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

DBRS Limited (Morningstar DBRS) confirmed Credit Union Central of Saskatchewan’s (SaskCentral) Short-Term Issuer Rating and Short-Term Instruments rating at R-1 (low). The trend on all credit ratings is Stable. The credit ratings for SaskCentral reflect Morningstar DBRS’ Intrinsic Assessment of the Saskatchewan Credit Union System (the System) and a Support Assessment (SA) of SA2. This support designation reflects the expectation of timely systemic external support from the Province of Saskatchewan (Saskatchewan; rated AA (low) with a Stable trend), particularly given that SaskCentral has been designated as a Provincial Systemically Important Financial Institution.

KEY CREDIT RATING CONSIDERATIONS
SaskCentral’s credit ratings are driven by the strength of the System, which collectively owns SaskCentral. The credit ratings reflect the System’s important role in the Saskatchewan economy, particularly in rural communities and small towns, along with its competitive position based on long-standing relationships in the small business and farming communities and its significant share of provincial loans and deposits. Moreover, the System continues to benefit from stable funding sources and capital levels that provide an adequate buffer against potential future losses.

In a challenging operating environment, the System’s asset quality remains resilient, with manageable levels of write-offs. Nevertheless, the System has a focus on lending to small businesses, many of which are susceptible to a downturn in Saskatchewan’s economic performance. As a result, Morningstar DBRS expects that asset quality metrics may deteriorate from current levels as the economy weakens. Additionally, the high interest rate environment, persistent inflation, and drought conditions in Saskatchewan may negatively affect loan growth and provisions, posing a risk to profitability.

CREDIT RATING DRIVERS
Over the longer term, Morningstar DBRS would upgrade SaskCentral’s credit ratings if the System materially strengthens its franchise through a sustained increase in its membership base, resulting in improved profitability and operating efficiency.

Conversely, a material and sustained weakness in financial performance or a substantial deterioration in asset quality metrics that reduce the intrinsic strength of the System would lead to a credit ratings downgrade. Additionally, an increase in the overall risk of SaskCentral’s investment portfolio or a reduction in Morningstar DBRS’ assessment of the likelihood of provincial support for SaskCentral would also result in a credit ratings downgrade.

CREDIT RATING RATIONALE
Franchise Strength
Credit unions play an important role in the Saskatchewan economy, providing financial services to retail and small business and agricultural clients. An important driver of financial strength for the System is its long-standing relationships within the farming/small business communities, a segment underserved by Canada’s large banks. As at September 30, 2023, 41.5% of Saskatchewan’s population comprised members of a credit union. The System includes 32 credit unions and 193 service outlets (excluding Innovation Federal Credit Union, rated R-1 (low) with a Stable trend), particularly in small towns and rural areas. At the end of 2022, the System held 34% of deposits, 48% of commercial loans, and 24% of residential mortgage loans in Saskatchewan. Revenue per member for the Saskatchewan System has been considerably higher than other credit union systems in Canada, reflecting the Saskatchewan System’s stronger share of higher-yielding nonresidential lending.

Earnings Power
The System generates good levels of recurring earnings and top-tier profitability versus Canadian peers; however, a high operating cost structure and limited sources of fee-based income constrain the credit ratings. In the face of a challenging operating environment, profitability has somewhat deteriorated. After-tax earnings totaled $96 million for year-to-date Q3 2023 and return on average assets was 0.49%, lower compared with the prior year at 0.60%. Net interest margin was 2.27% as of Q3 2023 compared with 2.38% in the same period last year, as members took advantage of higher interest rates offered on deposits, resulting in higher funding costs and margin compression. While comparing favourably with other credit union systems in Canada, the System’s efficiency ratio remained relatively weak at 73.9% as of Q3 2023. Amid a challenging economic environment, Morningstar DBRS expects the System’s profitability may further weaken from current levels in F2024.

Risk Profile
The System’s credit risk metrics continue to trend downward despite higher interest rates and debt servicing costs, which are putting pressure on members’ cash flows. Period-end loan growth slowed to 3.8% as at Q3 2023 compared with 5.0% in the same prior year period. Delinquencies continued to trend downwards and were 0.69% as of Q3 2023, below the prior-year period (0.82%) and substantially lower than the five-year average. Delinquencies greater than 90 days became increasingly concentrated in the commercial sector (69%), with consumer and agricultural delinquencies comprising 23% and 8% of the total. Provisions for credit losses were 0.12% as a percentage of assets as of Q3 2023, a modest decline from the same period last year. Nevertheless, Morningstar DBRS expects consumer and commercial delinquencies to rise as member cash flows become tightened from persistent inflation and higher borrowing costs.

Funding and Liquidity
System funding is stable, supported by relatively sticky retail deposits from members with whom credit unions have long-standing banking relationships. In Morningstar DBRS’ opinion, the sources and uses of funds are well aligned and interest-rate risk is manageable. Deposit growth of 4.7% in Q3 2022 was higher than the prior year (3.3%); however, most of this growth occurred in the first three months and was concentrated in term deposit and registered accounts as members were looking to take advantage of higher interest rates. The liquidity coverage ratio remained strong at 222.4% in Q3 2023 compared with 210.7% in the prior year period. Although liquidity levels may decline in 2024 as a result of a reduction in savings/deposits, Morningstar DBRS expects levels to remain adequate and continue to meet regulatory expectations. High quality liquid assets comprised 38% of cash and investments as of Q3 2023. The System’s liquidity is managed by SaskCentral and remains solid, given the relatively low-risk business profile of credit unions.

Capitalization
Total System eligible capital, as a percentage of risk-weighted assets, was 16.52% at Q3 2023, up 144 basis points from the prior year and well above the five-year average. The notable increase in capital is mostly attributed to the one-time dividend from the proceeds of SaskCentral’s sale of Concentra Bank. Capital levels remain sufficient to cushion against downturns in business cycles and help absorb potential future losses. The quality of consolidated capital remains strong, with retained earnings comprising 95% of total eligible capital.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS

Social (S) Factors
Morningstar DBRS finds the social impact of products and services ESG factor is relevant to the credit rating but does not change the assigned ratings or trends. The credit union systems play an integral role in providing banking services to local communities and funding to small and medium-size businesses and underbanked areas. The credit union systems operate on a community banking model where the social aspect of their activities strengthens their franchises, without the requirement or need to maximize profitability. As a result, this factor is incorporated into SaskCentral’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 Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (July 4, 2023) https://dbrs.morningstar.com/research/416784/dbrs-morningstar-criteria:-approach-to-environmental,-social,-and-governance-risk-factors-in-credit-ratings.

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://dbrs.morningstar.com/research/415978/global-methodology-for-rating-banks-and-banking-organisations). In addition, Morningstar DBRS uses the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (July 4, 2023; https://dbrs.morningstar.com/research/416784/dbrs-morningstar-criteria:-approach-to-environmental,-social,-and-governance-risk-factors-in-credit-ratings) in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.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 dbrs.morningstar.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.

Morningstar DBRS 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. Morningstar DBRS’s outlooks and credit ratings are under regular surveillance.

For more information on this credit or on this industry, visit dbrs.morningstar.com.

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