DBRS Limited (DBRS Morningstar) changed the trends on Credit Union Central Alberta Limited’s (Alberta Central or the Credit Union) Issuer Rating and Long-Term Senior Debt to Stable from Negative and maintained the Stable trends on the Short-Term Issuer Rating and Short-Term Instruments rating. DBRS Morningstar also confirmed its ratings on Alberta Central, including its Issuer Rating and Long-Term Senior Debt ratings at A and the two short-term ratings at R-1 (low). The rating confirmations reflect DBRS Morningstar’s Intrinsic Assessment of the Alberta Credit Union System (the System) and a Support Assessment (SA) of SA2, which reflects the expectation of timely systemic external support from the Province of Alberta (the Province; rated AA (low) with a Stable trend by DBRS Morningstar). This results in a one-notch uplift to “A” from the System’s Intrinsic Assessment of A (low).
KEY RATING CONSIDERATIONS
The Stable trends on Alberta Central’s ratings are based on the outlook for the System. The trend changes to Stable from Negative reflect DBRS Morningstar’s expectation that the System’s financial performance and credit profile will remain resilient. Amid the Coronavirus Disease (COVID-19) pandemic, the System showed improved financial performance in 2021 as well as the normalization of asset quality metrics to pre-pandemic levels. Moreover, Alberta’s economy showed signs of recovery in 2021, reflecting the global economic recovery, vaccine rollouts, recovery in oil prices and demand, and improving consumer and business sentiment. Nevertheless, DBRS Morningstar remains cautious of potential medium-term volatility stemming from the pandemic and other factors, including hydrocarbon prices and the gradual withdrawal of government stimulus.
DBRS Morningstar views Alberta Central as well placed in its rating category. Over the longer term, DBRS Morningstar would upgrade Alberta Central’s ratings if the System were able to strengthen its franchise through a sustained increase in its membership base and market shares, resulting in a material improvement in earnings, including a higher proportion of noninterest income and strong operating efficiency.
Conversely, a material and sustained weakness in financial performance or a substantial deterioration in asset quality metrics would lead to a ratings downgrade. A reduction in DBRS Morningstar’s assessment of the likelihood of provincial support would also result in a ratings downgrade.
Franchise Combined Building Block (BB) Assessment: Good/Moderate
Credit unions in Alberta are important providers of retail and commercial banking services to the Province’s population, of which about 14% were members of a local credit union in 2021. The System’s franchise strength is driven by its capacity to serve its members through 14 credit unions that collectively serve 119 communities across Alberta, particularly in rural areas where Canada’s larger financial institutions have a limited presence. This role underpins DBRS Morningstar’s view of the likelihood of support from the Province for the System and Alberta Central, if necessary. The System continues to maintain strong market shares despite competing against ATB Financial, the banking arm of the provincial government, as well as the large Canadian banks. We estimate that credit unions have a market share of about 9% in deposits, 7% in residential mortgages, and 7% in commercial loans.
Earnings Combined Building Block (BB) Assessment: Good/Moderate
The System generates relatively stable recurring earnings and strong profitability. However, a high operating cost structure and limited sources of fee-based income constrain the ratings. Following the deterioration in its financial performance in 2020 as a result of the challenging economic environment, the System’s net income before patronage and dividends increased 77% year over year (YOY) to $209.5 million in F2021. This was largely driven by higher net interest income and provision reversals. The loan growth of 4.4% YOY and lower funding cost supported a 10-basis-point increase of net interest margin to 2.3% in 2021. A net recovery of the performing loan provision reflected improvements in the near-term economic outlook and lower loan default expectations.
Risk Combined Building Block (BB) Assessment: Good
The bulk of the System’s credit risk is in the commercial loans and leases portfolio, including real estate lending, which remains highly sensitive to economic activity. The System’s asset quality, as measured by the percentage of gross impaired loans (GIL), normalized to the pre-pandemic level at 0.5% of gross loans in 2021 following a modest deterioration in 2020. The asset quality improvement mirrors an increase in loans returning to performing status across all asset classes. Amid the ongoing global pandemic, the System’s write-offs have remained manageable, reflecting the quality of the collateral and generally solid underwriting practices of the System. However, DBRS Morningstar notes that government stimulus and support programs have also provided substantial mitigation, the conclusion of which could pressure asset quality in the medium term.
Funding and Liquidity Combined Building Block (BB) Assessment: Good
The System’s funding and liquidity profile remains strong, reflecting the solid retail deposit franchises of the credit unions in Alberta and their low reliance on market-sensitive wholesale funding. System liquidity is represented by deposits at Alberta Central, with the statutory component of these deposits placed in high-quality liquid assets. While liquidity in the System remained strong during the pandemic, the ratio of liquid assets to total assets declined to 13.1% at year-end (YE) 2021 from 14.2% at YE2020. This level is still lower than its Canadian credit union system peers; however, DBRS Morningstar views liquidity levels as sufficient, given the low risk business model of credit unions together with the existence of an unlimited deposit guarantee that is explicitly backed by the provincial government of Alberta.
Capitalization Combined Building Block (BB) Assessment: Good
The System’s capital position is among the strongest compared with other DBRS Morningstar-rated Canadian credit union systems. The System maintains capital buffers that are sufficient for credit unions to absorb losses under stressed operating conditions. The capital ratio remained stable at 16.8% in 2021 and members' equity as a percentage of total assets improved slightly to 9.9%. The quality of the System’s capital base is high, with the primary capital constituting more than 95% of total capital. However, DBRS Morningstar notes that sources of new capital are limited to capital generated internally and the issuance of subscription shares, which is a constraint on the ratings.
Further details on the Scorecard Indicators and Building Block Assessments can be found at https://www.dbrsmorningstar.com/research/392883.
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.
For more information on this credit or on this industry, visit www.dbrsmorningstar.com.
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