DBRS Changes Trend on MCAP Commercial LP’s BBB (low) Long-Term Ratings to Positive

DBRS Limited (DBRS) confirmed MCAP Commercial LP’s (MCAP or the Partnership) Long-Term Issuer Rating and Senior Secured Notes ratings at BBB (low) and changed the trends on the ratings to Positive from Stable. MCAP has an Intrinsic Assessment (IA) of BBB (low) and a Support Assessment of SA3. The SA3 rating, which reflects the expectation of there being no timely external support, results in a final rating that is equivalent to the IA.

KEY RATING CONSIDERATIONS
MCAP’s ratings reflect DBRS’s view that the Partnership has now reached scale and is successfully competing against other mortgage originators. This view is supported by MCAP’s consistent top-three market share position in the independent mortgage broker channel over the last few years. Moreover, MCAP’s franchise strength and earnings continue to improve given its broader product suite and market share gains as compared with peers. The ratings also consider the diversification of MCAP’s investor base and funding sources, with the Partnership beginning to fund through its proprietary residential mortgage-backed securities (RMBS) program. However, DBRS remains concerned over the combination of highly leveraged consumers and elevated home prices in the Greater Toronto Area and Greater Vancouver Area. Despite new mortgage underwriting regulations and slowing home sales in these regions, home prices remain vulnerable to a correction. As a result, DBRS views MCAP as also susceptible to any adverse changes in the Canadian real-estate market given that single-family mortgages comprise the majority of the Partnership’s assets under administration (AUA).

The Positive trends reflect the strong momentum MCAP has exhibited in building its scale, with AUA growing over 15% per annum since 2013, while delivering consistent earnings growth and operating efficiencies. In addition, the Partnership has maintained a sound risk profile, with MCAP-originated mortgages continuing to perform better than or in line with the Canadian banks.

RATING DRIVERS
DBRS sees positive rating pressure if MCAP sustains the momentum in increasing its scale and making further improvements in operating efficiency that strengthen its earnings generation. Continued diversification of funding sources beyond government- and bank-sponsored securitization vehicles could also benefit the ratings. Conversely, DBRS sees negative rating pressures if MCAP incurs substantially higher delinquency rates due to deficiencies in risk management or underwriting that would significantly reduce the amount of business key institutional investors conduct with MCAP. A sustained deterioration in operating results or a material slowdown in capital retention as a result of a significant increase in MCAP distributions could also cause negative rating pressure. Lastly, any changes in government-backed securitization programs that constrain MCAP’s ability to fund mortgage originations may also pressure the ratings.

RATING RATIONALE
MCAP is the second-largest non-bank mortgage finance company in Canada, with AUA of $72.9 billion as at November 30, 2018, up 11% compared with last year. The Partnership’s AUA has grown over 15% per annum since 2013. MCAP continues to grow its market share within single-family residential mortgage origination and has held a top-three position over the last few years. During 2018, the Partnership had total new mortgage originations of $15.4 billion, which is up 6% compared with 2017. Additionally, renewals increased to $5.3 billion from $4.5 billion in the prior year, which supported growth in AUA.

Over the last three years, MCAP’s earnings have remained relatively stable. While originations and AUA have continued to grow, mortgage spreads have tightened, resulting in lower earnings in 2018. Specifically, net income of $94.6 million was down a modest 5% compared with $99.6 million in 2017. Nonetheless, MCAP continues to generate stable underlying cash flows given that the Partnership retains servicing rights on all of its AUA. In addition, MCAP has made great progress in operating efficiency, which has improved 2,210 basis points since 2013 and reflects the economies of scale MCAP has achieved through its AUA growth.

MCAP’s exposure to credit risk remains very limited, as almost all of its originated mortgages are securitized or sold to financial institutions with limited recourse to the Partnership. As a result, MCAP’s low-risk balance sheet is a key factor that underpins the ratings. Overall, DBRS notes that mortgages originated by the Partnership have performed well historically and better than or in line with the Canadian banks. Sustaining this performance is critical to MCAP’s business model of securitizing originated mortgages and conducting whole-loan sales to larger financial institutions. Similar to other mortgage originators, MCAP faces potential exposure to repurchase risk should the Partnership be required to repurchase mortgages or indemnify institutional investors for losses incurred on mortgages sold by MCAP that result from potential breaches of representations and warranties made to the purchaser or mortgage insurer. DBRS notes that loan repurchase volumes over the last number of years have been negligible, which reflects the strong underwriting and adjudication process MCAP has in place.

The Partnership is dependent on wholesale funding, particularly through securitization vehicles, which constrains the ratings. However, MCAP continues to diversify its funding portfolio by adding other large financial institutions as well as accessing the RMBS market. DBRS notes that since MCAP is not licensed to take deposits, it somewhat limits the traditional sources of funding the Partnership can access. As a result, MCAP is dependent on its strategic partners for equity capital and has established sufficient bank credit facilities to manage its liquidity. Overall, DBRS considers MCAP’s liquidity and funding as appropriately managed and aligned with the assets of the Partnership.

MCAP’s capitalization levels are viewed as adequate by DBRS, largely reflecting the limited exposure of the Partnership to credit risk. MCAP does not have a required minimum capital level given that it is not regulated by the Office of the Superintendent of Financial Institutions. However, the Partnership is required to maintain a certain level of capital as a result of being an approved issuer under Canada Mortgage and Housing Corporation’s MBS and CMB programs. As at November 30, 2018, tangible partners’ equity was $420 million, which is up from $400 million in 2017. This increase reflects a 17.5% increase in tangible assets, which was partly offset by an increase in the payout ratio to 59% compared with 36% in the prior year. As a result, tangible partners’ equity represented 1.2% of tangible assets, or 6.7% when securitized assets are excluded. MCAP expects to continue maintaining the payout ratio at approximately 50% of net income, which provides sufficient capital for growth opportunities.

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

The applicable methodology is the Global Methodology for Rating Non-Bank Financial Institutions (November 2018), which can be found on our website under Methodologies & Criteria.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found on the issuer page at www.dbrs.com.

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

Lead Analyst: Robert Colangelo, Senior Vice President, Canadian Banking Financial Institutions, Global FIG
Rating Committee Chair: Michael Driscoll, Managing Director, Head of NA FIG, Global FIG

For more information on this credit or on this industry, visit www.dbrs.com.

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