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

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. The trend on all ratings is Stable. 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 the final rating of MCAP to be equalized with the Partnership’s IA.

KEY RATING CONSIDERATIONS

The ratings confirmation and Stable trend reflect MCAP’s ranking as one of the largest nonbank Mortgage Finance Companies in Canada with over $154 billion of assets under management (AUM) as of Q1 2023 and its top-tier market share position in the independent mortgage broker channel. In addition, MCAP’s solid recurring earnings and underlying cash flows from its growing mortgage servicing operations underpin its credit profile. The ratings are constrained by MCAP’s funding profile, which predominantly comprises securitizations. Although mortgages originated by the Partnership are performing better than or in line with those originated by its peers, 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. DBRS Morningstar remains concerned about 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.

RATING DRIVERS
A sustained improvement in financial performance and further diversification in funding sources would lead to a ratings upgrade.

Conversely, 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 lead to a downgrade. Furthermore, 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’s franchise is anchored by 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 88% of AUM in F2022), predominantly originated through the independent mortgage broker channel, as well as multifamily residential and commercial mortgages, including construction loans (approximately 12% of AUM in F2022). MCAP maintains a top-tier market share in the mortgage broker channel. Amid a challenging macroeconomic environment, the Partnership’s AUM grew about 5% to $154.1 billion year over year (YOY) in Q1 2023. Total new mortgage originations and purchases stood at $4.1 billion in Q1 2023, compared with $6.3 billion for the same period of the prior year. DBRS Morningstar expects that the elevated interest rates and increased likelihood of recession could lead to a further slowdown in housing activity, which would be a headwind to MCAP’s new mortgage originations and AUM growth in 2023.

Reflecting the Partnership’s economies of scale, MCAP generates consistent earnings because of the recurring fee revenue produced from the retained servicing rights on all of its AUM. Total revenue is largely composed of fee income, which represented 46% (or 67% when including financial instrument gains) in F2022. Despite a marked decline in mortgage origination fees and lower net interest income, MCAP’s net earnings grew about 5.7% YOY to $192.8 million in 2022, largely supported by financial instruments gains and investment income. Gains on financial instruments were associated with gains on hedges, while investment revenue, which reflects interest on nonsecuritized mortgages, increased due to higher interest rates. Mortgage origination fees declined by 61% YOY in F2022 because of lower rates on originations resulting from a low mortgage spread environment throughout the majority of F2022. These revenue fees were also negatively affected by the lower volume of commitments and whole-loan sales.

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 awaiting to be securitized or sold. Overall, supported by strong underwriting and adjudication processes, 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.

MCAP's liquidity and funding are considered appropriately managed and well aligned with its assets. The Partnership is predominantly 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.

DBRS Morningstar views MCAP’s capital as sound, as the Partnership has limited exposure to credit risk, and capital predominantly 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. Supported by higher retained earnings, tangible partners’ equity increased notably to $404.5 million in F2022 from $299.5 million in F2021. Despite an increase in the Partner distributions, the payout ratio (calculated as a percentage of net income under IFRS) remained broadly stable at 69% in F2022. In the longer term, MCAP is expected to maintain the payout ratio at 65%.

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 (July 4, 2023; https://www.dbrsmorningstar.com/research/416784).

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, 2022; https://www.dbrsmorningstar.com/research/402314). In addition, DBRS Morningstar uses the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (July 4 , 2023; https://www.dbrsmorningstar.com/research/416784) in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.

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 rating was initiated at the request of the rated entity.

The rated entity or its related entities did participate in the rating process for this rating action.

DBRS Morningstar had access to the accounts, management and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

This is a solicited credit rating.

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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