DBRS Morningstar Confirms Canadian Western Bank at A (low), Trends on Long-Term Ratings Remain Negative

DBRS Limited (DBRS Morningstar) confirmed its ratings on Canadian Western Bank (CWB or the Bank), including the Bank’s Long-Term Issuer Rating at A (low) and its Short-Term Issuer Rating at R-1 (low). DBRS Morningstar maintained the trends for all long-term ratings at Negative, while the trends on all short-term ratings remain 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.

KEY RATING CONSIDERATIONS
DBRS Morningstar maintained the Negative trends as a result of the uncertainty surrounding the economic recovery in the wake of the Coronavirus Disease (COVID-19) pandemic, particularly for the Province of Alberta (Alberta; rated AA (low) with a Negative trend by DBRS Morningstar), where CWB has been reducing its loan exposure, which sat at 31% of total loans as of January 31, 2021. Alberta’s economy still faces challenges caused by the pandemic, oil price volatility, and quickly changing dynamics in the energy market. Although CWB’s earnings proved resilient and the Bank continues to successfully diversify into Ontario while growing directly sourced deposits, DBRS Morningstar is still cautious that the economic impact of the pandemic (particularly for midsize commercial firms, many of whom represent CWB’s core clientele) has yet to fully materialize.

In confirming the ratings, DBRS Morningstar recognizes 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 relative to peers, specifically to development projects in Western Canada, limited fee-based revenues, and the Bank’s weaker capital position relative to peers.

RATING DRIVERS
Given the Negative trends, an upgrade is unlikely at this time. The trends could revert to Stable if the impact of the current pandemic on CWB’s earnings and credit quality metrics remains manageable.

Conversely, material losses in the loan portfolio as a result of continued volatility in energy markets that affect the Alberta economy and a longer than expected adverse impact due to the coronavirus pandemic, the ratings would be downgraded. Furthermore, operational issues that negatively impact the Bank’s implementation of its various organizational systems and data projects or a reduction in capitalization to levels closer to regulatory minimums would also result in a ratings downgrade.

RATING RATIONALE
With assets of $35.3 billion as of January 31, 2021, CWB is Canada’s eighth-largest Schedule I bank by assets, specializing in commercial lending, leasing, and franchise finance to middle-market clients. In addition, CWB is active in the Alt-A residential mortgage space through its CWB Optimum Mortgage business, which represents 10% of the total loan book. CWB’s primary commercial lending activities remain within its traditional markets in Western Canada, although the Bank has been actively expanding into Eastern Canada over the last decade and making inroads into the Ontario market. Indeed, Ontario accounted for most of the loan growth seen in Q1 2021.

CWB has a proportionally higher exposure to commercial loans than its Canadian bank peers as they form 80% of the Bank’s portfolio, with the real estate sector accounting for 30% of total loans. Although the Bank maintains a conservative risk appetite and these loans are largely secured, higher credit impairments are possible given the current economic situation, particularly as middle-market borrowers have faced forced business closures and disruptions throughout the last year because of the pandemic. As a result, impaired loans have nearly doubled over the last year as gross impaired loans stood at 0.93% of gross loans in Q1 2021 versus 0.52% in Q4 2019, although they still remain at manageable levels as do losses, which remain very modest and consistent with historical results. However, government stimulus and aid has provided substantial mitigation.

Positively, CWB posted good earnings throughout 2020 and in Q1 2021 as the Bank managed to maintain a healthy net interest margin versus peers, owing to the commercial nature of its loan portfolio and lower funding costs. Furthermore, the Bank has been gradually increasing its proportion of noninterest income because of recent wealth management acquisitions and a broadening of its trust services.

CWB’s funding was stable throughout the pandemic, and the Bank maintained prudent levels of liquidity. DBRS Morningstar notes that the Bank continued to strengthen its funding profile by increasing directly sourced deposits, wholesale funding, and use of securitization, in addition to issuing new Limited Recourse Capital Notes. Furthermore, although capitalization is above regulatory requirements with a Common Equity Tier 1 ratio of 8.8% as of Q1 2021, in DBRS Morningstar's view, CWB should carefully manage capital levels, given both the current environment and the fact that the Bank has yet to formally apply for the advanced internal rating-based approach (AIRB). The Bank expects to progress with the 2021 parallel run of AIRB in order to resubmit its application for approval from the Office of the Superintendent of Financial Institutions in the first half of 2022.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

The Grid Summary Grades for CWB are as follows: Franchise Strength – Good; Earnings Power – Strong/Good; Risk Profile – Good; Funding & Liquidity – Strong/Good; Capitalization – 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 8, 2020; https://www.dbrsmorningstar.com/research/362170). Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (February 3, 2021; https://www.dbrsmorningstar.com/research/373262).

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

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.dbrsmorningstar.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.

Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar’s outlooks and ratings are under regular surveillance.

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

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