Fitch Places Montpelier's Ratings on Negative Watch Following Endurance Acquisition Announcement
KEY RATING DRIVERS
Fitch's rating action follows the announcement yesterday that Endurance Specialty Holdings Ltd. (NYSE: ENH) entered into a definitive merger agreement to acquire MRH for total consideration of \\$1.8 billion (approximately 75% stock and 25% cash). The close is expected in the third quarter of 2015, and is subject to regulatory approvals and approval by MRH and ENH's shareholders.
The Rating Watch Negative primarily reflects the existing Negative Outlook for MRH's ratings, reflecting pressures on its competitive market position due to the impact of adverse reinsurance market conditions. While Fitch believes an acquisition by ENH would likely help relieve many of those pressures, in the interim, the agency believes MRH is potentially more vulnerable should the merger fail to be completed, as the company would likely either seek to find a replacement buyer or look to continue to operate in the challenging reinsurance market environment as an independent entity after signaling to the market a need to merge.
If the transaction is completed as planned, Fitch could affirm MRH's current ratings with a Stable Rating Outlook post-closing. Such a rating action would be dependent upon Fitch undertaking a more detailed evaluation of ENH's credit quality and integration plan for MRH to determine if it is supportive of an 'A' IFS rating within Fitch's group rating methodology. Fitch has not maintained a rating on ENH since December 2013, but expects the post-merger profile of a combined ENH-MRH would likely be stronger than that of MRH stand alone.
On Dec. 12, 2014, Fitch affirmed MRH's 'A' IFS rating and revised the Rating Outlook to Negative from Stable reflecting the agency's view that, given MRH's comparatively narrow business focus and smaller size/scale, the company is relatively more exposed to the current difficult reinsurance market conditions. This is particularly the case in property catastrophe risk, where record capitalization among traditional reinsurers and the growing capacity provided by alternative capital market providers are softening reinsurance pricing and broadening policy terms and conditions. Barring an unexpected improvement in market conditions, or enhancement of MRH's competitive positioning and scale, Fitch's expectation was that MRH's ratings would likely be downgraded by one notch within the next 12 months.
Fitch views the transaction as an overall credit positive to MRH, as the purchase by ENH, a somewhat larger and more diversified company, would likely improve the competitive position of the combined organization. This includes benefits relating to diversification of earnings and business profile, as well as potential expense savings. In addition, a larger organization is under less pressure to retain business with less attractive terms under competitive market conditions.
The acquisition by ENH favorably serves to broaden MRH's business profile away from property catastrophe risk, which should help the company to reduce earnings and cash flow exposure to cyclical conditions in the property catastrophe market. Pro forma for the acquisition, property catastrophe reinsurance business declines to 20% of net premiums written (NPW) for the combined organization in 2014 from 39% of NPW for MRH alone in 2014. The acquisition also adds diversity into primary insurance lines with a pro forma combined 2014 NPW business mix of approximately 57% reinsurance, 33% insurance, and 10% Lloyds of London.
Fitch considers the combined organization to have a medium market position and size/scale with approximately \\$3.6 billion and \\$4.1 billion of pro forma gross premiums written (GPW) and GAAP common shareholders' equity, respectively. While MRH has a niche market position with regional and super-regional primary insurers, Fitch views MRH to have an overall small market position and size/scale with GPW of \\$740 million for full-year 2014 and total GAAP common shareholders' equity (available to the company) of \\$1.5 billion at Dec. 31, 2014.
Pro forma for the acquisition, financial leverage is expected to be near 17%, with no new debt being issued to finance the purchase. MRH and ENH maintain moderate amounts of financial leverage in their current capital structures, with financial leverage ratios of 19.8% and 14.4%, respectively, at Dec. 31, 2014.
RATING SENSITIVITIES
Fitch could downgrade the ratings should the acquisition fail to be completed or should MRH experience a significant loss of business, a departure of key personnel or an increase in risk profile prior to the closing of the acquisition by ENH.
Fitch could affirm the current ratings with a Stable Outlook following the successful completion of the acquisition by ENH within the stated terms. This would be dependent on Fitch first completing a ratings analysis of EHN-MRH on a combined group basis. Fitch would likely withdraw the rating for MRH upon close if the agency is unable to complete such an analysis.
However, assuming no material changes to MRH's credit, Fitch may not take any additional rating action prior to closing.
Fitch has placed the following ratings on Rating Watch Negative:
Montpelier Re Holdings Ltd
--Issuer Default Rating (IDR) 'A-';
--\\$300,000,000 4.7% senior notes due Oct. 15, 2022 'BBB+';
--\\$150,000,000 8.875% non-cumulative perpetual preferred securities 'BBB-'.
Montpelier Reinsurance Ltd.
--Insurer Financial Strength (IFS) Rating 'A'.
Montpelier Capital Trust III
--\\$100,000,000 floating rate trust preferred securities due March 30, 2036 'BBB-'.
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