DBRS Assigns Ratings of BBB (high)/R-1 (low) with Stable Trends to BlueShore Financial Credit Union

DBRS Limited (DBRS) assigned BlueShore Financial Credit Union (BlueShore Financial or the Credit Union) a Long-Term Issuer Rating of BBB (high) and a Short-Term Issuer Rating of R-1 (low). The trend on all ratings is Stable.

DBRS assigned BlueShore Financial a Support Assessment (SA) of SA2. This reflects DBRS’s expectation of timely systemic external support from the Province of British Columbia (B.C. or the Province; rated AA (high)/R-1 (high) with Stable trends by DBRS) through Central 1 Credit Union (Central 1; rated A (high)/R-1 (middle) with Stable trends by DBRS), particularly in the form of liquidity. This implicit support is factored into the Credit Union’s short-term ratings.

KEY RATING CONSIDERATIONS
The ratings reflect BlueShore Financial’s distinctive franchise position as a provider of mid-market private banking services to an affluent west coast credit union customer segment. The Credit Union’s emphasis on branding and quality of service should enable it to defend and grow this market niche. Its strong growth in income before provisions and taxes (IBPT) and improving operating efficiency are also important rating considerations. DBRS would view a greater share of fee-based income positively. While credit quality has improved, the majority of loans are concentrated in real estate in the Greater Vancouver Area (GVA). This concentration is seen as a significant source of retail and wholesale credit risk. Funding sources are viewed as relatively stable and well aligned with the Credit Union’s lending activities; its liquidity position is appropriate. Capital buffers are strong and should be sufficient to absorb potential losses under a normal business environment.

RATING DRIVERS
Although unlikely over the intermediate term, ratings could be positively affected by a significant improvement in the proportion of fee-based income. In addition, higher revenue per member, which further solidifies BlueShore Financial’s top-tier position relative to its credit union peers, could also benefit ratings. Conversely, an inability to sustain membership growth or maintain the existing membership base could exert downward pressure on the ratings. A substantial increase in risk appetite, specifically with respect to unsecured consumer and construction lending or significant losses in the loan portfolio because of unforeseen weakness in the underwriting and/or risk management process could pressure ratings.

RATING RATIONALE
BlueShore Financial has positioned itself as a niche player within B.C.’s credit union industry as the provider of mid-market private banking financial services to its relatively affluent member base. This strategy has been driven by BlueShore Financial’s members, who require a credit union that provides traditional banking services along with personalized private banking, wealth management and financial planning services. DBRS considers that BlueShore Financial’s targeted strategy aimed at this niche segment is an important driver of its franchise strength. This strategy provides BlueShore Financial with a competitive position that is defensible. BlueShore Financial has also been increasing its market share of credit union loans and deposits in B.C. Over the last five years, this share had reached slightly over 5% as at 2017 for each category.

In DBRS’s assessment, BlueShore Financial generates good levels of IBPT that have grown at a relatively strong annual rate of 17.4% over the last five years. Adjusting for one-time items related to the sale of properties, net income grew by 54% in 2017 compared with 2016. This was due to significant expansion in the business franchise resulting in solid revenue growth, which, along with effective cost control, generated strong operating leverage and a sharp increase in net income. DBRS notes that over 80% of operating revenue is derived from spread income, which should benefit from an environment of moderate rises in interest rates. DBRS would view positively a higher share of fee-based revenues, particularly if driven by further diversification of revenue sources. In addition, DBRS notes that good cost control has resulted in an improvement in BlueShore Financial’s efficiency ratio. Also, provisioning expense has been rising due to growth in BlueShore Financial’s loan portfolio and also because of prudent management policy to strengthen loan loss reserves. DBRS views the increase in provisioning as manageable given the level of recurring earnings.

BlueShore Financial’s risk profile has improved over the last five years. During this period, its gross impaired loans ratio declined to 0.13% at F2017 and its net write-off ratio remained very low. BlueShore Financial’s provisioning levels have increased, particularly since 2016. Up until that point, BlueShore Financial had under-provided for potential losses relative to its credit union peers in B.C. The decision to bolster loan loss reserves has been prudent given a backdrop of sharp house prices increments in 2016 and risks associated with a market correction. Positively, BlueShore Financial has also made significant investments to upgrade systems underlying credit and operational risk analytics. An important risk mitigant is that 97% of BlueShore Financial’s loans are secured by real estate assets at low loan-to-value (LTV) ratios. Also, it has very low exposure to unsecured consumer credit. DBRS considers that a key risk facing BlueShore Financial is its relatively high exposure to commercial loans (including construction loans and a small amount of equipment leases). These loans comprised 35.3% of its loan portfolio in F2017, which is comparable with credit unions across Canada. These loans pose concentration risk and can lead to high levels of asset impairments during economic downcycles. BlueShore Financial is also exposed to a sharp and sustained correction in residential real estate prices in the GVA. To some degree, this downside risk is mitigated by the lower LTVs in its loan portfolio and the affluent nature of its membership. This affluence indicates the likelihood that members can draw on financial assets to meet debt servicing payments if their income flow is disrupted by an economic downturn.

DBRS notes that BlueShore Financial generates a majority (79%) of its funding from stable branch-based deposits. Demand deposits account for a smaller portion (20%) of the retail deposit base compared with its credit union peers. This lower proportion reflects the affluent nature of BlueShore Financial’s members that have significant excess resources that are placed in higher interest earning term deposits. In DBRS’s opinion, the termed structure of the deposit base enables BlueShore Financial to effectively manage its interest rate and liquidity risks. Positively, DBRS notes loan growth has been largely funded through deposits over the last five years. BlueShore Financial’s ratio of liquid assets to total assets of 11.6% in 2017 is below the level of its credit union peers. However, this ratio remains above regulatory minimums and DBRS views it as sufficient given the term structure of its funding and BlueShore Financial’s low risk balance sheet.

BlueShore Financial’s total capital ratio of 12.5% in 2017 is significantly above regulatory requirements and provides a solid cushion against adverse events. DBRS concludes that BlueShore Financial holds sufficient capital relative to its risk profile and that the quality of capital is also strong, with 83% of regulatory capital being Tier 1. As is the case with other credit unions, sources of new capital are restricted to internally generated equity and membership shares. Positively, DBRS notes that BlueShore Financial’s internal equity growth of 7.9% in 2017 supports its growing franchise.

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: Roger Lister, Managing Director and Chief Credit Officer Global FIG and Sovereign Ratings

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.