Moody’s Investor Services has downgraded lenders’ mortgage insurance (LMI) provider Genworth Australia from A3 to Baa1 bringing the firm’s insurance financial strength rating (IFSR) from upper-medium grade to medium-grade.
The downgrade reflects a rising level of tail risks within the Australian housing market as well as a decreasing demand for LMI products, Moody’s analysts said. These factors overshadowed more positive developments such as the de-risking of the Genworth portfolio and stable regulatory capital.
Reduced LMI demand
Macro-prudential measures implemented by the Australian Prudential Regulation Authority
(APRA) have led to lower volumes of high loan-to-value ratio (LVR) loans.
“This development has in turn led to a sharp fall in gross written premiums for Australian LMI providers, with Genworth Australia reporting a 25% fall in gross written premium for FY2016 and a 20% decline for FY2015,” analysts wrote.
This has also increased pressure on the average premium which Genworth can charge clients with levels dropping from 1.82% in 1H 2014 to 1.65% in 1H 2017.
A number of other factors have also led to a lower demand for LMI products in the Australian market:
- Under the Advanced Basel approach, banks do not derive any regulatory capital benefits from using LMI
- Foreign LMI providers have entered the local market, some replacing Genworth within the banks
- RMBS are now more likely to be originated where ratings of senior tranches are not dependent on LMI
“While, in Moody's opinion, declining origination volumes do not pose an immediate concern for Genworth Australia's credit profile, they may over time elevate the risks of a loss of the company's pricing power, putting downward pressure on its profitability and market position,” analysts wrote.
Increasing tail risks
Rising house prices and an increased level of household debt indicate an increasing level of systemic risk in the market. Analysts predict that an increase on household stress could impact consumer confidence and consumption which will have a ripple effect on the economy.
“Consequently, Moody's believes that Genworth Australia is exposed to the risk of a sharper-than-anticipated downturn in the housing market and an increase in its loss ratio.”
Moody’s analysts conceded that the shift to lower LVR originations have meant a reduced level of risk for Genworth’s portfolio. This change in composition has led to a reduction in regulatory capital needs, they said.
“This has allowed Genworth Australia to pay out dividends in excess of current year earnings, while maintaining a healthy regulatory capital level that, at 1.48 times the Prescribed Capital Amount (PCA) at 31 December 2016, was above the company's target 1.32-1.44x PCA range.”
A stable outlook
The combination of these factors has led to a stable rating outlook by Moody’s, which predicts the insurer will be able to maintain financial metrics that fall within the Baa1 rating.
While a ratings upgrade is not likely in the medium-term due to continuing housing sector risks and lower LMI demand, analysts said that a further downgrade was possible if credit conditions deteriorate further.
“In particular, factors that increase the risk of a sharp correction in the housing market, such as material further increases in private sector credit-to-GDP and/or household debt-to-income ratio, would be credit-negative.”
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