Fitch Ratings-New York-October 22: Fitch Ratings has affirmed Central 1 Credit Union's (Central 1) Long-term Issuer Default Rating (IDR) at 'A' and Short-term IDR at 'F1'.
The Rating Outlook is Stable. A full list of rating actions follows at the end of this release.
KEY RATING DRIVERS VR, IDRs and SENIOR DEBT
Central 1's ratings reflect its high quality and liquid balance sheet compared to domestic banking peers. They also incorporate the central's established, well-diversified business model supported by a strong capital position. Fitch believes a limited franchise and competitive position of the member network offset the aforementioned strengths. Fitch views Central 1's highly liquid balance sheet as a key strength. The high proportion of investment grade securities in the investment portfolio and the solid loss track record in the loan portfolio are also viewed positively. Fitch incorporated in the ratings its assumption that market risk and credit risk associated with the loan and investment portfolio will continue to be measured and managed prudently. Fitch believes Central 1's franchise and overall competitive position is driven largely by its ability to offer value for its member network. Fitch sees Central 1's member-owned structure and integral role in the credit union system within English Canada as an important differentiator that drives a competitive advantage and makes for a loyal customer. Specifically, Central 1's role as the payments provider and clearer, liquidity manager and digital banking service provider demonstrates its systemically important role in the credit union network. Offsetting this competitive strength is Central 1's limited size and competitive position in the Canadian banking system relative to larger domestic banks. In Fitch's opinion, the ongoing competition from larger banks, especially in terms of their customer offerings in technology and digital, make it challenging for Central 1 and its members to compete due the relative lack of scale. These factors are likely to constrain Central 1's ratings over the long term. Fitch views Central 1's ability to execute on newly developed strategic initiatives as an important factor in maintaining a competitive position. The delivery of new digital offerings and user experience enhancements are also crucial to enable members to compete effectively with the larger banks. Furthermore, Fitch considers management stability an important factor when evaluating management and strategy. For Central 1, Fitch views this as a near-term rating weakness. Incorporated in the current rating and Outlook is Fitch's view that management turnover will be limited and strategic initiatives will be reasonably executed on. Fitch notes significant growth within the credit union system's assets and in Central 1's commercial loan portfolio in recent years. Fitch views this attribute, coupled with asset class concentration in construction and residential real estate, in the current frothy housing market, cautiously. The agency's rating incorporates the expectation that loan and securities portfolio impairments will continue to be lower than peers and that loan and counterparty exposures are prudently underwritten to withstand economic stress as it relates to trade activity, real estate value depreciation or otherwise. Fitch recognizes improvement within Central 1's risk management organization over recent years. As the company continues to grow into a larger and more complex organization, the rating incorporates the expectation that Central 1 will continue investing in headcount and the development of risk controls and infrastructure to enhance the risk measurement, monitoring and reporting capabilities across all risk types. Fitch views Central 1's earnings as well diversified with a good balance between financial and fee-driven income. While the fees and net interest income are viewed as stable sources of revenue, this is partially offset by periodic P&L swings related to fair value instruments that create earnings volatility. The rating assumes that Central 1 will successfully deliver on its strategic initiatives in the digital and payments space, and in tiered pricing, to maintain or grow earnings while managing costs. Central 1's significant capital buffer relative to peers and within the context of its overall risk profile is considered a rating strength. Incorporated in Fitch's rating is the expectation that Central 1's risk-based capital ratios could trend lower, especially after the finalization of a regulatory review in British Columbia (B.C.). However, in light of its size and complexity, Fitch would expect Central 1 to operate with risk-based capital ratios that are well above regulatory minimums and large domestic banking peers. Finally, Fitch views Central 1's liquidity management practices as sound for an institution of its size. The agency believes the high amount of on-balance sheet liquidity, access to debt capital markets and the predictable maturity profile of Central 1's deposits make for a manageable liquidity profile. However, the recent changes to the Bank of Canada's eligibility requirements for its Emergency Lending Assistance (ELA) program and the associated uncertainty it has created regarding Central 1's ability to access ELA modestly offset these strengths. SUPPORT RATING AND SUPPORT RATING FLOOR Central 1's Support Rating (SR) of '2' and Support Rating Floor (SRF) of 'BBB-' reflect the likelihood of government support for Central 1. Fitch views Central 1 as systemically import to the province of British Columbia and its plays a key role by providing its members and other centrals in Canada with access to Payments Canada. The Province of British Columbia is rated 'AAA'. While Fitch views the province as having the ability to support Central 1 if needed, it believes that the federal government would serve as a secondary source of support if necessary. This supports our rationale for assigning a SRF to Central 1. Bail-in initiatives demonstrate the Canadian government's progress to reduce the propensity of state support for banks going forward. At a national level, Fitch recognizes that the federal government's willingness to provide support for D-SIFI banks in Canada has decreased as demonstrated by the Department of Finance's recent Resolution Framework. In Fitch's view, the recent bail-in rules that took effect on Sept. 23, 2018 enhances resolution powers given to federal regulatory authorities under the CDIC Act. These bail-in initiatives demonstrate the Canadian government's progress to reduce the propensity of state support for banks going forward. However, while it is Fitch's expectation that provincial legislation and associated regulations in British Columbia will closely mirror the federal legislation, Fitch maintains its current view of government support for Central 1 while this legislation remains in flux. Under Fitch's rating framework, the IDR is the higher of the Viability Rating (VR) or the SRF. Because Central 1's VR exceeds Fitch's assigned SRF by multiple notches, any reduced likelihood of support would not currently impact Central 1's IDR.
SUBORDINATED DEBT
Central 1's subordinated debt is notched one level below its VR for loss severity. This is in accordance with Fitch's criteria and assessment of the instruments' non-performance and loss severity risk profiles, which Fitch has affirmed due to the affirmation of the VR.
RATING SENSITIVITIES IDRs, NATIONAL RATINGS AND SENIOR DEBT
Fitch views Central 1's ratings as firmly situated at their current level and at the high end of their range. Incorporated in the current ratings is Fitch's expectation that Central 1 will continue to make enhancements to its risk controls, resources and infrastructure. Also incorporated in the rating is Fitch's expectation that management will demonstrate successful execution against strategic objectives. Evidence to the contrary could pressure the ratings lower. Fitch believes Central 1's exposure to money laundering risks as high due to its role as domestic and cross-border payments clearer for the credit union network. Any lapses in controls in detection of illegal activity that leads to financial penalties or regulatory action may result in Fitch downgrading the ratings. Fitch considers the buffer in Central 1's risk-based capital ratios to be a rating strength. The agency's rating incorporates a gradual decline in these ratios over time, provided Central 1's capital buffer remains comfortably above the large Canadian banking peers and Desjardins Group by multiple percentage points. A significant and unexpected decline in Central 1's capital ratios due to capital actions or losses will likely prompt a review of the ratings for negative rating implications. Fitch views Central 1' good credit quality track record in both the loan and investment portfolios as a rating strength that supports the ratings. Significant deterioration in the quality of assets or unexpected losses or impairments in the loan or securities portfolios would result in a downgrade of the ratings. As noted above, there has been significant growth in the assets of member credit union assets in recent years, which tend to be concentrated in residential mortgages. Fitch remains concerned about the frothiness of the Vancouver and Toronto markets. While not Fitch's baseline expectation, a negative action could occur, given a significant correction in the housing market that results in borrower defaults and outsized credit losses for Central 1's network. Central 1 is dependent on its relationship with certain key software vendors for the delivery of its strategic objectives and maintenance of a competitive advantage. A loss of a key vendor relationship could prompt a review of the ratings. The existence of large credit unions in Central 1's network, especially in British Columbia, exposes Central 1 to risk associated with the loss of key customers. Furthermore, the recent establishments of laws and regulations and laws enabling a federal continuance options for members is also seen as a potential risk, although there is no hard evidence to support this at this stage. Should Fitch observe stress on Central 1's revenues as a result of a loss of key relationships, negative rating action may be taken. Over the longer term and all else equal, positive ratings momentum could develop should Fitch notice a significant improvement in risk management capabilities, management stability, solid execution on strategic objectives all the while demonstrating lower credit losses than higher rated peers through an economic downturn.
SUPPORT RATING AND SUPPORT RATING FLOOR
As evidenced in Fitch's assignment of a support rating floor of 'BBB-', the agency views sovereign support as likely despite the recent finalization of bail-in rules at the federal level. As the resolution legislation and framework in B.C. continues to develop, Fitch may consider moving this floor lower depending on the ultimate outcome of such laws and associated regulations. SUBORDINATED DEBT AND OTHER HYBRID SECURITIES The subordinated debt ratings are primarily sensitive to any change in Central 1's VR. Fitch has affirmed the following ratings: Central 1 Credit Union (Central 1) --Long-term IDR at 'A'; Outlook Stable; --Short-term IDR at 'F1'; --Viability Rating at 'a'; --Senior debt at 'A'; --Commercial Paper at 'F1'; --Subordinated debt at 'A-'; --Support Rating at '2'; --Support Rating Floor at 'BBB-'. Contact: Primary Analyst Johannes Moller, CFA Associate Director +1-646-582-4954 Fitch Ratings, Inc. 33 Whitehall Street New York, NY 10004 Secondary Analyst Christopher Baker, CFA Director +1-312-606-2361 Committee Chairperson Bain Rumohr, CFA Senior Director +1-312-368-5153 Media Relations: Sandro Scenga, New York, Tel: +1 212 908 0278, Email: sandro.scenga@fitchratings.com. Additional information is available on www.fitchratings.com Applicable Criteria Bank Rating Criteria (pub. 12 Oct 2018) https://www.fitchratings.com/site/re/10044408 Additional Disclosures Dodd-Frank Rating Information Disclosure Form https://www.fitchratings.com/site/dodd-frank-disclosure/10049319 Solicitation Status https://www.fitchratings.com/site/pr/10049319#solicitation Endorsement Policy https://www.fitchratings.com/regulatory
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