Pimco Warns Australia's Property Slump Threatens Banks, Economy

Pimco Warns Australia's Property Slump Threatens Banks, Economy

(Bloomberg) -- Australia’s housing slump has increased the possibility of debt downgrades for the country’s big banks, according to a report from Pacific Investment Management Co.

“We have grown more cautious with the external credits of Australian banks,’’ according to a note to clients from Pimco that was written by analysts and portfolio managers including Taosha Wang. “The probability of a market-moving agency downgrade that causes major banks to lose their AA- rating for the first time in history is now higher than before.’’

House prices in Australia have fallen for 12 straight months due to stricter lending standards and stretched affordability. Despite the central bank keeping interest rates on hold for the past two years, debt servicing costs have also begun to rise, with three of the four major banks lifting key mortgage rates in response to higher funding costs.

Pimco estimates that a 200 basis point increase in mortgage rates could lift borrowers’ repayments from 38 percent of their pre-tax income to close to 48 percent, which would see housing affordability worsen to levels last seen in the global financial crisis.

Pimco Warns Australia's Property Slump Threatens Banks, Economy

Tighter credit and a slower housing market will weigh on household consumption and keep the Reserve Bank of Australia on hold for longer, the fund manager said. This underpins its estimate that the central bank’s neutral interest rate -- which neither stimulates the economy nor cools it down -- is now around 3 percent compared to the RBA’s estimate of 3.5 percent.

More than 60 percent of Australian banks’ loans are in residential property, the highest proportion in the developed world and more than double the U.S. ratio, according to data from the International Monetary Fund.

While Pimco concludes that Australia “lacks the preconditions for a housing market crash,’’ it does expect prices to continue falling. It predicts a 10 percent decline over the next couple of years, highlighting the fall in auction clearance rates as a signal of “reduced liquidity in the physical market which often foreshadows further price declines.’’

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