A report from Pacific Investment Management Co. (Pimco) has suggested that the major banks in Australia could find themselves dealing with debt downgrades in the wake of a declining property market.

The report came with a note from leading analysts and investment managers, who revealed that they “have grown more cautious with the external credits of Australian banks” and said that there is an increasing likelihood that any of the Big Four banks could “lose their AA- rating for the first time in history.” This prediction has some investors worrying about the state of the Australian economy.

While the government believes that there is currently no cause for concern and has welcomed a steady decrease in house prices, troubling times could be ahead for the economy if these prices drop too steeply. News released this week that the big Australian banks could be involved with $500bn worth of fraudulently claimed mortgages could also add fuel to the fire.

As lending standards increase due to the fallout from the Royal Commission inquiry into financial misconduct and the average Australian’s ability to afford a home decreases, the housing market finds itself stretched between a significant number of people who need it to fall slightly and those who worry that it will fall too much and be hard to stabilize. People who have received mortgages with a higher value than their houses are now worth will also incur increased debt for having less of a market asset.

The Royal Commission inquiry also led to three of the four major lenders resorting to out-of-cycle mortgage rate rises as they sought to reclaim some of the lost profits from changes to their lending policies. This contributed to the continued charging of higher interest on dropping house prices, which is likely to impact heavily on affordability over the next year.

 

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Pimco said that if mortgage interest lending rates were to go up by 200 basis points, then this would lead to borrowers needing to spend even more of their income on paying off their mortgage and cause a massive knock-on effect on the spending power of each Australian household. Retail growth could plummet as the nation tightens its belt, which may kick it into a form of recession.

A 200-basis-point increase may cause homeowners’ repayments to climb from the current average level of 38% to 48% of their pre-tax income, according to Pimco. Most analyst measures consider this to be unaffordable for Australians at a level not seen since 2008, when the global financial crisis began.

The Reserve Bank of Australia (RBA) plans to taper this as best it can, primarily by holding off on changing the neutral interest rate and keeping it lower than the bank would like, at 3% rather than 3.5%.

One of the biggest problems for the big banks, according to forecasts from Pimco, is that 60% of their market is investing in home loans for Australians. This lack of diversity in the assets that they hold shows just how susceptible the banks are likely to be to a shift or volatility in the market. With house prices showing no sign of changing course, investors will remain unsure of backing the Australian economy.