DBRS Assigns R-1 (low) Short-Term Rating to Coast Capital Savings Credit Union

DBRS Limited (DBRS) has today assigned a Short-Term Instruments Rating of R-1 (low) to Coast Capital Savings Credit Union (Coast Capital or the Credit Union); the trend is Stable.The assignment of the rating follows a detailed review of the Credit Union’s operating results, financial fundamentals and future prospects.

Coast Capital’s rating reflects its satisfactory franchise strength with a material market presence in its footprint serving the Greater Vancouver area, the Fraser Valley and Vancouver Island. This position is bolstered by the strong position of credit unions in the province of British Columbia (B.C.; rated AA (high) with a Stable trend by DBRS), which account for about 31% of the branches of credit unions and major banks. The rating also considers the concentration risk of operating primarily in the Vancouver area, which has seen significant house price appreciation, making Coast Capital more susceptible to a regional downturn. Moreover, Coast Capital’s revenues per member trail its credit union peers.

Under DBRS’s support assessment criteria, Coast Capital is assessed as an SA2, reflecting the expectation of timely systemic external support from the provincial government through Central 1 Credit Union (Central 1), particularly in the form of liquidity, which is reflected in the Credit Union’s short-term rating. DBRS currently rates Central 1’s Medium & Long-Term Senior Notes & Deposits at A (high) and its Short-Term Instruments at R-1 (middle), both with Stable trends.

As a credit union, Coast Capital’s business model revolves around serving its membership base. Its activities primarily involve providing deposits, loans and related financial services to individuals and small commercial members. Predominantly funded by deposits, Coast Capital’s assets were $13.7 billion at December 31, 2015.

The Credit Union’s earnings power is considered passable because of steady returns that would adequately cover loan loss provisions under more adverse conditions and allow for capital growth. Pre-tax earnings excluding unusual items have generally been in the $75 million to $80 million range, with the exception of a dip in 2013 related to a reduction in insurance revenues, restructuring costs and costs associated with the conversion to a new banking system; earnings have since recovered.

Coast Capital’s risk profile is considered satisfactory with sound asset quality but with limited diversification by product and geography. About 70% of the loan portfolio comprises residential mortgages, and another 28% comprises commercial loans, the majority of which are real estate-secured, which strengthens Coast Capital’s asset quality. Nonetheless, DBRS remains concerned over the rapid house price appreciation seen over the past several years in the Vancouver area, especially the potential adverse impact on Coast Capital’s construction exposure, which totals 6% of the loan portfolio. DBRS also notes that Coast Capital did experience some weakness in its commercial portfolio that led to larger-than-normal write-offs in 2011, which the Credit Union has addressed by making structural changes in group risk management and commercial lending.

DBRS views Coast Capital’s funding and liquidity profile as satisfactory. Coast Capital is primarily funded by deposits, with 92.3% of funding coming from deposits, 4.5% from securitization and 3.2% from a line of credit with Central 1 at the end of 2015. The stability of credit union deposits is enhanced by the Credit Union Deposit Insurance Corporation, a statutory corporation that currently fully guarantees all deposits. However, a discussion is eventually expected that could result in a reduction of the deposit guarantee from full coverage. The potential implementation of a reduction in coverage of the guarantee could result in some outflows of deposits, although DBRS expects that it would be phased in over time, giving the credit unions time to manage their funding profiles.

Capitalization is satisfactory, with sizable capital buffers relative to regulatory requirements and high quality capital. Capital levels increased materially in 2013 from gains on the sale of insurance and other operations. Given Coast Capital’s relatively small distributions to its members out of its net income, its internal capital generation has averaged 7.4% over the past four years, which is sufficient to fund growth.

In its assessment, DBRS also recognizes various benefits that Coast Capital derives from being a member of the B.C. credit union system and the role of Central 1 within the system. The Credit Union’s franchise strength is buoyed by the significant presence, marketing efforts and social reputation of credit unions in B.C., whose membership is equivalent to about 41% of the provincial population. Coast Capital also gains from certain shared resources, including systems and clearing, some of which are provided through Central 1. By centralizing the provisions of these products and services, the member credit unions can benefit from economies of scale and reduce their costs. DBRS considers that individual credit unions are dependent on the reputation of the credit union system more broadly, and therefore, individual credit unions will likely support each other to the extent that their fiduciary and other responsibilities allow. Furthermore, DBRS recognizes that the B.C. provincial government, which regulates the B.C. credit unions and defines the deposit guarantee arrangements, has a vested interest in maintaining the credit union system given its importance to the B.C. economy and, by extension, the health of individual credit unions.

RATING DRIVERS
Upward pressure on the rating is unlikely at this time. A significant improvement in Coast Capital’s earnings power while maintaining its sound risk profile would be positive, as would further strengthening of the franchise through growth in membership and improved revenues per member. Downward pressure on the rating could occur if there were a sustained decline in Coast Capital’s internal capital generation, or if it experienced significant deposit outflows as a result of changes in the deposit insurance scheme that pressured its funding profile. While asset quality is satisfactory, a material deterioration in credit performance could also bring negative rating pressure, especially if it indicated weakness in credit underwriting or risk management.

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 on the issuer page at www.dbrs.com.

The applicable methodologies are the Global Methodology for Rating Banks and Banking Organisations (July 2016) and DBRS Criteria: Support Assessments for Banks and Banking Organisations (March 2016). Additionally, the methodology Rating Canadian Residential Mortgages, Home Equity Lines of Credit and Reverse Mortgages (November 2015) was applied via the use of DBRS’s RMBS model as a way of effectively stress testing the uninsured residential mortgage portfolio. These documents can be found on our website under Methodologies.

The primary sources of information used for this rating include company documents. DBRS considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

The rated entity or its related entities did participate in the rating process. DBRS had access to the accounts and other relevant internal documents of the rated entity or its related entities.

For more information on this credit or on this industry, visit www.dbrs.com.

Lead Analyst: Robert Long
Rating Committee Chair: Roger Lister
Initial Rating Date: August 11, 2016