SECTOR OUTLOOK 3Q14. Ontario Credit Unions and Caisses Populaires. In This Issue

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1 Ontario Credit Unions and Caisses Populaires SECTOR OUTLOOK 3Q14 November 2014 In This Issue Summary Results.Page 1 Sector Financial Highlights.Page 5 Sector Financial Statements..Page 6 Selected Performance Trends...Page 8 The information presented in this report has been prepared using a variety of sources, including unaudited reports submitted to DICO by Ontario s credit unions and caisses populaires. While DICO believes that the information contained in this report would be useful to readers, and considers the financial statements to be reliable, their accuracy and completeness cannot be guaranteed. Ce document est également disponible en français. Contact Us info@dico.com Summary Results 3Q14 Selected Aggregate Sector Performance Indicators As at September Total Assets Class 1 Institutions (millions) $443 $471 Total Assets Class 2 Institutions (millions) $40,897 $37,818 Total Sector Assets (millions) $41,340 $38,289 Number of Class 1 Institutions Number of Class 2 Institutions Total Number of Insured Institutions Number of Members (000 s) 1,552 1,567 Regulatory Capital (Aggregate Leverage Ratio) 7.06% 7.18% # institutions not meeting minimum regulatory capital level 0 1 Class 1 Institutions (Leverage) 8.47% 8.35% Class 2 Institutions (Leverage) 7.06% 7.18% Class 2 Institutions (BIS) 13.63% 13.70% Liquidity Class 1 Institutions 24.32% 28.60% Liquidity Class 2 Institutions 10.20% 11.09% Asset Growth 7.97% 7.00% Total Loan Delinquency (greater than 30 days) 0.86% 1.03% Commercial Loan Delinquency (greater than 30 days) 1.39% 1.77% Year to Date (annualized) Net Interest Income (Financial Margin) 2.22% 2.27% Other Income 0.57% 0.59% Return on Average Assets (ROAA) Class 1 Institutions 0.27% 0.23% ROAA Class 2 Institutions 0.39% 0.42% Total Sector ROAA 0.39% 0.41% Return on Regulatory Capital 5.50% 5.78% Efficiency Ratio (before dividends & interest rebates) 79.8% 80.6% Unless stated otherwise, all figures reported are as at 3Q14. Capital Aggregate regulatory sector capital decreased to 7.06% or $2.91 billion from 7.18% at 3Q13. Retained earnings represented approximately 62% ($1.8 B) of regulatory capital, investment and patronage shares accounted for 35% ($1.0 B) with the balance being membership shares of 3% ($74 million). Year over year, retained earnings grew 8.6%. While credit unions with $1 billion or more in assets are expected to stress test their capital under various risk scenarios to determine the impact on capital levels, institutions with assets greater than $500 million are encouraged to consider including stress testing as part of their annual planning process. Operating with capital levels just 3Q14 SECTOR OUTLOOK, November

2 ELECTRONIC PUBLICATION: The Sector Outlook is available in PDF format (readable using Adobe Acrobat Reader) and can be downloaded from the Insured Institution section on DICO s website at NOTE : Income Statement results are based on aggregate year to date annualized information for each institution. Comparative results may not always agree with previously reported information for the same period as a result of additional information received after the reporting date. Results are based on the latest available information as at October 27, sufficient to support operations in normal economic periods, or worse, where capital is near regulatory minimums, can potentially put an institution at risk in the event of a sudden economic downturn. Also, lower capital levels may result in higher premiums under the new Differential Premium System. Growth Sector consolidation continued over the last twelve months, with the number of credit unions decreasing by 15 to 118 and resulting in the average size increasing to approximately $350 million. Year over year, the number of Class 1 institutions declined by 5 to 23 and the average asset size increased from $17 million to $19 million due to the removal of smaller institutions. While the number of Class 2 credit unions declined by 10 to 95, aggregate assets grew approximately 8.1% resulting in average total assets per institution of $431 million. Total sector assets grew by almost 8.0% to $41.3 billion, largely due to growth in residential mortgage loans (11%), agricultural loans (12.2%), and commercial loans (9.7%). The following table outlines the changes in the number and average size of loans from 2012 to The average size of agricultural loans has increased by 15.1% over the past 2 years, commercial loans by 14.1% and residential loans by 9.6%. Due to the increasing size of loans, institutions are reminded that prudent underwriting practices should be used when pricing loans, including testing the impact of increases in loan rates on the borrower s ability to pay. Number of Residential Average Size of Residential Number of Commercial Average Size of Commercial Number of Agricultural Average Size of Agricultural $ ,242 $ 134,489 30,997 $ 326,631 8, , ,983 $ 127,066 30,831 $ 299,477 8,499 $ 155, ,221 $ 122,675 29,975 $ 280,573 8,426 $ 144,689 Year over year, total deposits grew by 5.6% matching the five year historical deposit growth trend. Term deposits increased by $250 million quarter over quarter increasing the annual growth rate from 3.2% last quarter to 5.4%. The annual growth rate in demand deposits decreased from 6.7% to 6.2% quarter over quarter. A sustained shift in deposits from demand to term would be a positive development, improving asset/liability matching and removing the variability associated with demand deposits. Deposits are growing at a slower rate than loans requiring an increase in other sources of funding, typically, securitization and borrowings. Increasing dependence on external sources of funding could result in increased risk arising from: Reduced access to borrowing if economic conditions worsen; Reliance on securitization requires that new deals can be placed in the marketplace. Negative changes in the economy or lower limits under CMHC or NHA programs could result in limits on this funding source. Further details are provided in the Liquidity and Borrowing section in this report. Profitability The low interest rate environment continued to constrain financial margin and is expected to persist into However, on the positive side, following many years of decreasing gross interest and investment income, it appears this trend may be beginning to level off aided by increasing mortgage yields helping to decrease it by 3bps. In an effort to improve margins, credit unions reduced interest paid on their deposits by 7 bps and non-interest expenses by 7 bps. ROAA for Class 1 institutions increased by 4 bps 3Q14 SECTOR OUTLOOK, November

3 to 27 bps while Class 2 ROAA decreased by 3 bps to 39 bps over the last 12 months. The efficiency ratio improved to 79.8% from 80.6% in 3Q13 due mainly to a reduction in interest expenses. Credit Risk Loan costs were up slightly from 7 bps in 3Q13 to 8 bps. Gross loan delinquency greater than 30 days was 0.86%, down 17 bps from 1.03% in 3Q13, continuing the downward trend from the high of 1.61% reached during the 2008 recession. Delinquencies were down in all categories, most notably in commercial loans, which declined to 1.42% from 1.78%. The reported total amount of impaired commercial loans, however, has increased by 18.2% to $203 million since 3Q13 due mainly to a $30 million increase at one credit union. Agricultural loan delinquency was unchanged year over year at 0.95% but up from 0.84% in the previous quarter due largely to increased delinquencies at two credit unions. Agricultural loans may present a higher risk than other types of loans as repayments are dependent on the success of crops and livestock. Rising rates could present a risk to the loan portfolio as the cost of borrowing increases and affects the ability of borrowers to make their payments. Current rate forecasts present the view that there is expected to be a measured pace to rate increases with a total rise in interest rates of 75 bps over a 12 to 15 month period after the start of rate increases beginning sometime in late 2015 or early This timeframe and anticipated pace of the overall rate increases should help minimize the risk to credit unions as members have time to adjust their borrowing to within affordable limits. Despite this prediction, loan underwriting should test the borrowers ability to pay using higher interest rates to determine their tolerances to a sudden unexpected increase in rates. Loan Mix and Yields Personal loans increased slightly by $13 million year over year, to $3.0 billion. However, they continue to represent a declining portion of the loan mix (down from 9.0% to 8.3% of the total loan portfolio) as other loan categories experience substantial growth. For example, residential mortgage loans with 11% growth and commercial loans with 9.7% growth. The following chart illustrates the current mix of the loan portfolio and yields versus the values from 3Q13 and their impacts on gross interest revenues. The decrease in earnings from lower interest rates in the past year is estimated at $1.5 million and is due to lower yields on agricultural, commercial and personal loans, offset to a large degree by higher mortgage yields. The notional impact of the change in portfolio mix on gross interest revenues is estimated to be a decrease of $4.7 million. Product % of portfolio Change ($M) % Change Yield 3Q 2014 Yield 3Q 2013 Notional impact (in Millions) on gross interest revenues due to change in portfolio mix interest rates Personal 8.3% 9.0% $ % 6.01% 6.22% (15.3) (5.8) Mortgage 59.1% 58.4% $ 2, % 3.85% 3.74% Commercial 28.3% 28.3% $ % 4.79% 4.94% (0.0) (14.2) Agricultural 4.4% 4.3% $ % 4.06% 4.28% 1 (3.2) Total 100% 100% (4.7) (1.5) While loan yields for all other products continue to decline, mortgage yields increased for the first time in several years as lenders begin to price in the expected increases in bond rates over the next few years. Higher mortgage yields would be good news for credit unions as mortgage interest comprises a large portion of revenue. Demand for new mortgages remains strong and is expected to continue in the near future until any 3Q14 SECTOR OUTLOOK, November

4 amelioration effects arising from increases in the Bank of Canada rate forecast to begin in late Credit unions should be conducting stress testing on their Mortgage Loan portfolio to determine the effects on the performance of these loans in the event of a possible correction in residential housing prices. Selected Loan Yields * As at September 30 (%) Total Personal Residential Mortgage Commercial Agricultural *Loan Yields adjusted for securitizations. Liquidity and Borrowings Year over year borrowings increased 38% due predominately to securitization of residential mortgages. Securitizations have increased by 35.1% since 3Q13 to $2.39 billion. Holdings of liquid assets declined by $50 million to $3.90 billion resulting in the liquidity ratio falling to 10.35% from 11.30% in 3Q13, its lowest level in ten years. The following chart shows how liquidity has reduced in asset size categories greater than $100 million. The movement of assets into less liquid assets could reduce an institution s ability to meet their obligations. To ensure sufficient funding exists, credit unions are encouraged to conduct liquidity stress testing under various scenarios. Institution by Total Assets Liquidity (%) September 30, 2014 September 30, 2013 Less than $50 million $50 million to $100 million $100 million to $250 million $250 million to $500 million $500 million to $1 billion Greater than $1 billion New Differential Premium System Implementation The new Differential Premium System comes into effect in 2015 and applies to all credit unions with a fiscal year commencing January 1. Using latest information available, under the new system it is estimated that 18 credit unions may pay a higher premium rate, with the remaining 100 credit unions either paying the same or a lower premium rate. Preliminary analysis suggests the credit unions that may experience an increase in rates are the result of lower capital levels. The estimated average premium rate is anticipated to fall from $1.11 per $1,000 of insured deposits in the current fiscal year to $1.07 in Q14 SECTOR OUTLOOK, November

5 Sector Financial Highlights 3Q 2014 ONTARIO SECTOR Selected Bank Information % average assets*, Year to date at... 3Q Q Q 2014 PROFITABILITY Net Interest and Investment Income 2.22% 2.27% 1.74% Loan Costs 0.08% 0.07% 0.16% Other (non-interest) Income 0.57% 0.59% 1.71% Total Income 2.71% 2.79% 3.28% Total Non-Interest Expenses (Operating Expenses) 2.23% 2.30% 2.10% Net Income/(Loss) before T axes and 0.48% 0.49% 1.18% Non-recurring & Extraordinary items Efficiency Ratio (% Operating Expenses to Total Income) 82.24% 82.57% 76.96% Efficiency Ratio (% Operating Expenses, before dividends & interest rebates to Total Income) 79.75% 80.57% 63.96% Return on Average Assets (ROA) before dividends etc. 0.48% 0.48% Return on Average Assets (ROA) 0.39% 0.41% 0.95% Return on Regulatory Capital before dividends etc. 6.68% 6.69% 18.92% Return on Regulatory Capital 5.50% 5.78% 10.38% CREDIT RISK, as at the quarter-end Gross Delinquency greater than 30 days (% of total loans) 0.86% 1.03% Gross Delinquency greater than 90 days (% of total loans) 0.45% 0.60% OFF BALANCE SHEET ACTIVITY Off balance Sheet Assets ($millions) 6,889 5,857 (Includes mutual fund sales and administered loans etc.) Income on Off Balance Sheet Activity ( % Other Income) 16.54% 14.81% OTHER INDICATORS, as at the quarter-end T otal Number of Active Insured Institutions T otal Assets ($ millions) 41,340 38,289 3,873,056 Average Assets per insured institution ($ millions) Median Assets ($ millions) Regulatory Capital 7.08% 7.19% (as a percentage of net assets) Number of Insured Institutions below 5% Capital 3 3 Liquidity 10.35% 11.30% * Year to date annualized unless otherwise stated. Totals may not agree due to rounding 3Q14 SECTOR OUTLOOK, November

6 Sector Financial Statements Balance Sheet 3Q 2014 ONTARIO SECTOR 3Q Q Q Q 2013 ($000) ($000) (Percentage of Total Assets) ASSETS Cash and Investments 4,895,377 5,037, % 13.2% Personal 2,964,754 2,952, % 7.7% Residential Mortgage 21,148,018 19,057, % 49.8% Commercial 10,124,909 9,233, % 24.1% Institutional 52,163 59, % 0.2% Unincorporated Association 28,293 21, % 0.1% Agricultural 1,480,264 1,319, % 3.4% Total 35,798,402 32,643, % 85.3% Total Loan Allowances 134, , % 0.3% Capital (Fixed) Assets 430, , % 1.0% Intangible & Other Assets 350, , % 0.9% Total Assets 41,340,603 38,289, % 100.0% LIABILITIES Demand Deposits 13,264,821 12,494, % 32.6% T erm Deposits 11,759,626 11,154, % 29.1% Registered Deposits 9,098,019 8,670, % 22.6% Other Deposits 237, , % 0.6% Total Deposits 34,359,719 32,542, % 85.0% Borrowings 3,359,488 2,437, % 6.4% Other Liabilities 711, , % 1.6% Total Liabilities 38,430,405 35,577, % 92.9% MEMBERS' EQUITY & CAPITAL Membership Shares 74,084 75, % 0.2% Retained Earnings 1,817,927 1,674, % 4.4% Other Tier 1 & 2 Capital 1,004, , % 2.5% Accumulated Other Comprehensive Income 13,540 2, % 0.0% Total Members' Equity & Capital 2,910,198 2,712, % 7.1% Total Liabilities, & Members' Equity & Capital 41,340,603 38,289, % 100.0% Totals may not agree due to rounding 3Q14 SECTOR OUTLOOK, November

7 Sector Financial Statements Income Statement 3Q 2014 ONTARIO SECTOR Canadian Chartered Banks ** Percentage of Average Assets * 3Q Q Q 2014 Interest and Investment Income Loan Interest Income 3.47% 3.47% 2.20% Investment Income 0.25% 0.29% 0.45% Interest Expense 3.73% 3.76% 2.65% Interest Expense on Deposits 1.25% 1.32% 0.67% Interest Rebates & Dividends on Share Capital 0.00% 0.00% Dividends on Investment Capital & Other Capital 0.08% 0.09% Other Interest Expense 0.17% 0.07% Other Interest Expense and Dividends 0.26% 0.16% 0.24% 1.51% 1.49% 0.91% Net Interest & Investment Income 2.22% 2.27% 1.74% Loan Costs 0.08% 0.07% 0.16% Net Interest & Investment Income after Loan Costs 2.14% 2.20% 1.58% Other (non-interest) Income 0.57% 0.59% 1.71% Net Interest, Investment & Other Income 2.71% 2.79% 3.28% Non-interest Expenses Salaries and Benefits 1.22% 1.25% 1.10% Occupancy 0.22% 0.22% 0.34% Computer, office & other equipment 0.21% 0.23% Advertising & Communications 0.15% 0.16% Member Security 0.10% 0.10% Administration 0.21% 0.21% Other 0.12% 0.14% 0.67% 2.23% 2.30% 2.10% Net Income/(Loss) Before Taxes and Nonrecurring 0.48% 0.49% 1.18% & Extraordinary items Non-recurring & Extraordinary gains/(losses) 0.00% 0.00% 0.00% Taxes 0.09% 0.07% 0.24% Minority Interests 0.00% 0.00% 0.00% Net Income/(Loss) 0.39% 0.41% 0.95% Average Assets ($000) 40,126,462 37,466,598 3,816,526 * Year to date annualized ** Source: Canadian Bankers Association, Detailed Financial Statistics. Totals may not agree due to rounding. 3Q14 SECTOR OUTLOOK, November

8 Selected Financial Trends 12.00% Selected Growth Trends 4.00% Selected Performance Trends 0.80% 10.00% 8.00% 3.75% 3.50% 3.25% 0.70% 0.60% 0.50% 6.00% 3.00% 0.40% 4.00% 2.00% 2.75% 2.50% 2.25% 0.30% 0.20% 0.10% 0.00% Assets Deposits 2.00% Financial Margin (L) Gross Margin (L) Operating Expenses (L) ROA (R) 0.00% 20.0% 15.0% Loan Growth 10.00% 9.00% 8.00% Loan Yields 10.0% 7.00% 5.0% 0.0% 6.00% 5.00% 4.00% 5.0% 3.00% Personal Mortgages Commercial Total Personal Mortgages Commerical Total 3.50% 3.00% 2.50% 2.00% 1.50% 1.00% 0.50% 0.00% Loan Delinquencies Greater than 30 Days Personal Mortgages Commercial Total $4,000 $3,500 $3,000 $2,500 $2,000 $1,500 $1,000 $500 $ 2009 Liquidity, Total Borrowings and Securitization % 14.00% 13.00% 12.00% 11.00% 10.00% 9.00% 8.00% 7.00% Total Borrowings in $millions (L) Securitizations in $millions (L) Liquidity Ratio (R) 0.30% Loan Cost and Return on Assets 0.70% 12.0% Deposit Growth 0.25% 0.20% 0.15% 0.60% 0.50% 0.40% 10.0% 8.0% 6.0% 4.0% 0.10% 0.30% 2.0% 0.05% 0.20% 0.0% 1Q Q Q Q Q Q Q Q % Loan Costs (L) ROA (R) 0.10% Demand Deposits Yearly Growth Registered Deposits Yearly Growth Average Total Deposit Growth Rate Term Deposits Yearly Growth Total Deposits Yearly Growth 3Q14 SECTOR OUTLOOK, November