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 solid regional retail franchise in Québec and growing national reach through B2B Bank, its commercial banking segment, as well as the Bank’s expanding commercial lending 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 reflect our expectation that asset quality metrics may modestly deteriorate from their current levels as the economy weakens. The rating constraints still are LBC’s relatively high proportion of brokered deposits, higher cost base, and lower capitalization levels compared with peer averages.
The ratings would be upgraded if there is sustained improvement in LBC’s franchise momentum, resulting in improved earnings and operating efficiency.
Conversely, a ratings downgrade would occur if LBC failed to execute on the strategic initiatives, leading to heightened operational risk, lower capitalization, or a deterioration in earnings. Furthermore, a significant deterioration in asset quality, especially as a result of unforeseen weakness in underwriting and/or risk management, would also result in a ratings downgrade.
Franchise Combined Building Block Assessment: Good/Moderate
LBC is Canada’s eighth-largest Schedule I bank with assets of $50.7 billion as at October 31, 2022. 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 midmarket businesses. Under its strategic plan, unveiled on December 10, 2021, the Bank is undertaking a digital-first approach and introducing new and enhanced digital capabilities to close gaps in its Personal Banking business, particularly across mortgage, Visa, and deposit products. LBC’s retail segment faced some customer attrition, shrinking loans, and stagnant deposits over the past few years. Furthermore, the Bank continues to grow its commercial segment by targeting niches where it has developed expertise and further expanding into the U.S. market.
Earnings Combined Building Block Assessment: Moderate
The revenue base is diversified with noninterest income at 29% of total revenue in F2022. While one-time impairment and restructuring charges of $191.8 million affected F2021 results, net income increased by 297% year over year (YOY) to $226.6 million in F2022. On an adjusted basis, net income grew 12% YOY in F2022. The DBRS Morningstar calculated net interest margin was almost flat at 1.57% in F2022 supported by a 5.9% growth in net interest income on the back of higher interest revenue from commercial loans, partly offset by higher funding costs. Adjusted operating efficiency calculated by DBRS Morningstar improved to 67.7% in F2022 from 68.9% in the prior year as noninterest expenses increased only marginally. DBRS Morningstar expects the efficiency ratio to improve over the medium term as the Bank benefits from operational enhancements while maintaining better cost discipline.
Risk Combined Building Block Assessment: Strong/Good
Gross loans increased by about 11% to $37.5 billion in F2022, driven mainly by inventory financing and commercial real estate lending. The bulk of credit risk lies in the commercial book, which accounted for about 49% of total loans in F2022. The Bank continued to demonstrate a solid track record of strong asset quality with low impairments and loan losses. The gross impaired loans ratio decreased to 42 basis points (bps) at the end of F2022 from 75 bps at the end of F2021 because of both favourable repayments and write-offs of previously provisioned for commercial loans. As with the rest of the banking sector, DBRS Morningstar expects asset quality metrics may moderately deteriorate from their current levels as the economy weakens. Furthermore, 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
Following the contraction trend in recent years, LBC’s personal deposits grew in F2022, mostly because it deepened and expanded relationships with advisors and brokers (from B2B Bank). Representing about two thirds of the total funding base, personal deposits stood at $22.2 billion at the end of F2022, up 22.5% compared with the prior year end. The Bank expects to attract more direct client deposits on a national level in the coming years as it rolls out its digital capabilities, which DBRS Morningstar would view positively. In F2022, direct retail client deposits made up about 27% of total deposits compared with broker-sourced deposits at 55% of total deposits. The Bank also focuses on its debt related to securitization activities to optimize funding sources. Liquidity levels, which include cash and Government of Canada securities, are sufficient to meet the Bank’s needs, with liquid assets forming 23% of total assets in F2022.
Capitalization Combined Building Block Assessment: Good/Moderate
LBC’s capital ratios under the Standardized Approach are above regulatory minimums and provide appropriate buffers to absorb stressed levels of loan losses, but they remain below peer averages. DBRS Morningstar would view favourably a larger capital buffer, sufficient to absorb significant losses, especially as the Bank continues to grow its commercial loan book, which may be more susceptible to weakness in the event of a sustained economic downturn. The CET1 capital ratio declined to 9.1% in F2022, compared with 10.2% in the prior year. The decrease mainly resulted from growth in risk-weighted assets, especially in the commercial book, partly offset by internal capital generation.
Further details on the Scorecard Indicators and Building Block Assessments can be found at https://www.dbrsmorningstar.com/research/407422.
ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
There were no environmental, social, and governance (ESG) 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, https://www.dbrsmorningstar.com/research/398692/global-methodology-for-rating-banks-and-banking-organisations (June 23, 2022). 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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