For its three decades, Canadian Western Bank has been a quintessential Western Canadian story. Yoked to its booming home province of Alberta, Canadian Western posted growth superior to that of the big country-wide banks. For this, investors historically paid a significant premium for Canadian Western shares.
Perhaps you know how the worm has turned. Canada may not be in recession, but Alberta most likely is. And well-founded worries about the future of the oil patch and the provinces that depend on it have crushed Canadian Western shares, down more than 20 per cent over the last 12 months. It is now the cheapest, as opposed to the most expensive, of the banks in the S&P/TSX composite based on trailing earnings and its price-to-book value.
Canadian Western says it has stress-tested its balance sheet and can remain strong, if markedly less profitable, if loan losses skyrocket. And in an acknowledgment of its regional concentration, Canadian Western has been adding businesses that expand its non-Alberta loan book.
This suggests that Canadian Western might, in the long term, emerge from these troubled times and bounce back from the bottom of the banking pile. But when it does, will it still be what its name implies – a Western Canadian bank?
It's been nearly five years since I first wrote about Canadian Western, noting that it was a heavily shorted stock with a relatively high level of problem loans for a Canadian bank. The shares have underperformed peers since, but not necessarily for the reasons I outlined. Canadian Western's credit profile is, as of today, strong compared with some of the bigger banks. The defence the bank gave me at the time was a good one: Canadian Western had little in the way of credit-card and other unsecured consumer loans, with secured real estate and commercial loans making up most of the balance sheet.
And yet, the Canadian Western story is driven by another number – the price of crude. Analyst John Aiken of Barclays Capital, in issuing his report on the bank's early-December earnings release, noted that the stock's correlation to crude remained above 90 per cent – even though the company's earnings per share, loan losses and loan growth showed little correlation to oil prices.
Chris Fowler, Canadian Western's CEO, is doing what he can to counter the market view, telling RBC Dominion Securities' 2016 Canadian Bank CEO Conference on Tuesday that the bank's direct exposure to oil – loans to companies in exploration and production, or oil-field services – is just 5 per cent of the bank's loans.
When asked whether the bank directly incorporates oil prices in its "stress testing," the answer was no. But to forecast the downside, Mr. Fowler said, the bank took the worst-ever bad-loan provisions in each of its lines of business and geographies and summed them. Then, it took the peak-loss numbers in Alberta (which is 40 per cent of the bank's portfolio) and Saskatchewan, and increased them by 50 per cent.
The result, he said, is a loan-loss provision, charged directly against income, of 63 basis points, or 0.63 per cent. And if that provisioning occurs three years in a row, accompanied by margin compression, it halves the bank's return on equity from 12.5 per cent to 6 per cent and cuts earnings per share from $2.70 to $1 while the bank maintains capital at 8.5 per cent. "It does reflect what we think would be a very significant decline," Mr. Fowler said. "We think it's a fairly robust and aggressive stress test."
That may reassure many about Canadian Western's staying power in a dismal oil environment. However, another key part of Mr. Fowler's message is that Canadian Western is making serious strides in "broadening our geography." Across the company, 25 per cent of the growth came east of the Manitoba border, he told the conference Tuesday. Canadian Western's Optimum residential mortgage unit has made 50 per cent of its recent originations in Ontario. Maxium Group, an equipment-financing company it will acquire this quarter, does about 80 per cent of its business in Ontario.
"We are incrementally adding on to what is a very strong core that we started with on the lending function, to broader relationships, greater geography, more diversified funding and strong capital management … we're adding a lot of tools to our tool chest," he said.
The goal, it seems, is to be more of a national bank, with many more lines of business than Western Canadian lending. That will certainly mitigate the downside the next time Alberta finds itself in trouble. In the next Western boom, however, it will also likely blunt some of the appeal that gave Canadian Western a premium price to its peers.