DBRS Morningstar Assigns Issuer Rating and Long-Term Debt Rating of AA (low), Stable Trends, to First Nations Finance Authority

DBRS Limited (DBRS Morningstar) assigned an Issuer Rating and Long-Term Debt rating of AA (low) with Stable trends to the First Nations Finance Authority (FNFA or the Authority). Concurrently, DBRS Morningstar confirmed the Authority’s Commercial Paper (CP) rating at R-1 (middle) with a Stable trend. FNFA is a not-for-profit, non-share capital corporation with a mandate to provide cost-effective financing, capital planning, and investment management services to First Nations communities in Canada. The credit ratings are predicated on the strength of the legislative framework that provides FNFA with (1) the ability to intercept generally high-quality revenues provided as security through the establishment of secured revenue trust accounts, (2) the ability to replenish debt reserves through a joint and several obligation of borrowers with outstanding loans, (3) the right to require third-party intervention in a borrowing member’s finances, and (4) credit characteristics of the underlying borrowers. Constraining the credit ratings, however, are the untested nature of the FNFA’s intervention and debt reserve fund (DRF) replenishment mechanisms, as well as uncertainty regarding the future composition of an expanding portfolio.

As of June 30, 2023, FNFA’s loan portfolio totalled approximately $1.83 billion, up from $1.66 billion for the prior-year period. Loan sizes range between $0.4 million and $173.9 million, with an average loan size of approximately $16.1 million. Over the years, FNFA’s portfolio has increasingly diversified, with borrowing members located across nine Canadian provinces and one territory.

As provided for under the First Nations Fiscal Management Act (the Act), First Nations governments can borrow against property tax revenues or other revenues that can come from a variety of eligible sources, including royalty payments, leases on reserve lands, contract revenues, band businesses, provincial or municipal transfers, and interest income (herein referred to as other revenues).

DBRS Morningstar notes that the majority of approved borrowers currently exhibit credit characteristics consistent with BB-range to BBB-range credit ratings, unchanged from the prior year. In addition, sound underwriting practices are intended to ensure that the quality of the borrowing pool is not materially diluted over time. For each loan financed by the Authority to a First Nation, 5% of the gross loan value is withheld in the DRF, subject to replenishment. This replenishment mechanism creates a joint and several obligation among borrowing members with outstanding loan amounts. DBRS Morningstar notes that the joint and several nature of membership promotes discipline in the future expansion of the pool as existing members will be mindful of not tying themselves to unduly weak borrowers.

The credit profile also benefits from a $53.2 million credit enhancement fund provided by the federal government to supply immediate, temporary liquidity to the DRF. Further, FNFA has a $400 million CP program that is used to fund the bridge financing program prior to loans being financed by long-term fixed-rate debentures. The CP program complies with the “DBRS Morningstar Global Criteria: Commercial Paper Liquidity Support for Nonbank Issuers.”

On June 20, 2023, the Act was amended to expand the potential pool of borrowers as well as revenue streams that FNFA can intercept, among other changes and clarifications. This leads DBRS Morningstar to believe that the number of First Nations borrowers and the size of the associated loan portfolio are expected to grow steadily over time, providing the pool with greater fiscal capacity to support the joint and several obligation to replenish the DRF. However, there exists the risk that new borrowing members may meet only the minimum established underwriting criteria, which could potentially lead to a gradual dilution in the quality of the pool over time. Conversely, intercepted revenue streams arising from federal revenues or provincial contracts have the potential to increase the quality of FNFA's loan portfolio.

CREDIT RATING DRIVERS
A positive credit rating action could result from improvement in the quality of the underlying borrowing pool or improvement in available credit enhancement relative to the overall portfolio size. A negative credit rating action could arise from (1) a material deterioration in the quality of the underlying loan portfolio; (2) a material reduction in funds available for credit enhancement relative to the overall portfolio size; and/or (3) evidence that structural features, such as the DRF replenishment mechanisms, oversight, and intervention of borrowers, do not work as intended.

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/416784 (July 4, 2023).

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

DBRS Morningstar applied the following principal methodology:
-- General Corporate Methodology: Appendix 3—Canadian Government Pooled Lending Vehicles (March 22, 2023; https://www.dbrsmorningstar.com/research/411487)

The following methodology has also been applied:
-- DBRS Morningstar Global Criteria: Commercial Paper Liquidity Support for Nonbank Issuers (February 24, 2023; https://www.dbrsmorningstar.com/research/410196)

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

A description of how DBRS Morningstar analyzes corporate finance transactions and how the methodologies are collectively applied can be found at: https://www.dbrsmorningstar.com/research/397223.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link under Related Documents or by contacting us at [email protected].

The credit rating was initiated at the request of the rated entity.

The rated entity or its related entities did participate in the credit rating process for this credit 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 credit 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 trends and credit ratings are under regular surveillance.

Information regarding DBRS Morningstar credit ratings, including definitions, policies, and methodologies, is available on www.dbrsmorningstar.com or contact us at [email protected].

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