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

DBRS Limited (DBRS) has today confirmed the Short-Term Instruments rating of Credit Union Central of Saskatchewan (SaskCentral or Central) at R-1 (low) with a Stable trend. In taking this action, DBRS is now utilizing the “Global Methodology for Rating Banks and Banking Organisations” (June 2015) and the related criteria, “DBRS Criteria: Support Assessment for Banks and Banking Organisations” (March 2015).

The confirmation of SaskCentral’s rating considers the fundamental strengths of Saskatchewan’s credit unions, which jointly own SaskCentral. An integral component of the Saskatchewan Credit Union System (the System), the Short-Term Instruments rating of SaskCentral of R-1 (low) reflects DBRS’s intrinsic assessment (IA) of the System at A (low). Given the importance of the System and SaskCentral’s key role, DBRS assigns an SA2 support assessment to SaskCentral reflecting DBRS’s expectation of timely external support from the Province of Saskatchewan (the Province), which is considered capable of providing support with a rating of AA with a Stable trend. However, there is no impact on SaskCentral’s short-term rating of R-1 (low).

Driving the IA for the System are its satisfactory franchise strength, earnings power and risk profile, strong funding and liquidity and satisfactory capitalization that reflect the combined strength of Saskatchewan’s credit unions. While the assessment of the System provides the starting point for SaskCentral’s rating, there are no material deficiencies at the Central that would affect the rating relative to the assessment of the System. The cohesiveness of the System is reflected in their joint ownership and funding of SaskCentral and their reliance on SaskCentral for critical services, as well as through the deposit insurance program that is primarily funded through annual assessments paid by the credit unions. The Credit Union Deposit Guarantee Corporation (CUDGC) is mandated by provincial legislation (The Credit Union Act, 1998) for the main purpose of guaranteeing the repayment of deposits. Saskatchewan credit unions are regulated by the CUDGC.

Modest in size, but an important component of the financial sector in Saskatchewan, the System has an extensive franchise in the Province, comprising 49 credit unions (after two post-year-end mergers) with 271 branches across the Province. With over 475,000 members, membership is equivalent to about 42% of the provincial population. DBRS estimates that the System’s credit unions operate in the order of 53% of the bank and credit union branches in the Province (based on the credit unions and the nine largest banks). With about $20 billion in assets, the combined credit unions hold about 23% of residential mortgage loans and 38% of deposits. Credit unions tend to be stronger in rural areas of provinces and smaller population centres where large Canadian banks do not compete as aggressively. Nevertheless, despite this strong market position, the System is experiencing declining membership. The System’s franchise is considered satisfactory.

The System’s adjusted earnings before membership dividends and patronage allocations of $132 million in 2014 represented a return on equity of 9.3%. Net interest spreads and margins were unchanged in 2014 compared with 2013, despite the low interest rate environment. Non-interest income represented 23.6% of operating revenues, which is a modestly higher proportion of revenue relative to other provincial credit union systems rated by DBRS. The System’s operating expense-to-operating revenue ratio was 74.0% in 2014; while this ratio remains high, it is somewhat stronger than the other credit union systems rated by DBRS and has been on a gradually improving trend for the past five years. Loan-loss provisions relative to operating profit remains at a comparatively low level of 4.7%. The System’s earnings power is considered satisfactory.

The System’s loan-loss provisions of $8.3 million in 2014 remains at a low level of 4.7% of operating profit. Likewise, gross non-performing loans-to-gross loans were at a low level of 20 basis points at the end of 2014. The System’s loan portfolio is comprised of 43% residential mortgage loans, 12% consumer loans, 29% commercial loans and 16% agricultural loans. While there will likely be some headwinds on the System’s very strong asset-quality metrics in the near term, the overall outlook remains encouraging. Commodity prices in general have the potential to be volatile over the longer term, with resulting implications for the economy and, as a result, the System’s asset quality. As with most Canadian lenders, the System has notable exposure to the Canadian residential mortgage market. Any slowdown in this market may slow earnings generation, while a downturn in the residential mortgage market could hurt asset-quality indicators and ultimately have an impact on provisioning levels (for uninsured mortgages). Although limited by geographic and agricultural sector concentration, the System’s risk profile is considered satisfactory.

The System’s funding profile is considered strong, as it is almost entirely funded by deposits. Member deposits currently fund 86% of the balance sheet and more than 100% of the loan book of the combined credit unions. The unlimited guarantee via the pool from CUDGC on credit union deposits enhances the appeal of credit union deposits and may contribute to greater stickiness of deposits and lower cost. The System’s liquidity levels have remained stable over the past few years, with liquid assets and securities representing 17.6% of assets at 2014 year end.

System capital levels are well above regulatory minimums at 11.5% Common Equity Tier 1 and 12.7% Eligible Capital at the end of 2014. The quality of capital is strong, with Tier 1 capital consisting almost entirely of retained earnings (Common Equity Tier 1 Capital and Tier 1 Capital are the same for the System). Internal capital generation is sufficient to support the growth of the System, running at 8.9% in 2014. The Saskatchewan System’s capitalization is considered strong.

DBRS views SaskCentral’s risk profile, funding, liquidity and capital as strong, while its earnings, given its role, are modestly positive. SaskCentral’s direct operations are largely focused on providing liquidity, clearing and settlement services for the System (including maintaining the liquidity portfolio supported by mandatory System deposits). Much of the services that other provincial centrals provide to their respective systems are provided for the System by 84%-owned Concentra Financial (Concentra); Central faces challenges in its exposure to Concentra, which represents a significant concentration of earnings, asset quality and financial risk.

The Stable trend takes into account the resiliency of the System’s franchise, its solid risk profile and strong funding profile and capitalization, together with the System’s ability to cope with the low interest environment. Positive ratings pressure could develop should the different provincial Centrals choose to merge, with improved System business franchise or meaningfully reversing the declining membership numbers, while negative ratings pressure could arise with weakening asset quality metrics caused by economic deterioration or other factors or a material deterioration in system earnings or financial risk profiles, as well as financial weakness at Concentra or a change in assessment of support.

Notes:
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 to the right under Related Research or by contacting us at info@dbrs.com.

The applicable methodologies are Global Methodology for Rating Banks and Banking Organisations (June 2015) and DBRS Criteria: Support Assessment for Banks and Banking Organisations (March 2015), which can be found on our website under Methodologies.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

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