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

• Solid Third Quarter Results: Branch-raised deposits increased 5% this quarter and 22% compared to last year, with the growth primarily driven by lower-cost demand and notice deposits. Net interest income increased 1% on an annual basis. The bank's loan book increased 5% on an annual basis driven by very strong growth in commercial loans. The bank's non-interest income recorded an annual growth of 37%, which was primarily driven by wealth acquisition.

• Continue to advance on the digital capabilities: The group has continued to advance its business transformation and digital capabilities to ensure that these are well-positioned to accommodate an expected shift in consumer preference towards digital banking. The company has launched end-to-end digital onboarding for Motive Financial clients that allows accounts to be opened virtually with the immediate ability to transact. These initiatives are likely to help the group in increasing its market share.

• A lower provision for Credit Losses: The bank's provision for credit losses as a percentage of average loans stood at 33 basis points, which was 16 basis points lower than the last quarter, reflecting a decline in the estimated provision on performing loans. The total provision for credit losses at the end of the Q3FY20 stood at CAD 24.36 million, 30% lower against CAD 34.90 million reported in the preceding fiscal quarter. The bank's estimated quarterly provision on performing loans stood at 11 basis points as a percentage of average loans, compared to 27 basis points last quarter, which reflected continued evolution of economic forecasts related to the impact of the COVID-19 pandemic.

• Significant Reductions in Deferral Arrangements: During the quarter under consideration, the bank has witnessed a sharp reduction in the loan deferral arrangements. At the end of the Q3FY20, 10% of loan balances remain under some form of payment deferral, significantly down from the peak of over 25%, with over half of those making interest-only payments.

• Strong Capital Position: At the end of the third quarter of 2020, the bank's CET1 ratio stood at 8.8%, while tier 1 and capital adequacy ratio stood at 10.2% and 12.0%, respectively. With the strong capital ratios, the bank is well-positioned to create increased value for shareholders while ensuring it remains conservatively capitalized through the current economic conditions. Further, Basel III leverage ratio of 8.1% on July 31, 2020, remains very strong. This reflects that the bank's capital position remained strong under the more conservative Standardized approach for calculating risk-weighted assets.

• Strong Upside Price Momentum: On August 28, 2020, the bank's shares crossed over the strong long-term resistance of 200-day Simple Moving Average (SMAs), which is also considered as long-term psychological resistance in an underlying security. Moreover, its shares ended the session approximately 4% above its long-term moving average, which reflects that the stock has created a strong long-term support level and trading above that support. Also, when the price of a stock crossover the 200-day resistance level, it typically reflects that the stock is entering into a bullish zone and also indicates a potential upside movement from the current trading level. Also, the Moving Average Convergence Divergence (MACD) oscillator is rising, and the difference between 12-day and 26-day Exponential Moving Averages (EMAs) is positive, which is a bullish price trend. Further, the short-term and long-term moving averages are increasing, which is another positive price indicator.

• 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.

3QFY20 Result Highlights

Source: Company filings

In the third quarter of 2020, the bank's Net Interest Income increased 1% on a YoY basis to CAD 200.7 million, as the benefit of 5% loan growth, including very strong growth in commercial loans, was largely offset by a 20 basis point decline in net interest margin in the current low-interest-rate environment. Non-interest income grew by 37% on a YoY basis to CAD 25.71 million, driven by the T.E. Wealth and Leon Frazer & Associates (the wealth acquisition). Due to the impact of the COVID-19 pandemic, a more pessimistic outlook for the Canadian economy resulted in a performing loan provision for credit losses of 11 basis points during the quarter as compared to a 3-basis point recovery in the previous corresponding period. Total revenue of the bank improved by 4% on a year-on-year basis to CAD 226.48 million.

Net income to the common shareholders declined by 12% on a YoY basis to CAD 62.25 million from CAD 70.96 million reported a year ago. The decline was primarily driven by higher provision created during the quarter compared to the previous corresponding period. The group made a credit loss provision of 33 basis as a percentage of average loans, which was 14 basis points higher than the same quarter of the last year due to an adverse shift in forward-looking economic conditions.

Total loans recorded an annual growth of 5% to CAD 29.7 billion, while total deposits increased 7% on an annual basis to CAD 26.5 billion.

Compared to the prior quarter, common shareholders' net income and diluted earnings per common share increased by 21% and 20%, respectively. Adjusted common shareholders' net income increased 24%, and adjusted earnings per common share were up 23%. Pre-tax, pre-provision income was up 6%. Total revenue increased 6% primarily due to a 5% higher net interest income, driven by the positive impacts of 2% loan growth, two additional interest-earning days and a stable net interest margin. Also contributing to higher total revenue was a 10% increase in non-interest income driven by higher wealth management fees related to the wealth acquisition, partially offset by lower net gains on securities. Non-interest expenses increased by 7%, entirely driven by wealth acquisition. The bank's provision for credit losses as a percentage of average loans of 33 basis points was 16 basis points below last quarter, reflecting a decline in the estimated provision on performing loans. Total loans, excluding the allowance for credit losses, of CAD 29.7 billion increased 2% from the prior quarter.

Top-10 Shareholders

The top 10 shareholders have been highlighted in the table, which together forms around 29.01% of the total shareholding. QV Investors Inc. and Dimensional Fund Advisors, L.P. holds the maximum interests in the company at 6.25% and 4.38%, respectively.  Further, the table reflects that 4 out of top-10 shareholders have increased their stake in the company over the last three months, with Leith Wheeler Investment Counsel Ltd. and QV Investors Inc. are among the top investors in the company which have increased their stakes by 0.24 million and 0.23 million, respectively. The institutional ownership in CWB stood at 44.78%, and ownership of the strategic entities stood at 2.7%, respectively.

Source: Refinitiv (Thomson Reuters)

Stock Performance

At the closing (on August 28, 2020), shares of CWB traded approximately 7.59% higher against the previous trading session at CAD 27.37. Over the last year, its shares have tested a 52W high price of CAD 36.61 on November 22, 2019, and a 52W low price of CAD 15.70 on March 23, 2020. At the last closing price, CWB shares have traded approximately 25% below its 52W high price level and traded approximately 74.33% above its 52W low price level, which reflects a sharp recovery in the stock price and stock is more tilted towards its 52W High price level. 

1-Year Price Performance (as on August 28, 2020). Source: Refinitiv (Thomson Reuters).

Over the past three months, its shares were in an uptrend, and increased 17.0. The stock generated a return of 16.82% in the last one month and 14.04% in the past five trading sessions. The stock has outperformed the benchmark indices at the same time by 7%, 13% and 13%, respectively. This shows the relative strength of the CWB shares on the stock exchange. However, on a YoY basis and YTD basis, its shares are featuring a negative price return of 14% and 12%, respectively.

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

*Note: All forecasted figures have been taken from the Thomson Reuters.

Stock Recommendation: The group delivered a solid result in the third quarter and prudently navigated through the impact of the COVID-19 pandemic on the Canadian economy and financial markets. On June 1, 2020, the company acquired the businesses of T.E. Wealth and Leon Frazer & Associates (the wealth acquisition). The wealth acquisition is expected to support adjusted earnings per common share modestly at first, with further accretion beginning in fiscal 2022. Moreover, the bank has delivered a solid financial performance on a sequential basis, where net earnings rebounded strongly, primarily due to a lower estimated performing loan provision for credit losses and the positive impacts of loan growth.

The bank's exposure to oil and gas production and oilfield service portfolios is negligible, which is a key positive considering the recent mayhem in the sector. Lower exposure to the troubled sectors would safeguard the bank's balance sheet in the near to medium term and reduce the risk of likely nonperforming assets. Further, at the last traded price, the stock was offering a dividend yield of ~4.24%, which is lucrative considering the current interest rate environment.

Also, On August 28, 2020, the bank's shares crossed over the strong long-term resistance of 200-day Simple Moving Average (SMAs), which is also considered as long-term psychological resistance in an underlying security. Moreover, its shares ended the session approximately 4% above its long-term average, which reflects that the stock has created a strong long-term support level and trading above that support.

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 27.37 (on August 28, 2020, after the market close), with lower double-digit upside potential, based on the NTM Price-to-Book Value Per Share multiple of 1.04x, on the FY20E Book Value Per Share.

*Recommendation is valid at August 31, 2020 price as well.

*Please be aware dividend is variable and not guaranteed.

Disclaimer

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