S&P Global Ratings acts on concerns over strong growth in Australian private sector debt and residential property prices

S&P Global Ratings says it expects to lower its credit ratings on the big four Australian banks and their New Zealand subsidiaries.

The credit rating agency says economic risks facing all financial institutions operating in Australia are rising due to strong growth in private sector debt and residential property prices over the past four years, notwithstanding some signs of growth moderation over recent months.

"Our ratings on the four major Australian banks remain unchanged and on negative outlooks. These ratings were already on negative outlooks reflecting the negative outlook on the Commonwealth of Australia. We expect to now lower our ratings on these major banks and their core subsidiaries [which include the big four NZ banks] under a scenario in which we reclassify our assessment of the Australian government's supportiveness toward systemically important private sector banks to supportive from highly supportive. We now see a one-in-three chance of this scenario eventuating," S&P says.

"Finally, similar to all other financial institutions operating in Australia, we expect to lower our assessment of the SACPs [stand alone credit profiles] of the Australian major banks, in our alternative scenario of continued strong growth in private sector debt or property prices."

ANZ NZ, ASB, BNZ and Westpac NZ currently all have AA- credit ratings with a negative outlook from S&P, equalised with their Australian parents. The outlook on these ratings was dropping to negative from stable in July. At that time S&P said the four banks potentially faced a one notch downgrade to A+. A credit rating downgrade would be likely to raise funding costs for NZ's major banks at a time when lending growth has been exceeding deposit growth, meaning the major NZ banks require more offshore funding.

S&P has also lowered the outlook on Fisher & Paykel Finance's BB credit rating to negative from stable, saying F&P Finance's Australian parent Flexi Group Ltd faces pressures on its group credit profile similar to those faced by other Australian financial institutions. 

Two-thirds of banks' lending assets secured by residential home loans

The credit rating agency points out that that Australian private sector debt has risen to about 139% of GDP as of June this year from 118% in 2012. That's an annual average increase of 5.2 percentage points. At the same time property prices nationally have recorded an average inflation-adjusted increase over the last four years of 5.3%. This is driving the potential increase in imbalances in the economy, S&P argues.

"Consequently, we believe the risks of a sharp correction in property prices could increase and if that were to occur, credit losses incurred by all financial institutions operating in Australia are likely to be significantly greater; with about two-thirds of banks' lending assets secured by residential home loans - 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."

S&P says its base-case scenario remains that the growth in Australian property prices and private sector debt will moderate and remain at relatively low levels in the next two years. But; "If risks in the economy continue to grow, other things equal, we expect to lower our assessment of the stand-alone credit profiles of all financial institutions operating in Australia."

Meanwhile, S&P says it believes the Australian government remains highly likely to provide timely financial support to the systemically important private banks in the country, if needed.

"Nevertheless, we now consider that there is a one-in-three chance that within the next two years, we will revise our assessment of government supportiveness to supportive from the current highly supportive." 

In July S&P revised its outlook on Australia's AAA credit rating to negative from stable because "without remedial action the government's fiscal stance may no longer be compatible with the country's high level of external indebtedness." See credit ratings explained here.

Here's S&P's statement 

S&P Global Ratings today said that it has revised its outlooks on the long-term ratings on 25 financial institutions operating in Australia to negative from stable. At the same time, we have revised our outlooks on three financial institutions to developing from positive (see ratings list below). 

The rating actions reflect S&P Global Ratings' view that the trend in economic risks facing financial institutions operating in Australia has become negative (see our BICRA snapshot, below). Strong growth in private sector debt (to about 139% of GDP in June 2016 from 118% in 2012, or an annual average increase of 5.2 percentage points) coupled with an increase in property prices nationally (average inflation-adjusted increase for the past four years was 5.3% nationally) are driving the potential increase in imbalances in the economy, in our view. Consequently, we believe the risks of a sharp correction in property prices could increase and if that were to occur, credit losses incurred by all financial institutions operating in Australia are likely to be significantly greater; with about two-thirds of banks' lending assets secured by residential home loans--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. 

Notwithstanding the growing imbalances in recent years, in our base case we consider that the growth in private sector debt and property prices will moderate and remain relatively low in the next two years. We believe that increasing apartment supply in Sydney and Melbourne, regulatory pressures on lending practices and capital, and recent trends (including declining sales volumes in the secondary market) should help moderate the growth in property prices and household debt. Nevertheless, in our alternative case, we consider that there is a one-in-three chance that the strong growth trend will resume within the next year, because in our view several other important factors that have supported the past trend are likely to persist, including low interest rates, a relatively benign economic outlook, and an imbalance between housing demand and supply; in addition, Australian banks could possibly target higher lending volumes to offset pressures on their earnings growth. We would see a resumption or continuation of this trend as indicative of a continued buildup of economic imbalances, posing greater risks to all financial institutions operating in Australia. 

Consequently, should our alterative scenario materialize (that is, if imbalances continue to build), we would expect to lower our stand-alone credit profiles (SACPs) and ratings on most of the financial institutions that have ratings on negative outlooks. Lower SACPs would also generally lead to lower ratings on hybrids and nondeferrable subordinated debt instruments issued by these banks.

Notwithstanding the rising economic imbalances, we believe that Australia remains among the lower risk banking systems globally. We consider that the financial institutions operating in the country benefit from a resilient economy, relatively benign economic outlook by global standards, conservative risk appetite and governance, and conservative prudential regulation. Partly offsetting these strengths are the Australian banking system's material reliance on offshore borrowing, high and rising economic imbalances, and increasing private sector indebtedness. 

AUSTRALIAN MAJOR BANKS

Our ratings on the four major Australian banks remain unchanged and on negative outlooks. These ratings were already on negative outlooks reflecting the negative outlook on the Commonwealth of Australia. We expect to now lower our ratings on these major banks and their core subsidiaries under a scenario in which we reclassify our assessment of the Australian government's supportiveness toward systemically important private sector banks to supportive from highly supportive--we now see a one-in-three chance of this scenario eventuating. Finally, similar to all other financial institutions operating in Australia, we expect to lower our assessment of the SACPs of the Australian major banks, in our alternative scenario of continued strong growth in private sector debt or property prices. 

MACQUARIE BANK AND CUSCAL

Our ratings on Macquarie Bank Ltd. and Cuscal Ltd. currently benefit from our expectation that the Australian government is likely to provide timely financial to support to these institutions, if needed. Consequently, our negative outlooks on these institutions reflect emerging pressures on the Australian government's supportiveness toward the banking system.  

We expect to lower our rating on Macquarie Bank if we formed a view that the tendency of the Australian government to support private sector commercial banks has weakened or economic risks facing Australian banks have heightened. We expect our rating on Macquarie Bank's parent, Macquarie Group, to remain unaffected by any change in our assessment of government supportiveness because our ratings on Macquarie Group do not benefit from government support. Nevertheless, we expect to lower our rating on Macquarie Group if we considered that economic risks facing Australian banks have heightened.

We expect to lower our ratings on Cuscal if we considered that economic risks facing Australian banks have increased, in conjunction with either a lower sovereign rating or a change in our assessment of the Australian government's supportiveness. But even under pressure from all three factors, we would expect to lower the long-term rating on Cuscal by no more than one notch. 

FPFL

The negative outlook on New Zealand-based Fisher & Paykel Finance Ltd. (FPFL) reflects our opinion that its Australian-based parent Flexi Group Ltd. faces pressures on its group credit profile--similar to those faced by other Australian financial institutions. 

FOREIGN OWNED BANKS, EFIC, AND SUNCORP-METWAY

Our ratings and outlooks on the following seven institutions also remain unchanged: five foreign-owned financial institutions, namely Citigroup Pty Ltd. (A-/Watch Pos/A-2), Goldman Sachs Financial Markets Pty Ltd. (A/Watch Pos/A-1), HSBC Bank Australia Ltd. (A+/Stable/A-1), ING Bank (Australia) Ltd. (A-/Positive/A-2), and JPMorgan Australia Ltd. (A+/Stable/A-1); and two domestically owned institutions, Export Finance & Insurance Corp. (EFIC; AAA/Negative/A-1+) and Suncorp-Metway Ltd. (A+/Stable/A-1). Our ratings on these entities incorporate our assessment of likely financial support from their parents. If we considered that economic risks that Australian banks face have increased, we would expect to lower our SACPs on HSBC Bank Australia, ING Bank Australia, and Suncorp-Metway (we do not currently assess SACPs on EFIC and the above-mentioned rated Australian subsidiaries of Citigroup, Goldman Sachs, and JPMorgan). Nevertheless, we consider that such an increase in risks for the Australian banking system would have no significant impact on the capacity for these entities' parents to support them, or the likelihood of such parent support being made available, if needed. We note that our outlook on EFIC has already been negative, reflecting the negative outlook on its parent and guarantor, the Commonwealth of Australia. 

MYSTATE, P&N, AND QUDOS MUTUAL

We have revised our outlooks on banking institutions MyState Bank Ltd., Police & Nurses Ltd., and Qudos Mutual Ltd. to developing from positive. This rating action reflects a one-in-three chance that we may raise or lower our ratings on these institutions within the next two years. Our ratings on these institutions were on positive outlooks reflecting institution-specific factors, which in our view are largely independent of the above mentioned negative industrywide pressures. Our rating outcome on these institutions would depend on the balance of the forces in opposing directions. For example, the following two scenarios could emerge for each of the institutions:

The institution meets the upgrade triggers that we have identified but we assess that economic risks faced by the Australian banks remain on a negative trend. In such a scenario, we expect to raise our rating on such an institution and revise the outlook to negative. 

There is no change in the upward rating momentum for an institution but we assess that economic risks that the Australian banks face have worsened. In this scenario, we would expect to lower our rating on such an institution and revise the outlook to positive. 

QTMB Our ratings on QT Mutual Bank Ltd. (QTMB; BBB+/Watch Dev/A-2) remain on CreditWatch with developing implications, pending finalization of QTMB's proposed merger with the Royal Automotive Club of Queensland.