DBRS Morningstar Confirms Long-Term Issuer Rating on First West Credit Union at BBB (high) With a Stable Trend

DBRS Limited (DBRS Morningstar) confirmed its credit ratings on First West Credit Union (First West or the Credit Union), including the Credit Union’s Long-Term Issuer Rating at BBB (high) and its Short-Term Issuer Rating at R-1 (low). The trend on all credit ratings is Stable. The Support Assessment (SA) for First West is SA2, which reflects DBRS Morningstar’s expectation of timely systemic external support from the Province of British Columbia (BC or the Province; rated AA (high) with a Stable trend by DBRS Morningstar) through Central 1 Credit Union (Central 1; rated A (high) with a Stable trend by DBRS Morningstar), particularly in the form of liquidity. The SA2 designation does not result in an uplift to First West’s ratings.

KEY CREDIT RATING CONSIDERATIONS
The credit rating confirmations recognize First West’s position as the third-largest credit union in the Province and the fifth-largest credit union in Canada. Furthermore, the credit ratings are supported by the Credit Union’s strong asset quality and sound balance sheet fundamentals, including stable funding sources and solid liquidity and capital positions. The credit ratings also consider First West’s weakened profitability amid the challenging economic environment. However, the Credit Union generates recurring earnings that are underpinned by a higher contribution from noninterest income relative to its credit union peers, as well as above-average revenue per member.

While asset quality remains sound with credit metrics at relatively low and manageable levels, First West has a larger commercial mortgage and construction and development lending portfolio relative to its credit union peers. DBRS Morningstar considers these exposures to be susceptible to a potential housing downturn, given that all mortgages are originated in BC, which has experienced dynamic growth in the real estate market. While the Credit Union’s residential mortgage lending is not focused on the City of Vancouver proper, the extensive price appreciation seen in this market has pressured neighbouring markets that are within First West’s footprint.

CREDIT RATING DRIVERS
Over the longer term, DBRS Morningstar would upgrade its credit ratings if the Credit Union is able to further strengthen its franchise through a sustained increase in membership resulting in a material improvement in earnings, while maintaining a conservative risk profile.

Alternatively, DBRS Morningstar would downgrade its credit ratings in the event of a material and sustained weakness in financial performance or a sustained deterioration in asset quality, especially from deficiencies in risk management resulting in a significant increase in loan losses

CREDIT RATING RATIONALE
Franchise Combined Building Block (BB) Assessment: Moderate
With about $17.4 billion in total assets and assets under administration as at December 31, 2022, First West has a well-established position, with strong market shares in deposits and loans in BC’s Lower Mainland, Okanagan, and Vancouver Island regions. First West operates through four community-based brand identities, which also contributes to its successful product diversification. The Credit Union’s membership grew by a modest 0.9% in F2022 to nearly 254,000 members, supported by net membership growth in both the retail banking and commercial business. Meanwhile, First West continues to work toward becoming a federal credit union.

Earnings Combined Building Block (BB) Assessment: Moderate/Weak
Amid the challenging economic environment, First West’s profitability has somewhat weakened since early 2022. Nevertheless, the Credit Union has a higher contribution from fee-based products than its credit union peers, which reflects its comprehensive suite of banking and wealth management products. In F2022, net income contracted about 44.7% year over year (YOY) to $37.0 million, primarily because of lower noninterest income, higher operating expenses, and increased provision for credit losses. Noninterest income decreased by 21.0% YOY in F2022 as a result of lower investment revenue and reduced loan administration fees including prepayment penalty fees, which were elevated in F2021. Meanwhile, noninterest expenses increased by 5.7% YOY during the same period, associated with continued investments in key projects and higher staffing expenses. As a result, the operating efficiency ratio deteriorated to about 85% in F2022 from 77% in the prior year. Partially offsetting the downward pressure on overall earnings, net interest income increased by 4.4% YOY in F2022, supporting a relatively stable net interest margin at 1.93%.

Risk Combined Building Block (BB) Assessment: Good
Overall, asset quality at First West is good, reflecting the Credit Union’s conservative risk profile and solid track record of credit performance. Gross impaired loans as a percentage of gross loans remained broadly stable at 0.11% in F2022, while net write-offs as a percentage of average gross loans, as calculated by DBRS Morningstar, stood at 2 basis points (bps) for the same period compared with 12 bps in F2021. Nevertheless, as with other banking organizations, DBRS Morningstar expects First West's credit quality metrics to deteriorate in F2023 amid a challenging economic backdrop with higher interest rates and persistent inflation. Furthermore, the Credit Union has a large commercial mortgage and construction and development lending portfolio when compared with its credit union peers, which DBRS Morningstar views as higher-risk, particularly in the event of a real estate market downturn.

Funding and Liquidity Combined Building Block (BB) Assessment: Strong/Good
The majority of First West's funding is provided through branch-raised deposits, with core member deposits representing 87% of the $11.4 billion total deposits in F2022. DBRS Morningstar observes that First West’s deposit base remains stable, while being cautious that the Credit Union could face some outflows as a 100% deposit guarantee reduces with the move to a federal charter. First West also participates in securitizations through the Canada Mortgage Bonds Program. The Credit Union’s liquidity position is strong, benefitting from access to liquidity through its lines of credit with Central 1, as well as from the major Canadian banks. As calculated by DBRS Morningstar, the liquidity ratio of 12.7% in F2022 normalized toward historical levels from an all-time high of 19.6% in F2020, as deposit growth has slowed and loan growth has remained strong since F2021.

Capitalisation Combined Building Block (BB) Assessment: Good/Moderate
DBRS Morningstar views First West’s capitalization as good, with the Credit Union holding capital buffers above regulatory minimums. In F2022, the total capital ratio was 13.8%, down 77 bps YOY. Despite increased total capital, the reduction in capitalization reflects higher risk-weighted assets associated with growth in commercial loans. Nevertheless, First West’s capital position remains sound and compares favourably with the regulatory minimum of 8.0% of total risk-weighted assets and the supervisory level of 10.0%. In addition, capital is largely composed of members’ equity and retained earnings.

Further details on the Scorecard Indicators and Building Block Assessments can be found at https://www.dbrsmorningstar.com/research/420917

ENVIRONMENTAL, SOCIAL, GOVERNANCE (ESG) CONSIDERATIONS

Social (S) Factors
DBRS Morningstar finds that the Social Impact of Products and Services ESG subfactor is relevant to the credit ratings but does not affect the assigned credit ratings or trends. As a credit union, First West 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 or 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/416784 (July 4, 2023).

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/416784) 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 credit rating was initiated at the request of the rated entity.

The rated entity or its related entities did participate in the credit rating process for this credit 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 credit 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 credit ratings are under regular surveillance.

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

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