July 26, 2017 / 8:19 PM / 2 years ago

Fitch Removes Arch's Debt Ratings from Negative Watch; Affirms Ratings with Stable Outlook

(The following statement was released by the rating agency) CHICAGO, July 26 (Fitch) Fitch Ratings has removed from Rating Watch Negative and affirmed the following Arch Capital Group Ltd. (ACGL) ratings: --Long-Term Issuer Default Rating (IDR) at 'A-'; --Senior unsecured notes at 'BBB+'; --Series C and E preferred securities at 'BBB'. Additionally, Fitch has affirmed the Insurer Financial Strength (IFS) ratings of ACGL's various primary insurance and reinsurance subsidiaries at 'A+' (Strong). The Rating Outlook for all ratings is Stable. A complete list of rating actions follows at the end of this release. KEY RATING DRIVERS Fitch's removal from Negative Watch and affirmation of ACGL's holding company ratings follows a detailed review of the credit quality of United Guaranty Corporation (UGC). ACGL purchased UGC, the leading provider of U.S. mortgage insurance (USMI), from American International Group, Inc. (AIG) for $3.26 billion on Dec. 31, 2016. While Fitch does not formally rate UGC, the typical IFS rating range for mortgage insurers is in the 'A' through 'BBB' category, with USMI companies more likely falling within the 'BBB' range. Fitch believes the likely stand-alone rating range for ACGL's USMI operations, which includes UGC and Arch Mortgage Insurance Company, would be an IFS rating of 'A-'/'BBB+', which is at the upper end of Fitch's typical ratings for USMI companies. Per its criteria for holding company notching, Fitch establishes an IFS anchor rating for ACGL. The acquisition of UGC adds complexity to that analysis, since there are now two large operations with divergent actual and implied IFS ratings. Fitch used the 'A+' IFS ratings of ACGL's primary insurance and reinsurance operations as the anchor, since these operations continue to be the majority of the company's operating earnings and capital. To the extent that the company shifts more of its business to the lower credit quality USMI operations, the 'A+' overall IFS anchor rating, and thus the holding company ratings, could be lowered. Fitch's affirmation of ACGL's ratings reflects the company's strong and diversified business profile in both insurance and reinsurance lines, reasonable financial leverage, strong fixed-charge coverage and very strong profitability. These favorable factors are partially offset by potential risks associated with its expanding USMI operations, primary of which are possible complications related to the ongoing integration of the operations and risk management practices of UGC into a combined USMI group. The ratings also reflect Fitch's negative sector outlooks on U.S. property/casualty (P/C) insurance and global reinsurance. ACGL has a strong business profile with a broad product portfolio of P/C insurance, reinsurance and mortgage (re)insurance business. Gross premiums written (GPW) for 2016 (excluding other segment) was 60% insurance, 30% reinsurance and 10% mortgage. This GPW split is expected to shift to approximately 50% insurance, 25% reinsurance and 25% mortgage in 2017 with the added UGC business. Fitch views this diversified source of revenues and earnings favorably. ACGL continues to expand and diversify into the USMI business, as overall mortgage market conditions remain favorable. The UGC acquisition helped reduce ACGL's overall combined ratio to 81.4% in first quarter 2017 (1Q17)from 88.4% in 1Q16, as the mortgage segment currently generates much lower combined ratios (40.8% in 1Q17) than the insurance and reinsurance businesses. The lower combined ratio levels primarily reflect accounting rules which prevent mortgage insurers from establishing a loss reserve for a loan that is not in default. As a result, mortgage insurance loss reserves are not an estimate of ultimate losses. Fitch views ACGL's financial leverage ratio as reasonable for the rating category at 20.6% as of March 31, 2017 (excluding $235 million of revolving credit agreement borrowings by Watford Re). This ratio is up noticeably from 12.6% at Dec. 31, 2015, as the company issued $950 million of senior debt in December 2016 and utilized $400 million of revolving credit agreement borrowings to partially finance the cash consideration for the UGC purchase. ACGL's GAAP fixed-charge coverage averaged a very strong 10.6x from 2012 to 2016. However, with the added debt from the UGC acquisition, fixed-charge coverage is expected to decline to a strong 7.0x-8.0x ACGL's profitability is very strong, characterized by low and stable combined ratios and high returns on average common equity, with the most recent five-year averages (2012-2016) at 89.6% and 11.8%, respectively. Favorably, ACGL has posted an underwriting and overall net income profit in every year of its 15-year operating history. RATING SENSITIVITIES ACGL's overall IFS anchor rating could be lowered if more than 40% of ACGL's operating earnings and capital are sourced from USMI, which would result in a downgrade of ACGL's holding company ratings based on standard notching. Key rating sensitivities that could result in a downgrade of both operating and holding company ratings outside of anchor rating considerations include: difficulties experienced in the USMI operations, including failure to successfully integrate UGC, or sizable adverse prior-year reserve development. In addition, increases in underwriting leverage above 1.0x net premiums written-to-equity ratio or a financial leverage ratio above 25% could generate negative rating pressure. ACGL's hybrid securities ratings could be lowered by one notch to reflect non-performance risk should Fitch view Bermuda's regulatory environment as becoming more controlling in its supervision of (re)insurers. Key rating sensitivities that could result in an upgrade include: continued improvement in ACGL's competitive market position while demonstrating favorable run-rate earnings and low volatility with a non-mortgage combined ratio in the low 90s; and successfully managing the expansion of its USMI operations with the UGC acquisition. In addition, continued growth in equity while maintaining a financial leverage ratio at or below 20%, fixed-charge coverage of at least 10x, and a net premiums written-to-equity ratio of 0.8x or lower could generate positive rating pressure. FULL LIST OF RATING ACTIONS Fitch has removed the following ratings from Rating Watch Negative and affirmed with a Stable Outlook: Arch Capital Group Ltd. --Long-Term Issuer Default Rating at 'A-'; --$300 million 7.35% senior unsecured notes due 2034 at 'BBB+'; --$325 million 6.75% series C non-cumulative preferred shares at 'BBB'; --$450 million 5.25% series E non-cumulative preferred shares at 'BBB'. Arch Capital Group (U.S.) Inc. --$500 million 5.144% senior notes due 2043 at 'BBB+'. Arch Capital Finance LLC --$500 million 4.011% senior unsecured notes due 2026 at 'BBB+'; --$450 million 5.031% senior unsecured notes due 2046 at 'BBB+'. Fitch has affirmed the following ratings with a Stable Outlook: Arch Reinsurance Ltd. Arch Reinsurance Company Arch Reinsurance Europe Underwriting Designated Activity Company Arch Insurance Company Arch Excess and Surplus Insurance Company Arch Specialty Insurance Company Arch Indemnity Insurance Company Arch Insurance Company (Europe) Limited --IFS at 'A+'. Contact: Primary Analyst Brian C. Schneider, CPA, CPCU, ARe Senior Director +1-312-606-2321 Fitch Ratings, Inc. 70 W. Madison Street Chicago, IL 60602 Secondary Analyst Martha Butler, CFA Senior Director +1-312-368-3191 Committee Chairperson Douglas Meyer, CFA Managing Director +1-312-368-2061 Summary of Financial Statement Adjustments Fitch has adjusted ACGL's financial leverage and fixed-charge coverage ratios to exclude Watford Re's revolving credit agreement borrowings and interest expense. ACGL only owns approximately 11% of the common equity of Watford Holdings Ltd. (parent of Watford Re). However, Watford Re's financial results are required to be consolidated into ACGL, as ACGL is considered the primary beneficiary of Watford Re. The noted adjustment did not result in a different rating than had the adjustment not been made, but it is material in how Fitch views financial leverage and fixed-charge coverage. Media Relations: Elizabeth Fogerty, New York, Tel: +1 (212) 908 0526, Email: elizabeth.fogerty@fitchratings.com. 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