DBRS Morningstar Places Laurentian Bank of Canada’s Credit Ratings Under Review With Negative Implications

DBRS Limited (DBRS Morningstar) placed its credit ratings on Laurentian Bank of Canada (LBC or the Bank), including the Bank’s Long-Term Issuer Rating of A (low), Under Review with Negative Implications following a series of recent adverse developments, including the departures of LBC’s chief executive officer (CEO) and chair of the board as well as a mainframe outage that lasted several days before being resolved. The Bank’s Intrinsic Assessment of A (low) and Support Assessment (SA) of SA3 remain unchanged. The SA3 designation reflects no expectation of timely external support.

KEY CREDIT RATING CONSIDERATIONS
The Under Review with Negative Implications designation reflects DBRS Morningstar’s view that these adverse series of events in aggregate have weakened LBC’s franchise strength and future growth prospects, pressuring the credit ratings. LBC’s Personal Banking business, which has already had weaker earnings than its peers, has been under pressure with customer attrition, shrinking loans, and stagnant deposits in recent years. In DBRS Morningstar’s view, the mainframe outage that disrupted online access to retail and business accounts for four days could make it even more difficult for current management to turn around the important Personal Banking segment.

DBRS Morningstar’s review will assess the extent the rapid succession of executive departures and operational missteps have had on the Bank’s franchise and risk profile, along with the Bank’s ability to improve earnings and future prospects in light of the uncertainty of its strategic direction moving forward.

CREDIT RATING DRIVERS
Given the credit ratings are Under Review with Negative Implications, credit rating upgrades are unlikely. DBRS Morningstar would confirm the credit ratings with Stable trends if DBRS Morningstar views recent events as having no impact on LBC’s financial performance or franchise.

The credit ratings would be downgraded if DBRS Morningstar views the executive departures and operational risks exposed by the extended mainframe outage as negatively affecting the franchise and the Bank’s ability to produce sustained improvement in its financial performance. Increased pressures on funding and liquidity or additional operational missteps would also result in a credit rating downgrade.

CREDIT RATING RATIONALE
Franchise Combined Building Block (BB) Assessment: Good/Moderate

LBC is Canada’s eighth-largest Schedule I bank with assets of $50.6 billion as at July 31, 2023. The Bank offers retail services in Québec through its branch network as well as commercial lending across Canada and in the U.S. LBC also distributes financial products to brokers and financial advisors across Canada through its wholesale arm, B2B Bank. Over the past few years through 2022, LBC’s Personal Banking business faced customer attrition, shrinking loans, and stagnant deposits. Almost two years into the current strategic plan that was unveiled on December 10, 2021, the Bank has undertaken a digital-first approach and introduced new and enhanced digital capabilities to close gaps in its Personal Banking business, particularly across mortgage, Visa, and deposit products. On October 2, 2023, following the mainframe outage, the Bank announced the sudden and unexpected departure of its president and CEO, Rania Llewellyn, and the resignation of its board chair, Michael Mueller. With Éric Provost only recently being appointed as president and CEO, there remains limited visibility on LBC’s long-term strategic direction, although the Bank’s current focus is on improving operating efficiency and simplifying the organizational structure.

Earnings Combined Building Block (BB) Assessment: Good/Moderate
Relative to its peers, LBC has demonstrated lower profitability although it has a higher share of noninterest income at about 28% of total revenue for the first nine months of F2023. The Bank’s net income decreased by about 12.0% year over year (YOY) to $150.5 million for the first nine months of F2023 as a result of lower noninterest income and higher provision for credit losses and operating expenses. While a decrease in noninterest income was driven by reduced capital market revenue, noninterest expenses increased on higher salaries, employee benefits, and ongoing investments in technology. As a result, the operating efficiency ratio deteriorated to 70.4% for the first nine months of F2023 from 67.6% for the same period of 2022. Partly offsetting the downward pressure on net earnings, net interest income grew 2.5% YOY to $563.4 million for the first nine months of F2023; however, the net interest margin as calculated by DBRS Morningstar compressed by 7 basis points (bps) to 1.52%, primarily from higher funding costs.

Risk Combined Building Block (BB) Assessment: Good
Amounting to $37.0 billion as at Q3 2023, gross loans saw sluggish growth of about 1.2% YOY compared with 10.9% in the prior-year period. Lower non-mortgage personal loans partly offset an increase in residential mortgages and commercial loans. The bulk of credit risk lies in the commercial book, which accounted for about 48% of total loans as at Q3 2023 and has concentrations in commercial real estate and inventory financing. Overall, the Bank’s asset quality is good with low impairments and loan losses. The gross impaired loans ratio marginally increased by 11 bps YOY to 55 bps at the end of Q3 2023, largely because of increased impairments in commercial mortgages. As with the rest of the banking sector, DBRS Morningstar expects asset quality metrics to further deteriorate from their current levels in the short to intermediate term amid the challenging macroeconomic environment. Furthermore, if not managed prudently, the Bank’s continued realignment of the loan portfolio and geographic expansion, as well as deficiencies in IT capabilities and uncertainties around its new strategic direction, could expose LBC to heightened levels of operational and credit risk.

Funding and Liquidity Combined Building Block (BB) Assessment: Good/Moderate
Despite recent events, LBC’s overall funding and liquidity position has remained stable. Accounting for about 66% of the funding base, total deposits, including capital market deposits, declined by 3.0% year to date to $26.3 billion for the first nine months of F2023 and were in line with a reduction in the loan book. Personal deposits, which represented 85% of total deposits, marginally increased to $22.4 billion for the first nine of months of F2023 on the back of an uptick in direct retail deposits, which were partly offset by a decline in broker-sourced deposits. The Bank expects to attract more direct client deposits on a national level in the coming years, which DBRS Morningstar would view favourably over broker deposits. Liquidity levels, which include cash and Government of Canada securities, are sufficient to meet the Bank’s needs, with liquid assets forming 24% of total assets as at Q3 2023.

Capitalisation Combined Building Block (BB) Assessment: Good/Moderate
LBC’s capital ratios under the standardized approach are above regulatory minimums and provide adequate buffers to absorb stressed levels of loan losses. DBRS Morningstar would view favourably a larger capital buffer, sufficient to absorb significant losses, especially as the Bank undertakes an “accelerated evolution of its strategic plan” and continues to grow its commercial loan book, which may be more susceptible to weakness in the event of a sustained economic downturn. The CET1 capital ratio increased to 9.8% as at Q3 2023, compared with 9.1% as at Q3 2022, primarily reflecting lower risk-weighted assets as well as internal capital generation.

Further details on the Scorecard Indicators and Building Block Assessments can be found at https://www.dbrsmorningstar.com/research/422800/.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
Social (S) Factors
The Social factor is relevant to LBC’s credit ratings but did not affect the credit ratings or trends assigned to the Bank. LBC noted that a mainframe outage occurred during its planned IT maintenance update in late September 2023, which affected retail and business clients, who lost online access to accounts for four days. However, customer data and financial information remained secure. The potential occurrence of such incidents could lead to a failure of the Bank in delivering quality products and services, cause damage to clients, and expose the Bank to financial and legal liability. As a result, this factor is incorporated into LBC’s Risk Profile grid grades. This factor is new and was not present in the prior credit rating disclosure and reflects the significant and material developments following the previous credit review.

Governance (G) Factors
The Governance factor is significant to LBC’s credit ratings and could affect the credit ratings or trends assigned to the Bank. Almost two years into its current strategic plan, LBC announced the sudden and unexpected departure of its president and CEO, along with the resignation of the board chair, on October 2, 2023. Given the macroeconomic headwinds and significant executive turnover, operational challenges have amplified at the Bank, which, if not managed prudently, could result in reputational risk, customer attrition, loss of market share, and impaired financial performance. As a result, this factor is incorporated into LBC’s Franchise Strength grid grades. This factor is new and was not present in the prior credit rating disclosure and reflects the significant and material developments following the previous credit review.

There were no Environmental 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 (July 4, 2023; 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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