DBRS Morningstar Confirms Laurentian Bank of Canada at A (low), Changes Trends to Negative

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). DBRS Morningstar changed the trends for all long-term ratings to Negative from Stable. All short-term ratings have a Stable trend. 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 Negative trend reflects the wide and growing scale of the economic disruption resulting from the Coronavirus Disease (COVID-19) pandemic, which pressured LBC’s Q2 2020 earnings and will negatively affect earnings and asset quality in future quarters. Nevertheless, unprecedented support measures have been put in place through monetary and fiscal stimuli, which in DBRS Morningstar’s view, could help to mitigate some of the negative impact of the crisis. However, should the crisis be prolonged, or if the recovery is muted, additional ratings pressure may occur.

The rating confirmations reflect LBC’s solid regional retail franchise in Québec and its growing national reach through B2B Bank, its commercial Business Services segment, and its online platform LBC Digital. Furthermore, the ratings are supported by LBC’s conservative credit culture and sound balance sheet fundamentals. 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
Given the Negative trend, an upgrade is unlikely. The trend would revert to Stable if the economic fallout from the coronavirus pandemic is not prolonged and outsized credit losses do not materialize.

Conversely, a material deterioration in loan performance, which results in a significant increase in loan losses because of longer-than-expected adverse coronavirus-related impacts, would lead to a ratings downgrade. Additionally, a reduction in capitalization to levels closer to regulatory minimums would pressure the ratings.

RATING RATIONALE
LBC is Canada’s seventh-largest Schedule I bank with assets of $45 billion as at April 30, 2020. The Bank is well positioned in Québec with the third-largest branch network, offering retail services in the province as well as commercial lending across Canada and in the 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.

LBC’s earnings were affected from significantly higher provisions for credit losses (PCL) because of the economic impact of the coronavirus pandemic. As a result, the Bank reported Q2 2020 net income of $8.9 million, a year-over-year decline of 79% as it took provisions of $54.9 million, which was a significantly higher amount than the $9.2 million PCL recorded in Q2 2019. The majority of the increase comprised PCL on performing loans reflecting changes in forward-looking macroeconomic indicators relating to the impact of the pandemic; however, LBC's income before provisions and taxes remained flat from the previous year at $56 million in Q2 2020. DBRS Morningstar notes that, as a result of the Bank’s various transformation initiatives, LBC’s efficiency ratio remains one of the weakest among peers at 76% for Q2 2020. 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 entered the current downturn with a solid track record of strong asset quality, resulting in low impairments and loan losses. At $16 billion as of April 30, 2020, residential mortgages made up 47% of LBC’s loan portfolio, with 41% 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 toward commercial loans and its geographic expansion exposes LBC to heightened levels of credit risk. As of April 30, 2020, the Bank granted $109 million in deferred payments on $4.4 billion of loans. The outstanding balance on these deferred loans represents 13.3% of the total loan portfolio. Meanwhile, gross impaired loans-to-gross loans rose to 0.7% in Q2 2020 from 0.6% in Q2 2019 largely because of increased impaired loans in the commercial portfolio. DBRS Morningstar expects impaired loans to trend upward as a result of the continued uncertainty about the duration of business closures and heightened unemployment levels.

DBRS Morningstar views LBC’s funding and liquidity positions as stable, especially given the Bank’s access to the various government liquidity programs. LBC maintains a strong branch-raised deposit base in Québec and has attracted direct deposits on a national level through LBC Digital. On the other hand, broker-sourced deposits through B2B Bank formed 47% of the Bank’s $25 billion of total deposits as at April 30, 2020. In DBRS Morningstar’s view, although mostly on nonredeemable terms, these deposits are more rate sensitive and thus a more volatile source of funds. Nonetheless, the Bank is not experiencing funding pressures in this channel, or in any other channel, despite the coronavirus pandemic. Furthermore, LBC supplemented its funding by accessing several of the Bank of Canada's liquidity facilities, including the Term Repo facility and the Bankers' Acceptance Purchase Facility. The Bank also conducted a test drawdown of the new Standing Term Liquidity Facility.

The Bank reported a CET1 ratio of 8.8% as of April 30, 2020. In addition, the Bank reduced its quarterly dividend by 40% to $0.40 per common share and announced its intention to delay the implementation of the advanced internal rating-based approach to at least 2023. In DBRS Morningstar’s opinion, although capitalization levels are above regulatory requirements, pressures on profitability and a potential increase in credit losses could affect the Bank’s ability to maintain capital at current levels.

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 Laurentian are as follows: Franchise Strength – Strong/Good; Earnings Power –Good; Risk Profile – Good; Funding & Liquidity – Strong/Good; and Capitalization – Good/Moderate.

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

The principal methodology is 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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