DBRS Upgrades Canada Guaranty Rating to AA (low), Trend Stable

DBRS has today upgraded the Financial Strength rating of Canada Guaranty Mortgage Insurance Company (Canada Guaranty or the Company, formerly AIG United Guaranty Mortgage Insurance Company Canada (AIGUG Canada)), to AA (low) from A (high). The trend is Stable.

The Company has been Under Review with Positive Implications since the announcement of the sale of AIGUG Canada on January 5, 2010. The upgrade reflects DBRS’s review of the Company’s capital adequacy as of the end of 2010 in the context of its existing portfolio of mortgage insurance policies and certain qualitative considerations. While the initial rating assessment of the Company based on the calculation of capital adequacy using the DBRS RMBS model and the Company’s available capital suggests a AA (high) rating, there are a number of qualitative aspects that have caused DBRS to reduce the Company’s rating by two notches to reflect the Company’s start-up nature, including the lack of critical scale, the absence of sustained profitability, and the relatively unseasoned nature of its insurance liabilities.

With new ownership and a new business strategy, the Company resembles a start-up operation. DBRS nevertheless believes that the Company is being built on relatively strong foundations. The experienced management team is largely unchanged following the sale. The Company will retain and continue to use the technological platform that was built at some cost to American International Group, Inc. (AIG). Despite a transition to the Company’s own operating platform, Canada Guaranty is expected to maintain the best controls and risk management processes of its former parent, while disassociating itself from any legacy credit concerns.

Building meaningful market share will be difficult, starting from a position of sub-optimal scale. However, the Company is targeting select prime mortgage origination customers, which will limit the costs and risks of market share expansion. The Company can be expected to achieve reasonable underwriting profitability with very modest gains in market share (currently estimated at just over 3% of new business written in Canada). Canada Guaranty is targeting a modest market share in the near term, which DBRS expects should be achievable given its evolving lender counterparty relationships.

The Company’s existing book of business was largely put in place in 2007 and 2008 at the top of the economic and housing cycles. The subsequent economic slowdown had a disproportionate adverse impact on the Company’s financial results in 2009. DBRS expects the Company’s reported loss ratio to continue to improve as the broader economy continues to recover and delinquencies decline. The recession may have accelerated paid losses, and much of the deterioration in loss ratio in 2009 resulted from a $43 million increase in loss reserves under AIG, ownership which assumed more adverse U.S. loss experience. Following the sale of the Company by AIG in early 2010, there was favourable reserve development in 2010 of $7.6 million. Correspondingly, even though paid losses continued to increase in 2010, the net loss incurred, including reserve adjustments, fell significantly so that the Company reported a much smaller underwriting loss in 2010 and a profit for the year after investment income is included.

DBRS estimates that following ten years of increases, Canadian house prices remain close to 30% in excess of their normal range relative to personal incomes and the rental market. (See recent DBRS Industry Study, Renovations Underway: Housing Markets, Residential Mortgages and Household Leverage in Canada, published in May 2010.) Given Canadian consumer debt loads, rising interest rates could result in a correction in house prices – especially if accompanied by a slowing economy. Such a development could cause the Company to return to a loss-making position, requiring additional capital injections from shareholders. This capital would be available to offset the adverse impact of any subsequent deterioration in loss experience.

The Stable trend assigned to the Company’s rating reflects an assumption that the Company’s shareholders will maintain its healthy capital adequacy under the DBRS methodology, as well as under the federal regulator’s MCT requirement. Moderate near-term growth expected in the Company’s insurance portfolio should be funded through organic capital generation. Under the new ownership, business plan and government guidelines for mortgage insurance, the Company will be underwriting more conservative mortgages while dealing with more prime mortgage originators than in its early years. Subject to Canada Guaranty’s growth rate, the policy portfolio is therefore expected to become less risky as new business is written and older business runs off.

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

The applicable methodology is Rating Mortgage Insurance Companies in Canada, which can be found on our website under Methodologies.