‘Latent risks’ in housing market trigger Genworth downgrade

Moody’s Investors Service has announced a shift in the insurance financial strength rating at Genworth from A3 to Baa1 with a stable outlook. The agency said that it believes Genworth is at risk of a “sharper-than-anticipated downturn in the housing market and an increase in its loss ratio”.

More broadly, the downgrade is the result of Moody’s view that “risks in the Australian housing market have risen, heightening the financial sector’s sensitivity to adverse shocks”.

Moody’s said that the downgrade reflects both the “high and rising level of tail risks” in the housing market and the reduced demand for lenders’ mortgage insurance (LMI) offerings in the Australian market.

“In Moody's view, these factors outweigh positive developments at Genworth, which include a de-risking of its portfolio and stable regulatory capital," the agency said.

“Latent risks in the housing market have been rising in recent years, because significant house price appreciation in the core housing markets of Sydney and Melbourne has led to very high and rising household indebtedness.”

Moody’s also expressed concern over “an elevated proportion” of lenders that were lending to housing investors or on interest-only terms.

“While mortgage affordability for most borrowers remains good at the current low interest rates, a reduction in the savings rate and the rise in household leverage are indicators of rising systemic risks and an increased vulnerability to economic or financial shocks,” Moody’s explained.

The macro-prudential measures introduced by the Australian Prudential Regulation Authority (APRA) in 2015 are also considered a contributing factor.

The measures, designed to settle a surging housing sector, directed lenders to restrain growth in higher risk segments of their lending portfolios, such as loans with high loan-to-value ratios (LVR).

A byproduct of this, Moody’s said, was a decline in the number of higher LVR loans, which are the most likely to be insured.

“This development has in turn led to a sharp fall in gross written premiums for Australian LMI providers, with Genworth Australia reporting a 25 per cent fall in gross written premium for FY2016 and a 20 per cent decline for FY2015.

“The shift to lower LTV origination is also putting pressure on the average premium that Genworth Australia is able to charge its customer base: the average premium of Genworth Australia's flow business declined to 1.65 per cent as at 1H 2017 from 1.82 per cent in 1H 2014.”

Moody’s noted that it does not believe declining origination volumes “pose an immediate concern for Genworth Australia’s credit profile”. Nevertheless, they could over time “elevate the risks of the company’s pricing power” and place downward pressure on market position and profitability.

The other side of the shift to lower LVRs, Moody’s added, is that Genworth’s portfolio has a lower level of risk.

“The stable rating outlook reflects Moody's expectation that, despite elevated risks in the housing market and the potential for further erosion in Genworth Australia's customer base, the improvement in the credit quality of Genworth Australia's portfolio, and the support this provides to its regulatory capital adequacy, should allow the insurer to maintain financial metrics that are within the rating agency's expectations for a Baa1 rating.”

Moody’s does not consider an upward shift in Genworth’s rating to be likely in the medium term. However, a shift to a positive outlook could occur if household leverage stabilises along with nominal income and price metrics.

Conversely, ratings could shift lower if “credit conditions in Australia continue to deteriorate”. A deterioration could be constituted by a material further increase in private sector credit-to-GDP and/or the household debt-to-income ratios, Moody’s concluded.

[Related: Mortgage insurer's profits drop by 35% as delinquencies rise]