Structural headwinds in the property market could result in heightened risks to the Australian mortgage insurance industry, according to a major international ratings agency.
In a new report from S&P Global Ratings, Insurance Industry and Country Risk Assessment: Australia Mortgage, analysts looked at the health of the industry and posited that the risk for the overall sector was intermediate.
Encroaching macroeconomic risks such as rising house prices and a growing ratio of household debt to disposable income have the potential to cause volatility in the mortgage insurance industry, analysts said.
If these factors cause a sharp correction in house prices – as mentioned in S&P’s recent downgrade of 23 Australian financial institutions – this could create a significant rise in credit losses.
“This increases the risk of material adverse claims experience for lenders’ mortgage insurers in Australia,” S&P said.
However, the agency’s base case scenario assumed that current and future actions by the government and regulators could lessen the impact of this scenario.
For the short term, analysts predicted that an “orderly correction” of house prices in Western Australia and Queensland would continue throughout the rest of the year.
“While the latter could increase insurance claims originating from these states, it is unlikely to pose a significant challenge to the credit profiles of insurers that offer lenders’ mortgage insurance (LMI).”
Furthermore, S&P predicts that employment levels – which can drive claims frequency for the sector – are likely to improve from 5.8% in fiscal year 2017 to approximately 5.2% in fiscal year 2019.
One pressure point highlighted by S&P was continued restrictions on lending practices put in place by the Australian Prudential Regulation Authority (APRA).
“We expect these regulatory actions to weaken LMI premium demand, absent a structural change to the product or market,” analysts said.
As well as reduced lender risk appetite in the high-LVR segment, S&P warned that outside factors could further drive market contractions as they have affected the market in the past.
“Other contributing factors include a major Australian bank shifting part of its mortgage insurance requirements offshore and, more recently, a material home lender choosing to retain the risk instead of purchasing insurance.”
As a result of these factors, S&P predicts a moderation in return on equity within the mortgage insurance sector over the next two to three years.
