S&P, Fitch Rate Arch Debt Issues

Standard & Poor’s Ratings Services announced that it has assigned its “BB+” preferred stock rating to the Bermuda-based Arch Capital Group Ltd.’s $100 million issuance of Class A, noncumulative preferred shares. Fitch Ratings assigned its “BBB-” rating to the issue, and also affirmed its “A-” insurer financial strength (IFS) ratings on Arch’s key insurance subsidiaries, indicating that they remain unchanged with a positive outlook.

S&P also affirmed its “BBB” counterparty credit and senior debt ratings on Arch Capital Group Ltd. and its ‘A-‘ counterparty credit and financial strength ratings on ACGL’s operating companies: Arch Reinsurance Ltd., Arch Reinsurance Co., Arch Insurance Co., Arch Specialty Insurance Co., and Arch Excess & Surplus Insurance Co. All the ratings have a stable outlook.

Fitch has upgraded its rating on Arch Capital’s $300 million issue of 7.35 percent senior unsecured notes to “BBB” from “BBB-.” The rating agency said its decision “reflects the company’s favorable operating trends and performance, especially in light of the large catastrophe-related losses incurred by the reinsurance sector in 2005. The upgrade also reflects favorable cash flow and earnings trends derived from Arch’s diversified book of property/casualty business.”

S&P credit analyst Laline Carvalho noted that the ratings are supported by the Group’s “growing business franchise, strong operating performance, strong capital adequacy, and strong financial flexibility.” These factors are partially offset, however, said S&P, by “Arch’s relatively short operating history and significant proportion of casualty writings that have not fully matured.

“The preferred stock issuance is expected to constitute a draw down on Arch’s existing universal shelf and is expected to be used to further strengthen the operating companies’ capital position,” Carvalho added. “Excluding the issuance of the Class A noncumulative preferreds, Arch was expected to post strong capital adequacy of about 150 percent at year-end 2005; with the preferred issuance, the group’s pro forma year-end 2005 capital adequacy ratio (CAR) is expected to improve to about 160 percent.”

Fitch said: “Given Arch’s cash flow characteristics and the regulatory environments the company operates in, Fitch believes it is appropriate to narrow the notching between Arch’s IFS ratings and its ratings on debt instruments. This degree of notching is consistent with both Fitch’s existing and proposed rating methodologies.

“Arch uses a moderate amount of financial leverage and on a run-rate basis generates strong interest coverage. At Sept. 30, 2005, the company’s ratio of debt-to-capital was 11 percent and through the first nine months of 2005, its operating earnings-based interest coverage was 6 times (x). Fitch believes that Arch’s proposed series A preferred stock issuance will result in a moderate increase to the company’s equity-credit adjusted debt-to-capital ratio.”

Discussing Arch’s overall picture, S&P indicated that it “expects Arch’s net exposures in property and other short-tail lines of business in 2006 (particularly in Arch’s reinsurance division) to grow moderately, reflecting the expectation of substantially improved market conditions in these lines. Other lines of business are expected to show flat growth for the year.”

S&P also indicated that “assuming normal catastrophe losses,” it “expects the group’s 2006 operating results to be very strong, with a combined ratio of 90 percent-92 percent and an ROR of 12 percent-14 percent. The CAR is expected to improve further to about 165 percent in 2006, reflecting the expectation of strong earnings for the year. Total debt plus preferred leverage is expected to remain supportive of the rating level at about 16 percent-18 percent in the medium term. Interest coverage is expected to remain very strong at more than 8x.”

Fitch explained that its positive rating outlook “reflects Arch’s moderating growth profile, and Fitch’s corresponding heightened comfort with the company’s underwriting discipline and operating leverage. The Positive Rating Outlook also reflects the company’s maturing position in the highly competitive reinsurance sector.”