Morningstar DBRS Confirms Home Trust Company's Credit Ratings at BBB With Stable Trends

DBRS Limited (Morningstar DBRS) confirmed the credit ratings of Home Trust Company (HTC or the Company), including the Company's Long-Term Issuer Rating at BBB and its Short-Term Issuer Rating at R-2 (high). The trends on all credit ratings are Stable. The combination of HTC with Fairstone Bank of Canada (Fairstone) completed on January 1, 2025, and HTC now operates as a fully owned subsidiary of Fairstone. Morningstar DBRS evaluates the Company's Intrinsic Assessment (IA) based on the combined group's (the Group) pro forma consolidated financials. The Company's IA of BBB and its Support Assessment of SA3 remain unchanged, which reflect no expectation of timely external support, resulting in HTC's Long-Term Issuer Rating being equivalent to the IA.

KEY CREDIT RATING CONSIDERATIONS
The credit rating confirmations and Stable trends reflect HTC's solid market position in the Alt-A mortgage space, particularly in the province of Ontario and Fairstone's growing franchise in near-prime consumer lending across Canada. Despite a challenging operating environment, HTC and the Group (on a pro forma basis) demonstrated resilient and robust profitability with good operating efficiency in 2024, compared with peers. The credit ratings are also supported by the Group's solid liquidity and capital position.

On the other hand, the Group's funding remains highly dependent on broker deposits, which, in Morningstar DBRS' view, is a key credit ratings constraint. The credit ratings also consider HTC's significant exposure to near-prime real estate lending, which heightens its risk profile as reflected by marked increases in impaired loans in the high-interest-rate environment. Morningstar DBRS is also concerned about the trade conflict between the U.S. and Canada and broad-based tariffs that could result in a combination of economic recession, rising unemployment, and pockets of higher inflation in Canada.

The HTC's IA is positioned below the IA range, reflecting HTC's highly concentrated exposure to real estate lending as well as significantly less funding diversity than its peers. Additionally, the more challenging operating environment as a result of macroeconomic uncertainty from the U.S. policy initiatives could potentially lead to higher-than-expected deterioration in the Group's asset quality.

CREDIT RATING DRIVERS
Morningstar DBRS would upgrade HTC's credit ratings if the Group continues to demonstrate strong financial performance and further diversification in funding sources. Continued diversification in business mix, while maintaining a similar risk profile, would also result in a credit ratings upgrade.

Conversely, Morningstar DBRS would downgrade the credit ratings if there were a significant deterioration in the Group's asset quality or a substantive funding pressure caused by deposit outflows. Additionally, the credit ratings would be downgraded if there were significant operational issues post-integration.

CREDIT RATING RATIONALE
Franchise Combined Building Block Assessment: Good/Moderate
On a consolidated basis, the Group's pro forma assets totalled about $30.9 billion as at December 31, 2024, with HTC accounting for about 74% of total assets. With about $28.4 billion in total pro forma loans for the same period, the combined businesses offer more diversified product lines, including residential and commercial mortgages, secured and unsecured personal loans, credit cards, and auto financing to more than 2 million customers with more than 250 branches across Canada. HTC is one of Canada's leading Alt-A mortgage providers for borrowers who are self-employed, new immigrants, or those recovering from bruised credit. Residential Alt-A mortgages formed about 47% of total on-balance sheet loans of the Group in 2024, with Ontario remaining HTC's largest market. HTC's mortgage originations decreased 12.5% year over year (YOY) to $5.3 billion in 2024, resulting primarily from both insured single-family and multi-unit residential mortgages as HTC ceased to originate both products in late 2023. Despite an expected decline in HTC's on-balance sheet loans in 2025-2026 (because of the discontinuation of insured mortgage originations), Morningstar DBRS expects a moderate expansion in the Group's total loans, supported by non-mortgage consumer loans.

Earnings Combined Building Block Assessment: Strong/Good
The Group's pro forma net income was $540.2 million in 2024, with HTC representing about 53% of the total. The Group's pro forma net income grew 32.3% YOY in 2024, supported by higher revenue but partially offset by an increase in total operating expenses and provision for credit losses (PCL). Net interest income grew 12.9% YOY to $1.8 billion in 2024, supported by a 49-basis-point (bp) expansion in the net interest margin of 6.3% for the same period (as calculated by Morningstar DBRS). The adjusted operating expenses increased by 3.1% YOY to $693.0 million in 2024 on other operating expenses, partially offset lower salaries and benefits. As a result, the efficiency ratio (as calculated by Morningstar DBRS) improved to 33.9% in 2024 compared with 37.0% in the prior year. Total PCL also increased to $581.6 million in 2024 compared with $502.4 million in 2023, largely driven by non-mortgage retail loans, as well as commercial mortgages. Nevertheless, PCL as a share of income before provisions and taxes remained broadly stable at 43.0% in 2024.

Risk Combined Building Block Assessment: Good/Moderate
The Group's pro forma gross loans increased 2.2% YOY to $28.4 billion in 2024, driven by growth across most business lines. However, HTC's gross loans contracted marginally at 0.4% YOY to $21.3 billion for the same period because of the discontinuation of insured mortgage originations. The Group exhibits somewhat weaker asset quality metrics compared with its peers, reflecting its material exposure to Alt-A mortgages and consumer loans offered to near-prime customers. According to Morningstar DBRS' calculations, the Group's impaired loans increased to 2.8% of gross loans in 2024 compared with 1.8% in the prior year, because of increased impairments across most business lines. Meanwhile, net write-offs amounted to 1.8% of gross loans in 2024 compared with 1.5% in the prior year. On a stand-alone basis, HTC's gross impaired loans ratio deteriorated by 119 bps YOY to 2.6% in 2024 on single-family residential and commercial mortgages. Nevertheless, the net write-offs ratio continued to be negligible at 5 bps for the same period.

Funding and Liquidity Combined Building Block Assessment: Moderate
The Group's funding is highly dependent on broker-sourced deposits, which accounted for about 74% of its $21.3 billion total deposits in 2024. In recent years, HTC has made a concerted effort to diversify its funding base through directly sourced deposits and various capital markets initiatives, including various securitization programs and institutional deposit notes. The Company continued to grow its direct-to-consumer deposits through its Oaken Financial offering, which amounted to $5.4 billion and accounted for 25% of the Group's total deposits in 2024. The Company ceased originating and securitizing insured single-family residential and insured multi-unit residential mortgages in late November 2023.

Capitalisation Combined Building Block Assessment: Good
The Group's capital position is good, with a pro forma CET1 ratio of 13.9% as of December 31, 2024. Reflecting an increase in risk-weighted assets, the Group's CET1 ratio decreased by 45 bps YOY in 2024. According to Morningstar DBRS calculations, the Group's dividend payout ratio was 98% in 2024 compared with 157% in the prior year. On a stand-alone basis, HTC maintained good levels of capital in 2024 as indicated by its CET1 ratio of 13.81%, well above the regulatory minimum of 7%. Despite a planned reduction in capital buffers in 2025, Morningstar DBRS expects HTC's and the Group's capital ratios to remain comfortably above the regulatory limits and broadly in line with the peer average.

Further details on the Scorecard Indicators and Building Block Assessments can be found at https://dbrs.morningstar.com/research/450476

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 Factors in Credit Ratings (August 13, 2024) at https://dbrs.morningstar.com/research/437781.

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

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (June 4, 2024), https://dbrs.morningstar.com/research/433881. In addition Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (August 13, 2024; https://dbrs.morningstar.com/research/437781) 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' trends 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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