Westpac takes a global punt on LMI

From Banking Day

A vibrant flow of premium income over high risk home loans is being farmed out by Westpac to the international reinsurance market.

Westpac has kicked Genworth, and maybe also QBE, off its reinsurance panel with others moving to fill the void.

Banking analysts and CLSA said Westpac would “effect a capital arbitrage with a Bermudan reinsurer whereby they can extract more (profit) commission for ceding the business than they could by keeping it in Australia.”

In a briefing note, analysts at UBS wrote: “We understand QBE LMI received similar notification.”

Genworth will also lose insurance business placed directly by Westpac, all of it relating to loans with LVRs of worse than 90 per cent. Loans in the less risky 80 to 90 per cent LVR range will continue to be supported by Westpac’s own insurance arm.

Well, there’s the answer to yesterday’s question of what comes next for LMI. Are there any systemic issues here?

A larger and more liquid international LMI market for Australian banks seems prima facie a very good idea. After all, the local monolines are appallingly under-capitalised and will be the first domino to fall when the housing bubble pops, depending upon how conservative are its re-insurance strategies.

Westpac may, in fact, be insuring itself against such an outcome and the Australian tax-payer ought to sigh with relief. Further, in going direct to the re-insurers, WBC can pocket some of the margin formerly taken by the LMIs.

But if we game this out, there is also a potential downside. When the bubble bursts, my working assumption is that the local LMIs will require swift nationalisation. The analogy is the AIG bailout in the US during the GFC, which provided much of the underpinning insurance for toxic RMBS. Had it not been quickly nationalised post-Lehman the entire banking system would have collapsed as everyone’s premiums instantly evaporated. Instead the US tax-payer paid out premiums no questions asked in what was effectively a backdoor bailout for Wall St.

In Australia the LMI sector would assume a similar pivotal role in a nasty housing crash and would be swamped by both claims and legal action that it would quite possibly be unable to process in meaningful time. They could try to raise capital but that avenue would close pretty quickly too. Thus, nationalisation seems rather a fait accompli.

If so, in the coming crisis, WBC may enjoy a smoother payout schedule for its LMI premiums than other banks in the early days of the crisis, but it has just cut itself off from a life support system that the other banks may well enjoy when the rubber really hits the road. Nationalised LMIs won’t be charging market rates for new premiums during and after the crisis but distant LMI re-insurers most certainly will!

Westpac should be praised for severing at least one of multitude of umbilical cords tying Megabank to the Australian tax-payer.


David Llewellyn-Smith

David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal.

He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.

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