Australian lenders’ mortgage insurers are on track to achieve “sound” earnings over the next 2-3 years despite the challenging economic climate and with further interest rate hikes looming on the horizon, S&P Global Ratings says in its latest industry update.

The rating agency says the likelihood of “outsized losses” is low despite the risk to earnings from interest rate increases and moderate declines in house prices.

Australia’s low unemployment rate, strong residential property prices in the last two years during the pandemic, along with strengthened underwriting practices in the past 6-7 years, provide the industry with buffers to weather the economic storm.

“We expect profitability for mortgage insurers to remain sound,” S&P says in the update. “A very low unemployment rate and significant house price appreciation over the past two years should support lower claims.”

S&P says it has revised its insurance industry and country risk assessment (IICRA) for the Australian mortgage insurance sector to low from intermediate, and the outlook for the industry to stable from negative.

The revision follows the industry’s recovery last year after earnings took a hit from the pandemic economic fallout, S&P says. Last year the industry reported strong earned premium and very low levels of claims, producing a return on equity of 13.2% and net combined ratio of -5%.

S&P Insurance Analyst Julian Nikakis says the revision takes into account the rating agency’s base case scenario for the cash rate to be 1.75% at the end of the year and 2.5% at the end of 2023. The cash rate is at 1.35% currently and the Reserve Bank of Australia has signalled more hikes are expected in the coming months as it seeks to tame inflation.

He says higher interest rates are not likely to dent the industry’s outlook as mortgage insurers would have factored that in their underwriting process.

“The ability to withstand higher interest rates has also been taken into account at the time of approving the home loan and mortgage insurance – so there’s some buffer already included,” Mr Nikakis said.

“Strong house price appreciation over the past two years, in particular, also means that the number of borrowers in negative equity positions is very low.

“We would typically see increases in unemployment and falling house prices as the two key items that affect mortgage insurance claims.”

While S&P has forecast house prices to fall by 10% over the next year, the level of claims generated by this moderation will be modest, given the strong level of employment, Mr Nikakis said.

“Other factors that support our stable outlook for the sector are the strong liquidity/savings buffers that borrowers have built up during covid, the relative decline in high risk lending in recent years, and the improvement in underwriting practices by banks and mortgage insurers.”