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Who has more to lose from housing bust: Largest Australian insurer or worlds most expensive bank?; Commonwealth Bank or QBE LMI Insurance
Topic Started: 30 Sep 2013, 08:53 PM (1,117 Views)
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A housing bust's biggest loser

September 30, 2013 - 3:29PM
Nathan Bell

Let's consider who has more to lose from a housing bust: Australia's largest insurer or the world's most expensive bank.

In the Commonwealth Bank's annual results presentation, you'll find a reassuring slide that shows the predicted losses from a three-year stress test.

Assuming property prices eventually fall 32 per cent, unemployment rises to 11.5 per cent and the official cash rate drops to 1 per cent, Commonwealth expects to lose only $1.9 billion from uninsured loans after collecting $2.1 billion of lenders' mortgage insurance, and that conservatively assumes that all loans 90 days in arrears trigger a claim.

That's just $4 billion of losses on a $373 billion mortgage book, or just over 1 per cent, and half of that is insured.

This seems a trivial amount for such a big economic dislocation, but let's look at the two largest players in lenders' mortgage insurance.

In October 2008 QBE Insurance bought mortgage insurer LMI. QBE LMI reportedly has about 35 per cent of the mortgage insurance market, with Genworth controlling 50 per cent, according to ratings agency Standard & Poor's.

In Australia, borrowers with deposits of less than 20 per cent of the purchase price of their new home are obliged to take out mortgage insurance, so if they default on their loan mortgage insurers such as QBE LMI are on the hook for any properties sold at a loss by lenders such as Commonwealth Bank.

At this point shareholders of the big banks, who include virtually every Australian through their superannuation portfolios, will be feeling safe and secure. But there's a problem.

Under the assumed conditions in Commonwealth's stress test, every other financial institution would be making claims as well. Let's say the total claim was $7 billion, though it could be far higher.

Now compare that to the $2 billion of shareholders' equity that Genworth reportedly has, and the roughly $1 billion QBE has invested in LMI, which is itself obliged to meet certain regulatory capital requirements.

Theoretically, the most QBE could lose is the $1 billion because LMI is ring-fenced to ensure that losses from QBE LMI never drag QBE down with it.

Suddenly bank shareholders aren't sitting so pretty. If QBE LMI is only good for $1 billion and Genworth $2 billion (it also has $1 billion of unearned premiums) who is going to cover the remaining $4 billion or more? If QBE LMI and Genworth don't have adequate reinsurance policies, it seems losses would be higher than Commonwealth, for example, is anticipating. But who would be worse off?

Even if Commonwealth suffered the full $4 billion ($1.9 billion + $2.1 billion) of losses, if that's as bad as things got, Commonwealth would get through the period relatively easily. But remember the government had to backstop the big banks' loans during the global financial crisis, even though there was no real trouble with bad debts.

In contrast, the losses could devour QBE LMI – $1 billion of capital is a drop in the ocean of the $500 billion mortgage insurance market. If QBE chipped in more capital to maintain its reputation, QBE's already leveraged balance sheet would come into question and also probably trigger a capital raising and a further cut to dividends unless its reinsurance policies paid off.

Read more: http://www.smh.com.au/business/a-housing-busts-biggest-loser-20130930-2uo4h.html
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miw
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Don't mortgage insurers reinsure with the big reinsurers like Swiss Re? All the other kinds of insurer do.

unless mortgage insurers don't reinsure, the analysis above is crap. You would need to look at what percentage of the risk is actually carried on the books of LMI and Genworth, then look at what percentage the laid-off risk constitutes for the big reinsurers and how that risk correlates with the other risk they carry.

Given that it looks like the entire Australian mortgage insurance book looks like it is less than the exposure from a US hurricane, probably not very much.
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b_b
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miw
1 Oct 2013, 12:00 AM
Don't mortgage insurers reinsure with the big reinsurers like Swiss Re? All the other kinds of insurer do.

unless mortgage insurers don't reinsure, the analysis above is crap. You would need to look at what percentage of the risk is actually carried on the books of LMI and Genworth, then look at what percentage the laid-off risk constitutes for the big reinsurers and how that risk correlates with the other risk they carry.

Given that it looks like the entire Australian mortgage insurance book looks like it is less than the exposure from a US hurricane, probably not very much.
+1

Crap analysis all round. Your point on reinsurance is spot on.

Also the author suggests foreigners will put their money from the banks causing funding issues -again total crap.

Having said that, the cba analysis is a bit sus to me. I wonder if the shape of the loan book is such looses explode higher for a slightly worse scenario.
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miw
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b_b
1 Oct 2013, 12:05 AM
Having said that, the cba analysis is a bit sus to me. I wonder if the shape of the loan book is such looses explode higher for a slightly worse scenario.
Yeah. 32% looked like a carefully chosen number to me.
The truth will set you free. But first, it will piss you off.
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b_b
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miw
1 Oct 2013, 12:26 AM
Yeah. 32% looked like a carefully chosen number to me.
Yes. Weird given most public commentators predict 40% declines.
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peter fraser
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b_b
1 Oct 2013, 12:29 AM
Yes. Weird given most public commentators predict 40% declines.
True but we only had a 10% correction.

Regarding the issue of reinsurance, I'm not altogether sure on that. It's easy for actuaries to calculate the risks of cyclones, floods and natural disasters, but how do they calculate the risk of a loan book unless it is fully disclosed for every re-insurer, and each has the ability to drill down into any loan to perform their own audits, and our privacy laws will forbid that.

The initial mortgage insurer has the right to full disclosure on every single loan they insure, but not subsequent parties. After the experience in the USA re-insurers would be very wary.

Perhaps they are one group who should hold gold.
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Billy Jack
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If any of these things happened Australia would resemble Detroit, or Britain which we all know which resembles Somalia.

It aint going to happen friends.
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propertymogul
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b_b
1 Oct 2013, 12:05 AM
+1

Crap analysis all round. Your point on reinsurance is spot on.

Also the author suggests foreigners will put their money from the banks causing funding issues -again total crap.

Having said that, the cba analysis is a bit sus to me. I wonder if the shape of the loan book is such looses explode higher for a slightly worse scenario.
I agree a fairly crap analysis - although the ability of the LMI insurers to pay in such a scenario is a relevant point. Sounds like absolute fantasy though the CBA analysis - a 32% drop in house prices, and 11.5% unemployment and they only anticipate losses of circa $2 billion. During the GFC CBA performed 2 (or was it 3) capital raisings, and had assistance from the government in terms of government guarantees. The share price dropped like a stone (almost 50%). That was with less than a 10% national house price drop and nowhere near 11.5% unemployment. In the scenario they discuss it would be Armageddon, capital markets would freeze and the flow on effects across all businesses would be dramatic also severely impacting business loans and deposit levels. CBA would be wiped out for sure unless there was a government bailout (which there probably would be, but the share price would get absolutely smashed). After their investor presentation a couple of years ago where they were shown to have fudged the numbers I'd be very wary of their vested interest analysis showing all is rosy.
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