Who’s the new loon gobbling up Aussie mortgage risk?

Via Banking Day:

Arch Capital Group is the rising titan of the Australian capital market, and jostling for claims as risk decision-maker-in-chief in a hyperventilating mortgage market.

Westpac and Macquarie Bank are the two banks offloading loss risks on home loans to Arch. The latter is a new user, while Westpac pioneered the industry embrace of Arch more than a year earlier.

National Australia Bank may well be looking at Arch as a replacement provider. The bank affirmed on Friday it had issued an RFP as it scouts the merit of a reinsurer panel to supply mortgage insurance, replacing the incumbent Genworth. The move is more or less a copy of Westpac’s and Macquarie’s initiatives and invites smaller banks to assess options.

But the NAB relationship may be one Genworth stands a chance of saving, as Arch could be distracted from making an optimum pitch on NAB’s RFP.

The company’s capability is now being tested serving the new business flow from Macquarie Bank, and there are suggestions it’s putting a priority on driving productivity and profits from its present contracts.

Using each of its two customers’ shares of the underlying mortgage market as a guide, Arch has waltzed to the vicinity of 25 per cent market share of LMI in Australia in short order, disrupting a provider set previously confined to only two names: Genworth and QBE LMI. MGIC Radian, a no-hope LMI challenger backed during the 2000s by two US insurance names with experience in the sector, pulled stumps and diverted to run-off mode years ago. That outfit attracted an inconsequential level of business, in contrast to the showy ease of the entry of Arch.

Arch’s Australian entry has also elbowed out established reinsurance names that responded to Macquarie’s request for an alternative to Genworth.

Greg Ward, Macquarie Bank’s head of banking and financial services, on Friday said the bank was moving its business to a “panel of offshore reinsurers” and demurred when Banking Day put it to him that Arch was the principle – and maybe only – insurer involved in any “panel”. As with Westpac, Macquarie will hold a co-insurance stake in the pool of protected mortgages.

A US funded and managed insurance entity, Arch brings US$5.6 billion in capital (at the group level) and a youthful 22 year history to underpinning the niche that is lenders’ mortgage insurance. LMI is the loss backstop relied on by banks and non-banks to contain losses on their mortgage portfolios, a segment with a long history of low losses on average, yet dotted by episodes of stress and underwriting losses for the insurer.

Arch is in the course of finalising registration in Australia as an insurer – a process going slower than it hoped, while APRA prolongs its assessment.

Arch’s reporting on its experience of underwriting Westpac’s loans is rolled up with the rest of the group’s mortgage segment, centred on the US market. Its Australian excursion will be one of many drivers behind the trebling in gross premiums (to US$348 million) written for Arch over the March 2017 quarter, compared with the same period in 2016. Its loss ratio of 11.9 per cent is 210 basis points better than a year earlier.

Arch’s global chair and CEO is Constantine Iordanou, an aerospace engineer turned insurance prodigy. Dominic Brannigan is country manager, hired from Lloyd’s agency DUAL Australia.

Westpac moved its LMI needs over to Arch more than a year ago, making use of the insurer’s reinsurance arm, headquartered in Bermuda. That allocated Arch the best part of a one quarter slice of the LMI pie, ripped from the ledgers of the long time second string supplier in this sector, QBE LMI.

My understanding of what’s happening here is that banks are effectively cutting out the middle man in the Aussie LMIs and going direct to the re-insurers that LMI’s used to offset risk to. Arch is a re-insurer. It’s cheaper thanks to LMI margins being cut out (which were fattened by monopoly rents).

Whether you think this is a good idea depends upon how stable Arch is. Given it’s $9bn in capital is rehypothecated across all sorts of assets, I am not reassured. Does it re-insurer its re-insurance?

There is one other question to ask. Although Arch may be able to absorb big Australian bank claims when they arrive en masse at some point in the future, there is clearly a risk that it will not be able to do so. While the LMIs were in place, the Aussie banks essentially had the comfort of knowing that the LMI sector would be bailed out via nationalisation in any major shock (GMA was, after all, a former government corporation). Can the same be said for some distant Bermudan re-insurer?

Interested in reader comments here.

Houses and Holes
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  1. Hmmm… this somehow kinda smells like pre-2008 shenanigans to me… repackage stuff, chop-mix-and-sell… make it someone else’s problem! And then when it all goes tits up – can’t find who owns your mortgage, can’t find the land title… it’s all good!

      • Yes – you would think so … but hey, you’re not the one selling them left right and centre…

      • How so?? Whether a State’s land titles office is public or privately owned, the service provided is that they register any interests (e.g. mortgages) in a property. I honestly do not see where you are going with this.

    • Would need more investigation about whats going on here but I do hope its not a Lehman – Hudson type arrangement

      • Well, that’s all we’ve got left: “hope”. And even that’s wearing pretty thin…

  2. scottb1978MEMBER

    If it is nationalised does it matter that the debt is local or foreign, either way the tax payer foots the bill.

  3. BrentonMEMBER

    The force behind them seems to be Paul Singer. They appear to have had first hand experience with the GFC; via Merrill Lynch and Warburg Pincus. Sharks smelling blood in the water, looking to feast on government bailouts?

    • Decent call. And Singer is a smart cookie. The precedent appears to have been set in 2008/2009. Always worth backing a venture that has implicit government support: too big/important to fail. However, is Arch TBTF? AIG, for sure.

      Speaking of which,

  4. The nationalisation assumptions are incorrect. ADIs are guaranteed up to a maximum of $20B per institution which means the big four are not fully-guaranteed.

    When SHTF and deposit-holders read the fineprint then expect to see another bank run to smaller institutions.

    • Why do you think smaller institutions aren’t going to be just as hosed?

      Not being a smarty-pants, genuinely curious.

      • Most smaller institutions have less than $20b in deposits and are therefore fully guaranteed. The institution itself might get hosed but deposit-holders will get their money back.

        Now consider that the big four each have $200b-$400b in deposits. Govt has no obligation to pay anymore than $20B in ADI guarantees.

    • BrentonMEMBER

      Those caps will mean next to nothing during a full blown collapse. I fully expect them to be overridden by ’emergency’ measures rushed through parliament. The banks, and their insurers, would know this, especially the insurer in this case, as they have had experience with this kind of panicked scenario during the US GFC.

      • Not that simple anymore. If you are old enough to remember last recession you will know Australia has doubled-down on industries that will get slaughtered during a recession.

        Tax revenues will collapse and welfare commitments will skyrocket. There will be another bank run led by foreign deposit-holders.

      • When you read that ADI guarantee fine print, the Government can pay any ADI more then the 20 billion by voting on it.

        So its a limit, but movable.
        And by the looks there will be a fair bit of moving 🙂

      • BrentonMEMBER

        @Freddy, that will not stop them. The ONLY nation in recent memory to handle their banking crisis by allowing their banks to fail, and subsequently nationalizing them, is Iceland. Australia will be no different to any other nation, from the US to the Euro countries.

        Here is how it will play out:

        – Housing market explodes/bank collapses
        – Amongst mass panic, government/media make a big push for bailing out banks: “Too big to fail”
        – Banks are bailed out
        – Sovereign debt instantaneously becomes huge, simultaneous to a collapse in government revenue
        – Austerity/tightening the belt becomes the new norm, as the 1% walk away richer and more powerful than they’ve ever been

      • BrentonMEMBER

        Interesting PA, that’s a nice little backdoor! Though, I doubt that they will need it anyway.

    • Ronin8317MEMBER

      That 20 billion dollars is effectively ‘infinity and beyond’. The Australian government will not let the Big 4 go down.

      • Do you think they would let Bendigo or SunCorp or Bank of Queensland go under too? There was a political massacre in the wake of the Pyramid disaster in Victoria; I can bet that every politician who was old enough will remember how bad it was.

    • MB readerMEMBER

      Freddy, Is there a source for your statement that there is a $20B cap?

  5. *Does it re-insurer its re-insurance?*

    Presumably this is what APRA is looking at in deciding whether to give it a licence.

  6. Gra ManMEMBER

    Arch’s exposure is still very small relatively. Best to wait and see how things develop. However, if our market collapses we’ll need all the risk capital we can get from anywhere

  7. Your insurance is only as good as your counter-party. $9bn at group level translates into how much support at operating level? Singer’s a very smart guy …

    Reminds me of my days in IB. It’s early 2008: the Head of Capital Markets calls the whole credit trading team into a meeting and says his sources tell him that Goldman has been buying credit protection in large size from somewhere. The boss is desperate to find out who this source of credit protection is as our books are heavily exposed — particularly RMBS. He’s assumed it’s a mainstream buy-side shop. We spend the whole week combing the street for the seller of protection (insurance) but nada. Not a dicky bird.

    Lehman eventually blows up and the dominoes start to fall, which exposes the mystery Goldman counter-party: AIG Financial Products in London. But AIG is on the ropes so Goldman’s insurance on tens of billions of credit risk is in jeopardy. Luckily the Squid has ex-CEO Hank Paulson at the helm at the U.S. Treasury and a bailout for Goldie’s insurer is a formality …

  8. sydboy007MEMBER

    if this means it’s easier to let investors lose some money i’m all for it.

  9. None of this matters
    The force of default and price collapse could only be saved by the IMF
    IMF aren’t going to put $1tn in a country with 24 million people