GLOBAL agency S&P has downgraded the credit ratings of 23 Australian financial institutions, warning of a sharp housing market correction which could lead to a taxpayer bailout of the major banks, because they are too big to fail.

S&P cited economic imbalances increasing due to strong growth in private sector debt and residential property prices over the past four years.

“Consequently, we believe financial institutions operating in Australia now face an increased risk of a sharp correction in property prices and, if that were to occur, a significant rise in credit losses,” S&P said.

Among those that had their credit ratings cut were Bank of Queensland, AMP, Bendigo and Adelaide Bank, whilst the four majors and Macquarie Group were exempted.

S&P estimate private sector growth will have increased to around 136% of GDP in June 2017, from 117% in 2013, at an annual average increase of4.6 percentage points, and property prices at an inflation-adjusted increase for the four years to June2017 by 6.4%.

The agency spared the big four banks on expectations of a taxpayer bailout and the federal government stepping in to offer “timely financial support”, but retained its negative outlooks for each.

“In addition, with residential home loans securing about two-thirds of banks’ lending assets, the impact of such a scenario on financial institutions would be amplified by the Australian economy’s external weaknesses, in particular its persistent current account deficits and high level of external debt,” it said.

However, the agency said its outlook for the Australian banks is “relatively benign by global standards”.

“We consider that recent and possible further actions by the Australian authorities should aid in an unwinding of the imbalances in an orderly fashion, as has generally been the case in the past several cycles in Australia – and may have already started in Sydney and Melbourne.”

Both Bank of Queensland and Bendigo and Adelaide Bank had their ratings lowered from A- with a negative outlook to BBB+ with a stable outlook, whilst AMP was taken down from A+ with a negative outlook to A with a stable outlook.

Financial institutions also downgraded were Australian Central Credit Union, Auswide Bank, Community CPS Australia, Credit Union Australia, Defence Bank, Fisher &Paykel Finance, G&C Mutual Bank, Greater Bank, IMB, Liberty Financial, mecu, Members Equity Bank, MyState Bank, Newcastle Permanent, Police Bank, Qudos Mutual, QPCU, Rural Bank and Teachers Mutual.

This week institutional investment fund JCP Investment Partners, one of three Future Fund-appointed Australian equities managers, said high-risk mortgage loans to over-extended borrowers had put as much as 20% of the major lenders’ equity base at risk.

“Interest only could be Australia’s sub-prime. Interest only loans proliferate throughout the mortgage book, across cohorts and circumstances. Only one trend emerges; interest only households tend to have lower incomes and higher amounts of credit outstanding and tend to use interest only to borrow more. With caps on interest only loans, only time will tell if such households can afford the mortgages they have,” S&P warned.

“Buffers are sometimes touted as the offset to systematic stress in the mortgage book. However, our analysis shows the buffers primarily reside with the low-risk cohort. That is, 60% of the buffers (five months) are with the low-risk households with low LTIs (loan to income) and/or low LVRs (loan to value), this cohort represent only 30% of the debt. The borrowers who need the buffers don’t have them.

“The risk in a banks book is a function of recent lending behaviour, especially in a market with low rates, high interest-only shares, and quickly growing prices.” S&P said.

Financial services firm KPMG last month released a report warning that an increasing number of poorer Australians are taking on negatively geared property investments despite an inability to manage financial risks, which will create problems should interest rates begin to go up.

It found the bottom 20% of households by income recorded the highest rate of growth in investment income, at 8.5% per annum compared to 2.3% on average for other households over the past decade.

KPMG Australia chief economist Brendan Rynne said the increase reflects a greater exposure to investment activities such as negatively geared property investment, confirmed by the substantial increase in value of second mortgage payments being paid by this quintile.

“While it is perhaps understandable that the poorest members of our society want to diversify and increase their incomes, this group is the least able to take on the financial risk associated with geared investment activity.

“It should be a matter of concern that households across the financial spectrum have been progressively increasing their debt levels at rates faster than their disposable incomes have grown.” Rynne said.

Australian Property Journal