DBRS Morningstar Confirms MCAP Commercial LP at BBB, Stable Trend, Following Paradigm Quest Acquisition Announcement

DBRS Limited (DBRS Morningstar) confirmed the Long-Term Issuer Rating and Senior Secured Notes rating of MCAP Commercial LP (MCAP or the Partnership) at BBB following the announcement that MCAP has reached an agreement to acquire the shares of Ashley Park Financial Services Corp. and all of its subsidiaries, including Paradigm Quest (Paradigm). The trend on all ratings is Stable. The transaction is expected to close in Q3 2021, subject to customary closing conditions.

KEY RATING CONSIDERATIONS
The confirmation of the ratings and Stable trend reflect DBRS Morningstar’s view that the acquisition of Paradigm is a long-term positive for MCAP. With $113.5 billion of assets under management (AUM) as of May 31, 2021, MCAP has a top-tier market share position in the independent mortgage broker channel. The addition of Paradigm’s AUM is expected to significantly increase MCAP’s scale and solidify the Partnership’s position as the largest mortgage finance company in Canada with over $140 billion of AUM. Given that Paradigm would operate as a stand-alone entity upon closing, integration risks are mitigated, but execution risk remains, as with any transaction.

Despite the impact the Coronavirus Disease (COVID-19) pandemic has had on the broader economy, housing activity in Canada has been robust, which has resulted in recent home price appreciation. This activity follows a period of stable prices, which reflected the actions taken over the last several years by regulators 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, DBRS Morningstar views MCAP as susceptible to any adverse changes in the Canadian real estate market, given that single-family mortgages comprise the majority of the Partnership’s AUM.

RATING DRIVERS
Successful completion and integration of the acquisition that is evidenced by MCAP’s ability to retain AUM and market share while capturing the benefits of scale through improved earnings over the medium term would lead to an upgrade of the ratings.

Conversely, the ratings would be downgraded if MCAP were to experience any operational missteps in the integration of the acquisition that would significantly impact its financial performance, or should MCAP not be successful in retaining AUM obtained via the acquisition. Furthermore, substantially higher delinquency rates caused by deficiencies in risk management or underwriting that could significantly reduce the amount of business the Partnership conducts with key institutional investors would also lead to a downgrade.

RATING RATIONALE
Founded in 2004, Paradigm is a full-service mortgage origination and servicing company offering products under several brands (Merix, Lendwise, NPX, and various private-label arrangements). While MCAP and Paradigm have similar products, this does enhance geographic diversification, as Paradigm has a solid presence in Québec and Alberta, provinces where MCAP has historically been relatively underweight.

MCAP expects the acquisition to be accretive to earnings in 2021. Importantly, the acquisition will strengthen MCAP’s recurring revenue generation given the resilient fee income derived from Paradigm’s business process outsourcing arrangements with its partner institutions. DBRS Morningstar expects the acquisition to have a modest impact on the Partnership’s leverage as MCAP is using existing liquidity to finance the acquisition and will not be incurring any new debt.

Positively, the Partnership generates consistent earnings and underlying cash flows, which are largely supported by growth in AUM. In addition, MCAP continues to achieve economies of scale that have benefitted earnings, as it reported record net income in F2020 despite the impact the coronavirus pandemic had on the broader economy. Moreover, since 2013, operating efficiency has improved more than 2,700 basis points to 54.2% at the end of F2020. Earnings momentum has been achieved while maintaining a sound risk profile, with mortgages originated by the Partnership performing better than or in line with those originated by the large Canadian banks.

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: 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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