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

DBRS Limited (DBRS) has today confirmed MCAP Commercial LP’s (MCAP or the Partnership) Issuer Rating and Senior Secured Notes ratings at BBB (low). The trend on all ratings is Stable. MCAP has an intrinsic assessment (IA) of BBB (low) and a support assessment of SA3. The SA3 rating, which reflects the expectation of no timely external support, results in the final rating being equivalent to the IA.

The ratings reflect MCAP’s low-risk balance sheet and the improving resiliency of the Partnership’s earnings, which benefit from the expansion of recurring revenue from net interest income as well as servicing and administration fee income. The ratings also consider the Partnership’s reliance on wholesale funding and mortgage brokers for asset originations. 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. In addition, MCAP needs to retain enough earnings to create and maintain an adequate capital buffer to absorb any potential losses.

MCAP is Canada’s second-largest non-bank mortgage originator and servicer with $60.6 billion in assets under administration (AUA) as of YE2016. The Partnership has been growing its market share and is predominantly active in single-family residential mortgage lending with commercial and construction mortgages contributing approximately 20% of annual originations. In 2016, in an effort to moderate the pace of growth in the Canadian housing market, the Department of Finance put into place several new rules on mortgage lending, including stress testing at higher borrowing rates and more restrictive criteria regarding eligibility for portfolio insurance. The last of these new regulations came into effect on November 30, 2016, MCAP’s fiscal year end; therefore, their impact on the Partnership’s originations have yet to be determined. Nevertheless, given the broad product offering of MCAP, including uninsured single-family and commercial mortgages, the Partnership sees this as an opportunity to grow these businesses.

Earnings have continued to strengthen with net income rising a very strong 34% in 2016, reflecting 14% growth in AUA that benefited both net interest income as well as servicing and administration-related revenues. Origination fees were up 7% year over year in 2016 as originations rose 11% to $15.9 billion. MCAP has also made notable progress in terms of operating leverage as AUAs have reached levels in which economies of scale are becoming more apparent, resulting in an improved efficiency. DBRS expects the Partnership to continue to improve efficiency in the future.

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 as any material weakening in performance, especially if it is an outlier to general Canadian mortgage performance, could reduce investor appetite for MCAP-originated mortgages. However, with rising housing prices in the greater Toronto and Vancouver areas, a real estate market correction in Canada could see a rise in delinquency rates, especially on the commercial side, which could affect MCAP’s origination volumes and funding as well as increase servicing costs, offset by higher servicing-related revenue.

MCAP is reliant on the secured forms of wholesale funding to finance its assets, which is considered a constraint on the ratings. Nevertheless, MCAP does benefit from a degree of diversification of the secured funding channels, which includes securitization vehicles, including Canadian Mortgage Housing Corporation’s National Housing Authority Mortgage Backed Securities, Canada Mortgage Bonds, Commercial Mortgage Backed Securities, Residential Mortgage Backed Securities and bank-sponsored asset-backed commercial paper. MCAP’s liquidity and funding are considered to be appropriately managed and aligned with its assets.

In DBRS’s opinion, MCAP’s capital levels are low, but in line with other mono-line lenders. At November 30, 2016, MCAP’s tangible partner equity-to-tangible assets declined modestly to 1.2% versus 1.4% in 2015, reflecting higher total assets. MCAP has changed its dividend payout policy to 50% of IFRS pro forma profits going forward which, in DBRS’s view, is a positive step toward enhancing capital since it allows for greater capital retention than previous policies.

RATING DRIVERS
Although unlikely, given the current economic environment, ratings could be positively affected over the medium term by continued strengthening of operating efficiency toward that of peers and a gain in market share while maintaining sound asset performance. Conversely, ratings could come under pressure should MCAP lose market share as a result of lower originations on the back of the new Department of Finance mortgage rules or if the Partnership shows sustained deterioration in operating results caused by its inability to respond to competitive or regulatory changes. Furthermore, any changes in government-sponsored securitization programmes that constrain MCAP’s funding or inadequate capital generation because of increased Partnership distributions could also negatively affect the ratings.

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.

The principal methodologies are Global Methodology for Rating Finance Companies (October 2016) and DBRS Criteria: Rating Corporate Holding Companies and their Subsidiaries (December 2016), which can be found on dbrs.com under Methodologies.

Lead Analyst: Maria-Gabriella Khoury, Vice President – Global FIG
Rating Committee Chair: Roger Lister, Managing Director, Chief Credit Officer, Global FIG & Sovereign Ratings

The rated entity or its related entities did participate in the rating process. DBRS had access to the accounts and other relevant internal documents of the rated entity or its related entities.

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