Fitch Ratings has downgraded the Long-Term Issuer Default Ratings (IDRs) of
Fitch has also downgraded
Today's rating actions have been taken as part of a periodic peer review of non-bank mortgage companies, which is comprised of six publicly rated firms.
Key Rating Drivers
The rating downgrade reflects the operating losses and resulting erosion of tangible equity FOA has experienced over the last year, which has resulted in continuing covenant breaches, which may limit the company's ability to extend debt maturities and secure future funding. High interest rates and borrower affordability challenges have reduced origination volumes, which, along with widening credit spreads, have resulted in significant negative fair value adjustments to FOA's assets. Tangible equity has decreased to negative
The Negative Outlook reflects Fitch's expectation that FOA's profitability will remain weak, challenging its ability to rebuild tangible capital levels over the Outlook horizon. Additionally, Fitch's believes execution risk remains with regard to the integration of
FOA's ratings remain supported by its market position within the reverse mortgage lending sector, its experienced senior management team and a history of strong support from shareholders
The ratings remain constrained by low capital levels, weak profitability, a senior unsecured debt maturity in 2025 and low levels of liquidity, as well as reliance on secured, short-term wholesale funding facilities, and elevated key person risk related to its founder and Chairman,
FOA reported a pre-tax loss of
Fitch believes that profitability will remain weak over the medium term as the company experiences elevated cash burn while integrating AAG, and industry origination volumes remain low. Cost reduction efforts are ongoing and have yielded a
Leverage is not measurable give FOA's negative tangible equity at 2Q23. The capital injections of
Similar to other mortgage peers, FOA is reliant on the wholesale debt markets to fund operations. The company's funding profile is comprised of warehouse facilities, secured lines of credit, securitizations, non-recourse debt and senior unsecured notes. Most of FOA's funding facilities mature within one year, which exposes it to increased liquidity and refinancing risk. Fitch would view an extension of the firm's funding duration or an increase in committed facilities favorably.
In conjunction with the closing of the forward mortgage business and to align with lower industry volumes, borrowing capacity has been significantly reduced over the last year, with total capacity available across warehouse facilities and lines of credit declining to
Senior unsecured debt as a proportion of total debt was 28% at 2Q23, which is an improvement from the prior year but largely driven by a decrease in warehouse borrowings outstanding. FOA's
At 2Q23, FOA had
Over the last year FOA received covenant waivers from its lenders related to profitability, debt service coverage and tangible net worth requirements in order to avoid technical default. Covenant breaches are viewed negatively by Fitch as continued breaches could materially weaken FOA's financial flexibility and ability to fund originations.
RATING SENSITIVITIES
Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade
Inability to build positive tangible equity and reduce leverage to below 15x over the Outlook horizon;
Sustained operating losses;
Inability to refinance secured funding facilities or avoid covenant breaches;
Inability to maintain sufficient liquidity to effectively manage servicer advances or to meet margin call requirements;
Regulatory scrutiny resulting in FOA incurring substantial fines that negatively affect its franchise or operating performance;
The departure of
Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade
Fitch believes the Negative Outlook could be revised to Stable if FOA successfully executes on its plan to improve profitability and earnings consistency and reduce leverage below 15x.
Longer-term, upward rating momentum could be driven by:
Sustained reduction in leverage to below 10x;
An enhanced liquidity profile and improved funding flexibility, including an extension of funding duration, an increase in committed faciltiies, and increased aggregate liquidity resources;
An increase in unsecured debt approaching 15% and a commensurate increase in unencumbered assets;
A continuation of strong asset quality performance;
Continued growth of the business that enhances FOA's franchise, including the successful integration of AAG and realization of cost and revenue synergires;
Demonstrated effectiveness of corporate governance policies, including enhanced management team depth and/or clearly articulated succession planning for key management positions.
DEBT AND OTHER INSTRUMENT RATINGS: KEY RATING DRIVERS
The senior unsecured debt rating is two notches below the Long-Term IDR, given the low capital levels, the funding mix, subordination to secured debt in the capital structure and a limited pool of unencumbered assets, reflecting poor recovery prospects in a stress scenario.
DEBT AND OTHER INSTRUMENT RATINGS: RATING SENSITIVITIES
The unsecured debt rating is primarily sensitive to changes in the Long-Term IDR and secondarily to the funding mix and available collateral. A material increase in unencumbered assets and recovery prospects could narrow the notching between the Long-Term IDR and the unsecured notes, while a material increase in secured debt could result in wider notching.
ADJUSTMENTS
The Standalone Credit Profile has been assigned below the implied Standalone Credit Profile due to the following adjustment reason: Weakest Link - Capitalization & Leverage (negative).
The Business Profile score has been assigned below the implied score due to the following adjustment reason: Business model (negative).
The Asset Quality score has been assigned below the implied score due to the following adjustment reason: Risk profile and business model (negative).
The Funding, Liquidity & Coverage score has been assigned below the implied score due to the following adjustment reason: Liquidity coverage (negative).
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG Considerations
FOA has an ESG Relevance Score of '4' for Governance Structure due to elevated key-person risk related to its founder and Chairman,
FOA has an ESG Relevance Score of '4' for Customer Welfare - Fair Messaging, Privacy and Data Security, due to its exposure to compliance risks that include fair lending practices, debt collection practices and consumer data protection. This has a negative impact on the credit profile and is relevant to the rating in conjunction with other factors.
The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit https://www.fitchratings.com/topics/esg/products#esg-relevance-scores.
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