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

DBRS Limited (DBRS Morningstar) confirmed the ratings of Canadian Western Bank (CWB or the Bank), including
the Bank’s Long-Term Issuer Rating at A (low) and Short-Term Issuer Rating at R-1 (low). The trend on all ratings is Stable. The Bank’s Intrinsic Assessment 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 Intrinsic Assessment. DBRS Morningstar also discontinued CWB’s legacy Subordinated Debt rating as all outstanding debt was repaid on November 18, 2019.

KEY RATING CONSIDERATIONS
The ratings and Stable trends reflect CWB’s well-established and growing franchise, operating in the middle-market commercial space across Canada. Furthermore, the Bank has been successful in executing strategic targeted acquisitions of loan portfolios that complement its existing book while providing geographic diversification. The ratings also consider the Bank’s high level of exposure to the real estate sector, specifically to development projects in Western Canada, reliance on brokered deposits and limited fee-based revenues.

RATING DRIVERS
A material and steady increase in the proportion of non-interest income in operating revenues or an increase in direct to client sourced funding could be beneficial for the ratings. Additionally, further geographic diversification of the loan book and a reduction in the relative exposure to real estate project finance could also have positive ratings implications.

Conversely, significant losses in the commercial lending portfolio as a result of unforeseen weaknesses in the risk management process or a sustained increase in impaired loans and charge-offs could have negative ratings implications. Furthermore, operational difficulties that would impact the Bank’s implementation of the various organizational, systems and data projects could also pressure the ratings.

RATING RATIONALE
With assets of $30.9 billion as of July 31, 2019, CWB is Canada’s eighth-largest Schedule I bank specializing in commercial lending, leasing and franchise finance. In addition, CWB is active in the Alt-A residential mortgage space through its CWB Optimum Mortgage business. The Bank has been on a growth trajectory since 2010, when it completed several acquisitions that have provided it with complementary portfolios that are well aligned with CWB’s existing business lines. In addition, these acquisitions have positioned CWB for expansion into eastern Canada, especially Ontario, as the Bank continues to enhance its geographic diversification outside of its traditional markets of Alberta and British Columbia.

Continued strong loan growth and higher asset yields contributed to the 9% annual increase in CWB’s net interest income, which totaled $584 million in the nine months ended July 31, 2019 (9M 2019). Although CWB’s profitability is steady, interest income continues to form the main component of the Bank’s operating revenues, which, in DBRS Morningstar’s opinion, is a ratings constraint. With its investment in core technology over the last couple of years, CWB has been developing new products aimed at driving higher non-interest income. Furthermore, the Bank expects to be able to better cross-sell products to clients of its different business lines, thus broadening its sources of revenue. Meanwhile, at 46%, CWB’s efficiency ratio remains one of best amongst similarly rated peers. Provisions for credit losses to income before provisions and taxes remains healthy at 13.3% in 9M 2019. This is the first fiscal year since the Bank adopted the International Financial Reporting Standards, and although management expects some volatility in provisioning as the forward-looking models are adjusted, it does not expect material changes in the normal course of business.

Despite the relative geographic and sector concentration of the loan portfolio, asset quality at CWB is sound with impaired loans at 0.5% of gross loans as of Q3 2019, unchanged from the previous year. However, DBRS Morningstar believes that the comparatively higher exposure to commercial real estate versus peers poses a significant risk for CWB as real estate construction and development project loans make up 14% of gross loans. These loans could come under pressure in the event of a real estate market downturn in Canada. Furthermore, as CWB achieves its geographic diversification targets through organic loan growth and acquisitions, DBRS Morningstar is cautious that the Bank might become exposed to greater credit and operational risk. Therefore, DBRS Morningstar will look to CWB to maintain its good underwriting standards and continue to develop risk management practices in parallel with expansion.

The Bank continues to improve and diversify its funding profile. CWB placed particular emphasis on growing branch raised deposits through the year as it rolled out new products and services to clients. Direct deposits reached $13.1 billion as of July 31, 2019, up 13% from the previous year, which DBRS Morningstar view positively. In addition, the Bank continued to tap into the capital markets for institutional deposits and increased its securitization-related debt by 5% to $1.9 billion. Meanwhile, the Bank issued its inaugural $250 million Non-Viability Contingent Capital Subordinated Debt in June 2019, the proceeds of which were used to redeem the legacy Subordinated Debt in November 2019. Liquidity levels are good with sufficient unencumbered assets to cover the Bank’s needs.

CWB’s CET1 ratio stood at 9.0% in Q3 2019, which is above regulatory minimums but below peer averages. Capitalization ratios are expected to improve as the Bank switches to an advanced internal rating-based (AIRB) model in fiscal 2020. Nevertheless, DBRS Morningstar is cognizant that CWB is exposed to heightened operational risk as it implements the various system and data projects that would enable the migration to AIRB.

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

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

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (June 2019), which can be found on our website under Methodologies & Criteria.

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 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.

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

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