DBRS Confirms MCAP Commercial LP’s Long-Term Issuer Ratings at BBB (low) with a Stable Trend

DBRS Limited (DBRS) confirmed MCAP Commercial LP’s (MCAP or the Partnership) Long-Term Issuer Rating and Senior Secured Notes ratings at BBB (low). The trend on all ratings is Stable. MCAP has an Intrinsic Assessment (IA) of BBB (low) and a Support Assessment of SA3. The SA3 rating, which reflects the expectation of no timely external support, results in a final rating that is equivalent to the IA.

The ratings reflect DBRS’s view that MCAP’s franchise strength and earnings power have continued to improve, and the Partnership has now reached a scale where, going forward, it can significantly compete with other major mortgage finance companies. Moreover, DBRS expects that MCAP will continue to gain market share, reflecting a broader product suite than other peers, which would also allow the Partnership to slowly diversify its funding base through the onboarding of new investors and the use of different securitization vehicles. However, DBRS remains concerned with rising housing prices, particularly in the greater Toronto and Vancouver areas, which could lead to a real estate market correction in Canada. As a result, MCAP may be susceptible to any adverse changes in the Canadian real estate market, given that single-family mortgages represent the majority of its assets under administration (AUA). In addition, new, more stringent, underwriting rules (which came into effect on January 1, 2018) and rising interest rates could dampen mortgage originations.

MCAP is the second-largest mortgage finance company in Canada, with $65.9 billion in AUA as at YE2017, which increased 8.7% compared with last year. MCAP continues to grow its market share within single-family residential mortgage lending, which represents approximately 87% of its AUA, with the balance comprised of commercial and construction mortgages. During 2017, MCAP originated $14.5 billion in mortgages, which was down 8.8% compared with $15.9 billion in 2016. This decrease largely reflected management’s decision to slow down originations, driven by tightening mortgage spreads and the negative impact from the new mortgage rules that were implemented by the Department of Finance Canada in October 2016, which included, among other measures, more restrictive criteria related to the eligibility for portfolio insurance.

Over the last few years, MCAP’s earnings performance has been solid and continued to improve. In 2017, net income rose 8.6% compared with 2016, largely reflecting growth in AUA, which benefited both net interest income as well as servicing and administration-related revenue. MCAP has also made notable progress on efficiency and operating leverage as it benefited from economies of scale, achieved through its AUA growth. Given that MCAP has reached a level of critical mass, DBRS believes that further improvements in operating efficiency will help strengthen MCAP’s earnings generation capacity.

MCAP’s exposure to credit risk is very limited. Indeed, almost all its originated mortgages are securitized or sold to financial institutions with limited recourse to the Partnership. As a result, DBRS believes that MCAP’s low-risk balance sheet is a key factor that underpins the ratings. Overall, DBRS notes that mortgages originated by MCAP have performed well historically, with very low delinquency rates. For DBRS, sustaining this performance is vital to MCAP’s model of securitizing and conducting whole-loan sales to larger financial institutions. Indeed, MCAP’s main risk is a breach of its representations and warranties as any material loss as a result of poor underwriting could reduce investor appetite for MCAP-originated mortgages. Since MCAP is predominately a single-family mortgage lender, the Partnership is susceptible to any adverse changes in the Canadian real estate market. This could affect MCAP’s origination volumes and its ability to fund future mortgages.

While MCAP is dependent on wholesale funding, particularly through securitization vehicles, it continues to diversify its funding profile by adding other large financial institutions. Since the Partnership is not regulated by the Office of the Superintendent of Financial Institutions (OSFI), it cannot access deposit funding. Therefore, MCAP is dependent on its strategic partners for equity capital and the wholesale market for liquidity. The Partnership is looking to diversify funding by using more residential mortgage-backed securities and bank-sponsored asset-backed commercial paper going forward, which DBRS would view positively. Overall, MCAP’s liquidity and funding are considered appropriately managed and aligned with the assets of the Partnership.

DBRS views MCAP’s capitalization levels as adequate and in line with other mortgage finance companies, given that the Partnership’s exposure to loan losses is limited as a result of MCAP securitizing and selling almost all its loan portfolio. As MCAP is not regulated by OSFI, it does not have a required minimum level of capital. However, since MCAP is an approved issuer under the Canadian Mortgage Housing Corporation’s National Housing Authority Mortgage-backed Securities and Canada Mortgage Bonds programs, MCAP is required to maintain a certain level of capital. At the end of 2017, MCAP’s tangible partner equity-to-tangible assets improved to 1.4% compared with 1.2% in 2016, as capital generation outpaced asset growth and MCAP’s dividend payout policy declined to 36% in 2017. The Partnership is targeting a payout ratio of 50% of IFRS net income based on International Financial Reporting Standards, which DBRS believes will continue to help strengthen MCAP’s internal capital generation.

RATING DRIVERS
Further significant improvements in operating efficiency that strengthens MCAP’s earnings generation capacity or demonstrated ability to successfully adapt to the changing regulatory environment related to mortgage originations could lead to positive rating actions. Moreover, a noticeable diversification of funding sources beyond government and bank-sponsored securitization vehicles would be viewed positively. Conversely, the ratings could come under pressure if MCAP were to experience a material loss of market share or substantially higher delinquency rates compared to other rated issuers that would cause key institutional investors to reduce the amount of business with the Partnership. Furthermore, a sustained deterioration in operating results or significant slowdown in capital generation due to increased Partnership distributions as well as changes in government sponsored securitization programs that constrain MCAP’s ability to fund mortgage originations could also lead to negative rating actions.

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

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 to the right under Related Research or by contacting us at info@dbrs.com.

The applicable methodologies are Global Methodology for Rating Finance Companies (November 2017) and DBRS Criteria: Rating Corporate Holding Companies and Their Subsidiaries (December 2017), which can be found on our website under Methodologies.

Lead Analyst: Robert Colangelo, Senior Vice President, Canadian Banking Financial Institutions
Rating Committee Chair: Michael Driscoll, Managing Director – NA FIG

The rated entity or its related entities did participate in the rating process. DBRS had access to the accounts and other relevant internal documents of the rated entity or its related entities.

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