DBRS Confirms Concentra Financial Services Association at R-1 (low), A (low), Trends Remain Stable

DBRS Limited (DBRS) has today confirmed Concentra Financial Services Association’s (Concentra or the Company) Issuer Rating of A (low) and Short-Term Instruments rating of R-1 (low), both with Stable trends. The Issuer Rating reflects an intrinsic assessment of BBB (high) and a support assessment of SA2, which provides a one-notch uplift in the final rating. The confirmation of the ratings follows a detailed review of Concentra’s operating results, financial fundamentals and future prospects.

The ratings reflect Concentra’s relationship with the credit union system throughout Canada with strong roots in the Prairie Provinces, particularly in Saskatchewan. Indeed, the Company is a leading provider of wholesale finance and trust solutions to credit unions in Canada. Moreover, Concentra’s sound balance sheet, which primarily comprises lower-risk residential mortgages, supports the ratings. The ratings also consider the Company’s reliance on nominee, broker-sourced and wholesale deposits, although Concentra’s liquidity coverage ratio is robust.

DBRS continues to anticipate a high level of implied support from the Saskatchewan credit union system (the System) through R-1 (low)-rated SaskCentral because of the Company’s strategic importance to SaskCentral and the System. Concentra remains closely associated with SaskCentral. In addition to providing critical services to the System, the credit unions have a substantial indirect investment in Concentra through SaskCentral, totalling $241 million at the end of 2015, an amount equivalent to almost 60% of SaskCentral’s equity. While credit union clients outside of Saskatchewan could potentially offer some assistance if Concentra comes under stress, the likelihood is not predictable enough to factor into the ratings.

Concentra’s mandate is to offer and provide wholesale services to credit unions nationally. The December 2015 issue of $111 million in Non-Viability Contingent Capital (NVCC)-compliant preferred shares was purchased by more than 25% of the credit unions in Canada, providing an indication of how deep Concentra’s roots are among Canadian credit unions; however, a material proportion of the Company’s activity is outside the credit union system where competitive advantages are more limited, including acquiring residential mortgages from third-party sources and securitizing them.

 
According to DBRS’s “Global Methodology for Rating Banks and Banking Organisations,” which replaced DBRS’s Credit Union Methodology in December 2015, Concentra’s earnings power is considered passable, although under pressure in recent years as a result of margin compression and rising expense levels. Revenues have been relatively flat in recent years. The Company is highly dependent on net interest income (NII), which has averaged 78% of total revenues over the past few years. Average earning asset growth has been offset by net interest margin compression in recent years, resulting in relatively stable NII of just under $70 million. Although expense levels had been decreasing, the trend was reversed in 2014 and 2015, recording 8.6% and 14.5% increases, respectively, which was partly because of one-time costs. Overall, loan-loss provisions relative to income before provisions and taxes have not been a challenge, averaging a very manageable 9.9% over the past five years.

The Company’s risk profile is considered satisfactory in DBRS’s view, given the sound asset quality, which is supported by a lower-risk loan portfolio (primarily comprising residential mortgages; 76.6% of the portfolio, of which 87.5% is insured) that has consistently produced good credit metrics. Specifically, gross impaired loans to gross loans have averaged 53 basis points (bps) over the past nine years with a high of 1.36% in 2009. More importantly, write-offs have been low, averaging just seven bps over the same period with a high of only 11 bps in 2015 and 2011; however, credit costs have come under pressure in H1 2016, rising to $6.2 million from an unsustainably low $0.6 million in H1 2015 according to the Office of the Superintendent of Financial Institutions filings. DBRS notes that the recent $339 million acquisition of TD Bank Group’s indirect home improvement financing assets further diversifies the loan portfolio.

DBRS views Concentra’s liquidity and funding profile as passable. The overall profile is limited by the dependence on nominee, broker-sourced and wholesale deposits as well as securitization. The Company remains relatively liquid with liquid assets of $1.5 billion, representing 19.0% of total assets at year-end. The liquidity coverage ratio was a very strong 155% for 2015.

Concentra’s capitalization is considered generally satisfactory by DBRS. While a large issue of NVCC preferred shares strengthened Tier 1 and Total capital in 2015, the quality of capital as measured by the Company’s Common Equity Tier 1 Ratio (CET1) deteriorated on a material increase in risk-weighted assets with CET1 retracting to 11.6% in 2015 from 13.3% in 2013.

RATING DRIVERS
While there is limited upside potential for the ratings given the current macroeconomic environment, improved franchise strength among credit union clients including gains in market share and more profitability directly linked to credit unions and/or increased scale and improved efficiency would strengthen the assessment. Conversely, a material decline in asset quality, particularly if it indicates weakness in credit underwriting or risk management, a sustained reduction in profitability or a change in the assessment of SaskCentral’s ability or willingness to provide support could put pressure on the ratings.

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 the Global Methodology for Rating Banks and Banking Organisations (July 2016), Criteria: Support Assessment for Banks and Banking Organisations (March 2016) and Rating Canadian Residential Mortgages, Home Equity Lines of Credit and Reverse Mortgages (November 2015), which can be found on our website at www.dbrs.com.

Lead Analyst: Maria-Gabriella Khoury
Rating Committee Chair: Roger Lister

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 or contact us at info@dbrs.com.