DBRS Confirms Ratings of Conexus Credit Union at R-1 (low), Stable Trends

DBRS Limited (DBRS) confirmed Conexus Credit Union 2006 (Conexus or the Credit Union)’s Short-Term Issuer Rating and Short-Term Instruments at R-1 (low). All trends remain Stable.

Additionally, DBRS assigned Conexus a Support Assessment (SA) of SA2, which reflects DBRS’s expectation of timely systemic external support from the provincial government through the Credit Union Central of Saskatchewan (SaskCentral), particularly in the form of liquidity, which is reflected in the Credit Union’s short-term ratings. Conexus has been designated a Provincial Systemically Important Financial Institution (P-SIFI), which also increases the likelihood that systemic external support would be forthcoming. DBRS currently rates SaskCentral’s Short-Term Instruments at R-1 (low) with a Stable trend. DBRS also rates the Province of Saskatchewan’s (the Province) Issuer Rating and Long-Term Debt rating at AA with Stable trends and its Short-Term Debt rating at R-1 (high) with a Stable trend.

KEY RATING CONSIDERATIONS
The ratings reflect Conexus’ solid retail and small business banking franchise, particularly in the city of Regina and in smaller towns across the Province. Conexus is the largest member-owned financial institution by assets in the Province and the fifth-largest provincially regulated credit union in Canada. Furthermore, Conexus continues to enhance its franchise through technology investments while remaining disciplined in regard to cost management. The ratings also consider the Credit Union’s ability to generate relatively stable recurring earnings with profitability metrics that compare favorably with those of its peers. Conversely, DBRS notes that Conexus’ loan portfolio has higher exposures to commercial and agricultural loans than other credit unions outside of the Province, which tend to be less granular and may 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 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 is the largest credit union in the Province by total assets, providing banking services to its members, who represent approximately 11% of the province’s population. The Credit Union’s distribution network includes 39 branches and 14 mobile mortgage specialists. Credit unions are well recognized in the Province for their history of serving the farming and small-business communities. In 2018, the Province’s credit unions held 36% of provincial deposits, with 41% of the provincial population being a member of a credit union. Over the last five years, Conexus has gained almost 13,000 net new members, which is in contrast to the 9,500 members lost by the Province’s credit union system during that same period. DBRS views this positively and considers membership growth as an important driver of franchise strength for Conexus. Furthermore, Conexus has been able to attract and retain younger members, particularly since it introduced a no-fee retail account.

In DBRS’s assessment, Conexus generates solid profitability and recurring earnings that can cover heightened levels of provisioning expenses. Conexus generates about 75% of its operating revenues through spread income, which is reflective of the Credit Union’s business model but exposes Conexus to interest rate volatility. In F2018, net income increased by 27% year over year (YOY), driven by solid improvement in its net interest margin (NIM), which was up by 20 basis points (bps) to 2.69%. Loan growth of 6.8% YOY also contributed to higher earnings in F2018. DBRS notes that spread compression across the yield curve in Canada could put some pressure on the NIM in F2019, although this should be manageable for Conexus given that it has operated profitably at a significantly lower NIM.

Although Conexus exhibits a good risk profile, it has significant exposures to higher-risk commercial, unsecured consumer and agricultural lending. Although Conexus maintains robust underwriting guidelines, some of its loan exposures, specifically those related to commercial real estate and construction loans that were underwritten at the height of the recent oil-price boom, continue to underperform in an economy that is operating below optimal capacity. This, along with a transition to International Financial Reporting Standards 9 and the acquisition of its credit card portfolio, resulted in the ratio of gross impaired loans to gross loans deteriorating by 64 bps to 1.7% in F2018. Conversely, net write-offs remain low and manageable, given that almost 80% of the loan book is secured either through real estate or government guarantees.

Conexus is largely funded through stable retail and business deposits, which contributed 84% of funding in F2018. DBRS views this positively and notes that the Credit Union’s lending activities are relatively well-aligned with its funding sources. The stability of local deposits is supported by the unlimited deposit guarantee provided by the Credit Union Deposit Guarantee Corporation (CUDGC). The ratio of liquid assets to total assets improved to 13.2% in F2018 (compared with 12.7% in the prior year) largely because of solid growth in deposits. In DBRS’s view, Conexus holds an appropriate amount of liquidity given its low-risk business model, a stable deposit base and ready access to multiple lines of credit from highly rated financial institutions.

Conexus maintains good capitalization that is sufficient to absorb potentially higher levels of provisioning and loan losses over the normal course of business. The CET 1 capital ratio declined marginally to 12.4% in F2018 from 12.9% in the prior year, mainly because of an 11% increase in risk-weighted assets following the inclusion of the credit card receivables and growth in the commercial and agricultural loan books. Positively, internal equity generation was solid at 8.8% in F2018 and the ratio of total equity to assets was 8.0%, both top tier compared with DBRS-rated Canadian peers. Furthermore, as a P-SIFI, Conexus is subject to stronger oversight by CUDGC and needs to establish a 1% conservation buffer, which DBRS also view positively.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The applicable methodology is the Global Methodology for Rating Banks and Banking Organisations (June 2019), which can be found on our website under Methodologies & Criteria.

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 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.

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

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

DBRS Limited
DBRS Tower, 181 University Avenue, Suite 700
Toronto, ON M5H 3M7 Canada