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 rating confirmations and Stable trends reflect FNF’s continued 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 having low delinquency rates. The Company’s ratings are also underpinned by FNF’s limited exposure to credit risk as originated mortgages are either sold to institutional investors and/or securitized through government- and bank-sponsored securitization programs. The ratings also take into consideration FNF’s large volume of originations and scalability of operations that result in consistent earnings generation and cash flows; however, operating efficiency notably deteriorated in F2021 because of tighter mortgage spreads along with increases in staffing and hedging costs. The ratings take into account FNF’s dependence on wholesale funding as well as its relatively higher dividend payout ratio that limits financial flexibility, along with the client concentration within the Company’s institutional investor funding pools.
DBRS Morningstar notes that housing activity in Canada remains robust, with supply-demand imbalances continuing to fuel house price appreciation. Housing inventory is at an all-time low while investors and a record level of new immigrants have intensified demand. Housing supply shortages remain a critical issue, with no concrete solution in the near to medium term. DBRS Morningstar remains concerned about elevated home prices (amplified in the greater Toronto and greater Vancouver areas) caused by the housing market imbalances, along with high household debt levels, and views housing prices as remaining vulnerable. FNF is susceptible to any adverse changes in the Canadian real estate market, with single-family residential mortgages representing more than two-thirds of its mortgages under administration (MUA). This is somewhat mitigated as approximately 65% are insured and 31% are serviced for other institutions, with no recourse to the Company.
FNF’s ratings would be upgraded if the Company were able to demonstrate a consistent reduction in its single-name institutional investor concentration and noticeably diversify its funding sources beyond existing securitization vehicles.
Conversely, ratings would be downgraded if the Company were to incur substantially higher delinquency rates and a sustained deterioration in asset quality metrics from deficiencies in risk management or underwriting, which could result in reduced investor appetite for FNF-originated mortgages. A prolonged 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 would also result in a downgrade of the ratings.
FNF is one of the largest non-bank mortgage finance companies in Canada, with more than $123.9 billion in MUA. The Company offers single-family residential mortgages (approximately 68% of MUA), predominately originated through the independent mortgage broker channel, as well as multifamily residential and commercial mortgages (approximately 32% of MUA). In F2021, MUA grew 4% year over year (YOY), driven by commercial mortgage growth, while total new mortgage originations rose 17% YOY to $33.2 billion. FNF also successfully renewed $9.0 billion in mortgages during F2021 as a 35% YOY increase in multi-unit and commercial renewals was partly offset by a 5% YOY reduction in single-family renewals. FNF indicated the decrease in single-family renewals was because of reduced opportunities to renew as some borrowers chose to refinance to take advantage of low interest rates.
Historically, the Company has generated consistent earnings and underlying cash flows from its mortgage servicing operations, with earnings in F2021 rising 2% YOY to $194.6 million. This increase was largely because of higher mortgage servicing income and net interest on securitized mortgages, partially offset by lower mortgage spreads and a shift to securitize a larger percentage of commercial mortgage originations (forgoing placement fees for future net securitization margin). The Company continues to be exposed to client concentration risk, as FNF generated approximately 19.6% of F2021 revenue from placement fees and mortgage servicing income from one major Canadian financial institution. Despite FNF’s efforts to add more institutional investors, this concentration is up sharply from 13.1% in the prior year because of higher placement transactions.
Since essentially 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 performed well with very low delinquency rates. Any credit risk faced by the Company stems from mortgages accumulated for securitization that are temporarily held on the balance sheet prior to securitization as well as a small portfolio of primarily first and second commercial mortgages that are held by the Company for investment purposes. Since FNF is well regarded in the institutional investor community for its underwriting standards, 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 reflect FNF's strong underwriting and adjudication processes.
FNF is predominately funded through government-sponsored securitization programs and a committed syndicated revolving credit facility. Given that FNF-originated mortgages only remain on the Company’s balance sheet for a short period, this funding model is viewed as appropriate and aligned with FNF’s assets. To support its business model, the Company has a $1.5 billion syndicated bank revolving credit facility ($965.4 outstanding at December 31, 2021); FNF recently increased the limit by $250 million and extended the term out two years to March 2026.
DBRS Morningstar views FNF’s capital as adequate and sound, particularly as the Company faces limited exposure to credit risk and its capital predominantly comprises 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 Canadian Mortgage and Housing Corporation’s (rated AAA with a Stable trend by DBRS Morningstar) National Housing Act Mortgage Backed Securities and Canada Mortgage Bond programs. FNF’s common share dividend payout ratio increased to 110% in F2021, above its recent average of approximately 80%, driven by the annual special dividend that more than doubled to $75 million from $30 million in the prior year. The increase in the special dividend was attributed to paying shareholders the additional equity retained in F2020 as a result of pandemic-related uncertainties and funding requirements that have since abated. DBRS Morningstar considers the high payout ratio as a ratings constraint as it limits financial flexibility.
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.
All figures are in Canadian dollars unless otherwise noted.
The principal methodology is the Global Methodology for Rating Non-Bank Financial Institutions (September 2, 2021; https://www.dbrsmorningstar.com/research/383936). Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (February 3, 2021; https://www.dbrsmorningstar.com/research/373262 ).
Each of the methodologies employed in the analysis addressed one or more particular risks or aspects of the rating and were factored into the rating decision. Specifically, the DBRS Morningstar Criteria: Preferred Share and Hybrid Security Criteria for Corporate Issuers (October 21, 2021; https://www.dbrsmorningstar.com/research/386355) was used to assess the treatment of the Class A Preference Shares and the DBRS Morningstar Criteria: Rating Corporate Holding Companies and Parent/Subsidiary Rating Relationships (October 29, 2021; https://www.dbrsmorningstar.com/research/386615) was used in the assessment of the rating of the holding company.
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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