Morningstar DBRS Confirms Sagen Mortgage Insurance Company Canada’s Financial Strength at AA, and Sagen MI Canada Inc.’s Issuer Rating at A (high); All Trends Are Stable

DBRS Limited (Morningstar DBRS) confirmed the Financial Strength rating of Sagen Mortgage Insurance Company Canada at AA with a Stable trend. In addition, Morningstar DBRS confirmed the Issuer Rating and Senior Unsubordinated Debt rating of Sagen MI Canada Inc. (Sagen or the Company) at A (high), the Preferred Shares rating at Pfd-2 (high), and the Fixed-to-Fixed Rate Subordinated Notes rating at A (low). All trends are Stable.

KEY CREDIT RATING CONSIDERATIONS
The rating confirmations and Stable trends reflect the Company's position as the largest private residential mortgage insurer in the Canadian market as well as its resilient earnings and capitalization levels. The ratings also reflect Sagen's exposure to lower-rated and less liquid assets. Sagen's robust risk management framework allows it to closely monitor and manage its insurance and investment risk in order to meet increasingly challenging market conditions that are expected to result in higher mortgage defaults compared to 2023 levels.

The recent slowdown in housing market activity has resulted in lower written premiums. However, profitability metrics show continued resilience. Borrower quality remains high and delinquency rates are comparable to the past two years and still below pre-pandemic levels. For most mortgages due for renewal in 2024, the payment shock arising from significantly higher interest rates is somewhat mitigated by income growth and strong housing market appreciation since the time of purchase, about five years ago. These mortgages are predominantly on a fixed-rate payment schedule. However, mortgages originated in 2021 and 2022, are subject to heightened risk as a larger proportion of them are on variable rate fixed payments and may be negatively amortizing. In order to mitigate the payment shock at renewal, lenders are offering longer amortization periods and other loan modifications to the most vulnerable borrowers, which should act to lessen the incidence of loan defaults. Unemployment rates remain close to their record lows, which should also reduce the potential losses for Sagen.

CREDIT RATING DRIVERS
A credit ratings upgrade is unlikely given the current high rating level. Conversely, a material deterioration in capitalization levels and profitability or a significant weakening of its investment risk profile would result in a credit ratings downgrade.

CREDIT RATING RATIONALE

Franchise Strength Building Block Assessment: Strong/Good
Sagen is the largest private mortgage insurer in Canada. It has a long-standing and well-established distribution network with an insured mortgage portfolio that is well diversified across regions and origination years. Recent and ongoing information technology investments are expected to further increase its operational effectiveness. However, as a pure Canadian monoline insurer, it lacks diversification by product and business type.

Risk Profile Building Block Assessment: Strong/Good
Sagen's large investment portfolio is primarily comprised of investment-grade bonds. The Company does not invest in equities but has been enhancing its investment returns through increasing allocations to alternative fixed income assets, including high-yield bonds, emerging market debt, and private loans. These assets are riskier compared to the plain vanilla bonds that used to make up the majority of its invested assets a few years ago. The Company has robust risk management capabilities and resources to closely monitor and manage its insurance and investment risks.

Earnings Ability Building Block Assessment: Very Strong/Strong
Sagen has demonstrated consistently strong financial results over the last few years, including very low combined ratios and a high return on equity. Investment income contribution to earnings has improved as a result of the higher reinvestment yields on maturing bonds, and because of variable rate investments. Mortgage delinquency rates remain low but are expected to rise as borrowers feel the strain of significantly higher interest rates and because of home price depreciation. This will lead to more mortgage defaults and higher loss ratios than the record lows experienced during the housing boom period.

Liquidity Building Block Assessment: Strong/Good
Sagen holds sufficient liquid assets to meet the liquidity needs arising from its liabilities under normal and stressed market conditions as illustrated through its stress testing. The high proportion of cash and equivalents, as well as Sagen's access to its liquidity facility, are viewed positively. Additionally, claims are fairly predictable with approximately 12-18 months of lead time, which aids in liquidity management.

Capitalization Building Block Assessment: Strong/Good
The Company's leverage ratio increased at the time of its privatization in 2021, and is currently close to its target leverage of 30%. Positively, its cash flow generation capabilities are solid and fixed charge coverage is very strong. Sagen's regulatory capital ratio exceeds its internal operating targets as a precautionary measure against heightened macroeconomic uncertainty.

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

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (January 23, 2024) https://dbrs.morningstar.com/research/427030.

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

The principal methodology is the Global Methodology for Rating Insurance Companies and Insurance Organizations (April 15, 2024) https://dbrs.morningstar.com/research/431180. In addition Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (January 23, 2024; https://dbrs.morningstar.com/research/427030)in its consideration of ESG factors.

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

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

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

Morningstar DBRS had access to the accounts, management and other relevant internal documents of the rated entity or its related entities in connection with this credit 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. Morningstar DBRS's outlooks and credit ratings are under regular surveillance.

For more information on this credit or on this industry, visit dbrs.morningstar.com.

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