DBRS Morningstar Confirms First West Credit Union at BBB (high), Stable Trend

DBRS Limited (DBRS Morningstar) confirmed First West Credit Union’s (First West or the Credit Union) Long-Term Issuer Rating at BBB (high) and both the Short-Term Issuer Rating and the Short-Term Instruments rating at R-1 (low). The trends on all ratings are Stable. The Support Assessment (SA) for First West is SA2, which reflects DBRS Morningstar’s expectation of timely systemic external support from the Province of British Columbia (BC or the Province; rated AA (high) with a Stable trend by DBRS Morningstar) through Central 1 Credit Union (Central 1; rated A (high) with a Negative trend by DBRS Morningstar), particularly in the form of liquidity. The SA2 designation does not result in any uplift to First West’s ratings.

KEY RATING CONSIDERATIONS
The ratings reflect First West’s ranking as the third-largest credit union in the Province and the fifth-largest credit union in Canada, with total assets and assets under management of $15.1 billion as at June 30, 2020. The Credit Union has a well-established market position, with strong market shares in deposits and loans in BC. First West operates through its four community-based brand identities, which also contribute to its successful product diversification. The ratings are also supported by First West’s strong earnings power, as well as solid liquidity and capital positions. The Credit Union has generated solid recurring earnings that are underpinned by a higher contribution from non-interest income relative to its credit union peers as well as an above-average revenue per member.

The ratings also reflect the likely impact of the wide and growing scale of the economic disruption caused by the Coronavirus Disease (COVID-19) pandemic. While asset quality remains sound with most credit metrics remaining at relatively low and manageable levels, current asset quality metrics provide little visibility into future credit performance, given the unprecedented nature of the current economic downturn and relief measures that have been implemented in parallel. The implications for the medium to long term will depend on the evolution of the outbreak, the length of the economic shutdown, and the transition phase of the recovery. In addition, First West has a larger commercial mortgage and construction and development lending portfolio relative to its credit union peers, and DBRS Morningstar considers these exposures to be more susceptible to an adverse economic downturn. Furthermore, DBRS Morningstar notes that the Credit Union, like many Canadian peers, may be susceptible to a potential housing downturn in Canada, given that all mortgages are originated in BC, which has experienced dynamic growth in the real estate market in recent years. While the Credit Union’s residential mortgage lending is not focused on the City of Vancouver proper, the extensive price appreciation seen in this market has pressured neighbouring markets that are within First West’s footprint.
 
RATING DRIVERS
Given the current environment, an upgrade of First West’s ratings is unlikely. Over the longer term, ratings would be upgraded if First West continues to strengthen its franchise through sustained membership growth, especially among younger members, and significantly improves financial results while maintaining a conservative risk profile. Conversely, a material and sustained weakness in asset quality, which results in a significant increase in loan losses, could lead to a ratings downgrade. In addition, a sustained reduction in internal capital generation could also have a negative impact on the ratings.

RATING RATIONALE
First West has generated solid recurring earnings that reflect its comprehensive suite of banking and wealth management products. Given its diverse product offering, the Credit Union has a higher contribution from fee-based products, making it less sensitive to spread income compared with credit union peers. In F2019, First West reported net income of $88.2 million, a strong increase of 52% compared with the prior year, largely driven by the sale of First West’s insurance business, which closed in Q3 2019. Moreover, First West has generated solid returns, with a return on average member equity of 12.3% in F2019, which has improved over the past four years. However, DBRS Morningstar notes that the current operating environment remains significantly pressured due to the coronavirus pandemic.

DBRS Morningstar views First West's risk profile as conservative, reflecting the Credit Union's solid track record of credit performance as most credit metrics remain at relatively low and manageable levels; however, current asset quality metrics provide little visibility into future credit performance, given the unprecedented relief measures that have been implemented and the unprecedented nature of the current downturn. In addition, First West has a larger commercial mortgage and construction and development lending portfolio relative to its credit union peers, although the majority of its loan portfolio is comprised of residential mortgages. DBRS Morningstar will continue to monitor the economic backdrop and its potential impact on First West's asset quality, as metrics are expected to worsen, albeit from a low base, as a result of the wide and growing scale of the economic disruption.

A majority of First West's funding is provided through branch-raised deposits or sourced from institutional depositors, including municipalities, universities, schools, and hospitals, with deposits funding 86% of total assets as at June 30, 2020. DBRS Morningstar assesses the Credit Union’s deposit base as stable and subject to relatively low flight risk as deposits are 100% guaranteed by the Credit Union Deposit Insurance Corporation. In addition to its deposit funding, First West has also participated in securitizations through the Canada Mortgage Bonds Program with the Credit Union securitizing $312 million in F2019 under this program, although this is down compared with $422 million securitized in the prior year. Moreover, First West's liquidity position is strong, benefitting from a mandatory liquidity pool that is externally managed by Central 1, and is above regulatory requirements.

DBRS Morningstar views First West’s capitalization as strong, with the Credit Union holding a sizable capital buffer above regulatory minimums. In F2019, the capital adequacy ratio was 14.3%, up 10 basis points compared with the prior year and well above the minimum and supervisory limits of 8.0% and 10.0%, respectively. In addition, capital is largely comprised of members’ equity and retained earnings. When compared with other credit union peers, the Credit Union's dividend payout ratio is considered low, allowing First West to utilize a higher earnings retention ratio to fund investments and support growth plans.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

The Grid Summary Grades for First West are as follows: Franchise Strength – Good; Earnings Power – Moderate; Risk Profile – Good/Moderate; Funding & Liquidity – Strong/Good; Capitalization – Good/Moderate.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (June 8, 2020): https://www.dbrsmorningstar.com/research/362170/global-methodology-for-rating-banks-and-banking-organisations

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found on the issuer page at www.dbrsmorningstar.com.

The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar’s outlooks and ratings are under regular surveillance.

For more information on this credit or on this industry, visit www.dbrsmorningstar.com.

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