Moody’s is taking another look at the way it rates Australian Residential Mortgage-Backed Securities.
We anticipate increases to Moody’s Aaa mortgage default probability and house price stress rate assumptions. Separately, Moody’s expects to modify its approach towards incorporating lenders’ mortgage insurance in Australian RMBS.
Senior AAA-rated tranches are unlikely to be affected, they say, but other levels may be:
Our review of the rating methodology will focus on severe, tail-end risks.
We believe that while the probability of a severe crisis remains low, a greater degree of caution in analyzing the performance of Australian mortgage portfolios may be warranted, given:
- Australia’s economic growth is increasingly driven by favorable terms of trade. However, the commodities-led structural transformation that the economy will undergo over the next two decades implies winners and losers, with certain industries and geographical regions coming under significant pressure. As a result, default and delinquency rates in the mortgage market are likely to be both variable and, in our view, on average higher over the coming decade than in the past.
- The data with regard to the sustainability of Australian house prices are ambiguous, with the run-up in prices over the past decade — in our view — only partially explained by fundamentals. We consider the possibility of major regional house price drops to be a material risk for the Australian market.
- Elevated mortgage debt levels point to vulnerability within the Australian financial system. The mortgage market’s robustness to an economic shock has not been tested at current levels of indebtedness, with the recent experience of other countries positing some questions in this regard.
In May Moody’s downgraded from Aa1 to Aa2 the big four Australian banks — thought by many to be indestructible due to their capital ratios (or more accurately, the government backstop).
One of the key reasons cited was reliance on overseas debt. And much of that credit goes into (you guessed it) mortgage loans! To which Australian households have some of the highest exposure in the world:
High levels of household indebtedness remain our key concern, and perhaps to a degree greater than house price levels in themselves. Both historically and in comparison to other OECD countries, Australian borrowers’ vulnerability to economic shocks is elevated and unprecedented. As demonstrated in the chart below, the levels of household debt have tripled in the last 20 years. This places Australian households among the most leveraged in the developed world, on par with those in the UK, US and Sweden.
On Australian house prices themselves, The Economist ranks Australia much closer to the top, on a price-to-rental-yield basis.
Back to RMBS. It’s not hard to see why Moody’s might be reconsidering their methods. Both Fitch and S&P have found fairly steep rises in delinquency rates among Australian mortgagees this year.
This review announcement is a gentle warning, mind; calling for submissions from interested market participants — as a parliamentary committee might. It notes that while Australia’s fortunes are very much tied to China’s, a reversal in terms of trade is not immediately likely.
On which topic, it would be interesting to see what an eventual downgrade to some Australian RMBS might mean for the government’s purchase programme. Launched during the financial crisis, the programme has set aside some A$22bn, and by April this year, $12.7bn had been spent. The programme requires that the government only buy into AAA-rated securities, but it allows up to 10 per cent “low-doc” loans (which look a lot like certain types of subprime) — albeit with some restrictions — in any mortgage pool in which is invests.
The good folk at Macrobusiness have the full Moody’s note.
Related links:
ABS, CDS and other acronyms in Australia - FT Alphaville
Live and lend loose, or mortgages down under - FT Alphaville
Why no Canadian, Australian housing busts? – FT Alphaville