Ontario Credit Unions and Caisses Populaires SYSTEM OUTLOOK 1Q02 INSIDE Economic Highlights: GDP in 2002 to exceed 3%.. Page 1 Focus on Interest Rates: Rates now expected to gradually increase Page 2 System Highlights: Strong asset growth continues Page 3 A Regional Breakdown.... Page 4 Off-balance sheet activity.......page 5 On-Site Verification (OSV) Findings... Page 6 System Financial Statements.. Pages 7, 8 and 9 Prepared by Deposit Insurance Corporation of Ontario Policy & Research Department E-mail: systemoutlook@dico.com May, 2002 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.
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Ontario Economic Highlights Growth in 2002 projected to exceed 3% The outlook for the Ontario economy has turned around rapidly. Just a few months ago, there was little hope for a quick rebound. Growth for 2002 has been revised dramatically upward following robust economic activity in the first quarter. The new forecast calls for growth of 3.2% compared to earlier projections of 1.4%. Consumer spending continued to grow rapidly in the first few months of this year. Retail sales in February posted a 1.9 % increase over fourth quarter 2001 results. This was attributable to a strong rebound in employment, a surge in consumer confidence, additional fiscal relief and a sizzling housing market. Real consumer spending is expected to rise by 2.7 % in 2002 and by 3.9 % in 2003. Consumers bought more than cars and clothes over the past few months; they also purchased homes. Housing starts were particularly strong in the first quarter of 2002, with annual levels at 90,000 units, although this is expected to soften over the next few quarters. The fourth quarter of 2001 brought a drastic liquidation of inventories, leaving stocks below normal levels in certain industries. As a result, inventories will have to be rebuilt to keep pace with sales. A relatively strong increase in employment in the first quarter of 2002, particularly in the manufacturing sector, illustrates that this phenomenon has already started. This should translate into employment growth in the second half of the year, and declining unemployment. Unemployment levels have decreased in recent months from 7.4% to 7.0% and are expected to continue to moderate slightly for the balance of 2002, before declining to even lower levels in 2003. 7 6 5 4 3 2 1 0 % 3.9 Ontario Real GDP Growth 1998-2003 5.9 5.2 1998 1999 2000 2001 2002 2003 Actual Forecast Implications for credit unions The expected improvements in the economy will gradually ease the impacts of recent industry specific cutbacks and layoffs. Asset growth has remained strong during the recent economic downturn, and improving economic conditions provide opportunities for additional growth. Residential construction remains strong as a result of the low interest rate environment although it is likely to moderate in line with anticipated interest rate increases. Demand for personal and commercial loans is likely to increase with improving economic conditions and projected business expansion. Higher interest rates will gradually result in improved financial margins, which have deteriorated significantly over the past twelve to eighteen months. Note: Economic data is provided by the Conference Board of Canada. 0.9 3.2 4.7 1Q02 SYSTEM OUTLOOK, May 2002 Page 1
Focus on Interest Rates Monetary Policy and Interest Rates Source: The Conference Board of Canada Interest rates have hit bottom and will spend the bulk of the near term period retracing the steps taken last year. Record low interest rates and a weak dollar at the beginning of this year made monetary conditions very stimulative. With the economy now showing clear signs of rebounding, less monetary stimulus will be necessary as we go forward. Indeed, the Bank of Canada (the Bank) concerned about near term inflation has already begun raising short-term interest rates. The Bank s immediate concern is the long lag between an interest rate movement and its impact on final prices. Growth in the CPI is expected to swell to 2.9 per cent in 2003, up from just 1.6 per cent this year, on the surface indicating the need for more aggressive monetary tightening. Although inflationary pressures are looming, there is on the other hand concern about the durability of the recent rapid rebound. Low interest rates and temporary incentives appear to have called forward a certain amount of sales activity from future periods, suggesting a lull in activity in the second half of this year. Aggressive rate hikes at this point could exacerbate such a lull and threaten the hard-won gains in consumer and business confidence seen over the last few months. The Bank raised short-term interest rates by 25 basis points on April 16. Rate hikes are expected to continue in small increments throughout 2003, reaching 5.75% in 2004. The Dollar The forecast calls for the Canadian dollar to remain weak. Demand for the loonie is expected to rise as global recovery injects new life into commodity prices, boosting the value of the dollar through 2002. However, further gains are likely to be muted. Interest rate hikes in Canada will not help much, as they will be accompanied by similar rate hikes in the U.S. As such, after averaging U.S. $0.646 in 2001, the dollar is expected to average U.S. $0.63 in 2002 and U.S. $0.638 in 2003. T-bill rate (%) 6.0 5.0 4.0 3.0 2.0 1.0 1Q99 T-bill rate: Canada vs. U.S. 1999 to 2001 actual, 2002 forecasts 3Q99 1Q00 3Q00 Canada Long-term Forecasts 2002 [2000 & 2001 actual results] 2000 2001 2002 3-Month Treasury Bill Yield 5.5% 3.8% 2.3% Chartered Bank Prime Lending Rate 7.3 5.8 4.0 5-year GIC Rate 5.3 4.0 4.1 5-year Mortgage Rate 8.4 7.4 7.1 10-year and Over GOC Bond Rate 5.9 5.8 5.8 Focus on Interest Rates and forecasts are provided by the Conference Board of Canada. Forecasts as at May 2002. 1Q01 3Q01 U.S. 1Q02 3Q02 1Q02 SYSTEM OUTLOOK, May 2002 Page 2
System Highlights Continued strong growth in system assets Ontario system assets increased by a further $294 million during 1Q02 and by $1.3 billion, or 8.0 %, for the latest twelve months. During the latest quarter, deposits increased by $213 million while the increase in total loans was $230 million. Over the latest twelve months, total loans have increased by $1.1 billion, or 8.9%. During this same period, personal loans have increased by less than 1%, while commercial and agricultural loans have grown $429 million (17.1%) and residential mortgages have increased by $631 million (9.2 %). System earnings have declined from 42 basis points in 4Q01 to 29 basis points. This is primarily due to lower financial margins as a result of interest rate compression in the current economic environment. Despite the continuing strong asset growth, aggregate member equity and capital has increased to $1.16 billion, or 6.8 per cent of assets. The number of member institutions has declined to 296 through further amalgamations. This compares to 302 at 4Q01 and 318 at 1Q01. Total gross loan delinquency (over 30 days) has declined from 1.40% as at 4Q01, to 1.38% during the latest quarter. Commercial loan delinquency has declined further from 2.23% to 2.12% during 1Q02. Total loan allowances have increased by approximately $4 million from 4Q01, although remain at 5 basis points. Basis Points Total loan allowances, as at 1Q02 were $82.3 million. This includes $33.7 million in non-specific provisions, an increase of $3 million from 4Q01. Per Cent 20 15 10 5 0 90.0 85.0 80.0 75.0 70.0 Loan Costs and Loan Allowances as a % of Total Assets: 4Q00 to1q02 4Q00 1Q01 2Q01 3Q01 4Q01 1Q02 Loan Costs Loan Allow ances Coverage Ratio: 4Q98 to 1Q02 Total Allowances as % of Impaired Loans 4Q98 4Q99 4Q00 4Q01 1Q02 Coverage The coverage ratio is based on the level of total loan allowances to gross impaired loans. The higher the ratio, the higher the protection against possible additional loan costs as a result of lower than anticipated recovery values of any security. At 1Q02, the coverage ratio increased to 84.2% compared to 80.4% as at 4Q01. 1Q02 SYSTEM OUTLOOK, May 2002 Page 3
Financial Highlights 1Q02 Regional Distribution of Assets, Earnings and Delinquency For comparison purposes, member institutions have been segregated into five main regions. The GTA region includes Oakville, Ajax and Newmarket. The Central region extends from Niagara Falls to Oshawa, and north to Barrie, but excludes the GTA. The South Western region includes London, Windsor, St. Thomas and Sarnia. The Eastern region includes Peterborough, Cornwall, Kingston and Ottawa. The Northern region extends from Barrie, and includes North Bay, Sudbury, Thunder Bay and Kenora. The following table provides a regional breakdown including the distribution of assets and earnings: Region Distribution of Assets and Earnings by Region as at 1Q02 # of Member Institutions Assets ($million) % of System Assets Net Interest and Other Income (basis points) Non Interest and Other Expenses (basis points) ROA (basis points) Eastern 48 3,226 19% 389 337 39 Northern 45 2,267 13% 396 358 26 Central 52 4,149 24% 384 349 26 Greater Toronto 78 4,237 25% 350 319 22 South Western 73 3,074 19% 373 314 38 Total (System) 296 16,953 100% 376 334 29 While system ROA is 29 basis points, there are significant differences in operating results across the various regions. Of particular note is: Higher net interest and other income in the Northern and Eastern regions. Lower operating expenses in the Greater Toronto and South Western regions. Higher ROA in the Eastern and South Western regions. The following table provides a regional breakdown of delinquency (as a percentage of loans) and loan costs (as a percentage of assets): Region Distribution of Delinquency and Loan Costs by Region as at 1Q02 Loans Delinquent over 30 Days Loans Delinquent Between 30 and 90 Days Loans Delinquent over 90 Days Loan Costs (basis points) Eastern 1.34% 0.76% 0.58% 15 Northern 2.72% 1.02% 1.70% 39 Central 0.86% 0.53% 0.33% 12 Greater Toronto 1.51% 0.51% 1.00% 11 South Western 1.07% 0.61% 0.46% 18 Total (System) 1.38% 0.64% 0.74% 17 While total system delinquency is approximately 1.4% and loan costs are 17 basis points, loan costs and delinquency levels continue to be substantially higher in the Northern region. 1Q02 SYSTEM OUTLOOK, May 2002 Page 4
Financial Highlights 1Q02 Off-balance Sheet Highlights The following table summarizes the volume of non-interest income producing activities that are not reported on the credit union s balance sheet, as well as the level of relative income generated at 1Q02. This information is compared to results at 4Q01. Highlights include: Total off-balance sheet activity has grown by 11.7% from 4Q01. Income from off-balance sheet activity has declined by to 7.8% of other income. Net mutual fund balances have increased 12.5% from 4Q01. Credit card receivables have decreased 8.6% from 4Q01. Off-balance Sheet Activity 1Q02 ($ 000) 1Q02 % of total 4Q01 ($ 000) Balance of administered loans at the end of the period 242,271 16% 279,570 Net mutual funds sold through mutual fund alliances 915,592 60% 814,087 Credit card receivables managed by credit card providers 32,630 2% 35,719 Other (incl. letters of credit and guarantees) 345,846 22% 246,631 Total off-balance sheet activity 1,536,339 100% 1,376,008 Total system assets and off-balance sheet activity 18,489,547 18,035,660 Income earned on off-balance sheet activity 11,546 11,996 Off-balance sheet income as a % of other income 7.8% 8.3% Number of MIs reporting off-balance sheet activity 123 137 1Q02 SYSTEM OUTLOOK, May 2002 Page 5
Financial Highlights 1Q02 On-Site Verification (OSV) Findings The following table provides a summary of OSV findings for the latest twelve months ended April 30, 2002 for different asset groups. Asset Size Group ($M s) Summary of OSV Findings by MI Asset Size Greater than 250 100 to 250 30 to 100 10 to 30 3 to 10 1 to 3 Less than 1 Risk Management % of % in % of MIs That Received an Effective Rating Practices Total 2001 Corporate Governance 80 83 60 60 52 53 44 60 55 Capital Management 100 100 90 93 95 93 75 92 70 Credit Management 30 42 48 31 33 27 6 33 21 Investment Management 90 100 85 93 100 73 75 89 64 A/L Management 100 92 83 88 81 67 56 82 57 Liquidity Management 100 92 95 100 100 87 75 94 80 Internal Controls 100 100 90 95 100 93 69 92 70 There has been a noticeable improvement in the results for all risk management practices in the latest twelve-month period compared to the same period ending in 2001. However, while the number of institutions receiving an effective rating for Credit Management has improved, this area still remains a concern. Common findings indicate: failure to perform sufficient credit analysis lack of tangible security appropriate for the loan size of the loan failure to appropriately monitor and control adherence to lending limits An ineffective Credit or Investment Management rating results in a deduction of 10 points each, out of a total 20 points available for the Corporate Governance (Management) component of the DPS rating. The current distribution of DPS scores for the Corporate Governance (Management) component is provided below: Summary of Corporate Governance (Management) Scores Total DPS Points 1Q02 1Q01 # of Member % of Assets # of MIs % of Assets Institutions 20 68 39% 37 26% 15 20 3% 19 3% 10 74 35% 102 35% 5 45 8% 39 14% 0 89 15% 121 22% 296 100% 318 100% The general improvement in OSV results is reflected in the latest distribution of Corporate Governance (Management) scores. As at 1Q02, 77% of member institutions by assets had 10 or more points compared to 64% at 1Q01. 1Q02 SYSTEM OUTLOOK, May 2002 Page 6
Financial Highlights 1Q02 Dollars are expressed in millions Percentages are % of average assets 1 1Q02 4Q01 1Q01 Total Number of Member Institutions 296 302 318 Number of Member Institutions below 5% Capital 5 2 3 Regulatory Capital (as per Ont Reg 76/95) $1,142 $1,128 $1,050 (as a percentage of net assets) 6.74% 6.78% 6.69% Net Interest and Investment Income $495 $510 $495 (Income from lending and investment activities) 3.02% 3.18% 3.27% Loan Costs $28 $26 $25 0.17% 0.16% 0.16% Gross Delinquency greater than 30 days $183 $181 $181 (as a percentage of total loans) 1.38% 1.40% 1.49% Gross Delinquency greater than 90 days $98 $97 $93 (as a percentage of total loans) 0.74% 0.75% 0.76% Other (non-interest) Income $147 $145 $135 (Fees and Commission Income) 0.90% 0.90% 0.89% Net Interest, Investment and Other Income $614 $629 $606 (Total Income) 3.76% 3.93% 4.00% Total Non-Interest Expenses $545 $540 $527 (Costs of Operations-excluding loan costs) 3.34% 3.38% 3.48% Net Income/(Loss) before Taxes and $68 $88 $79 Non-recurring & Extraordinary items 0.42% 0.55% 0.53% Net Income/(Loss) $48 $67 $65 0.29% 0.42% 0.43% Gross Liquidity as per Sections 16-18 of Ont Reg.76/95 17.46% 17.38% 16.99% Average Assets per member institution $57.3 $55.2 $49.4 Median Assets $20.3 $18.3 $15.3 DPS Rating of MIs at 1Q02 MIs with assets of $100 M and over MIs with assets from $ 10 M to $100 M MIs with assets below $10 M SYSTEM DPS Tier Scores within DPS Tier Number % of Assets Number % of Assets Number % of Assets Number % of Assets 1 From 85 to 100 3 4% 14 10% 9 8% 26 6% 2 From 70 to 85 16 37% 53 37% 30 32% 99 37% 3 From 55 to 70 17 55% 55 42% 34 26% 106 50% 4 From 40 to 55 3 4% 13 9% 35 29% 51 6% 5 From 0 to 40 0 0% 5 2% 9 5% 14 1% Total 39 100% 140 100% 117 100% 296 100% 1. Average assets do not include off-balance sheet items. Totals may not agree due to rounding. 1Q02 SYSTEM OUTLOOK, May 2002 Page 7
System Balance Sheet 1Q02 Percentage of Total Asset 1Q02 1Q01 1Q02 1Q01 ($000) ($000) ASSETS Cash and Investments 3,361,261 3,188,898 19.8% 20.3% Personal Loans 2,769,078 2,750,628 16.3% 17.5% Residential Mortgage Loans 7,464,968 6,833,658 44.0% 43.5% Commercial Loans 2,470,340 2,085,291 14.6% 13.3% Institutional Loans 50,893 41,188 0.3% 0.3% Unincorporated Association Loans 5,200 11,112 0.0% 0.1% Agricultural Loans 463,170 419,249 2.7% 2.7% Total Loan Allowances (82,384) (73,682) (0.5%) (0.5%) Capital (Fixed) Assets 293,067 287,117 1.7% 1.8% Intangible & Other Assets 157,615 152,368 0.9% 1.0% Total Assets 16,953,208 15,695,826 100.0% 100.0% LIABILITIES Demand Deposits 4,983,402 4,174,081 29.4% 26.6% Term Deposits 5,193,853 4,972,371 30.6% 31.7% Registered Deposits 5,045,082 4,817,639 29.8% 30.7% Other Deposits 207,930 326,921 1.2% 2.1% Borrowings 74,212 39,084 0.4% 0.2% Other Liabilities 289,720 304,208 1.7% 1.9% Total Liabilities 15,794,199 14,634,305 93.2% 93.2% MEMBERS' EQUITY & CAPITAL Membership Shares 86,334 88,607 0.5% 0.6% Retained Earnings 773,797 723,851 4.6% 4.6% Other Tier 1 & 2 Capital 298,879 249,064 1.8% 1.6% Total Members' Equity & Capital 1,159,010 1,061,521 6.8% 6.8% Total Liabilities, & Members' Equity & Capital 16,953,208 15,695,826 100.0% 100.0% Average Assets 16,370,883 15,124,294 1. Totals may not agree due to rounding. 1Q02 SYSTEM OUTLOOK, May 2002 Page 8
System Income Statement 1Q02 (with Industry Comparison) ONTARIO SYSTEM Canadian Chartered Banks 2 Percentage of Average Assets 1 12 Months to 1Q02 1Q01 1Q02 1Q01 1Q02 ($000) ($000) Interest and Investment Income Loan Interest Income 891,475 903,815 5.45% 5.98% 3.77% Investment Income 130,402 147,626 0.80% 0.98% 1.31% Total Interest and Investment Income 1,021,877 1,051,441 6.24% 6.95% 5.07% Interest Expense Interest Expense on Deposits 493,555 514,666 3.01% 3.40% 2.51% Other Interest Expense and Dividends 33,224 41,785 0.20% 0.28% 0.61% Total Interest Expense 526,778 556,452 3.22% 3.68% 3.12% Net Interest & Investment Income 495,098 494,989 3.02% 3.27% 1.95% Loan Costs 28,078 24,592 0.17% 0.16% 0.46% Net Interest & Investment Income after Loan Costs 467,020 470,397 2.86% 3.11% 1.49% Other (non-interest) Income 146,871 135,179 0.90% 0.89% 2.05% Net Interest, Investment & Other Income 613,891 605,576 3.76% 4.00% 3.54% Non-Interest Expenses Salaries and Benefits 268,788 249,797 1.64% 1.65% 1.49% Occupancy 45,128 42,477 0.28% 0.28% Computer, office & other equipment 64,997 61,854 0.40% 0.41% Advertising & Communications 35,743 31,457 0.22% 0.21% Member Security 25,652 34,160 0.16% 0.23% Administration 64,272 65,180 0.39% 0.43% Other 40,849 41,963 0.25% 0.28% 1.20% Total Non-Interest Expenses 545,428 526,889 3.34% 3.48% 2.69% Net Income/(Loss) Before Taxes and Non-recurring 68,463 78,687 0.42% 0.53% 0.85% & Extraordinary items Non-recurring & Extraordinary gains/(losses) (2,621) 3,759-0.02% 0.03% 0.00% Taxes 17,748 17,430 0.11% 0.12% 0.22% Minority Interests 0.03% Net Income/(Loss) 48,094 65,016 0.29% 0.43% 0.60% Average Assets -$000 16,370,883 15,124,294 1,519,115,783 1. Totals may not agree due to rounding. Ontario figures exclude leagues. 2. Source: Canadian Bankers Association, Detailed Financial Statistics. Consolidates all subsidiaries, such as investment dealers. 1Q02 SYSTEM OUTLOOK, May 2002 Page 9