LB Outlook Negative, says S&P

Standard & Poor’s has announced:

  • •On Dec. 5, 2017, Montreal-based Laurentian Bank of Canada disclosed mortgage documentation and client representation issues in connection with mortgages sold to a third-party purchaser, which resulted in some repurchase actions and raised concerns around the rigor of the company’s underwriting procedures and risk control functions.
  • •Since then, the bank has undertaken a sample review of its mortgage portfolio. While the review is still ongoing, company disclosures available so far suggest to us that widespread underwriting lapses or mortgage document falsification issues are unlikely to emerge.
  • •We understand that the documentation issues largely pertain to documentation deficiencies as opposed to intentional client fraud and misrepresentations. We expect the bank’s recent remedial initiatives to enhance its quality control functions and underwriting procedures, and note the company has not recorded any deterioration in loan performance.
  • •We are therefore removing the long- and short-term ratings from CreditWatch negative and affirming them at ‘BBB/A-2’.
  • •The negative outlook primarily reflects LBC’s relatively concentrated position in Canadian residential mortgages and our concern over a potential reduction in the company’s projected risk-adjusted capital ratio.

Our negative outlook, however, incorporates our view that the company continues to be exposed to risks associated with its more concentrated exposure to Canadian residential mortgages relative to peers’, with meaningful exposure to the non-prime segment (approximately 8% of total mortgage loans) at a time when we have concerns around consumer indebtedness (see: “Canada Economic Risk Higher On Elevated House Prices And Household Debt And Mortgage Fraud; No Ratings Affected,” published Feb. 23, 2018, on RatingsDirect). LBC’s total loans, net of allowances, stood at C$36.7 billion as at Jan. 31, 2018, of which C$18.6 billion (or approximately 50.7%) are Canadian residential mortgages (commercial loans make up about 33.5% of the loan book). This concentration in residential mortgages contributes to a meaningfully larger proportion of operating revenues being derived from net interest income (approximately 66.9% in first-quarter 2018) relative to the average of the larger Canadian banks (approximately 51.9% for the same period). LBC’s residential mortgage loans through independent brokers and advisors grew by 19% year-over-year as of first-quarter 2018. We will continue to monitor LBC’s asset quality metrics in a moderating housing market. As well, we note that LBC’s funding and liquidity ratios remain among the weakest of its peer banks, with a customer loans to deposits ratio, stable funding ratio, and broad liquid assets to short-term wholesale funding ratio of 156.4%, 91.82%, and 0.8x, respectively, compared with a peer average of 113.4%, 109.94%, and 1.38x, respectively). However, given the bank’s growth strategy and funding plans, we expect these metrics to improve over time.

In addition, we believe that LBC could experience some changes to its capital planning process as it adopts the advanced internal rating-based (AIRB) approach to credit risk measurement (projected for fiscal 2020), from the current standardized approach. The bank indicated that the implementation of the AIRB approach remains a key initiative of its transformation plan in order to optimize regulatory capital, and because its regulatory ratios are expected to increase (the exact extent is still not known), we believe that capital optimization strategies may negatively affect the risk-adjusted capital (RAC) ratio.

The outlook is negative, largely reflecting our view of LBC’s risks associated with a relatively concentrated position in Canadian residential mortgages consistent with our concerns around elevated house prices, household debt, and mortgage fraud. The negative outlook also reflects a potential reduction in LBC’s projected RAC ratio as a result of its expected transition to the AIRB approach to credit risk measurement, from the current standardized approach, which would likely reduce its regulatory capital requirements.

Affected issues are LB.PR.H and LB.PR.J

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