DBRS Confirms Affinity Credit Union at R-1 (low) with Stable Trend

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

Additionally, DBRS assigned Affinity 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. Affinity has been designated a Provincial Systemically Important Financial Institution, 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 (Saskatchewan or the Province) Issuer Rating and Long-Term Debt rating at AA with Stable trends and its Short-Term Debt at R-1 (high) with a Stable trend.

KEY RATING CONSIDERATIONS
The ratings reflect Affinity’s prominent position in Saskatchewan, particularly in the city of Saskatoon, which is the largest city in Saskatchewan and the Province’s business hub. Furthermore, Affinity is the second-largest credit union in the Province by assets and the largest in terms of membership base and total deposits. Affinity benefits from relatively strong member growth, as well as improving operating efficiency through investments in its operational infrastructure and branch rationalizations. Overall, the balance sheet remains strong, with funding sourced mainly from core retail deposits, top-tier liquidity levels and solid capital cushion. The ratings also consider relatively large single-party exposures that represent some concentration risk in the commercial loan portfolio, particularly in an environment where Saskatchewan’s agricultural industry is experiencing some stress related to weather conditions and trade relations with China.

RATING DRIVERS
Although Affinity is well-placed in its rating category, sustained growth in membership, particularly in the younger demographic, along with significant improvements in market shares, could bring positive ratings pressure. A significant increase in the proportion of revenues from fee-based income could also benefit ratings. Conversely, a sustained loss of market shares in loans or deposits could pressure ratings. Losses in the loan portfolio because of deficiencies in risk management processes could also have a negative impact on ratings.

RATING RATIONALE
Affinity maintains a solid franchise across its core operational footprint in Saskatchewan. At the end of 2018, Affinity served 12% of the provincial population through 56 branches and advice centres concentrated in Saskatchewan’s largest city, Saskatoon, and in the southeast regions of Saskatchewan. Affinity’s captive market is Saskatoon, which is Saskatchewan’s business capital and Canada’s youngest city. While membership in the Saskatchewan credit union system has declined by about 9,500 over the last five years, DBRS notes that Affinity has added over 10,200 members during this timeframe.

Driven by a strong operating franchise, Affinity generates solid recurring earnings. Notably, Affinity had the highest ratio of non-interest income as a portion of operating revenues in 2018 relative to its provincial peers, which DBRS views positively. Overall, Affinity’s net income grew a very strong 43% year over year to $42 million in 2018. Even adjusting for one-off gains on certain venture capital investments and dividends from SaskCentral, growth in net income was still strong at approximately 26%. Furthermore, cost control remains solid, and the ratio of cost to income, adjusted for one-off gains, improved to 65% in 2018 from 70% in the prior year. Positively, DBRS notes that Affinity has generated positive operating leverage in each of the last five years.

Affinity has a good risk profile that is driven by its generally conservative underwriting policies and practices. DBRS notes that asset quality metrics for Affinity are sensitive to concentration risk, particularly in the commercial segment where cyclical performance of key industries (oil and gas, potash and agriculture) can result in temporary deterioration in asset quality. The sub-optimal performance of Saskatchewan’s economy has contributed to a difficult operating environment for small businesses, resulting in heightened levels of loan impairment for Affinity. Consequently, asset impairment has risen substantially over the last three years. The ratio of gross impaired loans to gross loans reached 1.9% in 2018 up from 1.7% in the prior year. Although, DBRS notes that the ratio of net write-offs to average net loans remains low, at 10.0 basis points in 2018, as the majority of loans are secured by real estate, guarantees or insurance contracts.

Affinity is funded largely through stable, member-sourced core retail deposits. The retail base is granular, and there is a limited reliance on less stable institutional deposits. DBRS assesses Affinity’s funding sources to be well aligned with its lending activities. Moreover, the funding profile benefits from having the lowest ratio of gross loans to deposits relative to other DBRS-rated credit unions in Canada. Overall, Affinity’s liquidity position remains robust and also compares favourably with peers. Consequently, given its strong liquidity position and access to committed lines of credit from major Canadian financial institutions, DBRS views Affinity as being well placed to withstand a stressed environment.

Affinity maintains sound capitalization that in DBRS’s opinion provides a capital cushion that should allow the Credit Union to absorb stressed levels of losses. Specifically, Affinity held $186 million in excess capital over and above its ICAAP requirements in 2018. This excess capital represented 10.0 times Affinity’s provisioning expense, providing it with a solid buffer to absorb potential losses. Furthermore, Affinity’s total capital ratio improved to 14.0% in 2018 from 13.7% in 2017. DBRS also notes that the quality of Affinity’s capital is strong, with 97% of total capital being composed of Tier 1 capital, and internal capital generation compares favourably with peers.

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

The applicable methodology is 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, Canadian Financial Institutions Group
Rating Committee Chair: Michael Driscoll, Managing Director, Head of NA FIG, Global 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