Company Profile

Canadian Western Bank (TSX: CWB) is a diversified financial services organization. The bank’s key business lines include full-service business and personal banking offered through bank branches and Internet banking services provided by Motive Financial. The bank offers specialized financing under the banners of CWB Optimum Mortgage, CWB Equipment Financing, CWB National Leasing, CWB Maximum Financial and CWB Franchise Finance. The group also offers trust services and wealth management services. 

Investment Rationale

• Decent Loan Book Growth Amid Challenging Operating Environment: During 2QFY20, Total loans were up 7% to CAD 29,198 million from CAD 27,353 million reported in a year-over period, driven by 19% growth in the General commercial loans, 7% increase in the Personal loans and mortgages, 6% growth in the equipment financing and leasing. Real estate loan book declined 16% on account of completion of projects and the group’s focus on Tier 1 client. On a sequential basis, total outstanding loans were up ~2%, primarily related to a healthy growth of 5% in Ontario driven by general commercial loans as well as 1% growth in both Alberta and British Columbia. Further, despite a challenging economic condition, the bank is expecting a mid-single-digit loan growth for fiscal 2020.

• Prudent Lending Model: Actual credit losses as a percentage of total loans remain low at the end of Q2FY20 and continue to demonstrate the benefits of CWB's secured lending practices and disciplined underwriting. Further, the bank's exposure to oil and gas production and oilfield service portfolios represent only 1% and 2%, respectively of its total loan outstanding, which would shield the bank's loan book from the recent turmoil in the oil and gas market. The bank's exposure to the hospitality and leisure sectors is just under 5% of total loans, while office and retail real estate sector represent another 4%, and it has insignificant exposure to air travel. During the quarter, the bank adopted a conservative approach and made higher provisioning on performing loans (27 basis points), which increased the provision for credit losses as a percentage of loans to 49 basis points, compared to 23 basis points in the same period last year. Though higher provisioning took a hit on the profitability, it is likely to provide a cushion in the near to medium term, if any assets turn bad.

Source: Company Presentation

• Strong Capital Position: CWB has a strong regulatory capital position under the Standardized approach. As on April 30, 2020, the bank's Common Equity Tier 1 Capital ratio stood at 9.1%, 210 bps points higher against the regulatory requirement of 7.0%, Tier 1 capital ratio stood at 10.5%, 200 bps points higher than the regulatory threshold of 8.5%, Total capital ratio stood at 11.9%, 140 bps points above regulatory requirement, and Basel III Leverage ratio stood at 8.3%, 530 bps above the regulatory threshold of 3.0%. With a strong capital position, CWB is well-positioned to create increased value to shareholders while ensuring the bank remains capitalized through the current challenging environment.

Source: Company Presentation

• An Income Play: On May 20, 2020, the board of CWB has declared a quarterly dividend of CAD 0.29/share, which was 7% higher over the dividend declared in the same quarter of the previous financial year and consistent with the prior quarter. Further, the bank mentioned that; it is confident to deliver positive earnings for shareholders, maintain financial stability, current dividend levels, and a strong capital position despite the uncertain economic outlook. At the last traded price, the stock is offering a dividend yield of 4.86%, which is approximately 9.82 times of Canada’s 10 Year Benchmark Bond Yield of 0.52% and 1.2 times of the TSX 300 Composite Index’s dividend yield of 3.8%.
• Risk Associated to Investment: Given the economic uncertainties hovering over the Canadian economy and slowdown in the global economic growth, the group is exposed to increase in the Non-performing assets, primarily in the sectors like oil & gas, hospitality, tourism; however, the group's exposure towards these sectors is relatively low. Further, the bank is also exposed to the interest rate risk, any further policy rate cut by the Bank of Canada would drag the bank's interest margin, which would result in lower revenue, despite volume increase due to the credit offtake.

Recent development

• On June 29, 2020, the bank announced that it has closed the private placement of subordinated debentures and raised CAD 125 million. These debentures are carrying an interest of 4.840% and will be maturing on June 29, 2030.

• On June 1, 2020, the group announced that it had completed the acquisition of iA Investment Counsel Inc. (iAIC). iAIC is a leading provider of financial planning and wealth management services for high-net-worth Canadian families, delivered under the brand names T.E. Wealth (T.E.) and Leon Frazer & Associates (Leon Frazer).

Financial Highlights: Q2FY20 (April 30, 2020)

Source: Company filing

During the quarter under consideration, CWB's net interest income stood at CAD 190,988 million, slightly lower on a YoY basis despite a loan growth of 7%, which was partially offset by 23 bps reduction in the net interest margin. However, non-interest income surged approximately 25% to CAD 23,376 million in Q2FY20. As a result, the total revenue of the bank improved by 2% on a YoY basis to CAD 214,364 million.

Net interest margin stood at 2.40%, down 23 basis points from the previous corresponding period. The decline in net interest margin was driven by the negative impact of cumulative reductions in the Bank of Canada policy rate of 150 basis points in March, higher average liquidity levels held in light of ongoing market disruption and the impact of deposit pricing competition. This was partially offset by a favourable shift in funding mix due to strong branch-raised deposit growth and a resulting decline in broker deposits. Net income was down by 17% on a YoY basis, despite a 2% increase in total revenue. The decline was driven by higher provisioning charges.

CWB delivered robust branch-raised deposit growth of 20%, which included a 31% growth of notice and demand deposits, contributing to a 17% reduction in higher cost broker deposits. Higher deposits provide a stable funding base, which is a key positive for the group. Total funding during the quarter under review improved by 9%, including 6% improvement in the total deposits, 15% surge in the capital market deposits, 35% growth in securitization funding and partially offset by 17% decrease in broker term deposits. CWB's dependence on broker deposit funding continues to reduce with the ongoing growth in branch-raised deposits. Further, the bank's regulatory capital position remained strong with buffer above the regulatory threshold, with very conservative Basel III leverage ratio. At the end of the quarter, the bank’s debt to equity ratio stood at 0.9x. 

Stock Performance

At the closing (July 03, 2020), shares of CWB traded 0.25% higher at CAD 23.86. In the past year, its shares tested a 52w High of CAD 36.61 on November 22, 2019, and a 52w Low of CAD 15.70 on March 23, 2020. At the last closing price, its shares traded approximately 34.82% below its 52w high price level and approximately 51.97% above its 52w low price level, implies that despite a turmoil in the broader equity market, CWB shares are more tilted towards its 52w high price level.

1-year price performance (as on July 03, 2020, after the market close). Source: Refinitiv (Thomson Reuters).

In the last one year, shares of CWB corrected ~20%; however, on a relative performance basis, its shares have outperformed the sector by 6.30% during the same time. In the last three months, the stock rose ~34% and outperformed the benchmark index by ~11% at the same time.

At the last traded price, its shares ended approximately 7% above the crucial short-term support level of 50-day simple moving average, however, still traded approximately 15.77% below the long-term support level of 200-day SMA.

Top-10 Shareholders

The top 10 shareholders have been highlighted in the table, which together form around 28.13% of the total shareholding. QV Investors Inc. and Dimensional Fund Advisors, L.P.  holds the maximum interests in the company at 5.23% and 4.35%, respectively. Further, six out of top-10 shareholders have increased their stake in CWB as on June 30, 2020, with BlackRock Institutional Trust Company, N.A.  and British Columbia Investment Management Corp. are among the institutions that increased their stakes by 0.86 million and 0.21 million, respectively. The institutional ownership in the bank stood at 44.44%, and ownership of the strategic entities stood at 2.69%.

Source: Refinitiv (Thomson Reuters)

Valuation Methodology (Illustrative): Price to Book Value Based Valuation Metrics

Note: All forecasted figures have been taken from Refinitiv (Thomson Reuters).

Stock Recommendation: The bank’s disciplined and secured lending model, with no significant exposure to unsecured personal borrowing, continues to support the resiliency of its business. Its capital ratios stood strong and well above the regulatory threshold requirements.

The bank’s exposure to oil and gas production and oilfield service portfolios represent only 1% and 2%, respectively of the total loan outstanding, which is a key positive considering the current mayhem in the sector. Further, the bank has nil to limited exposure to hospitality and leisure, and the air travel sector. Lower exposure to the troubled sectors would safeguard the bank’s loan book in the near to medium term and reduce the risk of likely nonperforming assets.

The recent acquisition of iA Investment Counsel is likely to increase the penetration of the group in the wealth management market and would result in better business prospects. Further, the bank is offering a lucrative dividend yield of 4.86%, which is decent, given the low-interest-rate environment prevailing in the country.

Therefore, based on the above rationale and valuation done using the above methodology, we have given a “Buy” recommendation at the closing price of CAD 23.86 (July 03, 2020), with a lower double-digit upside potential based on NTM Peer’s Average Price-to-Book Value multiple of 0.89 on the FY20E Book Value per share. We have considered Bank of Montreal (TSX: BMO), Scotia Bank (TSX: BNS) and Canadian Imperial Bank of Commerce (TSX: CM), etc., as a peer group for comparison purpose.

*Recommendation is valid at July 6, 2020 price as well.

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