Morningstar DBRS Confirms Vancouver City Savings Credit Union Short-Term Credit Ratings at R-1 (low) With Negative Trends

DBRS Limited (Morningstar DBRS) confirmed Vancouver City Savings Credit Union's (Vancity or the Credit Union) Short-Term Issuer Rating and Short-Term Instruments credit ratings at R-1(low) with Negative trends. The Credit Union has a Support Assessment of SA2, reflecting Morningstar DBRS' expectation of timely systemic external support from the Province of British Columbia (B.C.; rated AA (high) with a Stable trend) through Central 1 Credit Union (rated A (high) with a Stable trend), particularly in the form of liquidity. The SA2 designation does not result in any uplift to the credit ratings.

KEY CREDIT RATING CONSIDERATIONS
The Negative trends reflect Morningstar DBRS' view that Vancity's profitability prospects and earnings capacity to absorb potential credit losses have weakened, which poses downside risks to the credit ratings. Although the Credit Union has begun a transformation path, higher funding costs and operating expenses could challenge its ability to improve earnings in the near to medium term while margin pressures will likely remain in 2024 and most of 2025. Morningstar DBRS notes that Vancity has historically reported weaker levels of profitability compared with most credit unions rated by Morningstar DBRS.

Vancity's credit ratings are supported by its good franchise as the largest credit union in B.C. by total assets and the second-largest by membership. The Credit Union's footprint is predominantly in the Greater Vancouver Area (GVA), where it holds strong market shares driven by its large and growing membership base. Furthermore, the Credit Union maintains sound balance sheet fundamentals, including stable funding sources, high liquidity levels, and a good capital cushion.

The credit ratings also incorporate Vancity's material exposure to commercial real estate, primarily in the GVA, which makes the Credit Union susceptible to a potential real estate market correction in Morningstar DBRS' view.

CREDIT RATING DRIVERS
Given the Negative trends, credit rating upgrades are unlikely. Morningstar DBRS would change the trends to Stable if the Credit Union demonstrates a sustained improvement in financial performance while maintaining a similar risk profile.

Alternatively, Morningstar DBRS would downgrade the credit ratings in the event of continued weakness in earnings performance, resulting in a sustained reduction in internal capital generation and loss-absorbing capacity. In addition, Morningstar DBRS would downgrade the credit ratings if there were significant losses in the loan portfolio as a result of unforeseen weakness in underwriting and/or risk management.

CREDIT RATING RATIONALE

Franchise
Vancity maintains a solid franchise in the GVA through its offering of community-based banking services and ranks as the largest credit union in Canada with total assets of $28.8 billion as of December 31, 2023. Vancity provides banking services to over 21% of the GVA's population. Over the past year, the Credit Union's membership base experienced growth of 1.2%, lagging the average B.C. population growth of 3%. The Credit Union continues to solidify its franchise by deepening its product suite and strengthening its sustainability product niches while making investments in digital infrastructure. Further, the Credit Union is undergoing a transformation path to strengthen revenue and reduce expenses.

Earnings
Since Q3 2022, Vancity's financial performance has been under pressure because of a sharp increase in interest rates, which have resulted in increased funding costs and margin compression. Net income before distributions significantly declined to $2 million in 2023 from $80 million in the prior year as a result of lower net interest income and higher operating expenses. In addition, Morningstar DBRS views the modest 25% contribution from noninterest income, relative to total revenue, as a constraint to the Credit Union's credit ratings. However, starting in Q1 2024, the Credit Union has implemented measures to improve profitability, including reducing headcount.

Risk
Vancity has historically generated some of the strongest asset quality metrics among its Canadian peers and continues to demonstrate sound risk management as demonstrated by its history of low loan loss levels. With total loan growth of 2.3% in 2023, impaired loans remained low and manageable at 0.18% of gross loans, while the net charge-offs ratio stood at a very low 6 basis points for the same period. Nevertheless, Morningstar DBRS expects Vancity's credit quality metrics to modestly deteriorate due to weakened earnings capacity to absorb potential credit losses amid economic challenges associated with higher interest rates and inflation. Furthermore, the Credit Union's exposure to residential and commercial real estate, primarily in the GVA, could make Vancity susceptible to a potential real estate market correction.

Funding and Liquidity
Vancity's funding remains good with prudent levels of liquidity. The Credit Union is funded largely through member-sourced deposits, which Morningstar DBRS views as stable. Total deposits grew by 2.6% year-over-year, reaching $25.1 billion in 2023. Reflecting higher market rates, term deposits grew by 5.5% while demand deposits shrank by 2% as members locked in higher yields following a prolonged low-rate environment. As a result, term deposits represented 53% of total funding at the end of 2023 compared with 51% in the prior year. Together, demand and term deposits accounted for about 92% of total funding in 2023. Liquid assets, as calculated by Morningstar DBRS, marginally increased to 13.3% of total assets in 2023 compared with 13.0% in the prior year.

Capitalization
Vancity's capitalization is good with a sufficient capital cushion to absorb losses in a stressed environment. The total capital ratio remained relatively stable at 14.0% in 2023 compared with 2022, above the minimum regulatory requirement of 8.0%. The Credit Union's capital quality is strong, with about 91% of total capital composed of Tier 1 capital.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
Social (S) Factors

Morningstar DBRS 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, Vancity 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 Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (23 January 2024) https://dbrs.morningstar.com/research/427030.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (4 June 2024) https://dbrs.morningstar.com/research/433881. In addition, Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (23 January 2024) https://dbrs.morningstar.com/research/427030 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 https://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' outlooks and credit ratings are under regular surveillance.

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

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