LB Rating Trend Negative: DBRS

DBRS has announced that it:

confirmed the ratings of Laurentian Bank of Canada (LBC or the Bank). The trends on all long-term ratings have been revised to Negative from Stable, while the trends on all short-term ratings remain Stable. The Bank’s Intrinsic Assessment (IA) of A (low) and Support Assessment of SA3 are unchanged. The SA3 designation, which reflects no expectation of timely external support, results in the final rating being equivalent to the IA.

In revising the trends to Negative, DBRS reflects its concern with the quality of LBC’s control functions and underwriting procedures at a sensitive time in the housing cycle and the potential impact of recent events on the Bank’s reputation and funding. These rating actions follow the Bank’s disclosure that residential prime mortgages the Bank had sold to third parties had documentation and client misrepresentation issues.

LBC continues to demonstrate a solid track record of strong asset quality resulting in low levels of impairments and loan losses. Residential mortgages make up just over half of the Bank’s loan portfolio. Out of the $18.5 billion mortgages in 2017, 50% were in Québec, where housing prices have kept pace with inflation over the last few years. Nevertheless, in DBRS’s opinion, the Bank’s more recent geographic expansion through its B2B Bank and its Commercial segments does expose LBC to heightened levels of operational risk and credit risk. Given recent events, DBRS is also concerned that risk management processes and policies have not evolved at a pace commensurate with the Bank’s growth.

While LBC has had a strong deposit funding base, thanks to its retail franchise, DBRS notes that the Bank is also reliant on broker sourced deposits that could be a more volatile source of funds should issues related to its mortgage underwriting practices persist. If the current issues persist and foster market uncertainty, LBC could face difficulty in attracting broker-sourced deposits which, in conjunction with any potential restrictions on accessing mortgage securitization conduits, could pressure the Bank’s funding and weaken its liquidity.

The Bank’s capital ratios are close to regulatory minimums and leave only a very limited buffer to absorb any significant losses. LBC’s CET1 ratio stood at 7.9% at the end of 2017, which was a slight deterioration from 8.0% at YE2016.

If the ongoing audits of the mortgage portfolio remain in line with current management expectations and the costs and sources of funding are not materially impacted, the ratings could be revised back to Stable. However, if further issues are discovered beyond the scope currently disclosed, or if funding costs were to materially increase, or if funding sources were to be significantly curtailed, the ratings could be downgraded. Furthermore, if DBRS were to see a material deterioration in liquidity, or a reduction in capitalization to levels closer to regulatory minimums, there could also be negative rating implications.

Laurentian’s mortgage documentation problems have been big news lately.

Affected issues are LB.PR.F (soon to be redeemed), LB.PR.H and LB.PR.J .

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