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Rating Action:

Moody’s affirms Arch Capital’s ratings (senior Baa1); upgrades Arch MI subsidiaries; outlooks stable

20 May 2021


Affirming ratings of Arch's P&C subsidiaries; upgrades mortgage insurance subsidiaries

New York , May 20, 2021 – Moody's Investors Service, ("Moody's") has affirmed the Baa1 senior debt rating of Arch Capital Group Ltd. (Arch Capital) and the A2 insurance financial strength (IFS) ratings of its principal property & casualty operating subsidiaries. In the same rating action, Moody's upgraded the IFS ratings of Arch Capital's principal mortgage insurance operating subsidiaries to A2 from A3. The rating outlook for Arch Capital and its subsidiaries is stable. For a complete rating list, please see below.

RATINGS RATIONALE

Ratings Rationale -- Arch Capital and its P&C (re)insurance subsidiaries

According to Moody's, Arch Capital's ratings reflect its established operating platform and good spread of risk in specialty insurance, reinsurance and mortgage insurance, its strong profitability and organic capital generation, as well as solid capitalization and ample liquidity at the holding company. Additionally, Arch Capital benefits from the diversification of earnings provided by its P&C (re)insurance and mortgage businesses. These strengths are tempered by underwriting volatility and pricing uncertainty inherent in many of the company's chosen lines of business, which include catastrophe-exposed property coverages and long-tail casualty business. The firm's mortgage insurance business creates systemic exposure to severe mortgage default activity during large scale economic downturns and high levels of unemployment.

Moody's notes that Arch Capital has made significant progress in deleveraging its balance sheet and has posted strong consolidated profitability generating robust earnings in its mortgage insurance operations. However, the company's P&C units have had disappointing underwriting results over the past several years due to catastrophe losses and coronavirus losses in 2020. For the first quarter of 2021, Arch Capital reported net income available to common shareholders of $428 million compared to $134 million in the prior year quarter, driven by strong earnings in mortgage insurance and realized investment gains. The insurance and reinsurance segments generated combined ratios of 97.7% and 102.9%, respectively, during the quarter, which included $188 million of catastrophe-related claims, mostly from US winter storms. Going forward, the rating agency expects improved profitability from the company's P&C segments as meaningful price increases across both insurance and reinsurance lines outpace rising loss cost trends.

Ratings Rationale -- Arch Mortgage Insurance subsidiaries

The upgrade of Arch Capital's mortgage insurance subsidiaries (Arch Mortgage) to A2 reflects one notch of rating uplift from the A3 stand-alone credit profile for implicit and explicit support from Arch Capital and Arch Reinsurance Ltd. (Arch Re Bermuda, IFS rating A2 stable). The ratings also reflect the firm's leadership position in the US mortgage insurance market, its strong core earnings power and the group's enhanced market presence and capabilities as a key operating unit within the larger group. These strengths are tempered by uncertainties related to credit performance for delinquent mortgage loans currently in forbearance, the commodity-like nature of the mortgage insurance product and the potential for price competition in the US mortgage insurance market.

Arch Mortgage's capital adequacy is bolstered by its substantial use of reinsurance to mitigate underwriting volatility in stress scenarios. At Q1 2021, Arch Mortgage had approximately $4.3 billion of excess of loss reinsurance protection through 13 Bellemeade Re insurance-linked note transactions. The group also has additional risk transfer protection through traditional quota-share and excess of loss reinsurance. Through these arrangements, Arch Mortgage has significant off-balance sheet capital resources to absorb losses during periods of elevated mortgage credit losses. As of March 31, 2021, Arch Mortgage reported a PMIERs sufficiency ratio of 190%, which is high relative to its peers.

Moody's notes that the US housing market has been resilient in the face of elevated unemployment levels and the economic uncertainties arising from the coronavirus pandemic. Given the strong economic outlook for the next couple of years, Moody's believes home prices will continue to rise, though a continued rapid increase in US home prices could lead to affordability issues, which often serves as a precursor to higher volumes of lower credit quality mortgage loans.

Through the first three months of 2021, the mortgage segment reported GAAP underwriting income of $200 million and a combined ratio of 42.4%. The default rate moderated to approximately 3.9%, as loans previously in forbearance continue to post strong delinquency cure rates. Due to the strong level of house price appreciation in recent years, Moody's expects that a significant majority of currently delinquent loans will either cure or be refinanced without paid mortgage insurance claims.

FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS

Arch Capital and its P&C (re)insurance subsidiaries

Factors that could result in an upgrade of Arch Capital's ratings: 1) improved underwriting profitability within its P&C operations, with combined ratios below 95%; 2) maintaining consolidated adjusted financial leverage in the low 20 percent range, or below; 3) maintaining moderate natural catastrophe exposures on a gross and net basis; and 4) maintaining comprehensive reinsurance coverage on the substantial majority of the primary risk in force within the company's US mortgage insurance business.

Factors that could lead to a downgrade of Arch Capital's ratings: 1) returns on capital below the mid-single digits across multiple years; 2) consolidated adjusted financial leverage above 30%; 3) gross underwriting leverage in excess of 3x; or 4) a decline in shareholders' equity (including share repurchases) by more than 10% over a rolling twelve month period.

Arch Mortgage Insurance subsidiaries

Given the current A2 IFS ratings on Arch Capital's mortgage insurance subsidiaries and the intrinsic risk profile of the group's business, a rating upgrade for the MI operating companies is unlikely over the medium term. Factors that could lead to downgrade of the ratings: 1) evidence of diminished explicit and/or implicit support from Arch Capital and Arch Re Bermuda; 2) downgrade of Arch Re Bermuda; 3) non-compliance with PMIERs; 4) significant weakening of underwriting standards or pricing; and 5) public policy decisions that significantly diminish the role of private mortgage insurance in the US housing finance market.

RATING LIST

The following ratings have been affirmed:

Arch Capital Group Ltd. -- senior unsecured debt at Baa1, senior unsecured debt at Baa1(hyb), Pref. Stock Non-cumulative at Baa3(hyb);

Arch Capital Group (U.S.) Inc.-- BACKED senior unsecured debt at Baa1;

Arch Capital Finance LLC -- BACKED senior unsecured debt at Baa1;

Arch Reinsurance Ltd. -- insurance financial strength at A2;

Arch Insurance (UK) Limited -- insurance financial strength at A2;

Arch Reinsurance Company -- insurance financial strength at A2;

Arch Insurance Company -- insurance financial strength at A2;

Arch Specialty Insurance Company -- insurance financial strength at A2; and

Arch Property Casualty Insurance Company -- insurance financial strength at A2.

The following ratings have been upgraded:

Arch Mortgage Insurance Company -- insurance financial strength to A2 from A3;

United Guaranty Residential Insurance Company -- insurance financial strength to A2 from A3;

Arch Mortgage Guaranty Company -- insurance financial strength to A2 from A3; and

Arch LMI Pty Ltd - insurance financial strength to A2 from A3.

Outlook actions:

The rating outlooks for Arch Capital Group Ltd., Arch Capital Group (U.S.) Inc., Arch Capital Finance LLC, Arch Reinsurance Ltd., Arch Insurance (UK) Limited, Arch Reinsurance Company, Arch Insurance Company, Arch Specialty Insurance Company and Arch Property Casualty Insurance Company remain Stable.

The rating outlooks for Arch Mortgage Insurance Company, United Guaranty Residential Insurance Company, Arch Mortgage Guaranty Company and Arch LMI Pty Ltd have been changed to Stable from Positive.

Arch Capital Group Ltd., through its subsidiaries, writes insurance and reinsurance on a worldwide basis through operations in Bermuda, the United States, Canada, Europe, Australia and South Africa, with a focus on specialty lines. The company has three operating platforms: insurance, reinsurance and mortgage. Through the first three months of 2021, Arch Capital reported $2.5 billion of net premiums written and $428 million of net income available to common shareholders. As of March 31, 2021, total shareholders' equity was approximately $14.0 billion.

The principal methodology used in rating Arch Capital Group Ltd., Arch Reinsurance Ltd., Arch Insurance (UK) Limited, Arch Reinsurance Company, Arch Insurance Company, Arch Specialty Insurance Company, Arch Property Casualty Insurance Company, Arch Capital Group (U.S.) Inc. and Arch Capital Finance LLC was Reinsurers Methodology published in November 2019 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1187551 . The principal methodology used in rating Arch Mortgage Insurance Company, United Guaranty Residential Insurance Company, Arch Mortgage Guaranty Company and Arch LMI Pty Ltd was Mortgage Insurers Methodology published in November 2019 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1187538 . Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of these methodologies.

REGULATORY DISCLOSURES

For further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004 .

For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

The ratings have been disclosed to the rated entity or its designated agent(s) and issued with no amendment resulting from that disclosure.

These ratings are solicited. Please refer to Moody's Policy for Designating and Assigning Unsolicited Credit Ratings available on its website www.moodys.com.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at http://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1263068 .

The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody's affiliates outside the EU and is endorsed by Moody's Deutschland GmbH, An der Welle 5, Frankfurt am Main 60322, Germany, in accordance with Art.4 paragraph 3 of the Regulation (EC) No 1060/2009 on Credit Rating Agencies. Further information on the EU endorsement status and on the Moody's office that issued the credit rating is available on www.moodys.com.

The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody's affiliates outside the UK and is endorsed by Moody's Investors Service Limited, One Canada Square, Canary Wharf, London E14 5FA under the law applicable to credit rating agencies in the UK. Further information on the UK endorsement status and on the Moody's office that issued the credit rating is available on www.moodys.com.

The person who approved Arch Capital Group Ltd., Arch Reinsurance Ltd., Arch Insurance (UK) Limited, Arch Reinsurance Company, Arch Insurance Company, Arch Specialty Insurance Company, Arch Property Casualty Insurance Company, Arch Capital Group (U.S.) Inc. and Arch Capital Finance LLC credit ratings is Sarah Hibler, Associate Managing Director, Financial Institutions Group, JOURNALISTS: 1 212 553 0376, Client Service: 1 212 553 1653. The person who approved Arch Mortgage Insurance Company, United Guaranty Residential Insurance Company, Arch Mortgage Guaranty Company and Arch LMI Pty Ltd credit ratings is Scott Robinson, CFA, Associate Managing Director, Financial Institutions Group, JOURNALISTS : 1 212 553 0376, Client Service : 1 212 553 1653.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

James Eck
VP-Sr Credit Officer
Financial Institutions Group
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS : 1 212 553 0376
Client Service : 1 212 553 1653

Sarah Hibler
Associate Managing Director
Financial Institutions Group
JOURNALISTS : 1 212 553 0376
Client Service : 1 212 553 1653

Releasing Office :
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS : 1 212 553 0376
Client Service : 1 212 553 1653

© 2021 Moody’s Corporation, Moody’s Investors Service, Inc., Moody’s Analytics, Inc. and/or their licensors and affiliates (collectively, “MOODY’S”). All rights reserved.

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