DBRS Assigns R-1 (low) Short-Term Instruments Rating to First West Credit Union

DBRS Limited (DBRS) has today assigned a Short-Term Instruments rating of R-1 (low) to First West Credit Union (First West); the trend is Stable. Under DBRS’s support assessment criteria, First West has been designated as an SA2, reflecting the expectation of timely systemic external support from the provincial government through Central 1 Credit Union (Central 1; rated A (high) with a Stable trend by DBRS), particularly in the form of liquidity, which is reflected in First West’s short-term rating. DBRS currently rates Central 1’s Medium & Long-Term Senior Notes & Deposits at A (high) and Short-Term Instruments at R-1 (middle), all with Stable trends.

The rating reflects First West’s position as the third-largest credit union in the Province of British Columbia (British Columbia; rated AA (high) with a Stable trend by DBRS) and its operations through several brands that contribute to successful product diversification and a larger portion of non-interest income. The rating also considers the potential for outflows of deposits if provincial deposit insurance coverage is lowered, as well as First West’s high operating costs relative to revenues in comparison with other credit unions, commercial loan portfolio that has rapidly grown through the acquisition of Island Savings and organic growth.

First West operates through four regional brands: Envision Financial, Valley First, Enderby & District Financial and Island Savings, the latter of which merged with First West on January 1, 2015. The merger added approximately $1.5 billion in assets, and further organic growth has increased First West’s balance sheet to $8.7 billion as at the end of 2015. It is now the fifth-largest credit union in Canada, with a material market presence in its footprint in southern British Columbia and southern Vancouver Island, with a membership that equates to an estimated 10% of the population in its operating area.

First West benefits from a relatively stable net interest margin, which reached 2.31% in 2015, and a diversified non-interest income base that makes up almost 37.0% of operating revenues. This is somewhat offset by its high cost/income ratio, which stood at 82.6% in 2015, and modest return on average member equity of 5.9%. The merger with Island Savings resulted in increased revenues in 2015, although the increase was more than offset by an increase in non-interest expense and loan loss provisions. DBRS expects the high level of expenses to decline over time through the integration of Island Savings’ operations and other efficiency measures. The higher level of loan loss provisions was in part because of collective allowance strengthening. Overall, First West reported net income of $30.1 million for 2015, down modestly from $32.1 million in 2014.

Around 69% of First West’s $7.2 billion gross loan portfolio is in retail loans, the majority of which are residential mortgages. Commercial lending has grown with the Island Savings merger to reach $2.2 billion in 2015 versus $1.7 billion in 2014. Credit metrics have been strong, including gross impaired loans to gross loans, which have averaged 0.49% over the last five years, and provisions for loan losses, which have not exceeded 17 basis points of average net loans. However, given First West’s area of operations in southern British Columbia and proximity to the Vancouver real estate market, DBRS believes delinquencies and losses may rise in the event of an economic and/or housing downturn in the area.

Branch-raised deposits make up the majority of liabilities and fund more than 100% of First West’s loans. Like other credit unions in British Columbia, a portion of First West’s deposit base could experience some outflows if the B.C. government decides to reduce the deposit guarantee from the current 100% coverage level. Any reduction in the deposit guarantee coverage is expected to be phased in, allowing the credit unions time to adjust their funding profiles. In terms of liquidity, First West benefits from the liquidity pool it shares with the other credit unions in British Columbia through Central 1. First West’s liquidity levels have significantly improved in the last year and are expected to remain higher than in the past, showing strong liquidity metrics for future periods.

First West’s capital ratios provide a sizable cushion above regulatory requirements. Specifically, First West reported a B.C. capital adequacy ratio of 14.2%, well above the minimum 8.0% required. Meanwhile, the quality of capital is good and mostly comprises retained earnings and contributed surplus that can absorb losses. Since credit unions are limited in their ability to raise capital externally, it is important that First West continue to generate sufficient internal capital to support its growth, which is reflected in its low dividend payout.

RATING DRIVERS
While DBRS believes there is little upside potential to the rating in the short term, significantly strengthened earnings through sustained revenue growth and/or improved efficiency or enhanced market share through membership growth and higher revenue per member could result in positive rating implications. Conversely, downward pressure would likely be driven by a material decline in asset quality, particularly if it indicates weakness in credit underwriting or risk management. In addition, inadequate management of funding if deposit insurance coverage is reduced, causing deposit outflows, or if First West is unable to adequately match its funding with its asset duration and/or a deterioration in internal capital generation could also have a negative impact on the rating.

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) as well as Rating Canadian Residential Mortgages, Home Equity Lines of Credit and Reverse Mortgages (November 2016), which can be found on the DBRS website under Methodologies.

Lead Analyst: Maria-Gabriella Khoury
Rating Committee Chair: William Schwartz

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