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

DBRS Limited (Morningstar DBRS) confirmed Credit Union Central of Saskatchewan's (SaskCentral) Short-Term Issuer Rating and Short-Term Instruments credit 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 reflect the System's stable franchise and its significant share of provincial loans and deposits, along with the System's important role in the Saskatchewan economy, particularly in rural communities and small towns including long-standing relationships in the small business and farming communities. Further, the System, which collectively owns SaskCentral, continues to benefit from stable funding sources and capital levels that provide an adequate buffer against potential future losses. The System's earnings and asset quality have been 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 and may lead to some further deterioration in asset quality in 2025 as the threat of U.S. tariffs and ongoing policy uncertainty may hurt exports and dampen new business investment in the near to medium term.

The credit ratings also incorporate SaskCentral's credit fundamentals, with its franchise supported by its core role in delivering liquidity management services and access to payment ecosystems to Saskatchewan credit unions. Additionally, Morningstar DBRS views operational and market risks as well managed, including interest rate risk related to SaskCentral's investment securities portfolio, and SaskCentral holds sufficient liquidity to meet the System's short-term liquidity needs.

CREDIT RATING DRIVERS
Over the longer term, Morningstar DBRS would upgrade SaskCentral's credit ratings if the System were able to notably strengthen its franchise, resulting in a material improvement in profitability and 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 ratings downgrade. Additionally, a weakening in SaskCentral's credit fundamentals or a reduction in Morningstar DBRS' assessment of the likelihood of provincial support 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 the System's financial strength is its long-standing relationships within the farming/small business communities, a segment historically underserved by Canada's large banks. As at September 30, 2024, 35.8% of Saskatchewan's population comprised members of a credit union. The System includes 30 credit unions (as at January 1, 2025) and almost 200 service outlets, particularly in small towns and rural areas. At the end of 2023, the System had substantial market shares in Saskatchewan, holding 32% of deposits, 47% of commercial loans, and 23% of residential mortgage loans. The System's revenue per member has been considerably higher than other credit union systems in Canada, reflecting its stronger share of higher-yielding nonresidential lending.

Morningstar DBRS considers SaskCentral's franchise position to be adequate. SaskCentral performs important functions as the liquidity manager for Saskatchewan's credit unions and through aggregating statutory liquidity deposits, it enables clearing and settlement, provides credit facilities that support daily cash flow management, coordinates emergency liquidity support, and provides investment management services.

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. Following a challenging operating environment in 2023, where profitability modestly declined year over year (YOY), aftertax earnings of $109 million year to date for Q3 2024 increased 14% YOY, while return on average assets (as calculated by Morningstar DBRS) was 0.55% compared with 0.47% in the prior year. The net interest margin was 2.35% as of Q3 2024 compared with 2.27% in the same prior-year period, as total interest income outpaced total interest expense. While comparing favourably with most other credit union systems in Canada, the System's efficiency ratio remained relatively weak at 73.6% as of Q3 2024.

SaskCentral manages core earnings to a low level in service of its credit union members; however, it can adjust credit union assessments or request capital as required. As the liquidity manager for the System, SaskCentral's interest income is primarily derived from the high-quality, liquid, but relatively low-yielding fixed income assets in its securities portfolio.

Risk Profile
Period-end loan growth for the System increased 4.9% as at Q3 2024, compared with 3.8% in the same prior-year period. Credit risk has increased but remains manageable, driven by the still-elevated interest rate environment, which has resulted in higher debt servicing costs. Delinquencies increased to 0.83% as of Q3 2024, up from 0.69% in the prior-year period but still lower than the five-year average. Delinquencies greater than 90 days continued to be concentrated in the commercial sector (69%), compared with the consumer (16%) and agricultural (15%) sectors. Provisions for credit losses were 0.09% of assets as of Q3 2024, marginally lower than the prior-year period and half of the five-year average. Morningstar DBRS views loans to small and medium-size businesses as being susceptible to weakness in an economic downturn, and credit unions' books have significant single-party exposure, which elevates the System's credit risk. However, the declining interest rate environment and additional anticipated rate cuts in 2025 should ease the pressure on members' cash flows.

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

Funding and Liquidity
System funding is stable, supported by relatively sticky retail deposits from members with whom the credit unions have long-standing banking relationships. In Morningstar DBRS' view, the sources and uses of funds are well aligned, and interest rate risk is manageable. Deposit growth of 4.3% in Q3 2024 was moderately lower than the prior year. The liquidity coverage ratio remained strong at 270.1% in Q3 2024, compared with 222.4% in the prior-year period, and Morningstar DBRS expects liquidity levels to remain adequate and continue to meet regulatory expectations. High-quality liquid assets represented 43% of cash and investments as of Q3 2024. The System's liquidity is managed by SaskCentral and remains solid, given the relatively low-risk business profile of its member credit unions.

SaskCentral, as a liquidity manager, is largely funded through required statutory deposits from the System. Overall, the sources and uses of funds are well aligned given SaskCentral's mandate to ensure that sufficient liquid assets are available to meet the short-term liquidity needs of the System. In addition, SaskCentral maintains sufficient short-term funding sources to meet its own liquidity needs, including a commercial paper program, repo facilities, an uncommitted line of credit, and a committed clearing line.

Capitalization
The System's total eligible capital, as a percentage of risk-weighted assets, was 16.77% at Q3 2024, up 25 basis points YOY and well above the five-year average. 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 Tier 1 capital representing 96% of total eligible capital. However, sources of new capital are limited to capital generated internally, which is a constraint on the credit ratings.

SaskCentral's capital is measured through a prescribed borrowing multiple which, at 12.6 times (x) as of Q3 2024, is well below the regulatory (20.0x) and board policy (18.0x) borrowing multiple ceilings. Additionally, member credit unions are required to hold between 0.01% and 1.00% of their assets in SaskCentral's membership shares, as determined annually by the board. Further, these credit unions are obligated to contribute share capital of up to 1.0% of their assets when the board announces an extraordinary event.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS

Social (S) Factors
Morningstar DBRS finds the Social Impact of Products and Services ESG subfactor is relevant and is a credit positive for the credit ratings 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, 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 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 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' trends 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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