Australian banks brace themselves for smooth sailing

Thanks to economic growth and asset quality.

Moody's Investors Service says that its outlook on Australia's banking system remains stable, reflecting its expectation of sustained economic growth and stable asset quality over the next 12-18 months.

According to a release from Moody’s Investors Service, Moody's "Banking System Outlook

Australia," this outlook is based on the firm’s “Banking System Outlook Australia” report.

"We believe that the banks' credit profiles will remain stable as sustained economic growth and low interest rates will support asset quality and stronger wholesale funding markets will help improve funding costs," says Frank Mirenzi, a Moody's Vice President and Senior Analyst.

The report -- whose outlook expresses Moody's expectations of how bank creditworthiness will evolve in this system over the next 12-18 months --looks at Australia's banking system in terms of five factors: Operating environment (which is classified as "stable"); asset quality and capital ("stable"); funding and liquidity ("stable"); profitability and efficiency ("stable"); and systemic support ("stable").

"Headline economic growth should remain sound, at around 3% for 2014, and again in 2015, underpinned by growth in resource related exports. Whilst rising house prices continue to be an area of focus, current housing market developments are not yet a threat to Australian banks' credit profiles, as the rise has not been fuelled by excessive credit growth or loosening of lending standards," says Mirenzi.

"Moreover, low interest rates have enabled a high level of mortgage prepayments, which can provide a buffer in case of borrower stress. Consequently, average loan-to-value ratios in major banks' housing books remain below 50%," Mirenzi adds.

Here’s more from Moody’s Investors Service:

"Nonetheless, there is the risk that, over the course of this outlook, net credit costs could rise moderately from their current low levels, as the current period of transition for Australia's economy, away from resources sector investment-led growth, may create some pockets of weakness," says Mirenzi.

The report further notes that the banks' capitalisation levels are likely to improve further as banks ready themselves for additional Basel III capital requirements that will be implemented in 2016.

The banks already have high levels of regulatory capital, which underpin their strong performance in Moody's stress tests.

And while the banks have increased their payments of dividends, they have done so on the back of strong profits and slow growth in risk-weighted assets (RWA).

In this context, Moody's expects the banks to readily revert to a strategy of capital preservation, if needed.

Moody's stable credit outlook for the banking sector is also underpinned by the significant improvements the banks have made in their funding and liquidity profiles.

While the larger banks are unlikely to be able to further reduce their reliance on wholesale funding, the need to meet the Basel III liquidity coverage ratio (LCR) requirement -- which will be implemented in January 2015, with no phased introduction -- will continue to drive them to improve the funding stability.

Moody's further notes that there are also signs that the low credit-growth environment is raising competition in lending, but the impact on profit is somewhat offset by lower wholesale funding costs and a consequent easing of competition in deposit gathering.

Moody's stable outlook for the banking system is consistent with the stable outlooks for the banks' size-weighted, average standalone bank financial strength of B- (which equates to a baseline credit assessment of a1) and long-term issuer ratings of Aa2. The outlook also echoes

Moody's stable outlook on the Aaa-rated Australian sovereign.

Moody's rates 13 of Australia's 23 domestic banks, and three of the seven foreign bank subsidiaries operating in the country.

At end-June 2014, the 16 rated banks accounted for 94% of total banking system loans.