DBRS Confirms Laurentian Bank of Canada Rating at A (low), Stable Trend

DBRS Limited (DBRS) has today confirmed Laurentian Bank of Canada’s (LBC or the Bank) Issuer Rating and Deposits & Senior Debt rating at A (low), its Short-Term Instruments rating at R-1 (low), its Subordinated Debt rating at BBB (high), its NVCC Preferred Shares rating at Pfd-3 and its Non-Cumulative Preferred shares at Pfd-3 (high). The trend on all ratings is Stable. The rating actions follow a detailed review of the Bank’s operating results, financial fundamentals and future prospects.

Under DBRS’s Global Methodology for Rating Banks and Banking Organisations, the Bank’s long-term Deposits & Senior Debt rating of A (low) has an intrinsic assessment of A (low) and a support assessment of SA3. The SA3 rating, which reflects the expectation of no timely external support, results in the final rating being equivalent to the intrinsic assessment.

In confirming the rating, DBRS acknowledges LBC’s retail-based business model in Québec, its good asset quality and historically low loan losses. In addition, the Bank has successfully developed its B2B Bank, which allows LBC to compete across the country, lessening its regional dependence. These positive attributes are offset by the Bank’s modest capitalization ratios and LBC’s inability to internally generate and retain capital at a pace that is sufficient to improve its capital position. Furthermore, the geographic concentration of loans in the province of Québec, where LBC competes against two dominant players, and its heavy cost base owing to the relatively large number of branches and retail products are a constraint on the rating.

LBC is Canada’s seventh-largest Schedule I bank, with assets of $40.3 billion at the end of Q3 2016. The Bank has the third-largest branch network in Québec, offering retail services in the province and commercial lending Canada-wide. The Bank also owns an integrated full-service institutional securities and investment banking firm, Laurentian Bank Securities & Capital Markets. Over the last few years, LBC has actively grown its B2B Bank, which distributes products through brokers and financial advisors across the country, giving LBC the diversification it seeks. In the same vein, LBC acquired CIT Canada’s $1 billion portfolio of equipment finance, leasing products and corporate financing activities in June 2016. Upon closing in October 2016, LBC created LBC Capital, a wholly owned subsidiary, to consolidate all equipment finance activities of LBC and CIT Canada.

Earnings and profitability have been stable, with over 30% of revenues coming from non-interest income. However, LBC has one of the weakest efficiency ratios among peers, which is attributed to its network of bricks and mortar branches, maintenance of legacy and redundant product offerings and outdated IT systems. The Bank announced in August 2016 that it will be consolidating 50 branches and has terminated a few IT contracts in favour of newer, more up-to-date account management systems. Most recently, LBC reported $134 million of net income for the nine months ended July 30, 2016 (9M16), up 10% from 9M15, as operating revenues, which increased by 2% to $679 million, were met by slightly lower expenses and a 10% decrease in provisions to $23 million.

With a regional retail and commercial focus, coupled with good underwriting practices and a well-managed loan book, LBC has historically been exposed to low levels of impairments and loan losses. Residential mortgages make up just over half of LBC’s loan portfolio. Out of the $16.4 billion mortgages in Q3 2016, 57% were in Québec, where housing prices have kept pace with inflation over the last few years. However, the Bank is looking to diversify both its geographic footprint and its offering by setting aggressive growth targets for B2B Bank and its Commercial segment. Although such targeted expansion can potentially have a positive impact on LBC’s franchise, such aggressive growth could lead to higher impairments and would be more appropriate once AIRB is implemented and enough capital is freed up to support these initiatives, in DBRS’s view.

LBC has a strong deposit funding base, thanks to its retail franchise. DBRS notes that the Bank sources over 40% of its deposits from brokers through its B2B Bank, which may be less stable than directly sourced funds. LBC is also active in the mortgage securitization market and is planning to securitize more of its assets in the future. Liquidity levels are good with sufficient unencumbered assets to cover the Bank’s needs.

The Bank’s capital ratios are close to regulatory minimums leaving a very limited buffer to absorb any major losses. LBC’s CET1 ratio stood at 7.9% at the end of Q3 2016, which was a small improvement from 7.6% at YE2015, despite organic growth. DBRS is cautious that LBC has to manage its capital levels well and improve its internal capital generation until it switches to an AIRB model in 2019, at which point capitalization is expected to further gain a few percentage points.

RATING DRIVERS
DBRS views LBC as being well-positioned within its rating category, so upward ratings pressure is unlikely over the intermediate term. Longer term, a broadening in the geographic footprint of the loan book and breadth of the Commercial segment offering leading to an improvement in the earnings profile, the successful implementation of AIRB and improvement in capitalization, as well as strengthening funding sources and enhanced efficiency through cost cutting and product rationalization, could result in positive ratings implications. Conversely, losses in the loan portfolio due to unforeseen weakness in the underwriting and/or risk management process could put downward pressure on the ratings. Furthermore, exponential increase in impaired loans and charge-offs as a result of aggressive growth in B2B Bank and the Commercial segment, and a reduction in capitalization to levels closer to regulatory minimums, could also negatively affect 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 on the issuer page at www.dbrs.com.

The applicable methodologies are Global Methodology for Rating Banks and Banking Organizations (July 2016), Rating Bank Capital Securities – Subordinated, Hybrid, Preferred & Contingent Capital Securities (February 2016) and DBRS Criteria: Support Assessments for Banks and Banking Organisations (March 2016), which can be found on the DBRS website under Methodologies.

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

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