Moody’s says house prices “arguably at unsustainable levels”, vulnerable to correction if Eurozone crisis worsens

Ratings agency Moody’s says Australia’s housing prices and mortgage debt levels are “arguably at unsustainable levels”, and says prices may tumble either in the short-term – if the European debt crisis worsens – or in the medium-term, as default and delinquent rates rise.

Moody’s lead analyst for the mortgage insurance sector, Ilya Serov, says the “combination of elevated house prices and unprecedented household indebtedness warrant in our opinion a degree of caution”.

“The degree of sensitivity of the housing market to a serious economic downturn, given these two factors, has not been tested. We believe it could be materially higher than in previous historical episodes,” he says.

“The recent experience of the US and certain European countries serves a useful cautionary reminder.”

Describing the data on the sustainability of Australian housing prices as “ambiguous”, Moody’s says its baseline expectation is “that of further declines, both in the short- and medium-term”.

According to Serov, challenges include:

• Australia’s reliance on resources.
• Australia’s banks reliance on external wholesale funding.
• The high Australian dollar pressuring other sectors such as tourism and retail. He says: “Should these trends persist, default and delinquency rates in the mortgage market are likely to be variably regionally and increase in the next decade.”

Serov notes that capital-city prices have quadrupled and household indebtedness tripled in the past 20 years.

“The market is undergoing a (to date) mild correction with a decline of approximately 4% off peak values nation-wide and up to 9.5% in Brisbane,” Serov writes.

“Housing credit growth has fallen to around a third of pre-crisis levels. Our baseline expectation is that of further declines, both in the short and medium term.”

Serov says although he expects economic conditions to remain supportive in 2012, the “potential for contagion from the Eurozone crisis represents a material downside risk”.

He adds that although the jury is out on whether the European sovereign crisis will drive economic weakness and provide a shock to the local financial sector, Australia’s reliance on resources and the dependence of local banks on wholesale funding “increase the Australian economy’s sensitivity to exogenous shocks”.

Moody’s further notes that the “excellent performance of Australian mortgage loans to date is beginning to be challenged, with 30 days past due delinquencies reaching their highest value of 1.76% in May 2011” – versus the 1% recorded prior to 2005.

Serov put the Australian mortgage insurance sector – dominated by QBE LMI and Genworth Financial ¬– on outlook negative, citing concerns about the “medium-term performance of the country’s housing market”.

The report comes as The Age reports that Australia’s big banks have been working on a contingency plan to ensure funding lines stay open should the Eurozone break up.

The newspaper says chief financial officers at the banks are understood to have updated their internal risk models, raise liquid-asset levels and reopened private funding placement channels with large investors in Asia.