CHICAGO--(BUSINESS WIRE)--Fitch Ratings has assigned an 'A-' rating to Arch Capital Finance LLC's (ACF) issuance of $500 million 4.011% senior notes due 2026 and $450 million 5.031% senior notes due 2046. The Ratings have been placed on Negative Watch. ACF is a wholly owned subsidiary of Arch Capital Group, Ltd. (ACGL), and ACGL has fully and unconditionally guaranteed the notes on a senior unsecured basis.
KEY RATING DRIVERS
The new issuance is rated equivalent to ACGL's existing senior notes. The net proceeds will be used to fund a portion of the cash consideration for ACGL's acquisition of United Guaranty Corporation (UGC) from American International Group, Inc. (AIG), to pay related costs and expenses, and for anticipated growth in the company's mortgage and other select businesses. The debt offering is not contingent on the closing of the UGC acquisition, which is expected to be completed by year-end 2016 or early first quarter 2017, subject to regulatory and government-sponsored enterprise (GSE) approval.
The Negative Rating Watch on ACGL's holding company ratings reflects Fitch's anticipated change to a 'ring-fencing' environment classification for ACGL from a 'group solvency' approach following the purchase of UGC, as the acquisition increases the amount of capital outside of the Bermuda group solvency environment. Under Fitch's rating criteria, a ring-fencing approach is applied to global groups that have more than 30% of capital or earnings from foreign subsidiaries. At year-end 2015, ACGL had 34% and 17% of capital and earnings, respectively, from foreign subsidiaries.
The Negative Rating Watch also reflects Fitch's potential concerns about the financial strength of UGC and its implications on the overall credit quality of ACGL's holding company. Fitch does not rate UGC. The agency expects to resolve the Negative Watch following a more detailed review UGC's credit quality. This includes gaining an understanding of ACGL's operating strategy, business growth expectations and capital management plans for UGC.
Financial leverage increases sizably from 10.9% at Sept. 30, 2016 to approximately 21% pro forma for the transaction due to a total $1.3 billion of senior debt and revolving credit agreement borrowings to partially finance the cash consideration for the acquisition. Following the debt issuance and purchase of UGC, pro forma fixed charge coverage declines to 7.8x from 9.9x at Sept. 30, 2016, which Fitch still views as strong. In addition, ACGL expects to issue $1.0 billion of convertible non-voting common equivalent preferred shares (100% equity credit) to AIG as stock consideration for the acquisition.
Fitch expects to downgrade the holding company ratings by one notch upon the closing of the UGC acquisition to reflect a 'ring fencing' classification. The holding company ratings could be downgraded by an additional notch should Fitch view UGC's credit quality as meaningfully weakening ACGL's overall financial strength or debt servicing capabilities.
Key rating triggers that could result in a downgrade of both the insurer financial strength (IFS) and holding company ratings include difficulties experienced in the mortgage insurance operations, including failure to successfully integrate UGC, or sizable adverse prior-year reserve development. In addition, increases in underwriting leverage above 1.0x net premiums written-to-equity ratio or a financial leverage ratio above 25% could generate negative rating pressure.
ACGL's hybrid securities ratings could be lowered by one notch to reflect non-performance risk should Fitch view Bermuda's regulatory environment as becoming more controlling in its supervision of (re)insurers.
Key rating triggers that could result in an upgrade include: continued improvement in ACGL's competitive market position while demonstrating favorable run-rate earnings and low volatility in the challenging (re)insurance environment, with a combined ratio in the low 90s; and successfully managing the expansion of its mortgage operations with the planned acquisition of UGC. In addition, continued growth in equity while maintaining a net premiums written-to-equity ratio of 0.8x or lower, a financial leverage ratio at or below 20%, and fixed charge coverage of at least 10x could generate positive rating pressure.
FULL LIST OF RATING ACTIONS
Fitch assigns the following ratings:
Arch Capital Finance LLC
--$500 million 4.011% senior unsecured notes due 2026 'A-'; Rating Watch Negative;
--$450 million 5.031% senior unsecured notes due 2046 'A-'; Rating Watch Negative.
The following current ratings are on Negative Watch:
Arch Capital Group, Ltd.
--Issuer Default Rating 'A';
--$300 million 7.35% senior unsecured notes due 2034 'A-';
--$325 million 6.75% series C non-cumulative preferred shares 'BBB+';
--$450 million 5.25% series E non-cumulative preferred shares at 'BBB+'.
Arch Capital Group (U.S.) Inc.
--$500 million 5.144% senior notes due 2043 'A-'.
The following are currently rated as indicated with a Stable Outlook:
Arch Reinsurance Ltd.
Arch Reinsurance Company
Arch Reinsurance Europe Underwriting Designated Activity Company
Arch Insurance Company
Arch Excess and Surplus Insurance Company
Arch Specialty Insurance Company
Arch Indemnity Insurance Company
Arch Insurance Company (Europe) Limited
--Insurer Financial Strength 'A+'.
Additional information is available on www.fitchratings.com.
Insurance Rating Methodology (pub. 15 Sep 2016)
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