‘Regulatory risk’ bad news for LMI

In a trading update on Friday, Genworth advised that its second-largest customer has provided the company with 30 days’ written notice that they are terminating the exclusivity agreement for the provision of LMI with effect from 8 April 2017.

The customer is understood to be Macquarie Bank.

“The company remains in discussions with this customer about managing default risk in the context of other insurance alternatives,” Genworth said in a statement.

In a research note this week, Morningstar forecast Genworth's gross written premiums (GWP) to decline 12.5 per cent in fiscal 2017.

“We continue to expect further weakness in fiscal 2018 and forecast a reduction in new business volumes when Genworth’s third-largest customer contract expires in November 2017,” Morningstar analyst David Ellis said.

“We also assume further regulatory initiatives will slow investor home lending growth, potentially impacting new business flows for Genworth,” Mr Ellis said.

Morningstar noted that Genworth primarily operates on short-term supply and servicing contracts for the banks, setting pricing and the percentage of high-LVR loans the banks will insure with the firm.

While Morningstar does not envisage any significant structural change in the use of LMI in Australia, analyst David Ellis highlighted that banks’ risk appetite is cyclical, changing with market conditions.

He noted that CBA, Genworth’s largest client, contracted a lower percentage of insurance in 2014, and lower again in 2015.

“While lenders may use other forms of risk mitigation, such as additional fees and higher interest rates, we believe they are limited by how far they can go with these options,” Mr Ellis said.

Regulatory risk

Morningstar warned that “regulatory risk” would impact Genworth as APRA seeks to ensure the stability of the Australian housing market and broader financial system.

Mr Ellis explained that while a mandatory requirement to purchase LMI on high-LVR loans would provide a tailwind for the LMI provider, the regulator has taken a view that “a reduction in high-LVR loans is appropriate”, effectively shrinking the potential size of the market in which Genworth operates.

“Pressure by APRA on the banks to reduce investor home lending is also having an adverse effect,” he said.

“In Australia, about 20 per cent of new residential lending is at an LVR above 80 per cent.”

Morningstar’s assumption of “further regulatory initiatives” come as investor lending continues to rise, despite existing measures imposed by APRA on the banks.

The latest ABS housing finance figures, released last week, show that investor lending was up 4.2 per cent in January to be 27.5 per cent higher over the year.

ANZ Research noted that the recent acceleration in investor activity “is sure to keep both the RBA and APRA on high alert, as market sentiment shows no signs of easing”.

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