Moody's downgrades Arch Capital after United Guaranty acquisition
Moody's has downgraded the insurance financial strength (IFS) rating of Arch Capital's principal P&C re/insurance operating subsidiaries to A2 from A1. The outlook for these ratings is stable.
At the same time Moody's downgraded the IFS rating of Arch Mortgage Guaranty Company (AMG) to Baa1 from A3. The outlook for AMG is positive. These rating actions conclude reviews for downgrade that were initiated on 17 August 2016.
Moody's also affirmed the Baa1 IFS rating of Arch Mortgage Insurance Company (AMI) with the outlook changed to positive from stable.
These rating actions follow the completion of Arch Capital's previously announced acquisition of United Guaranty Corporation, a holding company for a leading US mortgage insurance group, from American International Group. Arch Capital purchased UGC for approximately $3.3 billion in cash and stock.
Moody’s said the downgrade reflects its view that the acquisition of UGC increases the group's credit risk profile due to the substantial expansion of Arch Capital's mortgage insurance operations and a significant increase in the holding company's financial leverage following the issuance of debt and preferred shares to finance a portion of the UGC acquisition.
On a pro forma basis giving effect to the acquisition, Arch Capital's mortgage operations represent approximately 24 percent of the group's gross premiums written, up from around 8 percent.
Moody's said that it currently views the stand-alone credit profiles of leading US mortgage insurers to be in the Baa range due to the sector's historical deep cyclicality, its undifferentiated, commoditised product, and industry conditions that are largely tied to some of its main stakeholders (lenders and GSEs), public policy decisions, the performance of the housing sector, and other uncontrollable variables, including competition from the FHA.
Given the large amount of debt and preferred stock issued by Arch Capital in recent months to help finance the UGC acquisition, the firm's pro forma adjusted financial leverage has risen to around 25 percent, up from 19 percent at year-end 2015. While Moody's expects Arch Capital to gradually reduce its financial leverage through debt repayments and organic capital growth, the firm's leverage metrics are likely to remain elevated for several years.
Moody's added that the combination of UGC and Arch's existing mortgage insurance operations will create the market share leader in the US private mortgage insurance market. The acquisition also provides some diversification benefit to Arch Capital as its traditional P&C reinsurance business faces challenging competitive dynamics. Current mortgage insurance conditions are, by contrast, quite sound, with strong mortgage insurance profitability, supported by high quality mortgage loan origination and benign housing market conditions. Moody’s also said that it expects Arch Capital's profitability to be positively impacted by its mortgage insurance operations over the near to medium term.
