Amid the dominance of Canada's Big Six are two niche small-cap banks – Laurentian Bank of Canada and Canadian Western Bank – that both reported solid financial results this week, despite facing the challenge of tough competition and a low interest rate environment.
But the outlook for both banks is muted as Canada's economy sputters along and low interest rates continue to be a drag on profitability.
However, Edmonton-based Canadian Western Bank has an additional hurdle to overcome – its high exposure to Alberta, whose economy is struggling with the sharp drop in oil prices since late 2014 and severe cuts to both capital spending and employment.
Canadian Western Bank's cash adjusted earnings per share came in at 65 cents for the second quarter, up 10 per cent year-over-year, which was in line with expectations. Loan growth was positive, up 11 per cent year-over-year, and the bank's provisions for credit losses were stable. The big concern, however, is that loan growth will slow and loan-loss provisions may increase with a declining Albertan economy.
"We have continued to deliver strong loan growth and maintained sound credit quality against an uncertain macroeconomic backdrop within Alberta and Saskatchewan," said Chris Fowler, the bank's CEO, in a news release.
Investors' caution over the bank's ability to continue to generate profit at this rate has made it a market laggard so far this year. It's down about 13 per cent.
What has caused the company's stock price to torpedo are principally concerns surrounding the Albertan economy as the bank's operations are focused in Western Canada and 42 per cent of its loans are derived from Alberta.
Its stock price has reflected that concern, and it has fallen almost in lockstep with the price of oil in recent months. Consequently, the valuation for Canadian Western Bank's shares has sharply declined. Over the past few years, the stock has traded at a higher valuation compared to the big banks. Now, it trades at a discount.
Alberta is anticipated to report negative real gross domestic product growth in 2015, which has worrisome implications for housing prices, employment growth, consumer spending, consumer sentiment, business investment and in-migration. None of those outcomes are positive for a bank.
Mr. Fowler addressed concerns surrounding the plunge in oil prices. "While the full impact of lower oil prices has yet to make its way through all facets of the economy, we continue to work proactively with our clients to address specific challenges as they emerge," he said.
Although both Canadian Western Bank and Laurentian Bank face headwinds, they gave a boost of confidence in their ability to manage these challenges by raising their dividends. Canadian Western Bank boosted its quarterly dividend by 1 cent per share, or 5 per cent, to 22 cents, which gives it a 3.1-per-cent yield.
Laurentian Bank increased its quarterly dividend by 2 cents a share, or 4 per cent, to 56 cents for a yield of 4.6 per cent.
Technically, Canadian Western Bank's stock price looks weak. From late 2010 through to the second half of 2013, the stock price consolidated in the $25 to $30 range. It appears the stock is likely to return to that range in the near-term. The stock has resistance just above $29, then at $30, and $31.50, and downside support at $28 and $25.
The bottom line: Where there is uncertainty, there is a lack of conviction, and this equates to a lack of demand. This means it could be a volatile time for this stock. In the near-term, there are few catalysts for Canadian Western Bank shares, but there are risks. Besides the sluggish Albertan economy, other risk factors include the impact of a recently elected New Democratic Party government, the competition in the banking sector, the ongoing low interest rate environment and volatility of oil prices.
Jennifer Dowty, CFA, Globe Investor's in-house equities analyst, writes exclusively for our subscribers at Inside the Market.