DBRS Confirms Canada Guaranty Financial Strength at AA (low), Stable Trend

DBRS has today confirmed the Financial Strength rating of Canada Guaranty Mortgage Insurance Company (Canada Guaranty or the Company) at AA (low). The trend is Stable. The confirmation reflects the Company’s substantial capital adequacy as calculated following the application of the DBRS residential mortgage-backed securities (RMBS) valuation model, assuming a runoff scenario mitigated somewhat by a number of qualitative factors. The Company’s unseasoned business model, its past concentration with a limited number of originating lenders, suboptimal scale, which is expressed in a relatively high expense ratio, and the absence of a longer-term track record of sustained profitability contribute to a multiple-notch adjustment to the strict capital adequacy model result to arrive at the final AA (low) rating.

The quality of the Company’s portfolio of insurance in force has improved reflecting a continuing strong housing market and a strategic shift in favour of prime mortgages as captured by lower average LTV ratios and higher credit scores. However, this improvement has been offset by the Company’s larger portfolio of insurance in force, given a relatively modest increase in the level of available capital due to positive earnings and an injection of $17 million in equity capital in 2010 and 2011. Nevertheless, capital remains more than sufficient to support the AA (low) financial strength rating.

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 RMBS valuation methodology, as well as under the federal regulator’s minimum capital test (MCT) requirement, including providing enough capital to support organic growth. Under the new ownership, business plan and government guidelines for MI, the Company will be underwriting more conservative mortgages while sourcing insurance business through more prime mortgage lenders than in its early years. Subject to Canada Guaranty’s growth rate, the policy portfolio is therefore expected to become larger, albeit less risky as more conservative new business is written and older business runs off.

The Company’s underwriting results have improved in the context of the recent strong housing market, decent economic activity and a higher-quality insured loan portfolio; however, the portfolio is less seasoned than its peer group. While DBRS does not necessarily predict a Canadian housing crisis on par with that which has been experienced in the U.S., it does recognize that the housing market is vulnerable to any slowdown or a return to a normal interest rate environment. Should the Canadian housing market weaken, Canada Guaranty would be disproportionately more exposed than its peers given that it has written all of its policies in the most recent five-year period of increasing house prices. This negative consideration can only be addressed with the passage of time and portfolio growth through the business cycle.

The Company’s 2011 business volumes were dependent on close relationships with selected lenders who originate prime loan volumes in the mortgage space. In 2012, the Company expects to leverage its increasing connectivity with several of the major Canadian chartered banks to improve lender diversification and volumes. With an associated increase in scale, DBRS expects to see a reduction in the Company’s expense ratio over time.

However, with an expected increase in written premiums in the near term, resulting from expanding bank platforms and changes to the industry structure, the Company will require continuing capital injections in the near term. DBRS takes comfort that the Company has the demonstrated support of its shareholders, who injected $8 million in 2010 and $9 million in 2011. In the longer term, the Company is poised to achieve the scale and a corresponding track record of consistent profitability, which should allow it to become self-sustaining.

The Company is being built on the foundations of experienced owners and management with adherence to strong risk management processes and controls. The Company’s technological platform is very much state of the art and should require limited investment in order to accommodate organic growth targets.

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

The applicable methodology is Rating Canadian Mortgage Insurance Companies dated March 22, 2011, which can be found on our website under Methodologies.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.