DBRS: No Impact on Credit Union Centrals from New IFRS-Related OSFI Capital Adequacy Guidelines

DBRS has concluded that there are no credit rating implications for Canadian credit union Centrals (the Centrals) following the announcement on December 8, 2010, by the Office of the Superintendent of Financial Institutions (OSFI) of new capital adequacy requirements. The new requirements address changes in the borrowing multiple test arising from the implementation of international financial reporting standards (IFRS), primarily as a result of securitization activity. The initial impact on the Centrals’ regulatory borrowing multiple has been softened by grandfathering.

OSFI’s borrowing multiple test stipulates a Central’s total borrowings (as defined by OSFI) will not be greater than 20 times total capital (also defined by OSFI), although up to 23 times may be allowed in some cases with prior approval. From an accounting perspective, the implementation of IFRS is expected to result in an increase in this multiple for financial institutions that have been engaged in securitization activity on two fronts: (1) total borrowings will increase as securitizations are brought back on balance sheet and (2) retained earnings (and capital) will decrease as previously recorded gains on the securitization sales are de-recognized.

The grandfathering for regulatory capital calculations applies to both sides of this equation:

(1) On the borrowing side, liabilities related to Canada Mortgage and Housing Corporation (CMHC) programs (i.e., National Housing Act mortgage-backed securities (NHA-MBS), Canada Mortgage Bonds (CMBs) and the Insured Mortgage Purchase Program (IMPP)) completed up to and including March 31, 2010, and future reinvestments in these vehicles will not be considered borrowings for regulatory purposes. Virtually all of the securitization assets that the Centrals are exposed to are CHMC programs.

(2) On the capital side, Centrals will have to reverse prior-period gains on securitizations, which will result in an accounting reduction in retained earnings. However, a phase-in period over two years will be allowed for the gains related to CMHC programs for the borrowing multiple. Given that the typical life of these products is five years and many of them will already have been outstanding for several years, the impact is expected to be manageable.

Note:
The applicable methodology is Canadian Credit Union Methodology, which can be found on our website under Methodologies.