Following its RMBS re-risking this morning, Moody’s has also expanded its downgrade review of the LMI sector from QBE and Genworth to Westpac:
Sydney, May 31, 2012 — Moody’s Investors Service has announced a review of the Australian lenders’ mortgage insurance (LMI) sector.
Accordingly, Moody’s has placed on review for possible downgrade the insurance financial strength ratings (IFSR) of QBE Lenders’ Mortgage Insurance Limited (QMI, IFSR Aa3) and Westpac Lenders Mortgage Insurance Limited (‘WLMI’, IFSR Aa3). It has also extended its review for possible downgrade of the IFSRs of Genworth Financial Mortgage Insurance Pty Limited (Genworth Australia, IFSR A1) and Genworth Financial Mortgage Indemnity Limited (Genworth Indemnity, IFSR A2), announced on April 20, 2012.
Moody’s had previously on December 20, 2011, changed to negative from stable the ratings outlook for rated Australian mortgage insurance companies.
“The rating review reflects Moody’s continued concerns regarding Australian mortgage insurers’ exposure to tail-end outcomes in the Australian housing market”, says Ilya Serov, Moody’s Senior Credit Officer and lead analyst for the Australian LMI sector. “Although we expect the Australian housing market to remain relatively stable, our latest modeling indicates that potential losses in the case of an unexpectedly severe downturn would challenge these companies’ capital levels. Mortgage insurers are exposed to higher loan-to-value mortgages and would bear the heaviest losses in such a scenario”, he adds.
The review follows the release of Moody’s updated residential mortgage loss model. The revised model incorporates increased default probability and house price stress rate assumptions. Moody’s expects the updated mortgage loss assumptions to result in materially lower capital cushions for LMIs in stressed scenarios than those incorporated into existing ratings. The updated methodology is further described in a report titled “Moody’s Approach to Rating Australian RMBS”, published today.
“Our review will primarily focus on the sufficiency of the LMIs’ capital levels in the event of an extended downturn in the Australian housing market. Australian mortgage insurers are some of the highest rated financial institutions in the Moody’s rating universe. Our latest modeling suggests that their stand-alone credit profiles would now be more appropriately positioned in, or close to, the low single A range”, says Serov. However, Moody’s notes that the LMIs’ final assigned credit ratings are likely to continue to factor in the potential for parental support.
At the same time, Moody’s does not expect the review of the mortgage insurance sector to broadly affect its ratings of Australian banks and building societies. The mortgage loan books of Australian banks have low average loan-to-value ratios and a small percentage of riskier, non-standard loan products (such as low documentation loans). The modeling does however highlight the potential for elevated losses in some regions, which will inform ratings assigned to local financial institutions, depending on their individual mortgage portfolio composition. Moody’s also continues to monitor the extent to which the developments in the housing sector affect domestic and offshore investor confidence, and, consequently, the banks’ ability to access wholesale funding markets.
Rating Review Rationale
Moody’s central scenario for the Australian economy and housing markets continues to assume relative stability. Moody’s base forecast is for 2.5-3.5% GDP growth in 2012 and stable labor market conditions in the 4.5-5.5% unemployment range.
However, in Moody’s view, structural vulnerabilities inherent to the Australian housing market heighten the possibility of an adverse shock to asset quality in the event of an unexpected, sharp economic downturn. Moody’s updated residential mortgage loss model assesses the specific structural characteristics of the Australian housing market, its historical default and mortgage insurance claim frequency data, and benchmarks them against other economies that have encountered stress in the current crisis.
Specifically, Moody’s notes the following:
– Structurally elevated house prices and household debt levels. Despite the gradual correction over the past 18 months (with house prices declining approximately 6% off peak values on average), both price and debt levels remain at historically high levels. The resilience of household balance sheets and, consequently, mortgage insurers’ portfolios to a serious economic downturn has not been tested at these levels of house prices and indebtedness.
– Adverse effects arising from structural shifts in the Australian economy with the positive impact of the ongoing commodities boom tempered by fiscal constraint on behalf of both the private and public sectors, weakness in the housing market, and the negative effects of the strong Australian dollar. As a result, notwithstanding the stable headline economic data, certain industries and regions, most notably retail, tourism, and construction, are displaying material signs of weakness.
– Material variation across regional housing markets. Although, in overall terms, the decline in house prices and increase in mortgage
delinquencies have been muted, in some areas property price declines are double-digit (up to 20% is some regional areas). Similarly, mortgage delinquencies are particularly elevated in Queensland. Moody’s believes this divergence in performance to be predicated upon (a) exposure to the weaker non-mining economy in certain regions; as well as (b) the substantially different fundamentals evident in each local housing market. These factors expose Australian LMIs to the idiosyncratic risk of sharp, localized downturns.– Deteriorating operating environment during Q4 2011 and Q1 2012. During this period, house prices continued to decline and residential construction activity decelerated. Reflecting the deteriorating operating conditions, in April 2012, one of the rated mortgage insurers, Genworth Australia, announced a Q1 2012 operating loss, primarily as a result of elevated mortgage insurance claims incidence and severity in coastal Queensland.
Moody’s notes that while risk scenarios involving a sharp correction in the housing market are unlikely to eventuate, they are plainly identifiable and would present a considerable challenge to the Australian mortgage insurance sector, should they occur.
Although the LMI sector is capitalized at a level above regulatory requirements, Moody’s expects its revised mortgage loss assumptions to challenge LMIs’ capital cushions in stressed scenarios. Specifically, at the conclusion of the review, Moody’s anticipates that average standalone credit assessments (that is, the assessment of an entity’s creditworthiness, excluding considerations of parental support) for the affected companies will be in, or close to, the low single-A range.
Other Factors Considered In Review
Moody’s will evaluate the degree of integration the Australian LMI companies have with their corporate parents (Genworth Financial Inc. (senior unsecured rating Baa3 negative) in the case of Genworth Australia, QBE Insurance Group Limited (senior unsecured rating A3 negative) in the case of QMI, and Westpac Banking Corporation (‘Westpac’, Aa2 stable; B-/a1) in the case of WLMI), and the extent to which they may receive parental support, if needed.
The rating review will also focus on the risk management and loss mitigation practices of Australian LMIs, particularly at times of stress. Moody’s will also assess the quality of the LMIs’ re-insurance arrangements, taking note of any correlation within the LMI sector or between the re-insurance counterparties.
