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. All trends are 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 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. Positively, FNF has limited exposure to credit risk as originated mortgages are either sold to institutional investors or securitized through government- and bank-sponsored securitization programs. FNF’s earnings and cash flow benefit from large origination volumes and scalability of operations, but its monoline business model is a ratings constraint. The ratings also consider FNF’s dependence on wholesale funding as well as its relatively higher dividend payout ratio that limits financial flexibility (albeit dividends are at the Company’s discretion), along with the client concentration within the Company’s institutional investor funding pools.

DBRS Morningstar remains concerned about the combination of Canadian household debt levels that remain near an all-time high, still-elevated home prices, and materially higher interest rates. Despite the downturn in the housing market in Canada, record levels of immigration, structural supply-demand imbalances, and pent-up demand should continue to drive demand and support prices. Nonetheless, housing prices remain elevated from pre-Coronavirus Disease (COVID-19) pandemic levels and somewhat vulnerable, with materially higher borrowing costs and still-elevated inflation eating into consumers’ disposable income. FNF is susceptible to any adverse changes in the Canadian real estate market, with single-family residential mortgages representing roughly two-thirds of its mortgages under administration (MUA). This is somewhat mitigated by the fact that approximately 60% are insured. Additionally, 70% of its single-family residential MUA is administered for third-party investors with no recourse to the Company for credit losses and of the remaining 30%, 24% is insured by the three large Canadian mortgage default insurers.

RATING DRIVERS
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 caused by 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.

RATING RATIONALE
FNF is one of the largest non-bank mortgage finance companies in Canada, with $131.0 billion in MUA as of December 31, 2022. 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 F2022, MUA increased 5.7% year over year (YOY) to a record high; however, new mortgage originations decreased 12% YOY to $29.1 billion, driven by a YOY decrease in single-family residential originations from a slowing real estate market and more competitive environment. FNF successfully renewed $9.0 billion in mortgages during F2022, relatively flat YOY. An increase in YOY single-family renewals attributable to lower prepayment activity was offset by a decrease in conventional commercial renewals as a result of higher interest rates.

Historically, the Company has generated consistent earnings and underlying cash flows from its mortgage servicing operations, with reported earnings in F2022 rising 2% YOY to $197.7 million. Excluding the increase in realized and unrealized gains on financial instruments of $59.6 million in F2022 ($5.8 million in F2021), earnings decreased YOY by 19%. The decline reflected a 17% reduction in new single-family residential originations, increased competition for fewer opportunities which caused FNF to increase broker incentives for residential mortgage transactions, periodic tightening of spreads on floating-rate securitizations as short-term rates rose rapidly during the year, and higher staffing costs. Although the Company continues to be exposed to client concentration risk, this risk reduced YOY as FNF generated 12.7% of F2022 revenue (down from 19.6% in F2021) from placement fees and mortgage servicing income from one major Canadian financial institution.

FNF has limited credit risk exposure, which is a key factor supporting the rating, because essentially all mortgages originated by the Company are either securitized or sold to institutional investors. 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. FNF is well regarded in the institutional investor community for its underwriting standards, and 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 with negligible loan repurchase volumes historically, reflecting FNF's strong underwriting and adjudication processes.

FNF is predominately funded through government-sponsored securitization programs and a $1.5 billion committed syndicated revolving credit facility ($1.1 billion outstanding at December 31, 2022) that is used to fund mortgages it originates and warehouses, prior to settlement with the investor or funding with a securitization vehicle. Given that FNF-originated mortgages remain on the Company’s balance sheet for only a short period, this funding model is viewed as appropriate and aligned with FNF’s assets.

DBRS Morningstar views FNF’s capital as adequate and sound, particularly as the Company faces limited exposure to credit risk and its capital predominately comprises common shares and retained earnings. Because 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 Canada 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 regular common share dividend payout ratio was 73% compared with 71% in the prior year (110% in F2021 when including special dividend of $75 million), which limits financial flexibility.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
Governance (G) Factors
DBRS Morningstar finds corporate governance related to the issuer’s corporate structure limits appropriate board and audit independence. This ESG factor is relevant to the credit rating but does not affect the assigned ratings or trends. The board of directors consists of nine members, six of whom are independent. Two board members are senior executives (co-founders) who together control approximately 71% of FNF’s common shares. This factor is incorporated into FNF’s Franchise grid grades.

There were no Environmental or Social 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 (May 17, 2022).

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

The principal methodology is the Global Methodology for Rating Non-Bank Financial Institutions https://www.dbrsmorningstar.com/research/402314 (September 2, 2022). In addition, DBRS Morningstar uses the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings https://www.dbrsmorningstar.com/research/396929 (May 17, 2022) in its consideration of ESG factors.

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 Global Criteria: Preferred Share and Hybrid Security Criteria for Corporate Issuers https://www.dbrsmorningstar.com/research/404248 (October 20, 2022) was used to assess the treatment of the Class A Preference Shares, and the DBRS Morningstar Global Criteria: Rating Corporate Holding Companies and Parent/Subsidiary Rating Relationships https://www.dbrsmorningstar.com/research/404334 (October 26, 2022) 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.

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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