Time4VPS - VPS hosting in Europe

Canadian Western Bank: COVID-19’s Impact On Provisions Appears To Have Peaked

Earnings of Canadian Western Bank (OTCPK:CBWBF) plunged by 28% sequentially to C$0.59 per share in the second quarter of this fiscal year. A surge in provision expense amid the COVID-19 pandemic and the contraction in net interest margin were the major contributors to the earnings decline. The bank’s earnings will likely improve in the remaining half of the year from the second quarter’s decline. The second quarter’s provisioning will likely cover the pandemic-driven loan impairments in the remainder of the year; hence, the provision expense will likely decrease in the year ahead.

Moreover, loan growth and the acquisition of a wealth management company will likely help earnings recover. On the other hand, further contraction in the net interest margin will likely pressurize earnings. For the full year, I’m expecting earnings to decline by 12% year-over-year to C$2.68 per share (US$ 1.98 per share). The fiscal year-end target price suggests a high upside from the current market price; therefore, I’m adopting a bullish rating on CBWBF. The bank carries a high level of risk that makes CBWBF unsuitable for low risk-tolerant investors.

Provision Expense Appears To Have Peaked In The Second Quarter

CBWBF reported a provision expense of C$35 million in the second quarter ended April 30, 2020, up from C$13 million in the first quarter of the year. The management assumed a sharp contraction in Canadian GDP in the third quarter and a slow recovery over several quarters to determine the provisions for loan losses. Additionally, the management assumed a Canadian unemployment rate of 10% and an average WTI crude oil price of US$35 per barrel in the third quarter. The following table from the second quarter’s shareholder’s report shows the assumptions the management used to determine the provisions.Canadian Western Bank Expected CRedit Losses Macroeconomic Assumptions

The macroeconomic assumptions appear reasonable in the current environment. Hence, I believe the provisions will be sufficient to cover most of the pandemic-driven impairments that may arise in the remainder of the year. Consequently, I’m expecting the provision expense to decline in the remaining two quarters of the year compared to the second quarter.

However, I’m expecting the provision expense to remain above normal in the second half because risks will likely persist until the uncertainties related to COVID-19 are cleared. As mentioned in May’s investor presentation, CBWBF allowed payment deferrals on 22% of business and personal loans as of April 30, 2020. The deferrals do not currently impact the provision expense, but they could turn into impairments or troubled debt restructurings in the future if the pandemic lasts longer than expected. Moreover, although the oil sector makes up just 0.7% of total loans, CBWBF has indirect exposure to the sector through the bank’s exposure to loans in the province of Alberta. The province’s economy relies heavily on oil; therefore, turmoil in the international crude oil market can affect CBWBF’s Alberta exposure. As mentioned in the shareholder’s report, Albertan loans made up 32% of total loans as of April 30, 2020.

Considering the factors mentioned above, I’m expecting CBWBF to post provision expense of C$88 million in 2020, up from C$58 million in 2019.

Loan Growth To Counter Margin Contraction

CBWBF’s net interest margin, NIM, declined by 19bps in the April-ending quarter due to the 150bps cut in Bank of Canada’s target policy rate. The full impact of the policy rate cuts was not visible in the second quarter because the cuts were towards the middle of the quarter. Therefore, the full impact will be visible in the third quarter. The management mentioned in the second quarter’s conference call that they expect NIM to hover around 2.30% in the second half of the year. Based on the management’s guidance, I’m expecting NIM to decline by 28bps in the fiscal year 2020. The following table shows my estimates for yield, cost, and NIM.Canadian Western Bank Net Interest Margin

Continued loan growth will likely counter the impact of NIM decline on net interest income. The growth will likely be lower than last year because of the economic downturn and the uncertainties related to the COVID-19 pandemic. As mentioned in the conference call, the management expects loans to grow by mid-single digits in this fiscal year. Based on this guidance, I’m expecting loans to increase by 5% until the year-end from the end of the fiscal year 2019. The following table shows my estimates for loans and other balance sheet items.Canadian Western Bank Balance Sheet Forecast

Expecting Earnings Decline Of 12%

The reduction in provision expense and loan growth will likely help earnings improve in the year ahead. Additionally, CBWBF completed the acquisition of a wealth management company called T.E. Wealth and Leon Frazer & Associates in June. According to a press release, the acquisition will increase CBWBF’s assets under management to C$8 billion. Based on these factors, I’m expecting the bank’s earnings per share to increase to an average of C$0.63 in the third and fourth quarters from $0.59 in the second quarter. For the full year, I’m expecting the bank to post earnings of C$2.68 per share (US$ 1.98 per share assuming an exchange rate of C$1.35 per US$), down 12% from last year’s earnings. The following table shows my estimates for income statement estimates.Canadian Western Bank Income Forecast

High Level Of Risk Makes CBWBF Unsuitable For Some Investors

CBWBF currently carries a high level of risk due to the uncertainties surrounding the severity and duration of the COVID-19 pandemic. Additionally, CBWBF has high exposure to the province of Alberta whose economy is sensitive to the international oil market. Furthermore, CBWBF does not trade on a major U.S. exchange, which adds to the stock’s riskiness. Due to these risks, CBWBF appears unsuitable for low risk-tolerant investors.

However, the bank faces less risk than several U.S. banks because the COVID-19 situation is less dire in Canada. World Health Organization’s situation report for July 6, 2020, shows that new cases in Canada were just 226 compared to 57,186 in the United States. In other words, Canada had 0.61 new cases per 100,000 people, whereas the United States had 17.48 new cases per 100,000 people as of July 6, 2020.

CBWBF Has Potential For Price Appreciation

I’m using the historical price-to-book method, P/B, to value CBWBF. The bank traded at an average P/B multiple of 1.10 in the past, as shown in the table below.Canadian Western Bank Historical Price to Book

Taking the P/B ratio of 1.1 and multiplying it with the forecast October 2020 book value per share of US$23.6 gives us a target price of US$26.0. The price target implies a 47% upside from CBWBF’s July 6 closing price. The table below gives a sensitivity of the target price to the P/B multiple.Canadian Western Bank Valuation Sensitivity

The stock price is unlikely to rise to the target price by October because of the high level of risk. However, in my opinion, 10% to 15% price appreciation is possible from the current market price. Apart from the potential price upside, CBWBF is also offering a dividend yield of 4.8%, assuming the bank maintains its quarterly dividend at the current level of C$0.29 per share (US$ 0.21 per share). I’m not expecting a cut in dividends because the earnings and dividend estimates suggest a payout ratio of 47%, which is sustainable. Moreover, the management mentioned in the conference call that they were confident about maintaining their current dividend level.

Based on the potential price appreciation and modest dividend yield, I’m adopting a bullish rating on CBWBF. Investors should be cognizant of the high level of risk at the time of making an investment decision.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Disclaimer: This article is not financial advice. Investors are expected to consider their investment objectives and constraints before investing in the stock(s) mentioned in the article.

Leave a Reply