Edited Transcript of CWB.TO earnings conference call or presentation 29-May-20 2:30pm GMT

Black Lives Matter

Q2 2020 Canadian Western Bank Earnings Call

EDMONTON Jul 1, 2020 (Thomson StreetEvents) — Edited Transcript of Canadian Western Bank earnings conference call or presentation Friday, May 29, 2020 at 2:30:00pm GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* Carolyn J. Graham

Canadian Western Bank – Executive VP & CFO

* Christopher H. Fowler

Canadian Western Bank – President, CEO & Director

* R. Matthew Rudd

Canadian Western Bank – SVP of Finance & IR

================================================================================

Conference Call Participants

================================================================================

* Darko Mihelic

RBC Capital Markets, Research Division – MD & Equity Analyst

* Gabriel Dechaine

National Bank Financial, Inc., Research Division – Analyst

* Nigel R. D’Souza

Veritas Investment Research Corporation – Investment Analyst

* Scott Chan

Canaccord Genuity Corp., Research Division – Director of Research of Financials & Financial Services Analyst

* Sohrab Movahedi

BMO Capital Markets Equity Research – Analyst

* Stephen Gordon Theriault

Eight Capital, Research Division – Principal & Head of Research

* Sumit Malhotra

Scotiabank Global Banking and Markets, Research Division – Former MD of Canadian Financial Services

================================================================================

Presentation

——————————————————————————–

Operator [1]

——————————————————————————–

Good morning. My name is Sylvie, and I will be your conference operator today. At this time, I would like to welcome everyone to CWB’s Q2 Earnings Conference Call and Webcast. (Operator Instructions)

Mr. Matt Rad, you may now begin your conference, sir.

——————————————————————————–

R. Matthew Rudd, Canadian Western Bank – SVP of Finance & IR [2]

——————————————————————————–

Thank you, Sylvie, and good morning, everyone. Welcome to our second quarter 2020 financial results conference call. My name is Matt Rudd, and I’m the Senior Vice President, leading our Finance and Investor Relations team. Presenting to you today are Chris Fowler, our President and CEO; and Carolyn Graham, our Executive Vice President and CFO. I’d like to remind listeners and webcast participants that statements about future events made on this call are forward-looking in nature and based on certain assumptions and analysis made by management. Actual results could differ materially from expectations due to various risks and uncertainties associated with our business. Please refer to our forward-looking statement advisory on Slide 19. The agenda for today’s call is on the second slide, and to take us through that agenda, I’ll turn it over to Chris.

——————————————————————————–

Christopher H. Fowler, Canadian Western Bank – President, CEO & Director [3]

——————————————————————————–

Thanks, Matt. Clearly, the topic of the COVID-19 pandemic is the key matter for this quarter. I’ll begin by sharing my thoughts on the strength of CWB’s position going into this period of economic volatility and how we have used our proactive approach to assist our clients in these challenging times. Carolyn will follow with detail on our second quarter financial results, and then we’ll open the lines for the question-and-answer session before I provide closing comments.

We’ve made significant progress over the last decade to strengthen our business, which is highlighted on Slide 3. The actions taken by our dedicated team members to diversify our business and enhance our capabilities while maintaining our strong capital and funding levels with CWB Financial Group in a position of strength to navigate these challenging conditions and continue to support our clients.

Our disciplined and secured lending model with no significant exposure to unsecured personal borrowing, including credit cards, continues to support the resiliency of our business. Our capital ratios remain strong and well above regulatory requirements, and we hold ample liquidity to support our clients as we continue to invest in our strategic priorities. Our strong position heading into this period of economic uncertainty has allowed us to be proactive in supporting our clients.

Slide 4 displays how we quickly responded to this unprecedented situation, while keeping our people first core value firmly in focus. Throughout the entire quarter, we provided the full range of personalized service our clients expect from us through digital, remote and essential branch operations. Our past investment in technology infrastructure supported the rollout of our business continuity plan and enabled us to smoothly transition over 85% of our team members to work remotely. Our clients have leveraged our expanding digital capabilities, and in our branches, we have implemented additional precautions to keep our team members and clients safe. Beginning this week, our temporarily closed branches have reopened following provincial protocols and the implementation of a phased strategy that is focused on the continued well-being of our people and clients to support our teams as they gradually return to the workplace.

Turning to Slide 5. We quickly mobilized our teams to reach out to clients to provide advice, support and offer the right solutions for those in need of financial assistance using our CWB Has Your Back program. Our teams were among the first in the industry to deliver long relief to business, and at April 30, we had granted some form of payment relief on approximately 20% of our loans to help through the initial volatility of this challenging situation. Our process was to triage each loan for deferral and for those accepted, primarily grant a 3-month term. We saw the volume of deferral requests to slow down considerably as the quarter closed and the government-sponsored loan programs rolled out. As we work with our clients to find the right solutions for them in this challenging environment, whether that be payment relief or use of a government-sponsored lending program, we continue to triage our loan book to assess evolving risk profiles with a focus on portfolios, particularly affected by the economic slowdown.

We are also paying close attention to our Alberta exposures given the current downward pressure on oil prices, but so far have not seen trends that are any more concerning in granting payment relief, use of the government-sponsored programs or migration in risk ratings in our Alberta exposures compared to the remaining provinces. Alberta is a market we know well, and we have developed deep relationships, and with our entire footprint, follow our prudence — as we do with our entire footprint, we follow prudent, secured lending structures when granting credit. We are on top of our exposures and are more focused than ever to be ahead of anticipated challenges arising from the economic disruption. As you’ll hear from Carolyn later in our discussion of the second quarter financial results, we’ve recorded elevated levels of provisions for credit losses on our performing loans this quarter, as a result of an adverse shift in forecast for the Canadian economy.

We believe the prudent actions we have taken to diversify our portfolio over the last number of years, our secured and prudent lending approach with no significant exposures to unsecured personal lending or credit cards and our low historical credit losses realized through economic cycles, support the overall resiliency of our loans through this period of volatility. As you’ll see on Slide 6, the current operating environment has not stopped us from continuing to execute against our strategic priorities on all fronts. In fact, we remain extremely active preparing for the opportunities of tomorrow. Our people have worked tirelessly to enhance the agility of our teams with remote work arrangements and have kept our teams informed through virtual communication channels. I’m extremely proud of how our teams have adapted and collaborated to ensure we support each other and continue to have our clients’ backs when they need us the most. With so much change asked of our team members this quarter, it is especially rewarding that confidential employee survey results supported our recognition as one of the 50 best workplaces in Canada for 2020 and that CWB Optimum Mortgage’s was named one of the top mortgage workplaces.

This recognition reinforces that our actions to evolve our culture and our employee experience continue to create value for our people and ensure we are a career destination for top talent. During the quarter, we announced our strategic acquisition of T.E. Wealth and Leon Frazer & Associates, which will enhance our ability to provide broader and deeper investment counseling and planning capabilities with an extended geographic footprint. The acquisition will close on Sunday and will increase our total wealth assets under management, administration and advisement to approximately $8 billion. This acquisition accelerates our strategy to be a leading provider of wealth management services to successful business families across Canada and increase our addressable market to support further growth of full-service client relationships. We also made strong progress on the improvement in our digital capabilities and remain committed to achievement of key milestones despite the impacts of COVID-19.

Digital onboarding capability for motive financials personal clients will go live in the third quarter and support our strategy for continued growth of branch-raised deposits. This will be followed by digital onboarding of the remainder of our personal banking clients in Q4 and will expand to our business clients next year. Despite in this period of economic volatility, our strategy and focus remains unchanged. We are continuing our plan to transform our business to become a disruptive force in Canadian financial services, and a clear full-service alternative for business owners. I am confident that our ongoing initiatives will position us to deliver breakout growth and maximize value creation for our upcoming transition to the advanced internal ratings based approach for regulatory capital and risk management.

With our formal application submitted earlier this quarter, I’m pleased to confirm we continue to expect approval in fiscal 2020. I’ll now turn the call over to Carolyn, who will provide more detail on our second quarter financial performance.

——————————————————————————–

Carolyn J. Graham, Canadian Western Bank – Executive VP & CFO [4]

——————————————————————————–

Thank you, Chris, and good morning, everyone. Our second quarter performance highlights are on Slide 8, and you’ll see that the economic and financial market volatility has negatively impacted our financial performance. Compared to the second quarter last year, our pretax pre-provision income was up 1%, while our common shareholders’ net income and diluted earnings per common share were down 17%. Adjusted common shareholders’ net income and adjusted cash earnings per common share declined 20% and 19%, respectively. Common shareholders’ net income was lower compared to last year, as the 2% increase in total revenue was more than offset by an elevated performing loan provision for credit losses, which I’ll discuss in more detail shortly. Net interest income was stable and noninterest income increased 25%, primarily due to net gains on securities. Net interest expenses were up 3% compared to last year, as continued investment in our teams and technology to support overall business growth and execution of strategic priorities was partially offset by lower spending this quarter on certain expenses in light of the current operating environment. Our efficiency ratio of 47.1% compares to 46.8% last year and 45.5% in the previous quarter. The increase from last year and last quarter primarily reflects constrained revenue growth in the current low interest rate environment and sequentially, 2 fewer interest-earning days this quarter.

Operating leverage this quarter was negative 0.8%, improved from negative 3.1% last year and negative 2.6% last quarter. On a year-to-date basis, on Slide 9, pretax pre-provision income was up 1%, while our common shareholders’ net income and diluted earnings per common share were down 4% and 3%, respectively. Adjusted common shareholders net income and adjusted cash earnings per common share were down 8%. The year-to-date decline in common shareholders’ net income was driven by the same factors as the quarterly year-over-year comparison as well as higher noninterest expenses as we continue to invest in people and technology to support ongoing strategic execution.

Turning to Slide 10. Cumulative reductions in the Bank of Canada policy rate of 150 basis points in March negatively affected our net interest margin as our loans repriced more quickly than our deposits, and deposit costs have reached a notional floor due to very low interest rates. Our other funding costs were also slower to decline in comparison to the drop in the prime interest rate this quarter due to higher market demand for liquidity. This impact was partially offset by a favorable shift in our funding mix due to ongoing strong branch-raised deposit growth and a resulting decline in broker deposits. Our quarterly net interest margin of 2.40% does not reflect the full quarter impact of the cumulative Bank of Canada rate cuts. Our net interest margin for the month of April, up 2.30%, does reflect that full impact. And we consider it a reasonable expectation for the remainder of the year. There is potential upside if conditions are appropriate to prudently manage liquidity lower or if funding costs continue to trend down to further reflect the market interest rate declines.

Of course, net interest margin will also be impacted by any further Bank of Canada policy interest rate changes, competitive deposit pricing factors, changes to the cost effectiveness or accessibility of funding channels, loan growth, adjustments to loan pricing and our clients’ abilities to recommence contractual payments, following the completion of payment deferrable periods. In assessing deposit rate pricing, benefits to net interest margin will continue to be balanced against maintenance and branch-raised deposit balances to support appropriate levels of liquidity considering the market conditions.

Slide 11 demonstrates our success in executing on key strategic objectives to grow and diversify funding sources. This quarter marks our fifth consecutive quarter with a strong sequential increase in branch-raised deposits. Compared to last year, demand and notice deposits increased 31% to surpass $10 billion and now account for 35% of total funding compared to 29% last year. This robust performance drove branch-raised deposit growth of 20% and contributed to a 17% reduction in the total balance of broker deposits, which now represent 26% of total funding compared to 34% last year. The reduction in our reliance on the deposit broker network is another of our key strategic priorities. While the cost effectiveness of the broker deposit market was adversely impacted by the economic impacts of COVID-19 this quarter, I do want to note that this funding source remains a reliable and effective way to raise insured fixed-term retail deposits over a wide geographic base and remains a deep and liquid funding source.

You’ll see on Slide 12 that total loans were up 7% over the past year, with positive contributions from our strategically targeted areas of general commercial and in Ontario. On a sequential basis, total outstanding loans were up 2%, primarily related to strong growth of 5% in Ontario, driven by general commercial loans as well as 1% growth in both Alberta and British Columbia. Draws on lines of credit were not a contributor to loan growth this quarter as the average utilization of outstanding commercial and personal lines of credit remained stable compared to both last quarter and last year. The impact of loan deferrals also did not significantly contribute to loan growth this quarter.

Looking forward, while our original forecast anticipated double-digit loan growth always were prudent, we now expect mid-single digit loan growth for fiscal 2020 based on current conditions.

Turning to Slide 13. The credit quality of our portfolio and our [provision for impaired] and performing loans under IFRS 9 continues to reflect our secured lending business model, disciplined underwriting practices and proactive loan management, all hallmarks of our historic success. Gross impaired loans totaled $271 million at April 30 compared to $243 million last quarter and we recognized a provision for credit losses of 22 basis points on impaired loans. The increase in gross impaired loans compared to last quarter, primarily related to 2 Alberta-based oilfield service providers in our general commercial exposures that experienced financial difficulty prior to this period of disruption. These accounts were partially offset by the resolution with no loss of a portion of a significant Alberta-based commercial mortgage connection that we reported as impaired last quarter. As Chris noted, we continue to triage our loan portfolio to assess evolving risk profiles with a focus on portfolios, particularly affected by the economic shutdown. As we’ve highlighted many times before, our exposure to oil and gas production and oilfield service portfolios represent under 1% and 2%, respectively, of our total loans. We’ve also done an in-depth review of other portfolios, we believe, present a higher risk in the current operating environment. Our exposure to the hospitality and leisure sectors are just under 5% of total loans. While office and retail real estate sector represents another 4%, and we have insignificant exposure to air travel.

Our exposure within these industries is well diversified across the country and represent high-quality resilient borrowers that we have hand picked. We deeply understand their businesses and the individual exposures. We remain comfortable with our exposures in these areas. The second quarter IFRS 9 provision for credit losses on performing loans, calculated using our past performance as well as a forward-looking view of macroeconomic factors, totaled 27 basis points, a significant increase compared to 1 basis point last year and 3 basis points last quarter. As a result, our allowance for credit losses on performing loans was $111 million this quarter, an increase of $20 million or 22% compared to the previous quarter. The increase in the provision on the performing loans was driven by a material adverse shift in forward-looking economic conditions. The forecast calibrated to the average of the 6 large Canadian banks assumes a significant deterioration in GDP and unemployment to the end of the third quarter of fiscal 2020, followed by a recovery fueled by the reopening of the economy and the impact of various government and Central Bank stimulus programs. Housing price growth typically lags behind other economic factors, with the low point in housing prices forecast for the latter half of 2021, followed by a gradual recovery. The oil price forecast begins at the April 30 price with a gradual recovery following increased energy demand as the economy reopens. The impact of COVID-19 on the economy and the timing of recovery continued to evolve. As our performing loan allowance is estimated considering expectations for future macroeconomic factors, portfolio defaults or increases in the risk ratings of our performing loans, shift in these factors will impact the allowance balance in future quarters.

As you can see on Slide 14, our realized write-offs have been low over the last several years, with the exception of a unique situation in 2016 where we were prevented by provincial regulators from realizing our security rights in our oil and gas portfolio. While the current economic volatility and challenges are unprecedented, our solid credit performance in the past in both healthy and challenged economic times reflects our prudent underwriting and secured credit model. While there is uncertainty in what lies ahead, we are confident that our secured and high-quality credit portfolio provides a solid foundation as we navigate this period of economic volatility.

Our strong capital ratios at April 30 appear on Slide 15. Calculated using a standardized approach, our common equity Tier 1 ratio was 9.1%. Tier 1 ratio was 10.5%, and our total capital ratio was 11.9%. At 8.3%, our Basel III leverage ratio remains very strong. With these strong capital ratios and very low leverage, we are well positioned to create increased value for shareholders while ensuring we remain conservatively capitalized through the current economic challenges. We will invest approximately 30 basis points of capital in the wealth management acquisition set to close on Monday. As Chris mentioned, we have submitted our formal AIRB application. OSFI has publicly confirmed that our application review is not impacted by the various regulatory actions taken in response to COVID-19. Approval of our application, expected by the end of this fiscal year, will boost our already strong capital ratios as risk-weighted assets will be calculated using more risk sensitive models. Yesterday, our Board declared a common share dividend of $0.29 per share, up $0.02 or 7% from the common share dividend declared 1 year ago and consistent with the prior quarter. We are comfortable that our current dividend level remains appropriate given our conservative, strong capital position and the results of ongoing stress testing. And speaking of stress testing, I’ll turn now to Slide 16.

To satisfy ourselves that our allowance for credit losses on performing loans is adequate given the uncertainty of the economic outlook and to confirm the resiliency of our capital levels and earnings, we utilized our AIRB and IFRS 9 capabilities to perform additional stress testing to simulate the impact of a more severe and prolonged period of challenging economic conditions throughout our geographic footprint. As you can see, relative to the forward-looking macroeconomic scenario used to estimate our April 30 allowance for credit losses, our stress test assumed a deeper initial decline in GDP and lower oil prices and significantly higher levels of unemployment that recover at a much slower pace, remaining worse than prerecession levels through the duration of 2021. The allowance for credit losses produced under this stress scenario confirmed the resilience of our secured and diversified portfolio to economic volatility, further supported by our historical experience of low write-off. Considering the broader financial results of this stress test, we remain confident in our ability to deliver positive earnings for shareholders while we maintain financial stability, our current dividend level and a strong capital position as we manage through the uncertain economic outlook, while continuing to have our clients backed.

And with that, Sylvia, let’s open the lines for Q&A.

================================================================================

Questions and Answers

——————————————————————————–

Operator [1]

——————————————————————————–

(Operator Instructions)

And your first question will be from Sumit Malhotra at Scotia.

——————————————————————————–

Sumit Malhotra, Scotiabank Global Banking and Markets, Research Division – Former MD of Canadian Financial Services [2]

——————————————————————————–

I’ll start with a question on loan growth. I think you mentioned in your comments, perhaps given your business mix is skewed more to commercial borrowers and corporate line drawdowns were not a significant part of the growth. Just kind of curious from a business perspective, particularly following the month of March, how the activity levels from your client base have trended? Is there enough going on that they are still coming to the bank and looking for financing for project activity? Or has it slowed significantly in this environment that we’re in right now?

——————————————————————————–

Christopher H. Fowler, Canadian Western Bank – President, CEO & Director [3]

——————————————————————————–

Sumit, we actually have had — I’ve talked to all our main branch managers and business leaders, and there’s still being continued activity and interest by clients of — for different projects as they’re evaluating the future. So we have seen a continued pipeline of business, both on the project loan side but also on general commercial too, which is our key target area for growth.

——————————————————————————–

Sumit Malhotra, Scotiabank Global Banking and Markets, Research Division – Former MD of Canadian Financial Services [4]

——————————————————————————–

And one on the credit side, Chris, I’ll come back to you. I think you’ve given us some good detail here on how you thought about the provisioning trend and more so the factors that go into building allowance. I’ll make it a 2 parter. Number one, we’ve been through a few of these cycles in the past with the bank, and you’ve talked a lot about the secured nature or reserve-based nature of your lending. That said, when we look at your coverage ratios today, they’re materially lower than even the levels you’ve had in the past. And obviously, under IFRS 9, you do have more management overlay in terms of how aggressive you build reserves. Given your capital strength, why did you opt not to go for a bigger move and strengthen some of that allowance base? And then secondly, if you do feel what you’ve done in performing is adequate, how should we think about the trend line in provisioning for the rest of 2020?

——————————————————————————–

Carolyn J. Graham, Canadian Western Bank – Executive VP & CFO [5]

——————————————————————————–

So Sumit, as we thought about the performing loan allowance, and as you can imagine, we spent a lot of time over the last 2 or 3 months thinking very, very carefully about that. It came back to thinking carefully about what were the macroeconomic assumptions that we built into our forecast as well as the appropriateness of the numerous management overlays that we have in place that supplement the estimate that comes through from our risk-based models. And again, looked at a stress test to try to determine potential additional provisioning that may be required if the reopening doesn’t come to pass the way that we all hope that it does, and determine that this was the right level, thinking about our portfolio, thinking about our past experience and history, and the exposures that we have today.

Looking ahead and thinking about provisioning going forward, I think that we, like everyone believes that we are in for some challenging times. So we do think that there may be more impaired provisioning as our clients work through the economic recovery. I think on the performing loan allowance side, if the economic forecast deteriorates, we’ve provided what we would — we believe would be the estimate for additional provisioning related to those macro forecasts. The other factors are our individual clients shifts in risk rating, shifts in default rates, which could have a temporary impact on our performing provisions as well.

——————————————————————————–

Sumit Malhotra, Scotiabank Global Banking and Markets, Research Division – Former MD of Canadian Financial Services [6]

——————————————————————————–

So all else equal, and then thanks, you gave me a lot to think about there. It sounds like you’re of the view that the imperator are obviously going to increase, but the performing, given you’ve made this move in indicators, unless there’s something that causes you to go back to your models, the performing piece, while it’s not going to 0, it should be lower in your expectation from what we saw today.

——————————————————————————–

Carolyn J. Graham, Canadian Western Bank – Executive VP & CFO [7]

——————————————————————————–

Think that’s fair, assuming the forecast don’t materially deteriorate? Yes.

——————————————————————————–

Operator [8]

——————————————————————————–

Next question will be from Scott Chan at Canaccord.

——————————————————————————–

Scott Chan, Canaccord Genuity Corp., Research Division – Director of Research of Financials & Financial Services Analyst [9]

——————————————————————————–

Carolyn, when you referenced Slide 14 on the historical — on the write-offs. And you talked about ’16, can you remind us the experience during the GFC period in 2008 and 2009?

——————————————————————————–

Carolyn J. Graham, Canadian Western Bank – Executive VP & CFO [10]

——————————————————————————–

So in the — you can see right at the very beginning of the — of that chart on Page 14, in the Global Financial Crisis, our impaired loans peaked in the second quarter of 2010 and they peaked at 168 basis points of the total loan portfolio. But we really didn’t see a material shift in the level of actual write-offs coming out of that, they remained at our historic levels.

——————————————————————————–

Scott Chan, Canaccord Genuity Corp., Research Division – Director of Research of Financials & Financial Services Analyst [11]

——————————————————————————–

Okay. And then maybe just like a broader question on your wealth acquisition of T.E. and Fraser. When you think about what you have [at West] and what you’ve purchased, which is predominantly on the East side, what are your intentions on the bigger picture in terms of this acquisition to your overall wealth franchise or strategy?

——————————————————————————–

Christopher H. Fowler, Canadian Western Bank – President, CEO & Director [12]

——————————————————————————–

Well, we’re really excited to close on this acquisition on Monday. The footprint of T.E. Wealth and Leon Fraser is Vancouver, Calgary, Toronto and Montreal. So it fits very well with our footprint. Vancouver is new for us. We’ve got — our main acquisitions in the past in wealth management has been in Alberta, in Calgary and Edmonton. So this is a great addition for us. And also, as we really look at our growth in Ontario, the addition of the really strong teams of those 2 groups in Toronto are being — we see that as a great opportunity for us as we look to continue to build our franchise there. We have the opening of our Mississauga branch, which, of course, has been slowed because of the COVID situation with construction. But it will be opening in late summer, early fall in that time range. We see the teams that we’ll have on the commercial banking side, they work very collaborate with the wealth side. So we really are looking forward to that being a great opportunity for us to really continue to deliver full-service banking and a big step forward for the CWB.

——————————————————————————–

Scott Chan, Canaccord Genuity Corp., Research Division – Director of Research of Financials & Financial Services Analyst [13]

——————————————————————————–

Okay. And just lastly, Chris, while I have you. You talked about real estate project loans and called out [condo] developments or projects being delayed in BC. What about Ontario? And kind of what in your sense you see where it could resume and what factors might impact that?

——————————————————————————–

Christopher H. Fowler, Canadian Western Bank – President, CEO & Director [14]

——————————————————————————–

Well, we’ve seen — we see a continued paydown in our real estate project loan book, which means, of course, that, that successful completion of the projects. So we’re obviously very happy with the quality of that book and it’s being operated in terms of our focus on Tier 1 clients is operating very well. On Ontario, we participate there in syndicated exposures as opposed to in [PDC] and Alberta, where we have direct lending to clients. So Ontario has been very positive. And again, we participate there with typically the large banks as the leader of those projects. And we’ve seen good quality projects that will come forward with well capitalized Tier 1 borrowers there.

——————————————————————————–

Carolyn J. Graham, Canadian Western Bank – Executive VP & CFO [15]

——————————————————————————–

And Scott, I’ll just circle back on your first question. So just to confirm, in 2010, gross impaired loans peaked at 168 basis points. As I mentioned, our provision that year was about 22 basis points.

——————————————————————————–

Operator [16]

——————————————————————————–

Next question will be from Gabriel Dechaine at National Bank Financial.

——————————————————————————–

Gabriel Dechaine, National Bank Financial, Inc., Research Division – Analyst [17]

——————————————————————————–

I got a dumb question here, but — all those loans that are on deferred payment programs, you are still accruing interest for them? And — yes, let’s just ask that?

——————————————————————————–

Carolyn J. Graham, Canadian Western Bank – Executive VP & CFO [18]

——————————————————————————–

Yes. So they are — they remain performing, and we accrue interest on them.

——————————————————————————–

Gabriel Dechaine, National Bank Financial, Inc., Research Division – Analyst [19]

——————————————————————————–

So walk me through how this works in the next 4 to 6 months. Let’s say, I don’t know, half — I mean we’ll pick whatever number, if you want to answer me that way. But the customers that go back to paying you as they normally would, there’s no accounting noise. But then what would happen to the portion that don’t? Because subsequently, they’re impaired loans, and they’re not paying you, but would there be a reversal of sort?

——————————————————————————–

Carolyn J. Graham, Canadian Western Bank – Executive VP & CFO [20]

——————————————————————————–

So when loans move to impaired, the accounting that we use is that we do reverse interest that has been accrued but not collected. So that happens in normal course today, and it’s just part of the regular NIM that we see every day. Our deferrals were almost exclusively for a 3-month period. So we are coming up in the month of June. We will be reconnecting with all of those clients to get an update on their business, talk more about their current ability to restart making payments on their loans. So that will be work that we are actively doing. And so we would anticipate that some will restart making payments on their loan. We would expect that some may request an additional 3 month deferral period, and we will assess those on an individual basis as we have done now. You will notice in our financial statement note where we provide the detail of our deferrals by portfolio. You can see that about 15% of those loans are in Stage 2 at the end of April. So while they’ve remained performing, we did allow our models where the conditional probability of default indicated they should move to Stage 2. We did move them to Stage 2 and have estimated lifetime losses on them.

——————————————————————————–

Gabriel Dechaine, National Bank Financial, Inc., Research Division – Analyst [21]

——————————————————————————–

Okay. All right. So those deferrals would be the performing provision this quarter? That’s it.

——————————————————————————–

Carolyn J. Graham, Canadian Western Bank – Executive VP & CFO [22]

——————————————————————————–

Yes.

——————————————————————————–

Gabriel Dechaine, National Bank Financial, Inc., Research Division – Analyst [23]

——————————————————————————–

Okay. And then the rest wouldn’t. But like do you have any indications because we heard from some banks that they have this number out there, x for the percentage of customers not paying us right now, but some are already making minimum payments or I don’t know exactly how that works, but do you have any data or insight like that, that you could share?

——————————————————————————–

Christopher H. Fowler, Canadian Western Bank – President, CEO & Director [24]

——————————————————————————–

Well, we have about 86% of the deferrals are full payment deferrals and about 14% are interest only. And as Carolyn said, our teams are triaging these loans. So we’re staying on top of the clients, understanding what their prospects are, what does the relaunched economy look like? How does it impact their ability to generate there? We are very much on top of this. It’s a key focus, Gabe.

——————————————————————————–

Gabriel Dechaine, National Bank Financial, Inc., Research Division – Analyst [25]

——————————————————————————–

Yes. No, no, I don’t have it. But I just thought — just so I understand definitions, 14% of those are the ones that schedule are paying interest only.

——————————————————————————–

Christopher H. Fowler, Canadian Western Bank – President, CEO & Director [26]

——————————————————————————–

Interest only. Yes, yes.

——————————————————————————–

Gabriel Dechaine, National Bank Financial, Inc., Research Division – Analyst [27]

——————————————————————————–

The 86 or nothing, anything?

——————————————————————————–

Christopher H. Fowler, Canadian Western Bank – President, CEO & Director [28]

——————————————————————————–

They’re full payment deferrals, yes.

——————————————————————————–

Gabriel Dechaine, National Bank Financial, Inc., Research Division – Analyst [29]

——————————————————————————–

Okay. And just — what’s the other one I had here. The — can you maybe describe the base case worst-case economic — or optimistic case, like when you set your performing provisions, I assume you skewed heavily to the pessimistic case. Is that how it works?

——————————————————————————–

Carolyn J. Graham, Canadian Western Bank – Executive VP & CFO [30]

——————————————————————————–

So yes, our process is that rather than 3 or 4 finite individual cases that are then weighted, we start with our base case based on the average of the big 6 forecast. We apply — we look at — we do a Monte Carlo analysis, which increased our and then we potentially looked at other pessimistic scenarios like we’ve described in the stress test scenario to help us understand potential moves in the performing loan allowance moving forward. So we’ve described on Page 16 of the deck, sort of a broad comparison of the base case that we’ve used for Q2 and our stress test assumptions. When we’ve got a lot of detail by quarter on the base case scenario in the financial statement note.

——————————————————————————–

Gabriel Dechaine, National Bank Financial, Inc., Research Division – Analyst [31]

——————————————————————————–

And last one for me, another maybe a stupid question, but the average of the big 6 scenarios that you used, like was that Q1 or you saw something Q2 that after or something allowed you guys to see?

——————————————————————————–

Carolyn J. Graham, Canadian Western Bank – Executive VP & CFO [32]

——————————————————————————–

So we used the publicly available as they evolved through the quarter.

——————————————————————————–

Operator [33]

——————————————————————————–

Next question will be from Steve Theriault at Eight Capital.

——————————————————————————–

Stephen Gordon Theriault, Eight Capital, Research Division – Principal & Head of Research [34]

——————————————————————————–

Just maybe one to start on the deferrals. Chris, you said you saw a deceleration of deferrals in the quarter end. There’s a big focus here. So could we get — could you discuss a little more what you’ve seen through May? And as I look at what you’ve given us, there was $6.5 billion of deferred loans at the end of the quarter. Like can you put some numbers around how much higher that’s gotten over the last month or so?

——————————————————————————–

Carolyn J. Graham, Canadian Western Bank – Executive VP & CFO [35]

——————————————————————————–

Yes. So as of last Friday, we’re at about $7.1 billion of loans under deferral. So a difference of between 22% of the portfolio at April 30 and about 24% at — in May. 80% of the amounts that are deferred today were processed by April 16. So the last 6 weeks, that has really slowed, and that would be consistent with the timing of when the government loan program started to roll out and started to be funded. So clients may have taken, requested the initial deferral and then as the various government programs have been put in place, have been thinking about what makes sense for them over the next, say, 3 to 6 to 12 months.

——————————————————————————–

Stephen Gordon Theriault, Eight Capital, Research Division – Principal & Head of Research [36]

——————————————————————————–

Okay. That’s super helpful. And then just a question on credit. I was hoping we could take a couple of minutes, and you could just refresh us a little bit on the franchise finance business. Can you give some color on what level of deferrals you’re seeing there? Maybe remind us of the business mix of quick-serve versus the rest of the book? And how you’re feeling on credit for that portfolio in particular?

——————————————————————————–

Christopher H. Fowler, Canadian Western Bank – President, CEO & Director [37]

——————————————————————————–

So Steve, we’ve — obviously, we have a very strong team that runs that group that we acquired in 2016. They’ve done a very detailed review of their portfolio. So they’ve got about 75% of that is hotels, 25% is restaurants. On the hotel side, they’ve got very conservative loan to values in the 50% loan-to-value range for restaurant side based on leverage, very conservative leverage ratios. They do specialize in this area, so they’ve really looked at picking the borrowers that as they look at — think of credit risk, they’ve got good diversification. So that book, we are obviously working hard with. It’s got the highest level of deferrals in our overall portfolio, which makes sense given that it’s the most impacted by this economic shutdown that we’ve had. But we’ve got a team there that’s on top of it. We’ve got very strong borrowers there that have properties that would not just be necessarily located in one city. They’d have multiple locations in a number of cities, not focus at all in sort of the vacation parts where you’d have more — or sort of less chance of business travel. So they’re in more of that limited serve hotel space where it’s not dependent on a ton of services and conventions in that to generate revenue. And on the restaurant side, there’s a balance there between a quick service and full restaurant. So there’s a — it’s a good well balanced book, and we’re obviously working closely with the team there as they stay on top with their clients.

——————————————————————————–

Stephen Gordon Theriault, Eight Capital, Research Division – Principal & Head of Research [38]

——————————————————————————–

Would you — when we think about your performing allowances, is there any numbers you’d be comfortable giving us in terms of — with some of the calls this reporting season, we’ve gotten energy allowances, Stage 1, Stage 2. Could you — would you — have you, I guess, maybe if I haven’t seen it or could you split that for like the hotel and hospitality or franchise finance or give any numbers along those lines?

——————————————————————————–

Christopher H. Fowler, Canadian Western Bank – President, CEO & Director [39]

——————————————————————————–

Yes. Yes, that level of granularity, no. We’re sitting with — from an outcome perspective. So our oil and gas production book — I mean we have one impaired loan in there. That’s the same when we had last quarter, and you noticed it went down $1 million because we actually wrote off $1 million because the court approved sale of the company has occurred and it closed June 30. So we’re comfortable with our oil and gas production loans. I think we’re…

——————————————————————————–

Stephen Gordon Theriault, Eight Capital, Research Division – Principal & Head of Research [40]

——————————————————————————–

No, the question was really more just on the franchise finance stuff.

——————————————————————————–

Christopher H. Fowler, Canadian Western Bank – President, CEO & Director [41]

——————————————————————————–

Yes. Yes. In terms of having a detailed number, I think we haven’t segregated that out. We’re comfortable with the structure of the finance we have in place, the loan to values, the leverage ratios on the restaurants.

——————————————————————————–

Stephen Gordon Theriault, Eight Capital, Research Division – Principal & Head of Research [42]

——————————————————————————–

Okay. Then just if I could finish up. When — it’s great to see the ARB conversions happening on schedule and that OSFI’s and that there’s no delay there. I just did want to ask, though, is there any material change in how we should think about the conversion of risk-weighted assets, either given the credit migration that would be structurally a little bit different under advanced ARB or just the overall recession, the sensitivity to RWA under ARB versus standardized?

——————————————————————————–

Carolyn J. Graham, Canadian Western Bank – Executive VP & CFO [43]

——————————————————————————–

Yes, that’s a good question, Steve. As a standardized bank, your risk rates when a loan goes impaired depends on the level of specific allowance that you record against them. So for example, a commercial loan that is 100% [risk-weighted], when it is performing, if it goes impaired, if you have a 20% or higher specific allowance recorded against it, it remains at the 100% risk weight. No provision or less than 20%, it goes to 150%. So there is a cliff effect under the standardized approach that is already factored into the results that we continue to disclose. And so that’s a little bit different than in AIRB, where you would expect a gradual increase in their risk-weighted asset density as loans deteriorating credit quality. So there is a component of that in our — in the standardized calculations already.

——————————————————————————–

Operator [44]

——————————————————————————–

Next question will be from Sohrab Movahedi at BMO Capital Market.

——————————————————————————–

Sohrab Movahedi, BMO Capital Markets Equity Research – Analyst [45]

——————————————————————————–

Just a quick one, Carolyn. In the commentary you offered around the outlook for net interest margins, were you contemplating any shifts in your funding mix?

——————————————————————————–

Carolyn J. Graham, Canadian Western Bank – Executive VP & CFO [46]

——————————————————————————–

I think what we — we expect to continue to focus on branch-raised deposits. We did bring down the rate on our motive savvy savings account in both April and again, a small decrease in early May. We saw very strong growth in our CWB Trust Services deposits, notice deposits this quarter. That is a portfolio that we expect to flex. That’s portfolio where when equity markets are volatile and investors turn to cash, those balances increase. And so we do expect them to remain strong until equity markets settle. And so that gives us a bit of a natural hedge if we have other deposits where clients are using their cash balances. So that has been positive for us this quarter in those portfolio. And I would say all of our deposit balances have performed as we would expect them to in the quarter. We continue to access the broker deposit market as required as our marginal source of funding to balance off other things. So it remains deep and liquid, but it did become more expensive. And so the fact that our other deposit sources have been stronger, and we’ve reduced our reliance on the broker market has supported net interest margin. And in the third quarter, we drew $350 million — or the second quarter, sorry, we drew $350 million from the Bank of Canada’s new standing term liquidity facility. Whenever you’re a liquidity manager and there’s a new potential channel available to you, you want to put it in place and try it on and see how it works. So we drew March 31. It rolled over on April 30 for 90 days.

——————————————————————————–

Sohrab Movahedi, BMO Capital Markets Equity Research – Analyst [47]

——————————————————————————–

Perfect. And just maybe just to follow-up, I think, on Steve’s question. Are you, like, I assume, still standardized so your risk weightings and everything currently being calculated on that basis. But [would] you have a sense of what your (inaudible) quarter-over-quarter RWA inflation would have been under the AIRB approach?

——————————————————————————–

Carolyn J. Graham, Canadian Western Bank – Executive VP & CFO [48]

——————————————————————————–

I don’t have that handy, Sohrab.

——————————————————————————–

Operator [49]

——————————————————————————–

Next question will be from Darko Mihelic at RBC Capital Markets.

——————————————————————————–

Darko Mihelic, RBC Capital Markets, Research Division – MD & Equity Analyst [50]

——————————————————————————–

Just just a few questions here. I think I may have misheard you, Carolyn. So I just want to — and I apologize if we’re sort of going over something again. But did I hear you say that the Stage 2 loans that you’ve included all of the deferred in the Stage 2? Is that why there’s a big increase?

——————————————————————————–

Carolyn J. Graham, Canadian Western Bank – Executive VP & CFO [51]

——————————————————————————–

No. Not quite right, Darko. So we allowed the models to move loans with deferrals into Stage 2 if the conditional probability of defaults for those portfolios based on what industry segment they’re in, where they’re located in the country. If those conditional probabilities move the loans, we let them move. So about 15% of our deferred loan — our loans with deferred payments are in Stage 2. The other reason for the increase in Stage 2 allowances in the second quarter is just the impact of the deterioration in the macroeconomic forecasts. So our Stage 2, in total, our Stage 2 loans for the second quarter, 20% of them are in Stage 2 because of individual client characteristics. So they were past due. They were — they’re on our watch list. And the 80% of the loans in Stage 2 are in there because our models shifted them over there. So not because of any client behavior, but just the way the models work with our conditional PD estimates.

——————————————————————————–

Christopher H. Fowler, Canadian Western Bank – President, CEO & Director [52]

——————————————————————————–

And just to add to that, the — any client that was past due or in that watch list wasn’t eligible for a deferral.

——————————————————————————–

Darko Mihelic, RBC Capital Markets, Research Division – MD & Equity Analyst [53]

——————————————————————————–

Okay. It’s just that the number that are in Stage 2 is relatively high. That’s why I — I mean by our calculations, it’s 17% of the portfolio is now in Stage 2, and that’s significantly higher quarter-over-quarter and significantly different from peers. And this brings me really to my question, which is — and you’ve mentioned this a few times, you referred to this a few times in your remarks, which is your secured lending model is what gives you a lot of comfort. And the model could say a whole bunch of these are in a tough spot, but not to worry, we have secured lending. And so what I’m getting at is, I wonder if you’d be able to — be willing to share something for me to help sort of formalize something in my mind. And maybe the easiest way to do this is to look at Page 16 of your presentation. And when I look at this and I say, okay, there’s a stress test and it’s 19% higher your ACL versus the one you’ve just build. The question is, if I look at the existing performing loan allowance of [$111 million], I wonder if you can provide just a rough guide of the probability of default and then the loss given default. And then what would that look like under your stress test? And what I’m driving at, Carolyn, is I kind of feel like you’re relying on the asset value, and that’s why you simply just don’t get a lot of loss. And I’m wondering — I don’t want to get into what your house price number is and the value of the equipment falling or whatever, but I’m just really curious if under this extreme stress test, we have a significant reduction in the assets that are backing the loans and therefore, a significant increase in the loss given the fall.

——————————————————————————–

Carolyn J. Graham, Canadian Western Bank – Executive VP & CFO [54]

——————————————————————————–

Great questions. I think we’re going to have to come back to you, Darko. I don’t have the — that information right at my fingertips. I think one of the other things that we’ve realized this quarter, as we work through this process from multiple directions, is that — a couple of things. The first is that our portfolio has a relatively short life. So — and a number of our portfolios amortized materially and quite quickly. So the borrower has equity in the asset. And what that means for us is that if you look at the loss rates between Stage 1 and Stage 2 on average, for us, there is about — I’m going off my memory here, but about 115 basis point increase in the expected loss rate for us, if a loan is in Stage 1 versus Stage 2. And that differential for our peer group is more like 400 basis points. So that’s characteristics of our secured lending model, the duration of our loan portfolio, all of these things that impact that historic differential between Stage 1 and Stage 2.

——————————————————————————–

Darko Mihelic, RBC Capital Markets, Research Division – MD & Equity Analyst [55]

——————————————————————————–

Yes. I guess that’s what we — I mean, the general fear and the general sense I’m getting from many people that I’m speaking to today is just a kind of a scary reliance on models. And that’s why we had thought maybe the overlay would be bigger this quarter, the expert credit judgment. Just to say — and look, on the other side of this, if this gets really ugly, the assets will fall tremendously. House prices will fall significantly, equipment and in particular, in your case, just getting back to franchise finance. I mean, hotels and restaurants. This is kind of new. I don’t think it was really around during the financial crisis. So history doesn’t really help us too much, I don’t think. And that’s why I was really curious that you had some sort of statistic around the asset prices that are backing your loss given default numbers. So it is fine. I don’t mind coming back afterwards. That would be great to get some comfort on that, if at all possible.

——————————————————————————–

Christopher H. Fowler, Canadian Western Bank – President, CEO & Director [56]

——————————————————————————–

Yes. We can do that, Darko. In speaking of franchise finance, yes, that’s a group we bought. But actually, our percentage of hotel loans in our portfolio is actually lower today than it was in 2010 and ’09, just to be clear.

——————————————————————————–

Operator [57]

——————————————————————————–

Next question will be from Nigel D’Souza at Veritas Investment Research.

——————————————————————————–

Nigel R. D’Souza, Veritas Investment Research Corporation – Investment Analyst [58]

——————————————————————————–

So I had a quick question. And I wanted to circle back and follow-up on the stress test assumptions that you’ve outlined. And I was hoping you could perhaps maybe quantify some of the assumptions, just so it would help [doesn’t] kind of contextualizing your expected increase in provision. So for example, in your stress test, what is the percentage decline you expect for GDP? Where do you see unemployment peaking? And what’s the floor for oil prices in your stress test assumptions? And I think that would really help us put the increase in your PCLs relative to the base case in perspective.

——————————————————————————–

Carolyn J. Graham, Canadian Western Bank – Executive VP & CFO [59]

——————————————————————————–

Okay. I can give you a little bit a bit of perspective on that, Nigel. Our stress scenario assumes in the second quarter of 2020, a 45% decline in GDP, with a 20% recovery in the third quarter. Unemployment peaks at 14%, stays double-digit through the first half of 2021. Oil price, Q2 of 2020 of $16, recovering to just over $30 in the end of 2020 and remaining below $50 out through the end of 2021.

——————————————————————————–

Operator [60]

——————————————————————————–

Thank you. Ladies and gentlemen, this concludes the question-and-answer period. We will now turn the call back to Chris for his closing comments.

——————————————————————————–

Christopher H. Fowler, Canadian Western Bank – President, CEO & Director [61]

——————————————————————————–

Thank you, Sylvie, and thank you, everyone, for your continued interest in CWB. There’s no question that the current economic outlook will continue to challenge every Canadian. Actions we have taken over the last decade to strengthen and diversify our business enable us to face these challenges from a position of stability and confidence. We have a history of emerging from difficult economic periods with robust growth because of our approach with current and potential quality clients. We chose our small and [both] the medium-sized business owner clients carefully, and we stick with them through tough economic cycles, taking a proactive and long-term approach. We’re not the same bank we were in prior downturns. We’re stronger, we’re more diversified, and we have better tools. I’m confident that our sound business model, including our unchanged approach to strong underwriting will serve us well in this challenging environment as it has many times before. We have a tremendous opportunity in front of us and a solid plan to transform our bank to increase value for our people, our clients and our investors. We have a big year ahead with our transition to the ARB approach, the launch of digital banking, leveraging our wealth management acquisition into more full-service client relationships and opening of our first Ontario branch in Mississauga. Thank you, and I look forward to speaking with you when we report our third quarter financial results on August 27.

With that, we wish you all a good morning.

——————————————————————————–

Operator [62]

——————————————————————————–

Thank you, sir. Ladies and gentlemen, this does indeed conclude your conference call for today. Once again, thank you for attending. And at this time, we do ask that you please disconnect your lines. Have a good weekend.

Leave a Reply