DBRS Confirms Canadian Western Bank at A (low); Trends Stable

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.

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
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 could be beneficial for the ratings. Furthermore, a material and steady increase in non-interest income that would be accompanied by an increase in branch-raised funding would have positive implications.

Conversely, significant losses in the commercial lending portfolio as a result of unforeseen weaknesses in the underwriting and/or risk management process 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 pressure the ratings.

RATING RATIONALE
CWB is Canada’s eighth-largest Schedule I bank, with assets of $28.2 billion as of July 31, 2018. The Bank specializes 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. On January 31, 2018, CWB completed the acquisition of the Canadian Commercial and Vendor Finance assets of ECN Capital Corporation. The portfolio consisted of $850 million in equipment finance and leasing assets concentrated within the transportation, construction and health-care industries. The portfolio is well aligned with the Bank’s existing business lines and provides CWB with good growth opportunities and further geographic diversification.

Strong loan growth, higher asset yields and an accretive portfolio acquisition contributed to the 14% annual increase in CWB’s net interest income, which totalled $536 million in the nine months ended July 31, 2018 (9M 2018). Interest income continues to form the main component of the Bank’s operating revenues; however, CWB expects to be able to better cross-sell products to clients of its different business lines by leveraging its investment in core technology. DBRS will continue to look to the Bank to steadily increase the proportion of stable non-interest income in order to broaden its sources of revenue. Meanwhile, at 46%, CWB’s efficiency ratio remains one of best amongst similarly rated peers. Provisions to income before provisions and taxes stood at 11.7% in 9M 2018, sufficient to cover loan losses at current levels. As of November 1, 2018, the Bank adopted the International Financial Reporting Standards (IFRS 9), which might create some volatility in net income going forward; however, management does not expect material changes to provisioning in the normal course of business.

Despite the relative geographic and sector concentration of the portfolio, asset quality at CWB is sound with impaired loans at 0.5% of gross loans as of Q3 2018. However, DBRS believes that the comparatively higher exposure to commercial real estate versus peers could pose a significant risk for CWB as real estate project loans make up a high 16% of gross loans. This sector includes interim construction and land under development loans, which could come under pressure in the event of a real estate market downturn in Canada. Furthermore, as CWB achieves geographic diversification targets through organic loan growth and acquisitions, DBRS is cautious that the Bank might become exposed to greater credit and operational risk. Therefore, DBRS 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 its funding profile through the increased usage of institutional deposits and securitization channels. Institutional deposits raised through the capital markets almost doubled during the year to reach $3.0 billion in Q3 2018, while securitization-related debt was up by 68% to $1.8 billion. In addition, with the roll out of new products and services to clients, CWB is targeting further growth of its branch-raised deposits, which currently make up 51% of total deposits. Liquidity levels are good with sufficient unencumbered assets to cover the Bank’s needs.

CWB’s CET1 ratio stood at 9.3% in Q3 2018, which is above regulatory minimums; however, there is a limited cushion with which to absorb any potential major losses. Capitalization ratios are expected to improve as the Bank switches to an advanced internal rating-based (AIRB) model in fiscal 2020. 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.

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 on the issuer page at www.dbrs.com.

The applicable methodology is the Global Methodology for Rating Banks and Banking Organisations (July 2018), which can be found on our website under Methodologies.

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

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

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