DBRS Confirms Credit Union Central of Saskatchewan at R-1 (low), Stable Trend

DBRS Limited (DBRS) confirmed Credit Union Central of Saskatchewan’s (SaskCentral or the Credit Union) Short-Term Issuer Rating and Short-Term Instruments rating at R-1 (low). The trend remains Stable. Under DBRS’s support assessment criteria, SaskCentral is assessed as SA2, reflecting the expectation of timely systemic external support from the provincial government. The rating for SaskCentral reflects DBRS’s assessment of the Intrinsic Assessment (IA) of the credit union system (the System) in Saskatchewan.

In confirming the ratings for SaskCentral, DBRS takes into account the continued solid performance of SaskCentral as the statutory liquidity manager for credit unions in Saskatchewan and a conduit through which credit unions in Saskatchewan can access clearing and settlement, daily cash flow management and emergency liquidity support. SaskCentral also assists local credit unions in accessing wholesale financial markets. As a central entity, SaskCentral also provides certain collective solutions to the System for regulatory compliance support. SaskCentral is collectively owned by the 46 credit unions in Saskatchewan. Underpinning the rating for SaskCentral is the performance of the credit union system in Saskatchewan that owns and supports SaskCentral. The confirmation of the IA for the System takes into account the System’s well-established franchise position in the province, particularly within the small business and farming segments. With credit union membership representing about 41% of Saskatchewan’s population, the System has a strong presence in the province, and its share of banks and credit union branches is about 36%. While margins have been pressured by low interest rates, the System has been able to maintain overall earnings, which have grown at an annualized rate of 7.4% over the last three years. System liquidity remains solid and has shown a stable trend over the past three years, while growth in retained earnings has strengthened capitalization.

The System has good earning power that is reflected through stable recurring earnings despite recent fluctuations in energy prices resulting in some increase in provisioning expense. Nevertheless, this higher provisioning was readily absorbed by the solid earnings generated by the System. A high operating cost structure, while typical for credit union systems, remains a challenge, particularly given an increasingly competitive operating environment. Improving efficiency is an important opportunity for the System to enhance its earnings.

DBRS views the System’s asset quality as generally good. Given limited direct exposures to oil and gas exploration and development, write-offs have been low even with the impact of the oil price decline. Good credit performance reflects the generally secured nature of credit union lending to the retail, business and agricultural sectors. The System’s commercial lending activity tends to be riskier than its retail lending, as these commercial exposures tend to be lumpy and can lead to outsized losses. Mitigating this risk is the Credit Union Deposit Guarantee Corporation (CUDGC), the new regulator of SaskCentral, which has established single-party exposure limits. Positively, construction loans, another riskier segment, represent a relatively minor 3.6% of System loans.

DBRS sees the System’s funding profile as strong, given that the loan book is largely funded by relatively sticky insured deposits. Saskatchewan’s 100% provincial deposit insurance coverage for retail, commercial and institutional deposits contributes to the stickiness of these deposits and adds to the stability of the funding base for the System. This coverage is not expected to change, given the importance of the credit unions in the financial services sector in the province. In DBRS’s opinion, the sources and uses of funds are well aligned. Interest rate risk remains within acceptable parameters, and liquidity is solid. Positively, DBRS notes that the CUDGC has introduced liquidity standards for the credit unions based around the Basel Liquidity Coverage Ratio and Office of the Superintendent of Financial Institutions (OSFI) guidelines. The oversight of CUDGC has been assigned to the Financial and Consumers Affairs Authority. This is not expected to materially affect regulatory capital requirements, as CUDGC’s standards are broadly similar to OSFI’s.

DBRS views the System as well capitalized with a sufficient cushion to absorb a substantial increase in credit costs in a sustained economic downturn. The quality of capital is strong, composed mostly of equity representing member ownership and retained earnings. Regulatory capital requirements are generally similar to those established by OSFI for federally regulated institutions. While new sources of equity capital are limited for credit unions, DBRS notes that internal equity generation by the System has been strong with substantial retention of earnings.

DBRS notes that as of January 1, 2017, Concentra Financial Services obtained a federal banking licence and began operating as Concentra Bank (Concentra). SaskCentral continues to hold the majority (84%) economic interest, but it now has 84% of voting interest in Concentra, with the remaining 16% divided between credit unions across Canada (except Québec). Prior to the charter change, SaskCentral’s voting interest was constrained to 47.1%. As a consequence of its majority ownership and control, SaskCentral will consolidate Concentra’s financials beginning in 2017. While SaskCentral’s economic interest is unchanged, in DBRS’s opinion, this consolidation could result in higher volatility for reported earnings for SaskCentral. At the same time, this consolidation would make the contingent risk posed by Concentra’s activities, particularly its out-of-province commercial, Alt-A mortgage lending, and consumer credit exposures, more visible, as would its wholesale funding activities. About 94% of Concentra’s gross loans are out of province.

RATING DRIVERS
While upside for the ratings is currently limited, ratings could be positively impacted over time by a meaningful improvement in System membership growth, particularly within the younger demographic segments, increased efficiency and a greater proportion of operating revenues being generated through fee-based income. Conversely, ratings could come under pressure should the System’s franchise position weaken significantly or a deterioration in performance of the credit unions’ loan portfolios indicate greater inherent risk than currently assessed. Moreover, a reduction in the assessment of the likelihood of provincial support or significant financial weakness at Concentra could also bring negative 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 methodology is the Global Methodology for Rating Banks and Banking Organisations (May 2017), which can be found on our website under Methodologies.

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 was of satisfactory quality.

Lead Analyst: Sohail Ahmer, Vice President - Global FIG
Rating Committee Chair: Michael Driscoll, Managing Director, Head of NA FIG

Initial Rating Date: 29 June 2015
Most Recent Rating Update: 2 August 2017

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.

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