economy may have performed better than expected in the September quarter.
Dr Debelle said the RBA was releasing new forecasts next week, but his “best guess” was Victoria’s extended lockdowns did not have as large an impact on the national economy as expected.
That means Australia may not record three consecutive quarters of negative growth.
“It looks like the September quarter for the country probably recorded positive growth, rather than negative, and that is the best we can tell, and this will be confirmed when we see the national accounts,” Dr Debelle said.
“The strength of the growth of the rest of the country was more than the drag from Victoria, and possibly the drag from Victoria was a little less than we had forecast in August.”
Australia’s economy contracted by 0.3 per cent in the March quarter, and by 7 per cent in the June quarter.
There were 930,000 Australians considered officially unemployed.
The official employment rate is 6.9 per cent, the official underemployment rate is 11.4 per cent, and the employment to population ratio is a low 60.3 per cent.
In the Federal Budget, Treasury forecast that it could take “about five years” for the unemployment rate to fall to 5 per cent, and for inflation to be sitting comfortably within the 2 to 3 per cent range.
The RBA will announce its next interest rate decision this coming Tuesday.