DBRS Confirms Concentra Bank at A (low)/R-1 (low), Stable Trends

DBRS Limited (DBRS) confirmed Concentra Bank’s (Concentra or the Bank) Long-Term Issuer Rating at A (low) and its Short-Term Issuer Rating at R-1 (low). All trends are Stable. Concentra’s Support Assessment of SA1 reflects the Credit Union Central of Saskatchewan’s (SaskCentral: rated R-1 (low) with a Stable trend by DBRS) willingness and ability to support Concentra, which is 84% owned by SaskCentral.

KEY RATING CONSIDERATIONS
In DBRS’s opinion, Concentra’s franchise strength lies primarily in its utility to the credit union system in Saskatchewan and more broadly to credit unions across Canada (except Québec). Over time, Concentra has developed expertise in mortgage securitization, syndication, wholesale financing and the provision of trust services. These are important services that credit unions utilize regularly. A shift in business mix away from providing core services and products to credit unions would be viewed negatively by DBRS. Concentra generates relatively stable recurring earnings driven by spread income and the majority of loans on its balance sheet are low-risk. However, increased exposure to Alt-A and consumer lending, along with continuing exposure to commercial lending, originated outside the credit union system is a concern. Moreover, these assets are being funded primarily through wholesale sources, which tend to be less stable and more expensive during times of stress.

RATING DRIVERS
Though unlikely over the intermediate term, positive rating pressure could arise as a result of positive developments in the ratings of SaskCentral. Conversely, a reduction in SaskCentral’s ratings would negatively impact Concentra’s ratings. A significant increase in Concentra’s risk profile due to greater exposure to higher risk assets at the Bank and its increased reliance on funding that is external to the System could also negatively impact ratings by increasing contingent risk for SaskCentral. Excessive reliance on activities that do not provide direct and meaningful benefits to credit unions could lead to a reduction in DBRS’s assessment of the willingness and ability of SaskCentral to support Concentra.

RATING RATIONALE
Concentra’s franchise position reflects its role in meeting certain wholesale banking and trust service needs of credit unions across Canada. Credit unions in Saskatchewan are required to hold statutory reserves with SaskCentral and typically hold additional liquidity on deposit with Concentra. Deposits from credit unions account for 12% of Concentra’s funding. Concentra is also active in purchasing loans from credit unions. Concentra is indirectly owned by credit unions in Saskatchewan through SaskCentral (84%) and credit unions in other provinces through their Centrals (16%). However, a shift in Concentra’s focus leading to a weakening of its link to the credit union industry would be viewed negatively by DBRS.

DBRS views Concentra’s recurring earnings as solid, but susceptible to some volatility through fair value adjustments in its investment book and occasional spikes in its provision for credit losses (PCL) related to commercial loan concentrations in energy- and resource-dependent provinces in Canada. While Concentra generates income before provisions and taxes that has been sufficient to cover PCLs, excessive reliance on riskier activities could limit the available cushion, while resulting in greater earnings volatility. Most recently, Concentra reported Q2 2018 net income of $8.8 million, an 18% quarter-over-quarter decrease due to an increase in non-recurring costs related to severance and consulting expenses, in addition to an increase in PCLs to $0.2 million versus a negative amount (resulting from write-backs) of $3.0 million in the prior quarter.

DBRS views Concentra’s asset quality as generally solid, but its risk appetite is increasing in some higher-risk segments. There was a broad-based recovery in asset quality in 2017, due to a general recovery in economic performance across Canada, leading to reduction in the ratio of gross impaired loans to gross loans declining to 18 basis points (bps) from 30 bps in the prior year. While loans are composed primarily of relatively low-risk real estate secured residential mortgages, predominantly funded through securitizations, Concentra is also exposed to uninsured Alt-A residential mortgages, commercial mortgage loans, consumer loans and commercial leases. Concentra purchases Alt-A mortgages from third parties, exposing it to potential weakness in third-party underwriting systems. Commercial loan exposure is concentrated in the Prairies (Alberta, Saskatchewan and Manitoba), while the Alt-A exposure is concentrated in Ontario. Although DBRS views Concentra’s underwriting practices and risk management policies as solid, a sustained weakness in economic performance across the Prairies or in Ontario could significantly impair asset quality for Concentra.

Concentra obtains the majority of its long-term funding through securitization of residential mortgages originated by third parties. Concentra intends to grow its longer-term funding through an increase in its sizeable broker-sourced deposits and the issuance of medium-term notes. In terms of aligning sources and uses of funds, DBRS notes that the vast majority of Concentra’s broker-sourced deposits mature within one year to three years and only a very small portion are redeemable on demand. Deposit flight risk is limited in the short term, though credit union overnight deposits, which comprise about 9% of total deposits, can be volatile. DBRS notes that despite Concentra’s reliance on wholesale funding, maturity mismatch is limited, and its liquidity is sufficiently strong to withstand normal levels of deposit outflows. At F2017 Concentra’s liquid assets-to-total assets ratio stood at 15%, compared with 17% in 2016.

DBRS considers Concentra to be well-capitalized with a cushion that is sufficient to absorb potential losses given its current asset mix. Even including 2016, when the Bank purchased a consumer lending portfolio that significantly increased its risk-weighted assets, Concentra’s total capital ratio (TCR) has averaged about 18% and its ratio of equity to assets has averaged 4.8% over the last five years. In F2017, Concentra’s TCR improved as it significantly reduced its risk-weighted assets by lowering its exposure to non-government securities in its investment portfolio. The ratio of equity to assets also improved to 5.0% in F2017 from 4.6% the prior year. More recently, increased commercial lending has also resulted in higher risk-weighted assets. As a result, the Bank’s TCR declined to 17.0% in Q2 2018 from 17.5% at F2017.

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 under Related Documents or by contacting us at info@dbrs.com.

The principal methodology is Global Methodology for Rating Banks and Banking Organisations (July 2018), 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.

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