DBRS Confirms Credit Union Central of Saskatchewan at R-1 (low), Stable Trend

DBRS Limited (DBRS) confirmed Credit Union Central of Saskatchewan’s (SaskCentral or the Credit Union) Short-Term Issuer Rating and Short-Term Instruments rating at R-1 (low). The trend remains Stable. Under DBRS’s support assessment criteria, SaskCentral is assigned a SA2 reflecting the expectation of timely systemic external support from the Province of Saskatchewan (rated AA with a Stable trend by DBRS), particularly given that SaskCentral has been designated as a Provincially Systemically Important Institution (P-SIFI). The ratings for SaskCentral reflect DBRS’s assessment of the Intrinsic Assessment (IA) of the credit union system (the System) in Saskatchewan.

KEY RATING CONSIDERATIONS
In determining SaskCentral’s ratings, DBRS considers the strength of the credit union system in Saskatchewan as an important driver. Solid membership growth and revenues per member, along with the System’s strong competitive position, are supportive of SaskCentral’s ratings. In addition, DBRS views positively the System’s capacity to generate strong recurring income while maintaining manageable levels of provisioning and good cost control. While exposures to commercial real estate-backed lending have resulted in higher levels of impairments, DBRS view this as transitory and related to the energy price correction in 2014. A strong retail deposit base, sufficient liquidity and a solid capital cushion are also supportive of ratings. However, contingent risk associated with Concentra Bank (rated A (low) with a Stable trend by DBRS) represents a constraint on ratings.

RATING DRIVERS
Though unlikely over the intermediate term, positive rating pressure could arise from a meaningful improvement in System membership growth, particularly within the younger age bracket. Increased efficiency and a greater proportion of operating revenues being generated through fee-based income could also benefit ratings. Conversely, a significant increase in contingent risk due to majority-owned Concentra Bank’s growing exposure to higher-risk assets and its increased reliance on funding that is external to the System, could negatively impact ratings. A reduction in the assessment of the likelihood of provincial support would also pressure ratings.

RATING RATIONALE
In confirming the ratings for SaskCentral, DBRS considers the continued solid performance of SaskCentral as the statutory liquidity manager for credit unions in Saskatchewan and a conduit through which credit unions in Saskatchewan can access clearing and settlement, daily cash flow management and emergency liquidity support. As a central entity, SaskCentral also provides certain solutions to the System for regulatory compliance support. SaskCentral is collectively owned by the 44 credit unions in Saskatchewan.

Underpinning the rating for SaskCentral is the performance of the credit union system in Saskatchewan that owns and supports SaskCentral. DBRS’s assessment considers the System’s well-established franchise position in the province, particularly within the small business and farming segments. At F2017, the System held 36.7% of deposits, 22.7% of residential mortgages and 36.0% of commercial loans in Saskatchewan. Also, the credit union membership represents about 41% of Saskatchewan’s population.

The System has a history of generating solid recurring earnings. Operating revenues increased by 2.4% in F2017 to $734 million; however, higher provisioning expense resulted in net income declining by 3.8% in F2017. The higher levels of provisioning resulted from recessionary environments in 2016 and 2017, mainly due to the lagged impact of lower oil and gas prices, which has constrained business investment and employment growth. Nevertheless, this higher provisioning was readily absorbed by the solid earnings generated by the System. A high operating cost structure, while typical for credit union systems, remains a challenge, particularly given an increasingly competitive operating environment. Improving efficiency is an important opportunity for the System to enhance its earnings. Positively, DBRS notes that the efficiency ratio for the System improved to 70.3% in F2017 from 71.7% in the previous year.

DBRS views the System’s asset quality as generally good, although there is significant concentration risk related to large single-party exposures in the commercial real estate (CRE) portfolio. Related to this, a limited number of CRE loans were responsible for the bulk of loan impairment in 2017. The gross impaired loans ratio for the System increased to 0.87% in F2017 from 0.46% from the previous year. Nevertheless, net write-offs remained at a low level and are viewed as manageable by DBRS. Generally good credit performance is reflective of the largely secured nature of the System’s lending to the retail, business and agricultural sectors. The System’s commercial lending activity tends to be riskier than its residential lending but also more rate-sensitive, a positive with rates rising. DBRS notes that the System has the highest relative exposure to non-residential lending in its loan portfolio in comparison to other Canadian credit union systems rated by DBRS.

In DBRS’s assessment, Concentra represents contingent risk for SaskCentral. SaskCentral is exposed to Concentra’s higher-risk activities, particularly its out-of-province commercial, Alt-A mortgage lending and consumer credit exposures. At F2017, SaskCentral’s share of Concentra’s earnings represented 75% of SaskCentral’s pre-tax income. Given the significance of Concentra’s income to SaskCentral, large losses incurred by Concentra could affect SaskCentral’s equity.

DBRS sees the System’s funding profile as strong, given that the loan book is largely funded through relatively sticky insured deposits, which grew by 3.4% in F2017, slightly behind loan growth of 4.0%. DBRS views the System’s lending activity to be well-aligned with its funding profile. Saskatchewan’s 100% provincial deposit insurance coverage for retail, commercial and institutional deposits contributes to the stickiness of these deposits and adds to the stability of the funding base for the System. This coverage is not expected to change, given the importance of the credit unions in the financial services sector in the province. Interest rate risk remains within acceptable parameters, and liquidity is solid.

DBRS views the System as well-capitalized with sufficient cushion to absorb higher credit costs resulting from a sustained economic downturn. System capitalization improved in F2017, with the CET1 ratio increasing to 12.9% from 12.7% in F2016. The quality of capital is strong, composed mainly of equity representing member ownership and retained earnings. Regulatory capital requirements are generally similar to those established by the Office of the Superintendent of Financial Institutions for federally regulated financial institutions. Positively, DBRS notes that the designation of the large credit unions in Saskatchewan as P-SIFIs in 2018 will have a positive impact for System capitalization, since they will be required to maintain a capital conservation buffer of 1% of risk-weighted assets.

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 under Related Documents or by contacting us at info@dbrs.com.

The principal methodology is Global Methodology for Rating Banks and Banking Organisations (July 2018), which can be found on dbrs.com under Methodologies.

The primary sources of information used for this rating include company documents. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

Lead Analyst: Sohail Ahmer, Vice President – Global FIG
Rating Committee Chair: Michael Driscoll, Managing Director, Head of NA FIG

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

For more information on this credit or on this industry, visit www.dbrs.com.