DBRS Limited (DBRS Morningstar) confirmed Credit Union Central Alberta Limited’s (Alberta Central or the Credit Union) Long-Term Issuer Rating and Long-Term Senior Debt at “A.” DBRS Morningstar also confirmed the Credit Union’s Short-Term Issuer Rating and Short-Term Instruments at R-1 (low). All trends remain Stable. 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 Positive 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
Alberta Central’s ratings reflect the System’s significant share of loans and deposits in Alberta and its important economic role in the province, particularly in rural communities and small towns. DBRS Morningstar notes that the competitive landscape remains challenging for credit unions in Alberta, particularly with respect to growing their membership base. Positively, the System’s asset quality remains solid, exhibiting low and manageable levels of write-offs. The ratings also reflect our expectation that asset quality metrics may modestly deteriorate from their current levels as the economy weakens. The System also benefits from stable funding sources and strong levels of capitalization.
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. These credit unions collectively held on balance sheet assets of $30.5 billion in Q3 2022, which grew 6.7% compared with the same period of 2021. 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. Despite a 9.7% increase in total revenue, the System’s net income declined by 7.2% year over year (YOY) to $143.5 million in the first nine months of 2022. This was driven by operating expense, which increased by 13.7% during the same period on higher personnel and general expenses. As a result, the System efficiency ratio deteriorated to 72.6% in Q3 2022 from 70.0% for the same period of 2021. The contribution of noninterest income remained low at 20.4% of total revenue as of Q3 2022, although noninterest income expanded by 3.8% YOY to $135.4 million during the first nine months of 2022.
Risk Combined Building Block (BB) Assessment: Good
Overall, the System’s loan book expanded 7.9% YOY to $26.4 billion as of Q3 2022, largely supported by an 11.7% increase in commercial loans and leases and a 4.2% growth in residential mortgages. 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, normalized to the pre-pandemic level at 0.5% of gross loans in 2021 following a modest deterioration in 2020. Gross impaired loans stood at 0.37% as of Q3 2022. The asset quality improvement mirrors an increase in loans returning to performing status across all asset classes. The System’s write-offs have remained manageable, reflecting the quality of the collateral and generally solid underwriting practices of the System.
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. The System’s ratio of liquid assets to total assets declined to 13.1% at YE2021 from 14.2% at YE2020 and stood at 11.8% as of Q3 2022. This level is 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 16.1% as of Q3 2022, and members' equity as a percentage of total assets reduced slightly to 9.7% in Q3 2022 from 9.9% in YE2021. 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/405872.
ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
DBRS Morningstar finds the social impact of products and services ESG factor is relevant to the credit rating but does not affect the assigned ratings or trends. The credit union Systems play an integral role in providing banking services to local communities and funding to small and medium-size businesses and underbanked areas. The credit union Systems operate on a community banking model where the social aspect of their activities strengthens their franchises, without the requirement or need to maximize profitability. As a result, DBRS Morningstar incorporated this factor into Alberta Central’s Franchise Strength grid grades.
There were no Environmental//Governance factors that had a significant or relevant effect on the credit analysis.
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/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (May 17, 2022).
All figures are in Canadian dollars unless otherwise noted.
The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (June 23, 2022; https://www.dbrsmorningstar.com/research/398692). In addition DBRS Morningstar uses the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings, https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (May 17, 2022) in its consideration of ESG factors.
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.
The conditions that lead to the assignment of a Negative or Positive trend are generally 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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