QBE frets about viability of LMI product

As Genworth Financial (Genworth) prepares to sell part of its Australian lenders mortgage insurance (LMI) business through an initial public offering (IPO), its sole domestic competitor is worried about the product’s future.

Earlier this week the US insurance giant filed plans with the US Securities and Exchange Commission to sell up to 40 per cent of its Australian business, Genworth Mortgage Insurance Australia (Genworth Australia), one of only two providers of LMI in the Australian market. It has insured over $600 billion of residential mortgages since 1965.

According to the filing, Genworth Australia is expected to make an underlying net profit after tax of $231 million in the financial year that ends 31 December 2014 (FY14), up 4.6 per cent from FY13, and underlying return on equity of 10.2 per cent, down slightly from 10.4 per cent.

Its largest lender customer accounted for around a third of new insurance written in FY13 and 43 per cent of gross written premium. It estimated it had 45 per cent share of the market in FY13 but that its share of the high loan-to-valuation ratio (LVR) market will modestly decline this year.

Changed capital treatment

The partial IPO, slated for completion by the end of June, was originally planned for the June quarter of 2012 but has been pushed back several times for various reasons including uncertainty over the capital treatment that the Australian Prudential Regulation Authority (APRA) will give banks for mortgage insurance.

In Australia it‘s industry practice for lenders to require borrowers to have LMI if they can’t put down a deposit of 20 per cent of the valuation.

Prior to 2008, under Basel I, banks using LMI could apply a 50 per cent risk weighting, rather than 100 per cent, to standard loans with an LVR greater than 80 per cent and to non-standard loans such as low-doc mortgages with LVR higher than 60 per cent. This halved the banks’ capital requirement and reinforced their practice to insure high LVR loans.

However, “there is currently little capital incentive for the home lending market to use LMI because of the increasing dominance of internal ratings based (IRB) lenders,” QBE said in its submission to the financial inquiry.  The four big banks and Macquarie are on the IRB or advanced approach and account for over 80 per cent of the market.

While Basel guides for a minimum 10 per cent loss given default (LGD) on residential mortgages, APRA requires IRB lenders to maintain a LGD floor of 20 per cent, regardless of whether there is LMI “giving no recognition for the use of LMI by lenders and effectively negating any capital benefits for LMI," said QBE.

Banks may have to hold more capital

“In the absence of such regulatory or structural incentives, QBE is concerned about the ongoing viability of LMI as a product. Market forces may drive LMI as a product out of the market. This is the case in New Zealand where LMI is no longer available.”

QBE’s argument doesn’t hold with Martin North, founder of Digital Finance Analytics, who doesn’t believe the five lenders currently on the IRB approach should get further capital relief for using LMI. “That would be double-counting. Advanced Basel covers it off.”

QBE further argued that the demise of LMI would reduce the amount of capital in the system, something APRA doesn’t want, suggesting “any withdrawal of LMI would necessitate a change in regulations to compel mortgage lenders to carry the additional capital currently held by LMI providers.”

It noted that some lenders, including Commonwealth Bank of Australia and ING, have adopted the New Zealand practice of charging a low deposit fee in lieu of LMI.

QBE sees a strong risk lenders will under-price the low equity fee whereas LMI providers are separately capitalised to carry the mortgage risk and must make an adequate return on that capital. As such, they’re better placed to price for risk.

Banking, Insurance,
Genworth Financial, mortgage, insurance, US Securities and Exchange Commission, LMI, APRA, Basel, QBE, Digital Finance Analytics
Marion Williams, mwilliams@financialpublications.com.au
Article Posted:
April 10, 2014

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