DBRS Puts Kingsway Financial and Affiliates Under Review – Negative

DBRS has today placed its ratings on Kingsway Financial Services Inc. and affiliates (Kingsway or the Company) Under Review with Negative Implications and has removed the Negative trend following the pre-release of Q4 2008 results. The Company’s senior debt is rated BBB (low).

Among many negative developments, DBRS is foremost concerned that the Company’s largest subsidiary, Lincoln General Insurance Company (Lincoln), has continued to report adverse reserve development through each quarter of 2008, even as the Company argued that internal claims management and more conservative reserve assumptions established at year-end 2007 would limit further adverse development in 2008. Adverse reserve development totaled $70 million in Q4 2008, on top of $86.3 million in the first nine months of 2008, which followed close to $200 million reported in 2007 and $76 million in 2006 on the same account. In the current financial market environment, the Company’s underwriting results are only aggravated by net realized losses in the Company’s investment portfolio totaling $114 million in Q4 and $138.7 million for the year. Goodwill impairment and a future tax asset valuation adjustment related to the decision to exit non-core and unprofitable lines of business will add another $200 million to the Company’s 2008 loss. In aggregate, the Company expects to report a loss for the quarter of close to $340 million and $385 million for the year.

From a financial profile perspective, the erosion of common equity related to these recent losses will cause the Company’s senior debt ratio to increase to 26.8% from 18.3% at the end of March 2008. Total debt ratio, including preferred shares, is expected to increase to 38.7% from 26.4%. While representing an increase from March 2008 levels, these financial leverage ratios are no higher than they were at year-end 2007, prior to when the Company actively repaid close to $190 million of debt during 2008. From a statutory capital perspective, the Company is expected to be in discussions with Lincoln’s Pennsylvania regulator regarding a plan to restore the subsidiary’s capital adequacy, largely through limiting its business lines.

Confronted with its slumping financial performance, the Company has commenced a restructuring program that will see it exit non-core and unprofitable business segments, simplify its corporate structure and de-risk both sides of its balance sheet, including the elimination of its common equity portfolio. The Company expects the program to generate annual expense savings of $80 million, representing a 30% reduction to general expenses combined with an estimated 20% reduction in written premium. The Company’s employee complement is expected to drop by 750 positions within two years.

Management’s credibility has been badly eroded by ten consecutive quarters of adverse development on account of the Lincoln operation. DBRS acknowledges that the Company’s relatively new management team is dealing with what is now apparently a legacy of poor risk management policies and board governance, especially as it applies to its largest subsidiary.

The resolution of the Under Review with Negative Implications status will follow shortly after Kingsway’s full release of Q4 2008 results. While positive, recent efforts to cut costs, refocus the Company, free up and reposition surplus capital, and reduce debt are, on their own, not likely to warrant DBRS maintaining the investment-grade rating at this time.

Notes:
All figures are in US dollars unless otherwise noted.

The applicable methodology is Rating Canadian Property and Casualty Insurance Companies, which can be found on our website under Methodologies.

This is a Corporate (Financial Institutions) rating.