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: CWB delivered solid results in the third quarter of 2020, and prudently navigated through the impact of the COVID-19 pandemic on the Canadian economy and financial markets. The bank delivered 22% annual growth in branch-raised deposits, and carefully managed deposit pricing in this low interest rate environment to stabilize net interest margin. Further, the company achieved a key milestone on its digital roadmap with the launch of a fully digitized onboarding process for Motive Financial. Further, at the end of the Q3FY20, 10% of loan balances remain under some form of payment deferral, down from bank’s peak of over 25%, with over half of those making interest only payments.

• Strong loan growth: Gross loans of CAD 29.7 billion increased 5% (CAD 1.4 billion) from last year and 2% (CAD 0.5 billion) from the prior quarter. In the quarter under consideration, the company reported strong growth in general commercial loans of 12%, which reflects ongoing efforts to increase full-service relationships across the bank’s national footprint. General commercial loans now represent 32% of the total loan portfolio, compared to 30% a year ago. Personal loans mortgage increased 6%, which reflects “A” mortgage portfolio growth that largely consists of residential mortgages eligible for bulk portfolio insurance, to support the bank’s participation in the National Housing Act Mortgage Backed Securities (NHA MBS) program.

Source: Company Presentation

• Lower exposure to troubled sector: Oil & gas sector is going through a steep pain since the outbreak of COVID-19 pandemic. Most of the players are booking huge loss and asking for the deferral of loans. The bank’s exposure to oil & gas production sector and oil field services sector is less than 1% and 2%, respectively. Further, the bank is reducing its concentration in the real estate sector and focusing on Tier 1 borrowers.

• Secured and prudent lending model: The company is following a conservative approach and making provisions for performing loans as well, which would provide a cushion against future hiccups. Provision for credit losses on total loans as a percentage of average loans was 33 basis points, compared to 19 basis points last year and 49 basis points last quarter. The provision for credit losses on performing loans reduced to 11 basis points of average loans this quarter, reflecting a slight worsening of the economic outlook this quarter and migration of loans into Stage 2.

Source: Company Presentation 

• Strong capital ratios with buffers above the regulatory requirements: With capital ratios at 8.8% (CET1), 10.2% (Tier 1) and 12.0% (Total capital) at July 31, 2020, the bank is well positioned to create increased value for shareholders while ensuring that it remains conservatively capitalized through the current economic conditions. Basel III leverage ratio of 8.1% at July 31, 2020 also remains strong.

Source: Company Filing

• High quality balance sheet and strong liquidity: The bank’s cash and securities portfolio is comprised of high quality debt instruments that are typically held until maturity. Cash, securities and securities purchased under resale agreements totaled CAD 2.8 billion compared to CAD 2.2 billion last year. Average balances of cash and securities for the three months ended July 31, 2020 of CAD 3.1 billion were up 28% from last year and 13% from last quarter due to additional liquidity carried this quarter in light of ongoing market disruption and to fund the maturity of two senior deposit notes and the wealth acquisition. The bank’s liquidity management is based on an internal stressed cash flow model, with the level of liquid assets driven primarily by the term structure of both assets and liabilities, and the liquidity structure of liabilities. Consistent with the conservative risk appetite, the bank continues to maintain higher levels of cash and securities to support the bank’s strong liquidity position and manage market volatility.

Source: Company Presentation

• An Income Play: At the last closing price, shares of CWB are offering a dividend yield of 3.9%, which is decent given the lower interest rate environment. Further, the company has a track record of consistent dividend payment over the past 20-years. Given the high yield with the consistent track record of dividend payment is likely to bring CWB shares in the investor’s limelight, especially income seeking investors.

Dividend History. Source: Refinitiv (Thomson Reuters)

• Risk Associated to Investment: Given the uncertainties hovering over the Canadian economy and slowdown in the global economic growth, the group might witness an increased in the Non-performing assets, primarily in the sectors like oil & gas, hospitality, tourism. However, the group's exposure to these sectors is relatively low. Further, the bank is also exposed to the interest rate risk. Further policy rate cut by the Bank of Canada would weigh on the bank's interest margin, which would result in lower revenue, despite volume increase due to the credit offtake. 

Q3FY20: Financial Highlights

Source: Company Filing

• In the third quarter, total revenue grew 4%, which reflected a 37% increase in non-interest income, primarily due to higher wealth management fees contributed by the wealth acquisition and net gains on securities, combined with a 1% increase in net interest income.
• Net interest income increased slightly as the benefit of 5% loan growth was largely offset by a 20 basis point decline in net interest margin.
• Non-interest expenses increased 7% as the impact of the wealth acquisition and continued investment in the bank’s teams and technology to support overall business growth were partially offset by reduced spending on certain expenses in light of the current operating environment.
• Compared to last year, the third quarter return on common shareholders’ equity (ROE) of 9.1% was 220 basis points lower. Adjusted ROE of 9.4%, which removes the impact of one-time acquisition and integration costs as well as amortization of acquisition-related intangible assets, fell 200 basis points due to higher average common shareholders’ equity combined with lower earnings. However, ROE was 120 basis points higher and adjusted ROE increased 140 basis points compared to last quarter primarily driven by earnings growth.
• Total assets were CAD 33.2 billion, up 7% from a year ago and 1% from last quarter.
• Total loans, excluding the allowance for credit losses, of CAD 29.7 billion increased 5% from last year and 2% from the prior quarter. Total loans of CAD 3.0 billion within the bank’s broker-sourced residential mortgage business, CWB Optimum Mortgage (CWB Optimum), increased 2% from last year.
• Commercial mortgages increased 9%, reflecting strong growth in British Columbia (BC). Equipment financing and leasing segment grew 4%, which reflects increases across most provinces with over 50% of the growth driven by Ontario and Quebec.
• Real estate project loans declined 19%, driven by successful project completions, primarily in BC.
• The bank’s Oil and gas production loans were up CAD 104 million primarily due to participation in syndicated facilities that remain within the bank’s risk appetite. The bank’s exposure to oil and gas production and service businesses represent 1% and 2% of total loans, respectively.

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, it reflects that 5 out of top-10 shareholders have increased their stake in the company, 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%.

Source: Refinitiv (Thomson Reuters)

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

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

Peer Comparison

Source: Refinitiv (Thomson Reuters)

Stock Recommendation:

The group's sequential financial performance was robust, wherein net earnings rebounded strongly, primarily due to a lower estimated performing loan provision for credit losses and the positive impacts of loan growth and two additional interest-earning days while the company's net interest margin remained stable. However, third-quarter financial results were lower than the same quarter last year, reflecting an elevated estimated performing loan provision for credit losses and the impact of the lower interest rate environment.

Further, the bank recorded strong branch-raised deposit growth combined with the successful execution of the bank's diversified funding strategy, which provided a robust position leading into this market disruption. 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.

Also, the bank Continued to advance their digital capabilities, launching end-to-end digital onboarding for Motive Financial clients that allows accounts to be opened virtually with immediate ability to transaction.

Further, over the past three months, its shares recorded strength on the stock exchange, with CWB shares bagged 9.2% in the past three months, added approximately 20% over the past one month, and added 8.3% in the past 5-day trading sessions. Also, the shares recorded a solid relative outperformance at the same time. Also, at the last closing, its shares traded well above the crucial short-term and long-term support levels of 50-day, and 200-day SMAs, implies a bullish price trend.

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 29.32 on November 20, 2020.

1-Year Price Chart (as on November 20, 2020, acter the market close). Source: Refinitiv (Thomson Reuters)

*Recommendation is valid at November 23, 2020 price as well.

Disclaimer

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