Rating agency Moody's has issued a warning on the Australian housing market, saying mortgage default rates are likely to rise and that the run-up in house prices over the last decade is only partially explained by economic fundamentals.

Announcing a review of how it assesed Australian Residential Mortgage Backed Secutiries (RMBS), Moody's said elevated mortgage debt levels pointed to vulnerability in the Australian financial system.

Australia is New Zealand's biggest trading partner, and a contraction in the housing market there is likely to contribute to reduced demand for New Zealand exports. The big four Australian banks also own New Zealand's large banks, meaning financial implications for the Aussie parents could have flow-on effects to the New Zealand banking sector.

NZIER economist Shamubeel Eaqub said last month that he thought the biggest risk to New Zealand's economic recovery was a downturn in the Australian housing market, due to the strong growth correlation between the two economies.

The review would likely mean Aaa-rated tranches of Australian RMBS were likely to be only minimally affected due to the support they received from mortgage insurance and the significant build-up in credit enhancement because of seasoning, Moody's said in a media release. Moody's anticipated selective rating actions in respect of mezzanine, junior and less seasoned senior notes.

Vulnerabilities

Although the possibility of a severe crisis in the RMBS market remained low, Moody's said an investigation was warranted due to vulnerabilities in the housing market.

"Australia's economic growth is increasingly driven by favorable terms of trade. However, the commodities-led structural transformation that the economy will undergo over the next two decades implies winners and losers, with certain industries and geographical regions coming under significant pressure," Moody's senior credit officers Ilya Serov and Jennifer Wu said in a release.

"As a result, default and delinquency rates in the mortgage market are likely to be both variable and, in our view, on average higher over the coming decade than in the past," Serof and Wu said.

"The data with regard to the sustainability of Australian house prices are ambiguous, with the run-up in prices over the past decade -- in our view -- only partially explained by fundamentals. We consider the possibility of major regional house price drops to be a material risk for the Australian market," they said.

"Elevated mortgage debt levels point to vulnerability within the Australian financial system. The mortgage market's robustness to an economic shock has not been tested at current levels of indebtedness, with the recent experience of other countries positing some questions in this regard."