Morningstar DBRS Confirms Credit Ratings on Teranet Holdings LP at BBB With Stable Trends

DBRS Limited (Morningstar DBRS) confirmed the Issuer Rating and the Senior Secured Debt credit rating of Teranet Holdings LP (Teranet or the Company) at BBB with Stable trends. The credit ratings continue to be supported by the Company’s position as an exclusive service provider in the Province of Ontario (Ontario or the Province; rated AA with a Stable trend by Morningstar DBRS) and the Province of Manitoba (Manitoba; rated A (high) with a Stable trend by Morningstar DBRS), healthy margins, and low capital needs but are constrained by the debt service coverage ratio (DSCR).

KEY CREDIT RATING CONSIDERATIONS
Teranet operates primarily in Ontario, with operations in the Province contributing 89.3% of total gross revenue in 2023. The remainder comes from its operations in Manitoba. Ontario’s total registration volumes in 2023 were 23.5% lower compared with those in 2022, as a result of a slowdown in real estate transactions driven by the tightening interest rate policy measures to moderate persistent inflation. Search and writs volumes in Ontario for 2023 followed the same trend, finishing 10.6% and 17.7% lower, respectively. Gross revenue decreased by 12.1% in 2023 from the prior year, as the contractual CPI-linked fee increase mechanisms served to partially mitigate the declines in volumes.

During 2023, the elevated interest rate environment contributed to the affordability issue, which, along with the uncertain macroeconomic conditions, had kept many buyers and sellers on the sideline. Refinancing activities also declined because of the high interest rate environment as mortgage holders became reluctant to switch lenders to avoid stress tests. When borrowers remain with their current lenders, this does not trigger a registration for Teranet. Management executed expense mitigation plans and reduced operating expenses by $5.7 million, or 4.8%, in 2023. Nonetheless, the resultant DSCR declined to 1.65 times (x) in 2023 from 2.00x for 2022, lower than Morningstar DBRS’ expectation of 1.74x.

In early 2024, strained affordability levels continued to suppress registration volumes, as the interest rate cycle peaked in July 2023 and the recent Bank of Canada interest rate reductions have not yet stimulated a surge in homebuyer demand. While still subdued, the housing market has shown signs of a modest recovery. The year-over-year resale volumes in July 2024 showed growth for the first time since February following the two successive interest rate cuts of 25 basis points in June and July 2024. Ontario registration volumes increased by 1.4% in Q2 2024 versus Q2 2023. The DSCR increased slightly to 1.66x on June 30, 2024, still below the additional indebtedness covenant threshold of 1.70x.

Morningstar DBRS believes the Ontario real estate market and other key Canadian housing markets have shown resilience in the past, with housing supply and affordability remaining key issues. Morningstar DBRS noted recent government and regulatory reforms to mortgage rules, in attempts to address the affordability issues, including (1) the expansion of mortgage insurance qualification to $1.5 million from $1.0 million (effective on December 15, 2024), (2) the expansion of eligibility for 30-year mortgage amortization to all first-time homebuyers and purchasers of newly built homes (effective on December 15, 2024), and (3) the Office of the Superintendent of Financial Institutions’ removal of the requirement for a stress test on homeowners who make a straight switch of uninsured mortgages from one bank to another bank on renewal (effective November 21, 2024). While these measures are all beneficial to the market and will likely improve affordability to a degree and increase refinancing activities, Morningstar DBRS expects their impact on the number of home sales to not be significant. Nonetheless, Morningstar DBRS believes some homebuyers have delayed their home purchases to 2025, waiting for interest rates to come down further and for the changes to the mortgage rules to be effective. Morningstar DBRS expects some pickup in growth in market activities in 2025 and a generally stable market between 2026 and 2029, barring any further government stimulations or changes to the macroeconomic conditions. The medium- and longer-term fundamentals of the Ontario real estate market (strong immigration/population growth, housing density, and continued economic growth) remain intact.

CREDIT RATING DRIVERS
Absent material improvement on the DSCR on a sustainable basis, a credit rating upgrade is unlikely, given the inherent volume risks and the cyclicality of the sector. A negative credit rating action could result from a material erosion to the DSCR, which could stem from a prolonged economic downturn or protracted material weakening of the real estate market.

FINANCIAL OUTLOOK
Morningstar DBRS assumes registrations will increase by 10% in 2025 versus 2024, followed by 2% annual growth over the forecast period. Further, assuming the same operating expenses as the management case (based on a stronger volume rebound scenario), and that the Series 2020-1 bonds and the Series 2022-1 bonds will be fully refinanced in 2025 and 2029, respectively, at a 2% refinancing interest rate premium, Morningstar DBRS expects the DSCR to slightly decline until 2027 (mainly as a result of the assumed refinancing interest rate premium) but remain above 1.50x during the forecast horizon (2024–29), supportive of the credit ratings.

CREDIT RATING RATIONALE
The credit ratings are underpinned by (1) the Company being the exclusive provider of necessary service until 2067, (2) its solid cash-generating capacity driven by resilient volumes and very high margins, (3) its track record as a high-quality service provider, (4) the strong covenant and debt security package, and (5) its strong equity provider with long-term focus. The challenges include (1) fee increases limited to 50% of CPI, (2) the cyclicality of registration activity, (3) the Company’s exposure to parcel growth rate, and (4) concentration risk.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance factor(s) 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 Factors in Credit Ratings (August 13, 2024), https://dbrs.morningstar.com/research/437781.

RATING DRIVER AND FINANCIAL RISK ASSESSMENT (FRA)

(A) Weighting of Rating Driver Factors
In the analysis of Teranet, the Rating Driver factors listed in the volume-based section of the methodology are considered in the order of importance.

(B) Weighting of FRA Factors
In the analysis of Teranet, the following FRA factor listed in the volume-based section of the methodology was considered more important: minimum DSCR.

(C) Weighting of the Rating Driver and the FRA
In the analysis of Teranet, the FRA carries greater weight than the Rating Driver.

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

Morningstar DBRS applied the following principal methodology:
-- Global Methodology for Rating Public-Private Partnerships (August 13, 2024), https://dbrs.morningstar.com/research/437820.

Morningstar DBRS credit ratings may use one or more sections of the Morningstar DBRS Global Corporate Criteria (15, April, 2024; https://dbrs.morningstar.com/research/431186), which covers, for example, topics such as holding companies and parent/subsidiary relationships, guarantees, recovery, and common adjustments to financial ratios.

The following methodology has also been applied:
-- Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (August 13, 2024), https://dbrs.morningstar.com/research/437781.

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

A description of how Morningstar DBRS analyzes corporate finance transactions and how the methodologies are collectively applied can be found at: https://dbrs.morningstar.com/research/431153.

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 info-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 trends and credit ratings are under regular surveillance.

Information regarding Morningstar DBRS credit ratings, including definitions, policies, and methodologies, is available on https://dbrs.morningstar.com or contact us at info-DBRS@morningstar.com.

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