DBRS Morningstar Upgrades MCAP Commercial LP’s Long-Term Ratings to BBB, Changes Trend to Stable

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

KEY RATING CONSIDERATIONS
The upgrade reflects MCAP’s continued progress in achieving growth and economies of scale, particularly through the October 2019 transaction whereby it purchased the right to the difference between the servicing fees received and servicing costs paid on a portfolio of mortgages totalling $26.1 billion (the October 2019 transaction). The Partnership also purchased the right to certain cash flows, net of related financing, from the sale of the renewals of the $26.1 billion portfolio. Overall, MCAP’s assets under administration (AUA) reached $105.5 billion at November 30, 2019, nearly triple the level from 2012. This increased scale and improved competitive positioning has benefitted earnings.

The ratings and Stable trend reflect MCAP’s consistently strong top-three market share position in the independent mortgage broker channel. The ratings also consider the diversification of MCAP’s investor base and funding sources as the Partnership continues to fund through its proprietary residential mortgage-backed securities (RMBS) program. MCAP has generated stable earnings and cash flows while maintaining a sound risk profile as the mortgages it originates continue to perform better than or in line with the large Canadian banks; however, DBRS Morningstar remains concerned about highly leveraged consumers and elevated home prices, particularly in the greater Toronto and Vancouver areas. Despite tighter mortgage rules, DBRS Morningstar believes that housing prices in these regions remain vulnerable to a correction and views MCAP as susceptible to any adverse changes in the Canadian real estate market because single-family mortgages comprise the majority of the Partnership’s AUA.

RATING DRIVERS
DBRS Morningstar views MCAP as well placed in its rating category. Over the longer term, DBRS Morningstar sees positive ratings pressure if the Partnership continues to significantly increase its scale while generating higher and sustainable returns on total assets in line with higher-rated peers.

Conversely, negative ratings pressure could arise if MCAP incurs substantially higher delinquency rates due to deficiencies in risk management or underwriting that could significantly reduce the amount of business the Partnership conducts with key institutional investors. In addition, a sustained deterioration in financial performance or a material slowdown in capital retention caused by a significant increase in the partner distribution payout ratio could also result in negative ratings pressure. Any changes in government-backed securitization programs which would constrain MCAP’s ability to fund mortgage originations may also pressure the ratings.

RATING RATIONALE
MCAP ranks as one of the largest nonbank mortgage finance companies in Canada. The Partnership markets a national multibrand and multichannel mortgage origination platform which DBRS Morningstar views as the broadest and deepest product set in the industry. MCAP has successfully grown its AUA, which has nearly tripled in size since 2012, and continues to maintain a top-three market share. During F2019, total new mortgage originations grew by 10% to $16.9 billion compared with F2018. Over the same time period, renewals, which have supported AUA growth, also rose to $6.0 billion from $5.3 billion.

MCAP has generated stable earnings and underlying cash flows over the last few years, which reflects that the Partnership retains servicing rights on all of its AUA. F2019 earnings of $112.2 million improved by a strong 19% compared with the prior year, largely because of growth in AUA that reflects the October 2019 transaction and higher origination volumes. In addition, mortgage spreads improved, particularly toward the end of F2019, which contributed to improved earnings. MCAP continues to make steady progress in improving its operating efficiency, which is now in line with its peers.

MCAP has limited direct exposure to credit risk because almost all of its originated mortgages are securitized or sold to financial institutions with limited recourse. DBRS Morningstar views MCAP’s low-risk balance sheet as a key factor that underpins its ratings. Overall, mortgages originated by the Partnership have historically performed well with credit performance that is better than, or in line with, the large Canadian banks. Since MCAP is well regarded in the mortgage broker community for its level of service, sustaining this credit performance is critical to its business model of securitizing originated mortgages and conducting whole-loan sales to larger financial institutions. Similar to other mortgage originators, the Partnership faces potential exposure to repurchase risk if there is a breach of representations and warranties made to the purchaser or mortgage insurer. DBRS Morningstar notes that loan repurchases have been negligible over the last few years, which reflects the strong underwriting and adjudication process that MCAP has in place.

MCAP is predominately funded through government and bank-sponsored securitization programs, which DBRS Morningstar views as a rating constraint; however, the Partnership has diversified its funding by accessing the RMBS market and adding other institutional investors to its already-extensive list. While MCAP depends on its strategic partners for equity capital, it has established sufficient bank credit facilities to manage its liquidity. Given that the Partnership is not licensed to take deposits, this somewhat limits the traditional sources of funding MCAP can access. Overall, DBRS Morningstar considers the Partnership’s liquidity and funding as appropriately managed and well aligned with its assets.

DBRS Morningstar views MCAP’s capitalization levels as adequate, since the Partnership has limited exposure to credit risk. While MCAP does not have a required minimum capital level since it is not regulated by the Office of the Superintendent of Financial Institutions, the Partnership must maintain a certain level of capital because it is an approved issuer under the Canada Mortgage and Housing Corporation’s (rated AAA with a Stable trend by DBRS Morningstar) Mortgage-Backed Security and Canada Mortgage Bond programs. As at November 30, 2019, tangible partners’ equity rose to $468 million compared with $420 million in the prior year, primarily reflecting an increase of 11% in tangible assets. Tangible partners’ equity represents 1.2% of tangible assets, or 5.8% when securitized assets are excluded. While partner distributions rose slightly in F2019, the payout ratio remained relatively unchanged at 59% because of the increase in earnings. MCAP expects to continue to maintain the payout ratio at around 50% of net income calculated under IFRS, a level which DBRS Morningstar views as sufficient to support growth.

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

The principal methodology is Global Methodology for Rating Non-Bank Financial Institutions (September 2019), 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 Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

DBRS Morningstar will publish a full report shortly that will provide additional analytical detail on this rating action. If you are interested in receiving this report, contact us at [email protected].

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

DBRS Limited
DBRS Tower, 181 University Avenue, Suite 700
Toronto, ON M5H 3M7 Canada