DBRS Assigns R-1 (low) Short-Term Rating to Affinity Credit Union

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

The rating reflects Affinity’s generally satisfactory franchise strength that has a material market presence in its footprint in Saskatchewan. While membership growth has been negative over the past several years, exclusive of mergers and taking into account a 2014 file clean up, revenue per member has strengthened, suggesting a deeper penetration of existing members. This franchise strength is bolstered by the strong position of credit unions in the province, which account for about 52% of the branches of credit unions and major banks. The rating also considers Affinity’s geographic concentration within Saskatchewan, as well as the less granular commercial loan portfolio that can expose the Credit Union to larger losses.

Like most credit unions, Affinity’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. Affinity’s assets are predominantly funded by deposits and totalled $4.8 billion at December 31, 2015.

The Credit Union’s earnings power is considered passable because of its respectable profitability resilience over the past several years of low interest rates and its decent ability to absorb loan loss provisions under more adverse credit conditions. Earnings have grown materially over the past five years as a result of mergers with other credit unions, although organic revenue growth is low. Specifically, Affinity reported earnings of $32.7 million in 2015, up 3.0% from the $31.7 million 2014 profit. While under downward pressure, the proportion of Affinity’s revenues from non-interest sources is higher than its peers. Like most credit unions, non-interest expense is high relative to operating income, which constrains profitability and can be a competitive disadvantage relative to the banks.

Asset quality metrics have been at strong levels for the past five years because of the nature of the loan book, which is largely real estate secured, and an extended period of economic growth. About 80.9% of the loan portfolio is in conventional mortgages (both residential and commercial) or is government guaranteed or cash secured. However, like the Saskatchewan system as a whole, the Credit Union has proportionately more exposure to commercial and agricultural lending than credit unions in other provinces. Affinity did experience a material loss on one commercial exposure in 2009, which highlights the potential that a financial institution of this size could experience lumpy loss provisions at times because of the lower level of granularity of the commercial and agricultural book. The weakening provincial economy suggests that impairments could increase.

Affinity’s satisfactory funding and liquidity profile is underpinned by its stable deposit base, which comprises almost all of the Credit Union’s funding needs. While the majority of deposits are generated from the branch system in Saskatchewan, Affinity also raises a very small amount of deposits through the nominee deposit market. The stability of credit union deposits is enhanced by the unlimited guarantee from Saskatchewan’s Credit Union Deposit Guarantee Corporation (CUDGC) on credit union deposits in the province. The fund is funded by an annual assessment paid by credit unions and earnings from investments.

Capitalization is satisfactory with good capital buffers relative to newly increased regulatory requirements and high-quality capital. Affinity’s internal capital generation has averaged 9.6% over the past five years, which is good for a credit union and sufficient to fund growth.

Affinity’s SA2 assessment reflects DBRS’s expectation of timely systemic external support from the provincial government through Credit Union Central of Saskatchewan (SaskCentral), particularly in the form of liquidity, which is reflected in the Credit Union’s short-term rating. DBRS currently rates SaskCentral’s Short-Term Instruments at R-1 (low) with a Stable trend. DBRS also rates the province of Saskatchewan’s Issuer and Long-Term Debt at AA and its Short-Term Debt rating at R-1 (high). Trends are Stable.

In its assessment, DBRS also recognizes various benefits that Affinity derives from being a member of the Saskatchewan credit union system (the System) and the role of SaskCentral within the system. The Credit Union’s franchise strength is buoyed by the significant presence and marketing efforts of credit unions in Saskatchewan. Affinity gains from certain shared resources, including systems and clearing, some of which are provided through SaskCentral. 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 Saskatchewan provincial government, which regulates the Saskatchewan credit unions and defines the deposit guarantee arrangement, has a vested interest in maintaining the credit union system given its importance to the Saskatchewan economy and, by extension, the health of individual credit unions.

RATING DRIVERS
The Stable trend considers that Affinity’s rating is well positioned at its current rating level. Upward pressure on the rating is unlikely at this time. A significant improvement in Affinity’s franchise strength through growth in membership and improved revenues per member would be positive, as would an improvement in the granularity of the commercial and agricultural portfolio. While asset quality is considered passable, downward pressure on the rating could occur in the event of a material deterioration in credit performance, especially if it indicated weakness in credit underwriting or risk management. A sustained reduction in internal capital generation could also bring negative rating pressure.

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 the 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 DBRS’s website at www.dbrs.com.

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.

Lead Analyst: Robert Long
Rating Committee Chair: Roger Lister
Initial Rating Date: August 22, 2016