Morningstar DBRS Confirms Credit Ratings on Affinity Credit Union at R-1 (low) With Stable Trends

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

KEY CREDIT RATING CONSIDERATIONS
The credit rating confirmations and Stable trends reflect Morningstar DBRS' expectation that Affinity will maintain its strong franchise in Saskatchewan, particularly in the city of Saskatoon, the Province's largest city and business hub. The Credit Union generates adequate levels of recurring earnings, despite compressed net interest margins and low operating efficiency in recent years. Also supportive of the credit ratings are a balance sheet that remains strong, a funding base sourced mainly from core retail deposits, high liquidity levels, and a solid capital cushion. Conversely, the credit ratings are constrained by a relatively low share of noninterest income and large single-party exposures that represent some concentration risk in the Credit Union's commercial loan portfolio.

CREDIT RATING DRIVERS
Morningstar DBRS would upgrade Affinity's credit ratings if the Credit Union is able to further strengthen its franchise through a sustained increase in membership resulting in a material improvement in financial performance, including higher levels of noninterest income.

Conversely, a credit ratings downgrade would occur should there be significant losses in the loan portfolio or a perceived weakness in loan underwriting and/or risk management. Furthermore, material and sustained weakness in financial performance would also lead to a credit ratings downgrade.

CREDIT RATING RATIONALE

Franchise Strength
With about $7.7 billion in total assets as at December 31, 2023, Affinity maintains a solid franchise in Saskatoon and has a growing presence in Regina, the two largest cities in Saskatchewan. Affinity served about 12% of the provincial population through 49 advice centres across 41 communities in the Province, as of April 30, 2024. Affinity's membership grew 0.7% year-over-year (YOY) to more than 144,000 in 2023, slightly behind the provincial population growth. Affinity has been successfully targeting growth with a younger membership demographic, including in Saskatoon, one of the fastest-growing cities in Canada.

Earnings Power
Affinity generates adequate levels of recurring earnings with net interest income comprising 73% of total revenue in F2023. Net income declined 27% YOY to $37.5 million in F2023 (excluding the one-time large dividend from the sale of Concentra Bank in 2022), affected by compression in net interest margin (NIM) and higher operating expenses. Despite strong loan growth and higher interest rates, NIM (as calculated by Morningstar DBRS) contracted 23 basis points (bps) YOY to 2.03% in F2023, which reflects the Credit Union's strategy of competitive pricing on both loans and deposits. Affinity's adjusted efficiency ratio deteriorated to 72.6% from 65.4% in the prior year as a result of margin pressure and higher operating expenses. Furthermore, Morningstar DBRS views the Credit Union's low, albeit improving, noninterest income as a credit ratings constraint.

Risk Profile
Affinity's good risk profile is supported by its generally conservative underwriting policies and practices. Nevertheless, the Credit Union's asset quality is sensitive to concentration risk, particularly in the commercial segment where cyclical performance of Saskatchewan's key industries can result in asset quality deterioration. In last year's challenging operating environment, the credit quality of Affinity's consumer and agricultural portfolios remained resilient with low loan losses, while its commercial loans saw an increase in delinquencies. Affinity brought its credit card suite in-house last year and the high 90 day delinquency at 2.28% at YE 2023 was due to a delay in write-offs. Morningstar DBRS notes that the credit card portfolio accounts for a small percentage of the loan book. Overall, gross impaired loans declined by 22 bps YOY to 0.94% of gross loans in F2023. Nevertheless, Morningstar DBRS expects Credit Union's asset quality metrics to deteriorate modestly in 2024 because of elevated interest rates and continued market uncertainty.

Funding and Liquidity
Affinity'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 6.3% YOY to $6.8 billion in F2023. Accounting for about 54% of total deposits, term deposits grew 12.7% YOY to $3.7 billion in F2023, while demand deposits shrank by 1.5% YOY to $3.1 billion as members locked in higher yields as interest rates peaked in F2023. Liquid assets stood at 19.9% of total assets in F2023. In addition, Affinity maintains a strong liquidity coverage ratio of 162% as at YE 2023 compared with the regulatory minimum of 100%. Morningstar DBRS views the Credit Union's liquidity buffers as sufficient to withstand a stressed environment.

Capitalization
Affinity maintains good capitalization that provides a sufficient capital cushion for the Credit Union to absorb losses in a stressed environment. Affected by low level of retained earnings, the total capital ratio decreased by 27 bps YOY to 16.39% in F2023, however, with a 489 basis point cushion, it remained well above the minimum regulatory requirement of 11.5%. The quality of Affinity's capital is strong, with the majority of total capital composed of Tier 1 capital, and internal capital generation comparable with peers. In 2023, the Credit Union's minimum capital target by policy increased to 13.5% or 2% greater than the regulatory minimum.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS

Social (S) Factors
The following Social factors had a relevant effect on the credit analysis: Morningstar DBRS views the Social Impact of Products and Services ESG sub factor as relevant to the credit ratings, but it does not affect the assigned credit ratings or trends. As a credit union, Affinity 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 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 (January 23, 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 (June 4, 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 (January 23, 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 dbrs.morningstar.com.

The credit ratings were 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.

These are solicited credit ratings.

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 dbrs.morningstar.com.

DBRS Limited
DBRS Tower, 181 University Avenue, Suite 700
Toronto, ON M5H 3M7 Canada
Tel. +1 416 593-5577