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

DBRS Limited (DBRS Morningstar) confirmed the Financial Strength Rating and the 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 reflect the Company’s strong market position in France as the second-largest player in the home loan guarantee line of business and the extensive distribution reach it has through the Groupe BPCE banking networks, enabling it to generate good revenues. While the home loan guarantee product comprises the majority of the business, there is some additional diversification through the surety and financial guarantee businesses. The Company has excellent underwriting practices, 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 strong housing demand in France in the past few years, has allowed it to generate strong earnings. Capitalization has improved steadily in the past few years, with CEGC meeting its regulatory capital requirements through a mixture of reinsurance, debt, and common equity. The increase in available capital is particularly important given the current weak economic environment driven by the Coronavirus Disease (COVID-19) pandemic. Persistence of weak economic conditions could potentially result in lower demand for CEGC’s products as well as lead to an increase in defaults. DBRS Morningstar views these risks as largely mitigated by France’s strong social safety net, resilient housing market conditions, and very low interest rates on home loans. CEGC is exposed to some market volatility and credit risk through its investment portfolio, which includes a relatively high exposure to BBB-rated bonds and real estate. Additionally, the issuance of subordinated debt in the past two years, while important in bolstering the Company’s capital buffer, has resulted in leverage increasing significantly, decreasing future financial flexibility.

RATING DRIVERS
While an upgrade is unlikely in the near term, given the uncertain macroeconomic environment, an upgrade would occur from a substantial increase in capital or provisions, providing a larger buffer on top of regulatory minimums, along with success in increasing its market shares in its multiple business lines while maintaining a conservative risk profile.

Conversely, a downgrade would result 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, including imprudent growth in business lines with poor or more volatile underwriting profitability, an increase in the proportion of riskier assets in the investment portfolio, or leverage increasing beyond 50% would also result in a downgrade.

RATING RATIONALE
The quality of the Company’s home loan guarantee 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 guarantee business. DBRS Morningstar assesses 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 exposures, which should allow the Company to navigate a potential significant downturn in the French housing market.

As a home loan guarantee provider, CEGC is subject to the cyclical nature of the economic and housing markets. While the performance of CEGC’s portfolio is relatively predictable, with experience more or less in line with assumptions during stable economic times, risk can increase during periods of adverse economic cycles where borrowers may no longer be able to service their home loans. Such a scenario can result in an elevated frequency of defaults, although losses given default have historically been low at CEGC. Most recently for Q2 2020, CEGC reported a low loss rate of 27%.

CEGC’s earnings benefit from its distribution networks, which have contributed to increased premium volumes over the past few years, while expenses have remained well controlled despite the coronavirus pandemic. Earnings have also benefitted in the past few years from a higher-than-normal rate of refinancing activity in France, and from a low interest rate environment that has spurred housing demand. While the French housing market has historically been quite resilient, risks remain in the current environment, particularly if weak economic conditions persist. Given the pandemic, there is the potential for default rates to increase, increasing losses for the Company and affecting profitability. There is also the potential risk of an elevated amount of credit losses in the investment portfolio. Loss ratios for the smaller lines of businesses may also become more volatile, particularly in areas that have been more adversely affected by the economic slowdown, such as in the guarantees for professionals line of business, for example.

Underwriting and risk management 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, there is no ability to reprice a policy once it is issued. 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. France’s social safety net is expansive and includes the provision of unemployment benefits for an extended period of time, providing a cushion for borrowers against adverse economic shocks and making it a more favourable environment for lenders and home loan guarantee providers. As a result, France has experienced a relatively less volatile housing market and lower default rates historically than many other jurisdictions.

CEGC is subject to rigorous regulatory capital requirements, with the Company required to hold a minimum amount of qualifying available solvency resources equal to at least 2% of its outstanding home loan guarantee exposure of EUR 180 billion as at H1 2020. Regulatory capital requirements are met through a combination of common equity, debt, and reinsurance. The Company’s Solvency Capital Requirement (SCR) ratio has increased to 137% at YE 2019, demonstrating an improving trend and providing a good buffer above the regulatory minimum of 100%. The increase in the SCR ratio can be largely attributed to the subordinated debt issuances of EUR 250 million in October 2019 and EUR 150 million in October 2020 that, while increasing the amount of capital available to absorb losses, have also increased the leverage ratio substantially to 47% (calculated on a pro forma basis by DBRS Morningstar). Although leverage has increased significantly, the Company is comfortably able to cover the increased financing costs.

CEGC requires high amounts of capital to meet regulatory requirements for its current portfolio and to fund its high growth plans. The Company has high dividend payout rates, resulting in a lower level of retained earnings and presenting some risk that high capital requirements may impair its growth plans. Additionally, the Company depends significantly on high-quality reinsurance to meet its regulatory capital requirements. As such, continued management attention and monitoring of the reinsurance programs and reinsurer quality are key. CEGC’s large investment portfolio also subjects the Company to a moderate amount of credit risk exposure, resulting from the relatively high proportion of BBB-rated bonds as well as investments in real estate. Given that the Company’s performance can be correlated to general macroeconomic conditions, maintaining a larger proportion of safer assets that may be more diversified away from financial markets is important.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

The Grid Summary Grades for Compagnie Européenne de Garanties et Cautions are as follows: Franchise Strength – Strong/Good; Risk Profile – Strong/Good; Earnings Ability – Strong; Liquidity – Strong/Good; Capitalization – Good.

Notes:
All figures are in euros unless otherwise noted.

The principal methodology is the Global Methodology for Rating Life and P&C Insurance Companies and Insurance Organizations (July 21, 2020: https://www.dbrsmorningstar.com/research/364260/global-methodology-for-rating-life-and-pc-insurance-companies-and-insurance-organizations) .

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

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 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 (DBRS Morningstar) for use in the European Union. The following additional regulatory disclosures apply to endorsed ratings:

The last rating action on this issuer took place on October 24, 2019, when DBRS Morningstar confirmed all ratings.

Generally, 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 monitored.

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: Michael Driscoll, Head of North American FIG
Initial Rating Date: February 21, 2019

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

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