DBRS Confirms Central 1 Credit Union at A (high) and R-1 (middle), Stable Trend

DBRS Limited (DBRS) confirmed all ratings for Central 1 Credit Union (Central 1), including its Long-Term Issuer Rating at A (high) and Short-Term Issuer Rating at R-1 (middle). The trend on all ratings is Stable. Central 1 is assigned a Support Assessment of SA2 based on the likelihood of support from the provincial governments of British Columbia (B.C.; rated AA (high), Stable, by DBRS) and Ontario (rated AA (low), Stable, by DBRS).

The ratings and Stable trend of Central 1 consider the fundamental strengths of the B.C. System and Ontario System. Specifically, the ratings reflect the Intrinsic Assessment (IA) of “A” for the B.C. System and the IA of A (low) for the Ontario System. Central 1 provides liquidity management, payment solutions, clearing and settlement services to the B.C. System and to almost all of the Ontario System. These credit unions own Central 1 and account for it on a cost basis. The IAs of these two systems incorporate an analysis of the combined financials of the individual credit unions in each province.

KEY RATING CONSIDERATIONS
In determining Central 1’s ratings, DBRS views favourably the franchise strength of the B.C. System and growing market shares for residential mortgages and deposits in the Ontario System. Recurring earnings for both the B.C. and Ontario Systems are viewed as stable and sufficient to absorb provisioning expenses. The risk profile for both systems is solid, with most of the loan book exposure associated with real estate-backed residential mortgage lending, which has historically demonstrated low levels of delinquencies and loan losses in Canada. The ratings also factor in the funding profile of both systems; however, excessive reliance on broker-sourced funding would be viewed negatively. Liquidity positions and capital cushions are sufficient.

RATING DRIVERS
While the ratings are well placed, over the longer term, material strengthening of the two provincial systems’ franchises through membership, revenue per member and market share growth could have positive ratings pressure. Moreover, improved system earnings, including both a growing contribution from fee-based sources as well as improved operating efficiency could also result in positive ratings pressure. Conversely, a sharp correction in real estate prices accompanied by a material deterioration in employment levels resulting in substantial loan losses, a reduction in DBRS’s assessment of the likelihood of provincial support, or a sustained reduction in system internal capital generation could put downward pressure on the ratings.

RATING RATIONALE
DBRS views the B.C. System franchise as strong, given its solid market positions in key products. In F2017, 41.0% of the provincial population was a credit union member, and the System held a market share of 26.6% for commercial loans, 21.7% for deposits and 16.6% for residential mortgages. At the end of Q2 2018, the B.C. System was composed of 42 credit unions collectively holding on-balance sheet assets of $81.0 billion. This represents a strong annualized growth rate of 8.0% over the last three years. Recurring earnings and asset quality remain robust given that loans are backed by real estate-secured residential and commercial mortgage loans. Nonetheless, elevated house prices remain a risk.

DBRS considers the Ontario System franchise to be good, although market shares in key products remain modest. The Ontario System generates good levels of recurring earnings, but profitability remains challenged given the intense levels of competition from Canada’s large banks. The Ontario System’s risk profile is seen as solid, given that over 60% of loans are real estate-secured residential mortgages. However, exposure to real estate development remains an important source of risk. Funding is largely sourced through sticky retail deposits, although excessive reliance on broker deposits to fund growth would be viewed negatively. While liquidity levels trail those of peers, they are sufficiently strong.

DBRS views support from the provincial governments for Central 1 as likely, which reflects the importance of the credit unions in these provinces, especially in British Columbia where the provincial regulator, B.C. Financial Institutions Commission named Central 1 as a Domestic Systemically Important Financial Institution within the Canadian credit union system, as well as the key role of Central 1 in supporting these credit unions. As a result, Central 1’s Support Assessment is designated as SA2. Moreover, given DBRS’s long-term ratings of AA (high) with a Stable trend for British Columbia and AA (low) with a Stable trend for Ontario, the provinces are considered capable of providing such support, if needed.

DBRS views positively the emphasis Central 1 has placed on enhancing operational capabilities for credit unions across Canada, specifically with respect to digital banking and market intelligence. DBRS views Central 1’s earnings power as good considering its primary role as liquidity and service provider for the two systems. Central 1’s net income declined marginally by 1.0% quarter over quarter to $40.6 million in Q2 2018, as strong growth in net interest income was offset by higher losses related to fair value adjustments. DBRS recognizes that sequential earnings can be volatile for Central 1 due to changes in the fair value of its liquidity pools and investment book. At Q2 2018, Central 1’s total assets stood at $18.4 billion. Its balance sheet is considered low risk, given that the majority of assets held are in high-quality, government-issued liquid securities.

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 on the issuer page at www.dbrs.com.

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

Lead Analyst: Sohail Ahmer, Vice President, Canadian Financial Institutions Group
Rating Committee Chair: Michael Driscoll, Managing Director, Head of NA FIG, Global 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.

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