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Rating Action:

Moody's reviews Arch Capital Group's ratings for downgrade following agreement to acquire United Guaranty

17 Aug 2016

Affirms Baa1 IFS rating of Arch Mortgage Insurance Company

New York, August 17, 2016 -- Moody's Investors Service, ("Moody's") has placed the A3 senior unsecured debt rating of Arch Capital Group Ltd. (Arch) and the A1 insurance financial strength (IFS) ratings of Arch's insurance and reinsurance operating subsidiaries on review for downgrade following the announcement on 15 August that Arch has agreed to acquired United Guaranty Insurance Co. (UGC, Baa1 on review for downgrade) from AIG for $3.4 billion. Moody's also took various actions on various subsidiaries of the group, as listed below.

Arch plans to finance the acquisition through the issuance of $1,375 million of debt and perpetual preferred shares, draw $200 million on its revolving credit facility and $975 million of convertible non-voting common share equivalent to AIG and other internal resources. The transaction is expected to close in late 2016 or early 2017, subject to Government Sponsored Enterprises (GSEs) and regulatory approvals.

RATINGS RATIONALE

ARCH CAPTIAL GROUP AND ITS P&C INSURANCE AND REINSURANCE SUBSIDIARIES

The review for downgrade of Arch Capital Group's ratings reflects Moody's view that the acquisition of UGC would materially increase Arch Capital Group's credit risk profile by substantially expanding the group's mortgage insurance operations and meaningfully raise the group's financial leverage. On a proforma basis, the mortgage operations are expected to represent 24% of gross written premiums, up from 8% today.

Moody's currently sees the stand alone credit profile of US mortgage insurers in the Baa range for a number of reasons. These include the very low historical through-the-cycle profitability of US mortgage insurance, its undifferentiated commoditized product, and industry conditions that are largely tied to some of its main stakeholders (lenders and GSEs), public policy changes, the performance of the housing sector, and other uncontrollable variables.

The rating agency further commented that the acquisition provides some diversification benefits to Arch 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 origination and benign housing market conditions.

Arch's plan to fund a substantial portion of the acquisition through the issuance of debt and preferred securities would increase its financial leverage above current expectations, but still within the range for the broad rating category, and substantially in excess of historical levels. While Moody's believes that Arch will gradually reduce its financial leverage, it is likely to be elevated for some time.

RATING RATIONALE -- ARCH MORTGAGE INSURANCE COMPANY

Moody's affirmation of Arch Mortgage Insurance Company's (AMI) Baa1 rating reflects the anticipated improvement to its stand-alone credit profile following the UGC acquisition. UGC would bring a well-established US mortgage insurance franchise with strong near-term profitability to the Arch group. While the rating agency expect some overlap in lender relationships between UGC and AMI, that should results in some loss of combined business written, AMI's historical strength with credit unions channels supplements UGC's strong broad market position.

Moody's has a Baa2 stand-alone credit profile for United Guaranty Residential Insurance Company (public IFS rating Baa1, review down), versus a Baa3 stand-alone credit profile for AMI. These prospective strengths could be moderated by the lower expected future rating uplift from the support provided by Arch given the review for downgrade of Arch Reinsurance Ltd. (A1, review down) with which AMI has a quota share reinsurance agreement.

RATING RATIONALE -- ARCH MORTGAGE GUARANTY COMPANY

The review for downgrade of Arch Mortgage Guaranty Company (AMG) reflects the review for downgrade of Arch Reinsurance Ltd. (A1, review down) and Arch Reinsurance Corporation (A1, review down), the two affiliates that provide support in the form of extensive quota-share reinsurance. AMG has modest stand-alone resources and, as a non-GSE focused mortgage insurer, narrower business prospects.

RATING DRIVERS

The close of the acquisition of UGC by Arch under terms broadly consistent with those announced by the company would most likely lead to a rating downgrade by one notch of the Arch Group entities currently under review. This would reflect the group's substantially higher exposure to mortgage insurance and increased debt leverage.

As part of the review, Moody's will assess the role that AMG is expected to play in the group's mortgage insurance strategy and the support it receives from its higher rated affiliates, and whether these warrant harmonization of its rating with its mortgage insurance affiliates or translates into a distinct credit strength.

A termination of the planned transaction, with no material change to Arch's current financial profile would most likely stabilize Arch's ratings at current levels.

RATING LIST

The following ratings have been placed under review for downgrade:

Arch Capital Group Ltd. -- senior unsecured debt at A3; preferred stock at Baa2 (hyb);

Arch Reinsurance Ltd. -- insurance financial strength at A1;

Arch Insurance Company (Europe) Ltd. -- insurance financial strength at A1;

Arch Capital Group (U.S.) Inc.-- BACKED senior unsecured debt at A3

Arch Reinsurance Company -- insurance financial strength at A1;

Arch Insurance Company -- insurance financial strength at A1;

Arch Specialty Insurance Company -- insurance financial strength at A1;

Arch Excess and Surplus Insurance Company -- insurance financial strength at A1;

Arch Mortgage Guaranty Company -- insurance financial strength at A3.

The following rating has been affirmed with a stable outlook

Arch Mortgage Insurance Company -- insurance financial strength at Baa1.

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.

The principal methodology used in rating Arch Capital Group Ltd., Arch Reinsurance Ltd., Arch Insurance Company (Europe) Ltd., Arch Reinsurance Company, Arch Insurance Company, Arch Specialty Insurance Company, Arch Excess and Surplus Insurance Company, and Arch Capital Group (U.S.) Inc. was Global Reinsurers published in April 2016.The principal methodology used in rating Arch Mortgage Guaranty Company and Arch Mortgage Insurance Company was Mortgage Insurers published in April 2016. Please see the Ratings Methodologies page on www.moodys.com for a copy of these methodologies.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt 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.

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

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.

Siddhartha Ghosh
Vice President - Senior Analyst
Financial Institutions Group
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Stanislas Rouyer
Associate Managing Director
Financial Institutions Group
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

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

No Related Data.
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MJKK and MSFJ also maintain policies and procedures to address Japanese regulatory requirements.

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