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). The trend on all ratings is Stable. The ratings for SaskCentral reflect DBRS Morningstar’s Intrinsic Assessment of the Saskatchewan Credit Union System (the System) and a Support Assessment (SA) 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. The ratings reflect the System’s important role in the Saskatchewan economy, particularly in rural communities and small towns, along with its competitive position based on long-standing relationships in the small business and farming communities and its significant share of provincial loans and deposits. The System’s asset quality remains solid, with manageable levels of write-offs. The ratings also reflect our expectation that asset quality metrics may deteriorate from current levels as the economy weakens. The System has a focus on lending to small businesses, many of which are susceptible to downturns in Saskatchewan’s economic performance. The System also benefits from stable funding sources and adequate levels of capitalization. SaskCentral’s sale of its 84% ownership stake in Concentra Bank (Concentra) to Equitable Bank (rated BBB (high) with a Stable trend by DBRS Morningstar) closed on November 1, 2022; DBRS Morningstar views this transaction positively since it removed the contingent risk Concentra represented to the System.
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 its franchise through a sustained increase in its membership base, resulting in improved profitability and operating efficiency.
Ratings would be downgraded if the intrinsic strength of the System is reduced, or there is a material and sustained weakness in financial performance or a substantial deterioration in asset quality metrics. Additionally, a material risk increase in SaskCentral’s investment portfolio, an increase in operating risk, or a reduction in DBRS Morningstar’s assessment of the likelihood of provincial support would also result in a ratings downgrade.
Credit unions play an important role in the Saskatchewan economy, providing financial services to retail and small business and agricultural clients. An important driver of financial strength for the System is its long-standing relationships within the farming/small business communities, a segment underserved by Canada’s large banks. As at September 30, 2022, 41.5% of Saskatchewan’s population comprised members of a credit union and as at January 1, 2023, the System includes 33 credit unions servicing 197 communities through 224 service outlets, particularly in small towns and rural areas. At the end of 2021, the System held 34% of deposits, 48% of commercial loans, and 23% of residential mortgage loans. Revenue per member for the Saskatchewan System has been considerably higher than other credit union Systems in Canada, reflecting the Saskatchewan System’s stronger share of higher-yielding nonresidential lending.
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. Key metrics showed consistent results with previous years and higher than budgeted projections, led by moderate loan growth and higher interest rates. After-tax earnings totaled $125 million for year-to-date Q3 2022 and return on average assets was 0.60%. This is comparable with earnings achieved at the same period last year and 18 basis points higher than budget. Net interest margin was 2.38% as of Q3 2022 compared with 2.35% in the same period last year and the five-year average of 2.51%. The system’s efficiency ratio of 69.8% compares favourably with other credit union systems in Canada. DBRS Morningstar notes that economic conditions continue to pose a risk to future profitability levels. As the cost of borrowing goes up and becomes less appealing to members, loan growth is likely to decline and provisions are likely to increase in F2023.
The System’s credit risk metrics continue to trend downward despite interest rate increases, which are putting pressure on members’ cash flows. Loan growth had a modest increase of 5% compared with the five-year average of 3.1%. Delinquencies continued to trend downwards and were 0.82% as of Q3 2022, below the prior-year period and substantially lower than the five-year average (1.15%). Delinquencies greater than 90 days remain primarily concentrated in the commercial sector (57%), with consumer and agricultural delinquencies comprising 24% and 19% of the total. Provisions for credit losses were 0.13% as a percentage of assets as of Q3 2022, slightly up from the same period last year. Nevertheless, DBRS Morningstar expects that consumer and commercial delinquencies may rise as member cash flows become tightened as a result of inflation and higher borrowing costs from rising interest rates.
System funding is viewed as stable, given that the majority of funding is sourced through relatively sticky retail deposits from members with whom credit unions have long-standing banking relationships. In DBRS Morningstar’s opinion, the sources and uses of funds are well aligned and interest-rate risk, while increased, is manageable. Deposit growth of 3.3% in Q3 2022 was notably down from Q3 2021, as credit union members face higher interest rates and inflationary pressures. The liquidity coverage ratio declined to 210.7% in Q3 2022 compared with 247.2% in the prior year period as a result of increased loan growth, combined with a decline in asset and deposit growth and an increase in cash outflows. Nevertheless, liquidity levels remain adequate and continue to meet regulatory expectations. High quality liquid assets comprised 43% of cash and investments as of Q3 2022. 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.
Total eligible capital, as a percentage of risk-weighted assets, was 15.08% at Q3 2022. Capital levels have slightly declined from 2021 year-end results but remain well above the five-year average, which is just above 14%. Despite the downward trend, capital levels remain sufficient to cushion against downturns in business cycles and help absorb potential future losses. The quality of consolidated capital remains strong, with retained earnings comprising 94% of total eligible capital.
ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
Social (S) Factors
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, this factor is incorporated into SaskCentral’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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