DBRS Limited (DBRS Morningstar) confirmed Credit Union Central of Saskatchewan’s (SaskCentral) Short-Term Issuer rating and Short-Term Instruments rating at R-1 (low) with Stable trends. The ratings for SaskCentral reflect DBRS Morningstar’s Intrinsic Assessment of the Saskatchewan Credit Union System (the System) and a Support Assessment 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 by DBRS Morningstar), particularly given that SaskCentral has been designated as a Provincial Systemically Important Financial Institution.
KEY RATING CONSIDERATIONS
SaskCentral’s ratings are driven by the strength of the System, which collectively owns SaskCentral. While uncertainties related to the Coronavirus Disease (COVID-19) pandemic remain, economic performance and oil prices have rebounded with the System’s performance and health remaining resilient throughout the pandemic. The System’s performance has further improved in the first nine months of F2021, along with active loan deferrals declining to 0.55% of total loans. Furthermore, Concentra Bank (Concentra; rated A (low) with a Stable trend by DBRS Morningstar) represents a contingent risk to the System through SaskCentral’s ownership as Concentra’s total assets represented a significant 40% of the System’s assets at September 30, 2021. While Concentra's credit profile has remained resilient and financial performance has shown solid improvement, riskier activities undertaken by Concentra that are unrelated to serving the System could negatively affect SaskCentral's ratings.
DBRS Morningstar views SaskCentral’s ratings as well placed in their rating category. Over the longer term, ratings would be upgraded if the System materially strengthens through membership growth, particularly within the younger demographic. Improved efficiency and a significantly larger proportion of operating revenues generated through fee-based income would also lead to an upgrade of ratings.
Conversely, the ratings would be downgraded if the intrinsic strength of the System is reduced. A reduction in DBRS Morningstar’s assessment of the likelihood of provincial support or a material and sustained weakness in the System’s loan performance, resulting in a significant increase in loan losses, would result in a downgrade. Additionally, a significant and sustained financial weakness at majority-owned Concentra would also result in a downgrade of ratings.
SaskCentral is solely responsible for managing mandatory statutory liquidity deposits on behalf of member credit unions in Saskatchewan, reflecting its core function of providing liquidity management services and access to payment systems. The System’s franchise strength is driven by its strong competitive position in small and medium-size enterprise lending and a considerable retail banking presence. As at September 30, 2021, 41.4% of Saskatchewan's population comprised members of a credit union, and the System comprised 36 credit unions operating through 232 branches. At the end of 2020, the System held about 35% of deposits, 47% of commercial loans, and 23% of residential mortgage loans in Saskatchewan. DBRS Morningstar views the System’s franchise strength as solid, reflecting its strong competitive position and long-standing relationships in the small business and farming segments.
DBRS Morningstar recognizes that 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 ratings. While earnings declined by 14% in 2020 to $112 million due to higher provisioning expense and a low interest rate environment, net income has increased 69% year over year to $119 million in the first nine months of 2021 primarily due to provision reversals.
Despite a sharp pandemic-related reduction in economic activity and lumpy write-offs, the System’s asset quality metrics were relatively stable in 2020 and have improved in the first nine months of 2021. While still elevated in the nine-month period ended September 30, 2021, the gross impaired loans to gross loans ratio improved to 1.40% from 1.54% in the prior year period. The System’s provisioning levels have declined due to the improved macroeconomic outlook and resilient loan portfolio performance. On an annualized basis, the loan loss provision to average net loan ratio improved to 0.14% at Q3 2021 compared with 0.33% in the prior year period. However, the System’s loans remain susceptible to weakness in the current operating environment. Furthermore, credit union loan books have significant single-party exposure, which elevates credit risk for the System.
Funding and Liquidity
The System’s funding is sourced largely through core retail deposits from its membership base. In DBRS Morningstar’s opinion, the sources and uses of funds are well aligned and interest-rate risk is manageable. The System’s liquidity is managed by SaskCentral and remains solid, given the relatively low-risk business profile of credit unions and their limited reliance on market funding. By regulation, Saskatchewan-based credit unions must place 10% of their deposits with SaskCentral as statutory liquidity deposits. Most of these funds are placed in short-term liquid instruments that support clearing and settlement, daily cash flow management, and emergency liquidity support. The System-wide liquidity coverage ratio (LCR) was at 279.1% as at December 31, 2020, with an increase in the level of high-quality liquid assets and cash inflows offsetting cash outflows. The LCR decreased to 243.6% as at September 30, 2021, due to growth in net cash outflows, but remained significantly above the regulatory minimum.
The capital cushion for the System is sufficient to absorb normal levels of losses while overall capitalization remains solid. The System’s CET1 ratio, which is significantly above the regulatory minimum of 7%, increased to 13.9% in 2020 from 13.4% in the previous year. Total eligible capital as a percentage of risk-weighted assets continued an increasing trend and was well above the regulatory minimum of 10.5%, climbing to 15.0% at Q3 2021 compared with 14.9% in 2020 and 14.3% in 2019. Additionally, the quality of capital remains strong as the majority (94%) of the System’s capitalization is represented by CET1 capital. While capitalization levels are solid, the System is constrained in its ability to raise equity capital from market sources and, hence, relies on internal equity generation to fund growth. The System’s internal equity generation has been consistently strong.
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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