DBRS Morningstar Confirms Canada Guaranty Mortgage Insurance Company’s Financial Strength Rating and Issuer Rating at AA, Stable Trends

DBRS Limited (DBRS Morningstar) confirmed the Financial Strength rating and Issuer Rating of AA with Stable trends on Canada Guaranty Mortgage Insurance Company (Canada Guaranty or the Company).

KEY RATING CONSIDERATIONS
The AA rating confirmations and Stable trends reflect the Company’s operational excellence in achieving market share gains and diversifying its lender base over the past few years. The Company has also demonstrated consistently strong financial results, including in 2022. Its combined ratio of 14.5% is considered very strong and below historical trends, resulting in record high return on equity (ROE) for the Company in 2022. Canada Guaranty’s investment portfolio is of high quality and liquid. It is also of relatively short duration, allowing the Company to benefit from higher reinvestment yields and substantially increase the contribution to income coming from investments. The ratings also reflect DBRS Morningstar’s expectation that the housing market slowdown and high interest rates will lead to more mortgage defaults in 2023 compared to current levels. An economic slowdown or a recession resulting in a high unemployment rate, in combination with a housing market decline, presents risks to the mortgage insurance sector and Canada Guaranty. DBRS Morningstar believes that the Company is well equipped to manage higher anticipated claims given its strong financial performance and high capitalization levels, in addition to home assistance programs.

Mitigating the potential fallout from the housing market slowdown are the strong macroeconomic fundamentals in Canada, including the low and resilient unemployment rate and the GDP growth. Canada Guaranty’s insured portfolio borrower quality remains resilient as indicated by average credit scores for scheduled 2023 renewals that are expected to be even better than at origination. Past home price appreciation, income growth, and high savings rate prior to mid-2022 have allowed the borrowers to achieve significant home equity gains and reduce their loan-to-value ratios. Mortgages originated in the last two years are subject to heightened risk since a higher proportion have a variable rate and equity build-up that is small or negative. Depending on the lenders’ policies, some of these borrowers are required to increase the size of their mortgage payments with each interest rate increase, while others keep a fixed payment, but the proportion of payment that goes toward mortgage balance repayment is reduced, in some cases resulting in negative amortizations. In order to address those concerns, lenders are offering longer amortization periods and other loan modifications to the most vulnerable borrowers.

Positively, Canada Guaranty’s delinquency rate as of Q4 2022 is the same as in 2021 and below pre-pandemic levels, and historical long-term rates. Additionally, the mortgage market is regulated with very robust underwriting standards, ensuring that borrowers can withstand much higher rates than those prevailing at origination, which should limit potential losses.

RATING DRIVERS
A ratings upgrade is unlikely given the current high rating level. Conversely, a material deterioration in capitalization levels and profitability would result in a ratings downgrade.

RATING RATIONALE
The Company has maintained strong financial results continuing with its disciplined underwriting practices while growing its market share by increasing business allocations from new and existing lenders. DBRS Morningstar expects that this increased market share will be sustained over time as the mortgage insurance market in Canada trends to approximately equal shares amongst its three players. This outcome is a testament to the Company's strategic growth and operational excellence. Additionally, the Company has successfully improved the diversification of its lender base that is now at par with its peers. However, being a monoline insurer, the Company lacks diversification at the insurance product level.

Canada Guaranty has a conservative credit risk profile coupled with high levels of liquidity. The Company does not invest in common shares and has a short-duration investment portfolio predominantly comprising of highly rated government bonds. Cash and short-term investments are a significant portion of the portfolio, which contributes to its low market risk that is consistent with the Company’s high rating.

Canada Guaranty has demonstrated strong underwriting results, including an industry-leading combined ratio and a record-high ROE. Investment income more than doubled in 2022 owing to higher interest rates supported by the short duration of its investment portfolio. Borrower credit quality remains good despite the significantly higher interest rates, elevated inflation, and the slowdown in the housing market. Mitigating any potentially severe deterioration in the insurance portfolio is the large equity build up over the past several years prior to the second half of 2022 and low unemployment rate.

Canada Guaranty holds sufficient assets in low risk and liquid investments to meet the liquidity needs arising from its liabilities. While profitability levels are expected to stay resilient, revenue generation has slowed down. DBRS Morningstar expects delinquency rates to increase along with higher insured losses throughout the year because mortgage default claims are correlated with macroeconomic fundamentals, which have deteriorated over the past 12 months. However, claims are fairly predictable with approximately 12–18 months of lead time, which increases the importance of effective monitoring and homeowner assistance programs.

In addition to being well capitalized, the Company also enjoys strong shareholder financial support from Ontario Teachers’ Pension Plan Board (Issuer Rating of AAA, Stable trend, by DBRS Morningstar) and National Mortgage Guaranty Holdings Inc. The regulatory capital ratio is well above regulatory target. However, Canada Guaranty’s capital ratio is expected to decline somewhat to be closer to its operating range of 160%–165%, following the adoption of IFRS 17 in Q1 2023 and as the housing market adjusts in light of higher interest rates.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance factors that had a significant or relevant effect on the credit analysis.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/396929 (May 17, 2022).

The Grid Summary Grades for Canada Guaranty Mortgage Insurance Company are as follows: Franchise Strength – Strong/Good; Risk Profile – Strong; Earnings Ability – Very Strong/Strong; Liquidity –Strong; Capitalization – Strong/Good.

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

The principal methodology is the Global Methodology for Rating Insurance Companies and Insurance Organizations (August 31, 2022; https://www.dbrsmorningstar.com/research/402220). In addition, DBRS Morningstar uses the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (May 17, 2022; https://www.dbrsmorningstar.com/research/396929) in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found on the issuer page at www.dbrsmorningstar.com.

The rating was initiated at the request of the rated entity.

The rated entity or its related entities did participate in the rating process for this rating action.

DBRS Morningstar had access to the accounts, management, and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

This is a solicited credit rating.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. DBRS Morningstar’s outlooks and ratings are under regular surveillance.

For more information on this credit or on this industry, visit www.dbrsmorningstar.com.

DBRS Limited
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