DBRS Morningstar Confirms Laurentian Bank of Canada at A (low), Stable Trend

DBRS Limited (DBRS Morningstar) confirmed the ratings of Laurentian Bank of Canada (LBC or the Bank), including the Bank’s Long-Term Issuer Rating at A (low) and its Short-Term Issuer Rating at R-1 (low). The trend on all ratings is Stable. The Bank’s Intrinsic Assessment of A (low) and Support Assessment (SA) of SA3 are unchanged. The SA3 designation, which reflects no expectation of timely external support, results in the final rating being equivalent to the Intrinsic Assessment.

KEY RATING CONSIDERATIONS
The ratings and Stable trends reflect LBC’s solid regional retail franchise in Québec and its growing national reach through B2B Bank, its commercial Business Services segment, and most recently through its online platform LBC Digital. Furthermore, the ratings consider LBC’s history of low loan losses as the Bank implements its strategy of changing its asset mix to concentrate on key sectors while maintaining its risk appetite framework. The ratings also consider LBC’s relatively higher proportion of brokered deposits; its increasing, albeit temporary, operating expenses; as well as its weaker capital position relative to peers.

RATING DRIVERS
DBRS Morningstar views LBC as currently well placed within its rating category; however, a sustained improvement in earnings and operating efficiency, and the strengthening of capital buffers could positively affect ratings.

Conversely, material losses caused by operational difficulties as the Bank implements various organizational projects, or unexpected weakness in risk management processes, could lead to negative rating actions. In addition, an inability to improve earnings and efficiencies or a reduction in capitalization to levels closer to regulatory minimums could pressure the ratings.

RATING RATIONALE
LBC is Canada’s seventh-largest Schedule I bank with assets of $44.4 billion as at October 31, 2019. The Bank is well positioned in Québec with the third-largest branch network, offering retail services in the province together with commercial lending across Canada and in the United States (U.S.). LBC also distributes financial products to brokers and financial advisors across Canada through its wholesale arm, B2B Bank. In November 2019, the Bank launched an online platform under the LBC Digital brand to expand its direct to client reach nationally. Furthermore, the Bank has been refining its commercial portfolio mix over the last couple of years to focus more on certain sectors, including commercial real estate and equipment finance. This recalibration is expected to drive organic growth of higher-yielding assets both in Canada and the U.S. LBC also owns an integrated full-service institutional securities and investment banking firm, Laurentian Bank Securities, Inc., for which it has recently hired a new chief executive officer to further drive and grow the business.

In March 2019, the Bank successfully negotiated a new collective agreement with its unionized employees in Québec. Additionally, there was a change in the composition of the collective bargaining unit to cover mostly Québec-based retail front-line positions. These changes will now allow the Bank to optimize some of its back-office functions and to outsource certain tasks. The Bank’s subsidiary, LBC Tech, will aggregate and streamline many of the Bank’s systems, applications, and functions.

LBC’s earnings declined by 25% year over year (YOY) to $160 million as the Bank controlled growth on the retail and B2B Bank fronts in favour of holding more liquidity during the collective agreement negotiations, as well as completing the merger and transformation of all its branches to advice only centres called Financial Clinics. DBRS Morningstar notes that, as a result of the aforementioned and the Bank’s various transformation initiatives, LBC’s efficiency ratio deteriorated to 75.0% in F2019 from 68.7% in F2018 and remains one of the weakest ratios among peers. Management expects operating efficiency to improve over the next three years as it begins phasing out older systems and as the Bank begins to benefit from other investments in the franchise.

The Bank continues to demonstrate a solid track record of strong asset quality, resulting in low impairments and loan losses. At $16 billion in FY2019, residential mortgages made up 48% of LBC’s loan portfolio, with 42% of these loans underwritten in Québec, where housing prices have kept pace with inflation over the last few years. Nevertheless, in DBRS Morningstar’s opinion, the Bank’s more recent realignment of the loan portfolio and its geographic expansion exposes LBC to heightened levels of operational and credit risk.

LBC has maintained its strong branch-raised deposit base, despite branch rationalization over the last few years. In addition, the launch of LBC Digital should attract more direct deposits on a national level, which DBRS Morningstar views positively. On the other hand, broker-sourced deposits through B2B Bank form half of the Bank’s $26 billion total deposits as at October 31, 2019. In DBRS Morningstar’s view, although mostly non-redeemable term, these deposits are more rate sensitive and thus a more volatile source of funds; however, the Bank is looking at various programs to enhance its funding profile to balance out its reliance on broker deposits. Liquidity levels are good with sufficient unencumbered assets to cover LBC’s needs.

The Bank’s FY2019 CET1 ratio was unchanged YOY at 9.0%. In DBRS Morningstar’s opinion, LBC’s capital ratios remain close to regulatory minimums which leaves a limited buffer to absorb significant losses. Moreover, as the Bank grows its commercial loan book, the probability of incurring larger losses in the event of a sustained economic downturn increases. Nevertheless, capitalization ratios are expected to improve as LBC switches to an advanced internal rating-based model in FY2022.

The Grid Summary Grades for Laurentian are as follows: Franchise Strength – Strong/Good; Earnings Power –Good; Risk Profile – Good; Funding & Liquidity – Strong/Good; and Capitalisation – Good/Moderate.

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 Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

DBRS Morningstar will publish a full report shortly that will provide additional analytical detail on this rating action. If you are interested in receiving this report, contact us at [email protected].

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

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