NEW YORK--(BUSINESS WIRE)-- Fitch Ratings has downgraded CMG Mortgage Insurance Company's (CMG MI) Insurer Financial Strength (IFS) rating to 'BBB-' from 'BBB'. The Rating Outlook remains Negative.

Today's rating action is driven primarily by increased operational risk and increased senior management turnover at CMG MI over the past year. In Fitch's view, the operational risks facing the company have increased with the receivership of PMI Mortgage Insurance Co. (PMI) by the Arizona Department of Insurance. PMI is a 50% shareholder in CMG MI and a provider of key operational functions. Conversely, the recent positive trends in operating performance and CMG MI's insured portfolio help counterbalance some of the negative developments.

Fitch views the stability of senior management as an important rating driver, particularly in light of increased operational risks resulting from the PMI receivership. CMG MI's board of directors and organizational structure is represented by its two equal shareholders, PMI and CMFG Life Insurance Co. (CMFG). CMG MI's senior management team is also co-managed by individuals from both organizations. Over the past 12 months, a number of general managers have resigned from CMG MI for various reasons. While CMG MI has not experienced any notable operational issues to date, Fitch believes that the possibility of a lapse in underwriting, risk management, technology or accounting has increased as a result of potential future attrition and/or turnover.

Capitalization has marginally weakened over the past year, with CMG MI's risk-to-capital (RTC) ratio increasing to 20.8x at March 31, 2012 from 19.7x in the prior year. While the RTC remains elevated by historical standards, it is among the lowest among mortgage insurers and is below the 25.0x level mandated by some state regulators. CMG MI's shareholder agreement has an RTC trigger of 23.0x, which the company is managing to remain below. Approaching this trigger could put additional pressure on CMG MI's ratings.

CMG MI's rating continues to be supported by the quality of the insured portfolio, which has been improving since the first half of 2011. The percentage of defaulted loans (measured by loan count) has dropped to 4.80% in 2Q12 from a peak of 5.88% in the fourth quarter of 2010 (4Q'10). Even at its highest, CMG MI's default rate was materially lower than the default rates reported by its peers. Fitch would expect the quality of the insured portfolio to improve further as CMG MI puts on new business and continues to see declines in notices of default. CMG MI's niche credit union (CU) core market has provided the company with better underwritten mortgages during the housing boom, which resulted in lower rates of delinquencies and losses.

Operating performance has started to improve as a result of lower underwriting losses and a recent uptick in new business. In 1Q'12, CMG MI's loss ratio has dropped below 100% for the first time in several years and the company is close to breaking even. Fitch expects these positive trends to continue and believes CMG MI will return to profitability in the coming quarters.

Longer term, operating performance is likely to be restrained by a higher expense base, as CMG MI hires more full time employees for functions that were historically outsourced to PMI. Even though PMI currently allocates costs to CMG MI, Fitch expects the company to incur incremental expenses as it in-sources certain operational functions. Increased competition from both existing and start-up mortgage insurers in the CU space may also put additional pressure on CMG MI's pricing and underwriting standards.

Fitch views with caution the company's recent efforts to regain market share among its CU customers by relaxing some of its underwriting guidelines. This concern is mitigated to some extent by the better quality of the new business being underwritten, particularly in comparison to CMG MI's existing book of business. Furthermore, growth may be somewhat constrained by the aforementioned RTC trigger of 23.0x. Fitch analyzes CMG MI on a stand-alone basis and its IFS rating does not factor in any support from the company's owners.

RATING DRIVERS AND SENSITIVITIES

The Negative Outlook primarily reflects the increased operational risk, longer-term uncertainty regarding CMG MI's ownership structure and a generally difficult regulatory environment for mortgage insurers. Fitch expects there to be limited positive momentum in the ratings and/or Outlook for the foreseeable future given the constraints discussed above. Negative actions could result if delinquency levels start to deteriorate, capital levels fail to remain stable or grow over the next several years, or due to heightened uncertainty regarding CMG MI's ownership.

Headquartered in San Francisco and domiciled in Wisconsin, CMG MI is a 50/50 joint venture between CMFG and PMI. CMG MI, the smallest of the eight private mortgage insurers, is dedicated solely to insuring loans made by the CUs to their members that cover a broad variety of mortgage types strictly on a flow basis. As of March 31, 2012, the company had $4.9 billion of risk-in-force.

Fitch has downgraded the following rating:

CMG Mortgage Insurance Company

--IFS to 'BBB-' from 'BBB'.

The Rating Outlook remains Negative.

Additional information is available at www.fitchratings.com. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.

Applicable Criteria and Related Research:

--'Insurance Rating Methodology' (Sept. 22, 2011).

Applicable Criteria and Related Research:

Insurance Rating Methodology

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=651018

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Fitch Ratings
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Ilya Ivashkov, CFA, +1-212-908-0769
Director
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Source: Fitch Ratings