ONE of Australia’s premier fund managers has warned there is a real risk of a house price slump similar to that in the US and Ireland because banks aren’t properly accounting for household income risks.

Analysts at JCP Investment Partners, one of just three funds appointed to manage Future Fund cash, have warned that “as exuberance towards the Australian home grew to now irrational levels, the old credit rules of thumb appear to have been left by the wayside”.

The stark warning was backed up by ratings agency Standard & Poor’s which said economic imbalances in Australia had increased because of strong growth in private sector debt and residential property prices over the past four years, “notwithstanding some signs of moderation in growth in recent weeks”.

“Consequently, we believe financial institutions operating in Australia now face an increased risk of a sharp correction in property prices and, if that were to occur, a significant rise in credit losses,” the ratings agency said.

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JCP head of financial research Matthew Wilson and senior economist Craig Shepherd said in a client note that the old mortgage lending rule of thumb used to be to “lend no more than three times gross income unless it’s a doctor, then maybe stretch it to four times”.

But their research suggested banks were now lending at about six times income.

“The banks appear to have weakened underwriting standards to pursue the asset-backed, lend-sustaining, credit-fuelled house prices,” they said.

And it’s youngsters where most of the suffering could occur.

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Professional “young pretenders” with an average income of $110,000 and a mortgage outstanding of $810,000 are burdened with an “eye-watering” average loan-to-income ratio of 7.4 times.

“Interest-only could be Australia’s sub-prime,” they said, referring to the poor quality loans written in the US prior to 2007 that led to cascading defaults and the global financial crisis.

“Interest-only loans proliferate throughout the mortgage book, across cohorts and circumstances,” they said.

“Only one trend emerges; interest-only households tend to have lower incomes and higher amounts of credit outstanding and tend to use interest-only to borrow more.”

Bank defenders say borrower “buffers” where the house value is in excess of loans offset the risks, but JCP analysts maintain most of the buffers reside with the least risky borrowers.

“The long virtuous housing wealth cycle could easily transition to a vicious cycle,” they said.

“Smaller mortgages to deleveraging, flat-to-decreasing house prices and exuberant-to-melancholic animal spirits will likely expose much bad lending behaviour.”

However, S&P said despite increased downside risks, “in our base case we expect that recent and possible further actions by the Australian authorities should aid in an unwinding of the imbalances in an orderly fashion”.