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

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

KEY RATING CONSIDERATIONS
SaskCentral’s ratings are driven by the strength of the System, which collectively owns SaskCentral. Although System performance was relatively good, despite the difficult operating environment, DBRS Morningstar notes that credit performance remains under stress. Small and medium sized enterprises (SMEs), which are most affected by the decline in economic activity as a consequence of the Coronavirus Disease (COVID-19) pandemic, accounted for about 30% of the System’s gross loans at the end of F2020, with significant single-party exposures. A key uncertainty that remains is the extent to which SMEs will recover following the removal of the extraordinary support provided by the federal government in the absence of Saskatchewan’s economy returning to pre-pandemic economic potential. Furthermore, Concentra Bank (Concentra) represents a contingent risk to the System through SaskCentral, and as at December 31, 2020, Concentra’s total assets represented 42% of System assets. As such, a material deterioration in Concentra’s financial performance or liquidity position could have a negative impact on the System.

RATING DRIVERS
Although unlikely over the intermediate term, a ratings upgrade would result following a meaningful improvement in System membership growth, particularly within the younger demographic. Increased efficiency and a greater proportion of operating revenues generated through fee-based income would also lead to a ratings upgrade.

Ratings would be downgraded as a result of a reduction in the assessment of the likelihood of provincial support. A material and sustained weakness in System loan performance that leads to a significant increase in loan losses, resulting from a longer than expected recovery following the adverse impact of the coronavirus, would lead to a downgrade. Significant and sustained financial weakness at majority-owned Concentra would also result in a downgrade of ratings.

RATING RATIONALE
SaskCentral is solely responsible for managing mandatory statutory liquidity deposits on behalf of credit unions in Saskatchewan. SaskCentral also provides consulting and ancillary services to credit unions in Saskatchewan. The System’s franchise strength is driven by its strong competitive position in SME lending and a considerable retail banking presence. DBRS Morningstar recognizes that the System generates good levels of recurring earnings and top-tier profitability versus Canadian peers; however, a high operating cost structure and limited sources of fee-based income constrains the ratings. Furthermore, earnings have been under pressure. In F2020, System net income declined by 14% to $112 million due to higher provisioning expenses and a low interest rate environment.

System asset quality metrics were relatively stable in F2020 despite a sharp reduction in economic activity resulting from the pandemic. However, System loans remain susceptible to weakness in the current operating environment. Furthermore, credit union loan books have significant single-party exposure, which enhances credit risk for the System. System funding is sourced largely through core retail deposits. In DBRS Morningstar’s opinion, sources and uses of funds are well aligned and interest rate risk is manageable. Furthermore, System liquidity improved in F2020, driven by organic deposit growth, and remains solid, ranking top tier relative to Credit Union’s Canadian peers. The capital cushion for the System is sufficient to absorb normal levels of losses while overall capitalization remains solid, improving in F2020 to 14.9% from 14.3% in the prior year. Furthermore, internal equity generation has been consistently strong.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

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

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (July 08, 2020; https://www.dbrsmorningstar.com/research/362170). Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (February 03, 2021; https://www.dbrsmorningstar.com/research/373262).

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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