CWB Reports Solid Financial Performance From Core Operations
(firmenpresse) - EDMONTON, ALBERTA -- (Marketwired) -- 03/03/16 -- First Quarter 2016 Highlights(1,2) (compared to the same period in the prior year)
Canadian Western Bank (TSX: CWB) (CWB) today announced solid first quarter financial performance from core operations. The positive impact of strong year-over-year loan and deposit growth was offset by lower net interest margin, the impact of volatile financial markets on net gains/losses on securities, and the increase in Alberta's provincial corporate tax rate, resulting in common shareholders' net income from Continuing Operations of $52.1 million, down 1% compared to the same quarter last year. Diluted earnings per common share of $0.65 and adjusted cash earnings per common share of $0.66 were consistent with last year.
Common shareholders' net income from Continuing Operations, diluted earnings per common share and adjusted cash earnings per common share were each down 2% compared to the prior quarter.
Excluding net realized gains/losses on securities and the impact of higher Alberta corporate taxes from all periods, first quarter adjusted cash earnings per common share from Continuing Operations increased 6% from last year and the prior quarter.
"Solid first quarter results, despite persistent challenges related to low interest rates and volatile financial markets, have CWB well positioned at the outset of an important year," said Chris Fowler, President and CEO. "The recently closed acquisition of CWB Maxium Financial (Maxium) will be very positive for us moving forward. Maxium's specialized financing originations provide attractive returns and are complementary to our existing lending verticals. This acquisition brings an experienced, motivated and highly respected management group with a demonstrated history of delivering consistently strong financial performance and solid credit quality. With 80% of its business in Ontario, Maxium will accelerate expansion of CWB's geographic footprint in Central and Eastern Canada. Both the Maxium acquisition and the upcoming launch of our new core banking system represent significant steps in the continued execution of CWB's strategic direction."
"The Canadian economy continues to adjust to the impacts of low oil prices and we are working proactively with our clients, particularly in Alberta and Saskatchewan, to address related operating challenges," continued Mr. Fowler. "Solid credit quality through the first quarter reflects CWB's proven, secured lending business model, our disciplined underwriting and proactive loan management. We continue to maintain a realistic outlook in view of the opportunities and challenges presented to us, just as we've done through prior economic cycles. This perspective is supported through CWB's ongoing stress testing program, which is rigorous, comprehensive and conservative. Our stress test results continue to confirm the resilience of CWB's profitability and capital position inclusive of the impacts of extreme, adverse economic assumptions. On this basis we will continue to support our clients and pursue opportunities for profitable growth throughout our geographic footprint."
Medium-term Performance Target Ranges for Continuing Operations
CWB's performance target ranges reflect the objectives embedded within CWB's strategic direction and a time horizon consistent with the longer-term interests of CWB shareholders. Target ranges for key financial metrics over a three to five year time horizon are presented in the following table:
Medium-term performance target ranges are based on expectations for moderate economic growth in Canada over the three to five year forecast horizon. Achievement of overall financial results within these target ranges will be largely driven by management's commitment to continue to deliver ongoing strong and profitable loan growth at levels relatively consistent with CWB's recent performance, further optimization of CWB's funding mix, stable credit quality, effective expense management in consideration of revenue growth opportunities, and prudent capital management.
Outlook for Continuing Operations
CWB's outlook for 2016 remains positive despite caution related to the portions of our businesses in Alberta and Saskatchewan that are directly affected by persistent low energy and other commodity prices. Financial performance will continue to benefit from an expanding geographic footprint with increased business diversification, including the impact of Maxium, as well as ongoing success in other key strategic initiatives to build core funding sources, enhance client offerings, and leverage current and future investment in technology.
CWB's acquisition of the non-securitized lending assets and other business assets of Maxium closed on March 1, 2016. Securitized assets that were originated by Maxium prior to March 1, 2016 were not included in the transaction. Given the purchase structure, the acquisition is expected to have a moderate negative impact on CWB's consolidated adjusted earnings per common share in 2016. Meaningful positive contributions to adjusted earnings per share are expected to commence in 2018 and accelerate thereafter, once new originations and renewals build a material asset base supported by CWB's funding capabilities. Notwithstanding the expected benefits of the Maxium acquisition over the medium-term and continued implementation of CWB's well-defined strategic direction, the impacts of continued pressure on net interest margin, elevated economic uncertainty and slower economic growth compared to prior years are expected to affect near-term overall financial performance. As such, general profitability and earnings growth in fiscal 2016 are expected to fall below CWB's medium-term target ranges.
Summary and Outlook for Loans and Deposits
Loan growth of 12% over the past twelve months and 4% compared to the prior quarter was driven by strong activity within targeted portfolio segments, reinforcing our expectation for overall loan growth in fiscal 2016 to be relatively consistent with levels achieved in recent years. This expectation is primarily based on continued higher relative contributions from non-oil producing provinces across CWB's growing geographic footprint. Combined loan growth within BC and Ontario accounted for two thirds of the increase from the prior quarter, compared to less than one third in the same quarter last year. Although CWB's direct exposure to the energy industry is relatively small at approximately 5% of total loans outstanding, 2016 loan growth in Alberta and Saskatchewan is expected to slow compared to prior years due to the economic impact of low oil prices.
Initial participation in the National Housing Act Mortgage Backed Security (NHA MBS) program contributed $173 million to the increase in outstanding loans this quarter. Adjusted for this contribution, organic loan growth was 11% compared to last year and 3% compared to the prior quarter. Increased utilization of CWB's NHA MBS allocation and originations within Maxium are expected to contribute a total of up to $600 million in net 2016 loan growth. Maxium's originations are expected to be concentrated in Ontario, with anticipated full year originations in the range of $350 to $400 million commencing in fiscal 2017. CWB will continue to pursue opportunities to service high quality borrowers operating within our targeted industry segments, and further improve CWB's funding mix through an emphasis on growing preferred types of branch-raised deposits.
Summary and Outlook for Credit Quality
Overall credit quality is consistent with expectations, inclusive of the sequential increase in total gross impaired loans from $94.9 million to $111.5 million. The annual provision for credit losses is expected to migrate toward the higher end of a range between 18 and 23 basis points of average loans. As we work with our clients through a challenging operating environment, particularly in Alberta, we continue to carefully monitor the loan portfolio for signs of weakness resulting from the first and second order impacts of lower oil prices. Total impaired loans within Alberta of $45.2 million represent 41% of total impairments at January 31, 2016, consistent with the geographic composition of the overall portfolio. The level of impaired loans in Alberta compares to $30.2 million 12 months ago and $41.7 million in the prior quarter. Impaired loans related to CWB's equipment financing and energy exposures within Alberta of $33.0 million increased from $17.7 million last year and $27.4 million last quarter. We remain confident that our combination of disciplined underwriting, secured lending practices and proactive account management will continue to mitigate the financial impacts of further increases in impairments.
Based on the results of stress tests simulating severe economic conditions in Alberta and Saskatchewan, in combination with very challenging economic conditions throughout the rest of CWB's geographic footprint over a multi-year timeframe, management is confident CWB will continue to deliver positive earnings for shareholders while maintaining financial stability and a strong capital position. This expectation is supported through stress tests which incorporate multiple dimensions of artificially intensified severity. For reference, incorporated within the assumed consolidated loss rate of approximately 65 basis points within CWB's stress tests were loss rates related to direct lending to oil and gas producers of approximately 425 basis points, and loss rates related to CWB's equipment financing and leasing exposures within Alberta of approximately 175 basis points.
Summary and Outlook for Efficiency and Operating Leverage
Commencing this quarter, CWB revised its efficiency ratio calculation to exclude the pre-tax amortization of acquisition-related intangible assets and the non-tax deductible change in fair value of contingent consideration. These purchase accounting items represent non-cash charges that are not considered to be indicative of ongoing business performance. All periods presented have been recalculated to conform to the current period presentation.
In view of necessary investment in people and technology underway to facilitate ongoing implementation of CWB's strategic direction, including the impact of the launch of CWB's new core banking system, as well as the low probability of meaningful short-term improvement in net interest margin, management expects CWB's efficiency ratio to fluctuate at levels moderately higher than the recent past.
First quarter operating leverage was negative 1% as moderate year-over-year growth of 5% in non-interest expenses outpaced 4% growth in total revenues. Management is committed to disciplined control of all discretionary expenses and positive operating leverage is expected over the medium-term. However, in the absence of an increase in interest rates, continued pressure on net interest margin is expected to constrain revenue growth and operating leverage is likely to be slightly negative in fiscal 2016.
Summary and Outlook for Capital Management and the Dividend Payout Ratio
CWB maintains a strong capital position under the more conservative Standardized approach for calculating risk-weighted assets. Common share dividend increases are evaluated every quarter against the dividend payout ratio target of approximately 30%. The timing of future dividend increases will be influenced by capital requirements to support expected asset growth under the Standardized approach for calculating risk-weighted assets, as well as the impacts on earnings growth from challenges related to persistent net interest margin pressure and macroeconomic uncertainty.
About CWB Group
CWB Group (CWB) is a diversified financial services organization serving businesses and individuals across Canada. Operating from its headquarters in Edmonton, Alberta, CWB's key business lines include full-service business and personal banking offered through 41 branches of Canadian Western Bank and Internet banking services provided by Canadian Direct Financial (CDF). Highly responsive specialized financing is delivered under the banners of CWB Equipment Financing, National Leasing, CWB Maxium Financial and CWB Optimum Mortgage. Trust Services are offered through Canadian Western Trust. Comprehensive wealth management offerings are provided through CWB Wealth Management, which includes the businesses of Adroit Investment Management, McLean & Partners Wealth Management and Canadian Western Financial. As a public company on the Toronto Stock Exchange (TSX), CWB trades under the symbols "CWB" (common shares) and "CWB.PR.B" (Series 5 Preferred Shares). Learn more at .
Fiscal 2016 First Quarter Results Conference Call
CWB's first quarter results conference call is scheduled for Thursday, March 3, 2016, at 1:30 p.m. ET (11:30 a.m. MT). CWB's executives will comment on financial results and respond to questions from analysts and institutional investors.
The conference call may be accessed on a listen-only basis by dialing 647-788-4922 or toll-free 1-877-223-4471. The call will also be webcast live on CWB's website:
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A replay of the conference call will be available until March 17, 2016, by dialing 416-621-4642 (Toronto) or 1-800-585-8367 (toll-free) and entering passcode 50610298.
Selected Financial Highlights
Taxable Equivalent Basis (teb)
Most banks analyze revenue on a taxable equivalent basis to permit uniform measurement and comparison of net interest income. Net interest income (as presented in the Consolidated Statement of Income) includes tax-exempt income on certain securities. Since this income is not taxable, the rate of interest or dividends received is significantly lower than would apply to a loan or security of the same amount. The adjustment to taxable equivalent basis increases interest income and the provision for income taxes to what they would have been had the tax-exempt securities been taxed at the statutory rate. The taxable equivalent basis does not have a standardized meaning prescribed by International Financial Reporting Standards (IFRS) and, therefore, may not be comparable to similar measures presented by other financial institutions. Total revenues, net interest income and income taxes are discussed on a taxable equivalent basis throughout this quarterly report to shareholders.
Non-IFRS Measures
CWB uses a number of financial measures to assess its performance. These measures provide readers with an enhanced understanding of how management views the results. Non-IFRS measures may also provide readers the ability to analyze trends and provide comparisons with our competitors. Taxable equivalent basis, adjusted cash earnings per common share, return on common shareholders' equity, adjusted return on common shareholders' equity return on assets, efficiency ratio, net interest margin, common equity Tier 1, Tier 1 and total capital adequacy ratios, and average balances do not have standardized meanings prescribed by IFRS and therefore may not be comparable to similar measures presented by other financial institutions.
Management's Discussion and Analysis
This management's discussion and analysis (MD&A), dated March 2, 2016, should be read in conjunction with Canadian Western Bank's (CWB) unaudited condensed interim consolidated financial statements for the period ended January 31, 2016, and the audited consolidated financial statements and MD&A for the year ended October 31, 2015, available on SEDAR at and CWB's website at .
Continuing and Discontinued Operations
On May 1, 2015, CWB completed the divestitures of its property and casualty insurance subsidiary, Canadian Direct Insurance (CDI), and the stock transfer business of its subsidiary, Valiant Trust Company (Valiant), ("Discontinued Operations"). The remaining operations are defined as "Continuing Operations" and the total Discontinued Operations and Continuing Operations are defined as "Combined Operations". In accordance with IFRS 5 Non-current Assets Held for Sale and Discontinued Operations, revenue, expenses and gains on sale associated with the businesses sold have been classified as Discontinued Operations in CWB's interim consolidated statements of income for all periods presented. Associated assets and liabilities were classified as held for sale in CWB's interim consolidated balance sheets prospectively from January 31, 2015 until their sale on May 1, 2015, and comparative information has not been adjusted. Return on common shareholders' equity reflects equity from Combined Operations. All other measures reflect either Continuing or Combined Operations as indicated. The proceeds of sale may be subject to further post-closing adjustments and costs.
Forward-looking Statements
From time to time, CWB makes written and verbal forward-looking statements. Statements of this type are included in the Annual Report and reports to shareholders and may be included in filings with Canadian securities regulators or in other communications such as press releases and corporate presentations. Forward-looking statements include, but are not limited to, statements about CWB's objectives and strategies, targeted and expected financial results and the outlook for CWB's businesses or for the Canadian economy. Forward-looking statements are typically identified by the words "believe", "expect", "anticipate", "intend", "estimate", "may increase", "may impact", "goal", "focus", "potential", "proposed" and other similar expressions, or future or conditional verbs such as "will", "should", "would" and "could".
By their very nature, forward-looking statements involve numerous assumptions and are subject to inherent risks and uncertainties, which give rise to the possibility that management's predictions, forecasts, projections, expectations and conclusions will not prove to be accurate, that its assumptions may not be correct and that its strategic goals will not be achieved.
A variety of factors, many of which are beyond CWB's control, may cause actual results to differ materially from the expectations expressed in the forward-looking statements. These factors include, but are not limited to, general business and economic conditions in Canada, including the volatility and level of liquidity in financial markets, fluctuations in interest rates and currency values, the volatility and level of various commodity prices, changes in monetary policy, changes in economic and political conditions, legislative and regulatory developments, legal developments, the level of competition, the occurrence of natural catastrophes, changes in accounting standards and policies, the accuracy and completeness of information CWB receives about customers and counterparties, the ability to attract and retain key personnel, the ability to complete and integrate acquisitions, reliance on third parties to provide components of business infrastructure, changes in tax laws, technological developments, unexpected changes in consumer spending and saving habits, timely development and introduction of new products, and management's ability to anticipate and manage the risks associated with these factors. It is important to note that the preceding list is not exhaustive of possible factors.
Additional information about these factors can be found in the Risk Management section of CWB's annual Management's Discussion and Analysis (MD&A). These and other factors should be considered carefully, and readers are cautioned not to place undue reliance on these forward-looking statements as a number of important factors could cause CWB's actual results to differ materially from the expectations expressed in such forward-looking statements. Unless required by securities law, CWB does not undertake to update any forward-looking statement, whether written or verbal, that may be made from time to time by it or on its behalf.
Assumptions about the performance of the Canadian economy over the forecast horizon and how it will affect CWB's businesses are material factors considered when setting organizational objectives and targets. In determining expectations for economic growth, CWB primarily considers economic data and forecasts provided by the Canadian government and its agencies, as well as an average of certain private sector forecasts. These forecasts are subject to inherent risks and uncertainties that may be general or specific. Where relevant, material economic assumptions underlying forward looking statements are disclosed within the Outlook sections of this MD&A.
Acquisition of Maxium Group
On March 1, 2016, CWB completed the previously announced acquisition of the non-securitized lending assets and other net business assets of Maxium Financial Services Inc. and Desante Financial Services Inc., now referred to as "CWB Maxium Financial" (Maxium). Securitized assets that were originated by Maxium prior to March 1, 2016 were not included in the transaction. The purchase agreement is structured over three years with maximum total consideration of up to $120 million. The acquisition was funded at closing with 1,250,312 common shares and $19.5 million in cash. Remaining consideration consists of contingent payments that could total up to $70.5 million. Contingent payment installments will be made annually with determination of the total amount payable based on Maxium's cumulative business performance over a 36-month purchase price adjustment period. Up to 50% of the total contingent consideration may be settled with CWB shares, provided the share price at the time of issuance exceeds $30, with the remainder to be paid in cash. Full disclosure of the accounting treatment of the transaction will be provided in the second quarter.
Given the purchase structure, the transaction is expected to have a moderate negative impact on CWB's consolidated adjusted cash earnings per common share in 2016. Meaningful positive contributions to adjusted earnings per share are expected to commence in 2018 and accelerate thereafter, once new originations and renewals build a material base of on-balance sheet assets supported by CWB's funding capabilities.
Overview of Continuing Operations
CWB reported solid quarterly performance from core operations.
Q1 2016 vs. Q1 2015
Common shareholders' net income of $52.1 million was down 1% as the benefit of strong 12% loan growth was more than offset by an 11 basis point decrease in net interest margin (teb), lower non-interest income, growth in non-interest expenses and the increase in Alberta's provincial corporate tax rate. Non-interest income declined $3.4 million as the combined increase in credit related fee income, fees for retail services, and trust services revenues was more than offset by the change in net gains/losses on securities, and lower wealth management revenues. Net losses on securities of $2.9 million, compared to gains of $0.6 million last year, primarily reflect the impact of volatile financial market conditions on CWB's small portfolio of common equities. Diluted earnings per common share of $0.65 and adjusted cash earnings per common share, which excludes the after-tax amortization of acquisition-related intangible assets and non-tax deductible changes in fair value of contingent consideration, of $0.66 were both unchanged compared to last year.
Q1 2016 vs. Q4 2015
Common shareholders' net income was down 2% as the positive impacts of 4% loan growth and relatively stable net interest margin were more than offset by lower non-interest income and the impact of higher corporate taxes in Alberta. The decrease in non-interest income primarily resulted from net losses on securities, compared to nil gains last quarter, and lower 'other' non-interest income.
ROE and ROA
In order to adjust for the impact of purchase accounting items which represent non-cash charges not considered to be indicative of ongoing business performance, CWB will provide an adjusted return on common shareholders' equity commencing this quarter which excludes the after-tax amortization of acquisition-related intangible assets and the non-tax deductible change in fair value of contingent consideration from common shareholders' net income. All periods presented have been recalculated to conform to the current period presentation. First quarter adjusted return on common shareholders' equity (ROE) was 11.7%, compared to 13.4% last year and 12.0% in the previous quarter. Return on assets (ROA) of 0.90% was down from 1.01% a year earlier and 0.94% last quarter.
Outlook for Profitability Ratios
Capital generated from divestiture gains increased common shareholders' equity in 2015, and common shares issued in support of the Maxium acquisition will result in higher levels of common shareholders' equity this year. In view of these factors, as well as the impact of continued net interest margin pressure on growth in total revenues, adjusted return on shareholders' equity in fiscal 2016 is expected to fall below CWB's medium-term target range. CWB's capital levels are deemed to be prudent in view of current macroeconomic conditions.
Impact of net gains/losses on securities and the increase in Alberta's provincial corporate tax rate
Excluding net gains/losses on securities in all periods and the 20% increase in Alberta's provincial corporate tax rate, adjusted cash earnings per common share was up 6% from both the first quarter last year and the prior quarter. Adjusted return on common shareholders' equity (ROE) was 12.2%, compared to 13.1% last year and 11.9% in the previous quarter. Return on assets (ROA) of 0.95% was down from 1.01% a year earlier and up from 0.94% last quarter.
Total Revenues (teb) from Continuing Operations
First quarter total revenues of $158.7 million, comprised of both net interest income (teb) and non-interest income, grew 4% compared to the same quarter in 2015 and was relatively unchanged from the prior quarter. Excluding net gains/losses on securities in all periods, first quarter total revenues grew 7% compared to the same quarter in 2015, and 2% from last quarter.
Net Interest Income (teb)
Q1 2016 vs. Q1 2015
Net interest income of $144.1 million was up 7% ($9.7 million) primarily reflecting the benefit of strong 12% loan growth, partially offset by an 11 basis point decrease in net interest margin (teb) to 2.48%. The Bank of Canada's January and July 2015 interest rate cuts and the corresponding 15 basis point decreases in CWB's prime lending interest rate have had a negative impact on loan yields. Corresponding reductions in the cost of various deposits has not fully offset the impact of these changes on net interest margin. As such, various positive factors, including more favourable deposit costs, and strong growth in both higher yielding loan portfolios and preferred types of branch-raised demand and notice deposits, were more than offset by the impact of significantly lower loan yields and competitive factors, resulting in lower net interest margin.
Q1 2016 vs. Q4 2015
Net interest income was up 2% ($3.0 million) reflecting the benefit of 4% loan growth and relatively stable net interest margin (teb).
Interest rate sensitivity
Note 12 to the unaudited interim consolidated financial statements summarizes CWB's exposure to interest rate risk as at January 31, 2016. The estimated sensitivity of net interest income to a change in interest rates is presented in the table below. The amounts represent the estimated change in net interest income that would result over the following 12 months from a one-percentage point change in interest rates. The estimates are based on a number of assumptions and factors, which include:
In addition to the projected changes in net interest income noted above, it is estimated that a one-percentage point increase in all interest rates at January 31, 2016 would increase unrealized losses related to available-for-sale securities and the fair value of interest rate swaps designated as hedges, and result in a reduction in other comprehensive income of approximately $69.1 million, net of tax (January 31, 2015 - $47.3 million). It is estimated that a one-percentage point decrease in all interest rates at January 31, 2016 would have the opposite effect, increasing other comprehensive income by approximately $62.2 million, net of tax (January 31, 2015 - $40.8 million). Management maintains the asset liability structure and interest rate sensitivity within CWB's established policies through pricing and product initiatives, as well as the use of interest rate swaps.
Outlook for net interest margin (teb)
Continued pressure on net interest margin is expected to result from the combined impact of the current low interest rate environment, competitive factors and the persistently flat yield curve, as well as the likelihood that CWB will carry moderately higher average balances of cash and securities in view of current macroeconomic conditions. CWB will maintain its strategic focus on mitigating the earnings impact of ongoing margin pressure through efforts to achieve stronger relative growth in higher yielding loan portfolios with an acceptable risk profile, as well as managing the funding mix to optimize the overall cost of funds and liquidity adequacy requirements. Very strong 14% year-over-year growth in preferred types of branch-raised demand and notice deposits has provided incremental support to net interest margin, and CWB will maintain an ongoing strategic focus in this area.
Provision for Credit Losses
The quarterly provision for credit losses measured against average loans was 18 basis points, compared to 16 basis points in the same period last year and unchanged from the prior quarter. Annualized first quarter net new specific allowances of 18 basis points increased from 15 basis points last year and were consistent with the prior quarter. Expectations for credit quality include increased provisioning, with the 2016 provision as a percentage of average loans expected to migrate toward the higher end of a range between 18 and 23 basis points. The current level of provisioning compares to a peak annual provision during the prior economic cycle of 22 basis points in fiscal 2010.
Non-interest Income from Continuing Operations
Excluding net gains/losses on securities in all periods, non-interest income was relatively unchanged from both the same quarter last year and the prior quarter.
Q1 2016 vs. Q1 2015
Non-interest income of $14.6 million was down 19% ($3.4 million) as the combined increase in credit related fee income, fees for retail services, and trust services revenues was more than offset by the change in net gains/losses on securities and lower wealth management revenues. Net losses on securities of $2.9 million compare to gains of $0.6 million last year and primarily reflect the impact of volatile financial market conditions on CWB's holdings of common equities in the current period.
Q1 2016 vs. Q4 2015
Non-interest income was down 19% ($3.3 million), primarily attributed to lower net gains/losses on securities and decreased 'other' non-interest income. The decline in 'other' non-interest income reflects higher gains on the sale of residential mortgages in the prior period.
Outlook for non-interest income from Continuing Operations
The outlook for growth in banking-related fee income is relatively consistent with anticipated loan and deposit growth. Trust services is also expected to continue to provide stable growth and consistent contributions. Based on the current composition of the securities portfolio, net gains/losses on securities through the remainder of 2016 are not expected to have a material impact on non-interest income although equity and bond market conditions are inherently unpredictable in the short-term. Management will realize gains on the sale of residential mortgage portfolios as opportunities become available. Such gains are anticipated to be a recurring, although sporadic, source of 'other' non-interest income.
Significant progress has been made toward further implementation of CWB's wealth management strategy, including the appointment of David Schaffner as President and CEO to lead CWB's newly formed division, CWB Wealth Management. The new division consolidates oversight of the businesses of Adroit Investment Management (Adroit), McLean & Partners Wealth Management (McLean & Partners) and CWB's branch-based mutual fund distribution channel, Canadian Western Financial. Subsequent to quarter end, CWB Wealth Management received registration approval in the categories of Portfolio Manager, Investment Fund Manager and Exempt Market Dealer. In combination with the continued expansion of CWB's regional Wealth Management Specialist teams and the filing of a final prospectus for a series of new, proprietary mutual funds to be managed by the teams at Adroit and McLean & Partners, these developments enable CWB Wealth Management to introduce customized wealth management offerings and comprehensive financial planning services for high net worth clients through CWB's branch network.
Non-interest Expenses from Continuing Operations
Q1 2016 vs. Q1 2015
Quarterly non-interest expenses of $75.6 million were up 5% ($3.7 million) due to 6% ($2.9 million) higher salaries and benefits, and a 6% ($0.8 million) increase in general expenses. Premises and equipment expenses were relatively unchanged. The change in salaries and benefits mainly resulted from annual salary increments and modest increases in staff complement to support ongoing growth across all businesses.
Q1 2016 vs. Q4 2015
Non-interest expenses were unchanged from the prior quarter, as incremental increases in both salaries and benefits and premises and equipment expenses were offset by lower general expenses.
Outlook for non-interest expenses from Continuing Operations
One of management's key priorities is to deliver strong long-term growth in earnings per share through strategic investment while maintaining effective control of costs. This strategy is aligned with a commitment to maximize long-term shareholder value and is expected to provide material benefits in future periods. Upgrades and expansion of branch infrastructure continue, including work toward the addition of a full-service branch location in Lloydminster, Saskatchewan, scheduled for the third quarter of 2016. Compliance with an increasing level of regulatory rules and oversight for all Canadian banks requires the investment of both time and resources, which further contributes to higher non-interest expenses. Diligent cost control contributed to moderate non-interest expense growth over the past year. However, in view of necessary investment in people, technology and infrastructure underway to facilitate ongoing implementation of CWB's strategic direction, including the launch of CWB's new core banking system, as well as the addition of Maxium's non-interest expenses commencing March 1, 2016, non-interest expense growth is expected to increase moderately over the near term compared to the recent past.
Core banking system implementation
Work towards the launch of CWB's new core banking system continues. System integration testing is complete, user acceptance testing is approaching completion and client outreach is underway. Investment to date is consistent with estimated total costs of up to $71 million. Implementation is currently scheduled for May 2, 2016, after which the 15 year amortization of capitalized costs, as well as additional sustainment expenses related to the system, will commence.
Efficiency ratio
The first quarter efficiency ratio, which measures non-interest expenses, excluding the pre-tax amortization of acquisition-related intangible assets, as a percentage of total revenues (teb), excluding the non-tax deductible change in fair value of contingent consideration, was 46.9%, up slightly from 46.2% last year and consistent with the previous quarter. Compared to the first quarter last year, the positive impact on total revenues of strong loan growth was more than offset by the impact of lower net interest margin, reduced non-interest income and moderately higher expenses.
Excluding realized gains/losses on securities in all periods, the first quarter efficiency ratio (teb) was 46.0%, compared to 46.4% last year and 47.0% in the previous quarter.
Outlook for the efficiency ratio and operating leverage
The combination of ongoing pressure on net interest margin and net losses on securities has constrained revenue growth compared to expectations. In view of the level of necessary investment, as discussed above, as well as the low probability of meaningful short-term improvement in net interest margin, management expects CWB's efficiency ratio to fluctuate at levels moderately higher than the recent past. In the absence of an increase in interest rates and/or a sustained steepening of the yield curve, continued pressure on net interest margin is expected to constrain revenue growth and operating leverage is likely to be slightly negative in fiscal 2016.
Income Taxes
The first quarter effective income tax rate (teb) for Continuing Operations was 27.5%, compared to 26.3% last year. The 20% increase in Alberta's provincial corporate income tax rate, from 10% to 12%, effective July 1, 2015, had a negative impact on adjusted cash earnings per share of approximately $0.01 compared to the first quarter last year.
Outlook for income taxes
The full year impact of the increase in Alberta's provincial corporate income tax rate on common shareholders' net income is expected to be approximately $0.04 per share. CWB's expected income tax rate (teb) for 2016 is approximately 27.5%.
Overview of Discontinued Operations
The components of net income from Discontinued Operations included in the interim consolidated statements of income, which are attributable entirely to CWB common shareholders, follow:
First quarter common shareholders' net income from Discontinued Operations was nil, compared to $1.8 million, or $0.03 of adjusted cash earnings per common share, in the same quarter last year.
Overview of Combined Operations
Q1 2016 vs. Q1 2015
Common shareholders' net income of $52.1 million was down 4% primarily reflecting the factors discussed above within the overview of Continuing Operations, along with the absence of earnings contributions from Discontinued Operations this quarter. Diluted earnings per common share of $0.65 was down 3% and adjusted cash earnings per common share decreased 4% to $0.66.
Q1 2016 vs. Q4 2015
Common shareholders' net income decreased 2% reflecting the factors discussed above within the overview of Continuing Operations.
ROE and ROA
First quarter adjusted return on common shareholders' equity (ROE) was 11.7%, compared to 13.9% last year and 12.1% last quarter. Return on assets (ROA) of 0.90% compares to 1.03% a year earlier and 0.94% last quarter.
Comprehensive Income
Comprehensive income is comprised of common shareholders' net income from Combined Operations and other comprehensive income (OCI), all net of income taxes.
Q1 2016 vs. Q1 2015
Comprehensive income of $47.9 million was down from $55.0 million in the same period last year. The change reflects decreases of $5.0 million and $2.1 million in OCI and common shareholders' net income from Combined Operations, respectively.
Changes in OCI, all net of tax, resulted from a decrease in the change in fair value of derivatives designated as cash flow hedges and a lower reclassification to net income for these instruments, partially offset by a reduction in negative changes in fair value and a higher reclassification to net income for available-for-sale securities. CWB's portfolio of available-for-sale securities is comprised of debt securities, investment grade preferred shares and common equities. While the combined dollar investment in CWB's portfolios of preferred and common equities is relatively small in relation to total assets, volatility in the market value of these securities increases the potential for comparatively larger fluctuations in OCI.
Lower common shareholders' net income from Combined Operations resulted primarily from the absence of contributions from Discontinued Operations this year.
Balance Sheet
Total assets increased 10% in the past year and 3% in the quarter to reach $23,473 million at January 31, 2016.
Cash and Securities
Cash and securities totaled $2,770 million at January 31, 2016, compared to $2,530 million a year earlier and $2,995 million at the end of last quarter.
The cash and securities portfolio is comprised of high quality debt instruments, investment grade preferred shares and common equities that are not held for trading purposes and, where applicable, are typically held until maturity. Net unrealized losses on cash and securities from Continuing Operations recorded on the balance sheet of $84.9 million compare to net unrealized gains of $19.2 million as at January 31, 2015, and net unrealized losses of $76.2 million last quarter. Fluctuations in value are generally attributed to changes in interest rates, movements in market credit spreads and shifts in the interest rate curve. Volatility in equity markets also leads to fluctuations in value for common shares. The difference compared to last year primarily reflects decreases in the market value of preferred shares and fixed income securities. The change from last quarter reflects decreases in the market value of preferred shares, partially offset by lower unrealized losses on fixed income securities and common shares.
Net realized losses on securities in the first quarter were $2.9 million, compared to net gains of $0.6 million in the same period last year and nil in the previous quarter. Net losses on securities primarily reflect the impact of volatile financial market conditions on CWB's small portfolio of common equities this quarter. Based on the current composition of the securities portfolio, net gains/losses on securities through the remainder of 2016 are not expected to have a material impact on non-interest income although equity and bond market conditions are inherently unpredictable in the short-term.
Treasury Management
Average balances of cash and securities were higher than the same quarter last year and moderately lower than the prior quarter. Management held liquidity for several months, including the first month of this quarter, in preparation for the November 30, 2015, redemption of $300 million of subordinated debentures. Management expects to maintain a conservative level of liquid assets as a percentage of total assets in view of current macroeconomic conditions. CWB remains compliant with the Office of the Superintendent of Financial Institutions' (OSFI) Liquidity Adequacy Requirements guideline.
Loans
Total loans, excluding the allowance for credit losses, grew 12% ($2,210 million) in the past twelve months and 4% ($882 million) in the quarter to reach $20,452 million. Initial participation in the National Housing Act Mortgage Backed Security (NHA MBS) program, through the purchase of pooled, CMHC-insured mortgages, contributed $173 million to the increase in outstanding loans. Adjusted for this contribution, organic loan growth was 11% compared to last year and 3% compared to the prior quarter. In dollar terms, year-over-year growth by lending sector was led by personal loans and mortgages ($656 million). Growth in real estate project loans was also strong ($516 million) as CWB continued to identify opportunities to finance well-capitalized developers on the basis of sound loan structures and acceptable pre-sale/lease levels.
Growth in general commercial loans was $382 million, commercial mortgages were up $360 million, and equipment financing and leasing grew $270 million. Growth in oil and gas production loans of $64 million primarily reflects participation in three new syndicated facilities, partially offset by a decrease in loans to direct borrowers within this segment. Corporate lending declined by $39 million.
On a sequential basis, first quarter growth was led by real estate project loans ($374 million) and personal loans and mortgages ($244 million), followed by general commercial loans ($143 million) and commercial mortgages ($141 million). Oil and gas production loans were up $16 million, equipment financing and leasing was relatively unchanged and corporate lending contracted by $35 million.
Lending activity in British Columbia showed the highest growth in dollar terms on a year-over-year basis, followed by Alberta and Ontario. Combined first quarter loan growth within BC and Ontario accounted for two thirds of the increase from the prior quarter, compared to less than one third in the same quarter last year. In contrast, Alberta accounted for less than a third of CWB's sequential loan growth in the first quarter this year compared to 50% last year. Very strong 21% annual growth within National Leasing reflects the solid market position and coast-to-coast footprint of this business.
Optimum Mortgage
Net of portfolio sales, total loans of $1,996 million within Optimum increased 30% ($463 million) year-over-year and 4% ($73 million) compared to the prior quarter. Growth for the quarter was driven almost exclusively by alternative mortgages secured via first mortgages carrying a weighted average loan-to-value ratio at initiation of approximately 70%. The book value of alternative mortgages represented 90% of Optimum's total portfolio at quarter end, compared to 86% last year and 88% in the prior quarter. Ontario continues to account for more than half of all new originations. At approximately 43% of the total, Ontario also represents the largest geographic exposure by province within Optimum's portfolio, followed by Alberta at 28% and British Columbia at 16%. The average size of Optimum mortgages originated in the first quarter was approximately $300,000, and the average size of mortgage outstanding at January 31, 2016 was $266,000.
Outlook for Optimum Mortgage
Canadian residential real estate markets have been resilient and affordability in most geographic areas outside of certain neighborhoods in Toronto and Vancouver remains within historical ranges, largely reflecting very low interest rates. However, reduced housing sector activity and softer pricing is apparent in Alberta and Saskatchewan, and the combination of historically high price levels and sentiment related to potential economic headwinds caused by low energy prices could lead to further moderation of housing sector activity in these and other markets. Through ongoing selective underwriting in all of its markets, including reduced loans-to-value at initiation within markets perceived to be more vulnerable to price correction and manual adjudication of each loan application, in combination with the ongoing addition of business development staff to new markets, Optimum is expected to continue to deliver very strong performance with an attractive risk profile. Management believes Optimum's underwriting internal control appropriately manages key risk factors associated with this type of lending.
Outlook for loans
Growth in Canada's domestic economy is expected to continue at a moderate pace in 2016. CWB will continue to support high quality borrowers operating within targeted industry segments and pursue opportunities for profitable growth throughout CWB's geographic footprint.
Management expects overall loan growth in fiscal 2016 to be relatively consistent with levels achieved in recent years. This expectation is primarily based on continued higher relative contributions from non-oil producing provinces across CWB's growing geographic footprint. Continued economic strength in the U.S. and a lower Canadian dollar are expected to support an escalation of manufacturing and exporting activity in all provinces, especially BC, Ontario and Manitoba. Taken together, these three provinces account for greater than half of CWB's geographic exposure. Increased participation in the NHA MBS program, primarily through the ongoing purchase of insured loans originated across the country, is expected to support further geographic diversification, as will Maxium's originations. In combination, these two new sources of loan growth are expected to contribute up to a total of $600 million in net growth during fiscal 2016. Approximately 80% of Maxium's current business is in Ontario, and annual originations are expected to be in the range of $350 to $400 million commencing in fiscal 2017.
CWB's direct exposure to the energy industry is relatively small at approximately 5% of total loans outstanding, comprised of loans to exploration and production companies representing approximately 2%, and loans to energy service companies representing approximately 3%. However, Alberta and Saskatchewan are generally expected to underperform the rest of Canada, reflecting expectations for reduced capital investment and the potential for out-migration owing to diminished resource-related activity. As such loan growth in these two provinces is expected to slow in 2016 compared to the levels achieved in recent years.
Credit Quality
Overall credit quality reflects CWB's secured lending business model and continued strong underwriting practices, proactive loan management and the management experience and financial stability of its client base. CWB has no material exposure to unsecured personal borrowing, including credit cards. Nearly three quarters of CWB's direct exposure to exploration and production companies is constituted of syndicated advances to borrowers with strong balance sheets and substantial proven, developed and producing resources. 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, and management continues to proactively monitor all accounts with a particular focus on those located within the oil-exporting provinces as the full impact of lower oil prices continues to work its way through all facets of the economy.
The dollar level of gross impaired loans at January 31, 2016 totalled $111.5 million, up from $79.8 million last year and $94.9 million in the prior quarter. Total impaired loans within Alberta of $45.2 million represent 41% of total impairments, consistent with the overall portfolio composition, and compare to $30.2 million, or 38% of total impairments, 12 months ago, and $41.7 million, or 44% of total impairments, in the prior quarter. Impaired loans related to CWB's equipment financing and energy exposures within Alberta of $33.0 million, included within total Alberta impaired loans discussed above, increased from $17.7 million last year and $27.4 million last quarter.
The dollar level of gross impaired loans represented 0.55% of total loans at quarter end, compared to 0.44% last year and 0.49% at October 31, 2015, and the increase in gross impaired loans is consistent with management's expectations. 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 quarterly, or more frequent, 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 $20.9 million this quarter are specific allowances of $12.8 million on loans with Alberta-based security, up from $7.1 million one year ago and $11.0 million last quarter.
As at January 31, 2016, the collective allowance for credit losses exceeded the balance of impaired loans, net of specific allowances. The total allowance for credit losses (collective and specific) was $120.6 million at January 31, 2016, compared to $115.4 million last quarter and $100.5 million a year earlier. The total allowance for credit losses represented 108% of gross impaired loans at quarter end, compared to 122% last quarter and 126% one year ago. Growth of the collective allowance of 11% over the past twelve months was relatively consistent with growth in loans.
Outlook for credit quality
CWB continues to work with its clients through a challenging operating environment, particularly in Alberta, and is carefully monitoring the loan portfolio for signs of weakness resulting from the first and second order impacts of lower oil prices. Management remains confident that CWB's combination of disciplined underwriting, secured lending practices and proactive account management will continue to mitigate the financial impacts of further increases in loan impairments. In support of CWB's loan management processes, experienced credit adjudicators have been activated in the field to help branches and credit teams proactively identify and address higher risk loans. Gross impaired loans remain low as a percentage of total loans, with the current level of 0.55% comparing to a peak during the prior credit cycle of 1.68% in the second quarter of 2010. While expectations for credit quality include further increases in gross impaired loans from current levels, actual credit losses are expected to remain within CWB's historical range of acceptable levels.
Based on the results of stress tests simulating severe economic conditions in Alberta and Saskatchewan, in combination with very challenging economic conditions throughout the rest of CWB's geographic footprint over a multi-year timeframe, management is confident CWB will continue to deliver positive earnings for shareholders while maintaining financial stability and a strong capital position. This expectation is supported through stress tests which incorporate multiple dimensions of artificially intensified severity, including: the simultaneous application of 150% of CWB's historical peak loss rates within each portfolio segment to all exposures within Alberta and Saskatchewan; the simultaneous application of 100% of peak loss rates to all exposures in all other regions; significant net interest margin compression reflecting a persistent low interest rate environment, increased competition for core deposits and much higher levels of gross impaired loans; materially slower loan growth to reflect lower assumed levels of economic activity that may be attributed to protracted period of very low oil prices; and, all stressed conditions persisting over a three year period. For reference, incorporated within the assumed consolidated loss rate of approximately 65 basis points within CWB's stress tests were loss rates related to direct lending to oil and gas producers of approximately 425 basis points, and loss rates related to CWB's equipment financing and leasing exposures within Alberta of approximately 175 basis points.
Deposits and Funding
Total deposits were up 11% over the past year ($1,944 million), and 3% ($494 million) from the previous quarter. Total deposits by type and source are summarized below:
Personal deposits represented 61% of total deposits at January 31, 2016, compared to 58% one year ago and 59% in the prior quarter. Total branch-raised deposits, including trust services deposits, represented 53% of total deposits at January 31, 2016, down slightly from 54% both one year ago and in the previous quarter.
Lower cost demand and notice deposits increased 14% from the same quarter last year and now comprise 35% of total deposits, up from 34% one year ago and relatively consistent with the previous quarter. Term deposits raised through debt capital markets were $1,935 million at quarter end, representing 10% of total deposits, down from 12% last year reflecting the redemption of certain deposit notes, and consistent with last quarter.
Securitization
Securitized leases and mortgages are reported on-balance sheet with total loans. The gross amount of securitized leases at January 31, 2016 was $947 million, compared to $564 million one year ago and $635 million last quarter. The gross amount of mortgages securitized under the NHA MBS program was $173 million (Q1 and Q4 2015 - nil). Funding from securitization of leases in the first quarter was $354 million (2015 - $134 million). Increased utilization of securitization reflects the relative cost-effectiveness of this funding channel, as well as initiatives which resulted in lower overall capital requirements for CWB's existing pool of securitized leases.
Outlook for deposits and funding
One of management's long-term strategic objectives is to increase the level of deposits which strengthen relationships by providing clients with relevant tools for managing their business and personal finances. These deposits also have attractive liquidity characteristics, are typically lower cost, and provide associated transactional fee income. Specific emphasis is placed on growing personal and business deposits raised within the branch network, trust services and, given suitable market conditions, Canadian Direct Financial, the Internet-based division of CWB. Recent improvements to CWB's product offerings for business clients, including the introduction of a new US dollar Business Savings Account this quarter, along with ongoing training programs continue to support this focus on growing branch-raised deposits. CWB's expanding market presence, including ongoing expansion and upgrades to existing branches, also supports the generation of branch-raised deposits. Strong 14% year-over-year growth in preferred types of demand and notice deposits reflects this ongoing strategic focus.
Management remains committed to further enhance and diversify funding sources to support growth, manage the impact of competitive factors and mitigate pressure on net interest margin. The deposit broker network remains a valued channel for raising insured fixed term retail deposits and has proven to be an effective and efficient way to access funding and liquidity over a wide geographic base. Participation in the NHA MBS program provides liquidity in the near term and will provide an additional source of incremental funding over the medium term. Increased use of securitization and ongoing utilization of debt capital markets are also incorporated within management's strategy to further diversify the funding base. Assuming normal market conditions, CWB will seek to issue funding instruments through capital markets several times per year. In the absence of accommodative pricing in capital markets, management will continue to utilize the broker deposit network to supplement branch-raised deposits.
Other Assets and Other Liabilities
Other assets totaled $352 million at January 31, 2016, compared to $593 million one year ago and $369 million last quarter. Other liabilities were $483 million at quarter end, compared to $511 million a year earlier and $374 million the previous quarter. The decrease in other assets and other liabilities compared to last year primarily reflects the elimination of assets and liabilities held for sale resulting from closing the transactions involving CDI and the stock transfer business of Valiant Trust. A higher balance of securities sold under repurchase agreements this quarter partially offset the decrease in other liabilities.
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 $9,501 million at January 31, 2016, compared to $9,223 million one year ago and $9,294 million last quarter. Assets under management were $1,825 million at quarter end, compared to $1,868 million a year earlier and $1,883 million last quarter.
Other off-balance sheet items are comprised of standard industry credit instruments (guarantees, standby letters of credit and commitments to extend credit). CWB does not utilize, nor does it have exposure to, collateralized debt obligations or credit default swaps. For additional information regarding other off-balance sheet items refer to Note 10 of the unaudited interim consolidated financial statements for the period ended January 31, 2016, as well as Note 20 of the audited consolidated financial statements in CWB's 2015 Annual Report.
Capital Management
OSFI requires Canadian financial institutions to manage and report regulatory capital in accordance with the Basel III capital management framework. CWB's required minimum regulatory capital ratios, including a 250 basis point capital conservation buffer, are 7.0% common equity Tier 1 (CET1), 8.5% Tier 1 and 10.5% total capital.
At January 31, 2016, CWB's capital ratios were 8.6% CET1, 9.8% Tier 1 and 12.0% total capital. The increase in CWB's CET1 capital ratio compared to the prior quarter partially reflects initiatives which resulted in lower overall capital requirements for CWB's existing pool of securitized leases. CWB's current CET1 capital level is prudent in view of the expected 30 basis point impact of closing the Maxium acquisition during the second quarter, as well as current macroeconomic conditions. On November 30, 2015, CWB redeemed all $300 million outstanding 4.389% subordinated debentures which did not qualify as non-viability contingent capital under the Basel III regulatory capital requirements. The redemption resulted in an $80 million reduction in CWB's total regulatory capital. At 7.7%, the Basel III leverage ratio remains very conservative.
Further details regarding CWB's regulatory capital and capital adequacy ratios are included in the following table:
CWB currently reports its regulatory capital ratios using the Standardized approach for calculating risk-weighted assets, which requires CWB to carry significantly more capital for certain credit exposures compared to requirements under the Advanced Internal Ratings Based (AIRB) methodology. For this reason, regulatory capital ratios of banks that utilize the Standardized approach are not directly comparable with the large Canadian banks and other financial institutions which utilize the AIRB methodology.
CWB continues to monitor changes proposed to the Standardized approach for credit risk by the Basel Committee on Banking Supervision.
Planning for CWB's multi-year transition to an AIRB methodology for managing credit risk and calculating risk-weighted assets continues, including preliminary development of quantitative credit risk models specific to certain portfolios, as well as evaluation of resource requirements. Implementation of CWB's new core banking system, currently scheduled for May 2, 2016, is a critical component for a number of requirements necessary for AIRB compliance, including the collection and analysis of certain types of data.
Further information relating to CWB's capital position is provided in Note 13 of the unaudited interim consolidated financial statements for the period ended January 31, 2016 as well as the audited consolidated financial statements and MD&A for the year ended October 31, 2015.
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