Morningstar DBRS Maintains Under Review With Positive Implications Status on Canadian Western Bank's Credit Ratings, Including Long-Term Issuer Rating of A (low)

DBRS Limited (Morningstar DBRS) maintained the Under Review with Positive Implications status on all the credit ratings of Canadian Western Bank (CWB or the Bank), including the Bank's Long-Term Issuer Rating of A (low). The credit ratings were placed Under Review with Positive Implications following the June 11, 2024, announcement that the National Bank of Canada (National; rated AA with a Stable trend) entered into a definitive agreement to acquire CWB by way of a share exchange, valuing the Bank at about $5.0 billion. Morningstar DBRS expects to resolve the Under Review with Positive Implications designation on CWB's credit ratings once the transaction closes, which is expected to occur in 2025. In September 2024, National received the Competition Bureau's clearance for the proposed acquisition following CWB common shareholders' approval of the transaction in the same month. The proposed transaction also requires approval by the Office of the Superintendent of Financial Institutions (OSFI) and the Minister of Finance.

KEY CREDIT RATING CONSIDERATIONS
The Under Review with Positive Implications status continues to reflect Morningstar DBRS' view that CWB's credit ratings will benefit from the acquisition by National, a more highly rated and diversified financial institution. After the completion of the transaction, the Support Assessment (SA) designation of SA1 will be assigned to the Bank and its long-term credit ratings will be driven by those of National.

On an intrinsic basis, Morningstar DBRS views CWB's franchise as good, supported by its well-established and growing position in the middle-market commercial space across Canada, which includes an expanding presence in Ontario. Furthermore, the Bank continues to demonstrate resilient profitability and good asset quality despite some deterioration in the current operating environment. On the other hand, the credit ratings are constrained by the Bank's relatively high exposure to the real estate sector, including construction development projects in Western Canada, ongoing material reliance on brokered deposits, and limited fee-based revenues. Amid an environment of still elevated interest rates, Morningstar DBRS expects CWB's asset quality and profitability metrics to deteriorate modestly in F2025 from their current levels, in line with its peers.

CREDIT RATING DRIVERS
If the acquisition closes as expected, CWB's credit ratings would likely be equalized with the credit ratings of National. If the acquisition of CWB by National does not close, the credit ratings would likely revert back to Stable.

CREDIT RATING RATIONALE
Franchise Combined Building Block Assessment: Good/Moderate
With assets of $42.5 billion as of July 31, 2024, CWB specializes in general commercial lending, equipment financing, and commercial mortgages, including real estate project financing to middle-market clients. In addition, the Bank 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, 2024, about 62% of CWB's loan portfolio was exposed to its traditional markets in British Columbia and Alberta, although the Bank has been actively expanding into Eastern Canada, particularly Ontario, which accounted for about 25% of total loans. The Bank further expanded its presence in Ontario with a new Kitchener banking centre that opened in September 2024 and its flagship Toronto downtown location, which opened in January 2024.

Earnings Combined Building Block Assessment: Good/Moderate
In a challenging operating environment, CWB reported common shareholders' net income of $205.9 million during the first nine months of F2024 (9M 2024), a 16.9% decrease year over year (YOY). This was largely driven by higher provision for credit losses and noninterest expenses, partially offset by higher revenue. Noninterest expenses increased 7.1% YOY in 9M 2024, reflecting the impact of the recently opened banking centres in Toronto's financial district and Kitchener, continued investment in digital capabilities (including a new commercial digital and cash management platform) as well as professional fees and employee compensation directly associated with National's potential acquisition. Total revenue increased by 6.5% YOY to $874.4 million in 9M 2024, supported by higher net interest income and noninterest income. Net interest margin (as calculated by Morningstar DBRS) expanded by 13 basis points (bps) YOY to 2.48 % in 9M 2024 while CWB's efficiency ratio remained good at about 54% as at July 31, 2024.

Risk Combined Building Block Assessment: 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 commercial real estate sector accounting for 26% of total loans as at July 31, 2024. Gross loans and advances of $37.4 billion in Q3 2024 remained broadly flat YOY as higher general commercial loans and equipment financing and leasing were offset by a decline in almost all other loans. Despite an uptick in impairments, CWB's asset quality remains good with very low and manageable loan losses. Impaired loans increased by 49 bps YOY to 1.24% of gross loans in 9M 2023, reflecting the impact of sustained higher interest rates and overall economic conditions on personal and commercial loans, as well as some commercial borrower-specific circumstances. Morningstar DBRS 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 Assessment: Good/Moderate
CWB's funding base is good with sufficient levels of liquidity. Total deposits, including capital markets, declined marginally YOY to $33.4 billion in 9M 2024, consistent with broadly flat loan book growth. Branch-raised deposits, primarily in demand and notice products, comprised 63% of total deposits. Amid the still high interest rates environment, fixed-term deposits increased by 3.8% YOY in 9M 2024 and accounted for approximately 60% of total deposits (including capital markets deposits). The balance of liquid assets to total assets, which remained relatively stable YOY at 9.7% as at July 31, 2024, is sufficient to meet the Bank's operational needs. CWB is also compliant with OSFI's minimum Liquidity Adequacy Requirements, including the Liquidity Coverage Ratio.

Capitalization Combined Building Block Assessment: Good/Moderate
CWB's capital ratios using the standardized approach are above regulatory minimums and provide appropriate buffers to absorb stressed levels of loan losses. As of July 31, 2024, CWB's CET1 ratio increased by 80 bps YOY to 10.2 %, driven by higher accumulated other comprehensive income associated with an increase in the fair value of debt securities and retained earnings growth, partially offset by risk-weighted asset growth. Following the closing of its acquisition by National, Morningstar DBRS expects CWB to switch to the Advanced Internal Rating-Based methodology for capital and risk management (subject to regulatory approval). This would result in an increase in the Bank's current regulatory capital ratios.

Further details on the Scorecard Indicators and Building Block Assessments can be found at https://www.dbrsmorningstar.com/research/442915.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS

There were no Environmental/Social/Governance factors that had a significant or relevant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (August 13, 2024) https://dbrs.morningstar.com/research/437781.

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

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (June 4, 2024) https://dbrs.morningstar.com/research/433881. In addition, Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (August 13, 2024) https://dbrs.morningstar.com/research/437781 in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.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 dbrs.morningstar.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.

Morningstar DBRS 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. Morningstar DBRS's trends and credit ratings are under regular surveillance.

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

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