DBRS Morningstar Confirms Short-Term Credit Ratings of Conexus Credit Union 2006 at R-1 (low), Stable Trend

DBRS Limited (DBRS Morningstar) confirmed Conexus Credit Union 2006’s (Conexus or the Credit Union) Short-Term Issuer Rating and Short-Term Instruments rating at R-1 (low). The trend on all credit ratings is Stable. Conexus’ Support Assessment is SA2, which reflects DBRS Morningstar’s expectation of timely systemic external support from the Province of Saskatchewan (Saskatchewan or the Province; rated AA (low) with a Stable trend by DBRS Morningstar) through Credit Union Central of Saskatchewan (SaskCentral; rated R-1 (low) with a Stable trend by DBRS Morningstar), particularly in the form of liquidity. In addition, Conexus has been designated a Provincial Systemically Important Financial Institution (P-SIFI), which increases the likelihood that systemic external support would be forthcoming. At present, the SA2 designation does not result in any uplift for the credit ratings.

KEY CREDIT RATING CONSIDERATIONS
The credit rating confirmations and Stable trend reflect Conexus’ solid franchise within its operating area and the benefits of its membership in the well-established credit union system in Saskatchewan. Conexus generates sufficient earnings, including good levels of noninterest income. It also has a stable funding base, primarily composed of core member deposits, and liquidity and capital levels remain high. However, DBRS Morningstar notes the Credit Union is significantly exposed to commercial real estate (CRE) lending and automotive finance, which are sectors that can experience higher levels of delinquencies during periods of economic stress.

CREDIT RATING DRIVERS
Over the longer term, DBRS Morningstar would upgrade its credit ratings if the Credit Union is able to strengthen its franchise through a sustained increase in membership resulting in a material improvement in earnings, while maintaining a similar risk profile. Conversely, a material and sustained weakness in financial performance or a substantial deterioration in asset quality, especially from deficiencies in risk management, would lead to a credit ratings downgrade.

CREDIT RATING RATIONALE
Conexus is the second-largest credit union in the Province, with total assets of $6.9 billion as of June 30, 2023. The Credit Union provides a range of retail and business banking services to its members, who represent approximately 11.5% of Saskatchewan’s population, through 30 branches in its footprint area. Conexus has grown its membership base over the last five years, outpacing provincial population growth, with over 138,000 members at Q2 2023. However, loan growth has been challenging, with gross loans rising just 2 basis points (bps) in F2022 and declining in the previous two years. As a result, the Credit Union’s market share in the Province, particularly in commercial and agriculture loans, has seen modest declines in recent years.

Excluding a one-time $68.8 million dividend from SaskCentral’s sale of Concentra Bank (note all quoted earnings metrics are adjusted to exclude this dividend), Conexus’ net income attributable to members declined 34% year-over-year (YOY) to $22.4 million in F2022, driven by lower noninterest income and higher operating expenses, partially offset by lower provision for credit losses (PCL). Noninterest income decreased by 21% YOY in F2022, compared with a strong F2021 which saw large unrealized gains on investments, elevated prepayment penalty fees, and income from the Canada Emergency Wage Subsidy program. However, the Credit Union’s wealth management business continues to grow, and noninterest income comprised nearly 27% of total revenue, the highest among DBRS Morningstar-rated credit unions. Operating expenses increased 9% YOY, attributable to investments in technology and higher personnel, marketing, and credit card production costs. As a result, the efficiency ratio returned to a more normalized level of 76.1% in F2022, up from a strong 65.1% in the prior year. Net interest income was largely stable, declining less than 1% YOY, reflecting a slight 2-bp contraction in net interest margin. PCL fell 34% YOY in F2022 to $20.0 million, but still formed 40.1% of income before provisions and taxes, significantly higher than peers.

Conexus has significant exposures to higher-risk automotive finance and CRE lending. Accordingly, DBRS Morningstar notes asset quality metrics for the Credit Union are sensitive to concentration risk, particularly in the commercial segment where cyclical performance of Saskatchewan’s key industries can result in asset-quality deterioration. While gross impaired loans declined by 52 bps to 1.70% of gross loans in F2022, this improvement was largely driven by write-offs in the commercial nonmortgage portfolio and impairments remain materially higher than peers. Net write-offs, while still manageable, have been elevated in the past two years, forming 0.41% of average net loans in F2022 and 0.38% in F2021. Positively, both the consumer and agriculture portfolios have been resilient and impairments remained low. DBRS Morningstar expects Conexus’ credit quality metrics to somewhat deteriorate in F2023 amid economic challenges associated with higher interest rates and persistent inflation.

Conexus is largely funded through stable retail and business deposits, which comprised 93% of total funding in F2022. DBRS Morningstar views Conexus’ funding structure as well aligned with its lending activities. The stability of local deposits is supported by the unlimited deposit guarantee provided by the Credit Union Deposit Guarantee Corporation (CUDGC). The Credit Union also has access to wholesale funding in the form of brokered deposits (currently an immaterial amount outstanding) and securitized borrowings via the National Housing Act Mortgage Backed Securities (NHA MBS) program, the Canada Mortgage Bonds program, and auto loan securitizations. Beginning in F2022, Conexus began retaining certain amounts of its issued NHA MBS certificates for liquidity management purposes. In addition, Conexus has various sources of liquidity, including credit facilities with SaskCentral and Desjardins, and reported a solid liquidity coverage ratio of 162% in F2022, well above the regulatory minimum of 100%.

Conexus maintains good capitalization that is sufficient to absorb potentially higher levels of provisioning and loan losses. The CET1 capital ratio, which is based on Basel III requirements, improved 136 bps YOY to 16.1% in F2022, well above the regulatory requirement of 8.0%. In addition, the quality of Conexus’ capital is strong, with 97% of total capital composed of Tier 1 capital. As a P-SIFI, the Credit Union is subject to stronger oversight by CUDGC, which requires a 1% capital conservation buffer that DBRS Morningstar also views positively.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS

Social (S) Factors
DBRS Morningstar views the Social Impact of Products and Services ESG subfactor as relevant to the credit rating, but it does not affect the assigned ratings or trends. As a credit union, Conexus 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 factor(s) 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 (July 4, 2023) at https://www.dbrsmorningstar.com/research/416784.

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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