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

DBRS has today confirmed the Commercial Paper rating of Credit Union Central of Saskatchewan (SaskCentral or Central) at R-1 (low) with a Stable trend. The rating remains supported by the healthy credit union system in Saskatchewan (the System), with its defendable market niche in rural areas of the province and high penetration rate among the population. Limited System size, a high cost structure and asset concentration remain key challenges for the System.

Central’s operations are almost totally focused on providing liquidity, clearing and settlement services for the System (including maintaining the liquidity portfolio supported by mandatory System deposits) following the reorganization that saw much of its non-core functions transferred into Concentra Financial Services Association (Concentra) at the beginning of 2005 and the sale of the profitable card operations in 2007 and 2008. Central itself is not expected to generate high levels of profitability going forward, although this is not a critical aspect of DBRS’s rating methodology for credit union centrals as they exist to provide services to their members.

Central faces challenges in its material exposure to Concentra, which is expected to generate most of Central’s consolidated earnings and internal capital generation going forward. While Central does not guarantee any obligations of Concentra, DBRS ascribes a very high level of implied support, as Concentra performs functions that are critical to Central fulfilling its mandate to serve the credit unions of Saskatchewan, particularly in terms of taking deposits in excess of mandatory requirements and loans to credit unions. This implied support of Concentra by Central is integral in DBRS’s assessment of both Concentra’s and Central’s ratings.

Under DBRS’s global rating methodology for banks and bank-like financial institutions, Central has been assigned a short-term intrinsic assessment of R-1 (low) and a support assessment of SA2 (reflecting DBRS’s expectation of systemic and timely external support by the government of Saskatchewan). The SA2 does not have an impact on the final Commercial Paper rating of R-1 (low).

SaskCentral Operations (direct activities excluding Concentra Financial Services Association (Concentra) and Credit Union Payment Services (CUPS)) generated a net loss in 2008 primarily as a result of securities losses (about $50 million pre-tax from Montréal Accord asset-backed commercial paper (ABCP), which were restructured into Master Asset Vehicle Notes (MAV Notes) subsequent to year-end), although there was an operating loss in part due to a $4.7 loss at partially-owned Celero Solutions.

Profitability is not the only focus of Central and a high level of income is not a critical aspect of DBRS’s rating methodology for Central.

Concentra reported poor earnings in both 2008 and 2007 with a return on equity of 2.9% and 1.0%, respectively (excluding the discontinued operations). Concentra’s net interest income increased on both higher margins and increased interest earning assets; the margin improvement was largely as a result of the declining interest rate environment. However, the stronger net interest income was more than offset by $24 million in mark-to-market valuation adjustments on derivatives hedging interest rate risk. Concentra recorded an other-than-temporary impairment charge of $10.8 million on a portfolio of collateralized debt obligations, as well as an additional $2 million in charges against its own holdings (both on and off-balance sheet) of MAV Notes. While Concentra reported a strong H1 2009 ROE of 18.5%, approximately 75% of pre-tax income was generated by securitization gains.

The System recorded a 5% increase in income before membership dividends and patronage allocations in 2008, although the ROE was down modestly to 11.4% from 12.0% in 2007 (the 2007 ROE was the highest in over ten years).

SaskCentral, Credit Union Central Alberta and Credit Union Central of Manitoba have entered into discussions aimed at merging to become a single Prairie central. Should the proposal gain widespread approval, the targeted merger date is January 1, 2011.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The applicable methodology is Rating Canadian Provincial Credit Union Centrals, Credit Unions and Desjardins Group, which can be found on our website under Methodologies.

This is a Corporate (Financial Institutions) rating.