Moody’s warned yesterday (Wednesday) of an elevated risk of an eventual fall in house prices in Norway after a protracted boom, adding that the transfer of low risk loans to covered bond issuing vehicles increases risks for unsecured creditors.

House prices rose 7.1% in 2011 and 7.4% in the first half of 2012, according to Moody’s, which said that Norwegian banks’ household mortgage portfolios are sensitive to a potential deterioration in the housing market.

“In the rating agency’s view, market fundamentals – such as an increase in households’ disposable income and the number of households, or lack of growth in housing stocks – do not fully explain the sharp rise in housing prices since 1995,” it said.

Moody’s said that high levels of household indebtedness also threaten banks’ asset quality.

“An average Norwegian household’s debt burden equalled almost two times its disposable annual income at year-end 2011 (according to Norway’s central bank),” it said. “This high debt level compared with European peers partly reflects the high level of home ownership in Norway (around 85% of households) and tax incentives (mortgage-related interest expenses are fully deductible).”

Moody’s also noted that, following strong growth in covered bond funding, banks are increasingly transferring low risk mortgages as collateral to covered bond issuing vehicles.

“These low risk loans are no longer available as collateral for unsecured creditors, and banks are increasingly left with higher-risk mortgage loans that are not eligible as covered bond collateral,” it said. “This trend elevates the risk of loan losses for banks and their unsecured creditors in the event of a housing correction.”

However, the rating agency cited several mitigating factors: low and stable unemployment levels; a generous social security system supported by the strong fiscal position in Norway; substantial household wealth; the current low interest-rate environment; and low – albeit increasing – levels of property construction.

“In Moody’s view,” it said, “these mitigating factors reduce the likelihood of a sudden drop in housing prices and limit the fallout of this scenario for banks, but they do not completely offset the aforementioned risks.”