KBRA Affirms Ratings for Silver Queen Financial Services, Inc.

KBRA affirms the senior unsecured debt rating of BBB- and the short-term debt rating of K3 for privately-owned Silver Queen Financial Services, Inc. ("SQFS", "Silver Queen", or "the company"). In addition, KBRA affirms the deposit and senior unsecured debt ratings of BBB, the subordinated debt rating of BBB-, and the short-term deposit and debt ratings of K3 for Colorado Federal Savings Bank, the main subsidiary. The Outlook for all long-term ratings is Stable.

Key Credit Considerations

The ratings reflect the concentration risks on both sides of the balance sheet, including a loan portfolio largely concentrated in residential mortgages (75% of total as of 2Q23) and a funding base that is primarily comprised of servicing and escrow deposits from Provident Funding Associates ("PFA"). However, with regard to the former, KBRA recognizes the credit risk in the loan portfolio to be relatively minimal given that these are super-prime mortgages with a refreshed LTV around the low-40% level. As such, credit quality has been pristine in recent years, with very low levels of NPAs and NCOs. With rising interest rates and other headwinds in consumer credit, there is the potential for softening in the U.S. housing market, which could present some challenges for SQFS’ loan book, though given the aforementioned conservative underwriting criteria, the company has a substantial cushion from a credit loss perspective if there is a pullback in home values. Additionally, we take comfort in the fact that the portfolio is largely dispersed across the U.S., which mitigates against certain regional geographic risks. With respect to the latter, the PFA-related deposits are comparatively durable, albeit volatile given the timing of T&I (taxes & insurance) and P&I (principal & interest) payments, and low-cost (average cost of total deposits was 2.12% for 3Q23) as long as PFA continues to reflect healthy operating results, which appears to be the case during this challenging environment in the mortgage originator and servicer space. Moreover, the company maintains sufficient liquidity sources both on and off balance sheet, with over $700 million (or 54% of total deposits) available as of 3Q23. Despite the concentration in residential mortgages in the loan book, we acknowledge the solid IRR management results due to the shorter effective duration in the loan book. While the below peer NIM is a function of the loan mix, we believe it is suitable and provides adequate revenue generation in the context of the business model. Moreover, NIM has rebounded in 3Q23 (1.74% vs. 1.56% for 2Q23) and should reflect less variability prospectively given the core deposit gathering initiatives and the well-executed hedged MBS trades. As such, we view the profitability as solid, albeit concentrated (noninterest income has averaged under 5% since 2018) for the rating group, especially on a risk-adjusted basis, though can be volatile from mortgage banking component and the sizable unhedged MSA portfolio. Another key credit strength is the robust capital position, which is anticipated to remain within recent year operating levels, with a CET1 ratio averaging just above 17% over the last five years (17.1% as of 3Q23), given the conservative growth and manageable capital expenditures (dividends and/or buybacks) expected.

Rating Sensitivities

A rating upgrade is not expected, though continued diversification of the franchise, most notably on the funding side, including a higher level of core deposits, could result in positive momentum over time. A rating downgrade is not expected, though any unforeseen deposit outflows causing liquidity management issues, or any other slippage among key financial ratios could potentially pressure the ratings.

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Methodologies