Orderly correction in property prices forecast by S&P

The failure of regulators to halt recent east coast house price growth has led to the downgrade of the wider Australian banking sector.

The global ratings agency S&P Global Ratings has downgrade the credit quality of 23 banks and lenders, including Australia's biggest regional bank.

It comes as it warns of a sharp correction scenario in property prices and bigger bank losses.

The Ratings agency base case for the housing market is an "orderly unwind" of house prices.

"We still maintain our base case expectation that the unwinding of these imbalances will be orderly and we think that will be either a slowdown growth rate of property prices or a very mild decline in property prices," S&P advised.

"That is our base case."

The downgrades were triggered by S&P's decision to increase Australia's "economic risk" score, from three to four on account of economic imbalances, specifically rising property prices and high household debt.

The big four banks were spared because of their implied "too big to fail" government guarantee status. 

S&P Global Ratings director Sharad Jain said risks to the Australian economy had become even more pronounced since the ratings agency downgraded the Australian banking sector to negative watch back in October 2016 as house prices continued to move higher and higher.

"Growth in private sector debt was more or less in line with expectations since then while property prices accelerated in the two quarters," Mr Jain said.

Mr Jain said that until the imbalances had "substantially unwound" the banking sector remains exposed to an "elevated level of risk of a sharp correction for property prices".

"To reflect the increased risk, we have lowered our assessment of the standalone credit profiles [SACPs] of almost all financial institutions operating in Australia."

Mr Jain acknowledged that house price growth had begun to slow and that the macro-prudential interventions made by APRA were likely to have more impact in the months ahead and see the imbalances "move in the right direction".

Jain said that although he expected macro-prudential measures from the Australian Prudential Regulation Authority, such as caps on investor and interest only lending, to contribute to a further slowing of house price growth in Melbourne and Sydney, the impact of a correction on the banks "was no longer consistent with our previous assessment".

Among the bigger institutions to be hit by the downgrade are AMP Bank, Bank of Queensland and Bendigo and Adelaide Bank. AMP has been downgraded to A+ with a negative outlook to A with a stable outlook while Bank of Queensland and Bendigo and Adelaide Bank have both been downgraded from A- with a negative outlook to BBB+ with a stable outlook.

Among the others to be downgraded were Australian Central Credit Union, Auswide Bank, Community CPS Australia, Credit Union Australia, Defence Bank, Fisher & Paykel Finance, G&C Mutual Bank, Greater Bank, IMB, Liberty Financial, mecu, Members Equity Bank, MyState Bank, Newcastle Permanent, Police Bank, QPCU, Rural Bank, Teachers Mutual and Qudos Mutual (formerly Qantas Credit Union).

The downgrade brings S&P's ratings in line with rival Moody's.

Meanwhile the Australian Financial Review says investors are surging into mortgage bonds in Australia.

New residential mortgage-backed securities issuance has more than doubled so far this year to $10.5 billion from $5.1 billion a year earlier, data compiled by Bloomberg show.

More than half of the issuance has been fuelled by non-bank lenders.