Morningstar DBRS Confirms First National Financial LP’s Long-Term Issuer Rating at BBB, Stable Trend

DBRS Limited (Morningstar DBRS) confirmed the Long-Term Issuer Rating of First National Financial LP (FNF LP) at BBB and the credit ratings on the Senior Unsecured Debt and Class A Preference Shares of First National Financial Corporation (FNFC; together with FNF LP, FNF or the Company) at BBB (low) and Pfd-3, respectively. All trends are Stable. The Intrinsic Assessment (IA) for FNF LP is BBB. FNFC’s Support Assessment is SA3, which reflects no expectation of timely external support. This results in FNFC’s Senior Unsecured Debt credit rating being positioned one notch below FNF LP’s IA at BBB (low).

KEY CREDIT RATING CONSIDERATIONS
The credit rating confirmations and Stable trends reflect FNF’s ranking as one of the largest non-bank mortgage finance companies in Canada, with a top-tier market share position in the independent mortgage broker channel. FNF consistently generates stable earnings and underlying cashflows from its mortgage servicing operations, benefiting from large origination volumes and scalability of operations. FNF-originated mortgages have historically had low delinquency rates and, positively, the Company has limited exposure to credit risk as originated mortgages are either placed with institutional investors or are insured. Credit ratings are constrained by FNF’s monoline business model, dependence on wholesale funding, its relatively high dividend payout ratio that limits financial flexibility (albeit dividends are at the Company’s discretion), and the client concentration within the Company’s institutional investor customers.

Morningstar DBRS views FNF as susceptible to any material adverse changes in the Canadian real estate market, with single-family residential mortgages representing roughly two-thirds of its mortgages under administration (MUA). This is substantially mitigated by the fact that approximately 60% is insured and 71% of its single-family residential MUA is administered for third-party investors with no recourse to the Company for credit losses. Of the remaining 29%, 25% is insured by the three large Canadian mortgage default insurers. On the commercial side, 88% of MUA are insured.

CREDIT RATING DRIVERS
FNF’s credit ratings would be upgraded if the Company were able to demonstrate a consistent reduction in its single-name institutional investor concentration and noticeably diversify its funding sources beyond existing securitization vehicles.

Conversely, credit ratings would be downgraded if the Company were to incur substantially higher delinquency rates and a sustained deterioration in asset quality metrics caused by deficiencies in risk management or underwriting, which could result in reduced investor appetite for FNF-originated mortgages. A prolonged deterioration in financial performance or any changes in government-backed securitization programs that could constrain the Company’s ability to fund mortgage originations would also result in a downgrade of the credit ratings.

CREDIT RATING RATIONALE

Franchise Building Block (BB) Assessment: Good/Moderate
FNF is one of the largest non-bank mortgage finance companies in Canada, with $143.5 billion in MUA as of December 31, 2023. The Company offers single-family residential mortgages (approximately 66% of MUA), predominately originated through the independent mortgage broker channel, as well as multifamily residential and commercial mortgages (approximately 34% of MUA). In F2023, MUA increased 9.6% year over year (YOY) to a record high; however, new mortgage originations and renewals decreased 1.7% YOY to $37.5 billion. The YOY increase in commercial originations benefitted from FNF’s leading position in the insured multiresidential market, particularly with respect to affordable housing. The growth in commercial was more than offset by a YOY decrease in single-family residential originations resulting from the uncertain interest rate environment, which slowed housing purchases.

Earnings Building Block (BB) Assessment: Good
Historically, FNF has generated consistent earnings and underlying cash flows from its mortgage servicing operations, with reported earnings in F2023 rising 28% YOY to $252.8 million. Excluding the increase in realized and unrealized gains on financial instruments of $22.1 million in F2023 ($59.6 million in F2022), earnings increased YOY by 54%. The higher interest rate environment, while slowing originations, had favourable impacts on other parts of the business including slower mortgage prepayment speeds that benefitted portfolio growth, and increased mortgage servicing revenues where FNF earned higher interest income on escrow deposits. FNF continues to be exposed to institutional investor concentration risk with approximately 8.5% of its placement fees and mortgage servicing income in F2023 generated from one major Canadian financial institution. Morningstar DBRS notes, however, this was down YOY from 12.7%, attributable to higher securitization revenue and the Company securitizing more conventional business directly.

Risk Building Block (BB) Assessment: Good
FNF has limited credit risk exposure, which is a key factor supporting the credit ratings, as essentially all mortgages originated by the Company are either placed with institutional investors or insured. While arrears/delinquency levels have been trending upward, particularly with FNF’s non-conforming Excalibur product, mortgages originated by FNF continue to perform well with manageable upticks in overall arrears metrics. Any credit risk faced by the Company stems from uninsured mortgages that are temporarily held on the balance sheet prior to securitization, as well as a small portfolio of primarily first and second commercial bridge mortgages that are held by the Company until borrowers are approved by Canada Mortgage and Housing Corporation’s (CMHC; rated AAA with a Stable trend by Morningstar DBRS) for a traditional term mortgage. FNF is well regarded in the institutional investor community for its underwriting standards, and Morningstar DBRS notes that sustaining this credit performance is critical to the Company’s business model of securitizing or placing FNF-originated mortgages. Morningstar DBRS views this risk as well managed with negligible loan repurchase volumes historically, reflecting FNF's strong underwriting and adjudication processes.

Funding and Liquidity Building Block (BB) Assessment: Moderate
FNF is predominately funded through government-sponsored securitization programs and a $1.5 billion committed syndicated revolving credit facility ($1.1 billion outstanding at December 31, 2023) that is used to fund mortgages it originates and warehouses prior to settlement with the investor or funding with a securitization vehicle. FNF also has access to both committed and uncommitted repo facilities to fund a portion of its warehouse loans. Given that FNF-originated mortgages remain on the Company’s balance sheet for only a short period, this funding model is viewed as appropriate and aligned with FNF’s assets.

Capitalization Building Block (BB) Assessment: Moderate/Weak
Morningstar DBRS views FNF’s capital as adequate, particularly as the Company faces limited exposure to credit risk and its capital predominately comprises common shares and retained earnings. Because FNF is not regulated by the Office of the Superintendent of Financial Institutions, it is not subject to a minimum regulatory capital level; however, the Company must maintain a certain level of capital as an approved issuer under CMHC’s National Housing Act Mortgage-Backed Securities and Canada Mortgage Bond programs. FNF’s regular common share dividend payout ratio was 76% in F2023 (including a $45 million discretionary special dividend) compared with 73% in the prior year, which limits financial flexibility.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
Governance (G) Factors
The following Governance factor had a relevant effect on the credit analysis:
Corporate/Transaction Governance is a relevant factor in the credit analysis, but it does not affect the credit ratings or the trend assigned to FNF. Morningstar DBRS finds the issuer’s corporate structure limits appropriate board and audit independence. The board of directors consists of nine members, six of whom are independent, with three board members being senior executives (two of whom are co-founders who together control approximately 71% of FNF’s common shares). This factor is incorporated into FNF’s Franchise grid grades.

There were no Environmental or Social factors that had a relevant or significant 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) at 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 (September 1, 2023), https://dbrs.morningstar.com/research/420144. In addition Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (January 23, 2024) at https://dbrs.morningstar.com/research/427030 in its consideration of ESG factors.

The following methodologies have also been applied:
-- DBRS Morningstar Global Criteria: Rating Corporate Holding Companies and Parent/Subsidiary Rating Relationships (September 27, 2023), https://dbrs.morningstar.com/research/421119.

-- DBRS Morningstar Global Criteria: Preferred Share and Hybrid Security Criteria for Corporate Issuers (October 19, 2023), https://dbrs.morningstar.com/research/422134.

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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