PMI capital quarantined

PMI Mortgage Insurance Ltd will enter into an undertaking with its owner, PMI in the United States, which makes it difficult for the former to pay dividends to the latter.

The arrangement is central to the protection of the credit rating of PMI Australia from the full impact of the downgrade of the credit rating of its US owner.

Standard & Poor's said yesterday that it lowered its insurer financial strength rating on PMI Mortgage Insurance Ltd to AA- from AA. S&P said the rating remains on "credit watch with negative implications".

S&P lowered the rating of PMI in the US to A+ from AA. MGIC, which also trades in Australia, had its rating cut to A from AA-. The ratings of two other mortgage insurance entities were also cut. The revised credit ratings reflect recent losses and the ongoing effect of the likely rise in US unemployment and further decline in US house prices, themselves consequences of the original sub-prime mess.

In Australia PMI agreed "to implement various operational measures to further protect the Australian subsidiary's financial strength at the AA- level," S&P said.

Ian Graham, managing director of PMI said that the firm would "ring fence" its business. The chief initiative is to enter into agreements that PMI Australia won't pay a dividend to its owner and its owner won't seek a dividend from PMI Australia.

Graham said the local subsidiary had not paid a dividend to PMI since the firm bought the business (from AMP) in 1999. PMI has traded in Australia under different ownership since the 1960s.

He did not want to spell out all the measures to satisfy S&P, however. He said APRA would also take a close interest in the subsidiary's arrangements with the parent.

For the market for mortgage finance the impact of a reduction in the rating of PMI is that it might lead to a cut in the credit rating of the subordinated tranches of future issues of mortgage-backed securities. (Most senior tranches earn a AAA rating based on the percentage of subordination).
 
Graham said that "from an investor perspective, subordinated pieces are small in terms of the overall market and there's not usually a secondary market. Investors hold to maturity. AAA pieces are unaffected."

Speaking more widely on the market for mortgage-backed securities - for which there is no demand among investors and issuers at current prices - Graham said most activity involving his firm in structuring transactions related to reworking pools of mortgages to make them eligible for use in repurchase agreements with the Reserve Bank.