Moody's: Australian banks face increased tail risks from rising house prices

Moody's Investors Service says that signs of a re-acceleration in Australian house prices and increasing household leverage are credit negative for Australian banks, because these factors raise the banks' sensitivity to downside risk in the housing market, and can lead to potential second-order impacts on broader economic activity.

Nevertheless, strong employment conditions and low interest rates continue to support the quality of the banks' housing portfolios.

Data released by CoreLogic last week show that activity in the Australian housing market--after moderating in late 2015 and early 2016--is showing signs of reacceleration, led by strong price growth in Sydney and Melbourne during April and May 2016.

At the same time, household debt/income ratios continue to rise.

"These trends are unfolding against a backdrop of already high levels of household indebtedness, and elevated overall leverage in the economy," says Daniel Yu, a Moody's Vice President and Senior Analyst.

"The current trends are therefore credit negative for Australian banks, particularly in the context of the banks' high ratings, because these trends raise the banks' sensitivity to any potential deterioration in the housing market," adds Yu.

Moody's conclusions are contained in its just-released report, "House Price Growth is Increasing Tail Risks for Australian Banks".

Annual house price growth has risen over the past two months, increasing by 10% for the 12 months to May 2016. Sydney and Melbourne have led the rise.

Moody's says that there is evidence the banks' appetite for investor lending is returning, after a period of tighter underwriting to comply with the Australian Prudential Regulation Authority's 10% annual limit for growth in such loans.

Moody's points out that over the past month, a number of lenders have lifted their maximum loan to value ratios for investor lending, and there are indications that the banks are becoming more competitive in their pricing for investor loans.

Moody's notes, however, that some of the newer lending activity can be explained by investors bringing their purchase plans forward, ahead of the federal elections on 2 July 2016.

Overall, arrears rates remain very low, even though risks in Australia's housing market are skewed to the downside.

Moody's says that macroprudential measures introduced in 2015 have helped to firm underwriting standards. However, the effectiveness of such measures in fully offsetting upward pressure on housing prices remains to be seen.