by Alastair Thompson
It’s as if an earthquake has hit Wellington. Only no one will talk about it publicly, and nobody is willing to speak its name. It was the same earthquake that hit Christchurch. In Wellington, it rended asunder a market fault-line. As I understand it the facts are roughly this.
Before the earthquake in Christchurch, the Government had a $1billion excess $5billion reinsurance contract for earthquake damage – which automatically reset following a major event. We claimed $10billion on this policy.
We now have a $1billion excess $1.5billion EQC reinsurance contract in place – for the nation. I think that the rough figures for premiums were $500million a year for the $5billion + facility and $250million for what we have now.
For earthquake damage, NZ Inc. is – by necessity – self-insuring. Like the Japanese.
And we need to remember this happened last time we had a massively damaging quake – in Napier in 1931. EQC 1.0 died on February 22 2011. EQC 2.0 is yet to be created.
So how does this work out for Wellington?
Sources tell me that insurance chiefs from the biggest reinsurers in the world are now pricing Wellington as “ground Zero for earthquake reinsurance risk” in the world. Not the Asia-Pacific. Not the ring of fire. The world.
And as a result, practically speaking, earthquake reinsurance cover is not practically available for commercial property in Wellington.
Yes some policies are being written on some buildings (usually ones which are up to code and have blue chip tenants) for 400% to 600% premium increases.
And there are also policies being written for “functional” replacement – i.e. a specific less costly remedy.
But for most of the city, the insurance premium increases are unaffordable and irrational. In some cases they more than double the costs of building ownership. For unit title flat holders the prospect of monthly insurance bills in the order of $400 a month is normal, on a property which is no longer saleable and possibly in a negative equity.
For the purposes of illustration I provide a single example. Relatively new suburban building, outside of the CBD with retail, apartments and carparks. Unimpaired value $2.8 million, replacement insurance quote is for $5.8 million rebuild cost and quoted premiums are way up.
What will happen to the value of this business? To the businesses and apartment holders in it?
In the Wellington commercial property market, full insurance is a condition of all the mortgage business. Full replacement earthquake insurance is a standard term and condition.
In NZ most companies which carry business interruption insurance also need to have earthquake interruption cover to satisfy the conditions of the bank credit facilities. These often include warrantees around the quality of the building that business is being conducted out of – including the existence of earthquake insurance cover.
So what does this mean?
It means that the Wellington CBD property market is frozen. The only purchasers are ones which are buying with cash. There are hundreds, possibly thousands, of distressed mortgaged unit title and company share owners in the city.
It means rentals are falling and landlords are getting creative.
But above all else it means an enormous impairment -i.e. write down – of:
1) property assets (estimated in the $10+ Billion effective immediately across Wellington); and
2) the mortgages which are collateralised against those assets.
Knowing all the above, but being frustrated that literally nobody is willing to go on the record about this stuff – I recently ran into a finance guy and we had a chat.
I asked him what the story was inside the banks (he was in a position to know).
He confirmed the thesis that there are massive unrealised property losses in the Wellington and Auckland commercial property markets. And he also confirmed that everybody knew this was the case.
He said the current response of everybody was “head in the sand”, adding, “don’t get me wrong, not head in the sand don’t know, head in the sand deliberately.”
But what about IFRS accounting standards? I asked.
At which point he shrugged.
So it’s just a matter of time?
So what needs to be done?
This problem is not going to go away by itself. At present the banks are being accommodating with their commercial property debtors because the alternative is mutually assured destruction. There is nothing to be gained from banks taking ownership of all the property in Wellington.
But every mortgage document for every commercial property in Wellington needs to be amended. And probably many business loan agreements also. For this to happen new insurance arrangements – acceptable to creditors and debtors alike – need to be put in place for owners of property and businesses. It is likely that these will need to exclude earthquake cover for equity but include cover for loans lent against assets.
One suggestion being discussed is that central Government – through the EQC and possibly the Reserve Bank – could provide a “loan protection insurance scheme” which enables banks and debtors to at least insure the loans made against Wellington properties. Enabling them to at least roll-over all existing mortgages when they come to term.
But for this to happen central and local government, and banks need to get together and move very very fast.
At the moment nobody is even publicly acknowledging there is a problem.
Alastair Thompson is editor and co-founder of Scoop.