Moody's: Australian covered bond credit quality robust despite housing market risks

Moody's Investors Service says that the credit quality of Australian covered bond programs remains robust in the face of risks in the housing market, while issuance for 2017 is likely to broadly equal that for 2016.

"The continued robust credit quality of Australia's covered bond programs reflects the sound credit quality of mortgages in cover pools, even though risks in the Australian housing market have increased over recent years. Significant price appreciation in the core housing markets of Sydney and Melbourne has led to very high and rising household indebtedness," says Joanne Kung, a Moody's Associate Analyst.

"Moreover, new regulatory measures introduced in March to restrict growth in riskier mortgages - including limits on the origination of interest-only and housing investment loans - are credit positive and will help to limit the proportion of such riskier loans in cover pools going forward," adds Kung.

Moody's conclusions are contained in a just-released report on the Australian covered bond market, "Credit quality remains robust in the face of housing market risks". The report was authored by Kung.

"We further note that mortgage lenders have also raised their interest rates on interest-only mortgages since the new regulatory measures were introduced, while the underwriting criteria for such loans have been tightened in some instances," adds Kung.

Interest-only loans accounted for 26.8% of the total loans in cover pools in June 2017, compared with 28.2% in June 2016.

Furthermore, loan-to-value (LTV) ratios in Australian cover pools have remained steady, with the weighted-average LTV at 63.7% in June 2017, compared with 63.6% in June 2016.

On average, in all cover pools, the proportion of loans with high LTVs has also been declining, with just 1.4% having LTVs above 90% in June 2017, down from 2.4% in June 2016.

The credit quality of covered bonds also remains sound, despite Moody's ratings downgrade on 19 June 2017 of the four major Australian banks that sponsor covered bond programs.

Issuers provide an average of 10.7% over-collateralisation (OC) on a "committed" basis for Australian covered bonds to mitigate credit risk. This figure is well above the current minimum average of 2.3% required to support the Aaa ratings of the covered bonds.