Moody’s: Australian covered Bond Performance remained Stable in Q2 2015

Moody’s Investors Service says that the performance of Australian covered bond programs during Q2 2015 continued to be supported by the stable Aaa rating of the Australian sovereign, the stable credit profiles of the issuers and the stable credit quality of the cover pool assets. All Australian issuers are rated between A1 and Aa2 with a stable outlook. In Australia, the stable and healthy composition of the cover pool assets was reflected in an improved average collateral score — that reflects the credit quality of the underlying mortgages – of 6.8% in Q2 2015 compared to 7.2% in Q1 2015. The weighted average current loan-to-value ratios of the residential mortgage loans in the cover pools ranged between 56.7% and 65.4%. Although the Australian Prudential Regulation Authority (APRA) data showed that the 3-month annualized investment lending growth rates to June 2015 for Australia’s big four banks were 13.3% for Australia and New Zealand Banking Group Limited, 14.8% for Commonwealth Bank of Australia, 15.0% for National Australia Bank Limited and 10.0% for Westpac Banking Corporation, we witnessed only a slight increase in the proportion of investment loans in the cover pools — to a simple average of 25.14% in Q2 from 23.92% in Q1 2015. In July and early August, Australia’s big four banks and other major mortgage lenders increased the interest rates they charge on residential property investment loans and interest-only (IO) loans (IO loans are primarily taken out by investors). Earlier in 2015, some banks also lowered the maximum allowable loan-to-value (LTV) ratios and introduced stricter serviceability tests on investment and IO loans. These measures are credit positive for the cover pools because they will result in a lower proportion of investor and IO loans in these pools, in favor of safer owner-occupier and principal & interest loans. Over time, the measures that have been announced by banks are likely to slow growth in residential property investment loans to below 10% per annum, a level that has been deemed appropriate by APRA. In Q2 2015, there was a significant improvement in the minimum over-collateralization (OC) commensurate with Aaa — 0% and 7.1% from 7.9% and 14.9% in Q1 2015 for the four Australian major bank issuers and Suncorp-Metway Limited respectively. This improvement was mainly driven by the change in using Counterparty Risk Assessment (CR Assessment) instead of Senior Unsecured Rating (SUR) as the Covered Bond Anchor Point under Moody’s rating approach of covered bonds updated on 12 March 2015. The CR Assessment of all Australian covered bond issuers is one notch above their SUR. Despite the improvement, the Committed OC levels remained unchanged from Q1 2015 at 13.8%. Moody’s outlook for the Australian banking system is stable. Banks will navigate a challenging operating environment in the coming 12-18 months as economic growth slows on subsiding investments in the resources sector, while rising imbalances in the housing market are a notable downside risk. Moody’s expects the Australian banks’ bad debt metrics and net interest margins will come under increasing pressure in the second half of 2015 and into 2016. Nonetheless, the prevailing low interest rate environment will limit the extent of the increase in credit costs, which we expect to remain below-long term averages. In addition, the banks’ entrenched market positions will continue to underpin their solid credit profiles through the cycle. Australian covered bond issuance of AUD84.2 billion in Q2 2015 was similar to the AUD84.6 billion level in Q1 2015.

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