DBRS Morningstar Confirms MCAP Commercial LP’s Long-Term Ratings at BBB, Stable Trends

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 with Stable trends. MCAP has an Intrinsic Assessment (IA) of BBB and a Support Assessment of SA3, which reflects no expectation of timely external support. This results in a rating that is equivalent to the Partnership’s IA.

KEY RATING CONSIDERATIONS
The ratings confirmation and Stable trends reflect MCAP’s ranking as one of the largest nonbank mortgage finance companies in Canada and its top-tier market share position in the independent mortgage broker channel. Following the acquisition of Paradigm Quest Inc. (Paradigm) in August 2021, the Partnership further solidified its franchise as the largest mortgage finance company in Canada with over $146 billion of assets under management (AUM) as of Q1 2022. In addition, MCAP continues to achieve economies of scale with solid recurring earnings and underlying cash flows from its growing mortgage servicing operations that have contributed to an improving efficiency ratio. While this metric did deteriorate modestly in F2021 because of tighter mortgage spreads and the Paradigm acquisition, DBRS Morningstar expects the efficiency ratio to improve once Paradigm is fully integrated. The ratings are constrained by MCAP’s funding profile, which predominantly comprises securitizations. Positively, mortgages originated by the Partnership are performing better than or in line with those originated by its peers. Nonetheless, DBRS Morningstar remains concerned about the elevated home prices, particularly in the greater Toronto and Vancouver areas and believes that housing prices remain vulnerable against the backdrop of rising interest rates and highly leveraged consumers. 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
Continued successful integration of Paradigm that contributes to a sustained improvement in financial performance while further diversifying funding sources would lead to a ratings upgrade.

Conversely, the ratings would be downgraded if MCAP were to experience any operational missteps in the
integration of the acquisition that would significantly affect its financial performance. 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. 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 would also result in a downgrade of the ratings.

RATING RATIONALE
MCAP markets a national, multibrand, and multichannel mortgage origination platform, which DBRS Morningstar views as the broadest and deepest product set in the industry. The Company offers single-family residential mortgages (approximately 89% of AUM in F2021), predominately originated through the independent mortgage broker channel, as well as multifamily residential and commercial mortgages, including construction loans (approximately 11% of AUM in F2021). Supported by the acquisition of Paradigm and new mortgage originations, the Partnership’s AUM grew 31% to $146.6 billion as at Q1 2022, and MCAP maintains a top-tier market share in the mortgage broker channel. The Company’s total new mortgage originations rose 60% year over year to $30.9 billion in F2021. It also successfully renewed $8.0 billion in mortgages during the same year.

Reflecting the Partnership’s economies of scale, MCAP generates consistent earnings because it retains servicing rights on all of its AUM. Total revenue is largely composed of fee income, which represented 53.2% (or 54.5% when including financial instrument gains) in F2021. Affected largely by lower origination fee rates because of a low mortgage spread environment and the Paradigm acquisition, net income decreased by 25% to $182.3 million in F2021 compared with F2020; however, it remains significantly above historical levels. This follows the record earnings in F2020 when MCAP achieved net income of $241.7 million, more than double the level from the prior year. MCAP’s operating efficiency, which is now in line with its peers, has improved significantly since 2013.

MCAP has limited direct exposure to credit risk as almost all of its originated mortgages are securitized or sold to financial institutions with limited recourse. Any credit risk stems from the short time that mortgages are warehoused by the Partnership on its balance sheet until they are securitized or sold, which DBRS Morningstar views as well managed. Overall, MCAP-originated mortgages have historically performed well with credit performance that is better than, or in line with, its peers. Sustaining a strong credit performance is critical to MCAP’s business model of securitizing originated mortgages and conducting whole-loan sales to larger financial institutions. As a result, similar to other mortgage originators, the Partnership would face potential exposure to repurchase risk if there were to be a breach of representations and warranties made to the purchaser or mortgage insurer. DBRS Morningstar views this risk as well managed as loan repurchases have been negligible over the last few years, which reflects MCAP's strong underwriting and adjudication process.

The Partnership is predominately funded through government and bank-sponsored securitization programs. Although DBRS Morningstar views this as a ratings constraint, MCAP continues to diversify its funding by adding other institutional investors to its already-extensive list. To manage its liquidity, the Partnership has established sufficient bank credit facilities. Overall, DBRS Morningstar views MCAP's liquidity and funding as appropriately managed and well aligned with its assets.

DBRS Morningstar views MCAP’s capital as sound, as the Partnership has limited exposure to credit risk, and capital predominately consists of partners’ equity and retained earnings. Because MCAP is not regulated by the Office of the Superintendent of Financial Institutions, it is not subject to a minimum regulatory capital level; however, the Partnership must maintain a certain level of capital as 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. Despite the continued increase in retained earnings, tangible partners’ equity reduced significantly to $299.5 million in F2021 from about $593 million in F2020 reflecting higher intangible assets and goodwill associated with the Paradigm acquisition. As a result, tangible partners’ equity represented 3.4% of tangible assets, excluding securitizations, in F2021 compared with 7.0% in F2020. Partner distributions continued to increase in F2021, despite lower earnings for the year. As a result, the payout ratio reached 70% in F2021 compared with 46% in the prior year. Going forward, MCAP is expected to maintain the payout ratio at 65% of net income as calculated under IFRS. DBRS Morningstar continues to view this payout level as sufficient to support growth.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance factors that had a significant or relevant effect on the credit analysis.

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/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.

Notes:
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 (May 17, 2022; https://www.dbrsmorningstar.com/research/396929).

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.

The conditions that lead to the assignment of a Negative or Positive trend are generally 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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