DBRS Confirms MCAP Commercial LP at BBB (low), Trend Stable

DBRS Limited (DBRS) has today confirmed MCAP Commercial LP’s (MCAP or the Partnership) Issuer Rating and Senior Secured Notes at BBB (low) with Stable trends. The rating action follows a detailed review of the Partnership’s operating results, financial fundamentals and future prospects.

In confirming the ratings, DBRS recognizes the strength of MCAP’s franchise, which is anchored by the Partnership’s status as Canada’s second-largest non-bank mortgage originator and servicer with $53.1 billion in assets under administration (AUA) as of YE2015. The ratings also consider MCAP’s low-risk balance sheet and the improving resiliency of the Partnership’s earnings, which are benefiting from the expansion of recurring revenue from net interest income as well as servicing and administration fee income. These positive factors are offset by the Partnership’s reliance on wholesale funding and mortgage brokers for asset origination. Furthermore, although MCAP continues to make favourable progress toward reaching the critical mass necessary to generate positive operating leverage, the Partnership’s operating efficiency continues to trail its peer group.

While the economic environment in Canada remains challenging, the Stable trend reflects DBRS’s view that MCAP’s low exposure to credit risk and the Partnership’s improving earnings profile should afford it the ability to successfully navigate the environment. Although unlikely given the current environment, ratings could be positively affected over the medium term by further expansion of recurring income as a component of total income and the continued strengthening of operating efficiency toward that of peers. Additionally, further diversification of funding and stronger organic capital retention would be viewed favorably. Conversely, ratings could come under pressure should (1) MCAP incur material operational risk-related losses, (2) AUAs experience a sustained decline signalling a deterioration in the strength of the franchise and/or (3) MCAP’s access to liquidity become strained.

In 2015, the Canada Mortgage and Housing Corporation (CMHC) changed the limits of the amount of mortgage-backed securities that it will guarantee and increased the price on the guarantee stamping fee; however, this has not limited MCAP’s originations for the year since demand for the Partnership’s product fell within the assigned limit. On the other hand, the Canadian government’s intention to prohibit the use of insured mortgages as collateral in non-CMHC securitizations, which is effective as of July 1, 2016, may have some effect on MCAP’s future use of residential mortgage-backed securities (RMBS) and bank-sponsored asset backed commercial paper (ABCP). However, DBRS expects that MCAP will be looking to expand its use of private securitization pools for these products.

DBRS notes the positive trajectory of earnings with net income growing by 69% as net interest income as well as servicing and administration income increase as AUAs grow. Origination fees also witnessed a 60% increase in 2015 versus 2014 levels. In addition, MCAP has also made notable progress in terms of operating leverage as increased volumes beyond critical mass have improved efficiency and driven profits higher in 2015 relative to the prior year. Going forward, DBRS will look for the Partnership’s further progress in driving efficiency levels to those more in line with peers and for these improvements to be sustainable and positive for profitability.

In DBRS’s view, MCAP’s low-risk balance sheet is a key factor underpinning the ratings. Overall, DBRS notes that mortgages originated by the Partnership have performed well historically with very low delinquency rates. DBRS sees that sustaining this performance is critical to MCAP’s model of securitizing and conducting whole loan sales to larger financial institutions. While low energy prices continue to be a headwind for the Canadian economy, the impact on the Canadian housing market has largely been regional to date with some weakening of credit metrics in the western provinces. DBRS notes that, while Alberta comprises 20% of MCAP’s mortgage serving AUAs, its performance to date has been because of the Partnership’s focus on the larger cities in the province.

DBRS considers MCAP’s liquidity and funding to be appropriately managed and aligned with its assets. Capital is viewed as acceptable given the risk profile of the business. At December 31, 2015, MCAP’s tangible partner equity-to-tangible assets (excluding securitized mortgages) was 9.4%. Positively, MCAP’s partnership distribution ratio improved to 47% in 2015 from 115% in 2014. DBRS would view a lower and more consistent partnership payout ratio favorably.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

The applicable methodologies are the Global Methodology for Rating Finance Companies (October 2015) and Rating Holding Companies and Their Subsidiaries (January 2016). These documents can be found on DBRS’s website at www.dbrs.com.

For more information on this credit or on this industry, visit www.dbrs.com or contact us at info@dbrs.com.