Moody’s downgrades LMIs

From Moody’s:

Sydney, February 04, 2013 — Moody’s Investors Service has today announced the conclusion of its review of the Australian lenders’ mortgage insurance (LMI) sector, and downgraded the ratings of three LMI companies.

The actions are:

– Genworth Financial Mortgage Insurance Pty Limited’s (Genworth Australia) insurance financial strength rating (IFSR) was downgraded to A3 from A1;

– Genworth Financial Mortgage Indemnity Limited’s (Genworth Indemnity) IFSR was downgraded to A3 from A2;

– QBE Lenders’ Mortgage Insurance Limited’s (QBE LMI) IFSR was downgraded to A2 from Aa3;

– Westpac Lenders Mortgage Insurance Limited’s (WLMI) IFSR was confirmed at Aa3.

Today’s rating actions conclude the reviews initiated on 20 April 2012 in respect of Genworth Australia and Genworth Indemnity, and on 31 May 2012
in respect of QBE LMI and WLMI.

The new ratings all carry a stable outlook.

RATINGS RATIONALE

The rating review focused on the sufficiency of the LMIs’ capital levels in the event of an unexpectedly severe downturn in the Australian housing
market (such as in the US in 2007-11), as well as fundamental characteristics of the companies’ financial profiles. Today’s rating actions follow the publication of Moody’s updated global methodology for rating mortgage insurers on 11 December 2012 and incorporate stress tests based on its Australian residential mortgage loss model.

The rating actions reflect Moody’s view that the LMIs’ standalone capital adequacy scores are appropriately placed in the low single-A range. They
also reflect Moody’s view that from a business model perspective, the positive attributes of Australian LMIs’ strong franchises are partly
offset by their increased dependence on key customers and high levels of geographical concentration (relative to global averages). In the case of WLMI and QBE LMI, the potential for parental support lifts their IFSRs above their standalone credit assessments.

The key factors underlying Moody’s assessment of the insurance financial strength ratings of Australian LMI companies are:

1. Stress tests of Australian LMIs indicate that their standalone capital cushions correspond to low single-A insurance financial strength ratings. Moody’s stress tests suggest that although the LMIs’ capital levels would be sufficient to meet losses arising from a cyclical recession, losses
arising out of an unexpectedly severe downturn (such as in the US in 2007-11) would be challenging. The stress tests are based on Moody’s modeling of the expected losses in the portfolios of the LMIs in accordance with its methodology for assessing residential mortgage pools, primarily for the purposes of rating residential mortgage-backed securities (RMBS). While risk scenarios involving a sharp correction in the housing market remain a low-probability outcome, they are plainly identifiable, and would present a considerable challenge to the Australian mortgage insurance sector, should they occur.

2. Moody’s incorporates varying degrees of ratings uplift for potential parent support for the four companies:

a. WLMI is the captive insurer of Westpac Banking Corporation (‘Westpac’, Aa2 stable, B-/a1 stable). It maintains high levels of operational, brand and financial integration with the wider Westpac group. In Moody’s view, regulatory and reputational considerations provide Westpac with material incentives to support WLMI in the event of the insurer’s financial distress. WLMI’s relatively small size provides Westpac with ready ability to support the insurer. Moody’s incorporates multi-notch uplift into the rating of WLMI.

b. In the case of QBE LMI, in addition to close operational linkages with its parent QBE Insurance Group Limited (‘QBE’, A3 senior unsecured rating, on review for possible downgrade), Moody’s notes QBE LMI’s reinsurance arrangements with QBE’s captive re-insurer, Equator Re. Moody’s also notes QBE LMI’s small size. The relatively high degree of parental support enjoyed by QBE LMI, translates into an A2 IFSR, compared with a standalone credit assessment of a3.

c. The A3 IFSRs of Genworth Australia and Genworth Indemnity correspond to Genworth Australia’s standalone credit assessment. Moody’s views the
potential for parental support from Genworth Financial Inc. (‘Genworth’, Baa3 senior unsecured rating, stable outlook) to provide only modest support for Genworth Australia’s rating, noting the holding company’s comparatively lower ratings. While Moody’s recognizes that Genworth Australia is a core component of the wider Genworth group and would in current operating conditions enjoy support from its parent, Moody’s also notes that the parent holding company retains an ability to reduce linkages to its subsidiaries at times of severe stress.

3. Genworth Australia and QBE LMI have strong market positions that have enabled them to secure and maintain significant volumes of business and key customers, including the major Australian banks. However, their strong market presence comes at a time of declining volumes, reflecting reduced levels of activity in the Australian housing sector, weaker residential mortgage-backed securities (RMBS) volumes and more selective origination practices by the LMIs themselves, as they have tightened underwriting guidelines. The declining volumes and exit of non-bank RMBS originators have given rise to higher concentrations within each insurer’s portfolio. Moody’s believes that these increasing concentration exposures are introducing potential volatility in revenues and claims, and represent a trend that is weakening the LMIs’ otherwise strong business profiles.

4. The A3 IFSR of Genworth Indemnity reflects its close integration with Genworth Australia. Genworth Indemnity has been in run off since 2003 and does not originate any new business.

The stable outlooks assigned to the ratings of Australian mortgage insurers reflect Moody’s benign expectations for the Australian economy and housing market. From a risk perspective, Moody’s assesses Australian housing-market conditions as finely balanced, but slowly improving. High levels of household debt and housing prices are counterbalanced by strong mortgage underwriting standards and a supportive economic environment.

Moody’s believes that the continuing period of de-leveraging, together with controlled house price movements since the global financial crisis, are gradually decreasing the likelihood of a sharp, US-style correction in Australia. In addition, Moody’s expects that, over time, Australian LMI portfolios will improve as riskier, 2006-08 pre-crisis mortgage vintages repay, and are replaced with post-crisis originations, which include a markedly lower proportion of low documentation loans. Moody’s assessment of Australian housing-market conditions and the likely dynamics of mortgage insurer portfolios are built into the new ratings and stable outlooks of the mortgage insurers.

Moody’s is currently assessing the impact of the above rating actions on Australian RMBS transactions that benefit from LMI policies. Selected senior and mezzanine tranches are currently on review for possible downgrade. Those tranches whose subordination levels are not commensurate with their current ratings after incorporating the benefit of LMI may see downgrades of up to three notches. In most cases, junior tranches which rely wholly on LMI and lack structural protection to mitigate the risk of losses not covered by LMI are likely to see rating downgrades to the non-investment-grade range.

Moody’s does not expect the latest rating actions on the mortgage insurers to affect its ratings of Australian banks and building societies. The mortgage loan books of the 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, indicate the potential for elevated losses in some regions, which will continue to 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 Drivers — Genworth Australia and Genworth Indemnity

The rating agency said a material improvement in Genworth Australia’s portfolio composition, such that its capital adequacy score improves in the rating agency’s stress tests, could result in an upgrade to its ratings.

Conversely, a change in the current stable environment in the Australian housing market resulting in a sharper-than-expected correction could place downward pressure on the company’s ratings.

Genworth Indemnity’s IFSR is likely to continue being linked to that of Genworth Australia. Although its capitalization levels materially exceed regulatory minimums, its operational reliance on Genworth Australia may constrain the degree of divergence in its rating from that of Genworth Australia.

Rating Drivers — QBE LMI

The rating agency said a material improvement in QBE LMI’s portfolio composition, such that its capital adequacy score improves in the rating agency’s stress tests, could result in an upgrade to its ratings.

Conversely, the following could place downward pressure on the company’s ratings: 1) a change in the current stable environment in the Australian housing market, resulting in a sharper-than-expected correction; 2) a multi-notch downgrade of the parent; 3) a reduction in QBE LMI’s linkages with its parent, indicative of decreased parental support.

Rating Drivers — WLMI

The rating agency said that WLMI’s rating is unlikely to rise, given its portfolio concentration and relatively small size.

Conversely, the following could place downward pressure on the company’s ratings: 1) a change in the current stable environment in the Australian
housing market, resulting in a sharper-than-expected correction; 2) a downgrade of its parent; 3) a reduction in its linkages with its parent, indicative of decreased parental support.

David Llewellyn-Smith

Comments

  1. As i have said previously, the LMI’s are triple distilled risk: their portfolios contain only the highly geared exposed to the Australian property market at a time of extreme prices. They are much more exposed that the Aussie banks, whose books contain many well-aged mortgages. Moody’s forecast a slow deflate – a courageous call. Let us watch events unfold.

    Don’t Buy Now!

    • Banksia and 3rd tier lenders going under are the canaries at the deep end of the mine, the poison is yet to reach the banks canaries further up in the mine.

  2. “The stable outlooks assigned to the ratings of Australian mortgage insurers reflect Moody’s benign expectations for the Australian economy and housing market.”

    Archie – what does this say about your double digit growth expectation?

  3. Has anyone actively shorted these or bought puts? I can’t really find a way to short Aussie housing (or Canadian for that matter).

  4. The ratings agencies themselves have been so severly downgraded by the market, that the market no longer reads their ratings.

  5. And if the LMI’s suffer big losses of capital they lose their attractiveness as insurers to the big banks so need additional capital otherwise their major beneficiaries, the banks, won’t accept their policies so they can’t write new business.

    Mortgage insurers often need additional capital at the worst of possible times.