DBRS Confirms Canadian Western Bank’s Ratings, Stable Trends

DBRS Limited (DBRS) 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.

The rating confirmations and Stable trends reflect CWB’s well established and growing franchise, with a proven business model 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 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.

CWB is Canada’s eighth-largest Schedule I bank, with assets of $25.3 billion as of July 31, 2017, operating in different commercial segments including lending, leasing, franchise finance and sector-specific lending. In addition, the Bank is active in the Alt-A residential mortgage space through its CWB Optimum Mortgage business. On October 30, 2017, CWB entered into a definitive agreement to acquire the Canadian Commercial and Vendor Finance assets of ECN Capital Corp. for a cash consideration of approximately $900 million. The equipment finance and leasing assets to be acquired are concentrated within the transportation, construction and health-care industries and are distributed across the country. The portfolio, which is expected to be consolidated at the end of Q1 2018, and will be funded through CWB’s existing securitization facilities, is well aligned with the Bank’s existing business lines and provides good growth opportunities and further geographic diversification.

Net interest income totalled $472 million in the nine months ended July 31, 2017 (9M 2017) and continues to form the main component of the Bank’s operating revenues. With the successful implementation of the new core banking system, CWB expects to be able to better cross-sell products to clients of its different business lines, therefore DBRS will look to the Bank to steadily increase the proportion of stable non-interest income in order to broaden its sources of revenue. Positively, CWB’s efficiency ratio remained stable at 49% in 9M 2017, which compares favourably to those of similarly rated peers. DBRS notes that the Bank has improved the quality of its oil and gas portfolio by decreasing its exposure to small producers that typically lack the financial flexibility of larger producers, which should reduce provisions for credit losses in the sector going forward.

Asset quality is well managed at CWB with impaired loans at 0.7% of gross loans as of Q3 2017. The secured nature of the portfolio and good underwriting standards have helped maintain good performance; however, DBRS believes that the comparatively higher exposure to commercial real estate versus peers could pose a significant risk for CWB. Moreover, real estate project loans, which make up a high 18% of Q3 2017’s $22.8 billion gross loans, include interim construction and land under development loans, which could come under pressure in the event of a real estate market downturn in Canada.

CWB has been slowly improving its funding by increasing its usage of direct to customer and securitization channels in order to decrease its reliance on brokered deposits. Indeed, branch raised deposits represented 56% of total deposits in Q3 2017, compared to 52% in Q3 2016. Recently, in August 2017, the Bank was approved by the Canada Mortgage and Housing Corporation as an issuer of Canada Mortgage Bonds, which will further diversify CWB’s funding base. Liquidity levels are good with sufficient unencumbered assets to cover the Bank’s needs.

While CWB’s capital ratios are above regulatory minimums, there is a narrow cushion with which to absorb any potential major losses. Specifically, CWB’s CET1 ratio stood at 9.6% in Q3 2017, a slight improvement from 9.2% at YE2016. Capitalization ratios are expected to improve as the Bank switches to an advanced internal rating-based (AIRB) model in 2019. Nevertheless, DBRS 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.

RATING DRIVERS
Although DBRS believes CWB is currently well placed within its rating category, further geographic diversification of the loan book and a reduction in the relative exposure to real estate project finance would have positive implications. Furthermore, a material and steady increase in non-interest income that would be accompanied by an increase in direct to client funding could be positive for the ratings. Conversely, significant losses in the commercial lending portfolio as a result of unforeseen weaknesses in the underwriting and/or risk management process or a sustained increase in impaired loans and charge-offs as a result of a serious real estate market correction could have negative rating implications. In addition, losses caused by operational difficulties as the Bank implements the various organizational, systems and data projects could also negatively affect the ratings.

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 related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (May 2017), which can be found on dbrs.com under Methodologies.

Lead Analyst: Maria-Gabriella Khoury, Vice President, Canadian Financial Institutions Group
Rating Committee Chair: Michael Driscoll, Managing Director, Head of NA FIG, Global Financial Institutions Group

The rated entity or its related entities did participate in the rating process. DBRS had access to the accounts and other relevant internal documents of the rated entity or its related entities.

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