• We forecast that the increase in economic risks facing Australian banks due to the COVID-19 outbreak and containment measures should be substantial but temporary.
• We now view the economic risk trend as negative, reflecting a one-in-three possibility that the economic impact for the banking sector could be significantly more severe or prolonged than our base case.
• Should we assess our economic risk score for the Australian banking industry as having worsened, we expect our issuer credit ratings on nearly all Australian banks to remain unchanged.
• We now forecast credit losses to rise to about six times those in 2019. We also expect house prices to fall by about 10% before resuming modest growth around the middle of calendar 2021. Nevertheless, we assess that the major Australian banks should be able to absorb our forecast rise in credit losses within their earnings despite lower interest and fee income.

MELBOURNE (S&P Global Ratings) April 29, 2020--S&P Global Ratings today said that the economic risk trend for banks operating in Australia has turned negative, reflecting a one-in-three possibility that the economic downturn due to the COVID-19 outbreak and containment measures could be significantly more severe or prolonged than our base case. In such a scenario, we expect to assess our economic risk score within our Banking Industry Country Risk Assessment (BICRA) for Australia to have worsened by one category (see table below).

Nevertheless, we expect that our issuer credit ratings (ICRs) on nearly all Australian banks--including the four major banks--will likely remain unchanged in the event we revise our economic risk score. Increased uplift above the stand-alone credit profiles (SACPs) of the four major Australian banks due to likely government support should offset the impact of a one-notch weaker SACP on our ICRs on these banks, should this eventuate.

A contracting economy, rising unemployment, and weak consumer and business sentiment will impact the asset quality of banks in Australia, in our view. However, we consider that the substantial fiscal and policy support from the Australian authorities and a strong economic rebound during fiscal 2021 (year ending June 2021) should help to limit the rise in credit losses. In line with our broader economic forecast, we expect that the economic risks for Australian banks would revert broadly to pre COVID-19 outbreak levels by fiscal 2022 following the peak of the economic downturn.

Credit Losses To Rise To About Six Times Those In 2019

In our base case, we now forecast that the Australian banks' credit losses in the year to June 30, 2021, will rise to about 85 basis point of gross loans and advances (totaling about A$29 billion for the entire Australian banking system), nearly six times from their historic low in fiscal 2019. We believe that the full extent of losses will take some time to materialize. We expect that a number of businesses and households are likely to struggle to meet their financial obligations once the restrictions to contain the coronavirus outbreak are lifted, when the moratorium on debt servicing ends, and the government reduces fiscal support.

We forecast that credit losses will ease to about 0.5% of gross loans and advances in fiscal 2022--broadly in line with our expected long-term average for the Australian banks--on the back of improving economic growth and falling unemployment. Nevertheless, we consider that there remain significant risks on the downside. The credit losses could rise well above our base case if the economic downturn becomes significantly more prolonged or severe than our current forecasts.

House Prices To Fall By About 10%

We now expect house prices to fall by about 10% before resuming modest growth around the middle of calendar 2021. In the short term, restrictions on auctions and inspections are likely to curtail the volume of home sales. In addition, we expect that demand for housing will not be as buoyant as in the past several years as immigration will likely remain nonexistent for some time due to travel restrictions. At the same time, we expect the large fiscal stimulus from the government to reduce the severity in home price falls. Similarly, the six-month moratorium on home loan repayments should restrict distressed sales by homeowners.

We expect home prices to stabilize in line with our forecast rebound in economic activity and employment in calendar 2021. We also expect immigration driven population growth to resume during this time. Reduced construction of new homes in recent months is likely to persist in the next 12 months, which should amplify the persistent gap between demand and supply for housing--especially in Melbourne and Sydney, which attract most migrants. Finally, interest rates are likely to remain low, which should also support price growth when economic conditions improve.

Major Banks Well Placed To Absorb Increased Credit Losses Within Earnings

S&P Global Ratings' scenario and sensitivity analysis suggests that Australia's major banks retain sizeable headroom within their earnings to absorb our forecast increase in credit losses in conjunction with a large contraction in interest spreads and fee income (see "Australian Banks Resilient To COVID-19 Crisis," published on March 31, 2020). Furthermore, we expect that the major Australian banks would take actions to increase the absolute amount of capital they hold--by cutting dividend payments and issuing new capital--to maintain their regulatory capital ratios, which would be otherwise weakened due to credit transitions within the banks' internal ratings based capital models.

Economic Risk Trend For Australian Banking Sector Is Now Negative

In our view, the economic risk trend for banks operating in Australia has become negative. We consider that there is a one-in-three likelihood in the next two years that we assess the economic risk score as having worsened by one category within our BICRA for Australia. This could occur if we foresee the economic downturn--or its impact on the banking sector--becoming significantly more prolonged or severe than our current forecasts. For example, if we consider that the credit losses are likely to rise substantially above our current forecasts, or; if we see indications of structural weaknesses in the important factors driving the credit risks in the economy such as the financial strength of the corporate sector or underwriting standards followed by the banks.

Issuer Credit Ratings On Nearly All Australian Banks, Including Majors, Should Remain Unchanged

If we assess the economic risk score within our BICRA for Australia as having worsened, we would apply higher risk weights in our capital analysis to reflect the same, which would result in a weakening in our capital ratios for all banks in Australia. We estimate that in that scenario, the capital ratios of most rated banks will remain consistent with our current ICRs. At the same time, the SACP for one or more of the four major Australian banks may weaken in such a scenario. Nevertheless, increased uplift above their SACPs due to likely government support should offset the impact of a one-notch weaker SACP on our ICRs on the four major Australian banks.

Nevertheless, a lower SACP for a major Australian bank would result in lower ratings on its tier-1 and tier-2 regulatory capital instruments. We note that we improved our economic risk score within our BICRA for Australia in October 2019. That revision did not result in any change in our ICRs on any of the Australian banks or ratings on senior debt issued by them. We raised our ratings on the hybrid capital instruments issued by the major Australian banks at that time, however, reflecting a consequent improvement in their SACPs (see "Australian Major Bank Hybrid Issues Upgraded As Economic Risks Ease," published on Oct. 24, 2019). Therefore, we may reverse those rating actions, if we revised our economic risk score within our BICRA for Australia by one category.

We currently assess that the SACPs of up to four other Australian financial institutions may weaken in the above scenario but that we are likely to lower the ICRs on no more than two of them. We expect that likely group support, or capital injections, should offset the pressure on ratings for some of these financial institutions.

S&P Global Ratings acknowledges a high degree of uncertainty about the rate of spread and peak of the coronavirus outbreak. Some government authorities estimate the pandemic will peak about midyear, and we are using this assumption in assessing the economic and credit implications. We believe the measures adopted to contain COVID-19 have pushed the global economy into recession (see our macroeconomic and credit updates here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.

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• RBA's A$90 Billion Funding Salvo Softens COVID-19 Blow For Australian Banks, March 19, 2020