Morningstar DBRS Downgrades Central 1 Credit Union's Long-Term Issuer Rating to "A" From A (high); Changes Trend to Stable From Negative

DBRS Limited (Morningstar DBRS) downgraded its credit ratings on Central 1 Credit Union (Central 1), including Central 1's Long-Term Issuer Rating to A from A (high). Morningstar DBRS also changed the trends for all credit ratings to Stable from Negative. The credit ratings for Central 1 reflect Morningstar DBRS' Intrinsic Assessment (IA) of the British Columbia and Ontario Credit Union Systems (B.C. System and Ontario System, respectively, and together, the Systems) and a Support Assessment of SA2. The level of support results in a one-notch uplift to Central 1's Long-Term Issuer Rating, which is based on the aggregate IAs of the B.C. System (A (low)) and Ontario System (A (low)), and incorporates the credit fundamentals of Central 1. The SA2 designation reflects Morningstar DBRS' expectation of timely systemic external support from the Province of British Columbia (B.C.; rated AA (high) with a Negative trend) and the Province of Ontario (Ontario; rated AA with a Stable trend). Further, Central 1 is designated as a Provincial Systemically Important Financial Institution by the B.C. Financial Services Authority (BCFSA), the B.C. provincial regulator.

KEY CREDIT RATING CONSIDERATIONS
The credit rating downgrades reflect weak credit union systems' earnings performance, relative to the historical levels, particularly in the B.C. System, which is weighted more heavily in the overall assessment because of its strong competitive market position. In Morningstar DBRS' view, the B.C. System's slower earnings recovery could affect the System's ability to absorb potential credit losses and generate sufficient internal capital. The B.C. System's earnings remained under pressure in 2024, following significant deterioration in 2023. Despite a modest recovery of earnings in H1 2025, Morningstar DBRS believes margin pressure and high operating expenses are likely to challenge earnings recovery in the near to medium term. Furthermore, as with other banking organizations, Morningstar DBRS expects provision for credit losses (PCL) to rise, considering the uncertain operating environment associated with tariff threats and a weakening economy. These factors could create challenges for both Systems' earnings prospects.

Additionally, while Morningstar DBRS views the Systems' asset quality as generally good, it remains cognizant of significant exposures to commercial real estate (CRE) and construction lending in both Systems, making them susceptible to a market downturn.

The credit ratings are supported by the Systems' stable franchise in the deposit and loan markets, as well as good balance sheet fundamentals, including stable funding profiles and sufficient capital cushions. Additionally, Central 1 plays a significant role for its member credit unions, providing liquidity management, payments solutions, and clearing and settlement services to the B.C. System and most of the Ontario System.

The IA of A (low) for the B.C. System has been assigned at the high end of the Intrinsic Assessment Range, adjusting down from above the range previously. The IA range shifted downward as a result of the earnings deterioration since F2023, despite a modest recovery in H1 2025. Additionally, the current position of the IA incorporates the B.C. System's strong market position.

The Ontario System's IA range moved downward during the annual review in August 2024 following its weakened profitability, resulting in the IA's position at the high end of the IA range from the midpoint of the range.

CREDIT RATING DRIVERS
Morningstar DBRS would upgrade Central 1's credit ratings if the Systems were to demonstrate a material and sustained improvement in financial performance while maintaining a similar risk profile.

Conversely, Morningstar DBRS would downgrade the credit ratings if the Systems' weak earnings performance were to align with a lower credit rating category, or their asset quality metrics were to deteriorate substantially. Furthermore, a weakening in Central 1'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 Combined Building Block Assessment B.C. System: Good
Franchise Combined Building Block Assessment Ontario System: Good/Moderate

In Morningstar DBRS' view, the B.C. System maintains a good franchise. Nevertheless, its intrinsic strength could weaken if large credit unions in the B.C. System pursue a federal charter, leaving the local credit union systems. Morningstar DBRS considers the Ontario System's franchise adequate, despite modest market shares in the province in key products.

Central 1's franchise position is good. Although the credit union mandatory liquidity pools (MLPs) are managed on the credit union members' respective balance sheets and Central 1 manages only the funds in trust, it continues to perform important functions for credit unions, including core services such as treasury support, payments processing, and trust services. Earlier in 2025, Central 1 completed the transfer of its digital banking operations to Intellect Design Arena Ltd, allowing it to focus on its core service areas and priorities such as strengthening Treasury offerings, delivering cost-effective utility payment services, expanding into new product categories enabled by richer data streams, and providing solid and cost-effective services and pricing for members.

Earnings Combined Building Block Assessment B.C. System: Weak
Earnings Combined Building Block Assessment Ontario System: Moderate/Weak

In the elevated interest rate environment, the B.C. System's earnings were under pressure in 2022-2024. Credit unions in B.C. experienced an aggregate loss of $15.7 million in 2024 compared with $54.8 million in 2023 and reported a net gain of $74.3 million for H1 2025, largely driven by proportionally lower interest expenses. The aggregate net interest margin (NIM) dropped further by 44 basis points (bps) year over year (YOY) to 1.45% in 2024 but recovered to 1.76% in H1 2025 compared with 1.35% a year ago. Operating expenses remained elevated compared with historical levels on the back of higher salaries and benefits, although the operating efficiency ratio was reduced to 87.0% in H1 2025, compared with 104.9% in H1 2024. Despite the modest improvement in earnings in H1 2025, the B.C. System could face challenges in its earnings recovery in the remainder of 2025 and 2026 because of the uncertainty in the operating environment and sluggish economic growth prospects.

The Ontario System has also seen downward pressure on earnings since late 2022. Its aggregate net income totalled $135.7 million in 2024, down 6.9% YOY, largely because of higher operating expenses and PCL, partially offset by a rebound in total revenue. Specifically, noninterest expenses increased by 4.0% YOY in 2024 on higher salaries and benefits, and other nonfinancial expenses, while PCL amounted to $41.0 million compared with $26.9 million in 2023. NIM stabilized to 1.69% in 2024, compared with 1.71% in 2023 and 2.02% in 2022. The operating efficiency ratio stood at 80.7% in 2024, coming down marginally from 81.5% in 2023.

Morningstar DBRS views Central 1's earnings power as adequate, given its primary role as a liquidity and service provider for the Systems. In 2024, Central 1 generated 84% of total revenue from noninterest income, including its Treasury operations and fair value changes from financial instruments, while the majority of its net interest income came from managing credit unions' excess liquidity deposits. In 2024, Central 1 reported net income of $64.1 million, compared with $25.5 million in 2023, supported by a 34% YOY increase in noninterest income.

Risk Combined Building Block Assessment B.C. System: Good/Moderate
Risk Combined Building Block Assessment Ontario System: Good

The B.C. System's overall risk profile has significantly weakened between 2023 and 2024 because lower earnings have affected the credit metric of PCL over income before provisions and taxes. However, asset quality experienced only modest deterioration, as the gross impaired loans (GIL) ratio increased by 15 bps YOY in 2024 to 0.45%, largely because of higher delinquency in commercial loans. In addition, loan losses were negligible as most lending exposures are secured through real estate. Elevated housing prices and exposure to CRE, small and medium-size enterprises (SMEs), and construction projects remain key risks for the B.C. System. On the other hand, the B.C. System has a proportionally lower exposure to CRE and construction lending relative to the credit union systems in Alberta and Saskatchewan.

The Ontario System also reported higher impairments in 2024 with the GIL ratio increasing to 0.55% from 0.35% a year prior, largely because of increased delinquencies in commercial loans. Morningstar DBRS remains cautious of heightened exposure to real estate development and construction lending. As is the case for credit unions across Canada, credit unions in Ontario also have relatively large single-party commercial loan exposures. These can result in increased levels of loan impairment, and potentially large losses, in the event of a sustained economic slowdown.

Central 1's primary exposure to market/interest rate risk is through its management of treasury pool assets. In Morningstar DBRS' opinion, overall market risk is well-managed. Retail and wholesale credit risks are relatively limited for Central 1 because these are largely in the form of its commercial mortgage loans, which are entirely provided on a syndicated basis. Collectively, these represented about 18% of total assets as at YE 2024, with minimal loan impairment and write-offs in recent years.

Funding and Liquidity Combined Building Block Assessment B.C. System: Strong/Good
Funding and Liquidity Combined Building Block Assessment Ontario System: Good/Moderate

The B.C. System's funding profile is strong with solid levels of liquidity. The B.C. System's stable deposit base, comprising member-sourced retail and institutional deposits, represented 94% of total funding as at H1 2025 and benefits from a 100% provincial deposit guarantee.

The Ontario System's funding source is largely stable member-sourced deposits (88%) and the System has been reducing the reliance on market funding for growth since 2019. The Ontario System's liquidity levels have declined markedly since 2021 and remain the lowest among peers.

Central 1 is largely funded through excess liquidity deposits generated from the Systems, which Morningstar DBRS assesses to be relatively stable. Central 1 maintains good access to capital markets and diversified sources of funding, which include subordinated liabilities, medium-term notes, commercial paper, and repurchase agreements. Despite the segregation of the credit unions' MLPs into a bankruptcy remote structure, Central 1 continues to provide asset-management services for a substantial portion of the MLP funds.

Capitalization Combined Building Block Assessment B.C. System: Good/Moderate
Capitalization Combined Building Block Assessment Ontario System: Good/Moderate

Morningstar DBRS views the B.C. System's capital position as good with a solid capital cushion. The B.C. System's total capital ratio (TCR) decreased 30 bps YOY to 14.6% as at YE2024 compared with the prior year.

The Ontario System's capitalization is somewhat weaker than peers; however, the capital cushion is sufficient. The Ontario System's TCR improved 40 bps YOY to 14.3% in YE2024.

The BCFSA set a consolidated borrowing multiple of 18 times (x) for Central 1. As at March 31, 2025, Central 1's consolidated borrowing multiple was 11.6x, slightly down from 11.8x in the same prior-year period, largely because of the reduction in total borrowings and higher retained earnings.

Further details on the Scorecard Indicators and Building Block Assessments can be found at:
British Columbia Credit Union System -- https://dbrs.morningstar.com/research/460045
Ontario Credit Union System -- https://dbrs.morningstar.com/research/460046

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. The Systems play an integral role in providing banking services to local communities and funding to SMEs and underbanked areas, which is reflected in Morningstar DBRS' assessment of Central 1's franchise Building Block. The Systems operate on a community banking model wherein the social aspect of their activities strengthens their franchises without the requirement or need to maximize profitability.

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 (May 16, 2025) https://dbrs.morningstar.com/research/454196

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

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (May 23, 2025) https://dbrs.morningstar.com/research/454637. In addition, Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (May 16, 2025) https://dbrs.morningstar.com/research/454196 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.

For more information on Morningstar DBRS' policy regarding the solicitation status of credit ratings, please refer to the Credit Ratings Global Policy, which can be found in the Morningstar DBRS Understanding Ratings section of the website: https://dbrs.morningstar.com/understanding-ratings

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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