DBRS Confirms Affinity Credit Union at R-1 (low) with a Stable Trend

DBRS Limited (DBRS) confirmed Affinity Credit Union’s (Affinity) Short-Term Instruments rating and Short-Term Issuer Rating at R-1 (low). The trends on both ratings are Stable. DBRS previously assigned a Support Assessment (SA) of SA2, which is based on DBRS’s expectation of timely systemic external support from the Province of Saskatchewan (Saskatchewan; rated AA/R-1 (high) with Stable trends by DBRS) through Credit Union Central of Saskatchewan (SaskCentral; rated R-1 (low) with Stable trends by DBRS), particularly in the form of liquidity, which is reflected in Affinity’s short-term ratings.

KEY RATING CONSIDERATIONS
The confirmation and Stable trend reflects Affinity’s prominent position in Saskatchewan, where it has been designated a provincially significantly important financial institution. Indeed, Affinity is the second-largest credit union in the Province by assets and the largest in terms of the membership base and total deposits. Positively, Affinity has benefited from relatively strong member growth, as well as improving operating efficiency through investments in its operational infrastructure and branch rationalizations. Overall, the balance sheet remains strong with funding sourced mainly from core retail deposits, top-tier liquidity levels and solid capital cushion. The ratings also consider relatively large single-party exposures that represent some concentration risk in the commercial loan portfolio, as well as its expansion into Regina, where another credit union is firmly entrenched.

RATING DRIVERS
Although Affinity is well placed in its short-term rating category, continued improvement in membership growth and revenues per member could bring positive ratings pressure. A significant increase in the proportion of revenues coming from fee-based income would also be viewed positively by DBRS.

Conversely, sustained loss of market shares in loans or deposits could pressure short-term ratings. Also, losses in the loan portfolio because of unforeseen weakness in the underwriting and/or risk management process could also negatively impact ratings.

RATING RATIONALE
Affinity is one of two credit unions in Saskatchewan with a provincial reach. Consequently, it holds significant market shares of commercial, agricultural and residential mortgage loans in Saskatoon. As at F2017, Affinity held 11.3% of agricultural loans, 10.3% of commercial loans, 5.9% of residential mortgage loans and 9.1% of deposits in Saskatchewan. Competition for loans and deposits remains intense in Saskatchewan, particularly against Canada’s large banks. However, Affinity maintains a strong competitive position in smaller-sized commercial and agricultural loans, where the large banks are generally less active. Affinity has also demonstrated good membership growth, which indicates its strong franchise.

Affinity has generated good growth in recurring earnings over the last five years. These have been sufficient to cover higher provisioning expenses during recent periods of stress triggered by lower oil prices. Notably, provisions as a percentage of income before provisions and taxes has not exceeded 30% over the last five years. Overall, Affinity’s net income grew by 2.5% year over year in 2017 benefiting from solid average net loans growth of 4.1% and a stable net interest margin. Results have also benefited from improving operating efficiency, which is among the strongest relative to credit union peers across Canada. Specifically, the operating efficiency ratio improved to 70.3% in 2017 from 71.3% in 2016 primarily reflecting cost rationalization initiatives.

Affinity’s risk profile remains good. DBRS notes that losses remain low and manageable, despite cyclical increases in loan impairments. Loan losses have ranged from 5 basis points (bps) to 16 bps for the combined retail and commercial portfolio over the last five years. This performance is due to good underwriting practices. In particular, about 90% of the loan portfolio is either secured through real estate with low loan-to-value ratios, government guaranteed or cash secured. The ratio of gross impaired loans to gross loans increased to 107 bps in 2017 from 83 bps in the prior year, significantly above the five-year average of 49 bps. This increase was due to some large single-party exposures, cyclical factors related to lower oil prices and a recessionary environment in Saskatchewan in 2016 and 2017.

Affinity is funded largely through member-sourced core retail deposits, which are considered to be stable by DBRS. The retail base is granular and there is limited reliance on less stable institutional deposits. DBRS assesses Affinity’s funding sources to be well aligned with its lending activities; Affinity has the lowest ratio of gross loans to deposits in comparison to DBRS-rated credit unions in Canada. Affinity’s liquidity position has strengthened over the last five years and also compares favourably to peers. As a result of its strong liquidity position and access to committed lines of credit from major Canadian financial institutions, DBRS views Affinity as well placed to withstand a stressed environment.

DBRS considers Affinity’s capital cushion as providing a solid capital base to absorb a stressed level of loan losses. The total capital ratio improved in F2017 to 13.7% from 13.4% in the prior year and remains significantly ahead of regulatory requirements. Also, based on its internal capital adequacy assessment process, DBRS concludes that Affinity maintains a sufficient capital cushion. Positively, Affinity has been designated as a provincially systemically important institution (P-SIFI). Effective January 1, 2019, this brings maintenance of a capital conservation buffer and stronger regulatory oversight, both of which imply a stronger capital position for Affinity.

Notes:
All figures are in Canadian dollars unless otherwise noted.

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.dbrs.com.

The principal methodology is Global Methodology for Rating Banks and Banking Organisations (July 2018), which can be found on dbrs.com under Methodologies.

Lead Analyst: Sohail Ahmer, Vice President, Canadian Financial Institutions Group
Rating Committee Chair: Michael Driscoll, Managing Director, Head of NA FIG, Global FIG

The rated entity or its related entities did participate in the rating process for this rating action. DBRS had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

For more information on this credit or on this industry, visit www.dbrs.com.