DBRS Limited (DBRS Morningstar) changed the trends on Canadian Western Bank’s (CWB or the Bank) long-term ratings to Stable from Negative and maintained the trends on all short-term ratings at Stable. DBRS Morningstar also confirmed its ratings on CWB, including the Bank’s Long-Term Issuer Rating at A (low) and Short-Term Issuer Rating at R-1 (low). 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 trend changes to Stable from Negative reflect DBRS Morningstar’s view that, despite the potential for some near-term volatility, the economic uncertainties facing the Bank because of the Coronavirus Disease (COVID-19) pandemic have largely abated. Indeed, the Bank has maintained good asset quality metrics. Although impairments initially increased as expected, they reverted to the historical average in F2021, remaining at manageable levels. Additionally, CWB’s earnings have proved resilient and the Bank has continued growing and diversifying its franchise through further expansion into Ontario as well as improving its level of directly sourced deposits.
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 strategically targeted wealth and loan portfolio acquisitions that augment its business while providing some geographic and revenue diversification. The ratings also consider the Bank’s high level of exposure to the real estate sector, specifically to development projects in Western Canada; its modest level of fee-based revenues; and its lower capitalization relative to peers.
DBRS Morningstar would upgrade its ratings if CWB further diversifies its revenue mix with a material and sustainable increase in the level of noninterest income. Increased diversification of the loan book, including a reduction in the relative exposure to real estate project finance, would also result in a ratings upgrade.
Conversely, a ratings downgrade would occur should there be significant losses in the loan portfolio or a perceived weakness in loan underwriting and/or risk management. Furthermore, operational issues that negatively affect 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.
Franchise Combined Building Block (BB) Assessment: Good/Moderate
With assets of $37.3 billion as of October 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 about 9% of the total loan book. CWB’s large portion of commercial lending activities remains within its traditional markets in Western Canada, although the Bank has been actively expanding into Eastern Canada over the last decade, opening its first branch in Ontario in F2020. Ontario accounted for 40% of the loan growth in the general commercial portfolio in 2021. The Bank expects to further expand its presence in the province with the opening of a Markham location in F2022.
Earnings Combined Building Block (BB) Assessment: Good/Moderate
CWB posted strong earnings throughout F2021 supported by higher revenue and recovery in provision for credit losses. Net interest income grew by about 12% year over year reflecting strong organic loan growth, while the Bank managed to maintain a healthy net interest margin owing to the commercial focus 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 efficiency ratio remains one of the lowest among its peers because of the Bank's focus on high-yield commercial middle-market lending and its relatively small branch footprint.
Risk Combined Building Block (BB) Assessment: Good
CWB has a 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 30% of total loans. The Bank maintains prudent underwriting standards and these loans are largely secured; however, higher credit impairments are possible because of the conclusion of government support and stimulus. CWB’s asset quality was modestly pressured in F2020 as gross impaired loans rose to about 0.9% of gross loans before reverting back to the historical average of 0.6% in F2021, reflecting lower impaired loan formations and an increase in loans returning to performing status.
Funding and Liquidity Combined Building Block (BB) Assessment: Good
CWB’s funding has been resilient throughout the pandemic, and the Bank maintained prudent levels of liquidity. The Bank continued to strengthen its funding profile by increasing directly sourced deposits, wholesale funding, and use of securitization. Approximately 58% of deposits are fixed term as of October 31, 2021, which still broadly aligns with CWB’s loan portfolio. Branch-raised deposits, primarily generated in demand and notice products, contributes 64% to total deposits. Nevertheless, as with other financial institutions, the Bank could face some core deposit runoff in the near term as depositor savings are gradually channeled to finance domestic consumption and companies increase spending in line with the economic recovery.
Capitalization 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. CWB’s CET1 ratio remained broadly stable at 8.8% in F2021 compared with F2020 as retaining earnings and incremental common shares issued under an ATM program offset the impact of higher risk-weighted assets. According to DBRS Morningstar’s calculations, this translates to a capital cushion of $536 million, which is sufficient to absorb normal levels of loan losses. Capital ratios are expected to improve as the Bank switches to the Advanced Internal Rating-Based (AIRB) methodology for capital and risk management. Nevertheless, DBRS Morningstar is cognizant that the Bank remains exposed to operational risk as it implements the various projects that would enable the migration to AIRB. Issuance of additional shares under its ATM program, however, could help mitigate potential pressures.
Further details on the Scorecard Indicators and Building Block Assessments can be found at https://www.dbrsmorningstar.com/research/389493.
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.
All figures are in Canadian dollars unless otherwise noted.
The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (July 19, 2021; https://www.dbrsmorningstar.com/research/381742). 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).
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.
DBRS Tower, 181 University Avenue, Suite 700
Toronto, ON M5H 3M7 Canada
Tel. +1 416 593-5577