DBRS Limited (DBRS Morningstar) confirmed Innovation Credit Union’s (Innovation or the Credit Union) Short-Term Issuer Rating and Short-Term Instruments rating at R-1 (low) with Stable trends. Innovation’s Support Assessment (SA) is SA2, which reflects DBRS Morningstar’s expectation of timely systemic external support from the Province of Saskatchewan (Saskatchewan or the Province; rated AA (low) with a Stable trend by DBRS Morningstar) through Credit Union Central of Saskatchewan (SaskCentral; rated R-1 (low) with a Stable trend by DBRS Morningstar), particularly in the form of liquidity. At present, the SA2 designation does not result in any uplift for Innovation’s Short-Term Instruments rating.
KEY RATING CONSIDERATIONS
The ratings reflect Innovation’s solid franchise within its operating area, tempered by its moderate size, and the benefits of its membership in the well-established credit union system. Innovation’s above-average revenue per member underpins its good earnings power, which supports the ratings. Innovation presents solid asset-quality metrics, with most of the loan book secured against real estate. Moreover, the Credit Union’s pending move to a federal charter, while ultimately a potential growth engine, could pose some initial funding challenges and has led to an increase in expenses as the Credit Union prepares for a new primary regulator.
Over the longer term, sustained membership growth resulting in increased scale or a significant improvement in earnings metrics, especially through the growth of noninterest income and/or improved efficiency, would lead to an upgrade. Ratings would be downgraded should Innovation be unable to manage funding as it moves to a federal charter, causing potential deposit outflows. Furthermore, a material and sustained weakness in financial performance or a substantial deterioration in asset quality, especially from deficiencies in risk management, would lead to a ratings downgrade.
Innovation is the third-largest credit union in Saskatchewan with $3.3 billion in assets as of December 31, 2022. The Credit Union serves nearly 12% of the Province’s credit union system membership base through 26 advice centres in its footprint area and provides retail and small business commercial offerings, as well as an active digital platform. With approximately 59,500 members, Innovation has consistently grown its membership base since 2014, although member growth slowed in 2022 as the Credit Union paused incentive campaigns to focus on the digital onboarding experience.
In July 2018, Innovation submitted its formal application to the Office of the Superintendent of Financial Institutions (OSFI) and continues to work with all counterparties to finalize its federal charter application in 2023. In DBRS Morningstar’s opinion, while Innovation has strong fundamentals, the proposed conversion to a federal credit union raises significant uncertainties about its prospects, especially with respect to funding. With federal continuance, deposit insurance of up to $100,000 per account from the Canada Deposit Insurance Corporation, a federal Crown corporation, would replace Innovation’s previously unlimited deposit insurance coverage under Saskatchewan’s Credit Union Deposit Guarantee Corporation; thus, the Credit Union could potentially experience deposit outflows from retail and institutional depositors. Furthermore, although a federal charter would provide Innovation with access to prospective new members or retail customers, especially through online platforms, remote deposit acquisition might come at a higher cost than expected, given the highly competitive dynamics in a space that includes the large banks, other online platforms, and local credit unions.
Innovation generated good earnings in 2022 on strong revenue growth, and lower provision for credit losses (PCL), further bolstered by a one-time $30.9 million dividend from SaskCentral’s sale of Concentra Bank to Equitable Bank (note all quoted earnings metrics are adjusted to exclude this dividend). Overall, noninterest income formed about 16% of operating revenue in 2022, putting Innovation at the lower end of its peer group. The Credit Union seeks to replace income lost as a result of the 2020 sale of its insurance subsidiaries as required for federal continuance. The Credit Union continues to enjoy one of the highest net interest margins among its peers. Net Interest Margin improved by 50 basis points (bps) year over year (YOY) to 2.85% in 2022, driven by improving spreads in a rapidly rising interest rate environment and a continued shift in the balance sheet structure. The Credit Union’s efficiency ratio modestly improved YOY, by 95 bps, to a still-elevated 76.8% in 2022. PCL declined by 54% in 2022 to $3.4 million from $7.4 million in the previous year to form 13.4% of income before provisions and taxes.
Net loans grew 18.2% YOY to $2.7 billion in 2022, driven by the Credit Union’s strategic partnerships with third parties to purchase residential and commercial mortgages that fall within its risk appetite in order to offset a decline in loans sourced directly from members. Purchased loans now make up 36% of the total loan portfolio and have contributed to significant geographic diversification over the past two years. Agricultural loans have a long track record of strong performance, and there are currently zero impaired loans within this sector; however, DBRS Morningstar remains cautious that an uncertain economic outlook or pricing pressure in the agricultural sector could lead to increased impairments. Overall, impairment levels declined to 0.28% of gross loans from 0.94% in 2021, which can largely be attributed to the resolution of a large commercial relationship. Furthermore, net write-offs remain manageable, forming 0.38% of average net loans, given that the majority of the loan book is secured either through real estate or government guarantees.
Innovation maintains prudent levels of liquidity, with commercial and retail deposit funding remaining resilient. The Credit Union is largely funded through stable retail and business deposits. However, the majority of 2022 deposit growth was sourced from the broker channel to form 11% of total deposits. The Credit Union also has access to wholesale funding in the form of securitized borrowings via the Canada Mortgage Bonds program. In addition, Innovation has various sources of liquidity, including credit facilities with SaskCentral and several other large financial institutions, and reported a robust liquidity coverage ratio of 778% (184% using OSFI’s calculation), well above the regulatory minimum of 100%. While the Credit Union has not seen any core deposit runoff, its strong liquidity position should provide a buffer to meet increased liquidity needs from any potential deposit outflows related to federal continuance.
DBRS Morningstar views the Credit Union’s capitalization levels as good with a sizable cushion over regulatory and internal minimums to absorb potential losses. Innovation’s Common Equity Tier 1 ratio, which is based on Basel III requirements, stood at 14.59% in 2022, an improvement of 79 bps from the previous year.
ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
Social (S) Factors
DBRS Morningstar views the Social Impact of Products and Services ESG subfactor as relevant to the credit rating, but it does not affect the assigned ratings or trends. As a credit union, Innovation operates a membership-based community banking model where the social aspect of its activities strengthens its franchise. As a result, this factor is incorporated into the Credit Union’s Franchise Strength grid grades.
There were no Environmental or 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 (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; 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 credit rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.
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 rating was initiated at the request of the rated entity.
The rated entity or its related entities did participate in the rating process for this rating action.
DBRS Morningstar had access to the accounts, management and other relevant internal documents of the rated entity or its related entities in connection with this rating action.
This is a solicited credit rating.
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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