DBRS Limited (DBRS Morningstar) changed the trend on Central 1 Credit Union’s (Central 1) ratings to Stable from Negative. DBRS Morningstar also confirmed all of Central 1’s ratings, including its Long-Term Issuer Rating at A (high) and Short-Term Issuer Rating at R-1 (middle).
DBRS Morningstar views support from the Provinces of British Columbia (B.C.; rated AA (high) with a Stable trend by DBRS Morningstar) and Ontario (rated AA (low) with a Stable trend by DBRS Morningstar) for Central 1 as likely, which reflects the importance of the credit unions in these provinces. This importance and the role of Central 1 in serving the credit unions are evident, particularly in B.C. where the provincial regulator, B.C. Financial Services Authority, named Central 1 as a Domestically Systemically Important Financial Institution within the Canadian credit union system. Accordingly, DBRS Morningstar assigned Central 1 a Support Assessment as SA2. Furthermore, in DBRS Morningstar’s view the provinces are considered capable of providing such support, if needed. The level of support results in a one-notch uplift to Central 1’s Long-Term Issuer Rating from the Intrinsic Assessment (IA) of the B.C. and Ontario Credit Union Systems (the Systems).
KEY RATING CONSIDERATIONS
The trend change to Stable reflects DBRS Morningstar’s view that the considerable uncertainties facing financial institutions because of the Coronavirus Disease (COVID-19) pandemic have begun to abate. Moreover, B.C.’s and Ontario’s economies are beginning to show signs of gradual recovery in 2021, amid the backdrop of a global economic recovery and the accelerated deployment of vaccines.
The ratings of Central 1 consider the fundamental strengths of the Systems. Specifically, these ratings reflect the IAs of “A” for the B.C System and A (low) for the Ontario System. Central 1 provides liquidity management, payment solutions, and clearing and settlement services to the B.C. System and to most of the Ontario System. These credit unions own Central 1, and the IAs of these two systems incorporate an analysis of the combined financials of the individual credit unions in each province.
The ratings and Stable trends also reflect the strong market shares of credit unions in B.C. and growing market shares for residential mortgages and deposits of credit unions in Ontario. Furthermore, the solid performance of the relatively diverse provincial economies of B.C. and Ontario is supportive of the ratings. DBRS Morningstar also views the risk profiles of these Systems as generally robust, but remains cognizant of significant exposures to commercial real estate and construction lending in the B.C. and Ontario Systems and their susceptibility to a market downturn.
DBRS Morningstar views Central 1’s ratings as well placed in their rating category. Over the longer term, ratings would be upgraded if the franchises of the two provincial Systems materially strengthen through membership growth, increased revenue per member, and improved financial performance.
Conversely, the ratings would be downgraded if the intrinsic strength of either of the Systems is reduced. A reduction in DBRS Morningstar’s assessment of the likelihood of provincial support would also result in a downgrade, as would any material operational risk management issues at Central 1.
Franchise Combined Building Block (BB) Assessment BC System: Good
Franchise Combined Building Block (BB) Assessment ON System: Good/Moderate
Franchise Combined Building Block (BB) Assessment Central 1: Good/Moderate
In DBRS Morningstar’s view, the B.C. System continues to have a strong franchise. Nevertheless, DBRS Morningstar is concerned that the System’s intrinsic strength could be weakened if there is increased momentum from other large credit unions in B.C. and Ontario to also pursue a federal charter.
DBRS Morningstar considers the Ontario System franchise to be good, despite modest market shares in the province in key products.
In DBRS Morningstar’s view, Central 1’s financial fundamentals have remained strong. It continues to perform important functions for the credit unions, including helping them manage their liquidity and providing access to the national payments systems. DBRS Morningstar notes that effective January 1, 2021, the credit union mandatory liquidity pools (MLP) have been segregated into a bankruptcy-remote structure with Central 1 continuing to manage the funds in trust. Also viewed positively is the emphasis that Central 1 has placed on enhancing its operational capabilities to service credit unions across Canada, specifically with respect to digital banking and market intelligence.
Earnings Combined Building Block (BB) Assessment BC System: Good/Moderate
Earnings Combined Building Block (BB) Assessment ON System: Moderate/Weak
Earnings Combined Building Block (BB) Assessment Central 1: Moderate/Weak
The B.C. System generates strong levels of recurring earnings that are sufficient to absorb normal levels of loan losses.
The Ontario System generates good levels of recurring earnings and improving profitability, yet remains challenged by the strong competition from the large Canadian banks.
Central 1’s earnings power is viewed as good, given its primary role as liquidity and service provider for the Systems, although the majority of its net income is derived from managing credit unions’ excess liquidity deposits. Consequently, DBRS Morningstar is cautious that a sharp and sustained decline in excess liquidity deposits placed by credit unions with Central 1 could weaken its financial and operational position.
Risk Combined Building Block (BB) Assessment BC System: Strong/Good
Risk Combined Building Block (BB) Assessment ON System: Strong/Good
Risk Combined Building Block (BB) Assessment Central 1: Strong/Good
The B.C. System’s asset quality remains solid, given that the majority of lending exposures are secured through real estate; however, elevated housing prices remain a risk.
The Ontario System’s asset quality remains sound as the majority of lending exposures are secured through real estate. However, DBRS Morningstar remains cautious of heightened exposure to real estate development and construction lending.
In the near term, DBRS Morningstar expects impaired loans for the Systems to trend upward as government aid programs expire and businesses and employment start to recuperate from the forced closures experienced over the last year, which could be thwarted by renewed lockdowns given the increased prevalence of coronavirus variants.
Funding and Liquidity Combined Building Block (BB) Assessment BC System: Strong/Good
Funding and Liquidity Combined Building Block (BB) Assessment ON System: Good
Funding and Liquidity Combined Building Block (BB) Assessment Central 1: Strong
The B.C. System has a sticky retail deposit base that benefits from a 100% provincial deposit guarantee and overall solid liquidity.
The Ontario System’s funding is largely sourced through sticky retail deposits; however, excessive reliance on market funding to fund growth would be viewed negatively. While liquidity levels are lower than peers, they remain sufficient.
Central 1 is largely funded through excess liquidity deposits generated from the Systems in British Columbia and Ontario, which DBRS Morningstar assesses to be relatively stable, noting that deposit growth has been strong in each of the Systems since the onset of the coronavirus pandemic.
Capitalization Combined Building Block (BB) Assessment BC System: Good/Moderate
Capitalization Combined Building Block (BB) Assessment ON System: Good/Moderate
Capitalization Combined Building Block (BB) Assessment Central 1: Good/Moderate
DBRS Morningstar views the B.C. System’s capital position as strong, considering the solid capital cushion and good levels of internal equity generation.
DBRS Morningstar notes that the Ontario System’s capitalization is weaker than peers, although the capital cushion is viewed as sufficient.
The B.C. Financial Services Authority set a consolidated borrowing multiple of 18 times for Central 1 as of January 1, 2021. Central 1 previously had to manage separate Treasury and MLP borrowing multiples.
Further details on the Scorecard Indicators and Building Block Assessments for Central 1 can be found at https://www.dbrsmorningstar.com/research/383613.
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.
All figures are in Canadian dollars unless otherwise noted.
The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (July 19, 2021; https://www.dbrsmorningstar.com/research/381742). Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (February 3, 2021; https://www.dbrsmorningstar.com/research/373262).
For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.
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 www.dbrsmorningstar.com.
The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.
Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar’s outlooks and ratings are under regular surveillance.
For more information on this credit or on this industry, visit www.dbrsmorningstar.com.
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