DBRS Confirms Ratings of Credit Union Central Alberta Limited at “A,” Stable Trend

DBRS Limited (DBRS) confirmed the ratings of Credit Union Central Alberta Limited (Alberta Central or the Credit Union), including the Issuer Rating of “A” and the Short-Term Instruments rating of R-1 (low). The ratings reflect the Intrinsic Assessment (IA) of A (low) that DBRS has assigned to Alberta’s credit union system (the System). The trends remain Stable. Under DBRS’s support assessment criteria, Alberta Central is assessed as SA2. This reflects expectation of timely systemic external support from the provincial government, resulting in a one-notch uplift from the IA of Alberta Central of A (low) and a final rating of “A.”

KEY RATING CONSIDERATIONS
Alberta Central’s ratings reflect the System’s significant share of loans and deposits in Alberta and the important economic role it plays, particularly in the rural communities and small towns. DBRS notes that the evolving competitive landscape remains challenging for credit unions in Alberta, particularly with respect to growing their membership base. Positively, the System’s asset quality metrics improved in 2017 with net write-offs declining. However, asset quality remains susceptible to unexpected sharp declines in oil prices.

RATING DRIVERS
DBRS views Alberta Central’s ratings as well placed. Over the longer term, a significant expansion in the membership base, while deepening market shares, could have positive rating implications. Conversely, a material weakness in the commercial lending portfolio suggesting structural issues related to loan underwriting practices, a sustained decline in market shares and revenues per member or a reduction in DBRS’s assessment of the likelihood of provincial support could result in a negative rating pressure.

RATING RATIONALE
Credit unions in Alberta are important providers of retail and commercial banking services to the province’s population, of which 14% in 2017 were members of a local credit union. The operating environment, however, remains highly competitive, particularly given the presence of the Alberta government-owned ATB Financial (ATB), which competes directly with credit unions. Consequently, the System’s share of loans and deposits has been relatively stagnant over the last five years, averaging about 7.0% for residential mortgage loans, 7.5% for commercial loans and 9.5% for deposits. The System is dominated by two large credit unions — Servus Credit Union with assets of $15.4 billion and Connect First Credit Union with assets of $4.5 billion, which collectively represent over three-quarters of the System’s membership base, deposits and assets. The concentration of assets within two credit unions allows for scale and the capacity to adapt to a changing operating environment, helping to withstand competitive headwinds. Smaller credit unions can benefit by adopting successful strategies implemented by the largest two credit unions. Also, credit unions have been prioritizing the quality of their service offering in order to differentiate themselves from ATB. These dynamics could explain how credit unions in Alberta have sustained their market shares despite experiencing a declining membership base.

The System’s net income increased by 12.3% in F2017 to $167 million. Net interest margins remained under pressure due to a low interest rate environment and strong competition. Growth in net income was driven by residential mortgage underwriting, positive operating leverage and lower provisioning expenses, which declined by 42% to $22 million. Positively, recurring earnings have been relatively stable over the last five years, despite significant oil price volatility, and the operating expense ratio is among the strongest compared with Canadian peers. Provision for credit losses is also manageable, absorbing an average of 10% of income before provisions and taxes over the last five years.

Asset quality metrics improved in 2017 as the impact of the Fort McMurray wildfires subsided, and oil prices stabilized. The gross impaired loans ratio declined by four basis points (bps) to 54 bps in 2017, but remains at the higher end of Canadian peers. Positively, loan delinquencies decreased in all categories except agricultural loans due to exceptionally dry weather affecting crop output. Agricultural loan delinquencies remain manageable, increasing by six bps to 44 bps during the year. DBRS views favourably the largely collateralized nature of the System’s loans, noting the relatively low exposure to unsecured lending (only 9% of gross loans) compared with other Canadian credit union systems. Also, DBRS recognizes that gross impaired loans ratios can be volatile in Alberta given the reliance of Alberta’s economy on cyclical industries, such as oil and gas and agriculture. The System has indirect exposures to these industries. Consequently, during downturns, delinquencies can increase substantially. The relatively large size of individual commercial loan exposures also adds to the volatility in loan impairment metrics. However, given that loan exposures are mostly collateralized, loan losses have been manageable.

The System’s liquidity position improved in 2017 and in DBRS’s opinion is sufficient given the System’s low-risk cooperative banking structure. The implementation of a liquidity coverage ratio for the two largest credit unions in the System is expected to improve the quality of Alberta Central’s liquidity pool. DBRS notes that credit unions in Alberta are largely funded through relatively stable retail deposits. Nonetheless, deposit growth has been challenging for Alberta’s credit unions, averaging only 3% (versus 9% for ATB) over the last five years. This has resulted in an increased reliance on securitizations to fund loan growth, with almost 3% of funding in 2017 being derived through securitizations compared with nil in 2012. Securitization has been a relatively stable form of market funding for Canadian financial institutions. However, over reliance on market-based funding can heighten refinance risk, particularly during periods of stress.

DBRS views the System as well capitalized in comparison with peers, and that it holds sufficient cushion to absorb losses incurred in the normal course of business. Although the quality of capital is strong, because of the ownership structure, sources of new capital are restricted to internally generated equity and membership shares. Positively, internal equity growth improved to 4.5% in 2017 from 4.1% in 2016 and compares well with the five-year average of 4.2%.

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.

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

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.

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