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 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 exposure to Concentra, which is expected to generate most of Central’s consolidated earnings and internal capital generation for the foreseeable future. The DBRS press release on Concentra dated October 15, 2010, provides additional analytical rationale used in determining the DBRS rating on this important aspect of Central. 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 the 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 to 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 support assessment does not affect the final Commercial Paper rating of R-1 (low).

SaskCentral, Credit Union Central Alberta (CUCA) and Credit Union Central of Manitoba have called off discussions aimed at merging to become a single Prairie central as a result of the Alberta government’s reluctance to give up regulatory authority over CUCA. While DBRS believed the three-way merger would have strengthened the newly-formed Central and all three systems, we believe SaskCentral remains a strong credit in its own right. On a consolidated basis (excluding unusual items and discontinued operations), SaskCentral reported a profit of $48.2 million in 2009 versus a loss of $53.9 million in 2008 and a loss of $27.6 million in 2007. The volatility was primarily caused by gains and losses on securities and derivatives. Earning from unusual items and discontinued operations (primarily related to the card operations) modestly improved reported net income in 2009, reduced the reported net loss to $45.2 million in 2008 and turned the 2007 loss from continuing operations to a bottom line profit of $53.9 million.

Leverage was materially reduced in 2009 as a result of a capital injection and strong internal capital generation; the equity-to-assets ratio strengthened to 5.4% from 3.6% (consolidated) over the course of the year. Asset quality, which is almost entirely related to Concentra, is generally strong, although Concentra experienced an increase in gross non-performing loans in 2009 and H1 2010, largely as a result of economic conditions.

The System recorded a 35% decrease in income before membership dividends and patronage allocations in 2009 versus 2008, largely driven by margin compression and higher expense levels, partially offset by higher non-interest income. The System’s overall financial risk profile continues to compare favourably to the other large provincial credit union systems, although internal capital generation declined materially in 2009 compared to 2008 due to lower earnings. Although limited by agricultural and geographic concentration, the System’s asset quality is good. The level of gross non-performing loans to both the total loan book and well as equity and reserves increased somewhat in 2009 to 0.83% and 7.8% (from 0.71% and 6.6% respectively), although these levels are still considered reasonably strong.

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

The applicable methodologies are Canadian Credit Union Methodology (April 2010), Global Methodology for Rating Banks and Banking Organizations (January 2010) and Enhanced Methodology for Bank Ratings – Intrinsic and Support Assessments (February 2009), which can be found on DBRS’s website at www.dbrs.com.