DBRS Confirms Credit Union Central Alberta at “A,” Stable, Following Methodology Change

DBRS Limited (DBRS) has today confirmed Credit Union Central Alberta Limited’s (Alberta Central) Issuer Rating and its Senior Long-Term Debt rating at “A” and its Short-Term Instruments rating at R-1 (low). The trends remain Stable. 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 Alberta Central’s rating considers the fundamental strengths of Alberta’s credit unions, which jointly own the Central. An integral component of the Alberta credit union System (the System), the ratings of Alberta Central reflect DBRS’s intrinsic assessment (IA) of the System at A (low). Reflecting the importance of the credit unions and the role of Alberta Central, implicit support from the provincial government for Alberta Central is considered likely and is reflected in DBRS assigning a support assessment of SA2. With a AAA rating and a Stable trend, the Province of Alberta (the Province) is considered capable of providing support. This expectation of systemic and timely external support adds a notch uplift from the IA of the System resulting in the final rating of “A” for Alberta Central.

Driving the IA of the System are its satisfactory franchise strength, earnings power and risk profile, strong funding and liquidity and satisfactory capitalization of the combined credit unions in Alberta. The System is composed of 28 individual credit unions with 208 branches across Alberta. Membership totals approximately 638,000, or about 16% of the provincial population. DBRS estimates the credit unions operate about 19% of bank and credit union branches in the Province (treating Alberta Treasury Branches (ATB) as a bank). With $23 billion in assets, the combined credit unions hold about 7% of residential mortgage loans and about 10% of deposits (based on the credit unions, the nine largest banks and ATB). The System has strong rural member support, but faces competition from the banking and non-bank financial sectors, as well as ATB. Credit unions tend to be stronger in rural areas of provinces and smaller population centres where large Canadian banks do not compete as aggressively, with the exception of ATB. The cohesiveness of the System is enhanced by joint ownership, control and deposit funding of Alberta Central, reliance on the Central for critical services, as well as the provincial deposit insurance program. The System’s franchise is considered satisfactory

The System’s net income before patronage refunds (to members) decreased by $7.1 million, or 10.4%, to $143.6 million in 2014 compared to 2013; the decrease was entirely attributed to the lower special patronage dividends paid by Central to the System of $10 million in 2014 compared to $45 million in 2013. Net interest income (NII) decreased due to the lower special patronage dividend; excluding the special dividend, DBRS believes NII would have increased on a 6.2% increase in loan volumes partially offset by modest margin compression attributed to the ongoing low interest rate environment and competitive pressure. Non-interest income was a little under 20% of operating revenue in 2014; it has remained stable as a proportion of operating revenue over the past several years. Reflecting the high touch business approach of credits unions, the System’s ratio of operating expense-to-operating revenue was 72.7% in 2014, a slight deterioration over 2013. Income before provisions and taxes decreased to $180 million from $203 million as a result of the lower special patronage dividend. Helping sustain net income, loan loss provisions were $16.7 million in 2014, or 8.8% of adjusted operating profit, down from 9.2% in 2013. The return on equity declined to 7.8% in 2014 from 8.8% in 2013 as a result of the reduced special dividend; overall earnings remain satisfactory.

Over the course of 2014, the System’s strong asset quality improved, with gross impaired loans at year end representing 56 basis points of the overall loan portfolio (down from 72 basis points a year earlier) and 5.7% of members’ equity and reserves (down from 7.3% in 2013). Lower-risk residential mortgages make up over 55% of the combined portfolio, which contributes to the low level of loan losses (the other components are 10% consumer loans, 30% commercial loans and 4% agricultural loans). So far, there is no noticeable impact from the decline in oil prices on the System’s asset quality.

Assuming oil prices remain at a lower level as anticipated, DBRS would expect deterioration in asset quality metrics, although there are some mitigating factors. The provincial unemployment rate entered this period at a relatively low level and house price inflation in Alberta has been relatively muted over the past several years. As with most Canadian lenders, the Alberta credit unions have 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. The System’s risk profile is considered satisfactory.

Member deposits, which are generally stable, fund about 90% of the collective balance sheet or 106% of the loan book. The provincial deposit insurance program, which is operated through The Credit Union Deposit Guarantee Corporation (CUDGC), covers 100% of deposits at credit unions, which enhances the stability of their deposits. The Province ensures that the obligations of CUDGC will be carried out. System liquidity has remained stable for the past few years and was at a solid level at the end of 2014. The year-end liquid assets and other securities ratio to total assets of 12.1% is acceptable when combined with the support provided by Alberta Central. The System’s funding and liquidity profile is considered strong.

The System’s capital-to-risk-weighted assets ratio was 13.9% at the end of 2014. The quality of capital is satisfactory, although only about half of equity is in the form of retained earnings — the strongest form of equity for a credit union. Internal capital generation was relatively low at 3.8% in 2014, but remains sufficient for the System to sustain its growth. The growth of its equity is enhanced by its ability to pay a substantial portion of member dividends in equity. The regulatory environment in Alberta is relatively stable with Basel III capital guidelines having been introduced in 2013. The System’s overall capitalization is considered satisfactory.

Alberta Central is an important component of the System as the central liquidity provider and link between the credit unions and the payments system. It also provides other important products and services, including asset and liability management, government relations, audit, information technology, payment and statement and purchasing. Alberta Central has sound fundamentals that contribute to the System. While Alberta Central’s profitability is limited, its objective is only to be profitable. Alberta Central’s asset quality, funding, liquidity and capitalization are relatively strong.

The outlook for the System is linked to the economic environment in the Province, which is weakening with the decline in energy prices. Outside of economic performance, growth in the System will be dependent on the ability of credit unions to compete for market share against lending and banking peers.

The Stable trend considers the resiliency of the System’s franchise, its solid funding and liquidity, its sound risk profile and strong capitalization, although earnings remain under stress in the low interest rate environment. Negative ratings pressure may arise if the weakening of the economy with the decline in energy or housing prices reveals more-than-expected deterioration in credit performance or a material deterioration in system earnings or financial risk profiles. Pressure could also emerge in the event of one or more large credit unions choose to convert to federal charters or a change in implicit support. Positive ratings pressure could develop should the different provincial Centrals choose to merge, strengthened System business s franchise or improved System earnings.

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 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.