DBRS Limited (DBRS Morningstar) confirmed Affinity Credit Union’s (Affinity or the Credit Union) Short-Term Issuer Rating and Short-Term Instruments rating at R-1 (low). All trends remain Stable. Affinity’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 (rated R-1 (low) with a Stable trend by DBRS Morningstar), particularly in the form of liquidity. In addition, Affinity has been designated a Provincial Systemically Important Financial Institution, which increases the likelihood that systemic external support will be forthcoming. At present, the SA2 designation does not result in any uplift for the Short-Term Instruments rating.
KEY RATING CONSIDERATIONS
The rating confirmations and Stable trends reflect the expectation that Affinity will maintain its strong position in Saskatchewan, particularly in the city of Saskatoon, the Province’s largest city and business hub. Affinity is the largest credit union in the Province by assets and deposits. Overall, Affinity generates sufficient levels of recurring earnings, despite a compressing net interest margin and still low operating efficiency. Its balance sheet remains strong, with funding sourced mainly from core retail deposits, high liquidity levels, and solid capital cushion. The ratings are constrained by a relatively low share of noninterest income and large single-party exposures that represent some concentration risk in the commercial loan portfolio compared with most credits in the same rating category.
Over the longer term, DBRS Morningstar would upgrade Affinity’s ratings if the Credit Union is able to further strengthen its franchise through a sustained increase in membership resulting in a material improvement in financial performance and higher levels of noninterest income.
Conversely, a ratings downgrade would occur should there be significant losses in the loan portfolio or a perceived weakness in loan underwriting and/or risk management. Furthermore, material and sustained weakness in financial performance would also lead to a ratings downgrade.
Affinity maintains a solid franchise in Saskatoon and has a growing presence in Regina, the two largest cities in Saskatchewan. At the end of F2022, Affinity served 12% of the provincial population through 56 advice centres across 47 communities in the Province. To further optimize its footprint, the Credit Union is expecting to close additional advice centres in 2023 but will still have the largest physical distribution network among financial institutions operating in the Saskatchewan market. Following the contraction period associated with the Coronavirus Disease (COVID-19) pandemic, Affinity’s membership base grew 1.1% to about 143,100 in 2022, lagging slightly compared with provincial population growth. Affinity continues to target membership growth in the younger demographic, particularly in Saskatoon, Canada’s youngest city. In its strategic plan for 2022–24, Affinity intends to further expand its provincial market share.
Affinity generates sufficient levels of recurring earnings with about 75% of its revenue composed of net interest income. Net income grew 86.6% year over year (YOY) to about $120 million in 2022, primarily reflecting a large dividend of $68.3 million from the sale of Concentra Bank (rated BBB (high) with a Stable trend by DBRS Morningstar). Excluding this one-time gain, Affinity's net earnings declined by a significant 20% to $51.1 million for the same period (but remained higher compared with previous years), driven predominantly by lower noninterest income and higher expenses as well as provision for loan losses compared with a recovery in 2021. Despite strong loan growth and higher interest rates, the net interest margin as calculated by DBRS Morningstar contracted 8 basis points (bps) YOY to 2.26% in 2022, which reflects the Credit Union's strategic objective of competitive pricing both on loans and deposits. As a result of margin pressure and higher expenses, Affinity’s adjusted efficiency ratio deteriorated to 65.4% in 2022 from 60.0% in the prior year. Affinity expects the efficiency ratio to improve in 2024 on the back of higher revenue and reduced costs associated with the Credit Union's branch consolidation plan.
Affinity has a good risk profile supported by generally conservative underwriting policies and practices. Asset quality metrics for the Credit Union are sensitive to concentration risk, particularly in the commercial segment where cyclical performance of Saskatchewan’s key industries can result in asset quality deterioration. Gross impaired loans decreased by 46 bps to 1.16% of gross loans in 2022. This was predominantly driven by a 96-bp reduction in commercial impaired loans as a result of write-offs in commercial loans. Even with the write-offs, losses remain low. Meanwhile, both the consumer and agricultural portfolios remained resilient and experienced some reduction in the level of impaired loans. DBRS Morningstar expects Affinity's credit quality metrics to somewhat deteriorate in 2023 amid economic challenges associated with higher interest rates and inflation.
Affinity’s funding remains good with prudent levels of liquidity. The Credit Union is funded largely through member-sourced deposits, which DBRS Morningstar views as stable. Total deposits grew 5% YOY, reaching $6.4 billion in 2022. Amid an increased interest rate environment, term deposits grew 19.9%, while demand deposits shrank by 7.9% as members locked in higher yields following a prolonged low-rate environment. As a result, term deposits represented 52% of total funding at the end of 2022 compared with 45% in the prior year. Together, demand and term deposits accounted for 99% of total funding in 2022. Liquid assets decreased to 19.3% of total assets in 2022 compared with 21.1% in 2021. Nevertheless, Affinity’s liquidity remains sufficient to withstand a stressed environment.
Affinity maintains sound capitalization that provides a sufficient capital cushion for the Credit Union to absorb losses in a stressed environment. Supported by strong retained earnings, the total capital ratio increased by 190 bps to 16.7% in 2022, well above the minimum regulatory requirement of 11.5%. The quality of Affinity’s capital is strong, with 97% of total capital composed of Tier 1 capital. The Credit Union's minimum capital target by policy remained at 12.5%, or 1% greater than the regulatory minimum in 2022.
ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
Social (S) Factors
DBRS Morningstar views the Social Impact of Products and Services ESG subfactor as relevant to the credit ratings, but it does not affect the assigned ratings or trends. As a credit union, Affinity 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; 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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