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

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 with Stable trends. MCAP has an Intrinsic Assessment (IA) of BBB and a Support Assessment (SA) of SA3, which reflects no expectation of timely external support. This results in a rating that is equivalent to the Partnership’s IA.

KEY RATING CONSIDERATIONS
The rating confirmations and Stable trends reflect MCAP’s ranking as one of the largest nonbank mortgage finance companies in Canada and its top-tier market share position in the independent mortgage broker channel. The Partnership generates consistent earnings and underlying cash flows, which are largely supported by growth in assets under management (AUM). In addition, MCAP continues to achieve economies of scale that have benefitted earnings, as it reported record net income in F2020 despite the impact the Coronavirus Disease (COVID-19) pandemic had on the broader economy. Moreover, since 2013, operating efficiency has improved more than 2,700 basis points to 54.2% at the end of F2020. The ratings also consider the diversification of MCAP’s investor base and funding sources as well as the sound risk profile with mortgages originated by the Partnership performing better than or in line with those originated by the large Canadian banks. DBRS Morningstar notes that the pandemic has created a challenging economic environment. Despite this impact, housing activity in Canada has been robust, which has resulted in recent home price appreciation. This activity follows a period of stable prices which reflected the actions taken over the last several years by regulators to tighten mortgage rules. DBRS Morningstar remains concerned about the combination of highly leveraged consumers and elevated home prices, particularly in the greater Toronto and Vancouver areas and believes that housing prices remain vulnerable. As a result, 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.

RATING DRIVERS
The ratings would be upgraded if the Partnership significantly increases its scale while generating higher and sustainable returns on total assets in line with higher-rated peers.

Conversely, ratings would be downgraded if MCAP incurs 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. A sustained deterioration in financial performance or a material slowdown in capital retention caused by a significant increase in the partner distribution payout ratio would result in a ratings downgrade. Ratings would also be downgraded if there were any changes in government-backed securitization programs, which would constrain MCAP’s ability to fund mortgage originations.

RATING RATIONALE
MCAP markets a national, multibrand, and multichannel mortgage origination platform, which DBRS Morningstar views as the broadest and deepest product set in the industry. The Partnership’s AUM grew to $111.4 billion as at November 30, 2020, and MCAP maintains a top-tier market share in the mortgage broker channel. Total new mortgage originations in F2020 were $19.3 billion, an increase of 14% over the prior year. In addition, renewals increased to $7.0 billion compared with $6.0 billion in F2019, which has supported AUM growth.

Reflecting the Partnership’s economies of scale, MCAP has generated consistent earnings because it retains servicing rights on all of its AUM. In F2020, the Partnership achieved record earnings of $241.7 million, more than double the level from the prior year. These results were largely driven by AUM growth of 6% year over year, higher origination volumes, and a supportive mortgage spread environment compared with the prior year. MCAP’s operating efficiency, which is now in line with its peers, has improved significantly since 2013.

Underpinning the ratings, 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 until they are securitized or sold, which DBRS Morningstar views as well managed. Overall, MCAP-originated mortgages have historically performed well with credit performance that is better than, or in line with, the large Canadian banks. DBRS Morningstar will continue to monitor the impact of the pandemic, particularly on the Partnership's asset quality metrics. Considering that MCAP is well regarded in the mortgage broker community for its level of service, sustaining this strong credit performance is critical to its 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 faces potential exposure to repurchase risk if there was a breach of representations and warranties made to the purchaser or mortgage insurer. DBRS Morningstar views this risk as well managed as loan repurchases have been negligible over the last few years, which reflects MCAP's strong underwriting and adjudication process.

The Partnership is predominately funded through government and bank-sponsored securitization programs, as it is not licensed to take deposits. 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, as well as accessing the residential mortgage-backed securities market in the past. To manage its liquidity, the Partnership has established sufficient bank credit facilities, although it typically depends on its strategic partners for equity capital. Overall, DBRS Morningstar views MCAP's liquidity and funding as appropriately managed and well aligned with its assets.

DBRS Morningstar views MCAP’s capital as sound, as the Partnership has limited exposure to credit risk and capital predominately 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. Tangible partners’ equity rose to $593 million as at November 30, 2020, compared with $468 million in the prior year, primarily reflecting higher retained earnings. Tangible partners’ equity represents 1.4% of tangible assets, or 7.0% when securitized assets are excluded. While partner distributions increased in F2020, this was largely due to a significant increase in earnings for the year. As a result, the payout ratio improved to 46% from 59% in the prior year. Going forward, MCAP is expected to increase the payout ratio to 60% of net income calculated under IFRS from the previous 50%. Despite this modest increase, DBRS Morningstar continues to view this payout level as still sufficient to support growth.

ESG CONSIDERATIONS
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/373262.

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

The principal methodology is the Global Methodology for Rating Non-Bank Financial Institutions (September 29, 2020; https://www.dbrsmorningstar.com/research/367510/global-methodology-for-rating-non-bank-financial-institutions). Other applicable methodologies include DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (February 3, 2021; https://www.dbrsmorningstar.com/research/373262/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings).

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

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

Generally, the conditions that lead to the assignment of a Negative or Positive trend are 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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