Credit Unions and Caisses Populaires SECTOR OUTLOOK 2Q17

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1 Credit Unions and Caisses Populaires SECTOR OUTLOOK 2Q17 August 2017 Summary Results 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 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 Throughout this document, unless specifically indicated otherwise, credit union refers to both credit unions and caisses populaires. Selected Aggregate Sector Performance Indicators As at June Total Sector Assets (millions) $54,414 $49,303 Credit Unions (% of Total Sector Assets) Caisses Populaires (% of Total Sector Assets) Total Number of Credit Unions and Caisses Populaires Number of Credit Unions Number of Caisses Populaires Avg. Asset Size of Credit Unions and Caisses Populaires ($millions) $561 $483 Number of Members (000 s) 1,612 1,604 Regulatory Capital (Aggregate Leverage Ratio) 6.96% 7.12% Credit Unions (Leverage) 6.61% 6.88% Caisses Populaires (Leverage) 9.22% 8.64% Regulatory Risk Weighted Capital Ratio (Class 2 only) 13.38% 13.99% Credit Unions % Caisses Populaires 17.65% 16.87% Number not meeting minimum regulatory capital level 0 0 Liquidity 11.10% 10.95% Credit Unions 11.61% 11.28% Caisses Populaires 7.64% 8.79% Asset Growth 10.4% 10.4% Total Loan Delinquency (greater than 30 days) 0.52% 0.72% Credit Unions 0.49% 0.71% Caisses Populaires 0.77% 0.77% Commercial Loan Delinquency (greater than 30 days) 0.73% 1.17% Credit Unions 0.67% 1.21% Caisses Populaires 1.13% 0.95% Year to Date (annualized) Net Interest Income (Financial Margin) 1.90% 1.95% Other Income 0.53% 0.60% ROAA 0.32% 0.33% Return on Regulatory Capital 4.54% 4.51% Efficiency Ratio (before dividends & interest rebates) 79.8% 80.7% Credit Unions 82.1% 83.1% Caisses Populaires 66.8% 67.7% Unless stated otherwise, all figures reported are as at 2Q17. 2Q17 SECTOR OUTLOOK, August

2 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 NOTE : Income Statement results are based on aggregate year to date annualized information for each credit union. 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 July 21, Economic Overview In July, the Bank of Canada (BOC) raised their key interest rate for the first time in seven years by 25 bps to 0.75%. Factors influencing the decision were: lower unemployment, Q GDP growth of 3.7% and stronger than expected June employment numbers. BOC indicated more rate hikes would likely occur over the coming quarters as warranted based on their economic forecasts. The consensus view is that there will be another 25 bps increase before the end of 2017 and 2 more in 2018, bringing the overnight rate up to 1.5% by the end of In addition to the rate hike, the BOC revised their forecast upward for 2017 GDP growth to an annual rate of 2.8% from their April forecast of 2.6%. The housing measures recently introduced by the Ontario government seem to be having early success as average home prices have dropped slightly from the high point in April 2017 and houses are remaining on the market longer. The recent 25 bps rate increase (and the anticipated increases over the next 18 months) should put additional downward pressure on housing prices as buyers housing budgets are further constrained. The benefit to credit unions of higher mortgage rates will be tempered to some degree by the smaller mortgage sizes as affordability is further constrained. Capital While the dollar value of aggregate regulatory capital for the sector increased to $3.76 billion from $3.46 billion year over year, the leverage ratio (as a percent of total assets) decreased to 6.96% from 7.12% and risk weighted capital, as measured through the BIS ratio, decreased to 13.38% from 13.99% year over year as growth in assets outpaced earnings. While all credit unions are above the minimum requirements, they are encouraged to continually review their capital requirements to ensure sustainable growth. Capital consisted of: 1. Retained earnings $2.32 B (61.5%); 2. Investment and patronage shares $1.38B (36.7%); and 3. Membership shares $65.4 million (1.8%). There are currently three credit unions that are in the process of raising additional capital through the issuance of investment shares which will help to strengthen their capital bases. Credit unions should ensure their capital management stress testing models appropriately reflect any additional increases in interest rates. Growth Sector consolidation continued over the last twelve months with the number of credit unions decreasing by five to 97 resulting in an increase in the average size to $561 million. The number of credit unions declined by four to 73 resulting in an average asset size of $648 million compared to caisses populaires which decreased by one to 24 with an average asset size of $296 million. Total assets grew by 10.4% to $54.4 billion, largely due to growth in residential mortgage loans of 11.8% followed by commercial loans at 10.4%. The proportion of personal loans has decreased to 5.9% from 10.1% of total loans over the past five years while residential mortgages have increased to 60.2% from 57.8% and commercial loans have increased to 29.7% from 27.7%. Please refer to the following table for more information on lending activity. Sector Lending Activity 2Q Q Q 2012 $ Billions Percent of Percent of Percent of $ Billions $ Billions Total Loans Total Loans Total Loans Residential Mortgage Loans $ % $ % $ % Commercial Loans $ % $ % $ % Agricultural Loans $ % $ % $ % Personal Loans $ % $ % $ % Other Loans $ % $ % $ % $ % $ % $ % 2Q17 SECTOR OUTLOOK, August

3 Total deposits grew by 10.8% materially higher than the five-year average deposit growth trend of 7.7%. Demand deposit growth led the way with year over year growth of 12.7% (down from 14.4% in 2Q16), term deposits increased to 12.4% (up from 4.0% in 2Q16), and registered deposits grew by 5.9% (up from 5.2% in 2Q16). The increase in deposits was helped in part by the success of spring deposit campaigns at a number of credit unions. The gap between total loans and total deposits has decreased to 7.4% from 7.8% in 2Q16, however, in dollar terms the gap has increased to $3.48 billion from $3.30 billion the previous year. Insured deposits are estimated to be $29.3 billion or 67.4% of total deposits in contrast to the banking sector with insured deposits of 31% (source: CDIC). Efficiency Ratio Credit Unions Caisses Populaires Banks 82.1% 66.8% 59.8% The overall efficiency ratio (before dividends and interest rebates) for the credit union sector strengthened to 79.8% from 80.7% in 2Q16 due to improvements in many areas, led by salaries and benefits, occupancy costs and administration. However, it remains significantly higher than large Canadian banks at 59.8% (2Q17). Collectively, caisses populaires continue to report efficiency ratios (66.8%) that are closer to bank results. Caisses populaires benefit from increased economies of scale through an integrated model where most back-office functions (including credit underwriting and adjudication) are shared. This is illustrated by the fact that salaries and benefits for caisses populaires were 28 bps lower than credit unions (87 bps vs. 115 bps) in 2Q17. Profitability: Decreasing Over Time Return on average assets (ROAA) decreased marginally to 32 bps in 2Q17 from 33 bps in 2Q16. 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 Avg. Assets 2Q17 2Q16 2Q15 2Q14 2Q13 Interest and Investment Income 3.27% 3.33% 3.59% 3.66% 3.73% Other Income 0.53% 0.60% 0.55% 0.61% 0.59% Total Income 3.80% 3.93% 4.14% 4.27% 4.32% Interest Expense 1.05% 1.07% 1.23% 1.25% 1.34% Dividend Expense 0.33% 0.31% 0.29% 0.21% 0.16% Loan Costs 0.06% 0.04% 0.07% 0.05% 0.07% Total Expenses 3.48% 3.60% 3.82% 3.86% 3.93% Net Income 0.32% 0.33% 0.32% 0.41% 0.39% There has been a 46 bps decrease in interest and investment income (12.3% decrease) over the last five years because of low interest rates driving down rates charged on loans. Other income has decreased by 6 bps over the same period to 53 bps. Credit unions continue to seek alternative sources to increase income from non-interest earning related sources to bolster total income. Rising interest rates could allow credit unions to increase the current low spreads between interest income and interest expenses. Rising interest rates could also potentially lead to higher delinquencies and loan costs for credit unions as borrowers may begin to have trouble servicing their debt loads in a rising interest rate environment. Credit unions need to review their portfolios to understand how rising interest rates will affect all aspects of their operations. Most credit unions are still profitable even in the low interest rate environment by reducing noninterest expenses. Currently, seven credit unions are in a negative ROA position. All categories of non-interest expenses decreased over the last five years, however, the largest decline was in salaries and benefits of 13 bps. Total expenses decreased by 45 bps over the past five-year period. The BOC raised interest rates in mid-july for the first time in seven years, and forecasts further increase in the 2Q17 SECTOR OUTLOOK, August

4 foreseeable future which is anticipated to have a positive affect the credit unions net income. Credit Risk Gross loan delinquency greater than 30 days was 0.52% of total loans, down 20 bps from 0.72% in 2Q16. The improvement was due to lower delinquencies in commercial loans (0.80% vs.1.18%) and residential mortgages (0.38% vs. 0.47%) offset partially due to the increase in agricultural loans (0.96% vs. 0.90%). In dollar terms, the total commercial loan delinquencies decreased to $102.2 million in 2Q17 from $148.5 million in 2Q16. This decrease was largely down to resolutions of $47.0 million at five large credit unions. Total agricultural delinquencies increased to $17.1 million from $15.2 million year over year. The total amount of impaired commercial loans increased by $6.2 million year over year to $162.5 million from $156.3 million while the percentage of impaired loans has decreased to 1.16% from 1.23%. The following chart shows fluctuations in delinquencies greater than 30 days over the past ten years for different loan types. Commercial loan and residential mortgage delinquencies have steadily trended downward since the peak levels seen in the years directly after the recession and are now at the lowest level seen in over 10 years. Loan costs increased to 0.06% from 0.04% year over year due to one of the larger credit unions reported abnormally low loan costs in 2Q % Loan Delinquencies - Greater than 30 Days 2.50% 2.00% 1.50% 1.00% 0.50% 0.00% Personal Mortgages Commercial Total Loan Mix and Yields The following chart illustrates the current loan portfolio mix and yields versus the values from 2Q16 and their impacts on gross interest revenues. The decrease in interest revenues from lower loan yields in the past year is estimated at $20.8 million, due to lower yields in mortgages and agricultural loans, partially offset by increases in commercial and personal loans, while the notional impact of the change in portfolio mix on interest revenues is estimated to be a decrease of $5.1 million Product % of portfolio Change ($M) % Change Yield 2Q portfolio mix interest rates Personal Loans 5.9% 6.5% $ 4 0.1% 6.13% 6.06% (15.6) 1.7 Mortgage Loans 60.2% 59.4% $ 2, % 3.61% 3.72% 12.5 (27.6) Commercial Loans 29.7% 29.7% $ 1, % 4.52% 4.47% Agricultural Loans 4.2% 4.3% $ % 3.40% 3.46% (2.1) (1.0) Total 100% 100% (5.1) (20.8) Yield 2Q 2016 Notional impact (in Millions) on gross interest revenues due to change in Liquidity and Borrowings Securitization programs (on-balance sheet) have increased by $542 million (11.5%) year over year to $5.27 billion while borrowings from non-securitization sources decreased by $58 million (6.5%). The increased borrowings helped to fund the gap between loans and deposits which grew to $3.48 billion from $3.30 billion the previous year. There are currently 17 credit unions and 12 caisses populaires 2Q17 SECTOR OUTLOOK, August

5 that are involved in securitization programs. The following chart summarizes the level of securitizations as a percentage to a few key metrics. There are currently 10 credit unions where more than 20% of residential mortgages are securitized (largest percentage is 41.4%), five credit unions where securitizations are greater than 20% of deposits and regulatory capital (largest is 41.0%) and three credit unions where securitizations are greater than 20% of total assets (largest is 29.2%). DICO is closely watching the growth in the use of securitization programs by credit unions due to the concentration of this funding source at a few credit unions. Total Assets ($M) Credit Unions with On Balance Sheet Securitizations Total Residential Total Deposits ($M) Mortgages ($M) Total On Balance Sheet Securitizations ($M) $44,301 $22,723 $34,475 $5,254 Average of 29 Credit Unions with Securitizations Securitizations / Total Mortgages Securitizations / Deposits + Reg Cap Securitizations / Total Assets 23.1% 15.5% 11.9% Average of Entire Sector 18.6% 10.9% 9.7% Highest Individual Credit Union Ratios 41.4% 41.0% 29.2% Lowest Individual Credit Union Ratios 0.1% 0.1% 0.1% Liquid asset holdings increased by $597 million year over year to $5.51 billion improving the liquidity ratio to 11.10% from 10.95% in 2Q16. Liquidity at caisses populaires (7.64%) remains much lower than at credit unions (11.61%). This lower level of liquidity is due in large part to the ability of some caisses to access the Caisse Centrale Desjardins 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 (74.1%), followed by Deposits in deposit taking institutions (10.1%), Cash held for liquidity (4.8%) and Securities secured by mortgages and guaranteed by CMHC (3.4%) and Commercial paper, banker s acceptances and similar instruments (3.4%). 2Q Q Q 2015 Sources of Liquidity % of Total % of Total % of Total $ millions $ millions $ millions Liquidity Liquidity Liquidity Deposits in a League or Central $ 4, % $ 3, % $ 3, % Deposits in a deposit taking institution in $ % $ % $ % Canada Securities secured by mortgages and $ % $ % $ % guaranteed by CMHC held for liquidity Commercial paper, banker's acceptances and $ % $ % $ % similar instruments Cash held for liquidity $ % $ % $ % Other Sources of Liquidity $ % $ % $ % Total Sources of Liquidity $ 5, % $ 4, % $ 4, % Credit unions are encouraged to stress test their liquidity requirements sufficient to challenge the level of liquidity to which they have access and develop alternative contingency strategies to rectify potential liquidity shortages. 2Q17 SECTOR OUTLOOK, August

6 Sector Financial Highlights 2Q 2017 ONTARIO SECTOR Selected Bank Information % average assets*, Year to date at... PROFITABILITY 2Q Q Q 2017 Net Interest and Investment Income 1.90% 1.95% 1.60% Loan Costs 0.06% 0.04% 0.16% Other (non-interest) Income 0.53% 0.60% 1.48% Total Income 2.37% 2.50% 2.92% Total Non-Interest Expenses (Operating Expenses) 1.97% 2.10% 1.75% Net Income/(Loss) before Taxes and 0.40% 0.40% 1.17% Non-recurring & Extraordinary items Efficiency Ratio (% Operating Expenses to Total Income) 83.17% 83.89% 59.80% Efficiency Ratio (% Operating Expenses, before dividends & interest rebates 79.75% 80.67% Return on Average Assets (ROA) before dividends etc. 0.42% 0.42% Return on Average Assets (ROA) 0.32% 0.33% 0.93% Return on Regulatory Capital before dividends etc. 6.00% 5.86% Return on Regulatory Capital 4.54% 4.51% CREDIT RISK, as at the quarter-end Gross Delinquency greater than 30 days (% of total loans) 0.52% 0.72% Gross Delinquency greater than 90 days (% of total loans) 0.29% 0.39% OFF BALANCE SHEET ACTIVITY Off balance Sheet Assets ($millions) 14,074 11,279 (Includes mutual fund sales and administered loans etc.) Income on Off Balance Sheet Activity ( % Other Income) 22.91% 23.40% OTHER INDICATORS, as at the quarter-end Total Number of Credit Unions Total Assets ($ millions) 54,414 49,303 5,256,434 Average Assets per Credit Union ($ millions) Median Assets ($ millions) Regulatory Capital 6.96% 7.12% (as a percentage of net assets) Number of Credit Unions below Regulatory Minimum 0 0 Liquidity 11.10% 10.95% * Year to date annualized unless otherwise stated. Totals may not agree due to rounding 2Q17 SECTOR OUTLOOK, August

7 Sector Financial Statements 2Q 2017 Balance Sheet ONTARIO SECTOR 2Q Q Q Q 2016 ($000) ($000) (Percentage of Total Assets) ASSETS Cash and Investments 6,588,897 5,961, % 12.1% Personal Loans 2,784,978 2,780, % 5.6% Residential Mortgage Loans 28,292,365 25,309, % 51.3% Commercial Loans 13,978,170 12,658, % 25.7% Institutional Loans 109, , % 0.2% Unincorporated Association Loans 71,525 41, % 0.1% Agricultural Loans 1,788,225 1,696, % 3.4% Total Loans 47,024,492 42,586, % 86.4% Total Loan Allowances 138, , % 0.3% Capital (Fixed) Assets 494, , % 1.0% Intangible & Other Assets 445, , % 0.8% Total Assets 54,414,090 49,302, % 100.0% LIABILITIES Demand Deposits 18,263,341 16,200, % 32.9% Term Deposits 14,268,423 12,689, % 25.7% Registered Deposits 10,761,144 10,162, % 20.6% Other Deposits 250, , % 0.5% Total Deposits 43,543,261 39,283, % 79.7% Borrowings 819, , % 1.8% Securitization 5,264,810 4,723, % 9.6% Other Liabilities 1,022, , % 1.9% Total Liabilities 50,650,147 45,838, % 93.0% MEMBERS' EQUITY & CAPITAL Membership Shares 65,405 64, % 0.1% Retained Earnings 2,316,010 2,146, % 4.4% Other Tier 1 & 2 Capital 1,365,314 1,265, % 2.6% Accumulated Other Comprehensive Income 17,214 (13,189) 0.0% 0.0% Total Members' Equity & Capital 3,763,944 3,464, % 7.0% Total Liabilities, & Members' Equity & Capital 54,414,090 49,302, % 100.0% Totals may not agree due to rounding 2Q17 SECTOR OUTLOOK, August

8 Sector Financial Statements 2Q 2017 Income Statement ONTARIO SECTOR Canadian Chartered Banks ** Percentage of Average Assets * 2Q Q Q 2017 Interest and Investment Income Loan Interest Income 3.05% 3.15% 2.02% Investment Income 0.22% 0.18% 0.36% Interest Expense 3.27% 3.33% 2.39% Interest Expense on Deposits 1.05% 1.07% 0.59% Interest Rebates & Dividends on Share Capital 0.00% 0.00% Dividends on Investment Capital & Other Capital 0.10% 0.10% Other Interest Expense 0.22% 0.21% Total Rebates, Dividends & Other Interest Expense 0.33% 0.31% 0.20% 1.37% 1.39% 0.79% Net Interest & Investment Income 1.90% 1.95% 1.60% Loan Costs 0.06% 0.04% 0.16% Net Interest & Investment Income after Loan Costs 1.84% 1.90% 1.44% Other (non-interest) Income 0.53% 0.60% 1.48% Net Interest, Investment & Other Income 2.37% 2.50% 2.92% Non-interest Expenses Salaries and Benefits 1.11% 1.15% 0.96% Occupancy 0.19% 0.21% 0.13% Computer, office & other equipment 0.19% 0.20% 0.13% Advertising & Communications 0.11% 0.14% 0.06% Member Security 0.08% 0.08% Administration 0.17% 0.20% Other 0.12% 0.13% 0.47% 1.97% 2.10% 1.75% Net Income/(Loss) Before Taxes and Nonrecurring 0.40% 0.40% 1.17% & Extraordinary items Non-recurring & Extraordinary gains/(losses) 0.00% 0.00% 0.00% Taxes 0.08% 0.08% 0.25% Minority Interests 0.00% 0.00% 0.00% Net Income/(Loss) 0.32% 0.33% 0.92% Average Assets ($000) 53,212,363 47,934,608 5,081,128,320 * Year to date annualized ** Source: Canadian Bankers Association, Detailed Financial Statistics. Totals may not agree due to rounding. 2Q17 SECTOR OUTLOOK, August

9 Selected Financial Trends 11.75% Selected Growth Trends 3.75% Selected Performance Trends 0.80% 10.75% 3.50% 0.70% 9.75% 3.25% 0.60% 8.75% 3.00% 0.50% 7.75% 2.75% 0.40% 6.75% 5.75% 4.75% 3.75% Assets Loans Deposits 2.50% 2.25% 2.00% 1.75% Financial Margin (L) Gross Margin (L) Operating Expenses (L) ROA (R) 0.30% 0.20% 0.10% 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 3.00% Loan Delinquencies - Greater than 30 Days $7,000 Liquidity, Total Borrowings and Securitization 15.00% 2.50% $6, % 2.00% 1.50% $5,000 $4,000 $3, % 12.00% 11.00% 1.00% $2, % 0.50% 0.00% Personal Mortgages Commercial Total $1,000 $- Total Borrowings in $millions (L) Liquidity Ratio (R) 9.00% 8.00% Securitizations in $millions (L) 0.30% 0.25% 0.20% 0.15% 0.10% 0.05% Loan Cost and Return on Assets 0.70% 0.60% 0.50% 0.40% 0.30% 0.20% 18.0% 16.0% 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% -2.0% Deposit Growth 0.00% 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 NOTE: L refers to the Left Axis and R refers to the Right Axis 2Q17 SECTOR OUTLOOK, August