Fitch Assigns 'B+' First-Time Rating to Freedom Mortgage Corp; Outlook Stable

CHICAGO--()--Fitch Ratings has today assigned a first-time long-term Issuer Default Rating (IDR) of 'B+' to Freedom Mortgage Corporation (Freedom). The Rating Outlook is Stable.

KEY RATING DRIVERS

IDR

The IDR and Stable Rating Outlook are supported by Freedom's strong franchise, established position and historical track record as a prime nonbank mortgage company. Further supporting today's rating action is an experienced management team with extensive industry background, a sufficiently robust and integrated technology platform, good asset quality in its prime servicing portfolio, sufficient liquidity and reserves in place to absorb a reasonable level of loan repurchase demands by investors, and appropriate EBITDA coverage of interest expenses.

The highly cyclical nature of the mortgage origination business and the capital intensive and volatile nature of the mortgage servicing business represent primary rating constraints for nonbank mortgage companies, including Freedom, in Fitch's opinion. Furthermore, the mortgage business is subject to intensive regulatory and legislative scrutiny, which further increases business risk. These industry constraints typically limit ratings assigned to nonbank mortgage companies to below investment grade levels. Fitch notes that Freedom's retained-servicing business model serves as a natural hedge to the cyclicality of the mortgage origination business and the company's robust operational and regulatory framework help to mitigate some of these pressures.

Rating constraints specific to Freedom include elevated key man risk related to its founder and Chief Executive Officer, Stanley Middleman, who sets the tone, vision and strategy for the company. Additionally, elevated leverage levels, reliance on short-term wholesale funding, and the predominately secured funding profile of the company further constrain ratings. Fitch notes that there is also potential execution risk associated with anticipated business growth and expansion of mortgage origination channels.

Freedom has generated relatively consistent returns on average equity (ROAE), and overall margins have improved as the company has grown in scale. Between 2009 and Sept. 30, 2015, Fitch calculates that Freedom generated an average ROAE of 39.5%, which was bolstered by growth in its origination platform. Fitch views Freedom's multi-channel approach as well positioned relative to peers, as it can provide a more sustainable business model through various economic and interest rate environments. With expected increases in interest rates driving modestly lower levels of refinancing activity and new purchase growth, offset by improved valuations on the servicing portfolio boosting reported earnings, Fitch expects Freedom's profitability metrics to remain stable over the medium-term time horizon.

Asset quality performance of Freedom's servicing portfolio is considered to be good, as the dollar amount of nonperforming and real estate owned loans has remained relatively flat over the last several years. Additionally, overall delinquency rates have declined, which is in part due to recent loan origination growth (growth in the denominator of delinquency ratio calculations). Fitch expects asset quality performance to remain stable over time.

The company is not subject to material risks associated with holding a mortgage loan portfolio because the loans are generally sold to investors within 90 days of origination. However, as a mortgage originator and servicer, Freedom has exposure to possible losses on loans in the servicing portfolio and may be required to repurchase these loans or indemnify investors under certain warranty provisions. Freedom began to significantly build up its reserves following its acquisition of the origination platform of Irwin Financial Corporation (Irwin) in 2006 and expects to continue to build up reserves for new loan production going forward. Fitch believes Freedom's current reserves against repurchase and indemnification exposure are sufficient, relative to the assigned rating.

In 2013, Freedom entered into excess servicing rights sale agreements with related party and publicly traded REIT, Cherry Hill Mortgage Investment Corporation (CHMI). Pursuant to these agreements, Freedom retains all ancillary income associated with servicing the loans as well as the remaining portion of the excess cash flow after a base servicing fee. Freedom also retains all the servicing and advancing functions associated with the portfolio. Fitch notes that these agreements are similar arrangements undertaken by other nonbank mortgage companies in order to monetize a portion of the value of their servicing portfolio and to reduce the volatility associated with the mortgage servicing rights (MSR) assets. These transactions were accounted for as financings for accounting purposes, and as such are included in Fitch's leverage calculations.

Fitch evaluates Freedom's leverage primarily on the basis of debt-to-tangible equity and debt-to-EBITDA, which were 4.0x and 7.4x, respectively, as of Sept. 30, 2015. Freedom's leverage has remained relatively consistent over time, averaging 4.4x and 7.8x, respectively over the last several years. Leverage on the basis of debt to Fitch Core Capital, which excludes MSRs and intangible assets from equity, was high but consistent with other nonbank mortgage companies.

Fitch views Freedom as having sufficient liquidity given available balance sheet cash, availability under its various funding facilities, and appropriate interest coverage ratios. As a function of its business model, Freedom is predominately funded through short-term secured financing facilities, backed by loans-held-for-sale and MSRs. Fitch views this reliance on wholesale funding sources as a rating constraint, but consistent with its peers.

An increase in the percentage of unsecured debt in Freedom's overall funding profile would be viewed favorably by Fitch, as it could increase balance sheet flexibility in times of stress. That said, unless Freedom were to issue a material amount of unsecured funding, the rating of an unsecured debt issuance would likely be notched down from Freedom's IDR reflecting weaker recovery prospects given the preponderance of secured funding. Depending on the specific recovery prospects for the unsecured debt, if issued, it could be rated multiple notches below the IDR.

RATING SENSITIVITIES

IDR

Positive rating momentum for Freedom's IDR could be influenced by a formalized succession plan, demonstrated execution on growth aspirations, an increase in the percentage of unsecured funding, reduced reliance on short-term funding, and lower overall leverage. Improved governance, such as independent Board of Director membership and reduced related-party transactions, would also be viewed favorably.

Freedom's IDR could be negatively impacted by the departure of Mr. Middleman without appropriate succession plans being in place, rapid growth that is not accompanied by commensurate growth in common equity, as well as appropriate staffing and resource levels to support planned growth. Additional negative drivers to the rating include a material decrease in asset quality, particularly if it results in increased repurchased or advance obligations and a material increase in leverage. To the extent that the company is subject to material regulatory scrutiny or fines, this could also negatively impact ratings.

Although not currently contemplated by Freedom, should the company utilize leveraged third-party vehicles to finance interests in its servicing rights, such as servicing advances, Fitch could elect to include this debt in Freedom's consolidated leverage ratio calculations. To the extent that this has a material impact on Fitch's assessment of Freedom's leverage, this could also adversely impact the rating.

Founded in 1990 and based in Mount Laurel, NJ, Freedom is a leading, private, full-service, nonbank mortgage company engaged in origination, servicing, selling and securitizing residential mortgage loans. During the first nine-months of 2015, the company was a top-10 mortgage originator by volume, according to Inside Mortgage Finance. As of Sept. 30, 2015, Freedom had total assets of approximately $4 billion.

Fitch has assigned the following rating:

Freedom Mortgage Corporation

--Long-term IDR of 'B+'.

The Rating Outlook is Stable.

Date of Relevant Rating Committee: Dec. 11, 2015.

Additional information is available on www.fitchratings.com

Applicable Criteria

Global Non-Bank Financial Institutions Rating Criteria (pub. 28 Apr 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=865351

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Contacts

Fitch Ratings
Primary Analyst
Johann Juan, +1-312-368-3339
Director
Fitch Ratings, Inc.
70 West Madison Street
Chicago, IL 60602
or
Secondary Analyst
Richard Wilusz, +1-312-368-5459
Associate Director
or
Committee Chairperson
Justin Fuller, CFA, +1-312-368-2057
Senior Director
or
Media Relations
Hannah James, New York, +1-646-582-4947
hannah.james@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Johann Juan, +1-312-368-3339
Director
Fitch Ratings, Inc.
70 West Madison Street
Chicago, IL 60602
or
Secondary Analyst
Richard Wilusz, +1-312-368-5459
Associate Director
or
Committee Chairperson
Justin Fuller, CFA, +1-312-368-2057
Senior Director
or
Media Relations
Hannah James, New York, +1-646-582-4947
hannah.james@fitchratings.com