downgraded its credit ratings on Laurentian Bank of Canada (LBC or the Bank), including the Bank’s Long-Term Issuer Rating to BBB from BBB (high) and Short-Term Issuer Rating to R-2 (high) from R-1 (low). Morningstar DBRS changed the trends for all credit ratings to Stable from Negative. The Bank’s Intrinsic Assessment (IA) is BBB with a Support Assessment (SA) of SA3. The SA3 designation reflects no expectation of timely external support and results in the Bank’s Long-Term Issuer Rating being equivalent to the IA.
KEY CREDIT RATING CONSIDERATIONS
The credit rating downgrades reflect LBC’s weak earnings performance, which also affects Morningstar DBRS’ view of LBC’s competitive position and franchise strength. Earnings have remained under pressure in the first nine months of 2024 ended July 31, 2024 (9M 2024), and Morningstar DBRS expects continued weakness in earnings in the short to medium term as the new leadership team embarks on its turnaround strategy. Moreover, because of lack of scale, LBC has divested assets under administration to two different entities as part of its strategy to focus on areas of business where it can win and be more competitive. Other aspects of the new strategic plan include revamping its leadership team, simplifying the Capital Markets segment, and accelerating investments to improve operational and technological resiliency. Nevertheless, in Morningstar DBRS’ view, these initiatives could take some time to realize material benefits, considering the Bank’s previous transformations, which yielded less than desired levels of success. The Stable trends reflect Morningstar DBRS’ expectations that LBC’s new leadership will implement the strategic initiatives without operational missteps, while demonstrating a gradual improvement in earnings and franchise strength over time.
Supporting the credit ratings, LBC continues to demonstrate good credit quality with low impairments and loan losses; however, Morningstar DBRS expects asset quality metrics to modestly deteriorate from current levels in F2025 because of elevated debt-servicing costs for borrowers. The Bank’s balance sheet fundamentals remain stable with good levels of liquidity and capital buffers to deal with potential deposit outflows and absorb a stressed level of loan losses.
CREDIT RATING DRIVERS
Over the longer term, Morningstar DBRS would upgrade the credit ratings, if LBC demonstrates a material and sustained improvement in its franchise position and financial performance while maintaining a similar risk profile.
Conversely, additional missteps and/or a failure to execute on the Bank’s strategic initiatives would result in another credit ratings downgrade. In addition, pressure on funding and liquidity or a significant deterioration in asset quality would also result in another credit ratings downgrade.
CREDIT RATING RATIONALE
Franchise Combined Building Block (BB) Assessment: Moderate
LBC is Canada’s eighth-largest Schedule I bank with assets of $47.5 billion as at July 31, 2024. The Bank offers retail services in Québec through its branch network as well as commercial lending across Canada and in the U.S. LBC also distributes financial products to brokers and financial advisors across Canada through its wholesale arm, B2B Bank. During its Investor Day on May 31, 2024, LBC unveiled its new strategic plan developed by recently appointed President and Chief Executive Officer (CEO) Éric Provost. The plan lays out a path to profitability-driven growth, which includes improved efficiency in the Personal Banking part of the Personal and Commercial Banking segment through digitalization and simplification as well as a continued focus on commercial lending as the key growth engine. Furthermore, the Bank will be focusing on funding optimization, strengthening core retail deposit gathering, and expanding the Bank’s fixed income and foreign exchange specialization capabilities in its Capital Markets segment. As part of the revamped strategy, LBC has divested its full-service and discount brokerage divisions and equity research businesses, while accelerating investments to improve operational and technological resiliency.
Earnings Combined Building Block (BB) Assessment: Weak
LBC has experienced further earnings deterioration and continues to report weaker profitability relative to its peers, with reported adjusted net income declining by about 21.9% year over year (YOY) to $127.7 million for 9M 2024. Adjusted return on common equity, as reported by the Bank, fell to 6.1% in 9M 2024 from 8.1% for the same period of the prior fiscal year. Lower adjusted net earnings were largely driven by a 3.2% YOY reduction in net interest income on the back of lower commercial loan volumes and a 4.6% YOY increase in noninterest expenses largely reflecting technology costs and a higher provision for credit losses. As a result, the adjusted efficiency ratio, as reported by the Bank, deteriorated by 42 basis points (bps) YOY to 73.4% in 9M 2024, while the reported net interest margin remained stable at 1.8% for the same period. Of note, the Bank reported a net loss of $46.2 million in 9M 2024 (on an unadjusted basis) largely associated with the impairment and restructuring charges of $212.0 million ($166.8 million after income taxes) related to the Bank’s operations and the impairment of the Personal and Commercial Banking segment recorded in Q2 2024.
Risk Combined Building Block (BB) Assessment: Good
Amounting to $35.1 billion as at Q3 2024, gross loans contracted by 5.1% YOY, largely because of reductions in commercial and nonmortgage personal loans of 7.2% and 20.2%, respectively. The bulk of credit risk lies in the commercial book, which accounted for about 47% of total loans as at Q3 2024 and has concentrations in commercial real estate and inventory financing. The Bank’s asset quality is still good with low impairments and loan losses, although the gross impaired loans ratio increased by 53 bps YOY to 1.1% at the end of Q3 2024, largely because of increased impairments in commercial loans, including commercial mortgages. Morningstar DBRS expects asset quality metrics to further deteriorate from their current levels in F2025 despite the declining interest rate environment. Furthermore, Morningstar DBRS remains cautious that if not managed prudently, the Bank’s continued realignment of the loan portfolio and geographic expansion, as well as potential challenges with the execution of the revamped strategy, could expose LBC to heightened levels of operational and credit risk.
Funding and Liquidity Combined Building Block (BB) Assessment: Good/Moderate
LBC’s overall funding and liquidity position remains stable. The Bank has maintained a good branch-raised deposit base in Québec and also funds its operations through broker-sourced deposits. Accounting for about 65% of LBC’s total funding base, total deposits, including capital markets deposits, declined by 11.3% YOY to $23.3 billion in Q3 2024, in line with the contraction in the loan book. The decrease was largely driven by personal deposits, which represented 86% of total deposits as at Q3 2024. Meanwhile, deposits from the broker channel totalled $10.0 billion and accounted for about 43% of total deposits as at Q3 2024. As part of its revamped strategy, the Bank is seeking to attract additional deposits across Canada, especially direct retail deposits through expansion of its digital capabilities, which Morningstar DBRS views positively.
Capitalization Combined Building Block (BB) Assessment: Good/Moderate
LBC’s capital ratios under the standardized approach are above regulatory minimums and provide appropriate buffers to absorb stressed levels of loan losses. Morningstar DBRS would view favourably a larger capital buffer, sufficient to absorb significant losses, especially as the Bank is focused on commercial lending, which may be more susceptible to weakness in the event of a sustained economic downturn. The CET1 capital ratio increased by 110 bps YOY to 10.9% as at Q3 2024, primarily reflecting lower risk-weighted assets on the back of lower loan balances. The Bank reported a leverage ratio of 5.2% in Q3 2024 (compared with 4.8% as at Q3 2023) that was also above the regulatory minimum of 3.0%.
Further details on the Scorecard Indicators and Building Block Assessments can be found at https://www.dbrsmorningstar.com/research/442469.
LB.PR.H: Trend Now “Stable”, says DBRS
Friday, November 1st, 2024DBRS has announced that it:
The issue was downgraded to Pfd-3(low), Trend Negative last December. This downgrade does not affect the level of the rating, but changes the trend to stable.
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