Morningstar DBRS Confirms Credit Union Central Alberta Limited's Credit Ratings, Including Its Long-Term Issuer Rating at "A" and Short-Term Issuer Rating at R-1 (low), Stable Trends

DBRS Limited (Morningstar DBRS) confirmed the credit ratings on Credit Union Central Alberta Limited (Alberta Central or the Central), including the Central's Long-Term Issuer Rating at "A" and Short-Term Issuer Rating at R-1 (low). The trends on all credit ratings are Stable. The credit rating confirmations are based on (1) Morningstar DBRS' Intrinsic Assessment of the Alberta Credit Union System (the System), which incorporates Alberta Central's credit fundamentals; and (2) a Support Assessment (SA) of SA2, which reflects the expectation of timely systemic external support from the Province of Alberta (Alberta or the Province; rated AA with a Stable trend by Morningstar DBRS). The SA2 designation 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. Amid a challenging operating environment, the System's asset quality has been resilient with low and manageable levels of write-offs and marginal improvement in profitability despite some compression in interest margins. Furthermore, stable funding sources and good levels of capitalization support the System's credit profile. On the other hand, the System's limited sources of noninterest income and weak operating efficiency remain credit rating constraints. In addition, Morningstar DBRS expects that asset-quality metrics could deteriorate modestly in F2025 from current levels because of still-high, albeit decreasing, interest rates.

Alberta Central's franchise is supported by its role as the liquidity manager, direct clearing agent, and trade association for the credit unions in the Province. Furthermore, Morningstar DBRS views operational and market risks as well managed, including interest rate risk related to Alberta Central's investment securities portfolio, and the Central holds sufficient liquidity to meet the short-term liquidity needs of the System. On the other hand, compared with some other credit union systems in Canada, the System is relatively small and highly concentrated in a single large credit union, which Morningstar DBRS views as a negative factor in its assessment of the Central's franchise.

CREDIT RATING DRIVERS
Over the longer term, Morningstar DBRS would upgrade Alberta Central's credit ratings if the System were able to strengthen its franchise position, 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 the System's financial performance or a substantial deterioration in its asset quality metrics would lead to a credit rating downgrade. Furthermore, a reduction in Morningstar DBRS' assessment of the likelihood of provincial support would also result in a downgrade, as would a weakening in Alberta Central's credit fundamentals.

CREDIT RATING RATIONALE

Franchise Combined Building Block Assessment: Good/Moderate
Credit unions in Alberta (collectively referred to as the System) are important providers of retail and commercial banking services to the Province's population, of which about 13.5% were credit union members in F2023. The System's franchise strength is driven by its capacity to serve its members from 119 communities through 12 credit unions 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 $33.8 billion as at Q3 2024 that grew 3.3% year over year (YOY). The credit unions maintain stable shares in loan and deposit markets (about 9% in deposits, 7% in residential mortgages, and 9% 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. Membership in the System expanded 12.0% YOY to about 715,000 in Q3 2024, in part supported by the Province's population growth.

Morningstar DBRS considers Alberta Central's franchise position to be adequate; the Central performs important functions for credit unions, including liquidity management, clearing, payments, and ancillary services that, in Morningstar DBRS' view, may be cost-prohibitive for smaller credit unions to undertake individually. Nevertheless, compared with other centrals in Canada, Alberta Central is owned by the single largest credit union in the Province, Servus Credit Union, which accounts for about 83% of the System's assets.

Earnings Combined Building Block Assessment: Good/Moderate
In a challenging operating environment, the System's net income grew 10.1% YOY to $137.9 million in the first nine months of F2024 (9M 2024). This was supported by lower operating expenses, partially offset by a decrease in total revenue and a marginal increase in provision for credit losses. On the back of higher funding costs, net interest income declined 3.0% YOY in 9M 2024. As a result, net interest margin (as calculated by Morningstar DBRS) contracted by 20 basis points YOY to 2.2% in 9M 2024. Supporting net earnings, operating expenses declined 12.7% YOY in 9M 2024, reflecting lower staffing and general expenses. The System's efficiency ratio improved to 66% in 9M 2024 compared with 72% in 9M 2023. Nevertheless, in Morningstar DBRS' view, a still-high operating cost structure as well as limited sources of fee-based income remain credit rating constraints.

Morningstar DBRS views Alberta Central's earnings power as adequate, given its primary role as a liquidity and service provider for the System. In 9M 2024, the Central generated about 35% of total revenue from noninterest income, including its treasury operations. Alberta Central reported net income of $5.4 million in 9M 2024 compared with $0.9 million in 9M 2023, driven largely by an increase in net interest income on the back of high interest rates. As liquidity manager for the System, Alberta Central's interest income is primarily derived from the high-quality, liquid, but relatively low-yielding, fixed-income assets in its securities portfolio.

Risk Combined Building Block Assessment: Good/Moderate
Overall, the System's loan book expanded 3.1% YOY to $29.1 billion as of Q3 2024, largely supported by a 4.1% increase in residential mortgages and a 2.0% increase in commercial loans and leases. 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. Loan delinquencies picked up in the 9M 2024 period; however, the gross impaired loans ratio improved to 0.52% as at Q3 2024 from 0.73% for Q3 2023 from a reduction in impaired commercial loans. The System's net charge-offs were at low and manageable levels, supported by collateral quality and generally good underwriting practices.

Alberta Central is primarily exposed to market/interest rate risk as it manages the System's statutory liquidity pool. In Morningstar DBRS' opinion, this risk is well managed. The Central's investment securities portfolio comprises primarily very low credit risk, highly liquid assets with limited duration mismatch in relation to funding sources.

Funding and Liquidity Combined Building Block Assessment: Good
The System's funding is good, reflecting the solid retail deposit franchises within the System and the low reliance on market-sensitive wholesale funding. The System's total deposits grew 2.2% YOY to $28.3 billion in 9M 2024, driven largely by registered plan deposits. Demand deposits declined by 3.9% YOY and accounted for about 45% of total deposits at Q3 2024, while term deposits remained relatively stable YOY. The System's liquidity is represented by the System 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 was relatively stable at 12.8% YOY as at Q3 2024. Morningstar DBRS views liquidity levels as sufficient, given the low-risk business model of credit unions in the Province together with the existence of an unlimited deposit guarantee that is explicitly backed by the provincial government of Alberta.

As a liquidity manager, Alberta Central is funded through required statutory deposits from the System. Overall, the sources and uses of funds are well aligned given Alberta Central's mandate to ensure that sufficient liquid assets are available to meet the short-term liquidity needs of the System. In addition, the Central maintains sufficient short-term funding sources to meet its liquidity needs, including a commercial paper program. However, the Central currently has no access to the Bank of Canada emergency liquidity facilities.

Capitalization Combined Building Block Assessment: Good
The System's capital position is among the strongest compared with other Morningstar DBRS-rated Canadian credit union systems. The System maintains capital buffers, sufficient for credit unions to absorb losses under stressed operating conditions. The capital ratio was relatively stable YOY at 15.1% as at Q3 2024, as higher-risk weighted assets were offset by an increase in total capital. The quality of the System's capital base is high, with primary capital constituting more than 95% of total capital. However, sources of new capital are limited to capital generated internally and the issuance of subscription shares, which is a constraint on the ratings.

Alberta Central's capital is largely sourced from the System as, under Alberta Central's bylaws, member credit unions are required to maintain 1% of their assets as equity in the Central. The provincial regulator requires Alberta Central to maintain a prescribed borrowing multiple (member deposits, loans and notes payable, and certain derivative liabilities), which is not to exceed 15 times (x) regulatory capital. As at Q3 2024, Alberta Central's borrowing multiple was 9.9x.

Further details on the Scorecard Indicators and Building Block Assessments can be found at https://dbrs.morningstar.com/research/444129.

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 affect the assigned credit 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 its activities strengthens its franchises, without the pressure to maximize profitability. As a result, Morningstar DBRS incorporated this factor into Alberta Central'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 Factors in Credit Ratings (August 13, 2024) https://dbrs.morningstar.com/research/437781.

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 Factors in Credit Ratings (August 13, 2024) https://dbrs.morningstar.com/research/437781 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 trends 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