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CWB reports strong second quarter financial performance – Part 5

CWB Optimum has recently experienced higher-than-normal mortgage application volumes as a result of challenges faced by its largest competitor. CWB Optimum's manual adjudication and underwriting processes remain consistent with CWB's conservative risk appetite and management continues to be very selective in approving new loans.

Credit Quality

Overall credit quality is consistent with expectations and continues to reflect CWB's secured lending business model, disciplined underwriting practices and proactive loan management. CWB has no material exposure to unsecured personal borrowing, including credit cards. Last year management took a proactive approach to resolve positions within CWB's small portfolio of loans to oil and gas producers.

Remaining direct exposure to borrowers in this category represents less than 1% of the overall portfolio. Loans to service companies are primarily comprised of term-reducing advances against standard industrial equipment, as opposed to operating lines of credit or loans secured against receivables and/or inventory.

These factors mitigate the risk of CWB's limited direct exposures to the energy sector. Management continues to proactively monitor all accounts with a particular focus on those located within Alberta and Saskatchewan as the lagging impacts of the 2015 - 2016 regional recession continue to work through all facets of the affected economies.


For the three months ended ------------------------------------------ (unaudited) Change from ($ thousands) April 30 January 31 April 30 April 30 2017 2017 2016 2016 ----------------------------------------------------------------------------
Gross impaired loans, beginning of period $ 124,439 $ 127,212 $ 111,507 12% New formations 37,705 31,486 69,905 (46) Reductions, impaired accounts paid down or returned to performing status (16,538) (20,554) (20,741) (20) Write-offs (7,772) (13,705) (15,708) (51) ---------------------------------------------------------------------------- Total(1) $ 137,834 $ 124,439 $ 144,963 (5)% ----------------------------------------------------------------------------
Balance of the ten largest impaired accounts $ 67,402 $ 55,544 $ 85,756 (21)% Total number of accounts classified as impaired(3) 234 228 166 40 Gross impaired loans as a percentage of total loans 0.62% 0.57% 0.68% (6)bp(2)(2)

1. Gross impaired loans include foreclosed assets held for sale (primarily

residential mortgages) with a carrying value of $3,436 (January 31, 2017 - $2,419 and April 30, 2016 - $3,392). 2. bp - basis point change. 3. Total number of accounts excludes National Leasing.


The dollar level of gross impaired loans at April 30, 2017 totaled $137.8 million, down from $145.0 last year and up from $124.4 million in the prior quarter. Gross impaired loans within Alberta of $64.7 million accounted for 47% of total impairments. This percentage share was down from 55% last year and up from 41% in the prior quarter.

The dollar level of gross impaired loans represented 0.62% of total loans at quarter end, compared to 0.68% last year and 0.57% at January 31, 2017. The level of gross impaired loans fluctuates as loans become impaired and are subsequently resolved, and does not directly reflect the dollar value of expected write-offs given tangible security held in support of lending exposures. The overall loan portfolio is reviewed regularly with credit decisions undertaken on a case-by-case basis to provide early identification of possible adverse trends. Loans that have become impaired are monitored closely by a specialized team with regular reviews of each loan and its realization plan. Specific allowances for expected write-offs are established through detailed analyses of both the overall quality and marketability of security held against each impaired account. Within total specific allowances of $18.3 million this quarter are specific allowances of $4.5 million on loans with Alberta-based security, down from $34.8 million last year and $5.1 million last quarter. Unusually high specific allowances last year were primarily related to energy loans.

As at April 30, 2017, the total allowance for credit losses (collective and specific) was $136.4 million, compared to $145.8 million a year ago and $129.5 million last quarter. The total allowance for credit losses represented 99% of gross impaired loans at quarter end, compared to 101% last year and 104% in the prior quarter. The collective allowance for credit losses increased 18% over the past twelve months and 2% from last quarter.

Provision for Credit Losses

The second quarter provision for credit losses of 25 basis points of average loans compares to 78 basis points in the same quarter last year and 27 basis points in the prior quarter.

On a year-to-date basis, the provision for credit losses as a percentage of average loans was 26 basis points, down from 48 basis points a year ago. The full-year provision is expected to fall toward the lower end of a range between 25 and 35 basis points.

Outlook for credit quality

Gross impaired loans remain low as a percentage of total loans, with the current level of 0.62% comparing to a peak during the prior credit cycle of 1.68% in the second quarter of 2010. Partially due to the lagging impacts of the regional 2015 - 2016 recession, management expects periodic further increases in the balance of impaired loans across the portfolio; however, material credit impacts related to the small balance of remaining oil and gas loans are not expected. Loss rates on current and future impaired loans are expected to reflect the combined positive impact of CWB's disciplined underwriting, secured lending practices and proactive account management, and to be more consistent with our prior experience where write-offs have been low as a percentage of impairments. Ongoing loan management processes include assignment of experienced credit adjudicators to assist branches and credit teams proactively identify and address higher risk loans. Gross impaired loans within CWB Optimum Mortgage are expected to increase in view of softer housing market conditions, particularly in Alberta. Management remains confident in the strength, diversity and underwriting structure of the overall loan portfolio and lending exposures continue to be closely monitored. CWB continues to carefully monitor the entire portfolio for signs of weakness.

Based on the results of stress tests simulating severe economic conditions across CWB's geographic footprint over a multi-year timeframe, including consideration for the impact of a severe housing market correction, management is confident CWB will continue to deliver positive earnings for shareholders while maintaining financial stability and a strong capital position. Stress test assumptions include severe credit losses, a persistent low interest rate environment and significantly slower loan growth to reflect lower assumed levels of economic activity, as well as increased competition for deposits and much higher levels of gross impaired loans that could combine to result in significant compression of net interest margin.

Deposits and Funding

Total deposits were up 1% over the past year ($133 million) and down 1% ($209 million) from the previous quarter. Relationship-based branch-raised funding increased 9%, including very strong 15% growth of lower-cost demand and notice deposits. Total deposits by type and source are summarized below:


As at --------------------------------------------- (unaudited) Change from January 31 April 30 April 30 2017 2017 April 30 2016 2016
($ millions) ---------------------------------------------------------------------------- Deposits by type Demand and notice deposits $ 8,012 $ 7,615 $ 6,941 15% Term deposits 10,697 11,292 11,480 (7) Capital markets 1,765 1,776 1,920 (8) ---------------------------------------------------------------------------- Total Deposits $ 20,474 $ 20,683 $ 20,341 1% ----------------------------------------------------------------------------
As at --------------------------------------------- (unaudited) Change from January 31 April 30 April 30 2017 2017 April 30 2016 2016
($ millions) ---------------------------------------------------------------------------- Deposits by source CWB Group branch- raised $ 11,714 $ 11,414 $ 10,701 9% Deposit brokers 6,995 7,493 7,720 (9) Capital markets 1,765 1,776 1,920 (8) ---------------------------------------------------------------------------- Total Deposits $ 20,474 $ 20,683 $ 20,341 1% ----------------------------------------------------------------------------


Personal deposits represented 62% of total deposits at April 30, 2017, compared to 61% last year and 63% last quarter. Total branch-raised deposits, including trust services deposits, represented 57% of total deposits at April 30, 2017, up from 53% last year and 55% last quarter. Demand and notice deposits now comprise 39% of total deposits, up from 34% one year ago and 37% last quarter. The deposit broker network remains an efficient source for raising insured fixed term retail deposits and has proven to be a reliable and effective way to access funding and liquidity over a wide geographic base. CWB raises only fixed-term broker deposits, with terms to maturity between one and five years, and does not offer a High Interest Savings Account (HISA) product. Term deposits raised through the broker network represented 34% of total funding at quarter end, compared to 38% last year and 36% last quarter. Term deposits raised through debt capital markets of $1,765 million represented 9% of total deposits this quarter, consistent with last year and last quarter.


Securitized leases and mortgages are reported on-balance sheet with total loans. The gross amount of securitized leases at April 30, 2017 was $906 million, compared to $969 million last year and $996 million last quarter. The gross amount of mortgages securitized under the National Housing Act Mortgage Backed Securities (NHA MBS) program was $373 million (January 31, 2017 - $381 million; April 30, 2016 - $171 million). Year-to-date funding from the securitization of leases and mortgages was $190 million (2016 - $465 million).

Outlook for deposits and funding

CWB's strategic focus to increase relationship-based branch-raised deposits will continue, with particular emphasis on demand and notice deposits. This funding segment is typically lower cost and provides associated transactional fee income. Continued growth in the proportion of branch-raised funding is also a key strategic objective because it reflects success in strengthening targeted multi-product client relationships. CWB's growing market presence, which includes the periodic expansion of full-service branches, supports objectives to generate branch-raised deposits, and the capabilities of CWB's new core banking system are expected to support various growth initiatives related to branch-raised funding over the medium term.

For example, implementation of the new banking system enabled CWB to upgrade its client digital banking experience during the second quarter through targeted improvements to CWB Direct Online Banking. The updated design provides a more consistent visual experience across CWB's digital platforms and complements new financial and communication tools within CWB's mobile banking app. CWB also renewed its processing agreement with Everlink Payment Services Inc. and expanded the scope of services to enable CWB to offer tap-enabled debit cards to CWB clients for the first time. The release of CWB PayHQ, in partnership with Payfirma, on May 1, 2017, represents the addition of a fully integrated, omni-channel payment technology platform to CWB's growing portfolio of business services products, and another step forward to enhance CWB's banking experience for business owners. Together these initiatives are expected to improve the convenience and user experience of CWB's overall suite of business and personal banking tools, and support development of broader, multi-product client relationships.

On April 18, 2017, CWB launched Motive Financial (Motive), a new brand for its on-line bank. The switch to Motive reflects a renewed focus on creating valuable savings opportunities for clients from coast-to-coast, and is expected to re-position CWB's on-line bank as an effective channel for funding growth.

Pricing of term deposits raised through the broker market was disrupted beginning in late April, primarily due to publicity related to challenges faced by the most active issuer in this market, a non-bank mortgage originator. The broker deposit market remains deep, liquid and highly accessible to CWB. Despite the impact of recent price disruption, the weighted average cost of funding for broker deposits issued by CWB across all maturities in May 2017 was lower than the same month in both of the last two years. In view of expectations for accelerating loan growth in the second half of the year, management expects to increase usage of the broker deposit channel relative to the first half of the year.

Selectively utilizing the debt capital markets remains part of management's strategy to further augment and diversify both the long- and short-term funding base over time.

Ongoing utilization of lease securitization is expected in view of the addition of a second lease securitization funding partner last quarter and the relative cost-effectiveness of these funding channels. CWB commenced securitization of residential mortgages in 2016 through the NHA MBS program, and was approved by the Canada Mortgage and Housing Corporation (CMHC) as an issuer of Canada Mortgage Bonds (CMB) subsequent to quarter end. Management expects to initiate participation in the CMB Program in 2017.

Other Assets and Other Liabilities

Other assets totaled $467 million at April 30, 2017, compared to $462 million one year ago and $490 million last quarter. Other liabilities were $567 million at quarter end, relatively unchanged from a year earlier and up from $534 million the previous quarter.

Off-Balance Sheet

Off-balance sheet items include assets under administration and assets under management. Total assets under administration, which are comprised of trust assets and third-party leases under administration, as well as mortgages under service agreements, totaled $11,614 million at April 30, 2017, compared to $10,288 million one year ago and $11,120 million last quarter. Assets under management were $2,064 million at quarter end, compared to $1,834 million a year earlier and $1,972 million last quarter.

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