Is Canadian Western Bank a Home Capital Group Inc. 2.0?

Here are a few reasons I remain very bearish on Canadian Western Bank (TSX:CWB), suggesting caution as I did with Home Capital Group Inc. (TSX:HCG).

| More on:

Alternative lending is typically a category reserved for a few select leaders in the Canadian high-risk lending sector, namely Home Capital Group Inc. (TSX:HCG) and Equitable Group Inc. (TSX:EQB). What many investors don’t know is that regional lenders such as Canadian Western Bank (TSX:CWB) also have a significant alternative lending portfolio, one which is expected to grow over the coming year due to the decline (and possible exit) of rival Home Capital.

Loan quality aside (with loan-loss provisions for most alternative lenders still sitting at a fraction of 1%, which boggles my mind), the reality is that given the current overheated markets in Toronto and Vancouver, alternative lenders will likely be the first to take a hit should the market go south.

Let’s take a look at how exposed Canadian Western Bank really is, and try to quantify what sort of exposure Canadian Western Bank investors have to this sector.

Alternative lending portfolio

Canadian Western Bank estimates that its “Optimum” business segment has increased 18% year over year in the second quarter of 2017 based on increasing loan origination for alternative mortgages.  This portfolio exists to serve the needs of a very similar clientele to that of other alternative Canadian lenders: new homebuyers, immigrants, the self-employed, or otherwise “non-prime” borrowers traditional banks do not wish to serve.

While the Optimum portfolio totals only 11% of Canadian Western Bank’s total loan exposure, this segment is significant in that it represents one of the fastest-growing loan segments — a segment with a much riskier pool of loans with loan-to-value ratios exceeding 68% compared to a much lower LTV ratio of its traditional commercial and residential lending portfolios.

The geographic makeup of the bank’s customer base is also something to note. Currently, more than 50% of the bank’s optimum loans are generated in Ontario (primarily in Toronto) with 21% of originations taking place in Alberta and 17% in B.C.

With economists from around the world noting that some of the largest housing bubbles globally currently exist in the Vancouver and Toronto markets, and the oil market decline still hampering the economic prospects of Alberta, it appears that CWB’s exposure to all of the riskiest elements of the Canadian economy put it at a disadvantage compared to the larger, more diversified Canadian banks.

Provision for credit losses concerning

One thing which has stood out to me specifically with the balance sheet of alternative lenders such as Home Capital and Equitable, and now Canadian Western Bank, is the existence of unrealistically low loan-loss provisions.

I have written about these loan-loss provisions ad nauseam for both Home Capital and Equitable; however, it appears that Canadian Western Bank is playing a very similar game.

In the bank’s Q2 2017 financial statements, it notes that impaired loans totaled 0.62% of total loans this past quarter, yet the company has posted an average loan-loss provision of 0.26%, or 26 basis points on a year-to-date basis.

In the earnings release, the lender noted, “management expects periodic further increases in the balance of impaired loans across the portfolio,” while stating “the full-year provision is expected to fall toward the lower end of a range between 25 and 35 basis points.”

The math just doesn’t add up.

Bottom line

As a long-term investor taking a very bearish perspective on the Canadian oil and gas and real estate industries, I am very concerned about Canadian Western Bank’s prospects moving forward. Investors should take extreme caution with this name, given the economic headwinds and huge downside potential with this bank.

Stay Foolish, my friends.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Chris MacDonald has no position in any stocks mentioned.

More on Dividend Stocks

Canadian Dollars bills
Dividend Stocks

3 Monthly-Paying Dividend Stocks to Boost Your Passive Income

Given their healthy cash flows and high yields, these three monthly-paying dividend stocks could boost your passive income.

Read more »

Make a choice, path to success, sign
Dividend Stocks

The TFSA Blueprint to Generate $3,695.48 in Yearly Passive Income

The blueprint to generate yearly passive income in a TFSA is to maximize the contribution limits.

Read more »

hand stacks coins
Dividend Stocks

3 Ultra-High-Yield Dividend Stocks You Can Buy and Hold for a Decade

These three high-yield dividend stocks still have some work to do, but each are in steady areas that are only…

Read more »

senior man and woman stretch their legs on yoga mats outside
Dividend Stocks

TFSA: 2 Canadian Stocks to Buy and Hold Forever

Here are 2 TFSA-worthy Canadian stocks. Which one is a good buy for your TFSA today?

Read more »

calculate and analyze stock
Dividend Stocks

This 5.5% Dividend Stock Pays Cash Every Single Month!

This REIT may offer monthly dividends, but don't forget about the potential returns in the growth industry its involved with.

Read more »

Silver coins fall into a piggy bank.
Dividend Stocks

How to Use Your TFSA to Earn up to $6,000 Per Year in Tax-Free Passive Income

A high return doesn't mean you have to make a high investment -- or a risky one -- especially with…

Read more »

path road success business
Dividend Stocks

2 High-Yield Dividend Stocks to Buy Hand Over Fist and 1 to Avoid

High yields are great and all, but only if returns come with them. And while two of these might, another…

Read more »

Man holds Canadian dollars in differing amounts
Dividend Stocks

This 7% Dividend Stock Pays Cash Every Month

A high dividend yield isn't everything. But when it pays out each month and offers this stability, it's worth considering!

Read more »