DBRS Confirms First West Credit Union Ratings at R-1 (low), Stable Trend

DBRS Limited (DBRS) confirmed the Short-Term Issuer Rating and Short-Term Instruments rating of First West Credit Union (First West or the Credit Union) at R-1 (low). All trends are Stable.

The support assessment for First West of SA2 is unchanged. First West’s SA2 reflects DBRS’s expectation of timely systemic external support from the provincial government through Central 1 Credit Union (Central 1), particularly in the form of liquidity, which is reflected in First West’s short-term ratings. DBRS currently rates Central 1’s Short-Term Instruments at R-1 (middle) with a Stable trend. DBRS also rates the Province of British Columbia’s (B.C. or the Province) Issuer Rating and Long-Term Debt rating at AA (high) and its Short-Term Debt rating at R-1 (high), all with Stable trends.

DBRS’s ratings reflect First West’s well-established position as the third-largest credit union in B.C. and its operations through several brands that contribute to its successful product diversification and a larger contribution from non-interest income than most credit unions. The rating also considers First West’s high operating costs relative to revenues in comparison with peers, which were driven by the integration of four regional credit unions. In addition, the ratings also factor in the Credit Union’s growing commercial loan portfolio with a large real estate development component that makes it more susceptible to credit risk in case of a real estate market correction in the Province.

First West operates through four regional brands: Envision Financial, Valley First, Enderby & District Financial and Island Savings that reflect the credit unions that were combined into First West. The Credit Union enjoys a material market presence in its footprint areas in southern B.C. and Vancouver Island. This position is bolstered by the strong position of credit unions in the Province, which together account for about 16% of residential mortgages in B.C. and about 26% of small business loans. With $9.5 billion in assets as of December 31, 2016, First West offers retail, commercial, wealth management and insurance products through its 54 branches. In addition, the Credit Union has a small national presence through its commercial leasing subsidiary First West Leasing and its specialty financing subsidiary First West Capital.

Indicative of First West’s strength, it generates one of the best revenue per member ratios among large credit unions in B.C. At $1,143 per member in 2016, First West benefits from its aging membership base by providing more fee-based products through its wealth management and insurance services, which help bolster the Credit Union’s earnings. This is somewhat offset by having an efficiency ratio of 84.6% in 2016, which is weaker than peers. DBRS expects this high level of expenses relative to revenues to decline over time through First West’s integration of operations and IT systems among its four regional brands, in addition to other efficiency measures.

While more than half of First West’s $7.5 billion loan portfolio is in relatively low-risk residential mortgages, approximately 30% is in commercial mortgages, slightly higher than B.C. peers. Although favourable overall, asset quality metrics seem relatively weaker than for credit union peers, with an impaired loans ratio of 0.44%, in part due to First West’s larger exposure to commercial loans. After a period of decline, this ratio has been trending up modestly since 2014, reflecting First West’s efforts to address credit quality issues with its more recently combined credit unions. Nevertheless, loan loss provisioning has generally absorbed only about 16% of annual income before provisions and taxes over the last five years. In DBRS’s opinion, given First West’s area of operations in southern B.C. and its proximity to the Greater Vancouver Area, delinquencies and losses may rise in the event of a downturn in the regional economy and housing markets.

First West is mainly funded through relatively stable deposits, both retail and institutional, which fund 89% of assets. The stability of credit union deposits in the province is enhanced by a full provincial guarantee provided by the Credit Union Deposit Insurance Corporation. With respect to its liquidity position, First West benefits from a mandatory statutory liquidity pool that it shares with credit unions in B.C. This pool is externally managed by Central 1. In addition, First West has strengthened its liquidity position since its merger with Island Savings in 2015 and is now well above the required statutory limits.

Capitalization levels are good in DBRS’s view, with a sufficient buffer to absorb potential losses. In 2016, First West reported a B.C. capital adequacy ratio of 13.4%, well above the minimum 8.0% required. Since credit unions are limited in their ability to raise capital externally, it is important that First West continues to generate sufficient internal capital to support its growth, which is reflected in its low dividend payout. DBRS expects that the recent decision by the new provincial government to make the tax exemption of credit unions permanent will improve the level of retained earnings.

RATING DRIVERS
Although unlikely over the intermediate term, ratings could be positively affected by enhanced market share through membership growth, especially among younger members, or significantly strengthened earnings through sustained revenue growth and/or improved efficiency. On the other hand, ratings could come under pressure should First West experience material losses in the loan portfolio as a result of unexpected weakness in the underwriting and/or risk management process. In addition, an 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 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, Vice President, Canadian Financial Institutions Group
Rating Committee Chair: Michael Driscoll, Managing Director, Head of North American Financial Institutions Group

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.

DBRS will publish a full report shortly that will provide additional analytical detail on this rating action. If you are interested in receiving this report, contact us at info@dbrs.com.