A heavy storm approaching Sydney. (Photo by Sergio Dionisio/Getty Images)

Credit rating agency Moody’s has downgraded Australia’s big four banks.

Following Standard and Poor’s (S&P) decision to downgrade the credit ratings of 23 Australian financial institutions in May, Moody’s Investor Services has followed suit, lowering the ratings of 12 lenders on the back of what it describes as “elevated risks” in Australia’s household sector.

Unlike S&P, Moody’s decided to downgrade not only smaller lenders, but also Australia’s largest banks.

The group said that “risks associated with the housing market have risen sharply in recent years”, adding that Australia’s very high levels of household debt are “particularly concerning” given low income growth experienced in Australia over the past few years.

“Whilst mortgage affordability for most borrowers remains good at current interest rates, the reduction in the savings rate, the rise in household leverage and the rising prevalence of interest-only and investment loans are all indicators of rising risks,” it said.

Contributing to the ratings downgrades, the group said it has changed its assessment of Australia’s Macro Profile to “Strong +” from “Very Strong -“.

Moody’s sounded a note of caution on Australian labour market conditions, noting that while unemployment remains low at 5.5%, rising levels of underemployment indicate spare capacity within the labor market “which could constrain wage growth over the medium term”.

As such, the group said that household sector’s resilience to weaker employment levels or rising interest rates has “materially reduced”.

“Any increase in household sector stress would have the potential to weaken consumer confidence and consumption, creating negative second and third order impacts on overall economic activity and, accordingly, bank balance sheets.”

Given that assessment, the group cut the long-term ratings of Australia’s four major banks — ANZ, CBA, NAB and Westpac — to Aa3 from Aa2, with a stable ratings outlook.

Moody’s noted some recent efforts to slow investor lending, but noted Australia’s record levels of household debt. It said (emphasis added):

Whilst capital adequacy is likely to strengthen further — as a result of regulatory action — and macro prudential measures will alleviate a further build-up of risks, the very high level of household sector indebtedness will take a considerable period of time to unwind.

The resilience of household balance sheets and, consequently, bank portfolios to a serious economic downturn has not been tested at these levels of private sector indebtedness.

It also said that the long-term ratings of Newcastle Permanent Building Society and Bendigo and Adelaide Bank Limited were downgraded to A3 from A2, with those from Heritage Bank, Members Equity Bank, Newcastle Permanent Building Society, QT Mutual Bank, Teachers Mutual Bank, Victoria Teachers Mutual Bank and Credit Union Australia downgraded to Baa1 from A3.

Via Moody’s

Along with the big four banks, the ratings outlook for Members Equity Bank was also revised from negative to stable.

“In Moody’s view, elevated risks within the household sector heighten the sensitivity of Australian banks’ credit profiles to an adverse shock, notwithstanding improvements in their capital and liquidity in recent years,” the group said. “While Moody’s does not anticipate a sharp housing downturn as a core scenario, the tail risk represented by increased household sector indebtedness becomes a material consideration in the context of the very high ratings assigned to Australian banks.”

The bank said it had arrived at the view that “the credit conditions in Australia have deteriorated.” It added:

High levels of debt and rapid credit expansion can signal credit quality problems that emerge later. High and rising household debt in the context of low nominal wage growth has led to very high levels of household leverage, thereby increasing the household sector’s and, by extension, the banking sector’s sensitivity to a potential shock. In assessing a given country’s credit conditions, Moody’s considers the level of private-sector debt to GDP and the growth in private sector debt.”

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