DBRS Morningstar Confirms Credit Union Central Alberta Limited’s Credit Ratings, Stable Trends

DBRS Limited (DBRS Morningstar) confirmed the credit ratings on Credit Union Central Alberta Limited (Alberta Central or the Credit Union), including the Credit Union’s Long-Term Issuer Rating at “A” and Short-Term Issuer Rating at R-1 (low). The trend on all credit ratings is Stable. The credit ratings are based on DBRS Morningstar’s Intrinsic Assessment of the Alberta Credit Union System (the System) and a Support Assessment (SA) of SA2, which reflects the expectation of timely systemic external support from the Province of Alberta (the Province; rated AA with a Stable trend by DBRS Morningstar). This results in a one-notch uplift to “A” from the System’s Intrinsic Assessment of A (low).

KEY CREDIT RATING CONSIDERATIONS
Alberta Central’s credit ratings reflect the System’s stable franchise in the deposit and loan markets in Alberta and the important economic role of credit unions in the Province, particularly in rural communities and small towns. The competitive landscape, however, remains challenging for credit unions in Alberta, although their membership grew last year following contraction in the preceding six years. In the challenging operating environment, the System’s asset quality remains resilient, exhibiting low and manageable levels of write-offs, although profitability has been negatively affected. Furthermore, stable funding sources and good levels of capitalization support the System’s credit resiliency. The credit ratings also reflect DBRS Morningstar’s expectation that profitability and credit quality metrics may modestly deteriorate from their current levels over the credit ratings horizon amid the challenging operating environment.

CREDIT RATING DRIVERS
Over the longer term, DBRS Morningstar would upgrade Alberta Central’s credit ratings if the System were able to strengthen its franchise through a sustained increase in its membership base and market shares, resulting in a material improvement in earnings, including a higher proportion of noninterest income and strong operating efficiency.

Conversely, a material and sustained weakness in financial performance or a substantial deterioration in asset quality metrics would lead to a credit ratings downgrade. A reduction in DBRS Morningstar’s assessment of the likelihood of provincial support would also result in a credit ratings downgrade.

CREDIT RATING RATIONALE
Franchise Combined Building Block (BB) Assessment: Good/Moderate
Credit unions in Alberta are important providers of retail and commercial banking services to the Province’s population, of which about 14% were members of a local credit union in F2022. The System’s franchise strength is driven by its capacity to serve its members through 13 credit unions that collectively serve 119 communities across Alberta, particularly in rural areas where Canada’s larger financial institutions have a limited presence. These credit unions collectively held on balance sheet assets of $32.7 billion as at Q3 2023 that grew 5.6% compared with the same period in F2022. The credit unions maintain stable shares in loan and deposit markets (about 9% in deposits, 7% in residential mortgages, and 8% in commercial loans) although they face strong competition from ATB Financial, the banking arm of the provincial government, as well as the large Canadian banks. Following the contracting trend over F2016–21, membership at the credit unions grew by 2.1% year over year (YOY) to about 623,000 in F2022 and by a further 2.6% for year-to-date 2023 (i.e., the first nine months of 2023 (9M 2023)) to about 639,000.

Earnings Combined Building Block (BB) Assessment: Good/Moderate
Amid the challenging economic backdrop, the System’s profitability has weakened since early F2022. Furthermore, a high operating cost structure and limited sources of fee-based income constrain the credit ratings. The System’s net income fell by 12.7% YOY to $125.3 million for 9M 2023 as a result of higher operating expenses and increased provision for credit losses (PCL). However, the System’s efficiency ratio remained relatively stable at about 72% for the same period. PCL increased to $52.7 million for 9M 2023 compared with $11.2 million for the same period of the prior year, largely driven by PCL in commercial and agriculture loans. Partly offsetting downward pressure on net earnings, operating revenue grew 7.0% YOY, supported by an increase in both net interest income and noninterest income. Nevertheless, net interest margin compressed by 10 basis points YOY to 2.33% in 9M 2023 because of rising funding costs, while the share of noninterest income remained low at 23.5% of total operating revenue.

Risk Combined Building Block (BB) Assessment: Good
Overall, the System’s loan book expanded 6.9% YOY to $28.2 billion as of Q3 2023, largely supported by a 13.1% increase in commercial loans and leases and a 2.3% growth in residential mortgages. The bulk of the System’s credit risk is in the commercial loans and leases portfolio, including real estate lending, which is highly sensitive to economic activity. Despite Alberta’s relatively volatile economy, the System’s overall asset quality remained resilient over past credit cycles with gross impaired loans averaging 0.47% of gross loans over F2012–22. In the challenging operating environment, loan delinquencies picked up during 2023 as reflected by a gross impaired loans ratio of 0.73% as at Q3 2023 compared with 0.33% for the same period in 2022. Commercial loans contributed most to impairments, with rising delinquencies across all loan categories. Nevertheless, the System’s net charge-offs were at low and manageable levels, supported by the collateral quality and generally good underwriting practices.

Funding and Liquidity Combined Building Block (BB) Assessment: Good
The System’s funding is good, reflecting the solid retail deposit franchises of the credit unions in Alberta and their low reliance on market-sensitive wholesale funding. The System’s total deposits grew 6.7% YOY to $27.5 billion as at Q3 2023, supported by rising term deposits, partly offset by a marginal decline in demand deposits. The System’s liquidity is represented by the credit unions’ deposits at Alberta Central, with the statutory component of these deposits placed in high-quality liquid assets. The System’s ratio of liquid assets to total assets declined to 11.9% in F2022 from 13.1% in F2021 and stood at 12.1% as at Q3 2023. This level is lower than its Canadian credit union system peers; however, DBRS Morningstar views liquidity levels as sufficient, given the low-risk business model of credit unions together with the existence of an unlimited deposit guarantee that is explicitly backed by the provincial government of Alberta.

Capitalization Combined Building Block (BB) Assessment: Good
The System’s capital position is among the strongest compared with other DBRS Morningstar-rated Canadian credit union systems. The System maintains capital buffers, sufficient for credit unions to absorb losses under stressed operating conditions. The capital ratio fell to 15.1% by the end of Q3 2023 from 16.1% in F2022 as a result of higher risk weighted assets, reflecting the credit unions’ stronger loan and asset growth. The quality of the System’s capital base is high, with the primary capital constituting more than 95% of total capital. However, DBRS Morningstar notes that sources of new capital are limited to capital generated internally and the issuance of subscription shares, which is a constraint on the ratings.

Further details on the Scorecard Indicators and Building Block Assessments can be found at https://www.dbrsmorningstar.com/research/424423.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
Environmental (E) Factors
There were no Environmental factors that had a relevant or significant effect on the credit analysis.

Social (S) Factors
DBRS Morningstar finds the social impact of products and services ESG factor is relevant to the credit rating but does not affect the assigned ratings or trends. The System plays an integral role in providing banking services to local communities and funding to small and medium-size businesses and underbanked areas. The System operates on a community banking model where the social aspect of their activities strengthens their franchises, without the pressure to maximize profitability. As a result, DBRS Morningstar incorporated this factor into Alberta Central’s Franchise Strength grid grades.

Governance (G) Factors
There were no Governance factors that had a relevant or significant 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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