DBRS Confirms Canadian Western Bank Rating at A (low), Stable Trend

DBRS Limited (DBRS) has today confirmed Canadian Western Bank’s (CWB or the Bank) Issuer Rating and Deposits & Senior Debt rating at A (low), its Short-Term Instruments rating at R-1 (low), its Subordinated Debt rating at BBB (high) and its NVCC Preferred Shares rating at Pfd-3. The trend on all ratings is Stable. The rating actions follow a detailed review of the Bank’s operating results, financial fundamentals and future prospects.

Under DBRS’s “Global Methodology for Rating Banks and Banking Organisations,” the Bank’s long-term Deposits & Senior Debt rating of A (low) has an intrinsic assessment of A (low) and a support assessment of SA3. The SA3 rating, which reflects the expectation of no timely external support, results in the final rating being equivalent to the intrinsic assessment.

In confirming the rating, DBRS recognizes CWB’s proven business model, operating in the middle-market commercial space across the country, and its ability to successfully grow through the strategic acquisition of companies and loan books. In addition, the Bank has successfully migrated to a core banking system, which should enhance its risk management and capital control. These positive factors are offset by the concentration of the Bank’s loan portfolio in Western Canada, as well as its proportionately large book of real estate project loans that would be adversely affected by a significant decline in real estate prices within the provinces of Alberta and British Columbia. In addition, CWB is heavily reliant on interest income and lacks earnings diversification.

As Canada’s eighth-largest Schedule I bank, with assets of $25.2 billion at the end of Q3 2016, CWB has grown its business in commercial lending in sectors that include real estate, construction financing, equipment financing and leasing, and energy loans. The Bank’s disposal of non-complementary business lines in the last couple of years and its growth through the acquisition of synergistic loan portfolios have solidified CWB’s competitive position and helped the Bank diversify its geographic footprint away from Western Canada.

CWB has enjoyed steady profitability and efficiency, with sufficient pre-provision income to absorb loan losses at current levels, which are relatively low. However, in DBRS’s opinion, a dependence on interest income coupled with increased provisioning for oil and gas loans and a potential correction in the real estate markets could impact that earning stability. Most recently, CWB reported $130 million of net income for the nine months ended July 31, 2016 (9M16), down 16% from 9M15, despite an 8% increase in operating revenues to $490 million in 9M16. The reduction was mainly due to increased provisioning, especially for the energy portfolio, with provisions for credit losses nearly tripling to $66 million in 9M16.

The Bank’s risk, while well managed given the secured nature of CWB’s loan book and the historical low level of impairments, which show good underwriting standards, has comparatively higher exposure to commercial real estate, especially development projects, versus its peers. As of Q3 2016, gross real estate project loans stood at a high of 186% of shareholders’ equity. DBRS is cautious that the challenging economic environment in Alberta or stress in the real estate market in Western Canada could pose a significant risk to CWB’s real estate project exposure, which includes interim construction and land under development, which makes up approximately 20% of the Bank’s total loan portfolio.

Funding diversification at CWB has been slowly improving over the past several years, but the Bank continues to rely more heavily on brokered deposits relative to its Canadian banking peers. Liquidity levels are good with sufficient unencumbered assets to cover the Bank’s needs.

CWB’s capital ratios are above regulatory minimums but with a narrow cushion to absorb any major losses. Specifically, CWB’s CET1 ratio was 9.0% at Q3 2016, which was a modest improvement from YE2015 despite several acquisitions and organic growth. DBRS believes that the Bank’s good internal capital generation and its ability to raise equity in the markets will be supportive to CWB’s operations until it switches to an advanced internal rating-based model in 2019, at which point capitalization is expected to further improve.

RATING DRIVERS
DBRS views CWB as being well positioned within its rating category, so upward ratings pressure is unlikely over the intermediate term. Longer term, a broadening of the geographic footprint of its loan book while reducing its concentration in real estate project lending, a greater contribution from its fee-based businesses and a lower reliance on brokered deposits could result in positive ratings implications. Conversely, losses in the commercial lending portfolio because of unforeseen weaknesses in the underwriting or risk management process could put downward pressure on the ratings. Furthermore, an exponential increase in impaired loans and charge-offs as a result of a serious real estate market correction, and a deterioration in efficiency or profitability could also negatively affect the ratings.

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

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.dbrs.com.

The applicable methodologies are Global Methodology for Rating Banks and Banking Organizations (July 2016), Rating Bank Capital Securities – Subordinated, Hybrid, Preferred & Contingent Capital Securities (February 2016) and DBRS Criteria: Support Assessments for Banks and Banking Organisations (March 2016), which can be found on the DBRS website under Methodologies.

Lead Analyst: Maria-Gabriella Khoury
Rating Committee Chair: Roger Lister