DBRS Morningstar Confirms A (high) Stable Ratings of Compagnie Européenne de Garanties et Cautions

DBRS Limited (DBRS Morningstar) confirmed the Financial Strength Rating and Issuer Rating of Compagnie Européenne de Garanties et Cautions (CEGC or the Company) at A (high). All trends are Stable.

KEY RATING CONSIDERATIONS
CEGC’s ratings take into consideration the Company’s strong market position in the Republic of France as the second-largest player in the home loan guarantees line of business, the extensive distribution reach it has through the Groupe BPCE banking networks and the additional diversification of earnings through its surety and financial guarantees businesses. The Company exercises prudent and conservative underwriting, which has resulted in a high-quality insurance portfolio, as evidenced by a history of consistent underwriting profitability. The Company’s focus on expense management and prudent underwriting, complemented by a strong housing market in France in the past few years, has allowed it to generate excellent earnings. CEGC has good and improving capitalization, meeting its regulatory capital requirements through a mixture of reinsurance, debt and common equity.

RATING DRIVERS
Positive rating pressure may arise from an increase in market share in the home loan guarantees business line, combined with a significant increase in scale in the smaller businesses, while maintaining a prudent risk profile. A substantial improvement in capitalization that provides a larger buffer on top of regulatory minimums, would have positive rating implications.

Conversely, negative rating pressure may arise from a material decline in underwriting profitability, as measured by an increase in the combined ratio above 95%, resulting in a sustained reduction in earnings. A shift in the risk profile, with increasing growth in business lines with poor or more volatile underwriting profitability or an increase in the proportion of riskier assets in the investment portfolio, may also have negative rating implications.

RATING RATIONALE
The sound quality of the Company’s home loan guarantees portfolio is one of the primary factors in the ratings, given that the large majority of the Company’s risk exposure arises from its home loan guarantees business. The performance of CEGC’s insurance portfolio is relatively predictable, with experience more or less in line with assumptions, during stable economic times. Risk rises during periods of adverse economic cycles where there is also a corresponding sharp increase in unemployment. In this scenario, there is an increased possibility that borrowers may no longer be able to service their home loans, resulting in an elevated frequency of defaults. The timing and amount of these claims are relatively difficult to predict and may increase significantly in times of stress. CEGC’s prudently underwritten portfolio helps mitigate this risk.

CEGC’s earnings are strong reflecting a steady source of revenues from its distribution networks. The Company has increased the premium volumes it generates over the past few years. Expenses have remained steady, and the overall loss ratio is quite low at 28% for YE2018. Earnings have also benefited from a higher-than-normal rate of refinancing activity in France in the past few years due to the low interest rate environment and a strong housing market that is experiencing good sales activity and price increases overall. Loss ratios for the smaller lines of business may be more volatile, with very low loss ratios in the social economy and social housing line and higher ratios in the professional line, for example.

DBRS Morningstar has assessed CEGC’s portfolio quality as strong, with a good borrower profile resulting from conservative underwriting practices. Home loan guarantees being underwritten go through a double-screening process, first through the lending financial institution and then independently by CEGC. Portfolio quality is reflected in the good underwriting results, as evidenced by low loss ratios. CEGC also has a strong recovery program in place, resulting in high ultimate recovery rates on defaulted loans. Overall, DBRS Morningstar has confidence in the Company’s ability to navigate a downturn in the French housing market.

Risk management is excellent and is key to CEGC being able to generate good profitability, considering the nature of the home loan guarantee product. Since the entire premium is collected upfront with no repricing ability and considering the relatively modest pricing of the product (around 1% of the loan amount), underwriting and management of risk become paramount. DBRS Morningstar also takes into consideration the specifics of the housing market in France when assessing the risk profile of CEGC’s home loan guarantee portfolio. The expansive social safety net in France, which provides unemployment benefits for an extended period of time, provides a cushion against this shock, making it a more favourable environment for mortgage insurers and home loan guarantee providers. As a result, France has experienced a relatively less volatile housing market than many other jurisdictions.

CEGC maintains a sizeable cushion over its rigorous regulatory capital requirements, which require the Company to hold a minimum amount of qualifying available solvency resources equal to at least 2% of its outstanding home loan guarantee exposure of EUR 159 billion as at YE2018. The Company has calculated its Solvency Capital Requirement coverage ratio to be 121% as at YE2018, demonstrating an improving trend and providing a good buffer above the regulatory minimum of 100%. Regulatory capital requirements are met through a combination of common equity, debt and reinsurance. The Company raised EUR 250 million in subordinated debt in October 2019, its first debt issuance, which, while increasing the amount of capital available to absorb losses, has also increased the leverage ratio to approximately 35% from nil historically (as calculated by DBRS Morningstar on a pro forma basis).

While CEGC’s capitalization is sound, it needs significant amounts of capital to fund growth. The Company has a high dividend payout rate, resulting in a lower level of retained earnings and raising some concern that high capital requirements may impair its growth plans. Additionally, the Company depends significantly on high-quality reinsurance to meet its regulatory capital requirements. DBRS views the current components of capital to be well structured, but continued management attention and monitoring of the reinsurance programs and reinsurer quality is important.

Notes:
All figures are in euros unless otherwise noted.

The applicable methodology is Global Methodology for Rating Life and P&C Insurance Companies and Insurance Organizations, which can be found on our website under Methodologies & Criteria.

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.dbrs.com.

The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

This rating is endorsed by DBRS Ratings Limited for use in the European Union. The following additional regulatory disclosures apply to endorsed ratings:

This is the first rating action since the Initial Rating Date.

For further information on DBRS Morningstar historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Lead Analyst: Komal Rizvi, Vice President, Canadian FIG & Insurance
Rating Committee Chair: Roger Lister, Managing Director, Chief Credit Officer – Global FIG and Sovereign Ratings
Initial Rating Date: February 21, 2019.

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

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