OREANDA-NEWS. Fitch Ratings has affirmed Australia-based Westpac Lenders Mortgage Insurance Limited's (WLMI) Insurer Financial Strength Rating (IFS) at 'AA-'. The Outlook is Stable.

KEY RATING DRIVERS

The IFS rating and Stable Outlook of WLMI is driven by the credit profile of its ultimate parent Westpac Banking Corporation (WBC; IDR AA-/Stable), and reflects Fitch's assessment of its strategic importance to the group. Reliance on the group to support financial flexibility at WLMI increased following the issuance of AUD80m of subordinated debt and the introduction of financial leverage. The rating also reflects the company's solid financial profile, which includes a robust standalone capital position and conservative investment approach. WLMI's operating and underwriting performance has historically been strong and interest coverage is sound.

The group has maintained its reduced risk appetite for lenders mortgage insurance risk, and WLMI continues to avoid new exposure to mortgages with a loan/value ratio (LVR) greater than 90%. Moreover, from fiscal year end-September 2014 (FY14), the company renewed its 60% quota share reinsurance arrangement which cedes a large percentage of its remaining business to the reinsurance market.

As a result of a reduced risk appetite and the run-off of higher LVR - and more capital intensive - risks, the company continues to generate significant levels of surplus capital. WBC repatriated AUD179m of WLMIs ordinary equity through a share buy-back in addition to AUD25m in dividends in FY14. Despite this, WLMI's coverage of its regulatory prescribed capital amount increased to a strong 1.41x at FYE14 (FYE13: 1.25x).

Part of the capital initiatives conducted during FY14 included the AUD80m issuance of Tier 2 compliant subordinated notes from WLMI to WBC. Fitch employs a regulatory override for compliant securities in Australia and gives these 100% equity credit in its internal assessment of capital adequacy. However, the agency treats these hybrids as 100% debt in the financial leverage calculation. As a result, WLMI's financial leverage increased to 34% at FYE14 which is higher than the agency's median criteria guidelines for a 'AA' rated insurer, and increases the company's reliance on WBC.

In Fitch's opinion, WLMI would have sufficient capital to withstand a range of severe downturn scenarios, although in the more severe scenarios WLMI would most likely require recapitalisation to continue to operate within prudential guidelines. In such a scenario, the agency believes WBC would be willing and capable of providing such support.

Net profits after tax declined 31% to AUD29m in FY14 from FY13 as a result of lower premium volumes and investment income. Net earned premiums declined 31% to AUD46m and more than offset the strong underwriting result. WLMIs loss ratio improved to 21% in FY14 (FY13: 37%) and resulted in a very low combined ratio of 32% (FY13: 44%). Absolute investment returns declined as WLMI's investments were reduced by 29% to AUD321m following the reduction in capital.

The company's geographically diverse mortgage portfolio reduces its exposure to any one state or region. Fitch considers this diversification to be important given that periods of economic stress in Australia have historically varied considerably at a state and regional level.

RATING SENSITIVITIES

There is little prospect of WLMI's rating being upgraded as this would require an uplift from the group rating which was affirmed in June 2014.

The key rating driver that could lead to a downgrade of WLMI is a downgrade of WBC's ratings given its increased reliance on WBC.

A severely deteriorating economic environment that ultimately leads to a weakening of WLMI's capital position, could lead to a downgrade in the unlikely event that capital support were not forthcoming from WBC. In such a scenario WLMI may find itself unable to meet high minimum regulatory capital requirements.