DBRS Morningstar Confirms Coast Capital at BBB (high); Trend Stable

DBRS Limited (DBRS) confirmed the ratings of Coast Capital Savings Federal Credit Union (Coast Capital or the Credit Union), including the Credit Union’s Long-Term Issuer Rating of BBB (high) and Short-Term Issuer Rating of R-1 (low). The trend for all ratings is Stable. Coast Capital’s Support Assessment remains SA3 as the Credit Union is regulated by the Office of the Superintendent of Financial Institutions (OSFI) under the Bank Act. The Credit Union has the potential to access the Bank of Canada’s (BoC) Emergency Liquidity Assistance, subject to BoC terms and conditions at the time of any application request for funding. Consequently, the Credit Union’s short-term ratings now benefit from the exception granted to deposit-taking institutions on DBRS Morningstar’s short-term scale.

KEY RATING CONSIDERATIONS
The ratings reflect Coast Capital’s important franchise in its footprint area in the lower mainland of British Columbia (B.C. or the Province; rated AA (high) with a Stable trend by DBRS Morningstar). This position is bolstered by the importance of credit unions in the province, which count 39% of the provincial population as members (including Coast Capital members). Furthermore, the Credit Union successfully moved to a federal charter with little impact on its funding. On the other hand, the ratings also consider the concentration risk of operating primarily in the Greater Vancouver Area, which makes Coast Capital more susceptible to a potential real estate market correction. Moreover, DBRS Morningstar is also cautious that earnings and asset quality could face headwinds over the short term due to the abrupt and severe economic disruption caused by the Coronavirus Disease (COVID-19) pandemic.

RATING DRIVERS
Given the current economic environment an upgrade is unlikely at this time. Over the longer term, ratings could improve if the franchise strengthens further through a sustained increase in member share of wallet, an improvement in earnings through the growth of non-interest income, and/or improved efficiency.

Alternatively, material and sustained weakness in loan performance, which results in a significant increase in loan losses because of a potentially longer-than-expected adverse coronavirus-related impact, could lead to a ratings downgrade. In addition, an inability to control costs or a sustained reduction in internal capital generation could also have a negative impact on the ratings.

RATING RATIONALE
Coast Capital is the second-largest credit union in B.C., with $20.2 billion in assets as of YE2019. The Credit Union serves 30% of the Province’s credit union system membership base through both retail and small business commercial offerings. Coast Capital has 52 branches in its footprint area in addition to a growing digital presence. Moreover, the Credit Union has a national presence through its commercial leasing subsidiaries: Coast Capital Equipment Finance Ltd. and Travelers Finance Ltd. During its first year under the OSFI federal regime, Coast Capital continued to strengthen its digital capabilities as well as enhance its product offerings with the objective of deepening its relationships with existing members while attracting members outside its trade area in B.C. and nationally.

As the Credit Union earned higher yields on its growing book of assets in 2019, funding costs rose in tandem as Coast Capital shored up liquidity in anticipation of potential deposit outflows ahead of federal continuance. Owing to its value based type of accounts and relatively younger membership, Coast Capital has one of the lowest revenue per member ratios among credit unions at $717 for 2019. Meanwhile, the Credit Union’s expenditure continues to increase due to the costs of federal continuance and the ongoing technology investments to drive the strategic transformation and national growth. As a result, the efficiency ratio deteriorated to 85% in 2019 (excluding one-time gains from the redemption of Central 1 Class E shares) from 80% in 2018. Although Coast Capital now has access to prospective new members outside B.C., DBRS Morningstar is cautious that remote deposit acquisition might come at a higher cost than expected, given the highly competitive dynamics in an industry that includes the large banks, other online platforms, and local credit unions. Furthermore, DBRS Morningstar expects the Credit Union’s earnings to face some headwinds from the coronavirus-related economic deterioration that will affect many industries in B.C.

Coast Capital continued to grow its loan book, with residential mortgages up by 4% in 2019 to $11.5 billion while commercial loans, including equipment finance, increased by 9% to $5.1 billion. Although asset quality metrics remain strong with gross impaired loans at only 0.08% of gross loans, DBRS Morningstar remains cautious of Coast Capital’s commercial construction loans, which comprise 10% of its total portfolio, a proportion that is relatively high for credit union peers, especially in the event of a real estate market correction. Furthermore, DBRS Morningstar expects impaired loans to continue to trend upward as businesses remain closed and unemployment levels rise. The continued uncertainty about the duration of business closures will likely affect Coast Capital’s commercial portfolio that caters mainly to small- and medium-sized enterprises.

In its first year under federal continuance, Coast Capital managed to grow its deposit base by 2% in 2019 to $16.6 billion, despite transitioning to OSFI’s less generous deposit insurance. In addition, Coast Capital broadened its $2.2 billion in wholesale funding sources to include secured borrowing through the Canada Mortgage Bond program, deposit notes, short-term commercial paper, and subordinated debt. In addition, Coast Capital maintains healthy liquidity levels and, unlike provincial credit unions, has access to some of the BoC emergency liquidity programs instated to cope with the coronavirus pandemic, which DBRS Morningstar views positively.

Capitalization levels are good, in DBRS Morningstar’s view, as there is a sizable cushion over regulatory minimums to absorb potential losses. Coast Capital’s Common Equity Tier 1 stood at 11.5% in 2019, implying a capital cushion of $447 million over the minimum regulatory requirement. However, in DBRS Morningstar’s view, headwinds to earnings due to the coronavirus could potentially affect the Credit Union’s ability to generate sufficient capital to support balance sheet growth over the short term.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

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

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

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (June 11, 2019): https://www.dbrsmorningstar.com/research/346375/global-methodology-for-rating-banks-and-banking-organisations

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

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.dbrsmorningstar.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.

Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar’s outlooks and ratings are under regular surveillance.

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

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