DBRS Morningstar Confirms Vancouver City Savings Credit Union at R-1 (low) With Stable Trends

DBRS Limited (DBRS Morningstar) confirmed Vancouver City Savings Credit Union’s (Vancity or the Credit Union) Short-Term Issuer Rating and Short-Term Instruments rating at R-1 (low) with Stable trends. The Credit Union has a Support Assessment of SA2 reflecting DBRS Morningstar’s expectation of timely systemic external support from the Province of British Columbia (B.C.; rated AA (high) with a Stable trend by DBRS Morningstar) through Central 1 Credit Union (rated A (high) with a Stable trend by DBRS Morningstar), particularly in the form of liquidity. The SA2 designation does not result in any uplift to the ratings.

KEY RATING CONSIDERATIONS
The ratings reflect Vancity’s solid franchise as the largest credit union in Canada by total assets and the second-largest by membership. The Credit Union’s footprint is predominantly in the Greater Vancouver Area (GVA), where it attracts a large and growing membership base. Furthermore, the ratings are supported by Vancity’s solid underwriting standards and strong asset quality as well as sound balance sheet fundamentals, including stable funding sources, high liquidity levels, and solid capital cushion. The ratings also consider Vancity’s modest profitability metrics, a high reliance on spread income, and a material exposure to commercial real estate, primarily in the GVA, which makes the Credit Union susceptible to a potential real estate market correction in DBRS Morningstar’s view.

RATING DRIVERS
Over the longer term, DBRS Morningstar would upgrade its ratings if Vancity is able to further strengthen its franchise through a sustained increase in members resulting in a material improvement in earnings, including a higher proportion of noninterest income and improved operating efficiency.

Alternatively, DBRS Morningstar would downgrade the ratings in the event of a material and sustained weakness in asset quality, especially from deficiencies in risk management. In addition, DBRS Morningstar would downgrade the ratings if the Credit Union were unable to control costs or experience a sustained reduction in internal capital generation.

RATING RATIONALE
Vancity maintains a solid franchise in the GVA through its offering of community-based banking services and ranks as the largest credit union in Canada with total assets of $28.6 billion as of May 31, 2023. Vancity provides banking services to about a quarter of the GVA’s population, which is a strong indicator of its competitive position within its geographical footprint. Over the past four years, the Credit Union’s membership base experienced an average growth rate of 1.3%, slightly lower than the average B.C. population growth. Furthermore, the Credit Union continues to solidify its franchise by deepening its product suite and strengthening its sustainability product niches while making investments in digital infrastructure.

Vancity generates adequate levels of recurring earnings. Its efficiency (cost-to-income) ratio is relatively high and profitability metrics remain below the average of its Canadian credit union peers. A modest 19% contribution from noninterest income, relative to total revenue, is viewed as a constraint on its ratings. Net income before distributions significantly declined to about $80 million in F2022 from $124 million in F2021 as a result of lower net interest income (NII) and rising provision for credit losses (PCL). Since Q3 2022, Vancity’s NII has been under pressure because of a sharp increase in interest rates, which have resulted in increased funding costs and margin compression. Net interest margin calculated by DBRS Morningstar reduced by 18 basis points (bps) year over year (YOY) to 1.77% in F2022. Reflecting an uncertain economic outlook, PCL stood at about $26 million in F2022 compared with a $20 million PCL recovery in the prior year. In DBRS Morningstar’s view, Vancity’s profitability is likely to remain under pressure in F2023, potentially starting to strengthen in F2024 as market conditions improve and loans reprice.

Vancity has historically generated some of the strongest asset quality metrics among its Canadian peers and continues to demonstrate sound risk management as illustrated by its history of low loan losses. With total loan growth of 5.9% in F2022, impaired loans remained low and manageable, forming 0.27% of gross loans, while net charge-offs stood at 4 bps of net loans for the same period. Nevertheless, as with other banking organizations, DBRS Morningstar expects Vancity's credit quality metrics to modestly deteriorate in 2023 amid economic challenges associated with higher interest rates and inflation. Furthermore, the Credit Union’s exposure to residential and commercial real estate, primarily in the GVA, could make Vancity susceptible to a potential real estate market correction.

Vancity’s funding remains good with prudent levels of liquidity. The Credit Union is funded largely through member-sourced deposits, which DBRS Morningstar views as stable. Customer deposits grew 7% YOY, reaching $24.5 billion in F2022. Reflecting higher market rates, term deposits grew about 25%, while demand deposits shrank by 9% as members locked in higher yields following a prolonged low-rate environment. As a result, term deposits represented 51% of total funding at the end of F2022 compared with 44% in the prior year. Together, demand and term deposits accounted for about 92% of total funding in F2022. Liquid assets, as calculated by DBRS Morningstar, marginally increased to 13.0% of total assets in F2022 compared with 12.5% in F2021.

Vancity’s capitalization is sound with a sufficient capital cushion to absorb losses in a stressed environment. Despite lower net earnings, the total capital ratio remained broadly stable at 14.1% in F2022, above the minimum regulatory requirement of 8%. The quality of the Credit Union’s capital is strong, with more than 91% of total capital composed of Tier 1 capital.

ENVIRONMENTAL, SOCIAL, GOVERNANCE (ESG) CONSIDERATIONS
Social Factors
DBRS Morningstar finds that the Social Impact of Products and Services ESG subfactor was relevant to the credit rating but does not affect the assigned ratings or trends. As a credit union, Vancity operates a membership-based community banking model where the social aspect of its activities strengthens its franchise. As a result, this factor is incorporated into the Credit Union’s Franchise Strength grid grades.

There were no Environmental/Governance factors that had a significant or relevant effect on the credit analysis.

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/396929 (May 17, 2022).

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

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (June 22, 2023; https://www.dbrsmorningstar.com/research/415978). In addition, DBRS Morningstar uses the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings, https://www.dbrsmorningstar.com/research/396929 (May 17, 2022), in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.

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 rating was initiated at the request of the rated entity.

The rated entity or its related entities did participate in the rating process for this rating action.

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

This is a solicited credit rating.

The conditions that lead to the assignment of a Negative or Positive trend are generally 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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