Concentra Financial Services Association

Transcription

1 Rating Report Previous Report: May 26, 2014 Analysts Robert Long, CFA John van Boxmeer, CFA The Company Concentra is Canada s only cooperative financial services association, a federally legislated form of financial institution. It was formed from Cooperative Trust Company of Canada and a number of other former business units of Credit Union Central of Saskatchewan. Concentra Ratings Debt Rating Rating Action Trend Issuer Rating A (low) New Rating Stable Short-Term Instruments R-1 (low) Confirmed Stable Rating Rationale On June 29, 2015, DBRS Limited (DBRS) assigned an Issuer Rating of A (low) to Concentra (Concentra or the Company) and confirmed its Short-Term Instruments rating at R-1 (low) with Stable trends. The Issuer Rating reflects an intrinsic assessment of BBB (high) and a support assessment of SA2. DBRS continues to anticipate a high level of implied support from Credit Union Central of Saskatchewan (SaskCentral) because of the strategic importance of the Company to SaskCentral and the Saskatchewan credit union system (the System); however, ongoing efforts to diversify away from Concentra s traditional base in the Prairies suggest that direct support at the SA1 level may no longer be appropriate. DBRS has therefore assigned an SA2 support assessment to Concentra, with SaskCentral and the Canadian credit union system in general providing the support. On a stand-alone basis, Concentra s primary strength is in its relationship with the credit union system throughout Canada, with particularly strong roots in the Prairie Provinces. Its profitability is better than many other institutions operating in the credit union space and other strengths include asset quality and liquidity. Concentra s major challenges include size-related issues and improving its funding base (quality, cost and diversification). Concentra has been improving its financial risk profile in a number of ways in recent years. Funding avenues are becoming more diverse, with new committed lines and the development of access to the nominee deposits market. Interest rate exposure, which in the past has resulted in volatility in profitability and internal capital generation, has improved. It will be important for Concentra to maintain this more disciplined approach with regard to interest rate risk management, as well as maintaining high levels of liquidity. On December 18, 2014, Concentra and Central 1 Credit Union (Central 1) announced the signing of a Memorandum of Understanding exploring the possibility of combining their respective trust services, securitization, derivatives, commercial lending, credit union lending, foreign exchange and funding operations; discussions are ongoing. DBRS expects that a deal, should it occur, would be an encouraging event for the Company, although limited market size and scale are expected to remain challenges for Concentra. Rating Considerations Strengths (1) Relationship with the co-operative network (2) Relationship with SaskCentral (3) Strong asset quality (4) Highly liquid balance sheet Challenges (1) Limited market size (2) risk profile could be strengthened (3) Comparative scale (4) Regulatory developments Information 1 Institutions: Credit Unions (DBRS Calculated) ($millions) Operating Expense/Operating Revenue 55.4% 51.5% 54.2% 59.1% 55.7% Net Interest Margin 1.06% 1.18% 1.23% 1.40% 1.56% Tier 1 Capital Ratio (Basel II) n.a. n.a. 12.7% 12.4% 13.1% Common Equity Tier 1 (Basel III) 13.2% 13.3% n.a. n.a. n.a. Net Impaired Loans/Net Loans 0.10% 0.38% -0.08% 0.03% 0.07% Gross Impaired Loans/ Common Equity & Reserve 8.20% 11.37% 3.84% 6.76% 8.75% Operating Profit Earnings bef. Non-Recurring to Members & Owners Common Equity Total Assets 6,746 6,058 5,820 5,576 5,233

2 Rating Considerations Details Strengths (1) Relationship with the co-operative network. Concentra enjoys many benefits of being associated with Canada s co-operative business network. While other financial services providers could offer some of these services to Concentra s clients, the links to credit unions, credit union centrals and other co-operative organizations provide relationship advantages that are not available to outside organizations. Although the credit union clients could potentially offer some assistance should Concentra come under stress, the likelihood is not definite enough for explicit consideration in DBRS s rating. (2) Relationship with SaskCentral. While there are no guarantees in place, Concentra is strategically important to SaskCentral. The two organizations share office space and some expenses. From the System s perspective, Concentra supplies services to Saskatchewan credit unions that are integral to SaskCentral s mandate, including managing offerings for deposits in excess of statutory requirements and facilitating system funding programs, including loan purchase, syndication and securitization programs. Concentra supplies some risk management, asset/liability reporting and partial back-office services to SaskCentral. SaskCentral has critical financial ties to Concentra in its ownership of 84% of Concentra (a $226 million investment equivalent to about 59% of SaskCentral s own equity at year-end) and a $100 million line of credit. As a result, DBRS has ascribed a high level of implied support, now reflected in the support assessment of SA2. (3) Strong asset quality. Asset quality is strong, with a substantial proportion of the loan book in low-risk loans, including residential mortgage loans, credit unions, municipalities and schools. (4) Highly liquid balance sheet. Concentra s balance sheet remains highly liquid, with on-balance sheet liquid assets, particularly government securities, representing a good portion of non-securitized assets. Liquidity is further enhanced with the line of credit from SaskCentral and facilities from third-party financial institutions. The portfolio of residential mortgages not securitized (particularly insured residential mortgages) provides a secondary source of liquidity. Challenges (1) Limited market size. Although Concentra has opportunities to increase market penetration within the credit union system throughout Canada (with the exception of Québec), its chosen market niche is limited by the absolute size of the credit union system in Canada. In addition, a number of credit unions have grown in size to a level that they can provide many of the services Concentra provides in house, further restricting the potential customer base. (2) risk profile could be strengthened. Although liquidity is strong and duration mismatches in asset/liability management have improved relative to past years, there is room for improvement in other aspects of Concentra s financial risk profile. Although the Company has broadened its deposit base to include nominee deposits, the combination of nominee, wholesale and broker-sourced deposits and securitization is a funding profile less diverse than many large-scale financial institutions. (3) Comparative scale. Although Concentra is a market leader in providing services to Canadian credit unions, it remains a comparatively small financial institution in the overall market, particularly in the securitization of residential and commercial real estate loans. The potential combination with Central 1 s trust services, securitization, derivatives, commercial lending, credit union lending, foreign exchange and funding operations would reduce but not eliminate this challenge. (4) Regulatory developments. Concentra is federally regulated by the Office of the Superintendent of Institutions (OSFI) and, with OSFI ceasing to regulate credit union centrals in the near future, it will be the only federally regulated institution in the credit union space (short of a credit union successfully applying for a federal mandate). It is unclear if the differing federal/provincial regulatory frameworks could become a problem in the event that Concentra faces challenges. 2 Institutions: Credit Unions

3 Rating Drivers Factors with Positive Rating Implications Improved franchise strength Increased scale Description of Operations Factors with Negative Rating Implications Market share losses Sustained reduction in profitability An increase in credit risk Evidence of trouble funding at a reasonable cost Change in the assessment of SaskCentral s ability or willingness to provide support Concentra, Canada s first and only co-operative financial services association, was formed by the continuance of Co-operative Trust Company of Canada on December 31, On January 1, 2005, SaskCentral sold a substantial portion of its assets that were not required for statutory liquidity management purposes to the new entity. While SaskCentral currently holds an 84.3% economic interest in Concentra, it only holds a 47.1% voting interest since, by statute, this type of business cannot be controlled by SaskCentral. Minority voting shareholders include the other provincial credit union centrals and other co-operative financial institutions. Concentra remains closely associated with SaskCentral, in some cases with shared resources. Concentra s mandate is to offer services to credit unions nationally. offered primarily include financial intermediation, management of credit union deposits in excess of statutory liquidity held with provincial centrals and facilitation of investment opportunities and funding requirements available to credit unions, which includes buying credit union loans, syndicating and securitizing loans, leasing services as well as personal and corporate trust services (through wholly owned subsidiary, Concentra Trust). One key product is to provide access to the National Housing Act Mortgage Backed Securities and Canada Mortgage Bond programs to the credit unions. Earnings and Outlook Adjusted Return on Average Total Equity 8.1% 10.0% 12.9% 12.0% 17.6% Adjusted Return on Average Total Assets 0.36% 0.45% 0.56% 0.50% 0.66% Loan Loss Provision/Operating Profit 17.8% 12.9% 8.6% 4.5% 11.7% Operating Expense/Operating Revenue 55.4% 51.5% 54.2% 59.1% 55.7% Salaries and Benefits/Operating Revenue 32.8% 31.3% 32.8% 36.4% 29.4% Operating Profit/Operating Revenue 44.6% 48.5% 45.8% 40.9% 44.3% Effective Tax Rate 26.3% 26.0% 13.0% 18.2% 12.0% Net Interest Spread 0.97% 1.08% 1.13% 1.30% 1.47% Net Interest Margin 1.06% 1.18% 1.23% 1.40% 1.56% Net Interest Income/Operating Revenue 78.3% 81.5% 79.2% 89.0% 79.4% Total Dividend & Patronage Payout 13.6% 19.1% 18.3% 34.2% 31.1% Concentra s net income declined by $3.4 million to $23.2 million in Operating revenue was essentially unchanged in 2014 compared with 2013 as lower net interest income, service charges and higher losses on derivatives were offset by gains on financial instruments. Net interest income declined on some margin compression, which was partially offset by loan growth. Service charges declined primarily as a result of lower foreign exchange income caused by the lower Canada/U.S. exchange rate. Operating expenses increased by 9%, driven by higher personnel costs and higher professional fees (including legal costs related to commercial loans). The higher cost levels reduced efficiency, driving the cost-to-income ratio to 55.4% in 2014 compared with 51.5% in Loan-loss provisions relative to operating profit increased to 17.8% in 2014 from 12.9% in 2003 as a result of one commercial exposure combined with higher collective provision. The tax rate remained relatively steady following a large increase in 2013; consequently, Concentra can no longer claim a credit union deduction for which it was previously eligible. 3 Institutions: Credit Unions

4 The Company targets a range of 8% to 12% return on common equity (ROE), which it managed to achieve in ROE has been under pressure for several years as a result of margin compression and, for the last two years, the higher tax rate. Outlook Like most, if not all, lenders, Concentra s earnings are under pressure from the low interest rate environment; continued low interest rates will result in ongoing headwinds on net interest margins. Any increase, should it occur, could improve the outlook. In the longer term, the Company s national expansion strategy may allow for further opportunities to generate earnings growth. Risk Liquid Assets & Other Securities/Total Assets 18.4% 19.0% 18.2% 20.1% 19.1% Average Loans/Average Interest Earning Assets 80.9% 80.9% 80.1% 79.5% 79.4% Demand Deposits/Total Deposits 20.8% 19.4% 22.5% 22.5% 21.9% Deposits/Net Loans 70.4% 64.1% 57.6% 64.3% 75.7% Common Equity Tier 1 (Basel III) 13.2% 13.3% n.a. n.a. n.a. Tier 1 Capital Ratio (Basel II) n.a. n.a. 12.7% 12.4% n/a Total Capital Ratio* 17.8% 18.7% 19.1% 16.7% n/a Assets to Capital Multiple n/a Common Equity/Total Assets 4.3% 4.5% 4.4% 4.2% 4.0% Adjusted Internal Equity Growth 7.0% 8.0% 10.6% 7.9% 12.1% Shareholders' Equity/Total Assets 4.4% 4.6% 4.4% 4.3% 4.0% 4 Institutions: Credit Unions Concentra s liquidity and funding profile is adequate. While strong liquidity levels are maintained, the overall profile is limited by the dependence on nominee, broker-sourced and wholesale deposits. The Company does have the ability to ramp up funding activity should it choose to do so. Concentra has made positive steps in reducing its dependence on wholesale funding, notably through establishing retail nominee platforms with large Canadian banks, which provide access to a differentiated source of longer-term deposits relative to prior funding channels. The nominee deposit channel has materially reduced wholesale deposit reliance in favour of retail deposits; retail deposits accounted for 64% of deposits at the end of 2014, up from 45% at the end of The majority of wholesale deposits are credit union deposits in excess of mandatory liquidity requirements (primarily from the Prairie Provinces). The credit union deposits have historically been fairly stable in nature, providing a secure funding base, albeit one that must pay market or near-market rates. While DBRS does not view brokered deposits as contributing to the strength of the business franchise, the fixed maturity dates do provide benefits in liquidity planning and asset/liability matching. Other sources of funding include the company s $300 million short-term promissory note program. Concentra remains relatively liquid, with liquid assets of $1.2 billion representing 18.4% of total assets at yearend. The quality of Concentra s securities portfolio, which was already strong, was further enhanced in advance of the implementation of OSFI s Liquidity Coverage Ratio (LCR). The securities are generally short term in nature, which is supportive of liquidity. Other sources of liquidity include lines of credit with SaskCentral ($100 million), a $500 million tri-party bank syndicate facility backed by residential mortgages and credit facilities related to securities repurchase agreements (policy maximum of $500 million). The portfolio of residential mortgages not securitized (particularly insured residential mortgages) provides an additional potential source of liquidity. The maintenance of high levels of liquidity is an important factor for the rating. Concentra adopted the Basel III capital framework effective January 1, Concentra s capital ratios remain above regulatory guidelines, with a Common Equity Tier 1 Ratio of 13.2% at YE2014 relative to OSFI s 7.0% minimum requirement. While at an acceptable level, Concentra s ownership constraints, relatively small size and nominee/broker/wholesale funding dependence suggest that it should generally be managed with comparatively higher capital levels. In 2014, adjusted internal capital generation declined to 7.0% from 8.0% a year earlier, although it would have been lower if Concentra had not reduced its dividend rate. Dividends are paid early in the year, based on prior-year earnings.

5 The affiliation with SaskCentral continues to positively influence Concentra s financial risk profile with respect to capital as a result of implied support. Interest rate risk has improved dramatically from historical levels when management assumed significant risk through balance-sheet positioning, resulting in revenue volatility either through net interest income or realized or unrealized gains and losses on derivatives and securities. Outlook Concentra was in compliance with the LCR at YE2014 (required in January 2015) and expects to be in compliance with the Net Stable Funding Ratio when it becomes mandatory in January Funding diversity efforts are likely to continue at the Company with a focus on reducing wholesale deposit reliance. DBRS expects Concentra to maintain interest rate risk consistent with current levels and, accordingly, much lower than historical levels. Risk Profile Asset Quality and Outlook Loan Loss Provision/Operating Profit 17.8% 12.9% 8.6% 4.5% 11.7% Loan Loss Provision/Average Net Loans and BA's 0.13% 0.11% 0.08% 0.04% 0.13% Gross Impaired Loans/Gross Loans 0.47% 0.67% 0.22% 0.38% 0.47% Gross Impaired Loans/ Common Equity & Reserve 8.2% 11.4% 3.8% 6.8% 8.8% Net Impaired Loans/Net Loans 0.10% 0.38% -0.08% 0.03% 0.07% Loan Loss Reserves/Gross Loans 0.37% 0.29% 0.29% 0.35% 0.40% Loan Loss Reserves/Gross Impaired Loans 79.6% 43.8% 134.8% 92.0% 85.7% Collective Allowance/Risk Weighted Assets 0.57% 0.46% 0.51% 0.46% 0.65% The Company s overall asset quality remains strong. The loan portfolio is relatively lower risk with a high weighting of residential mortgages. Gross impaired loans to gross loans declined to 47 basis points (bps) in 2014 from 67 bps in 2013; the improvement was largely the result of the full recovery of one significant commercial loan located in Saskatchewan that was impaired at the end of Loan-loss provisions as a percentage of operating profit increased to 17.8% as a result of a separate single-name exposure combined with higher collective provision associated with growth in the commercial loan book. Provisions remain well covered by operating profit and remain at a reasonable level. Concentra s loan portfolio is geographically diverse with 36% of the loans made in Ontario, 25% in Alberta, 17% in Saskatchewan, 13% in British Columbia and 9% elsewhere in Canada. About 75% of the Company s loan portfolio is in low-risk residential mortgage lending, resulting in a solid base of high-quality assets. (DBRS notes that about 61% of this portfolio represents securitizations that do not qualify for de-recognition.) The remaining 25% of the portfolio is largely commercial and credit union loans. Although the bulk of credit risk lies in the commercial lending area, exposure remains at acceptable levels. As with most Canadian lenders, Concentra has notable exposure to the Canadian residential mortgage market. Any slowdown in this market may slow earnings generation, while a downturn in the residential mortgage market could hurt asset-quality indicators and ultimately have an impact on provisioning levels (for the relatively small levels of uninsured mortgages on Concentra s books). 5 Institutions: Credit Unions

6 Securities The asset quality of the securities portfolio is very strong, with over 99% of securities having an R-1 (low) or an A rating or better. Net Loan Portfolio Commercial loans* 1, Commercial mortgages Credit union loans Residential mortgages 4, , , , ,083.9 Accrued interest Total Net Loans 5, , , , ,162.9 * includes Commercial mortgages and credit union loans beginning in 2014 Commercial loans 25.0% 4.0% 4.9% 8.3% 9.5% Commercial mortgages 19.4% 19.7% 12.5% 10.7% Credit union loans 2.7% 4.0% 5.4% 5.3% Residential mortgages 74.9% 73.6% 71.2% 73.4% 74.1% Accrued interest 0.2% 0.3% 0.3% 0.4% 0.4% Total Net Loans 100.0% 100.0% 100.0% 100.0% 100.0% Outlook Concentra s asset mix suggests that its asset quality will remain strong, although some headwinds should be anticipated from loan exposure to the Alberta and Saskatchewan economies. Ongoing compliance with the LCR suggests that the securities portfolio will remain at very high quality. Rating Methodologies The applicable methodologies are Global Methodology for Rating Banks and Banking Organisations (June 2014), Rating Canadian Credit Union Centrals and Desjardins Group (December 2014) and Criteria: Support Assessment for Banks and Banking Organisations (March 2015), which can be found on the DBRS website under Methodologies. The methodologies identify how funding and liquidity are assessed for banking organizations in general. 6 Institutions: Credit Unions

7 Balance Sheet (millions) Assets Cash and Securities Trading Securities Available-for-Sale Securities 1, , , , Residential Mortgages 4, , , , ,078.8 Other Loans 1, , , , ,084.0 Fixed Assets Goodwill and Intangibles Derivative Instruments Other Assets Total Assets 6, , , , , ,471.5 Liabilities and Equity Total Deposits 3, , , , ,151.9 Subordinated Debt Other Debt 2, , , , ,735.3 Repos Derivatives Other Liabilities Total Liabilities 6, , , , ,021.3 Common Equity Preferred Equity Total Equity Total Liabilities and Equity 6, , , , ,232.7 Income Statement (millions) Interest Income Interest Expense Net Interest Income Service Charges Securitization Revenue Other Non-Interest Income (5.7) 5.2 Operating Revenue Salaries and Benefits Other Expenses Total Operating Expenses Operating Profit Provision for Credit Losses Adjusted Pre-Tax Income Adjusted Income Tax Adjusted Total Earnings Non-Recurring Items Reported Total Earnings After Tax Dividends Institutions: Credit Unions

8 Ratings Debt Rating Rating Action Trend Issuer Rating A (low) New Rating Stable Short-Term Instruments R-1 (low) Confirmed Stable Rating History Debt Current Short-Term Instruments R-1 (low) R-1 (low) R-1 (low) R-1 (low) R-1 (low) R-1 (low) Issuer Rating A (low) NR NR NR NR NR 8 Institutions: Credit Unions Notes: All figures are in Canadian dollars unless otherwise noted. For the definition of Issuer Rating, please refer to Rating Definitions under Rating Policy on Generally, Issuer Ratings apply to all senior unsecured obligations of an applicable issuer, except when an issuer has a significant or unique level of secured debt. 2015, DBRS Limited, DBRS, Inc. and DBRS Ratings Limited (collectively, DBRS). All rights reserved. The information upon which DBRS ratings and reports are based is obtained by DBRS from sources DBRS believes to be reliable. DBRS does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance. The extent of any factual investigation or independent verification depends on facts and circumstances. DBRS ratings, reports and any other information provided by DBRS are provided as is and without representation or warranty of any kind. DBRS hereby disclaims any representation or warranty, express or implied, as to the accuracy, timeliness, completeness, merchantability, fitness for any particular purpose or non-infringement of any of such information. In no event shall DBRS or its directors, officers, employees, independent contractors, agents and representatives (collectively, DBRS Representatives) be liable (1) for any inaccuracy, delay, loss of data, interruption in service, error or omission or for any damages resulting therefrom, or (2) for any direct, indirect, incidental, special, compensatory or consequential damages arising from any use of ratings and rating reports or arising from any error (negligent or otherwise) or other circumstance or contingency within or outside the control of DBRS or any DBRS Representative, in connection with or related to obtaining, collecting, compiling, analyzing, interpreting, communicating, publishing or delivering any such information. Ratings and other opinions issued by DBRS are, and must be construed solely as, statements of opinion and not statements of fact as to credit worthiness or recommendations to purchase, sell or hold any securities. A report providing a DBRS rating is neither a prospectus nor a substitute for the information assembled, verified and presented to investors by the issuer and its agents in connection with the sale of the securities. DBRS receives compensation for its rating activities from issuers, insurers, guarantors and/or underwriters of debt securities for assigning ratings and from subscribers to its website. DBRS is not responsible for the content or operation of third party websites accessed through hypertext or other computer links and DBRS shall have no liability to any person or entity for the use of such third party websites. This publication may not be reproduced, retransmitted or distributed in any form without the prior written consent of DBRS. ALL DBRS RATINGS ARE SUBJECT TO DISCLAIMERS AND CERTAIN LIMITATIONS. PLEASE READ THESE DISCLAIMERS AND LIMITATIONS AT ADDITIONAL INFORMATION REGARDING DBRS RATINGS, INCLUDING DEFINITIONS, POLICIES AND METHODOLOGIES, ARE AVAILABLE ON