Fitch Rates Arch Capital's $450MM Preferred Shares 'BBB+'
KEY RATING DRIVERS
This new issue is rated equivalent to ACGL's existing series C non-cumulative preferred shares. The net proceeds will be used to fund a portion of the cash consideration for ACGL's acquisition of United Guaranty Corporation (UGC) from American International Group, Inc. (AIG), to pay related costs and expenses and for general corporate purposes.
Fitch's hybrid securities rating methodology allocates 100% of the preferred shares' principal to equity in evaluating financial leverage. The offering is expected to close on Sept. 29, 2016 and is not contingent on the closing of the UGC acquisition, which is expected to close in either late fourth-quarter 2016 or early first-quarter 2017, subject to regulatory and government-sponsored enterprise (GSE) approval.
The Negative Rating Watch on ACGL's holding company ratings reflects increased financial leverage to finance the purchase of UGC. It also reflects Fitch's anticipated change to a 'ring-fencing' environment classification for ACGL from a 'group solvency' approach following the purchase of UGC, as the acquisition is likely to increase the amount of capital outside of the Bermuda group solvency environment.
Financial leverage pro forma for the purchase of UGC increases sizably from 11.9% at June 30, 2016 to approximately 20%-25% pro forma (depending on final Fitch equity credit). The increase is due to an expected $1.125 billion in debt issued to partially finance the cash consideration for the acquisition. In addition, ACGL expects to issue $975 million of convertible non-voting perpetual preferred stock (either 100% or 50% equity credit depending on final terms) to AIG as stock consideration for the acquisition.
Fitch would expect to downgrade the holding company ratings by one notch following the increase in financial leverage or upon the closing of the UGC acquisition.
Key rating triggers that could result in a downgrade of both the IFS and holding company ratings include difficulties experienced in the mortgage insurance 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 triggers that could result in an upgrade include continued improvement in ACGL's competitive market position while demonstrating favorable run-rate earnings and low volatility in the challenging (re)insurance environment, with a combined ratio in the low 90s; and successfully managing the expansion of its mortgage operations with the planned acquisition of UGC. In addition, continued growth in equity while maintaining a net premiums written-to-equity ratio of 0.8x or lower, a financial leverage ratio at or below 20%, and fixed charge coverage of at least 10x could generate positive rating pressure.
FULL LIST OF RATING ACTIONS
Fitch assigns the following rating and places it on Rating Watch Negative:
Arch Capital Group, Ltd.
--$450 million 5.25% series E non-cumulative preferred shares at 'BBB+'.
Fitch currently has the following ratings on Negative Watch:
Arch Capital Group, Ltd.
--Issuer Default Rating 'A';
--$300 million 7.35% senior unsecured notes due 2034 'A-';
--$325 million 6.75% series C non-cumulative preferred shares 'BBB+'.
Arch Capital Group (U. S.) Inc.
--$500 million 5.144% senior notes due 2043 'A-'.
Fitch currently rates the following 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
--Insurer Financial Strength 'A+'.