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

DBRS Limited (Morningstar DBRS) confirmed the Long-Term Issuer Rating and Senior Secured Notes credit rating of MCAP Commercial LP (MCAP or the Partnership) at BBB. The trends on both credit ratings are 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 final credit ratings on MCAP equal to its IA.

KEY CREDIT RATING CONSIDERATIONS
The credit rating confirmations and Stable trends reflect MCAP's franchise as one of the largest nonbank mortgage finance companies in Canada with $154.9 billion of assets under management (AUM) as of Q1 2024 and its top-tier market share position in the independent mortgage broker channel. Further, MCAP's good levels of recurring earnings and underlying cash flows from its growing mortgage servicing operations underpin its credit profile. The credit ratings are constrained by MCAP's limited funding sources, which predominantly comprise securitizations. In addition, although mortgages originated by the Partnership are performing better than or in line with those originated by large Canadian banks, Morningstar DBRS views MCAP as susceptible to any adverse changes in the Canadian real estate market, as single-family mortgages comprise the majority of the Partnership's AUM. Morningstar DBRS 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 higher interest rates and highly leveraged consumers.

CREDIT RATING DRIVERS
A sustained improvement in financial performance, resulting in stronger capital levels and further diversification in funding sources would lead to a credit 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 credit rating downgrade. Furthermore, sustained deterioration in financial performance, any changes in government-backed securitization programs that could constrain MCAP's ability to fund mortgage originations, or a significant slowdown in capital retention would also result in a downgrade of the credit ratings.

CREDIT RATING RATIONALE
Franchise Building Block (BB) Assessment: Good
MCAP's franchise is anchored by a national, multibrand, and multichannel mortgage origination platform, which Morningstar DBRS views as the broadest and deepest product set in the industry. The Partnership offers single-family residential mortgages (about 86% of AUM as at Q1 2024), predominantly originated through the independent mortgage broker channel, as well as multifamily residential and commercial mortgages, including construction loans (about 14% of AUM as at Q1 2024). MCAP maintains a top-tier market share in the mortgage broker channel. In a challenging operating environment, the Partnership's AUM marginally grew year over year (YoY) to approximately $154.9 billion in Q1 2024. Total new mortgage originations and purchases stood at $4.4 billion in Q1 2024, compared with $4.1 billion for the same period in the prior year. Further interest rate cuts in 2024 by the Bank of Canada, combined with strong population growth, could potentially drive an increase in overall real estate activity, which in Morningstar DBRS' view, would support MCAP's new mortgage originations and AUM growth in F2024.

Earnings Building Block (BB) Assessment: Good
Reflecting its economies of scale, MCAP generates good levels of recurring earnings supported by fee revenue produced from the retained servicing rights on all of its AUM. Overall, noninterest income accounted for about 58% of total revenue in the year ending November 30, 2023 (F2023). In a challenging operating environment, MCAP recorded net income of $160.1 million in F2023, compared with $192.7 million in the prior year. The 16.9% decrease in net earnings is largely associated with higher interest expense on MCAP's floating rate credit facilities, lower noninterest income, as well as higher securitization and operating expenses. Noninterest income was reduced by 7.9% YOY to $610.2 million in F2023, driven largely by a 98.3% decrease in financial instrument gains as a result of lower fair value adjustments on securitized and non-securitized mortgages and lower hedge gains. Mortgage origination fees also decreased by 7.0% YOY to $91.4 million in F2023 because of a lower volume of mortgages sold to whole-loan and commitment investors.

Risk Building Block (BB) Assessment: Good
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 waiting 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 industry 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. Morningstar DBRS views this risk as well managed.

Funding and Liquidity Building Block (BB) Assessment: Moderate
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, which Morningstar DBRS views as a credit ratings constraint. As part of the strategy to diversify its funding, MCAP added other institutional investors to its already-extensive list in past years. To manage its liquidity, the Partnership has established sufficient bank credit facilities.

Capitalization Building Block (BB) Assessment: Moderate/Weak
Morningstar DBRS views MCAP's capital as adequate, as the Partnership has limited exposure to credit risk, and capital predominantly consists of partners' equity and retained earnings. Supported by higher retained earnings and lower intangible assets, tangible partners' equity increased to $446.1 million in F2023 from $404.5 million in the prior year. Nevertheless, tangible partners' equity represented only 3.4% of tangible assets, excluding securitizations, in F2023 compared with 5.7% in F2022. The Partner distributions payout ratio (calculated as a percentage of net income under IFRS) stood at about 81% in F2023. In the longer term, MCAP expects to maintain the payout ratio at 65%. Morningstar DBRS would consider this retention level as sufficient to support growth.

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

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (January 23, 2024) https://dbrs.morningstar.com/research/427030.

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

The principal methodology is the Global Methodology for Rating Non-Bank Financial Institutions (April 15, 2024) https://dbrs.morningstar.com/research/431187. In addition, Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (January 23, 2024) https://dbrs.morningstar.com/research/427030 in its consideration of ESG factors.

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

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.

Morningstar DBRS 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. Morningstar DBRS's outlooks and credit ratings are under regular surveillance.

For more information on this credit or on this industry, visit dbrs.morningstar.com.

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