Morningstar DBRS Confirms Innovation Federal Credit Union's Long-Term Issuer Rating at BBB (high), Stable Trend

DBRS Limited (Morningstar DBRS) confirmed its credit ratings on Innovation Federal Credit Union (Innovation or the Credit Union), including the Credit Union's Long-Term Issuer Rating of BBB (high) and Short-Term Issuer Rating of R-1 (low). The trend on all credit ratings is Stable. As a federally regulated credit union, Innovation's Support Assessment (SA) is SA3, which reflects no expectation of timely systemic external support, resulting in the Credit Union's Long-Term Issuer Rating being equivalent to its Intrinsic Assessment (IA). The Credit Union has been regulated by the Office of the Superintendent of Financial Institutions (OSFI) under the Bank Act since June 2023 and has the potential to access the Bank of Canada's (BoC) Standing Term Liquidity Facility (STLF) and Emergency Lending Assistance (ELA) programs, although these are subject to the BoC terms and conditions at the time of any application request for funding. Consequently, the Credit Union's short-term credit ratings benefit from the exception granted to deposit-taking institutions on Morningstar DBRS' short-term scale.

KEY CREDIT RATING CONSIDERATIONS
The credit ratings reflect Innovation's solid franchise within its primary Province of Saskatchewan (Saskatchewan or the Province; rated AA (low) with a Stable trend) operating area and the benefits of its membership in the well-established credit union system, tempered by its moderate size. The credit ratings are also supported by Innovation's earnings power, where it largely outperforms peers, although the Credit Union remains highly reliant on spread income. Innovation's asset-quality metrics remain good, although delinquencies have increased and credit risk is heightened through an increased proportion of Alt-A residential third-party-sourced mortgages. The Credit Union continues to source both loans and deposits from third parties, which increases operational risk and potentially exposes it to elevated credit risk; however, positively in 2024 the organic book grew at a similar pace to the third-party book, reversing a trend in recent years where substantially all of Innovation's loan and deposit growth came from third parties. Morningstar DBRS notes that federal continuance provides a potential future growth engine, and the Credit Union has made modest progress in diversifying its membership base outside of Saskatchewan by leveraging its digital platforms. Additionally, Innovation's federal status enables it to pursue mergers outside of the Province, exemplified by its proposed merger with ABCU Credit Union.

Morningstar DBRS is concerned about the trade conflict between the U.S. and Canada and ongoing uncertainty related to specific tariffs on industries crucial to the Canadian economy, and to Ontario in particular, where Innovation has material exposure in both its retail and commercial loan books. U.S. tariffs, and reciprocal Canadian tariffs, could result in a combination of economic recession, rising unemployment, and pockets of higher inflation in Canada.

Innovation's IA of BBB (high) has been assigned at the midpoint of the Intrinsic Assessment Range, as Morningstar DBRS views the Credit Union's credit fundamentals and performance as commensurate with those of similarly rated peers.

CREDIT RATING DRIVERS
Over the longer term, sustained membership growth resulting in increased scale or a significant improvement in earnings metrics, especially through the growth of noninterest income and/or improved efficiency, would lead to a credit ratings upgrade.

Conversely, a material and sustained weakness in financial performance would lead to a credit ratings downgrade. A substantial deterioration in asset quality, especially from third-party-sourced loans, would also result in a downgrade.

CREDIT RATING RATIONALE
Franchise Combined Building Block Assessment: Moderate/Weak
Innovation is the third-largest credit union in Saskatchewan with $4.2 billion in assets as of December 31, 2024. The Credit Union provides retail and small business commercial offerings to its membership base through 28 advice centres in Saskatchewan, as well as through a national digital platform. Innovation is the third federal credit union in Canada and the first in the Province. The Credit Union's membership increased a strong 9.3% (compared to a restated 2023) in 2024 to about 67,500 members. Although total membership remains significantly concentrated in Saskatchewan, Innovation has had some success attracting members outside of the Province, with members in other provinces accounting for about one third of consumer membership growth in 2024. Additionally, Innovation's proposed merger with ABCU Credit Union, the first-ever interprovincial merger, would provide some geographic diversification through the addition of over 7,000 members in the Province of Alberta (rated AA with a Stable trend).

Earnings Combined Building Block Assessment: Good/Moderate
Innovation generated good earnings before member distributions in 2024 of $29.9 million, up 22% year over year (YOY), driven by continued strong revenue growth, partially offset by higher operating expenses and provision for credit losses (PCL). The Credit Union is more reliant on net interest income than its peer group, with noninterest income forming only 14% of revenue in 2024, unchanged from the prior year. Net interest margin was largely flat YOY (compared with the restated 2023 figure) at 3.2%, remaining materially higher than the peer average because of Innovation's higher-yielding mortgages sourced from third parties. The Credit Union's efficiency ratio improved significantly YOY, down approximately five percentage points to 67.3%, and is now in line with historical levels. PCL more than doubled in 2024 to $9.5 million, forming about 20% of income before provisions and taxes, and Morningstar DBRS expects that provisioning levels could remain elevated in 2025 given the highly uncertain macroeconomic environment.

Risk Combined Building Block Assessment: Good/Moderate
Loan growth continued its rapid pace in 2024, with gross loans up 17% to $3.8 billion; however, Morningstar DBRS expects this growth rate to moderate going forward. Loans sourced directly from members grew at a similar rate to those sourced from third parties, leaving the proportion of third-party-sourced loans unchanged at 45% of the total loan portfolio. While the influx of third-party loans, which began in earnest in 2021, has contributed to significant geographic diversification for Innovation, it also presents material third-party risk and loan exposure to Ontario which could be disproportionately affected by the trade war with the U.S. Additionally, Alt-A mortgages, which Morningstar DBRS views as higher risk, particularly in the current operating environment, make up one third of the residential mortgage portfolio (largely unchanged from the prior year), driven by third-party loan sourcing. Overall, gross impaired loans increased fourfold YOY to 0.95% of gross loans, driven by impairments in the commercial loan book, although net write-offs remained low at 9 basis points (bps), up slightly from 7 bps. Morningstar DBRS is concerned the more challenging operating environment resulting from the ongoing trade war could potentially lead to higher-than-expected deterioration in the Credit Union's asset quality.

Funding and Liquidity Combined Building Block Assessment: Good
Innovation maintains prudent levels of liquidity, and is largely funded through stable retail and business deposits. However, broker-sourced deposits, which Morningstar DBRS views less favourably than member deposits, have grown significantly in recent years, forming 22% of total deposits as of December 31, 2024, largely stable YOY but up from just 4% in 2021. The Credit Union also has access to wholesale funding in the form of Bearer Deposit Notes, which it began issuing in 2024 ($110 million outstanding at the end of the year) as well as securitized borrowings via the Canada Mortgage and Housing Corporation's (rated AAA with a Stable trend) National Housing Act Mortgage-Backed Securities program. Innovation has various sources of liquidity, including mortgage securitization pools held on-balance sheet as high-quality liquid assets, and credit facilities with Central 1 Credit Union (rated A (high) with Negative trend) and several other large financial institutions. The Credit Union reported a liquidity coverage ratio of 158%, well above the regulatory minimum of 100%, but down from 239% in 2023 as Innovation redeployed some of its excess liquidity into loans.

Capitalisation Combined Building Block Assessment: Good
Morningstar DBRS views the Credit Union's capitalization levels as good with a sizable cushion over regulatory minimums to absorb potential losses. The quality of Innovation's capital is strong, with 97% of total capital composed of CET1 capital. The Credit Union's Common Equity Tier 1 ratio declined 165 bps YOY to 14.78% in 2024, as growth in risk-weighted assets outpaced retained earnings. Innovation, similar to peer credit unions, generally has limited flexibility to raise external capital given its co-operative nature.

Further details on the Scorecard Indicators and Building Block Assessments can be found at https://dbrs.morningstar.com/research/452062.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
ESG Considerations had a relevant effect on the credit analysis.

Social (S) Factors

The following Social factor had a relevant effect on the credit analysis: Morningstar DBRS views the Social Impact of Products and Services ESG subfactor as credit positive for the credit ratings, but it does not affect the assigned credit ratings or trends. As a credit union, Innovation 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 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.

For more information on Morningstar DBRS' policy regarding the solicitation status of credit ratings, please refer to our Credit Ratings Global Policy, which can be found in the Morningstar DBRS Understanding Ratings section of our website.

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 https://dbrs.morningstar.com.

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