DBRS Limited (DBRS Morningstar) confirmed the Financial Strength Rating of Genworth Financial Mortgage Insurance Company Canada (Genworth or the Company) at AA. DBRS Morningstar also confirmed the Issuer Rating and Senior Unsubordinated Debt rating of Sagen MI Canada Inc. (Sagen; previously Genworth MI Canada Inc.), Genworth’s holding company, at A (high), the Preferred Shares rating at Pfd-2 (high), and the Fixed-to-Fixed Rate Subordinated Notes rating at A (low). DBRS Morningstar changed all trends to Stable from Negative.
KEY RATING CONSIDERATIONS
The trend change to Stable from Negative reflects the reduction in risk regarding the Canadian economic outlook from the prior year, when DBRS Morningstar changed the trends to Negative due to increased risk of mortgage defaults arising from the steep increase in unemployment levels resulting from the Coronavirus Disease (COVID-19) pandemic. DBRS Morningstar’s expectation of higher defaults resulting from elevated unemployment levels has not materialized primarily as a result of government actions intended to prevent homeowner defaults, including the Canada Emergency Response Benefit and the Canada Emergency Wage Subsidy. The improvement in Canada’s economic conditions in recent months includes a reduction in unemployment levels and a more positive GDP outlook compared with a year ago, combined with strong housing market conditions, all of which are factors that contribute positively to Sagen’s risk and earnings profile. Nonetheless, while risks are significantly reduced compared with the prior year, uncertainty remains regarding future economic conditions particularly as stimulus measures intended to protect the economy from the negative impacts resulting from the ongoing coronavirus pandemic slowly wind down, likely resulting in higher loss rates. It is important to note, however, that current delinquency levels are still very low relative to the historical norm, and the Company maintains an adequate amount of capital to protect itself against any unexpected losses. Despite an uncertain operating environment, Sagen has performed well in 2020, with the Company maintaining strong financials, as evidenced by low loss ratios, and increasing its market share and new business volumes. In our view, Sagen’s strong fundamentals provide strength to its rating assessment and positions it well to handle any unexpected developments regarding the length and nature of the eventual economic recovery. DBRS Morningstar recognizes the Company’s ability to navigate through the ongoing uncertain economic environment, given its proactive management, a conservatively underwritten insurance portfolio, and high levels of regulatory capital.
RATING DRIVERS
Given the current high rating level, an upgrade of the ratings is unlikely especially given continuing economic uncertainty. Conversely, a ratings downgrade would result if Sagen’s capital adequacy deteriorates substantially, leading to a reduced buffer over regulatory capital requirements, or if there is a material deterioration in its loss ratios over an extended period of time that negatively affects earnings. A ratings downgrade would also occur if there is a sustained increase in leverage from current levels, combined with a reduction in cash flow.
RATING RATIONALE
Despite the challenging operating environment, Sagen experienced a strong year in 2020, as evidenced by low loss ratios, high cure activity, and increases in new business volumes. As in prior years, Sagen’s financial metrics have benefitted from a strong housing market, resulting in stable and predictable earnings despite elevated unemployment levels. Government measures to support the economy through the pandemic also proved key to protecting the housing market and, consequently, the mortgage insurers from financial losses. Sagen also benefitted from market opportunities arising from the Canada Mortgage and Housing Corporation’s decision to tighten its underwriting criteria and consequently reduce its borrower base, allowing the private mortgage insurers to gain a significant amount of new business volumes in a short period of time. There remains some uncertainty regarding the nature of the eventual economic recovery and how long the stressed conditions will persist; however, Sagen’s continual efforts to strengthen its borrower profile, enhance its risk management, and maintain adequate amounts of regulatory capital should enable it to navigate a challenging environment successfully.
The Company’s capital structure has undergone a significant change in recent months, with the leverage ratio (calculated by DBRS Morningstar as debt plus preferred shares to total capital) increasing to 30% (on a proforma basis) from prior levels of approximately 10% to 15%. The Company has recently introduced preferred shares and hybrid bonds in its capital structure as well as increased the amount of senior debt. While Sagen’s net income and cash flow can comfortably support this higher level of debt, the increased leverage reduces some of its financial flexibility. While the ratings have not been negatively affected by the increase in debt, given the Company’s stable financials and high coverage ratios, a sustained increase in debt levels, particularly if combined with a reduction in cash flow, would put negative pressure on the ratings.
Brookfield Business Partners L.P. together with certain of its affiliates and institutional partners (collectively “Brookfield”) also recently wholly acquired the Company, increasing its ownership in Sagen to 100% effective April 2021 from 57% in 2020. The shift to a private one from a publicly traded company reduces Sagen’s ability to raise capital by issuing common shares, consequently reducing some of its financial flexibility. The ratings on Sagen have not been affected by the ownership change, given that there has been minimal change to the insurance operations while the Company’s risk profile has remained strong.
Canada’s strong housing market has bolstered the Company’s financials. The housing market has not been adversely affected so far in 2020 and 2021 because of several factors, including increased fiscal stimulus, lower interest rates, and a strengthened consumer balance sheet. By and large, homeowners that had initially opted to defer their mortgage payments have resumed making payments, eliminating the risk of delinquencies sharply rising as the deferral period from most lenders expires. While the recent runup in home prices increases the risk of a housing market bubble, it can also provide a greater equity cushion and result in lower average loan-to-value ratios, providing protection against an increase in claims losses.
Some regulatory risk remains on the horizon, as a heated housing market and rapid price increases in many parts of Canada may pressure governmental authorities to take certain actions, such as further tighten underwriting requirements to reduce the risk to the overall economy. Depending on future government actions, such measures may result in lower sales and consequently, lower new business volumes for mortgage insurers, including Sagen.
Canadian mortgage insurers are highly regulated, with insurers subject to stringent underwriting criteria and minimum regulatory capital levels. The credit profile of the Company’s average borrower is strong and is reflected in its loss ratios, which have been low for the past few years relative to the historical norm before the pandemic. As a monoline insurer, the Company has significantly increased risk during economic downturns, when economic growth prospects weaken and unemployment increases. Generally, mortgage default rates are closely linked to changes in unemployment. Given DBRS Morningstar’s current expectations, claims are likely to increase in 2021 and 2022, increasing the Company’s loss ratios from their current low levels, although the increase in losses is likely to remain manageable for the Company. Elevated levels of regulatory capital also provide an adequate buffer against unexpected increases in losses. To note, Sagen maintained minimum regulatory capital requirements through the 2008 economic downturn in Canada.