DBRS Assigns R-1 (low) Short-Term Ratings to Innovation Credit Union

DBRS Limited (DBRS) has today assigned a Short-Term Issuer Rating and a Short-Term Instruments rating of R-1 (low) to Innovation Credit Union (Innovation or the Credit Union), both with Stable trends.

Additionally, Innovation is assigned a support assessment of SA2, which 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 ratings. DBRS currently rates SaskCentral’s Short-Term Instruments at R-1 (low) with a Stable trend. DBRS also rates the Province of Saskatchewan (the Province), with an Issuer Rating and a Long-Term Debt rating of AA and a Short-Term Debt rating of R-1 (high), with Stable trends.

DBRS considers Innovation to have good franchise strength that is tempered by its moderate size. This strength reflects its solid positioning within its home markets, its successful cooperative nature and the benefits of being part of the well-established credit union system in Saskatchewan. The ratings are supported by Innovation’s strong earnings power with above-average revenues per member. The ratings also consider Innovation’s higher proportion of commercial loans, especially agricultural loans, relative to peers, a slow growth operating footprint, as well as an aging membership base.

Innovation is the third-largest credit union in Saskatchewan with $2.3 billion in assets as of December 31, 2016. The Credit Union was formed in 2007 though the combination of Southwest Credit Union and BCU Financial (formerly Battlefords Credit Union and Meadow Lake Credit Union). Innovation has been successfully growing its membership base over the last five years and now has over 50,000 members and 23 branches. The Credit Union positions itself in smaller cities in the Province with a rural presence predominantly in the western half of the Province.

DBRS views Innovation’s earning power as good since the Credit Union has managed to generally maintain earning levels despite the pressures of the low interest rate environment. As is typical for credit unions, Innovation relies more on net interest income as a source of revenues relative to fee-based income. Net interest margin (NIM) has declined to 2.72% in 2016 from 3.08% in 2012 primarily due to low interest rates; nevertheless, even at this level, the NIM is still higher than many other larger credit unions. Although credit unions tend to have a high cost base due to their business model, Innovation has good expense control with one of the lowest efficiency ratios among peers at 68% in 2016.

Innovation’s risk profile is considered to be good, which is a reflection of its positive track record of credit performance. The $1.9 billion credit portfolio is comprised of mortgage loans, business lending and agricultural lending, much of which is secured. Innovation has a higher proportion of agricultural loans, which represent over 20% of the portfolio, nearly double peer levels, but DBRS notes that Innovation has a strong track record of managing this asset class. Impaired loans have been low over the last ten years as the Credit Union benefited from moderate economic growth in the Province and the absence of a sustained downturn in 2008 to 2010; however, a weakening Saskatchewan economy suggests impairments could increase.

As with other credit unions, Innovation is predominantly deposit funded, with stable branch-raised deposits forming 84.5% of assets. In addition, the stability of deposit funding is enhanced by the unlimited guarantee from the Saskatchewan’s Credit Union Deposit Guarantee Corporation (CUDGC), which is funded by an annual assessment paid by credit unions and earnings from investments. Additionally, Innovation has various sources of liquidity including credit lines with SaskCentral.

Capitalization levels are good in DBRS’s opinion with a sizeable cushion over regulatory minimums to absorb potential losses. Innovation’s Common Equity Tier 1 ratio, which is based on Basel III requirements, stood at 11.38% in 2016 versus the 7% regulatory minimum requirement. Positively, the Credit Union’s earnings are generating sufficient capital to support balance sheet growth.

The Credit Union is pursuing federal continuance, which would enable it to operate nationally, not just in Saskatchewan, and bring it under the supervision of the Office of the Superintendent of Financial Institutions rather than the provincial regulator. A 75% approval vote is required by members to allow Innovation to pursue the federal charter. The vote is planned for November 2017, and if approved, management expects to operate nationally by 2020.

In DBRS’s opinion, while Innovation has significant strengths in its fundamentals, its proposed conversion to a federal charter raises significant uncertainties about its prospects, most importantly around funding. With a federal continuance, Innovation would lose the unlimited deposit coverage provided by CUDGC and become limited to the $100,000 deposit insurance provided by the Canada Deposit Insurance Corporation. Thus, the Credit Union could potentially experience deposit outflows, especially large retail and business deposits. Furthermore, although a federal charter would provide Innovation with access to prospective new members or retail customers, especially through online platforms, remote deposit acquisition might come at a higher cost as Innovation would have to compete with banks and local credit unions.

RATING DRIVERS
Although unlikely over the intermediate term, ratings could be positively affected by sustained membership growth, especially among younger members, or significant improvement in revenue through the growth of non-interest income. Alternatively, ratings could come under pressure should there be significant losses in the loan portfolio as a result of unforeseen weakness in the underwriting and/or risk-management process. Furthermore, inability to control costs or a sustained reduction in internal capital generation could also have a negative impact 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 principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations (May 2017), which can be found on dbrs.com under Methodologies.

Lead Analyst: Maria-Gabriella Khoury
Rating Committee Chair: Michael Driscoll

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.