DBRS Confirms Credit Union Central of Saskatchewan at R-1 (low), Stable Trend

DBRS Limited (DBRS) confirmed Credit Union Central of Saskatchewan’s (SaskCentral or the Credit Union) Short-Term ratings at R-1 (low) with Stable trends. The ratings for SaskCentral reflect DBRS’s Intrinsic Assessment (IA) of the Saskatchewan credit union system (the System), as well as a Support Assessment of SA2. This support designation reflects the expectation of timely systemic external support from the Province of Saskatchewan (rated AA with a Stable trend by DBRS), particularly given that SaskCentral has been designated as a Provincially Systemically Important Institution.

KEY RATING CONSIDERATIONS
DBRS considers the strength of the System to be an important driver in determining the ratings for SaskCentral. Solid growth in revenues per member, along with the System’s ability to generate strong recurring income, while maintaining manageable levels of provisioning and improving cost control, are also supportive of ratings. Although asset impairments on commercial real estate-backed loans remain elevated, DBRS views this as transitory and manageable. Furthermore, the ratings take into consideration the contingent risk associated with Concentra Bank (Concentra or the Bank; rated A (low) with a Stable trend by DBRS), to the extent that it undertakes riskier activities that are unrelated to serving the System, which could negatively impact ratings for SaskCentral.

RATING DRIVERS
Although unlikely over the intermediate term, positive ratings pressure could arise from a meaningful improvement in System membership growth, particularly within the younger demographic. Increased efficiency and a greater proportion of operating revenues being generated through fee-based income could also benefit the ratings. Conversely, negative ratings pressure could result from a reduction in the assessment of the likelihood of provincial support. Moreover, if the System’s franchise position weakened significantly or loan performance of the credit unions’ loan portfolios deteriorated, indicating greater inherent risk, the ratings could come under pressure. Furthermore, significant and sustained financial weakness at majority-owned Concentra Bank could negatively impact the ratings.

RATING RATIONALE
In confirming the ratings for SaskCentral, DBRS considers the continued solid performance of SaskCentral as the statutory liquidity manager for credit unions in Saskatchewan and a conduit through which the credit unions can access clearing and settlement, daily cash flow management and emergency liquidity support. As a central entity, SaskCentral also provides certain solutions to the System for regulatory compliance support. SaskCentral is collectively owned by the 40 credit unions in Saskatchewan.

Underpinning the ratings for SaskCentral is the performance of the provincial credit union system, which owns and supports SaskCentral. DBRS considers the System’s franchise position within the province to be well established, especially within the small business and farming segments. Credit union membership currently represents 41.1% of the provincial population, while at F2018, the System held 36.4% of provincial deposits, 23.3% of residential mortgages and 46.1% of commercial loans.

The System generates solid recurring earnings and its profitability metrics are top-tier compared to peers. Underlying this performance is a strong franchise in residential, commercial and agricultural lending in Saskatchewan. System net income before patronage increased a solid 25% year over year in F2018 to $173 million, largely due to an expanding net interest margin, which, together with good cost control, drove positive operating leverage. As a result, the System’s cost- to-income ratio improved substantially to 66.4% in F2018 compared to 70.3% in the prior year. Although loan loss provisions climbed again in F2018, at 21% of income before provisions and taxes, they remain manageable.

DBRS views the System’s asset quality as good, which generally reflects the secured nature of credit union lending to the retail, business and agricultural sectors. The System continues to see growth in loan impairments following the recessionary environment of 2016 and 2017, with gross impaired loans representing 1.10% of gross loans. Positively, net write-offs remain low given the mostly secured nature of the loan book. Also, DBRS notes that the regulatory framework in Saskatchewan is well aligned to that recommended by the Office of the Superintendent of Financial Institutions for Canada’s large banks.

In DBRS’s assessment, Concentra represents contingent risk for SaskCentral and the System given Concentra’s higher-risk activities, particularly its out-of-province commercial, Alt-A mortgage lending and consumer credit exposures. Furthermore, DBRS notes that Concentra’s risk appetite has increased relative to its position last year. Through SaskCentral, the System owns 84% of Concentra, and the System’s share of Concentra’s pre-tax income accounted for 22% of System pre-tax and patronage dividend income in F2018. Given the size of Concentra relative to the System, large losses at the Bank could affect SaskCentral’s equity, which could necessitate contributions from the System.

DBRS views the System’s funding profile as strong, given that the loan book is largely funded through relatively sticky insured deposits, which grew by 6.3% in F2018, slightly ahead of 5.4% loan growth. Also, DBRS views the System’s lending activities to be well aligned with its funding profile. Saskatchewan’s 100% provincial deposit insurance coverage for retail, commercial and institutional deposits contributes to the stickiness of these deposits and adds to the stability of the funding base for the System. Furthermore, interest rate risk remains acceptable and liquidity is solid.

DBRS considers the System to be well capitalized with a sufficient cushion to absorb higher credit losses resulting from a sustained economic downturn. Core capitalization was relatively stable in F2018, with the CET1 ratio increasing to 13.0% from 12.9% in the previous year. The quality of capital is strong, comprised largely of equity, representing member ownership and retained earnings. Furthermore, the System’s internal equity generation has been robust over the last three years and ahead of the System’s 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.

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

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