What is the future for Lenders Mortgage Insurance?Future Landscape 6. What if? 1. Historical Reasons...
Transcript of What is the future for Lenders Mortgage Insurance?Future Landscape 6. What if? 1. Historical Reasons...
What is the future for Lenders Mortgage Insurance?
Aaron Cutter & Susie Bowden
Contents
1. Historical Reasons for LMI2. Recap of recent LMI experience3. LMI’s place in the sub-prime picture4. Australia v US Mortgage Market5. Future Landscape6. What if?
1. Historical Reasons for LMI
• Capital• Risk Transfer• Product Innovation• Risk Selection
Capital
• Support ADI return on capital– Reduce level of ADI capital– LMI providers (arguably) expect a lower return
than ADIs– LMI providers accept volatile returns
• Facilitate growth in smaller players and entry of non-bank lenders
Risk Transfer - Diversification
• Removes volatility from lenders’ losses• Delinquency rates and losses different
by lender in the recent benign economic times
• Even in “recent” down-turns LMI providers help smooth losses
Product Innovation
• Security for lenders• Global experience
Risk Selection• Discouraging inappropriate lending• Providing outsourced expertise to lenders
– fraud detection models,– credit score – underwriting standards.
2. Recap of Recent LMI Experience
• Australian Experience• US Experience
Australia
• Recent LMI losses have been very low (til 2007)• Favourable national economic environment• But history shows losses can be large (80s and 90s)• Where to for 2008 and 09?
0%
20%
40%
60%
80%
100%
120%
91/9
2
92/9
3
93/9
4
94/9
5
95/9
6
96/9
797
/98
98/9
9
99/0
0
00/0
1
01/0
202
/03
03/0
4
04/0
5
05/0
6
06/0
7
07/0
8
Loss
Rat
io
0%
5%
10%
15%
20%
Econ
omic
Fac
tors
Loss Ratio House Price Appeciation
Unemployment Mortgage Rates
?
Source: APRA Statistics, ASB
United States of America
• Up until 2006, stable experience• Then very unfavourable conditions producing loss ratios in the
hundreds
0%
50%
100%
150%
200%
250%
92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08
Loss
Rat
io
-20%
-15%
-10%
-5%
0%
5%
10%
15%
20%
Eco
nom
ic F
acto
rs
Loss Ratio House Price Appeciation
Unemployment Mortgage Rates
Source: S&P, U.S. Bureau of Labour Statistics
Big falls in US house prices
50
100
150
200
250
300
Jun-
91
Jun-
92
Jun-
93
Jun-
94
Jun-
95
Jun-
96
Jun-
97
Jun-
98
Jun-
99
Jun-
00
Jun-
01
Jun-
02
Jun-
03
Jun-
04
Jun-
05
Jun-
06
Jun-
07
Jun-
08
Hous
e P
rice
Appr
ecia
tion
(% p
.a.)
Miami USA
“Small” falls in Aus house prices
50
100
150
200
250
300
Jun-
91
Jun-
92
Jun-
93
Jun-
94
Jun-
95
Jun-
96
Jun-
97
Jun-
98
Jun-
99
Jun-
00
Jun-
01
Jun-
02
Jun-
03
Jun-
04
Jun-
05
Jun-
06
Jun-
07
Jun-
08
Hou
se P
rice
Appr
ecia
tion
(% p
.a.)
Miami USA NSW Australia
3. LMI’s Place in the Sub-Prime Crisis
• Traditional US lending structure• Traditional securitisation• Recent departure from tradition
Traditional Lending Structure
RMBS1RMBS1 RMBS2RMBS2 RMBSnRMBSn
LenderLender InstitutionalInvestors
InstitutionalInvestors
CDO1CDO1 CDO2CDO2 CDOnCDOn
CDO2CDO2
Package
Invest
Invest
Borrow
MIMI GSEsGSEs
Wall StreetWall Street
Byp
ass
GS
Es
Insure
RMBS1RMBS1 RMBS2RMBS2 RMBSnRMBSn
LenderLender InstitutionalInvestors
InstitutionalInvestors
CDO1CDO1 CDO2CDO2 CDOnCDOn
CDO2CDO2
Package
Invest
Invest
Borrow
MIMI GSEsGSEs
Wall StreetWall Street
Byp
ass
GS
Es
Insure
RMBS1RMBS1 RMBS2RMBS2 RMBSnRMBSn
LenderLender InstitutionalInvestors
InstitutionalInvestors
CDO1CDO1 CDO2CDO2 CDOnCDOn
CDO2CDO2
Package
Invest
Invest
Borrow
MIMI GSEsGSEs
Wall StreetWall Street
Byp
ass
GS
Es
Insure
Traditional Securitisation
RMBS1RMBS1 RMBS2RMBS2 RMBSnRMBSn
LenderLender InstitutionalInvestors
InstitutionalInvestors
CDO1CDO1 CDO2CDO2 CDOnCDOn
CDO2CDO2
Package
Invest
Invest
Borrow
MIMI GSEsGSEs
Wall StreetWall Street
Byp
ass
GS
Es
Insure
RMBS1RMBS1 RMBS2RMBS2 RMBSnRMBSn
LenderLender InstitutionalInvestors
InstitutionalInvestors
CDO1CDO1 CDO2CDO2 CDOnCDOn
CDO2CDO2
Package
Invest
Invest
Borrow
MIMI GSEsGSEs
Wall StreetWall Street
Byp
ass
GS
Es
Insure
RMBS1RMBS1 RMBS2RMBS2 RMBSnRMBSn
LenderLender InstitutionalInvestors
InstitutionalInvestors
CDO1CDO1 CDO2CDO2 CDOnCDOn
CDO2CDO2
Package
Invest
Invest
Borrow
MIMI GSEsGSEs
Wall StreetWall Street
Byp
ass
GS
Es
Insure
Recent Departure from Tradition
RMBS1RMBS1 RMBS2RMBS2 RMBSnRMBSn
LenderLender InstitutionalInvestors
InstitutionalInvestors
CDO1CDO1 CDO2CDO2 CDOnCDOn
CDO2CDO2
Package
Invest
Invest
Borrow
MIMI GSEsGSEs
Wall StreetWall Street
Byp
ass
GS
Es
Insure
RMBS1RMBS1 RMBS2RMBS2 RMBSnRMBSn
LenderLender InstitutionalInvestors
InstitutionalInvestors
CDO1CDO1 CDO2CDO2 CDOnCDOn
CDO2CDO2
Package
Invest
Invest
Borrow
MIMI GSEsGSEs
Wall StreetWall Street
Byp
ass
GS
Es
Insure
RMBS1RMBS1 RMBS2RMBS2 RMBSnRMBSn
LenderLender InstitutionalInvestors
InstitutionalInvestors
CDO1CDO1 CDO2CDO2 CDOnCDOn
CDO2CDO2
Package
Invest
Invest
Borrow
MIMI GSEsGSEs
Wall StreetWall Street
Byp
ass
GS
Es
Insure
4. Australia v US Mortgage Market
• Mortgage Products• Lending Practices• Property Markets
Mortgage Products• US
– Increase in sub-prime loans (i.e. high risk of default)– ARMs with ‘teaser’ rates (3/27s or 2/28s)– Sub-prime loans grew “nearly ten-fold in nine years”– Negative amortisation loans
• Australia– Less than 1% non-conforming – ARMs with teaser rates not offered in Australia
Lending practices• US
– ARM 2/28s offered to those less able to afford the repayments
– Serviceability calculated on an optimistic basis– Lenders by-passing LMI
• Australia– serviceability is generally calculated at a buffer over
benchmark interest rates• But
– Australian households are move leveraged – Some questionable underwriting has occurred
Property Markets• US
– Property slumps have been geographically isolated– Now, the US has experienced a nationwide downturn– Mortgage products and practices led to speculative
bubble and its bursting in some states– auto-manufacturing sector in trouble at the same time
• Australia– Property slumps also have been geographically isolated– Recently, property market has remained reasonably
stable– Could a nationwide property downturn occur
5. Future Landscape
• The Mortgage Market• LMI and Capital• Risk Selection and Product Innovation• Risk Transfer
The Mortgage Market
• Consolidation of the LMI providers• Regional banks will be at a
disadvantage to the larger banks • Assistance with quality control and
intellectual support
Capital
95.01 –100%
90.01 –95%
85.01 –90%
80.01 –85%
70.01 –80%
60.01 –70%
< 60.01% 0%
10%20%30%40%50%60%70%80%90%
100%
Cap
ital R
isk
Wei
ght
ADI Risk Weight – With LMI LMI Risk WeightADI Risk Weight – no LMI Basel I ADI plus LMI
• Capital previously main driver of LMI use
• Capital benefits are lower under Basel II for Standard Approach banks
• Capital position is complex for IRB banks
• Reasons for LMI may move toward true risk assessment and mitigation
Relative capital levels required by LVR
Risk Selection & Product Innovation• LMI providers still facilitate market discipline• The majority of the LMI business can be
expected to be unchanged• LMI may become the quasi ‘gold stamp’ of
underlying business
Risk Transfer - Diversification
0
100
200
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400
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800
A B C D E F G H I J K L M N O P Q R S T U V W X Y Total
Del
inqu
ency
rate
rela
tivity
Jun-07 Jun-08
Delinquency rate (3 months in arrears) for Australian lenders as at 30 June
2007 and 30 June 2008
0
250
500
750
1,000
1,250
1,500
A B C D E F G H I J K L M N O P Q R S T U V W X Y Total
Del
inqu
ency
rate
rela
tivity
30-Jun-07 30-Jun-08
Relative delinquency rate for US lenders as at 30 June 2007 and 30
June 2008 – Prime loans
• LMI does provide true insurance risk transfer • In very stressed environments the level of risk transfer is
arguably lower• Maximum benefit provided by global LMI
6. What if?
0%
100%
200%
300%
400%
500%
600%
700%
800%
Sep-08
Dec-08
Mar-09
Jun-0
9Sep
-09Dec-0
9Mar-
10Ju
n-10
Sep-10
Dec-10
Mar-11
Jun-1
1Sep
-11Dec-1
1Mar-
12Ju
n-12
Sep-12
Dec-12
Mar-13
Jun-1
3
Future Claim Costs Relativity between “baseline” Australian losses and a US like scenario
• 7 times current level of losses = 200% loss ratio
Where will it settle
• Market consolidation and Basel II may lead to a declining LMI industry
• However, risk selection/acceptance and transfer have significant value
• How these opposing forces finally settle will determine whether overall use of LMI becomes less or more…