DBRS Morningstar Confirms Canadian Western Bank’s Long-Term Issuer Rating at A (low); Stable Trend

DBRS Limited (DBRS Morningstar) confirmed its credit 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). The trend on all credit ratings is Stable. The Bank’s Intrinsic Assessment (IA) of A (low) and Support Assessment (SA) of SA3 remain unchanged. The SA3 designation, which reflects no expectation of timely external support, results in the final Long-Term Issuer Rating being equivalent to the IA.

KEY CREDIT RATING CONSIDERATIONS
The credit rating confirmations and Stable trends reflect CWB’s well established and growing franchise, operating in the middle-market commercial space across Canada. Furthermore, the Bank continues to expand nationally, particularly into Ontario. DBRS Morningstar considers CWB’s resilient profitability and good asset quality to be supportive of the credit ratings. On the other hand, the credit ratings are constrained by the Bank’s relatively high exposure to the real estate sector, including development projects in Western Canada, ongoing material reliance on brokered deposits and limited fee-based revenues. Amid the challenging macroeconomic environment, DBRS Morningstar expects that CWB’s asset quality and profitability metrics will likely modestly deteriorate from their current levels over the credit ratings horizon in line with the peers.

CREDIT RATING DRIVERS
DBRS Morningstar would upgrade the credit ratings if CWB were to further diversify its revenue base with a material and sustainable increase in the level of noninterest income. A material reduction in the proportion of brokered deposits and increased diversification of the loan book, including from its commercial real estate lending, would also result in a credit ratings upgrade.

Conversely, a credit ratings downgrade would occur should there be significant losses in the loan portfolio, especially as a result of unforeseen weakness in underwriting and/or risk management. Furthermore, operational issues that would negatively affect the Bank’s implementation of its various organizational systems and data projects or a material reduction in capitalization levels would also result in a credit ratings downgrade.

CREDIT RATING RATIONALE
Franchise Combined Building Block (BB) Assessment: Good/Moderate
With assets of $42.6 billion as of July 31, 2023, CWB is Canada’s ninth-largest Schedule I bank by assets, specializing in general commercial lending, equipment financing, and commercial mortgages, including real estate project financing to middle-market clients. In addition, CWB operates in the Alt-A residential mortgage space through its CWB Optimum Mortgage business, which represents less than 10% of the total loan book. As at July 31, 2023, about 62% of CWB’s loan portfolio remained in BC and Alberta; although, the Bank has been actively expanding into Eastern Canada, particularly Ontario with banking centres opened in Mississauga and Markham, over the last decade. Ontario accounted for more than 44% of the total loan growth year-over-year (YOY) as at July 31, 2023 and included growth across all lending portfolios. The Bank expects to further expand its presence in Ontario with the opening of its flagship Toronto downtown location before the end of 2023, along with a Kitchener banking center in 2024.

Earnings Combined Building Block (BB) Assessment: Good/Moderate
In a challenging operating environment, CWB posted common shareholders’ net income growth of 2.0% YOY in the first nine months of F2023 (9M 2023) to $247.5 million, largely supported by higher net interest income and lower provision for credit losses. However, net interest margin (as calculated by DBRS Morningstar) compressed by 12 basis points (bps) to 2.35% because of slower growth in fixed term asset yields and rising funding costs. Meanwhile, noninterest income remained broadly stable over the same period in F2023, accounting for about 12% of total revenue. Despite a 6.8% growth YOY in operating expenses, CWB's efficiency ratio remained good at about 54% for 9M 2023, reflecting the Bank's focus on commercial middle-market lending and its relatively small branch footprint.

Risk Combined Building Block (BB) Assessment: Strong/Good
CWB has proportionally higher exposure to commercial loans than its Canadian bank peers as they account for 81% of the Bank’s portfolio, with the real estate sector accounting for 28% of total loans as at July 31, 2023. Underpinned by its sound underwriting standards and largely secured loans, CWB’s asset quality remains good with very low and manageable loan losses. Impaired loans increased by 22 bps YOY to 0.75% of gross loans as at July 31, 2023, largely driven by impairments in the commercial real estate portfolio; however, the ratio remained low compared with the recent years’ peak level of 0.95% in Q2 2021. DBRS Morningstar remains cautious that the Bank’s concentration risk in the loan book, including relatively high exposure to real estate related lending makes it more susceptible to asset-quality deterioration in the event of a sustained economic downturn compared with its peers.

Funding and Liquidity Combined Building Block (BB) Assessment: Good/Moderate
CWB’s funding base is good with sufficient levels of liquidity. The Bank continued to strengthen its funding profile by increasing directly sourced deposits, wholesale funding, and the use of securitization. Total deposits, including capital markets, increased by 4.0% YOY to $33.7 billion as at July 31, 2023. Branch-raised deposits, primarily generated in demand and notice products, comprised 62% of total deposits. Amid high interest rates, fixed term deposits increased by 9.2% YOY and accounted for approximately 57% of total deposits as at July 31, 2023. The balance of liquid assets to total assets, which declined to 9.1% as at July 31, 2023 from 10.4% a year earlier is sufficient to meet the Bank’s operational needs. CWB is also compliant with the minimum Liquidity Adequacy Requirements of the Office of the Superintendent of Financial Institutions (OSFI), including the Liquidity Coverage Ratio.

Capitalisation Combined Building Block (BB) Assessment: Good/Moderate
As with other banks using the standardized approach, CWB’s capital ratios are above regulatory minimums but remain below peer averages. As of July 31, 2023, CWB’s CET1 ratio increased by 50 bps to 9.4% compared with the same date in 2022. The increase was associated with the adoption of the 2023 OSFI Capital Adequacy Requirements guideline, common shares issued under the Bank’s at-the-market program, and retained earnings growth, partially offset by risk-weighted asset growth. Regulatory capital ratios are expected to improve once the Bank switches to the Advanced Internal Rating-Based (AIRB) methodology for capital and risk management. Nevertheless, DBRS Morningstar is cognizant that the Bank could be exposed to operational risk as it implements the various projects that would enable the migration to AIRB.

Further details on the Scorecard Indicators and Building Block Assessments can be found at https://www.dbrsmorningstar.com/research/423293.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
Environmental (E) Factors
There were no Environmental factor(s) that had a relevant or significant effect on the credit analysis.

Social (S) Factors
There were no Social factor(s) that had a relevant or significant effect on the credit analysis.

Governance (G) Factors
There were no Governance factor(s) that had a relevant or significant effect on the credit analysis.

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/416784 (July 4, 2023).

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

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (June 22, 2023; https://www.dbrsmorningstar.com/research/415978). In addition, DBRS Morningstar uses the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (July 4, 2023; https://www.dbrsmorningstar.com/research/416784) in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies.

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 credit rating was initiated at the request of the rated entity.

The rated entity or its related entities did participate in the credit rating process for this credit rating action.

DBRS Morningstar had access to the accounts, management, and other relevant internal documents of the rated entity or its related entities in connection with this credit rating action.

This is a solicited credit rating.

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

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

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