DBRS Assigns Short-Term Ratings of R-1 (low) to Conexus Credit Union 2006

DBRS Limited (DBRS) assigned a Short-Term Issuer Rating and Short-Term Instruments rating of R-1 (low) to Conexus Credit Union 2006 (Conexus or the Credit Union), both with Stable trends.

Additionally, Conexus has been 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 (Saskatchewan or the Province) with an Issuer Rating and a Long-Term Debt rating of AA and a Short-Term Debt rating of R-1 (high), all with Stable trends.

KEY RATING CONSIDERATIONS
The ratings reflect Conexus’s position as the largest member-owned financial institution in Saskatchewan and the sixth largest in Canada, providing financial services to about 10.8% of the provincial population, which are its members, through 39 branches and mobile representatives. Moreover, Conexus has grown its membership base each year since 2013. The ratings also consider the Credit Union’s ability to generate relatively stable recurring earnings with profitability metrics that compare favorably with those of peers. Conversely, DBRS notes that Conexus’s loan portfolio has higher exposures to commercial and agricultural loans than other credit unions outside of Saskatchewan, which tend to be less granular and lead to more volatile asset quality metrics.

RATING DRIVERS
Although unlikely over the intermediate term, ratings could be positively affected by sustained membership growth, particularly in the younger demographic, combined with significant improvement in market shares. An improving share of fee-based income could also benefit ratings. Conversely, ratings could come under pressure from material declines in asset quality due to deficiencies in underwriting or risk management that translate into significant loan losses. Excessive reliance on wholesale sources to fund loan growth, resulting from an inability to grow stable retail deposits, could also pressure ratings.

RATING RATIONALE
Conexus enjoys a strong franchise in Saskatchewan with an 8.3% market share in deposits, 6.0% share in residential mortgages, 13.9% share in commercial loans and 12.8% share in agricultural loans in the Province. Historically, Conexus has operated in and around the city of Regina, but over the last five years, it has gradually expanded in the city of Saskatoon (Canada’s youngest city and Saskatchewan’s business hub). DBRS views this positively, as a growing franchise in Saskatoon should benefit Conexus over the longer term. Competition from Canada’s big banks remains strong, although the Credit Union’s member-centric model and deep relationships with small- to medium-sized businesses remain an important source of competitive strength. This is reflected in strong market shares in small business loans for Conexus.

Conexus generates relatively stable recurring earnings. These are derived through basic banking and wealth management services provided to a mostly retail and small- to medium-sized business customer base. Net income declined 17% in 2017 to $33.5 million, down from $40.4 million last year. However, adjusting for one-off gains in 2016, income before tax increased by 16% in 2017. Growth in operating revenues and good cost control resulted in Conexus realizing significant operating leverage in 2017. The adjusted efficiency ratio also improved to 71% in 2017 from 76% in the prior year. Though provisions as a percentage of income before provisions and taxes increased in 2017 to 19% from 7% in 2016, DBRS notes that recurring earnings remain sufficient to absorb heightened provisioning expense even during economic downturns.

Credit quality metrics deteriorated in 2017 as the ratio of gross impaired loans-to-gross loans increased substantially to 1.1% in 2017 from 0.4% in 2016. DBRS notes that Conexus’s loan portfolio is concentrated toward commercial lending (32.6% of gross loans), where a few large delinquencies can significantly affect credit quality metrics in any given year. Nonetheless, the vast majority of Conexus’s loans are secured by real estate, which has limited loan losses. Specifically, losses have been manageable, ranging from 7 basis points (bps) to 28 bps over the last five years. Exposure to auto financing, the equivalent of 7.7% of gross loans, is also susceptible to increased delinquencies during adverse operating environments.

Conexus is mainly funded through member-sourced retail deposits in addition to longer-term wholesale financing generated through an established securitization program. DBRS views these sources as relatively stable and assesses the Credit Union’s funding to be well aligned with lending activities. However, DBRS notes that because of intense competition for demand deposits, significant reliance has been placed on securitizations to fund loan growth. Consequently, Conexus has the highest loans-to-deposit ratio among Canadian credit unions rated by DBRS. Positively, Conexus has not relied on broker-sourced deposits in any meaningful way to fill the funding gap and has been able to increase institutional deposits in its funding base. Although liquid assets declined marginally in 2017, DBRS views the Credit Union’s liquidity position as appropriate to support operations.

In DBRS’s opinion, Conexus maintains sufficient capital to absorb potentially higher levels of provisioning and loan losses over the normal course of business. Also, the quality of capital remains strong with 96% of regulatory capital sourced through members’ equity and retained earnings. The provincial regulator for credit unions in Saskatchewan, Credit Union Deposit Guarantee Corporation (CUDGC) has designated Conexus and two other large credit unions as provincially systemically important financial institutions (P-SIFI). DBRS views this positively, as it is expected to lead to enhanced reporting requirements for the P-SIFIs and stronger oversight by CUDGC and will require a recovery plan, as well as the establishment of a 1% capital conservation buffer. In DBRS’s opinion, these measures should strengthen existing capital management structures and practices, which are already closely aligned to guidelines issued by the Office of the Superintendent of Financial Institutions.

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 principal methodology is Global Methodology for Rating Banks and Banking Organisations (May 2017), which can be found on dbrs.com under Methodologies.

Lead Analyst: Sohail Ahmer, Vice President, Canadian Financial Institutions Group
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 for this rating action. DBRS had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

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