DBRS Limited (DBRS Morningstar) confirmed its 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 ratings is Stable. The Bank’s Intrinsic Assessment (IA) of A (low) and Support Assessment (SA) of SA3 are unchanged. The SA3 designation, which reflects no expectation of timely external support, results in the final rating being equivalent to the IA.
KEY RATING CONSIDERATIONS
The rating confirmations and Stable trends recognize CWB’s well-established and growing franchise, operating in the middle-market commercial space across Canada. Furthermore, the Bank is expanding nationally, particularly into Ontario through organic growth and targeted loan and wealth portfolio acquisitions. The ratings also consider 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.
DBRS Morningstar would upgrade the ratings if CWB were to further diversify its revenue mix with a material and sustainable increase in the level of noninterest income. Increased diversification of the loan book, including a material reduction in the relative exposure to real estate related finance, while lowering the proportion of brokered deposits, would also result in a ratings upgrade.
Conversely, a ratings downgrade would also 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 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 $40.4 billion as of July 31, 2022, 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 below 10% of the total loan book. A large portion of CWB’s 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 and has opened its second banking centre in Markham, Ontario, in July 2022. Ontario accounted for more than 33% of the total loan growth year over year (YOY) during the first nine months of F2022 (9M 2022), largely in the strategically targeted general commercial portfolio. The Bank expects to further expand its presence in the province with the opening of a Toronto downtown location in F2023.
Earnings Combined Building Block (BB) Assessment: Good/Moderate
Despite a 13.0% increase in noninterest expense, CWB posted a 2.2% growth YOY in common shareholders’ net income to $242.6 million for 9M 2022. Net interest income grew 5.6% YOY to $699.8 million for 9M 2022 as higher interest revenue more than offset rising interest expense. However, because of the impact of stronger growth in lower-yielding portfolios as well as higher interest expense, the net interest margin declined 7 basis points (bps) YOY to 2.47% for the same period. In recent years, the Bank has modestly increased its proportion of noninterest income, which stood at about 12% of total revenue as of July 31, 2022. CWB's efficiency ratio of 52% is one of the lowest among its peers because of 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 30% of total loans. The Bank maintains prudent underwriting standards, and these loans are largely secured. CWB’s asset quality remains sound with impaired loans averaging 0.65% of gross loans over F2017–21. The ratio further fell to 0.53% during nine months of F2022 compared with the recent years’ peak level of 0.85% in F2020 because of lower impaired loan formations and an increase in loans returning to performing status post-pandemic. Nevertheless, 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
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. Total deposits, including capital markets increased by 9% to $32.4 billion in the nine months of F2022 compared with $29.6 billion in the same period of F2021. Branch-raised deposits, primarily generated in demand and notice products, comprise 63% of total deposits. Approximately 55% of deposits are fixed term as of Q3 2022, broadly aligning with CWB’s loan portfolio.
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. As of July 31, 2022, CWB’s CET1 ratio increased by 10 bps to 8.9% compared with the same period in 2021. This was primarily due to retained earnings growth and common shares issued under the at-the-market equity (ATM) program, which more than offset risk-weighted asset growth and the accumulated other comprehensive income loss related to fair value through other comprehensive income (FVOCI) securities. 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/405364.
ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
There were no Environmental/Social/Governance (ESG) factors that had a significant or relevant 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/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (May 17, 2022).
All figures are in Canadian dollars unless otherwise noted.
The principal methodology is the Global Methodology for Rating Banks and Banking Organisations, https://www.dbrsmorningstar.com/research/398692/global-methodology-for-rating-banks-and-banking-organisations (June 23, 2022). In addition DBRS Morningstar uses the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings, https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (May 17, 2022) in its consideration of ESG factors.
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.
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 ratings are under regular surveillance.
For more information on this credit or on this industry, visit www.dbrsmorningstar.com.
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