DBRS Limited (DBRS Morningstar) confirmed its ratings on Laurentian Bank of Canada (LBC or the Bank), including the Bank’s Long-Term Issuer Rating at A (low) and its Short-Term Issuer Rating at R-1 (low). All ratings have Stable trends. The Bank’s Intrinsic Assessment of A (low) and Support Assessment (SA) of SA3 are unchanged. The SA3 designation, which reflects no expectation of timely external support, results in the final rating being equivalent to the Intrinsic Assessment.
KEY RATING CONSIDERATIONS
The rating confirmations and Stable trends recognize LBC’s still solid regional retail franchise in Québec and growing national reach through B2B Bank, its commercial banking segment, as well as the Bank’s expanding footprint in the U.S. Furthermore, the ratings are supported by LBC’s conservative credit culture, strong asset quality with a history of low loan losses, and sound balance sheet fundamentals. The ratings also consider LBC’s relatively high proportion of brokered deposits and its higher cost base.
Over the longer term, the ratings would be upgraded if there is sustained improvement in LBC’s franchise momentum resulting in better earnings and operating efficiency.
Conversely, failure to execute on the new strategic initiatives that could lead to heightened operational risk, sustained negative operating leverage, or a deterioration in earnings would result in a rating downgrade. Furthermore, a rating downgrade would occur if there are significant losses in the loan portfolio or a perceived weakness in loan underwriting and/or risk management.
Franchise Combined Building Block Assessment: Good/Moderate
LBC is Canada’s seventh-largest Schedule I bank with assets of $45 billion as at October 31, 2021. The Bank is well positioned in Québec through its branch network, offering retail services in the province as well as commercial lending across Canada and in the U.S. LBC also owns an integrated full-service institutional securities and investment banking firm, Laurentian Bank Securities, Inc., targeting mid-market businesses. On December 10, 2021, the Bank unveiled its new strategic plan at its Investor Day, under the leadership of its new president and chief executive officer, following a year-long review of the Bank’s operations. Among other initiatives, this strategy will introduce new and enhanced digital capabilities to close key foundational gaps in the Personal Banking business, which has faced some customer attrition, shrinking loans, and stagnant deposits over the past few years. The strategy will also focus on improving key products by streamlining the mortgage process, accelerating the transformation of the Visa product suite, and simplifying deposit products and processes. Furthermore, the Bank plans to continue growing its commercial segment by targeting niches where it has developed expertise.
Earnings Combined Building Block Assessment: Moderate
The Bank's nonrecurring restructuring and impairment charges of $191.8 million pressured net earnings in F2021, whereas the net interest margin remained broadly stable at 1.61% and noninterest income continued the growth trend. The impairment charges are mainly related to the strategic review of the Bank's operations completed in Q4 2021, and both tangible and intangible impairments in the Personal Banking segment. This also resulted in a deterioration of LBC’s reported efficiency ratio, which at 88% in F2021 is already one of the weakest ratios among peers. However, on an adjusted basis, net income increased 53% to $211.2 million, reflecting higher operating revenue and lower noninterest expenses, while the adjusted efficiency ratio improved by 410 basis points to 68.2% in F2021. Looking forward, DBRS Morningstar expects the efficiency ratio to improve over the medium term as the Bank begins to benefit from operational enhancements while maintaining better cost discipline.
Risk Combined Building Block Assessment: Strong/Good
Despite the Coronavirus Disease (COVID-19) pandemic, the Bank continued to demonstrate a solid track record of strong asset quality with low impairments and loan losses. Gross impaired loans remained broadly stable at 0.75% of gross loans in F2021, as a decrease in personal and residential mortgage impaired loans was offset by a rise in nonperforming commercial loans. DBRS Morningstar notes that, like other banks, higher credit impairments are possible over the short to medium term as the Canadian economy begins to recover from the pandemic, and government support and stimulus expire. Furthermore, in DBRS Morningstar’s opinion, if not managed prudently, the Bank’s continued realignment of the loan portfolio and its geographic expansion as well as its new strategic initiatives could expose LBC to heightened levels of operational and credit risks.
Funding and Liquidity Combined Building Block Assessment: Good
Despite the continued contraction of its retail deposit base, LBC’s overall funding position has been stable throughout F2021, and the Bank maintained prudent levels of liquidity. Broker-sourced deposits, which make up 47% of total deposits, decreased 3% year over year to $10.7 billion in F2021 as the Bank scaled up its debt related to securitization activities as well as covered bond issuance in order to optimize its funding mix to better align with its asset levels. With the launch of its new strategic plan, the Bank expects to attract more direct client deposits on a national level, which DBRS Morningstar would view positively. As of October 31, 2021, direct retail client deposits made up about 32% of total deposits. Debt related to securitization activities increased 11% year over year in F2021 and stood at $11.3 billion, contributing to the improvement in funding costs. Liquidity levels, which include cash and Government of Canada securities, are sufficient to meet the Bank’s needs with liquid assets forming 22% of total assets as of October 31, 2021.
Capitalization Combined Building Block Assessment: Good/Moderate
LBC’s capital ratios under the Standardized Approach are above regulatory minimums, providing sufficient buffers to absorb stressed levels of loan losses. The Bank’s CET1 ratio stood at 10.2% in F2021, compared with 9.6% in the prior year, which implies a $638 million capital cushion according to DBRS Morningstar’s calculations. The marginal increase was driven by internal capital generation and gains related to employee benefit plans and equity securities through other comprehensive income, which offset the higher risk-weighted assets. As with other banks, LBC announced a 10% increase of its dividends for the first quarter of F2022 and the launch of a normal course issuer bid.
Further details on the Scorecard Indicators and Building Block Assessments can be found at https://www.dbrsmorningstar.com/research/389912.
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).
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.
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