DBRS Morningstar Changes Trend on Central 1 Credit Union to Negative, Confirms Long-Term Ratings at A (high)

DBRS Limited (DBRS Morningstar) changed the trend on Central 1 Credit Union’s (Central 1) ratings to Negative from Stable. DBRS Morningstar also confirmed all of Central 1’s ratings, including its Long-Term Issuer Rating at A (high) and Short-Term Issuer Rating at R-1 (middle). DBRS Morningstar assigned Central 1 a Support Assessment of SA2 based on the likelihood of support from the provincial governments of British Columbia (B.C.; rated AA (high) with a Stable trend by DBRS Morningstar) and Ontario (rated AA (low) with a Stable trend by DBRS Morningstar). This results in a one-notch lift to Central 1’s Long-Term Issuer Rating from the Intrinsic Assessment (IA) of the B.C. and Ontario Credit Union Systems (the Systems).

KEY RATING CONSIDERATIONS
The ratings of Central 1 consider the fundamental strengths of the Systems, while the Negative trend reflects the impact from the Coronavirus Disease (COVID-19) on the earnings power, risk profile, and capital generation of the Systems. Central 1’s ratings reflect the IAs of “A” for the B.C. System and A (low) for the Ontario System. The ratings for the Systems also reflect the strong market shares of credit unions in B.C. and growing market shares for residential mortgages and deposits of credit unions in Ontario. Central 1 provides liquidity management, payment solutions, clearing, and settlement services to the B.C. System and to most of the Ontario System. These credit unions own Central 1 and account for it on a cost basis. The IAs of these two systems incorporate an analysis of the combined financials of the individual credit unions in each province.

RATING DRIVERS
Given the current environment, DBRS Morningstar views an upgrade of Central 1’s ratings as unlikely. The ratings would be downgraded as a result of a material deterioration in asset quality in either the B.C. System or Ontario System that significantly affects Central 1’s financial performance.

RATING RATIONALE
DBRS Morningstar expects the economic impact from the coronavirus pandemic to negatively affect both the B.C. and Ontario credit union systems, specifically regarding the Systems’ significant exposures to commercial real estate (CRE) loans and business loans. In DBRS Morningstar’s assessment, performance of these loans will come under substantial pressure, resulting in elevated levels of loan losses, should economic activity remain subdued for a prolonged period. Indicative of this pressure, provisioning for loan losses will likely increase. Although the Systems were in a relatively strong position heading into the pandemic, they face significant challenges in the ongoing economic deterioration.

In DBRS Morningstar’s view, the B.C. System continues to have a strong franchise with credit unions holding solid market shares in loans and deposits in B.C. The credit unions generate good levels of recurring earnings that are sufficient to readily absorb normal levels of loan losses. Although the B.C. System has generated strong asset quality metrics in the past, a significant proportion of loan balances have been placed under a payment deferral plans in recent months, indicating an increase in risk. DBRS Morningstar expects these payment holidays to expire toward the end of September and into October, at which point delinquencies could increase sharply. Furthermore, CRE and small business loans, which are particularly susceptible to weakness in the current environment, accounted for 29% of system loans at the end of F2019. Positively, the B.C. System has a sticky retail deposit base that benefits from a 100% provincial deposit guarantee and overall solid liquidity.

DBRS Morningstar considers the Ontario System franchise to be good, despite modest market shares in the province in key products. The Ontario System generates good levels of recurring earnings and improving profitability, yet remains challenged by the strong competition from the large Canadian banks. Rising risk is indicated by the significant proportion of the Ontario System’s loans that are under payment deferral plans. Also at risk in the current environment is the System’s exposure to CRE and small business loans, which represent 29% of System gross loans at the end of F2019. Funding is largely sourced through sticky retail deposits. While liquidity levels are lower than other Systems, they remains sufficient.

DBRS Morningstar considers Central 1’s financial fundamentals to be sound. Central 1 performs important functions for the credit unions, including helping them manage their liquidity, which is particularly useful in the current environment, as well as providing access to the national payment systems. Furthermore, Central 1 has access to the Bank of Canada’s (BOC) Standing Term Lending Facility (STLF), which Central 1 has drawn on a number of times. Under the STLF, Central 1 can access liquidity by placing National Housing Association Mortgage-Backed Securities with the BOC. Subsequently, Central 1 can enter into a repo agreement with individual credit unions to provide them with liquidity. Central 1 also has its own commercial paper program of up to $1 billion, which, in conjunction with access to BOC’s Commercial Paper Purchase Program, guarantees Central 1 access to short-term liquidity.

DBRS Morningstar views support from the provincial governments for Central 1 as likely. This view reflects the importance of the credit unions in each of these provinces. Central 1 plays an important role in serving the credit unions, which is evidenced particularly in B.C. where the provincial regulator, B.C. Financial Services Authority, named Central 1 as a Domestically Systemically Important Financial Institution within the Canadian credit union system. Accordingly, Central 1’s Support Assessment is designated as SA2. Furthermore, given DBRS Morningstar’s long-term ratings for B.C. and Ontario, the provinces are considered capable of providing such support, if needed.

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.

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

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (June 8, 2020) https://www.dbrsmorningstar.com/research/362170/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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