Bermudian insurance and reinsurance firm Arch Capital Group Ltd. and its Arch Reinsurance Ltd. subsidiary have both had negative outlooks assigned to their credit ratings by A.M. Best.
The negative outlooks are due to A.M. Best’s view that Arch has experienced a “significant increase in financial leverage” due to the issuance of $950 million of senior unsecured notes and $450 million of preferred shares at the end of 2016 to help fund the purchase of mortgage insurer United Guaranty Corporation.
“While financial leverage and coverage remain supportive of the ratings, the outlooks reflect the additional risk assumed by the organization, which may manifest itself in lost opportunity costs as Arch has made a significant commitment to the mortgage insurance industry.
“Additionally, the assigned negative outlooks reflect the significant mortgage insurance risk assumed by Arch upon the purchase of United Guaranty and the integration risk of this large acquisition,” A.M. Best explains.
The rating agency said that Arch could get downgraded should, “Mortgage insurance model results vary materially compared with underlying actual results, or if there is a degradation in underwriting standards in the mortgage insurance market or any other early warning sign of increasing unexpected risk.”
Also any loss or expense issues that arise should the integration of United Guaranty into the company and the mortgage risk underwritten into the Arch book be unsuccessful, could cause additional rating pressure.
Should the leverage drop and the mortgage book look acceptable in terms of risk, or the integration be successful, then the ratings outlook could be revised to stable, A.M. Best said.
The negative outlook simply reflects the complexity of mergers & acquisitions, particularly when they involve assuming a large book of business that changes the overall company risk profile significantly, as the addition of a large mortgage insurance book does in this case.
Arch remains a strong re/insurer, and A.M. Best notes that it actually outperforms many of its peers on a number of metrics, and performed particularly well in times of reinsurance market stress after major losses.
But perhaps here’s the underlying reason for the negative outlook.
“Arch has demonstrated that it will actively manage the re/insurance cycle, and over the past several years, Arch has strived to seek opportunities for return wherever they present themselves. Arch’s foray into the mortgage insurance business is a recent example of this flexibility. Arch has demonstrated that it prudently executes its business plan but remains nimble enough to take advantage of opportunities,” A.M. Best explains.
So the rating agency believes that the venture into the mortgage insurance business is partly a response to the soft and challenging reinsurance market, hence A.M. Best wants to ensure the venture has the desired results and has been well thought through, the results of which take time to manifest. Hence the negative outlook for now while the United Guarantee M&A beds in and the Arch mortgage book is seasoned.
A.M. Best comments on the risks of, “The soft market conditions in insurance and reinsurance that Arch must contend with on a daily basis, and the integration risk of assuming a large acquisition. These market conditions will continue to challenge Arch to retain and find profitable business, as well as retain talented professionals.”
However, Arch is one of the more successful at navigating challenging times, A.M. Best believes, highlighting that, “Despite the adversarial market conditions, Arch’s operating performance has held steady, and return-on-revenue and return-on-equity (compared with peer companies) measures indicate successful soft market navigation thus far.”
