Credit Unions and Caisses Populaires SECTOR OUTLOOK 4Q17 February 2018

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1 In This Issue Summary Results... 1 Sector Financial Highlights... 7 Sector Financial Statements... 8 Selected Performance Trends The information presented in this report has been prepared using the unaudited year-end financial filings submitted by credit unions and caisses populaires to DICO and as such their accuracy and completeness cannot be guaranteed. Income Statement results are based on aggregate year-to-date annualized information for each credit union. Results are based on the latest available information received by January 31, Throughout this document, unless specifically indicated otherwise, credit union refers to both credit unions and caisses populaires. Credit Unions and Caisses Populaires SECTOR OUTLOOK 4Q17 February 2018 Summary Results Selected Aggregate Sector Performance Indicators As at December Total Sector Assets (millions) $57,237 $51,876 Credit Unions (% of Total Sector Assets) 87.1 Caisses Populaires (% of Total Sector Assets) Total Number of Credit Unions and Caisses Populaires Number of Credit Unions Number of Caisses Populaires Avg. Asset Size of Credit Unions and Caisses Populaires ($millions) $616 $524 Number of Members (000 s) 1,654 1,609 Regulatory Capital (Aggregate Leverage Ratio) 7.15% 7.02% Credit Unions (Leverage) 6.81% 6.68% Caisses Populaires (Leverage) 9.39% 9.22% Regulatory Risk Weighted Capital Ratio (Class 2 only) 13.75% 13.59% Credit Unions 13.12% 12.99% Caisses Populaires 17.91% 17.44% Number not meeting minimum regulatory capital level 0 0 Liquidity 10.40% 11.31% Credit Unions 10.76% 11.84% Caisses Populaires 7.81% 7.72% Asset Growth 10.3% 11.2% Total Loan Delinquency (greater than 30 days) 0.67% 0.70% Credit Unions 0.60% 0.67% Caisses Populaires 1.08% 0.89% Commercial Loan Delinquency (greater than 30 days) 0.93% 1.07% Credit Unions 0.89% 1.09% Caisses Populaires 1.23% 0.98% Ce document est également disponible en français. ELECTRONIC PUBLICATION: The Sector Outlook is available in PDF format (readable using Adobe Acrobat Reader) and can be downloaded from the Publications section on DICO s website at Contact Us: info@dico.com Net Interest Income (Financial Margin) 1.97% 1.94% Other Income 0.53% 0.56% ROAA 0.39% 0.32% Return on Regulatory Capital 5.46% 4.53% Efficiency Ratio (before dividends & interest rebates) 78.3% 81.8% Credit Unions 81.4% 84.0% Caisses Populaires 61.8% 69.8% Unless stated otherwise, all figures reported are as at 4Q17. 4Q17 SECTOR OUTLOOK February

2 Economic Overview On January 17, 2018, The Bank of Canada (BOC) increased the overnight rate by 25 bps to 1.25%, the highest level since Factors that led to BOC s decision included stronger than expected economic data in the second half of 2017, increased confidence in the future from Canadian businesses, a falling unemployment rate, and inflation close to target of 2%. Rising interest rates should have a cooling effect on growth and help keep inflation near the 2% target. The BOC remains concerned about household debt levels. According to the Bank of International Settlements, Canada has the fourth highest risk of a debt crisis in the world behind Hong Kong, China and Singapore as real estate prices are extremely high and may be prone to a price correction. Additionally, BOC continues to monitor the uncertainty surrounding NAFTA which could potentially reduce investment in Canada. In 2017, the housing market started off strong with home prices increasing at more than 20% year over year for the first four months. The implementation of new municipal and provincial rules regarding new home purchases in the second quarter of 2017, aimed at slowing down the rise in housing prices, resulted in a cooling of housing prices in the GTA over the summer months. Two increases in the BOC s overnight rate in 2017 and one in early 2018 have further tempered the pace of house price increases and reduce the probability of a housing market crash. The Office of the Superintendent of Financial Institutions (OSFI) amended guideline B-20: Residential Mortgage Underwriting Practices and Procedures came into effect January 1, As a result, buyers were incented to complete their purchases before the new stress testing rules came into place and housing sales were up in November and December. The housing market has experienced robust growth since the global financial crisis of 2008, supporting economic growth in the country. However, this growth was fueled by consumers taking on record levels of household debt to income (currently at 171% of income) while taking advantage of the low interest environment. The effects of rising interest rates on those with high debt levels should be carefully monitored as the ability to service these debt levels may become more difficult. Capital Aggregate regulatory capital for the sector increased to $4.09 billion from $3.60 billion year-overyear. The leverage ratio (as a percent of total assets) increased to 7.15% from 7.02% (required regulatory minimum is 4%), however, risk weighted capital, as measured through the BIS ratio, increased to 13.75% from 13.59% year-over-year (required regulatory minimum is 8%) as growth in total assets outpaced earnings. Capital consisted of: 1. Retained earnings of $2.44 B (59.7%), up $212 million year over year; 2. Investment and patronage shares of $1.58B (38.7%), up $278 million year over year; and 3. Membership shares of $63.1 million (1.6%), down $1.5 million year over year. During 2017, four capital offering statements closed raising approximately $260 million. While all credit unions are above the minimum capital requirements, they are encouraged to continually review their growth strategies and future requirements to ensure the credit union is sustainable. Credit unions should ensure their capital management stress testing models appropriately reflect additional increases in interest rates and resulting impacts from the tightening of mortgage lending rules. Growth The sector has continued to consolidate over the last twelve months with the number of credit unions decreasing by six to 93 with an average asset size of $616 million. The number of credit unions declined by five to 69 with an average asset size of $722 million compared to caisse populaires which 4Q17 SECTOR OUTLOOK February

3 decreased by one to 24 with an average asset size of $308 million. These amalgamations should result in larger, more stable entities capable of achieving greater economies of scale. Total assets for Ontario credit unions grew at a rate of 10.3% to $57.2 billion over the past year. This was largely due to growth in residential mortgage loans of 15.3%, agricultural loans at 9.6% and commercial loans at 9.3%. In comparison, asset growth for Canadian banks was 2.3% in Residential mortgages as a percentage of total loans has increased to 61.2% from 58.1% and commercial loans have increased to 29.9% from 27.9% over the past five years. The decrease in personal loans of $435.8 million was due largely to a credit union reclassifying Home Equity Line of Credit loans (HELOCs) to residential mortgage loans resulting in an increase in residential mortgage loans. The disproportionate growth in credit unions assets versus banks assets is largely due to credit unions having a much higher percentage of residential mortgages (61.2% at credit unions versus 25% to 30% at banks) along with increasing average mortgage size due to rising housing prices as demonstrated in the following table: Sector Lending Activity 4Q Q Q 2012 % of % of % of $ $ $ Total Total Total Billions Billions Billions Residential Mortgage $ % $ % $ % Commercial $ % $ % $ % Agricultural $ % $ % $ % Personal $ % $ % $ % Other $ % $ % $ % Total $ % $ % $ % Total deposits grew by 9.9%, higher than the five-year average deposit growth trend of 7.8%. Term deposit growth led the way with year-over-year growth of 15.7%, followed by demand deposits at 10.2% and registered deposits at 4.9%. In the past, U.S. dollar deposits that were documented as Other Deposits have now been reclassified as term and demand deposits categories. Loan growth is outpacing the growth in deposits resulting in the differential growing to 8.7% or $4.3 billion (7.4% in 4Q16) of loans. Efficiency Ratio Sector Average Credit Unions Caisses Populaires Banks 4Q % 81.4% 61.8% 55.3% 4Q % 84.0% 69.8% 56.2% The overall efficiency ratio (before dividends and interest rebates) for the credit union sector strengthened to 78.3% from 81.8% in 4Q16 largely as the result of slower growth in salaries and benefits as compared to assets, occupancy costs and administration, however, it still remains significantly higher than large Canadian banks (55.3% at 3Q17). Collectively, caisses populaires continue to report efficiency ratios of 61.8% that are closer to bank results and more favourable than ratios reported by the credit unions (81.4%) due to their integrated model where many back-office functions are centralized. This is illustrated by the fact that salaries and benefits for caisses populaires were 27 bps lower than credit unions (87 bps vs. 114 bps) in 4Q17. On January 1, 2018, twelve caisse populaires amalgamated to create one new caisse populaire that further consolidates the sector and should result in greater operational efficiencies. 4Q17 SECTOR OUTLOOK February

4 Profitability: Increasing Marginally Return on average assets (ROAA) increased to 39 bps in 4Q17, 7 bps higher year over year. The following table provides the income and expense breakdown for the sector over the last 5 years. Breakdown of Income and Expenses for Sector (as a percentage of total assets) 4Q17 4Q16 4Q15 4Q14 4Q13 Interest and Investment Income 3.34% 3.33% 3.52% 3.75% 3.77% Other Income 0.53% 0.56% 0.58% 0.55% 0.59% Total Income 3.87% 3.89% 4.10% 4.30% 4.36% Interest Expense 1.06% 1.07% 1.17% 1.27% 1.31% Dividend Expense 0.31% 0.32% 0.31% 0.29% 0.18% Loan Costs 0.04% 0.06% 0.09% 0.09% 0.09% Total Expenses 3.48% 3.57% 3.83% 3.94% 3.91% Net Income 0.39% 0.32% 0.27% 0.36% 0.45% There has been a 43 bps decrease in interest and investment income (11.4% decrease) over the last five years due to declining and sustained low interest rates. In response, credit unions have reduced interest paid on members deposits however, this was partially offset by increased dividends paid over the same time period. Favorable loan experience has kept loan costs low. When the recent interest rate increases begin to be priced into new loans and investments, this should allow credit unions to increase the spreads between interest income and interest expenses resulting in increased revenue. Non-interest expenses (1.99% in 4Q17) decreased by 8 bps year over year over but remain higher than the banks (1.72% in 2Q17). Although the BOC raised the overnight rate to 1.25% at its January meeting, additional increases in 2018 are forecasted that is expected to have a positive effect on the credit unions overall profitability. Out of 93 credit unions, eight have a negative return on assets. DICO closely monitors credit unions that are unprofitable, identifies core challenges and works with the credit unions to develop strategies to resolve the situation with the intention of returning to profitability. Credit Risk Gross loan delinquency greater than 30 days continues to improve and represented 67 bps of total loans, down 3 bps from 0.70% in 4Q16. The improvement was due mainly to lower delinquencies in commercial loans (0.93% vs.1.07%) and agricultural loans (0.76% vs. 1.00%). The following chart illustrates fluctuations in delinquencies greater than 30 days over the past ten years for different loan types. Residential mortgage delinquencies are now at the lowest level since the recession. Loan costs decreased by $12 million to $16.3 million or 0.04% of average assets from 0.06% the prior year and are at their lowest level seen over the past 10 years. Four large credit unions accounted for majority of the decrease. 4Q17 SECTOR OUTLOOK February

5 3.00% Loan Delinquencies - Greater than 30 Days 2.50% 2.00% 1.50% 1.00% 0.50% 0.00% Personal Mortgages Commercial Total Should the BOC decide to further increase interest rates, there is a greater probability that the sector could experience an increase in delinquencies and loan costs as highly leveraged borrowers may begin to have trouble servicing their debt loads. Loan Yields Year & Quarter Personal Types of Loan Yields Mortgage Commercial Agricultural Total 4Q % 3.60% 4.40% 3.34% 4.06% 4Q % 3.68% 4.37% 3.52% 4.09% 4Q % 3.74% 4.57% 3.74% 4.21% 4Q % 3.84% 4.81% 4.17% 4.37% 4Q % 3.67% 4.90% 4.18% 4.33% Total loan yields have decreased to 4.06% from 4.09% in 4Q16 led by decreasing residential mortgage yields (3.60% versus 3.68% in 4Q16) and agricultural yields (3.34% versus 3.52%) offset slightly by the increase in commercial yields to 4.40% from 4.37%. As mentioned earlier, $430 million in personal loans (HELOCs) were reclassified to mortgage loans which increased the yield for personal loans and decreased yields for mortgage loans. As the effect of the 75 bps increase in interest rates since July 2017 are priced into new loans, yields should begin to rise. Liquidity and Borrowings While total deposits increased by 9.9% year-over-year, liquid assets only increased by 1.6% ($85 million) to $5.43 billion which resulted in a decrease in liquidity ratio to 10.40% from 11.31%. For the purpose of the calculation, securitization was included in the calculation. Liquidity ratios at individual credit unions ranged from 4.37% to 56.37%. The average liquidity at caisses populaires (7.81%) remains much lower than at credit unions (10.76%). This lower level of liquidity is due mainly to the ability of some caisses to access the Fédération des caisses Desjardins du Québec for funding should it be required. In comparison, liquidity of Canada s banks was approximately 11%. The following chart provides a breakdown of liquidity sources. The largest source of liquidity is Deposits in a League or Central (80.8%), followed by Deposits in deposit taking institutions (6.8%). 4Q17 SECTOR OUTLOOK February

6 Sources of Liquidity $ millions % of Total Liquidity $ millions % of Total Liquidity Credit unions are encouraged to stress test their liquidity requirements sufficiently to challenge the level of liquidity and develop alternative contingency strategies to resolve potential liquidity event. The difference in deposit and loan growth is being bridged by borrowings and funding provided through securitizations. On-balance sheet securitizations have increased by $484 million (9.6%) year over year to $5.8 billion while borrowings from non-securitization sources increased by $305 million (53%) to $876 million. Presently, there are two credit unions with a differential greater than 30%, seven credit unions with a differential between 20% and 30% and 11 credit unions with a differential of 10% to 20%. Credit Unions with On-Balance Sheet Securitization (in $ billions) 4Q17 $ millions % of Total Liquidity 4Q16 Total Assets $47,704 $41,775 Residential Mortgages $25,184 $20,965 Regulatory Capital + Deposits $41,132 $36,107 On-Balance Sheet Securitization $5,795 $5,286 $ millions % of Total Liquidity Deposits in a League or Central $ 4, % $ 3, % $ 3, % $ 3, % Deposits in a deposit taking institution in Canada $ % $ % $ % $ % Securities secured by mortgages and guaranteed by CMHC held for liquidity 4Q Q Q Q 2014 $ % $ % $ % $ % Commercial paper, banker's acceptances $ % $ % $ % $ % and similar instruments Cash held for liquidity $ % $ % $ % $ % Other Sources of Liquidity $ % $ % $ % $ % Total Sources of Liquidity $ 5, % $ 5, % $ 4, % $ 4, % In 4Q17, there were 31 credit unions (20 credit unions and 11 caisses populaires) with total assets of $47.7 billion (83% of sector assets) participating in the securitization programs. The range of onbalance sheet securitizations as a percentage of regulatory capital plus deposits ranged between 0% to 45%. Out of the 31 credit unions, seventeen had securitization of less than 10% of regulatory capital and deposits, ten credit unions were between 10% to 25% and four credit unions were greater than 25%. Securitization can be a beneficial tool for credit unions to use to fund their growth, however, overreliance on a single funding source increases liquidity risk. DICO will be publishing a guidance note on Securitizations in the first quarter of 2018 encouraging credit unions to take a prudent, balanced and diversified approach to funding growth to prevent overreliance on any one source. DICO is monitoring the use of securitization programs by credit unions due to the concentration of this funding source at a few credit unions. 4Q17 SECTOR OUTLOOK February

7 Sector Financial Highlights 4Q Q17 SECTOR OUTLOOK February

8 Sector Financial Statements 4Q 2017 Balance Sheet 4Q17 SECTOR OUTLOOK February

9 Sector Financial Statements 4Q 2017 Income Statement 4Q17 SECTOR OUTLOOK February

10 Selected Financial Trends Deposit Growth NOTE: L refers to the left axis and R refers to the right axis 4Q17 SECTOR OUTLOOK February