DBRS Morningstar Confirms First National Financial LP’s Long-Term Rating at BBB, Stable Trend

DBRS Limited (DBRS Morningstar) confirmed the Long-Term Issuer Rating of First National Financial LP (FNF LP) at BBB and the ratings on the Senior Unsecured Debt and Class A Preference Shares of First National Financial Corporation (FNFC; together with FNF LP, FNF or the Company) at BBB (low) and Pfd-3, respectively. The trend on all ratings is Stable. The Intrinsic Assessment (IA) for FNF LP is BBB. FNFC’s Support Assessment is SA3, which reflects no expectation of timely external support. This results in FNFC’s Senior Unsecured Debt rating being positioned one notch below FNF LP’s IA at BBB (low).

KEY RATING CONSIDERATIONS
The ratings confirmation and Stable trends reflect FNF’s ranking as one of the largest non-bank mortgage finance companies in Canada. The Company consistently maintains a strong top-tier market share position in the independent mortgage broker channel, with FNF-originated mortgages outperforming the industry with very low delinquency rates. Moreover, the Company’s ratings are underpinned by FNF’s limited exposure to credit risk as originated mortgages are either sold to institutional investors or securitized through government and bank-sponsored securitization programs. The ratings also take into consideration FNF’s history of generating consistent earnings and cash flows as well as its solid operating efficiency, which reflect its large volume of originations and the scalability of operations. Conversely, the ratings take into account the client concentration within the Company’s institutional investor funding pools and FNF’s dependence on wholesale funding as well as its relatively higher dividend payout ratio, which limits financial flexibility. DBRS Morningstar would view positively any effort undertaken to diversify funding sources and enhance capital retention.

DBRS Morningstar notes that the Coronavirus Disease (COVID-19) pandemic has created a challenging economic environment. Despite this, housing activity in Canada throughout the pandemic has been robust, which has resulted in recent home price appreciation. This activity follows a period of stable prices, which reflects the actions taken by regulators over the last several years to tighten mortgage rules. DBRS Morningstar remains concerned about the combination of highly leveraged consumers and elevated home prices, particularly in the greater Toronto and Vancouver areas, and believes that housing prices remain vulnerable. As a result, FNF is susceptible to any adverse changes in the Canadian real estate market because single-family residential mortgages comprise 70% of its mortgages under administration (MUA).
 
RATING DRIVERS
FNF’s ratings would be upgraded if the Company were able to noticeably diversify its funding sources beyond existing securitization vehicles and bank credit facilities and to further reduce its single-name institutional investor concentration. Conversely, ratings would be downgraded if the Company incurred substantially higher delinquency rates from deficiencies in risk management or underwriting, which could result in reduced investor appetite for FNF-originated mortgages. A sustained deterioration in financial performance, any changes in government-backed securitization programs that could constrain the Company’s ability to fund mortgage originations, or a significant slowdown in capital retention as a result of a significant increase to the dividend payout ratio would also result in a downgrade of the ratings.

RATING RATIONALE
FNF is one of the largest non-bank mortgage finance companies in Canada, with over $118 billion in MUA. The Company offers single-family residential mortgages, predominately originated through the independent mortgage broker channel, as well as multifamily residential and commercial mortgages. In F2020, MUA grew 7% compared with the prior year, while total new mortgage originations rose 35% to 28.3 billion compared with F2019. In addition, FNF successfully renewed $8.6 billion in mortgages during F2020, which compares with renewals of $7.5 billion in the prior year.

Historically, the Company has generated consistent earnings and underlying cash flows from its mortgage servicing operations, with earnings in F2020 rising 7% year over year to $190.2 million. This increase was largely due to strong mortgage origination and improving mortgage spreads. FNF generated approximately 13.1% of revenue in F2020 from one major Canadian financial institution, exposing the Company to client concentration risk. Despite FNF’s efforts to add more institutional investors, this concentration is up sharply from 8.7% in the prior year.

Since all mortgages originated by the Company are either securitized or sold to institutional investors, FNF has limited credit risk exposure, which is a key factor supporting the rating. Historically, mortgages originated by the Company have outperformed the industry with very low delinquency rates. DBRS Morningstar will continue to monitor the impact the pandemic, particularly on FNF's asset quality metrics. Any credit risk faced by the Company stems from a portfolio of mortgages accumulated for securitization that are temporarily held on the balance sheet prior to securitization as well as a small portfolio of commercial first and second mortgages that are held by the Company for investment purposes. Since FNF is well regarded in the mortgage broker community for its level of service, DBRS Morningstar notes that sustaining this credit performance is critical to the Company’s business model of securitizing or selling FNF-originated mortgages. DBRS Morningstar views this risk as well managed as, to date, loan repurchase volumes have been negligible, which reflects FNF's strong underwriting and adjudication processes.

FNF is predominately funded through government-sponsored securitization programs and committed revolving credit facilities. Although DBRS Morningstar views this as a rating constraint, FNF-originated mortgages only remain on the Company’s balance sheet for a short period of time. As a result, this funding model is viewed as appropriate and aligned with FNF’s business model. In addition, DBRS Morningstar views positively that access to Canada Mortgage and Housing Corporation’s (CMHC) National Housing Act Mortgage-Backed Security (NHA MBS) and Canada Mortgage Bonds (CMB) programs remained stable during the pandemic. To supplement its funding, the Company also has access to a $1.25 billion syndicated bank revolving credit facility, with $682.8 million drawn as of December 31, 2020.

DBRS Morningstar views FNF’s capital as adequate and sound, particularly as the Company faces limited exposure to credit risk and its capital is predominantly comprised of common shares and retained earnings. Since FNF is not regulated by the Office of the Superintendent of Financial Institutions, it is not subject to a minimum regulatory capital level; however, the Company must maintain a certain level of capital as an approved issuer under the CMHC’s NHA MBS and CMB programs. Historically, FNF has maintained an elevated common share dividend payout ratio averaging approximately 80% over the past five years, including special dividends. DBRS Morningstar views this high payout ratio as a ratings constraint as it limits financial flexibility. Given the impact of the pandemic and the resulting payment deferrals that were offered, FNF was required to utilize its own funds to ensure that any principal and interest payments on deferred mortgage balances were made to the securitization programs as per the amortization schedule. DBRS Morningstar would therefore view positively any effort undertaken by FNF to enhance capital retention.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at: https://www.dbrsmorningstar.com/research/373262.

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

The principal methodology is the Global Methodology for Rating Non-Bank Financial Institutions (September 29, 2020; https://www.dbrsmorningstar.com/research/367510). Other applicable methodologies include DBRS Morningstar Criteria: Preferred Share and Hybrid Security Criteria for Corporate Issuers (November 2, 2020; https://www.dbrsmorningstar.com/research/369165), DBRS Morningstar Criteria: Rating Corporate Holding Companies and Parent/Subsidiary Rating Relationships (November 2, 2020; https://www.dbrsmorningstar.com/research/369167), and DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (February 3, 2021; https://www.dbrsmorningstar.com/research/373262 ).

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

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.dbrsmorningstar.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.

Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar’s outlooks and ratings are under regular surveillance.

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

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