2015 Annual Report
Pacific & Western Bank of Canada
Suite 2002, 140 Fullarton Street Investor Relations London, Ontario T 800 244 1509 N6A 5P2 E [email protected] T 519 645 1919 www.pwbank.com F 519 645 2060 TABLE OF CONTENTS
2 Financial Highlights
3 President’s Message
5 Chair’s Message
6 Charitable & Community Support
7 Financing Solutions
9 Management’s Discussion And Analysis
49 Corporate Governance
53 Management’s Responsibility For Financial Reporting
55 Independent Auditors’ Report
56 Consolidated Balance Sheets
57 Consolidated Statements Of Income
58 Consolidated Statements Of Comprehensive Income
59 Consolidated Statements Of Changes In Shareholders’ Equity
60 Consolidated Statements Of Cash Flows
61 Notes To Consolidated Financial Statements
97 Board Of Directors
98 Offi cers
99 Corporate Information
1 FINANCIAL HIGHLIGHTS
(thousands of Canadian dollars, except per share amounts) 2015 2014 2013
RESULTS OF OPERATIONS Net interest income$ 33,974 $ 27,874 $ 25,655 Net interest margin-% 2.21% 1.96% 1.75% Non-interest income 1,394 2,633 2,320 Total revenue 35,368 30,507 27,975 Provision for credit losses 1,545 919 524 Non-interest expenses 24,784 22,947 22,882 Net income$ 8,218 $ 5,676 $ 1,764
PER COMMON SHARE Earnings per share Basic$ 0.33 $ 0.29 $ 0.11 Diluted 0.33 0.29 0.11 Book value 7.47 7.14 6.85
BALANCE SHEET ITEMS Assets: Cash and securities$ 149,511 $ 193,940 $ 216,214 Loans 1,447,660 1,224,247 1,158,933 Other assets 28,635 27,673 29,461 Total$ 1,625,806 $ 1,445,860 $ 1,404,608
Liabilities: Deposits$ 1,325,828 $ 1,193,797 $ 1,187,404 Other liabilities 111,397 85,681 63,739 Subordinated notes payable 13,959 13,863 20,332 1,451,184 1,293,341 1,271,475
Shareholders' equity 174,622 152,519 133,133 Total$ 1,625,806 $ 1,445,860 $ 1,404,608
CAPITAL ADEQUACY Common equity Tier 1 ratio 10.32% 11.25% 11.29% Tier 1 ratio 12.54% 12.43% 11.29% Total ratio 13.51% 13.69% 12.99% Total regulatory capital$ 178,291 $ 158,326 $ 143,029
OTHER INFORMATION Gross impaired loans as a percentage of total loans 0.00% 0.00% 0.00% Number of full-time equivalent staff 79 78 76
2 PRESIDENT’S MESSAGE
I am pleased to report that our Bank has completed another very successful year. The considerable investment we have made in technology is starting to pay-off. Assets increased by 12% over the previous year and net interest margin (NIM) increased by 13%, resulting in Net Income increasing by more than 45% over the previous year.
Loans and leases acquired and warehoused through our Bulk Purchase Program increased more than 150% over the previous year, with the year-end balance reaching over $600 million. We purchase loans and leases from an increasing number of non-bank and fi ntech fi nanciers who operate throughout Canada in a variety of industries, many of which are taking advantage of new technologies to reach their customers. Our program facilitates this type of fi nancing and indirectly provides much needed fi nancing for small businesses and greater choice for consumers across Canada. We have developed state of the art, high capacity systems that allow us to process large numbers of these small ticket transactions. Credit risk is reduced to acceptable levels by substantial cash deposits made by our partners to be available to offset potential credit losses. Our Bank is at the leading edge of this new method of fi nancing and this business is rapidly becoming a major portion of the Bank’s total assets and revenue stream.
Our well established Commercial Real Estate fi nancing business again made signifi cant contributions to the Bank’s overall earnings. Total loans in this division increased to $667 million. The Bank lends to well established real estate developers with projects mainly located in Ontario, occasionally lending in other markets throughout Canada.
Asset quality again remained industry leading with the Bank again reporting no impaired loans. The Bank prides its self on maintaining stellar credit adjudication and processes that consistently deliver industry leading results.
Many years ago the Bank developed custom software to enable it to gather deposits without the need for traditional branches. Our Bank now has a substantial network of over 100 deposit gathering partners that includes many of the larger banks’ brokerage fi rms. This channel provides a steady reliable stream of low cost deposits. In addition, our Bank opened up a new channel for gathering deposits that involved developing a custom banking solution for niche markets that may have unique challenges in dealing with the traditional banks. This new channel for deposit gathering is not only diversifying the Bank’s deposit base, but is also serving to lower its cost of funds. The Bank’s overall cost of funds decreased by 7% to 1.98% over the previous year.
Total revenue for the year increased by 16% to $35.4 million over the previous year and NIM increased by 13% to 2.21% over the previous year. Net income for the year was $8.2 million versus the previous year’s $5.7 million. Earnings per common share increased by 14% from $0.29 cents to $0.33 cents over previous year.
We have designed a state of the art Bank that, through utilization of specialized software and well-experienced staff, is able to rapidly acquire large amounts of loans, leases and deposits with minimal costs. By targeting niche markets that are not well served by the larger fi nancial institutions, our Bank is able to earn excellent margins without accepting much risk. The fi nancial market place is embracing innovative new ideas and your Bank is at the forefront of prudently applying new ideas and technology to provide Canadians with greater choice and more economical fi nancing solutions.
David R. Taylor President & Chief Executive Offi cer
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4 CHAIR’S MESSAGE
The fi nancial services industry continues to evolve at a seemingly ever increasing pace creating challenges for its participants but also revealing opportunities. David Taylor and his team have created an innovative technology based fi nancial institution that is effectively dealing with these challenges while taking full advantage of the opportunities, with impressive results. The Bank operates using an “electronic branchless model”. It sources deposits, consumer loans, commercial loans and leases electronically throughout Canada. Additionally, it provides commercial mortgages sourced through a well-established network of brokers and through direct contact with its lending staff, primarily in Ontario.
Your board is composed of nine dedicated and well qualifi ed directors, of which eight are independent. They are each committed to the highest level of governance and are passionate about ensuring that the long-term interests of our stakeholders are balanced and protected.
In 2015, our Bank’s electronic model began to deliver signifi cant value to stakeholders; the considerable investment we made in people and technology began to bear fruit. I want to thank my fellow Board members for their valuable contribution, and on their behalf, extend our sincere thanks to the management team and all of our dedicated employees who strive each day to provide the very best service possible to our clients in niche markets located throughout Canada.
Hon. Thomas A. Hockin Chair of the Board
5 CHARITABLE & COMMUNITY SUPPORT
Abilities Centre, Dream Gala London Community Hebrew Day School
B’nai Brith Youth Organization (BBYO) London Food Bank
Camp Trillium/Rainbow Lake London Hunt Club Horse Show
Canadian Finance & Leasing Association London Junior Knights AA
Children’s Health Foundation London Junior Knights Minor Atom AA Green
Crime Stoppers London Regional Cancer Program
Cystic Fibrosis Canada McCormick Home Foundation
Dove Missions Canada Negev Gala
Easter Seals North Minor Novice 2008
FRC Team 3739 Ontario Expos Baseball
Harbourfront Centre Ovarian Cancer Canada
Heart & Stroke Foundation Pillar Nonprofi t Network
Hockey Helps the Homeless Princess Margaret Cancer Foundation
Hospital for Sick Kids Princess Margaret Hospital
Ignat Kaneff Charitable Foundation Salvation Army
Jeans’n Classics Sports Celebrity Dinner
Junior Achievement of London & District Trinity United Church
Junior Mustangs Purple The Unity Project
Kids Ability Foundation Wellspring
Kidney Foundation Western Ontario HOBY
London Abused Women’s Shelter World Partnership Golf
London Bandits Minor Bantam MD Black
6 FINANCING SOLUTIONS Streamlined, Effi cient and Flexible
Structured Finance Public Sector In 2011, PWB introduced the Bulk Receivable Pacifi c & Western understands the unique Purchase program and we are very pleased operational challenges faced by public sector with its market acceptance. Since inception, to entities and has developed fi nancing solutions the end of fi scal 2015, the Bank has completed which include fl exible terms, and customized receivable purchases in excess of a total of $1 payment schedules that are aligned with Billion. the unconventional cash fl ow streams encountered by complex organizations such Real Estate as municipalities, hospitals, school boards, Our highly experienced real estate lending universities and federal, provincial and team have been providing tailor made territorial governments. fi nancing solutions to real estate developers in Southern Ontario and other key Canadian Syndication Desk markets for well over twenty years, making Pacifi c & Western runs an active syndication Pacifi c & Western the Bank to turn to for real desk on both the buy and sell side. The Bank estate fi nancing. is active in purchasing or participating in loan syndications with other fi nancial institutions Condominium Corporation Financing in the commercial real estate and corporate Pacifi c & Western provides tailor made lending space to maximize its national fi nancing solutions to assist professionally presence and take advantage of relationships managed condominium corporations faced developed with its partners across Canada. with large costs related to the repair or upgrade of common elements. Condominium Credit Card owners benefi t from having necessary projects Pacifi c & Western provides fi nancing and credit completed in a timely manner and are afforded services for Home Hardware’s private label the opportunity of paying for the repairs over credit card program, the Home Credit Card, an extended period of time. used at over 1,075 locations across Canada including: Home Hardware, Home Building Corporate Finance Centre, Home Hardware Building Centre and Pacifi c & Western provides term loans and Home Furniture locations. leases to investment grade corporations, near investment grade corporations, reputable mid-market commercial and small & medium enterprises. Our lean organizational structure allows us to service our clients effi ciently which we believe is key to maintaining long term, highly productive business relationships with our clients.
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8 MANAGEMENT’S DISCUSSION AND ANALYSIS
BUSINESS PROFILE ...... 91 2015 FINANCIAL SUMMARY ...... 11 3 KEY PERFORMANCE INDICATORS AND SELECTED ANNUAL FINANCIAL INFORMATION ...... 13 5 OVERVIEW OF 2015 PERFORMANCE ...... 13 5 TOTAL REVENUE ...... 15 7 NET INTEREST INCOME AND NET INTEREST MARGIN...... 15 7 NON-INTEREST EXPENSES ...... 17 9 CORPORATE INCOME TAXES ...... 1810 COMPREHENSIVE INCOME ...... 1911 ACCUMULATED OTHER COMPREHENSIVE INCOME ...... 1911 BALANCE SHEET REVIEW ...... 2012 LIQUIDITY ...... 2921 OFF-BALANCE SHEET ARRANGEMENTS ...... 2921 RELATED PARTY TRANSACTIONS ...... 3022 CAPITAL MANAGEMENT AND CAPITAL RESOURCES ...... 3022 SUMMARY OF QUARTERLY RESULTS AND FOURTH QUARTER REVIEW ...... 3527 CRITICAL ACCOUNTING POLICIES AND ESTIMATES ...... 3628 ENTERPRISE RISK MANAGEMENT ...... 3931 FACTORS THAT MAY AFFECT FUTURE RESULTS ...... 4638 CONTROLS AND PROCEDURES...... 4840
BUSINESS PROFILE Overview
Pacific & Western Bank of Canada (the “Bank”), a technologically proficient Canadian Schedule I chartered bank, operates using an “electronic branchless model”. It sources deposits, consumer loans, commercial loans and leases electronically. The Bank also makes residential development and commercial mortgages it sources through a well-established network of brokers and direct contact with its lending staff. The Bank’s shares trade on the Toronto Stock Exchange and the Bank is the principal subsidiary of PWC Capital Inc. (the “Corporation” or “PWC”) whose securities are also listed and trade on the Toronto Stock Exchange.
Strategy and Strengths
The Bank’s vision is to be the preferred provider of financial solutions to its clients and its mission is to deliver a competitive and sustainable rate of return to shareholders by delivering ideally suited financial products, services and solutions to its clients in selected niche markets across Canada. As a result of the Bank’s disciplined underwriting approach, it has been able to grow its loan portfolio over the years with minimal loan losses. Operating as a branchless financial institution, the Bank emphasizes the use of technology and based on its ratio of total assets to full time employees is one of the most efficient financial institutions in Canada.
9 Goals and Objectives
The Bank’s goal is to provide financial solutions to its clients and deliver a competitive and sustainable rate of return to its shareholders. The Bank’s objectives in 2015 included the following:
x Increase profitability by increasing net interest income and spread through loan growth in its established markets and expansion of commercial and consumer loans and lease receivables sourced through its bulk purchase program.
x Maintain high credit quality by continuing its disciplined approach to financing and management of its lending portfolios.
x Increase its regulatory capital through earnings and new capital sources to allow it to pursue its growth strategy.
x Expand the use of its banking software for trustees in the bankruptcy industry, reducing its cost of funds and bringing diversity to its deposit gathering network.
x Control growth of non-interest expenses.
Forward-looking statements
The statements in this Management’s Discussion and Analysis which relate to the future are forward- looking statements. By their very nature, forward-looking statements involve inherent risks and uncertainties, both general and specific, and risks exist that predictions, forecasts, projections and other forward-looking statements will not be achieved. Readers are cautioned not to place undue reliance on these forward-looking statements as a number of important factors could cause actual results to differ materially from the plans, objectives, expectations, estimates and intentions expressed in such forward-looking statements. These factors include, but are not limited to, the strength of the Canadian economy in general and the strength of the local economies within Canada in which we conduct operations; the effects of changes in monetary and fiscal policy, including changes in interest rate policies of the Bank of Canada; changing global commodity prices; the effects of competition in the markets in which we operate; inflation; capital market fluctuations; the timely development and introduction of new products in receptive markets; the impact of changes in the laws and regulations regulating financial services; changes in tax laws; technological changes; unexpected judicial or regulatory proceedings; unexpected changes in consumer spending and savings habits; and our anticipation of and success in managing the risks resulting from the foregoing.
The foregoing list of important factors is not exhaustive. When relying on forward-looking statements to make decisions, investors and others should carefully consider the foregoing factors and other uncertainties and potential events. Except as required by securities law, there is no undertaking to update any forward-looking statement that is contained in this Management’s Discussion and Analysis or made from time to time by the Bank.
10 Non-GAAP and Additional GAAP Measures
Net Interest Income and Net Interest Margin or Spread
Most banks analyze profitability by net interest income (as presented in the Consolidated Statements of Income) and net interest margin or spread. Net interest margin or spread is defined as net interest income as a percentage of average total assets. Net interest margin or spread 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.
Book Value Per Common Share
Book value per common share is defined as Shareholders’ Equity less amounts relating to preferred shares recorded in equity, divided by the number of common shares outstanding.
Basel III Common Equity Tier, Tier 1 and Total Capital Adequacy Ratios
Basel III Common Equity Tier 1 (CET1) and total capital adequacy ratios are determined in accordance with guidelines issued by the Office of the Superintendent of Financial Institutions Canada (OSFI).
Return on Average Common Shareholders’ Equity
Net income available to common shareholders divided by average common shareholders’ equity.
Total Assets to Full Time Employee Ratio
The ratio of total assets to full time employees is determined by dividing total assets of the Bank by the number of full time employees.
Non-Interest Expenses to Total Assets Ratio
The ratio of non-interest expenses to total assets is determined by dividing non-interest expenses by total assets.
2015 FINANCIAL SUMMARY (compared to 2014)
x Net income of the Bank for the year ended October 31, 2015 increased 45% to $8.2 million or $0.33 per common share (basic and diluted) from $5.7 million or $0.29 per common share (basic and diluted) for the same period a year ago. Net income for the current year includes an income tax recovery of $1.7 million related to previously unrecognized deferred income tax assets compared to $1.2 million for the same period a year ago. x Net interest margin or spread for the year ended October 31, 2015, increased to 2.21% from 1.96% a year ago. x Lending assets grew to $1.45 billion from $1.22 billion a year ago. The growth in loans was a result of increases in loans and lease receivables sourced through the Bank’s bulk purchase program. x Credit quality remains exceptional with no gross impaired loans at October 31, 2015, or a year ago.
11 x At October 31, 2015, the Bank’s CET1 ratio was 10.32% compared to 11.25% a year ago. The Bank’s total capital ratio was 13.51% at October 31, 2015, compared to 13.69% last year. The change in the CET1 ratio was due to growth in the Bank’s lending assets from a year ago.
Actual 2015 Performance Compared to Objectives
2015 Objectives 2015 Results
Improve profitability by increasing net interest Net income of the Bank improved from a year income and spread through loan growth in its ago primarily as a result of an increase in net established markets and expansion of interest income and spread through a decrease commercial and consumer loans and lease in the cost of funds relating to deposits and receivables sourced through the Bank’s bulk from growth in commercial and consumer loans purchase program. and lease receivables sourced through the bulk purchase program. Maintain high credit quality by continuing its strict Credit quality remained strong in the year with disciplined approach to financing and no impaired loans at the end of year and the management of its lending portfolios. provision for credit losses as a percentage of average loans less than the target for the year.
Expansion of new banking product to trustees in Deposits from trustees in the bankruptcy the bankruptcy industry, reducing its cost of funds industry increased to $111 million at the end of and bringing diversity to its deposit gathering the year from $84 million a year ago with network. continued growth and expansion of the product across Canada. Increase regulatory capital in the Bank to allow Common equity Tier 1 capital of the Bank at the Bank to carry out its growth strategy. the end of the year increased to $136 million from $130 million a year ago and Tier 1 capital increased to $166 million from $144 million last year. In February 2015, the Bank completed an offering of 6 year rate reset preferred shares for net proceeds of $15.7 million which qualify as Additional Tier 1 capital. Control growth of non-interest expenses Non-interest expenses divided by total assets for the year ended October 31, 2015 was 1.61%, unchanged from the prior year.
12 KEY PERFORMANCE INDICATORS AND SELECTED ANNUAL FINANCIAL INFORMATION
(thousands of Canadian dollars October 31 October 31 October 31 except per share amounts) 2015 2014 2013 Net interest income$ 33,974 $ 27,874 $ 25,655 Net interest margin (%)* 2.21% 1.96% 1.75% Non-interest income 1,394 2,633 2,320 Total revenue 35,368 30,507 27,975 Provision for credit losses 1,545 919 524 Non-interest expenses 24,784 22,947 22,882 Restructuring charges - 434 2,064 Net income$ 8,218 $ 5,676 $ 1,764 Income per common share: Basic$ 0.33 $ 0.29 $ 0.11 Diluted $ 0.33 $ 0.29 $ 0.11
Return on average common equity 4.50% 4.17% 1.56% Provision for credit losses as a % of average total loans 0.12% 0.08% 0.04% Gross impaired loans to total loans 0.00% 0.00% 0.00% Assets to full time employees*$ 20,502 $ 18,537 $ 18,482 Book value per common share*$ 7.47 $ 7.14 $ 6.85
Financial Position: Cash and securities 149,511 193,940 216,214 Total loans 1,447,660 1,224,247 1,158,933 Total assets 1,625,806 1,445,860 1,404,608 Subordinated notes payable 13,959 13,863 20,332
Capital Ratios: Common Equity Tier 1 capital 136,254 130,179 124,247 Total regulatory capital 178,291 158,326 143,029 Risk-weighted assets 1,320,158 1,156,832 1,101,190 Common Equity Tier 1 ratio 10.32% 11.25% 11.29% Tier 1 capital ratio 12.54% 12.43% 11.29% Total capital ratio 13.51% 13.69% 12.99% * This is a non-GAAP measure. See definition in 'Non-GAAP and Additional GAAP Measures'.
OVERVIEW OF 2015 PERFORMANCE
Net income for the year ended October 31, 2015 increased 45% to $8.2 million or $0.33 per common share (basic and diluted) from $5.7 million or $0.29 per common share (basic and diluted) for the same period a year ago. Earnings per share amounts are after the deduction for dividends on preferred shares. Net income for the current year includes an income tax recovery of $1.7 million relating to previously unrecognized deferred income tax assets compared to $1.2 million for the same period a year ago. Net income for same period a year ago included restructuring charges of $434,000 related to the early repayment of subordinated debt.
13 Net interest income and net interest margin for the year ended October 31, 2015 were $33.9 million and 2.21% respectively compared to $27.9 million and 1.96% a year ago. The increase in net interest income from the previous year was due to higher levels of interest income in the current year primarily as a result of growth in lending assets as well as a lower cost of funds. For the year ended October 31, 2015, the cost of funds decreased to 1.98% from 2.13% for the previous year.
At October 31, 2015, total assets were $1.63 billion compared to $1.44 billion a year ago. Total loans increased to $1.45 billion from $1.22 billion a year ago with the increase due primarily to growth in commercial and consumer loans and lease receivables sourced through the Bank’s bulk purchase program. The Bank has maintained its strong underwriting standards and credit quality remains exceptional with no gross impaired loans at October 31, 2015, or a year ago.
At October 31, 2015, the Bank continued to exceed the Common Equity Tier 1 (CET1) capital requirement of 7.0% with a CET1 ratio of 10.32% compared to 11.25% a year ago. The decrease in the CET1 ratio from last year was due to the growth in lending assets. At October 31, 2015, the Bank’s Tier 1 capital ratio was 12.54% compared to 12.43% a year ago and the Bank’s total capital ratio was 13.51% compared to 13.69% a year ago. The increase in the Bank’s Tier 1 capital ratio from a year ago was a result of the issue over the past year of preferred shares which qualify as Additional Tier 1 capital. Required minimum regulatory capital ratios are a CET1 capital ratio of 7.0%, a Tier 1 capital ratio of 8.5% and a total capital ratio of 10.5%, all of which include a 2.50% capital conservation buffer.
During the current year, the Bank issued 1,681,320 Non-Cumulative 6-Year Rate Reset Series 3 Non-Viability Contingent Capital (NVCC) Preferred Shares for net proceeds of $15.7 million. For the initial 6-year period ending April 30, 2021, these Series 3 Preferred Shares yield 7% annually, payable quarterly as and when declared by the Board of Directors of the Bank.
Outlook
The outlook for the Bank in 2016 is positive as the Bank expects to build on its operating results of 2015 which included increased earnings, net interest income and net interest margin. The growth in lending assets in 2015, primarily commercial and consumer loans and leases, is expected to see continued growth in 2016. Financial performance is expected to benefit from increased geographic diversity and increased loan diversification through the Bank’s bulk purchase program and by leveraging current and future investment in technology.
Overall credit quality is expected to continue to reflect the Bank’s secured lending model, strong underwriting practices and proactive loan management. Based on results from ongoing stress testing of the loan portfolio under various scenarios and the secured nature of the existing loan portfolio, the Bank is of the view that any credit losses which exist but cannot be specifically identified at this time are adequately provided for. The Bank’s exposure to losses in the province of Alberta and to the oil and gas industry is not significant. As well, the Bank has minimal direct exposure to the housing markets in Toronto, Calgary and Vancouver.
14 TOTAL REVENUE
Total revenue consists of net interest income and non-interest income. For the year ended October 31, 2015, total revenue increased to $35.4 million from $30.5 million a year ago, an increase of 16%. Total revenue increased from last year as a result of an increase in net interest income in the current period which was due to growth in loans and lease receivables sourced through the Bank’s bulk purchase program. Total revenue a year ago included gains of $1.2 million from the sale of loans. There were no loan sales in the current year.
NET INTEREST INCOME AND NET INTEREST MARGIN
Net interest income is the difference between interest earned on assets and interest expense on deposits and other liabilities, including subordinated notes payable. Net interest margin or spread is net interest income as a percentage of average total assets (See Non-GAAP and Additional GAAP measures) and is presented in the tables below.
2015 Average Interest (thousands of Canadian dollars) BalanceMix Interest Rate Assets Cash and securities$ 171,726 11.18 %$ 1,484 0.86 % Loans and leases 1,335,954 86.99 62,973 4.71 Total interest earning assets 1,507,679 98.17 64,457 4.28 Other assets 28,154 1.83 - - Total assets$ 1,535,833 100.00 %64,457$ 4.19 % Liabilities and shareholders' equity Deposits and financings$ 1,259,813 82.03 %$ 27,554 2.19 % Subordinated notes payable 13,911 0.91 1,392 10.01 Securitization liabilities 43,496 2.83 1,537 3.53 Total interest bearing liabilities 1,317,219 85.78 30,483 2.31 Other liabilities 55,044 3.58 - - Shareholders' equity 163,571 10.65 - - Total liabilities and shareholders' equity$ 1,535,833 100.00 %30,483$ 1.98 % Net interest income and net interest margin$ 33,974 2.21 %
15 2014 Average Interest (thousands of Canadian dollars) BalanceMix Interest Rate Assets Cash and securities$ 205,077 14.39 %$ 2,883 1.41 % Loans and leases 1,191,590 83.61 55,278 4.64 Total interest earning assets 1,396,667 98.00 58,161 4.16 Other assets 28,567 2.00 - - Total assets$ 1,425,234 100.00 %58,161$ 4.09 % Liabilities and shareholders' equity Deposits and financings$ 1,190,601 83.54 %$ 27,232 2.29 % Subordinated notes payable 17,098 1.20 1,520 8.89 Securitization liabilities 43,438 3.05 1,535 3.53 Total interest bearing liabilities 1,251,136 87.79 30,287 2.42 Other liabilities 31,272 2.19 - - Shareholders' equity 142,826 10.02 - - Total liabilities and shareholders' equity$ 1,425,234 100.00 %30,287$ 2.13 % Net interest income and net interest margin$ 27,874 1.96 %
Net interest income for the year ended October 31, 2015 increased to $34.0 million from $27.9 million a year ago. The increase in net interest income from a year ago was due to higher levels of interest income in the current period primarily as a result of growth in lending assets as well as a lower cost of funds. For the year ended October 31, 2015, the Bank’s cost of funds decreased to 1.98% from 2.13% for the previous year.
Net interest margin for the year ended October 31, 2015, increased to 2.21% from 1.96% a year ago. Net interest margin increased from a year ago primarily as a result of a more optimal asset mix and increase in loan yield. Net interest margin of the Bank has not been impacted significantly by reductions in the interest rate by the Bank of Canada over the past year.
Outlook
In 2016, the Bank expects that net interest income and net interest margin will continue to increase as a result of anticipated growth in lending assets, particularly commercial and consumer loans and leases sourced through the bulk purchase program. Changes in balances of cash and securities can also have an impact on net interest margin with lower balances generally enhancing net interest margin and higher balances reducing net interest margin. The Bank expects to maintain balances of cash and securities as a percentage of total assets consistent with that at the end of 2015.
Non-Interest Income
(thousands of Canadian dollars) 2015 2014
Credit card non-interest revenue$ 1,308 $ 1,369 Other income 86 57 Gain on sale of loans - 1,207 $ 1,394 $ 2,633
16 Non-interest income includes revenues not included in the determination of net interest income. Non- interest income for the year was $1.4 million compared to $2.6 million for the same period a year ago. Non-interest income in the current and year consists primarily of fees from credit cards. Last year it also included gains from the sale of loans as noted above. There were no loan sales in the current year.
Outlook
In 2016, the Bank expects that the amount of total other income will remain at the same level as that in the current year with the majority of the non-interest income coming from credit card operations.
NON-INTEREST EXPENSES
(thousands of Canadian dollars) 2015 2014 Change from 2014 $ % Salaries and employee benefits Salaries and benefits$ 13,041 $ 11,273 $ 1,768 16 % 13,041 11,273 1,768 16 Premises and equipment Rent-premises 673 610 63 10 Depreciation 393 395 (2) (1) Other 1,029 1,080 (51) (5) 2,095 2,085 10 0 General and administrative Capital taxes and other assessments 3,641 3,313 328 10 Insurance 394 385 9 2 Listing, sustaining and annual meeting fees 310 227 83 37 Marketing and business development 298 482 (184) (38) Professional fees and services 754 626 128 20 Credit card administration 1,394 1,476 (82) (6) Other 2,857 3,080 (223) (7) 9,648 9,589 59 1 $ 24,784 $ 22,947 $ 1,837 8 % Restructuring charges - 434 (434) (100) Total non-interest expenses$ 24,784 $ 23,381 $ 1,403 6 %
Non-interest expenses, excluding restructuring charges, for the year ended October 31, 2015, totalled $24.8 million compared to $22.9 million for the same period a year ago. Restructuring charges in the previous year totalling $434,000 related to the repayment in December 2013 of subordinated debt of the Bank. Non-interest expenses were higher than a year ago due to increases in professional and consulting fees, employee compensation and costs relating to the issue of preferred shares as well as higher capital taxes.
17 Number of Full-Time Equivalent Staff
83 79 76 78
64
2011 2012 2013 2014 2015
The number of full-time equivalent staff has remained relatively constant over the past several years.
Outlook
In 2016 the Bank anticipates that non-interest expenses will increase slightly, primarily as a result of anticipated increases in volume related expenses and salaries, particularly those related to the lending activities where we anticipate increases in staff complement. As well, compliance with an increasing level of regulatory rules and oversight for all Canadian banks will require additional investment of both time and resources.
CORPORATE INCOME TAXES
The Bank’s statutory federal and provincial income tax rate is approximately 27%, similar to that of the previous years. The effective rate is impacted by certain items not being taxable or deductible for income tax purposes as well as a positive adjustment in the deferred tax asset relating to the recognition of previously unrecognized loss carryforwards discussed below.
For the year ended October 31, 2015, the provision for income taxes was $821,000 compared to $531,000 last year with the increase due primarily to the higher level of earnings offset by income tax recoveries recorded on account of previously unrecognized deferred income tax assets.
At October 31, 2015, the Bank has a deferred income tax asset of $8.8 million compared to $8.5 million a year ago with the change as a result of the drawdown of loss carry-forwards due to earnings over the past year, offset by the recognition of previously unrecognized deferred income assets as discussed above. The deferred income tax asset is primarily a result of income tax losses totalling approximately $27.0 million from previous periods. The income tax loss carry-forwards are not scheduled to begin expiring until 2027.
18 Outlook
In 2016 the Bank does not expect its combined federal and provincial statutory tax rate to change materially from 2015. The Bank will not see future income tax recoveries similar to those recorded in 2014 and 2015 as the benefit of its loss carry forwards has now been fully recognized in the value of its deferred income tax asset.
COMPREHENSIVE INCOME
Comprehensive income is comprised of net income for the period and other comprehensive income (loss) which consists of unrealized gains and losses on available-for-sale securities. Comprehensive income for the year ended October 31, 2015 was $8.2 million compared to $5.7 million a year ago. Due to the current composition of the Bank’s treasury portfolio which consists primarily of liquid securities, unrealized gains or losses in the portfolio are not significant and as a result, comprehensive income does not materially differ from net income.
Details of comprehensive income are as follows:
Change from (thousands of Canadian dollars) 2015 2014 2014
Net income$ 8,218 $ 5,676 $ 2,542
Other comprehensive income (loss), net of tax Net unrealized losses on assets held as available-for-sale (1) (6) (5) (1) (6) (5) (1)
Comprehensive income $ 8,212 $ 5,671 $ 2,541
(1) Net of income tax benefit of $2 (2014 – $2)
ACCUMULATED OTHER COMPREHENSIVE INCOME
Accumulated other comprehensive income is a separate component of shareholders’ equity and was $13,000 at October 31, 2015 compared to $19,000 a year ago. Accumulated other comprehensive income consists of net unrealized gains on securities held and classified as available-for-sale.
19 BALANCE SHEET REVIEW Balance Sheet Assets
(thousands of Canadian dollars) 2015Mix 2014 Mix
Cash and cash equivalents$ 127,078 7.82 %$ 145,140 10.05 % Securities: Issued by Canadian federal government, provinces or municipalities 9,886 0.61 10,135 0.70 Term deposits - - 26,055 1.80 Debt of other financial institutions 12,547 0.77 12,610 0.87 Total cash and securities 149,511 9.20 193,940 13.42 Loans: Government financing 72,181 4.44 87,332 6.04 Residential multi-family mortgages 112,759 6.94 122,686 8.49 Commercial and consumer loans and leases 783,780 48.20 548,240 37.92 Commercial mortgages 445,941 27.43 432,567 29.92 Credit card receivables 27,447 1.69 27,972 1.93 Other loans 3,721 0.23 3,967 0.27 Collective allowance (3,212) (0.20) (2,905) (0.20) Accrued interest 5,043 0.31 4,388 0.30 Total loans 1,447,660 89.04 1,224,247 84.67 Other assets 28,635 1.76 27,673 1.91 Total assets$100.00 1,625,806 %$100.00 1,445,860 %
Total consolidated assets at October 31, 2015 increased to $1.63 billion from $1.45 billion a year ago. This increase was due to growth in lending assets which grew to $1.45 billion from $1.22 billion a year ago. Growth in lending assets was primarily a result of an increase in commercial and consumer loan and lease receivables sourced through the Bank’s bulk purchase program as discussed below.
Outlook
In 2016, the Bank is expecting to see growth in total assets of approximately 14% with the growth being in loans, particularly commercial and consumer loans and lease receivables sourced through the bulk purchase program.
Cash and Securities
The Bank holds treasury assets primarily for liquidity management purposes. Cash and cash equivalents consist of deposits with Canadian financial institutions and government treasury bills with less than ninety days to maturity from the date of acquisition. Securities in the treasury portfolio typically consist of Government of Canada and Canadian provincial and municipal bonds, term deposits and debt of other financial institutions. Amounts invested in each of these securities are determined based on liquidity needs, investment yield and capital management considerations.
Cash and securities totalled $150 million or 9.2% of total assets compared to $194 million or 13.4% of total assets a year ago. The decrease in cash and securities from a year ago was due primarily to a lower level of deposits maturing in the coming months requiring a lower level of cash and liquid securities.
20 At October 31, 2015, unrealized gains in the available-for-sale securities portfolio were $18,000 compared to unrealized gains of $26,000 a year ago. In addition, there was an unrealized loss of $47,000 at October 31, 2015 relating to a security that is classified as held-to-maturity. This unrealized loss is due to factors other than changes in credit risk and management is of the opinion that no impairment charge is required. This security matures in June 2016.
The Basel III Committee on Banking Supervision (the Basel Committee) has issued a framework outlining new liquidity standards. The framework prescribes two new standards being the Liquidity Coverage Ratio (LCR) and the Net Stable Funding Ratio (NSFR) as minimum regulatory standards beginning in 2015 and 2018 respectively. The LCR establishes a common measure of liquidity risk and requires financial institutions to maintain sufficient liquid assets to cover a minimum of 30 days of cash flow in a stressed scenario. The NSFR describes a second common measure of liquidity establishing a minimum acceptable amount of stable funding based on the liquidity characteristics of an institution’s assets and activities over a one year time horizon. Although the Basel Committee has introduced a phase-in period for compliance with the LCR guidelines, banks in Canada were required to fully comply with the LCR in January 2015 with no phase-in. The Bank is in compliance with the new LCR requirements and is well positioned to comply with the new NSFR requirements.
Outlook
In 2016, the Bank expects the amount of cash and securities as a percentage of total assets to approximate 9% of total assets, similar to that at the end of 2015 and the composition of treasury assets is expected to remain similar to that at the end of the current year.
Loans
The Bank places an emphasis on lending in niche markets that have lower than average administrative requirements. This includes providing financing in the form of commercial and consumer loans and lease receivables sourced primarily through the Bank’s bulk purchase program. In addition, the Bank finances a select number of real estate developers, primarily in Southwestern Ontario and provides consumer lending through its private label credit card program. The Bank’s loan portfolio is categorized into residential multi-family mortgages, commercial and consumer loans and leases, commercial mortgages, government financings and credit card receivables.
At October 31, 2015, loans increased to $1.45 billion from $1.22 billion a year ago. The increase from the previous year was due primarily to growth in commercial and consumer loans and lease receivables sourced through the Bank’s bulk purchase program.
Government Financings
Government financings consist of loans and leases to federal, provincial, territorial and municipal governments. At October 31, 2015, government financings totalled $72.2 million compared to $87.3 million a year ago with the decrease a result of a reduced focus on government financing due to market conditions. It is not expected that this portfolio will see any growth in the coming year due to the emphasis on commercial and consumer lending opportunities, particularly those commercial and consumer loans and lease receivables sourced through the bulk purchase program.
21 Residential Multi-family Mortgages
The Bank has insured and uninsured residential mortgages outstanding which are comprised primarily of multi-family residential units. Total residential mortgages were $112.8 million at the end of 2015 compared to $122.7 million at the end of 2014. The decrease in the amount of residential multi- family mortgages outstanding from last year was primarily a result of the timing of loan transactions.
Residential mortgage exposure
In accordance with the Office of the Superintendent of Financial Institutions (OSFI) Guideline B-20 – Residential Mortgage Underwriting Practices and Procedures, additional information is provided regarding the Bank’s residential mortgage exposure. For the purposes of the Guideline, a residential mortgage is defined as a loan to an individual that is secured by residential property (one to four unit dwellings) and includes home equity lines of credit (HELOC’s). This differs from the classification of residential mortgages used by the Bank which also includes multi-family mortgages.
Under OSFI’s definition, the Bank’s exposure to residential mortgages at October 31, 2015 totalled $761,000 compared to $1.1 million a year ago. The Bank did not have any HELOC’s outstanding at October 31, 2015, or a year ago.
Commercial and Consumer Loans and Leases
Commercial and consumer loans and leases consist primarily of commercial loans to investment grade corporations and commercial and consumer loans and lease receivables sourced through the bulk purchase program. At October 31, 2015, commercial and consumer loans and leases totalled $783.8 million compared to $548.2 million a year ago with the growth being due to increased fundings as well as the addition of new vendors from whom loans and lease receivables are sourced. As noted above, this is expected to be the most significant area of growth in the coming year.
Commercial Mortgages
Commercial mortgages consist primarily of residential and commercial construction mortgages primarily in Southwestern Ontario. At October 31, 2015, commercial mortgages totalled $445.9 million compared to $432.6 million a year ago with the increase due to timing of loan transactions.
Credit Card Receivables
At October 31, 2015, the Bank had credit card receivables of $27.4 million compared to $28.0 million a year ago. The Bank is continuing to review and assess opportunities in this lending niche.
22 Diversification of Loan Portfolio Outstanding Loans by Portfolio
2015 2014
Otherloans Otherloans 0.26% 0.32% Creditcardreceivables Creditcardreceivables 1.90% 2.29% Governmentfinancing Governmentfinancing 4.99% 7.14% ResidentialmultiͲfamily ResidentialmultiͲfamily mortgages mortgages 7.80% 10.03% Commercialmortgages Commercialmortgages 30.84% 35.38% Commercial/consumer Commercial/consumer loansandleases loansandleases 54.21% 44.84%
Geographic Breakdown
2015 NWT, NU & MB & (thousands of Canadian dollars) ON YT AB PQ BC Atlantic SK Total
Government financing$ 44,442 $ 6,525 $ 906 $ - $ 17,043 $ 3,265 $ - $ 72,181 Residential multi-family mortgages 75,038 1,269 14,797 1,718 - 5,400 14,537 112,759 Commercial and consumer loans and leases 410,171 4,290 145,383 15,106 85,485 60,107 63,238 783,780 Commercial mortgages 397,907 5,652 25,437 4,502 - 10,213 2,230 445,941 Credit card receivables 8,838 115 997 5,153 1,483 8,329 2,532 27,447 Other loans 3,363 - 323 - - - 35 3,721 $ 939,759 $ 17,851 $ 187,843 $ 26,479 $ 104,011 $ 87,314 $ 82,572 $ 1,445,829 65% 1% 13% 2% 7% 6% 5% 100%
2014 NWT, NU & MB & (thousands of Canadian dollars) ON YT AB PQ BC Atlantic SK Total
Government financing$ 51,570 $ 9,808 $ 3,351 $ - $ 17,991 $ 4,396 $ 216 $ 87,332 Residential multi-family mortgages 76,561 1,724 15,055 1,748 - 5,400 22,198 122,686 Commercial and consumer loans and leases 327,667 2,652 90,915 8,261 59,334 37,447 21,964 548,240 Commercial mortgages 388,845 17,690 17,837 - - 5,774 2,421 432,567 Credit card receivables 8,840 146 1,153 5,769 1,463 8,166 2,435 27,972 Other loans 3,519 - 345 - - - 103 3,967 $ 857,002 $ 32,020 $ 128,656 $ 15,778 $ 78,788 $ 61,183 $ 49,337 $ 1,222,764 70% 3% 11% 1% 6% 5% 5% 100%
Note - The above tables do not include an allocation of the allowance for credit losses and accrued interest.
23 There was no significant change in the geographic distribution of the Bank’s loans in 2015 from the previous year. A large majority of the Bank’s loans continues to be in the province of Ontario, particularly Southwestern Ontario where the Bank has well-established long-term relationships. The Bank is further diversifying the geographic distribution of its loans through the increased emphasis on commercial and consumer loans and lease receivables sourced through the bulk purchase program.
Total Loans and Leases Based on Industry Sector by Value*
2015 2014 Real estate, rental and leasing 26 30 Consumer 25 17 Health care and social assistance 10 12 Construction 9 11 Transportation and warehousing 6 5 Finance and insurance 4 3 Educational services 3 3 Arts, entertainment and recreation 2 3 Accommodation and food services 2 2 Credit card receivables 2 2 Public administration 2 2 Mining 2 2 Manufacturing 2 2 Professional, scientific and technical services 1 1 Other 4 5 Total % 100 100 * Table is based on North American Industry Classification System (NAICS) codes.
Loans and leases based on industry sector at October 31, 2015 are comparable to the previous year with the only significant change being in consumer loans which increased to 25% from 17% last year. This increase was due to the growth in loans and lease receivables sourced through the bulk purchase program during the current year.
Outlook
In 2016, the Bank expects that lending assets will increase by approximately 14% with the primary area of growth expected to come from commercial mortgages and commercial and consumer loans and leases. Loan growth is expected to benefit from increased geographic diversity and increased loan diversification through the bulk purchase program and by leveraging current and future investment in technology.
Credit Quality
The Bank maintains high credit quality and strong underwriting standards and as a result traditionally requires minimal provisions for credit losses. Gross impaired loans at October 31, 2015, were $nil, unchanged from a year ago. For the year ended October 31, 2015, the provision for credit losses totalled $1.6 million or 12 basis points of average loans compared to $919,000 or 8 basis points of average loans for the same period a year ago. The provision for credit losses increased from a year ago due to an increase in the collective allowance as a result of the growth in loans. Loan write offs
24 during the past two years relate solely to credit card receivables, however the total provision for credit losses still remains below the Bank’s target of 17 basis points of average loans for the current year.
At October 31, 2015, the collective allowance totalled $3.2 million compared to $2.9 million a year ago. Included in the collective allowance at October 31, 2015 was $1.0 million relating to credit card receivables, compared to $962,000 a year ago.
Based on results from ongoing stress testing of the loan portfolio under various scenarios and the secured nature of the existing loan portfolio, the Bank is of the view that any credit losses which exist but cannot be specifically identified at this time are adequately provided for. The Bank’s exposure to loan losses in the province of Alberta and to the oil and gas industry is not significant. As well, the Bank has minimal direct exposure to the housing markets in Toronto, Calgary and Vancouver.
The ratio of gross impaired loans to total loans over the past 5 years is portrayed in the chart below:
Gross Impaired Loans to Total Loans
0.14% 0.13%
0.00% 0.00% 0.00%
2011 2012 2013* 2014 2015
* Gross impaired loans for 2013 were negligible.
The following table summarizes the allowances and provision for credit losses for the year:
2015 2014 Total Total (thousands of Canadian dollars) Collective Individual Allowance Allowance
Balance, beginning of year$ 2,905 $ - $ 2,905 $ 3,275 Provision for credit losses 1,545 - 1,545 919 Write-offs (1,238) - (1,238) (1,289) Balance, end of year $ 3,212 $ - $ 3,212 $ 2,905
25 The following graph shows the provisions as a percentage of average loans over the past 5 years.
Provisions as a % of Average Loans
0.12%
0.08%
0.04% 0.04% 0.03%
2011 2012 2013 2014 2015
The Bank has experienced increased provisions over the last 5 years as a result of write-offs in its credit card portfolio.
Other Assets
Other assets totalled $28.6 million at October 31, 2015, compared to $27.7 million a year ago. Included in other assets is the deferred income tax asset of $8.8 million compared to $8.5 million a year ago. Also included in other assets are capital assets and prepaid expenses of $18.2 million compared to $17.5 million a year ago.
Deposits
(thousands of Canadian dollars) 2015 Mix 2014 Mix
Demand deposits$ 17,048 1.29 %$ 19,311 1.62 % Trustee chequing accounts 110,575 8.34 83,814 7.02 Term deposits Non retirement savings products 1,178,930 88.92 1,067,654 89.43 Retirement savings products 19,275 1.45 23,018 1.93 $ 1,325,828 100.00 %$ 1,193,797 100.00 %
Deposits are used as a primary source of financing growth in assets and are raised primarily through a well established and well diversified deposit broker network across Canada. The deposit broker network remains an efficient source for raising deposits and has proven to be a reliable and efficient way to access deposits over a wide geographical area. Deposits at October 31, 2015, totalled $1.33 billion compared to $1.19 billion a year ago, and consist primarily of guaranteed investment certificates. The increase in deposits from a year ago was due to the raising of deposits to fund the increase in lending assets.
26 Of the total amount of deposits outstanding, $17.0 million or approximately 1.3% of total deposits at the end of the year were in the form of demand savings accounts compared to $19.3 million or approximately 1.6% of total deposits a year ago. In addition, the Bank has chequing accounts related to trustees in the Canadian bankruptcy industry as discussed below.
The Bank continues to grow and expand its deposit broker network across Canada. In addition, in order to further diversify its sources of deposits and reduce its cost of new deposits, the Bank identified another source, that being chequing accounts of trustees in the Canadian bankruptcy industry. The Bank has developed banking software to enable this market to efficiently administer its chequing accounts. These services are provided to trustees in the bankruptcy industry across Canada and at October 31, 2015, balances from this source totalled $110.6 million compared to $83.8 million a year ago.
The Bank strives to diversify its deposit gathering activities both geographically and among deposit brokers and has internal policies to monitor deposit broker concentrations. These internal policies include targets for the amount of new deposits from a deposit agent in a rolling 12 month period and for the amount of new deposits from its three largest deposit brokers in a rolling 12 month period.
The following is a summary of deposits by maturity, excluding accrued interest:
2015 Within 3 3 months to 1 year to 2 years to (thousands of Canadian dollars) months 1 year 2 years 5 years Total
Demand deposits$ 17,048 $ - $ - $ - $ 17,048 Trustee chequing accounts 110,575 - - - 110,575 Term deposits 159,891 413,310 393,073 218,981 1,185,255 $ 287,514 $ 413,310 $ 393,073 $ 218,981 $ 1,312,878
2014 Within 3 3 months to 1 year to 2 years to (thousands of Canadian dollars) months 1 year 2 years 5 years Total
Demand deposits$ 19,311 $ - $ - $ - $ 19,311 Trustee chequing accounts 83,814 - - - 83,814 Term deposits 143,770 340,854 338,559 254,958 1,078,141 $ 246,895 $ 340,854 $ 338,559 $ 254,958 $ 1,181,266
Outlook
The Bank expects the level of deposits to increase in 2016 at the same rate as the increase in total assets. As well, the Bank will continue to expand deposits sourced through trustees in the bankruptcy industry in 2016 and will maintain its strategy of using its deposit broker network across Canada to raise the majority of its deposits.
27 Other Financings
Another source of financing growth in assets, and a source of liquidity is the use of margin lines and securities sold under repurchase agreements. At October 31, 2015, the Bank did not have any amounts outstanding relating to margin lines or securities sold under repurchase agreements nor were any amounts from these sources outstanding a year ago.
Securitization Liabilities
The Bank has securitization liabilities outstanding which relate to amounts payable to counterparties for cash received upon initiation of securitization transactions. At October 31, 2015, securitization liabilities totalled $43.5 million compared to $43.5 million a year ago. The Bank has not entered into any securitization transactions in the past year. The amounts payable to counterparties bear interest at rates ranging from 1.97% - 3.95% and mature between 2016 and 2020. Securitized insured mortgages and other assets with a carrying value of $43.4 million are pledged as collateral for these liabilities.
Other Liabilities
Other liabilities consist of accounts payable, accruals, holdbacks payable on the bulk purchase program and securities sold under repurchase agreements. At October 31, 2015, other liabilities totalled $67.9 million compared to $42.2 million a year ago with the increase from last year due to larger holdbacks associated with the loan and lease receivables sourced through the bulk purchase program which have shown significant growth over the past year.
Subordinated Notes Payable
The Bank has the following subordinated notes payable outstanding:
(thousands of Canadian dollars) 2015 2014
Ten year term, unsecured, callable, subordinated notes payable to an unrelated party, maturing between 2019 and 2021, net of note issue costs of $541 (2014 - $637), effective interest of 10.06% (2014 - 10.06%)$ 13,959 $ 13,863
$ 13,959 $ 13,863
During the year ended October 31, 2014, the Bank repaid $7,000,000 in notes payable that had a carrying value of $6,566,000. The difference of $434,000 relating to unamortized note issue costs was included in restructuring charges in the Consolidated Statements of Income.
Shareholders’ Equity
At October 31, 2015, shareholders’ equity was $174.6 million compared to $152.5 million a year ago. The increase from a year ago was due to earnings and proceeds received from the issue of Series 3 Preferred Shares as discussed below.
Common shares outstanding at October 31, 2015 totalled 19,437,171, unchanged from a year ago. Common share options totalled 40,000 at October 31, 2015, also unchanged from a year ago.
28 On February 26, 2015, the Bank issued 1,681,320 Non-Cumulative 6-Year Rate Reset Series 3 Non- Viability Contingent Capital (NVCC) Preferred Shares for net proceeds of $15.7 million. For the initial 6-year period ending April 30, 2021, these Series 3 Preferred Shares yield 7% annually, payable quarterly as and when declared by the Board of Directors. These preferred shares qualify as Additional Tier 1 Capital. Issue costs of $1,538,000, net of income taxes of $415,000, were allocated directly to share capital. At October 31, 2015, there were 1,681,320 Series 3 preferred shares outstanding.
The Bank’s book value per common share at October 31, 2015 was $7.47 compared to $7.14 a year ago.
Stock-Based Compensation
Stock options are accounted for using the fair value method which recognizes the fair value of the stock option over the applicable vesting period as an increase in salaries and benefits expense with the same amount being recorded in share capital. During the year ended October 31, 2015, the Bank recognized $23,000 (2014 - $68,000) of compensation expense relating to the estimated fair value of stock options granted in previous years. There were no stock options granted in the current year. See Note 15 to the Consolidated Financial Statements for more information with respect to stock options.
Updated Share Information
As at January 26, 2016, there were no changes since October 31, 2015 in the number of outstanding common shares, Series 1 and Series 3 Preferred Shares and common share options.
LIQUIDITY
The Consolidated Statement of Cash Flows for the Bank for the year ended October 31, 2015 shows cash used in operations in excess of cash provided by operations of $57.4 million compared to cash used in operations of $29.0 million last year. The Bank`s operating cash flow is primarily affected by the change in the balance of its deposits (an increase in deposits has a positive impact on cash flow and a decrease in deposits has a negative impact on cash flow) as compared to the change in the balance of its loans (an increase in loans has a negative impact on cash flow and a decrease in loans has a positive impact on cash flow). Based on factors such as liquidity requirements and opportunities for investment in loans and securities, the Bank may manage the amount of deposits it receives and loans it funds in ways that result in the balances of these items giving rise to either negative or positive cash flow from operations. The Bank will continue to fund its operations and meet contractual obligations as they become due from cash on hand and from managing the amount of deposits it receives as compared to the amount of loans it funds.
OFF-BALANCE SHEET ARRANGEMENTS
As at October 31, 2015, the Bank does not have any significant off-balance sheet arrangements other than loan commitments, undrawn credit card lines and letters of credit resulting from normal business activities. See Note 24 to the Consolidated Financial Statements for more information.
29 Commitments and Contingencies
At October 31, 2015, the Bank had loan commitments totalling $243.3 million compared to $195.1 million at the end of 2014 and undrawn credit card lines of $140.1 million compared to $159.3 million a year ago. Letters of credit at the end of 2015 totalled $39.0 million compared to $43.9 million at the end of the previous year. Loan commitments, undrawn credit card lines and letters of credit were entered into during the normal course of business. Under certain circumstances the Bank may cancel loan commitments and undrawn credit card lines at its option.
Contractual Obligations
At October 31, 2015 the Bank had the following scheduled repayments of financial liabilities and off- balance sheet obligations:
2015 Less than Over (thousands of Canadian dollars) Total 1 Year 1-2 Years 2-5 Years 5 Years Deposits$ 1,312,878 $ 700,824 $ 393,073 $ 218,981 $ - Subordinated notes payable 13,959 - - 4,277 9,682 Securitization liabilities 43,525 - 10,371 - 33,154 Accounts payable 6,869 6,869 - - - Operating leases 3,111 841 796 1,445 29 $ 1,380,342 $ 708,534 $ 404,240 $ 224,703 $ 42,865
RELATED PARTY TRANSACTIONS
During the year ended October 31, 2015, the Bank paid management and other fees totalling $600,000 (2014 - $980,000) respectively to the Corporation and a subsidiary of the Corporation.
The Bank’s and the Corporation’s Board of Directors and Senior Executive Officers represent key management personnel. See Note 23 to the Consolidated Financial Statements for more information.
CAPITAL MANAGEMENT AND CAPITAL RESOURCES Capital Management The Bank’s policy is to maintain a strong capital base so as to maintain investor, creditor and market confidence and to sustain future development of the business. The impact of the level of capital on shareholders’ return is also important and the Bank recognizes the need to maintain a balance between the higher returns that might be possible with greater leverage and the advantages and security afforded by a sound capital position.
The Bank operates as a Schedule 1 bank under the Bank Act (Canada) and is regulated by the Office of the Superintendent of Financial Institutions Canada (OSFI). Capital is managed in accordance with policies and plans that are regularly reviewed and approved by the Bank’s Board of Directors and take into account the risk profile of the Bank, forecasted capital needs and markets. The goal is to maintain appropriate regulatory capital to be considered well capitalized, protect consumer deposits and to provide capacity for internally generated growth and strategic opportunities that do not
30 otherwise require accessing the public capital markets, all the while providing a satisfactory return for shareholders. Regulatory capital is comprised of the qualifying amount of subordinated notes, share capital, retained earnings and net after-tax unrealized gains and losses on available-for-sale securities. Consistent with capital adequacy guidelines issued by OSFI, the Bank has implemented an internal capital adequacy assessment process (ICAAP) aimed at ensuring that capital levels remain adequate in relation to current and future risks.
The Basel Committee on Banking Supervision has published the Basel III rules supporting more stringent global standards on capital adequacy and liquidity (Basel III). Significant changes under Basel III that are most relevant to the Bank include:
x Increased focus on tangible common equity.
x All forms of non-common equity such as the Bank’s conventional subordinated notes must be non-viability contingent capital (NVCC) compliant. NVCC compliant means the subordinated notes must include a clause that would require conversion to common equity in the event that OSFI deems the institution to be insolvent or a government is ready to inject a “bail out” payment.
x Changes in the risk-weighting of certain assets.
x Additional capital buffers.
x New requirements for levels of liquidity and new liquidity measurements.
OSFI requires that all Canadian banks must comply with the Basel III standards on an “all-in” basis for purposes of determining its risk-based capital ratios. Required minimum regulatory capital ratios are a 7.0% Common Equity Tier 1 (CET1) capital ratio and an 8.5% Tier 1 capital ratio and 10.5% total capital ratio, all of which include a 2.5% capital conservation buffer. The Basel III rules provide for “transitional” adjustments whereby certain aspects of the new rules will be phased in between 2013 and 2019. The only available transition allowed by OSFI for capital ratios is related to the 10 year phase out of non-qualifying capital instruments. At October 31, 2015 the Bank exceeded the Basel III capital requirements as described above.
Under the Basel III standards, total regulatory capital of the Bank was $178.3 million at October 31, 2015 compared to $158.3 million a year ago. The increase in total regulatory capital from a year ago was due to earnings in the Bank and the issue of Series 3 Preferred Shares in 2015 as noted below.
At October 31, 2015, the Bank had a CET1 ratio of 10.32% compared to 11.25% a year ago. The decrease in the CET1 ratio from a year ago was due primarily to an increase in risk-weighted assets resulting from the growth in lending assets. At October 31, 2015, the Bank’s Tier 1 capital ratio was 12.54% compared to 12.43% a year ago. In addition, the Bank’s total capital ratio was 13.51% compared to 13.69% a year ago. At October 31, 2015, the Bank’s leverage ratio was 9.53%. On January 1, 2015, the previous Assets–to-Capital Ratio was replaced by the Leverage Ratio which is prescribed under the Basel III Accord.
31 Leverage Ratio
The leverage ratio is a supplementary measure that is prescribed under the Basel III Accord and is defined as the ratio of Tier 1 capital to its total exposures. The Bank is in compliance with its leverage ratio that is calculated as follows:
2015
On-balance sheet assets $ 1,625,806 Asset amounts deducted in determining Basel III "all in" Tier 1 Capital (9,031) Total on-balance sheet exposures 1,616,775
Off-balance sheet exposure at gross notional amount$ 422,339 Adjustments for conversion to credit equivalent amount (301,674) Off-balance sheet items 120,665
Tier 1 Capital 165,591 Total Exposures 1,737,440
Basel III Leverage Ratio 9.53%
Risk-Based Capital Ratio
OSFI requires banks to measure capital adequacy in accordance with guidelines for determining risk- adjusted capital and risk-weighted assets including off-balance sheet credit instruments. The Bank currently uses the Standardized Approach to calculate risk-weighted assets for both credit and operational risk. Under the Standardized Approach for credit risk, for each type of asset, a weighting of 0% to 150% is assigned to determine the risk-based capital ratio. Off-balance sheet assets, such as credit commitments, are included in the calculation of risk-weighted assets and both the credit risk equivalent and the risk weighted calculations are prescribed by OSFI.
The Bank’s risk-based capital ratios are calculated as follows:
32 (thousands of Canadian dollars, except capital ratios) 2015 2014 "All-in" "Transitional" "All-in" "Transitional"
Common Equity Tier 1 (CET1) capital Directly issued qualifying common share capital$ 142,369 $ 142,369 $ 142,346 $ 142,346 Retained earnings (deficit) 2,903 2,903 (3,493) (3,493) Accumulated other comprehensive income 13 13 19 19 CET1 before regulatory adjustments 145,285 145,285 138,872 138,872 Regulatory adjustments applied to CET1 (9,031) (3,612) (8,693) (1,739) Total Common Equity Tier 1 capital$ 136,254 $ 141,673 $ 130,179 $ 137,133
Additional Tier 1 capital Directly issued qualifying Additional Tier 1 instruments$ 29,337 $ 29,337 $ 13,647 $ 13,647 Total Tier 1 capital $ 165,591 $ 171,010 $ 143,826 $ 150,780
Tier 2 capital Directly issued capital instruments subject to phase out from Tier 2$ 12,700 $ 12,700 $ 14,500 $ 14,500 Tier 2 capital before regulatory adjustments 12,700 12,700 14,500 14,500 Regulatory adjustments applied to Tier 2 - - - - Total Tier 2 capital$ 12,700 $ 12,700 $ 14,500 $ 14,500 Total capital $ 178,291 $ 183,710 $ 158,326 $ 165,280 Total risk-weighted assets$ 1,320,158 $ 1,325,576 $ 1,156,832 $ 1,163,786 Capital ratios CET1 Ratio 10.32% 10.69% 11.25% 11.78% Tier 1 Capital Ratio 12.54% 12.90% 12.43% 12.96% Total Capital Ratio 13.51% 13.86% 13.69% 14.20%
The Bank’s risk-weighted assets consist of the following:
Notional/drawn amount Risk Cash/ Off -balance Weighted (thousands of Canadian dollars) Securities Loans Other sheet items Total Balance
Corporate$ - $ 849,705 $ - $ - $ 849,705 $ 813,853 Sovereign 97,849 70,233 - - 168,082 12,352 Bank 51,662 22,106 - - 73,768 14,754 Retail residential mortgages - 58,596 - - 58,596 393 Other retail - 447,020 - - 447,020 300,298 Other items - - 28,635 39,015 67,650 38,829 Undrawn commitments - - - 383,324 383,324 83,071 Operational risk ¹ - - - - - 56,608 As at October 31, 2015$ 149,511 $28,635 1,447,660 $$ 422,339 $ 2,048,145 $ 1,320,158
33 Notional/drawn amount Risk Cash/ Off -balance Weighted (thousands of Canadian dollars) Securities Loans Other sheet items Total Balance
Corporate$ - $ 793,549 $ - $ - $ 793,549 $ 763,664 Sovereign 102,627 67,726 - - 170,353 12,472 Bank 91,313 25,187 - - 116,500 23,300 Retail residential mortgages - 62,264 - - 62,264 1,250 Other retail - 275,521 - - 275,521 188,086 Other items - - 27,673 43,926 71,599 40,661 Undrawn commitments - - - 354,454 354,454 78,200 Operational risk ¹ - - - - - 49,199 As at October 31, 2014$ 193,940 $27,673 1,224,247 $$ 398,380 $ 1,844,240 $ 1,156,832
¹ The charge for operational risk is determined using the Basic Indicator Approach as prescribed by OSFI.
Notional/drawn amount Risk Weighted (thousands of Canadian dollars) 0% 20% 35% 75% 100% 150% Total Balance
Corporate$ 20,032 $ 19,774 $ - $ - $ 809,899 $ - $ 849,705 $ 813,853 Sovereign 106,400 61,662 - - 20 - 168,082 12,352 Bank - 73,768 - - - - 73,768 14,754 Retail residential mortgages 57,472 - 1,124 - - - 58,596 393 Other retail 40,135 6,689 - 404,944 (4,748) - 447,020 300,298 Other items 9,029 713 - - 57,908 - 67,650 38,829 Undrawn commitments - - - 140,072 243,252 - 383,324 83,071 Operational risk ¹ ------56,608 As at October 31, 2015$ 233,068 $ 162,606 $ 1,124 $ 545,016 $- 1,106,331 $ $ 2,048,145 $ 1,320,158
Notional/drawn amount Risk Weighted (thousands of Canadian dollars) 0% 20% 35% 75% 100% 150% Total Balance
Corporate$ 13,895 $ 19,988 $ - $ - $ 759,666 $ - $ 793,549 $ 763,664 Sovereign 108,198 62,105 - - 50 - 170,353 12,472 Bank - 116,500 - - - - 116,500 23,300 Retail residential mortgages 59,929 - 1,669 - 666 - 62,264 1,250 Other retail 24,965 1,779 - 244,184 4,593 - 275,521 188,086 Other items 8,692 716 - - 62,181 10 71,599 40,661 Undrawn commitments - 390 - 159,306 194,758 - 354,454 78,200 Operational risk ¹ ------49,199 As at October 31, 2014$ 215,679 $ 201,478 $ 1,669 $ 403,490 $10 1,021,914 $ $ 1,844,240 $ 1,156,832
¹ The charge for operational risk is determined using the Basic Indicator Approach as prescribed by OSFI.
Capital Resources
The operations of the Bank are not dependent upon significant amounts of capital assets to generate revenue. Currently, the Bank does not have any commitments for capital expenditures or for significant additions to its level of capital assets.
34 SUMMARY OF QUARTERLY RESULTS AND FOURTH QUARTER REVIEW Quarterly Financial Highlights
(thousands of Canadian dollars except per share amounts) 2015 2014 Q4 Q3 Q2 Q1 Q4 Q3 Q2 Q1
Results of operations: Total interest income $ 16,685 $ 16,513 $ 15,630 $ 15,629 $ 15,078 $ 14,156 $ 13,978 $ 14,949 Interest expense 7,724 7,786 7,375 7,598 7,469 7,469 7,335 8,014 Net interest income 8,961 8,727 8,255 8,031 7,609 6,687 6,643 6,935 Net interest margin (%) 2.23% 2.24% 2.22% 2.15% 2.16% 1.94% 1.93% 1.95% Non-interest income 384 368 304 338 791 619 886 337 Total revenue 9,345 9,095 8,559 8,369 8,400 7,306 7,529 7,272 Provision for credit losses 319 297 427 502 400 303 267 (51) Non-interest expenses 6,562 6,421 6,264 5,537 6,243 5,588 5,582 5,534 Restructuring charges ------434 Income before income taxes 2,464 2,377 1,868 2,330 1,757 1,415 1,680 1,355 Income tax provision (recovery) (306) 670 (194) 651 (719) 398 472 380 Net income$ 2,770 $ 1,707 $ 2,062 $ 1,679 $ 2,476 $ 1,017 $ 1,208 $ 975 Income per share* Basic$ 0.11 $ 0.05 $ 0.09 $ 0.07 $ 0.13 $ 0.05 $ 0.06 $ 0.05 Diluted$ 0.11 $ 0.05 $ 0.09 $ 0.07 $ 0.13 $ 0.05 $ 0.06 $ 0.05 Return on average shareholders' equity 6.11% 2.64% 5.24% 4.04% 7.14% 2.97% 3.68% 2.89% Return on average total assets 0.55% 0.24% 0.49% 0.45% 0.70% 0.29% 0.35% 0.27% Gross impaired loans . . to total loans 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%
Financial position: Cash and securities$ 149,511 $ 157,357 $ 151,821 $ 183,689 $ 193,940 $ 145,659 $ 250,364 $ 271,713 Mortgages and loans 1,447,660 1,376,237 1,344,181 1,305,142 1,224,247 1,181,379 1,107,349 1,136,132 Other assets 28,635 29,508 29,617 29,964 27,673 28,049 28,325 29,443 Total$ 1,625,806 $ 1,563,102 $ 1,525,619 $ 1,518,795 $ 1,445,860 $ 1,355,087 $ 1,386,038 $ 1,437,288
Deposits$ 1,325,828 $ 1,275,523 $ 1,245,271 $ 1,246,943 $ 1,193,797 $ 1,124,602 $ 1,164,735 $ 1,221,247 Other liabilities 67,872 57,610 51,480 60,397 42,215 36,696 28,646 24,537 Subordinated notes payable 13,959 13,934 13,910 13,885 13,863 13,840 13,818 13,796 Securitization liabilities 43,525 43,625 43,495 43,596 43,466 43,567 43,438 43,539 Shareholders' equity 174,622 172,410 171,463 153,974 152,519 136,382 135,401 134,169 Total$ 1,625,806 $ 1,563,102 $ 1,525,619 $ 1,518,795 $ 1,445,860 $ 1,355,087 $ 1,386,038 $ 1,437,288
The financial results for each of the last eight quarters are summarized above. The results, particularly total interest income and net interest income, are comparable between quarters and over the past eight quarters reflect some seasonality occurring, primarily in residential construction lending. Total interest income increased in 2015 as a result of growth in lending assets, specifically loans and leases sourced through the bulk purchase program. The Bank’s cost of funds decreased over the past eight quarters as a result of reductions in the Bank of Canada interest rate, an increase in chequing accounts of trustees in the Canadian bankruptcy, as well as the Bank being able to hold lower amounts of cash and securities which reduces the amount of deposits being raised and its related cost.
Non-interest income during the quarters shows variability due to the level of gains realized on the sale of loans in 2014. The other component of non-interest income consists primarily of credit card fees which have been comparable over the quarters.
Non-interest expenses increased since the first quarter of 2015 primarily due to increases in professional and consulting fees, employee compensation and costs relating to the issue of NVCC Preferred Shares. Restructuring charges in the first quarter of 2014 resulted from the write-off of unamortized issue costs related to the repayment of subordinated notes.
35 The provision for income taxes in each of the quarters reflects the effective statutory income tax rate applied to earnings. The provision for income taxes in the fourth and second quarters of 2015 and the fourth quarter of 2014 includes positive income tax adjustments of $1.0 million, $724,000 and $1.2 million respectively relating to a change in the estimate of previously unrecognized deferred income tax assets.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Significant accounting policies are detailed in Note 3 of the Bank’s 2015 Audited Consolidated Financial Statements. There has been no change in accounting policies nor any significant new policies adopted during the current period.
In preparing the consolidated financial statements, management has exercised judgment and developed estimates in applying accounting policies and generating reported amounts of assets and liabilities at the date of the financial statements and income and expenses during the reporting periods. Areas where significant judgment was applied were in the assessments of impairment of financial instruments. Estimates were developed in the calculation of the allowance for credit losses and the measurement of deferred income taxes.
It is reasonably possible, on the basis of existing knowledge, that actual results may vary from that expected in the generation of these estimates. This could result in material adjustments to the carrying amounts of assets and/or liabilities affected in the future.
Estimates and their underlying assumptions are reviewed on an ongoing basis. Revisions to accounting estimates are applied prospectively once they are recognized.
The policies discussed below are considered particularly significant as they require management to make estimates or judgements, some of which may relate to matters that are inherently uncertain.
Financial Instruments
All financial assets are classified as one of the following: held-to-maturity, loans and receivables, or available-for-sale. All financial liabilities are classified as other liabilities. Financial assets held-to- maturity, loans and receivables and financial liabilities are measured at amortized cost based on the effective interest method. Available-for-sale instruments are measured at fair value with gains and losses, net of tax, recognized in other comprehensive income.
Securities
The Bank holds securities primarily for liquidity purposes with the intention of holding the securities to maturity or until market conditions render alternative investments more attractive. Settlement date accounting is used for all securities transactions.
At the end of each reporting period, the Bank assesses whether or not there is any objective evidence to suggest that a security may be impaired. Objective evidence of impairment results from one or more events that occur after the initial recognition of the security which has an impact that can be reliably estimated on the estimated future cash flows of the security such as financial difficulty of the issuer. An impairment loss is recognized for an equity instrument if the decline in fair value is significant or prolonged; as such circumstances provide objective evidence of impairment.
36 Impairment losses on a held-to-maturity security are recognized in income and loss in the period they are identified. When there is objective evidence of impairment of an available-for-sale security, the cumulative loss that has been recorded in accumulated other comprehensive income is reclassified to income or loss. For available-for-sale debt securities, if in a subsequent period the impairment loss decreases and the decrease can be related objectively to an event occurring after the impairment was first recognized, then the previously recognized impairment loss is adjusted through income or loss to reflect the net recoverable amount of the impaired security. No adjustments of impairment losses are recognized for available-for-sale equity securities.
Loans
Loans are initially measured at fair value plus incremental direct transaction costs. Loans are subsequently measured at amortized cost, net of allowance for credit losses, using the effective interest method. On a monthly basis, the Bank assesses whether or not there is any objective evidence to suggest that the carrying value of the loans may be impaired. Impairment assessments are facilitated through the identification of loss events and assessments of their impact on the estimated future cash flows of the loans.
A loan is classified as impaired when, in management's opinion, there has been deterioration in credit quality to the extent that there is no longer reasonable assurance as to the timely collection of the full amount of principal and interest. Loans, except credit cards, where interest or principal is contractually past due 90 days are automatically recognized as impaired, unless management determines that the loan is fully secured, in the process of collection and the collection efforts are reasonably expected to result in either repayment of the loan or restoring it to current status. All loans, except credit cards, are classified as impaired when interest or principal is past due 180 days, except for loans guaranteed or insured by the Canadian government, provinces, territories, or a Canadian government agency, which are classified as impaired when interest or principal is contractually 365 days in arrears. Credit card receivables are written off when payments are 180 days past due, or upon receipt of a bankruptcy notification.
As loans are classified as loans and receivables and measured at amortized cost, an impairment loss is measured as the difference between the carrying amount and the present value of future cash flows discounted using the effective interest rate computed at initial recognition, if future cash flows can be reasonably estimated. When the amounts and timing of cash flows cannot be reasonably estimated, the carrying amount of the loan is reduced to its estimated net realizable value based on either:
(i) the fair value of any security underlying the loan, net of expected costs of realization, or,
(ii) observable market prices for the loan.
Impairment losses are recognized in income or loss. If, in a subsequent period, the impairment loss decreases and the decrease can be related objectively to an event occurring after the impairment was first recognized, then a recovery of a portion or all of the previously recognized impairment loss is adjusted through income or loss to reflect the net recoverable amount of the impaired loan.
Real estate held for resale is recorded at the lower of cost and fair value, less costs to sell.
37 Allowance for Credit Losses
An allowance for credit losses is maintained which, in management’s opinion, is adequate to absorb all credit related losses in its loan portfolio. The allowance for credit losses consists of both individual and collective allowances and is reviewed on a monthly basis. The allowance is included in loans on the Consolidated Balance Sheets.
Evidence of impairment of loans is assessed at both an individual asset and collective level. All individually significant loans are assessed for impairment first. All individually significant loans found not to be specifically impaired and all loans which are not individually significant are then collectively assessed for impairment.
The collective allowance is determined by separating loans into categories that are considered to have common risk elements and reviewing factors such as current portfolio credit quality trends, exposure at default, probability of default and loss given default rates and business and economic conditions. The collective allowance may also be adjusted by management using its judgment taking into account other observable and unobservable factors.
Corporate Income Taxes
Current income taxes are calculated based on taxable income at the reporting period end. Taxable income differs from accounting income because of differences in the inclusion and deductibility of certain components of income which are established by Canadian taxation authorities. Current income taxes are measured at the amount expected to be recovered or paid using statutory tax rates at the reporting period end.
The Bank follows the asset and liability method of accounting for deferred income taxes. Deferred income tax assets and liabilities arise from temporary differences between financial statement carrying values and the respective tax base of those assets and liabilities. Deferred income tax assets and liabilities are measured using enacted or substantively enacted tax rates expected to apply to taxable income in the years when temporary differences are expected to be recovered or settled.
Deferred income tax assets are recognized in the Bank’s consolidated financial statements to the extent that it is probable that the Bank will have sufficient taxable income to enable the benefit of the deferred income tax asset to be realized. Unrecognized deferred income tax assets are reassessed for recoverability at each reporting period end.
Future accounting standard changes
Financial instruments (IFRS 9)
In July, 2014, the International Accounting Standards Board (IASB) issued the final revised IFRS 9 standard which addresses classification, measurement and impairment of financial instruments and hedge accounting. IFRS 9 specifies that financial assets be classified into one of three categories: financial assets measured at amortized cost, financial assets measured at fair value through profit or loss or financial assets measured at fair value through other comprehensive income. The standard also includes an expected credit loss model and a general hedging model.
38 IFRS 9 will be mandatorily effective for the Bank’s fiscal year beginning on November 1, 2018, although early adoption is permitted. In January 2015, OSFI determined that Domestic Systematically Important Banks (D-SIBs) should adopt IFRS 9 for their annual periods beginning November 1, 2017, while early adoption is permitted but not required for other federally regulated Canadian banks with October year ends such as the Bank.
ENTERPRISE RISK MANAGEMENT
The Bank recognizes that risk is present in all business activities and that the successful management of risk is a key factor in the success of the Bank. As such, the Bank has an Enterprise Risk Management (ERM) Program to identify, evaluate, monitor and report risks that impact the Bank.
The Bank’s ERM program has been designed to ensure:
x Significant current and emerging risks are identified and understood; x It supports the Board’s corporate governance needs; and x It strengthens the Bank’s management practices in a manner visible to external stakeholders.
The goal of risk management is not to eliminate risks but to control risks within the context of the Bank’s Risk Appetite Statement. The ERM program enhances the effectiveness, efficiency and understanding of risk and risk management at an individual and enterprise level.
The ERM program improves the Bank’s ability to identify risks and increases the likelihood of the Bank achieving its objectives, provides a regular, up to date view of risks confronting the Bank, and results in the Bank utilizing capital and human and other resources more efficiently.
Guiding Principles of the Bank’s ERM Program
x Responsibility for risk management belongs to everyone in the Bank, from the Board of Directors to individual employees. They are expected to understand the risks that fall within their areas of responsibility and to manage these risks within approved risk tolerances. x Risk management is a comprehensive, structured and continuous process in which risks are identified, evaluated and accepted or mitigated within approved risk tolerances. x Risk management is based on open communication of the best available information, both quantitative and qualitative, from a range of sources, including historical data, experience, stakeholder feedback, observation, forecasts and expert judgment. x Enterprise risk management is integrated with the Bank’s processes including strategic planning, business planning, operational management, and investment decisions to ensure consistent consideration of risks in all decision-making. x Risk owners are identified through the risk management process and are responsible to address and implement risk mitigation strategies to minimize the risk impact to the Bank. x The Bank undertakes risk assessments on no less than an annual basis.
Enterprise Risk Management Framework
The Bank ERM program and Risk Management Process is based upon guidance provided by the International Organization for Standardization (CAN/CSA-ISO31000-10 – January 2010); Risk Management – Principles and Guidelines. ISO31000-10 is used as it provides guidance of the ERM process and how to implement it.
39 Enterprise Risk Management Governance Structure
Roles and responsibilities are clearly communicated through Board policy and job descriptions. A Chief Risk Officer has been appointed who provides training to all levels of employees within the Bank to reinforce the culture of risk management.
The Board of Directors maintains an oversight function, ensuring that the Risk Appetite remains suitable and reflective of the Bank’s values and shareholder expectations. The Board is proactive in monitoring the risk management process to ensure that management is working within its stated risk appetite. The Board challenges the development of a Risk Appetite Statement and requires any changes to ensure that it remains within risk tolerance levels. The Risk Appetite Statement may change over time and the Board ensures that they consistently provide a ‘tone from the top’ and communicate their views of the Bank’s risk appetite.
The Bank’s Risk Oversight Committee provides regular Board oversight and approves the ERM program on at least an annual basis. The Risk Oversight Committee ensures management has an appropriate risk management process to identify and manage significant risk on an enterprise wide basis. The Risk Oversight Committee provides direction on the evolution of risk management processes and identifies priority areas of focus for risk assessment and mitigation planning. The Risk Oversight Committee reports on significant risks to the Board, and regularly reviews and provides recommendations to changes to the Risk Appetite Statement and risk tolerance levels for approval to the Board.
The President and CEO has ultimate accountability for managing the Bank’s risks. This is managed through the Chief Risk Officer who meets regularly with Senior Management to identify and assess risks and evaluate any significant or emerging risks requiring Senior Management and Board attention. In addition, the President and CEO leads the setting of Bank’s strategic objectives and fosters cultural change in support of Enterprise Risk Management as a value and best practice for the Bank.
The Chief Risk Officer has specific accountability for ensuring that Enterprise Risk Management processes are established, properly documented and maintained by the Bank. The Chief Risk Officer provides support to the President and CEO and Senior Management within the Bank. This support includes development of risk management policies, frameworks and processes, introducing and promoting new techniques, maintaining a registry of key business risks and facilitating risk assessments across the Bank. The Chief Risk Officer regularly presents a report to the Risk Oversight Committee summarizing developments in the risk environment, performance trends in key portfolios and the Bank’s compliance with the Risk Appetite Statement.
Senior Management of the Bank is responsible for managing risks related to their business unit objectives and ensures operating policies and procedures are developed and maintained to manage risk within the Bank’s risk appetite framework. Senior Management must understand the nature and magnitude of risks within their area of responsibility and identify emerging factors and changes in the business environment which could impact risks and risk management. Senior Management integrates the risk management process in business unit strategy and utilizes the risk management process to assist in the identification of emerging factors and changes in the business environment which could impact risks and risk management. Senior Management also assists the Chief Risk Officer in promoting risk management and Enterprise Risk Management competence.
40 Internal Audit’s primary function is to examine, evaluate, report and recommend improvements to the adequacy and effectiveness of risk controls and report on the performance of the Enterprise Risk Management Framework.
Risk Appetite Statement
The Bank has developed a comprehensive Risk Appetite Statement that measures and establishes risk tolerances in the pursuit of the Bank’s strategic objectives.
The Risk Appetite Statement represents the amount of risk the Bank is willing to pursue, retain or take to achieve its strategic objectives whereas risk tolerances represent the Banks’ maximum risk bearing capacity before financial or capital distress may occur. Risk tolerance measures are contained within this Risk Appetite Statement and Board policies.
The Risk Appetite Statement and risk tolerances are measured against the following seven pillars of risks:
x Liquidity Risk
x Operational Risk
x Market Risk
x Credit Risk
x Legal and Regulatory Risk
x Strategic Risk
x Reputational Risk
The Bank believes these seven pillars of risk are a reflection of risks that face any financial institution and represent threats to the successful achievement of Bank strategic objectives.
Liquidity Risk in the Bank
The Bank has established policies to ensure that its cash outflows and inflows are closely matched and that its sources of deposits are diversified between funding sources and over a wide geographic area. The Bank maintains a conservative investment profile by ensuring:
x all Bank investments are high quality and include government debt securities, bankers acceptances and Canadian bank debt;
x specific investment criteria and procedures are in place to manage the Bank's securities portfolio;
x regular review, monitoring and approval of the Bank's investment policies by the Risk Oversight Committee of the Board of Directors; and
41 x quarterly reporting to the Risk Oversight Committee on the composition of the Bank's securities portfolio.
Liquidity management is further supported by processes, which include but are not limited to:
x monitoring of liquidity levels;
x monitoring of liquidity trends and key risk indicators;
x scenario stress testing;
x monitoring the credit profile of the liquidity portfolio; and
x monitoring deposit concentration.
In order to manage its liquidity needs, the Bank has a liquidity risk management program that is comprised specifically of the following policies and procedures:
x Holding sufficient liquid assets which results in positive cumulative cash flow for a period of 31 to 60 days.
x Holding of high quality liquid securities at levels that represent no less than 6% of total assets. High quality liquid securities include Canadian federal, provincial and municipal debt, debt of federally regulated Canadian financial institutions, widely distributed debt instruments, all of which are to be rated investment grade, cash on deposit and banker’s acceptances.
x Maintaining liquid assets at no less than 65% of obligations payable within 90 days.
x On a weekly basis, monitoring its cash flow requirements using a liquidity forecasting template under a highly stressed scenario.
x On a monthly basis, testing liquidity using three specific disruption scenarios; specifically, industry specific disruption scenario, company specific liquidity disruption scenario and a systematic disruption scenario.
x Managing liquidity in accordance with guidelines specified by OSFI.
Cash and Securities
(thousands of Canadian dollars) 2015 2014
Cash and cash equivalents$ 127,078 $ 145,140 Securities 22,433 48,800 Total cash and securities$ 149,511 $ 193,940 Total assets$ 1,625,806 $ 1,445,860 Cash and securities as a percentage of total assets 9.20% 13.41% Total deposits$ 1,325,828 $ 1,193,797 Cash and securities as a percentage of total deposits 11.28% 16.25%
42 Cash and securities totalled $149.5 million at October 31, 2015 compared to $193.9 million a year ago and as a percentage of total assets, cash and securities were 9.20% at October 31, 2015 compared to 13.41% last year. As a percentage of total deposits, cash and securities reduced to 11.28% at October 31, 2015 from 16.25% last year. As discussed previously, cash and securities decreased from a year ago primarily as a result of lower funding requirements for deposits maturing in the coming months compared to the end of the previous year.
See Note 21 to the audited consolidated financial statements for information relating to liquidity risk associated with the gaps in the Bank’s asset and liability maturity or reset dates.
Operational Risk
Operational Risk is the risk of loss resulting from inadequate or failed processes, technology, people, systems or external events.
Its impact can be financial loss, loss of competitive position or regulatory penalties. The Bank employs the following strategies in its efforts to monitor and manage operational risk to acceptable levels:
x Comprehensive internal control policies which provide clear direction to all areas of its business and employees and establish accountability and responsibilities to identify, assess, appropriately mitigate and control operational risk.
x Hiring of banking professionals with many years of related experience.
x Use of technology through automated systems with built in controls.
x Maintenance of a compliance monitoring program.
x Continual review and upgrade of systems and procedures.
Market Risk
Market Risk is the risk of a negative impact on the balance sheet and/or income statement resulting from changes or volatility in market factors such as interest rates or market prices.
The Bank’s principal market risk arises from interest rate risk as the Bank does not undertake foreign exchange or trading activities. In addition, the Bank is subject to market price volatility with respect to available-for-sale securities due to the resulting impact on regulatory capital.
The Risk Oversight Committee of the Bank is charged with recommending policies that govern market risk to its Board of Directors for approval and with reviewing the policies on an ongoing basis.
Interest rate risk is the risk that a movement in interest rates could negatively impact spread, net interest income and the economic value of assets, liabilities and shareholders’ equity. The Bank manages interest rate risk by employing a number of methods including income simulation analysis and interest rate sensitivity gap and duration analysis. Management prepares regular reports to the Board to allow for ongoing monitoring of the Bank’s interest rate risk position.
43 The Bank’s Asset Liability Committee reviews the results of these analyses on a monthly basis and monitors compliance with limits set by corporate policy. The Bank’s policy is to maintain the matching of its cash inflows and outflows so that (i) in any 12 month period, a 100 basis point change in rates across the entire yield curve would not result in a decline greater than 4% of regulatory capital on the Bank’s earnings and (ii) in any 60 month period, a 100 basis point change in rates across the entire yield curve would not result in a decline greater than 4% of regulatory capital on the Bank’s equity. As well, the policy indicates that at no time shall the duration difference between the Bank’s assets and liabilities exceed four months. The interest rate risk position and results of the Bank’s duration analysis are presented in the table below.
Interest Rate Position
2015 2014 Increase Decrease Increase Decrease (thousands of Canadian dollars) 100 bps 100 bps 100 bps 100 bps
Sensitivity of projected net interest income during a 12 month period$ 3,371 $ (3,114) $ 3,543 $ (3,493) Sensitivity of reported equity during a 60 month period 295 (86) (319) 484
Duration difference between assets and liabilities (months) 0.8 0.2
The Bank’s sensitivity to changes in interest rates and its duration difference between assets and liabilities at October 31, 2015 has not changed significantly since a year ago. As indicated by the above, at October 31, 2015, the impact on net interest income during a 12 month period of a 100 basis point increase would be approximately $3.4 million and the impact on net interest income of a 100 basis point decrease would be approximately ($3.1 million). Similarly at October 31, 2015, the impact on equity during a 60 month period of a 100 basis point increase would be approximately $295,000 and the impact on equity of a 100 basis point decrease would be approximately ($86,000). As indicated by the above, the duration difference between assets and liabilities has not changed significantly from a year ago and shows that the Bank’s assets and liabilities would reprice at approximately the same time in the event of a change in interest rates. As at October 31, 2015, the Bank did not have any outstanding contracts to hedge fair value exposure attributed to interest rate risk. The Bank uses on-balance sheet strategies to manage its interest rate risk.
Credit Risk
Credit Risk is the risk of loss associated with a borrower, guarantor or counterparty’s inability or unwillingness to fulfill its contractual obligations.
The Bank manages its credit risk using policies that have been recommended by management to its Risk Oversight Committee, which then recommends the policies to the Board of Directors of the Bank for approval. These policies consist of approval procedures and limits on loan amounts, portfolio concentration, geographic concentration, industry concentration, asset category, loans to any one entity and associated groups, a risk rating policy that provides for risk rating each asset in its total asset portfolio, and early recognition of problem accounts (watch list accounts) with action plans for each account. The Risk Oversight Committee of the Bank reviews these policies on an ongoing basis.
44 The Risk Oversight Committee of the Bank is comprised entirely of independent directors and performs the following functions related to credit risk:
x Recommends policies governing management of credit risk to the Bank’s Board of Directors for approval and reviews credit risk policies on an ongoing basis to ensure they are prudent and appropriate given possible changes in market conditions and corporate strategy
x Ensures that procedures and controls for managing credit risk are in place
x Concurs with credits exceeding the levels delegated to management, prior to commitment
x Reviews, on a regular basis, watch list accounts, impaired loans and accounts that have gone into arrears.
Legal and Regulatory Risk
Legal and Regulatory Risk are the risks of adverse outcomes due to non-compliance to laws, rules, regulations, standards or other legal requirements.
The business of the Bank and its subsidiaries is highly regulated through laws and regulations that have been put in place by various federal and provincial governments and regulators. Changes to laws and regulations, including changes in their interpretation or implementation could adversely affect the Bank. The Bank’s failure to comply with applicable laws, regulations, or regulatory expectations could result in sanctions, financial penalties and costs associated with litigation that could adversely impact the Bank’s earnings as well as damage its reputation.
Strategic Risk
Strategic Risk is losses or forgone revenues resulting from improper or ineffective business strategies, resource allocation and/or decision-making or from an inability to adapt to changes in the business environment.
The Bank manages strategic risk through a board approved, robust, annual business planning process which includes the development of a comprehensive business plan, operating budget, and capital plan that exhibit planning horizons ranging from twelve to sixty months. The Bank augments its annual enterprise business planning process with the development of rigorous economic forecasts, risk and operational impact assessments related to any new business initiatives being contemplated as well as through the performance of an annual internal capital adequacy assessment process (ICAAP) for the Bank. The ICAAP is employed to determine if the Bank’s budgeted capital amounts will provide adequate capital buffers against the occurrence of its identified business objective risks under both expected and stressed operating conditions.
Reputational Risk
Reputational Risk is the risk that an activity undertaken by the Bank or its representatives will impair its image in the community or lower public confidence in it, resulting in the loss of business, legal action or increased regulatory oversight.
An institution’s reputation is a valuable business asset in its own right, essential to optimizing shareholder value, and as such is constantly at risk. Reputation risk cannot be managed in isolation
45 from other forms of risk since all risks can have an impact on reputation, which in turn can impact the Bank’s brand, earnings and capital. Credit, market, operational, strategic and liquidity risks must all be managed effectively in order to safeguard the Bank’s reputation.
Ultimate responsibility for the Bank’s reputation lies with Senior Management and the Board of Directors and related committees which examine reputation risk as part of their ongoing duties. In addition, every employee and representative of the Bank has a responsibility to contribute in a positive way to the Bank’s reputation by ensuring that ethical practices are followed at all times. The Bank also has specific board approved policies in the Bank which consider reputation risk and include the following:
x Anti-money Laundering and Anti-terrorist Financing Policy and Procedures.
x Code of Conduct.
x Computer System Use Policy and Procedures.
x Corporate Disclosure Policy.
x Customer Complaint Policy and Procedures.
x Related Party Transactions Policy and Procedures.
x Workplace Anti-harassment Policy and Procedures.
x Anonymous Employee Reporting Procedures.
FACTORS THAT MAY AFFECT FUTURE RESULTS
As noted in the section “Forward-looking Statements”, the Bank is subject to inherent risks and uncertainties which may cause its actual results to differ materially from its expectations. Some of these risks are discussed below.
Execution of Strategic Plans
The Bank’s financial performance is influenced by its ability to execute strategic plans developed by management. If these strategic plans do not meet with success or there is a change in strategic plans, the Bank’s earnings could grow at a slower pace or decline.
Changes in Laws and Regulations
Laws and regulations are in place to protect clients, investors and the public. Changes in laws and regulations, including how they are interpreted and enforced, could adversely affect the Bank’s earnings by allowing more competition in the marketplace and by increasing the costs of compliance. In addition, any failure to comply with laws and regulations could adversely affect the Bank’s reputation and earnings.
46 Level of Competition
The level of competition among financial institutions is high and non-financial companies are increasingly offering services provided by banks. This could have an effect on the pricing of the Bank’s deposits and its lending products and together with loss of market share, could adversely affect the Bank’s earnings.
General Economic Conditions
The Bank conducts its business in various regions within Canada. Factors such as financial market stability, interest rates, foreign exchange rates, changing global commodity prices, business investment, government spending and stimulation initiatives, consumer spending, and the rate of inflation can affect the business and economic environments in each geographic region in which the Bank operates. Therefore, the amount of business the Bank conducts in a specific geographic region may have an effect on the Bank’s overall revenues and earnings.
Monetary Policy
Financial markets’ expectations about inflation and central bank monetary policy have an impact on the level of interest rates. Fluctuations in interest rates that result from these changes could have an impact on the regions in which the Bank operates and on its earnings.
Reliance on Deposit Brokers
The Bank raises its deposits primarily through a network of independent deposit brokers across Canada. The failure by the Bank to secure sufficient deposits from its broker network could negatively affect its financial condition and operating results. The Bank mitigates this risk by establishing and maintaining good working and mutually beneficial relationships with a diverse group of deposit brokers so as not to become overly reliant on any single deposit broker.
Technology Risk
Technology risk is related to the operational performance, confidentiality, integrity and availability of information systems and infrastructure. The Bank is highly dependent upon information technology and supporting infrastructure such as data and network access. Disruptions in information technology and infrastructure, whether attributed to internal or external factors, and including potential disruptions in services provided by various third parties, could adversely affect the ability of the Bank to conduct regular business and or deliver products and services to clients.
47 CONTROLS AND PROCEDURES Disclosure controls and procedures
Disclosure controls and procedures are designed to provide reasonable assurance that all material information is gathered and reported to senior management, including the Chief Executive Officer and the Chief Financial Officer, on a timely basis so that appropriate decisions can be made regarding public disclosure.
As at October 31, 2015, an evaluation was carried out by management of the effectiveness of the Bank’s disclosure controls and procedures. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer will file a certificate that the design and operating effectiveness of those disclosure controls and procedures were effective.
Internal control over financial reporting
Internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with International Financial Reporting Standards. Management is responsible for establishing and maintaining adequate internal control over financial reporting for the Bank.
At October 31, 2015, an evaluation was carried out by management of the effectiveness of internal controls over financial reporting to provide reasonable assurance regarding the reliability of financial reporting and financial statement compliance with International Financial Reporting Standards. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer will file a certificate that the design and operating effectiveness of internal control over financial reporting were effective. These evaluations were conducted in accordance with the standards of the 2013 Internal Control - Integrated Framework of the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and the requirements of National Instrument 52-109 Certification of Disclosure in Issuers’ Annual and Interim Filings of the Canadian Securities Administrators.
A Disclosure Committee, consisting of members of senior management, assists the Chief Executive Officer and the Chief Financial Officer in their responsibilities. Management’s evaluation of controls can only provide reasonable, not absolute, assurance that all internal control issues that may result in material misstatement, if any, have been detected.
There were no changes in the Bank’s internal controls over financial reporting that occurred during the year ended October 31, 2015 that have materially affected, or are reasonably likely to materially affect, internal controls over financial reporting.
Additional information relating to the Bank, including the Bank’s Annual Information Form, can be found on SEDAR at www.sedar.com.
Dated: January 26, 2016
48 CORPORATE GOVERNANCE
Pacifi c & Western Bank of Canada (the “Bank”) is committed to upholding strong corporate governance practices in order to help create long-term value for its shareholders. This commitment is refl ected in the Bank’s organizational structures and policies, and is embodied in the role of the Bank’s Board of Directors (the “Board”).
Board of Directors
The Bank’s Board is comprised of nine members, and with the exception of David Taylor, the Bank’s President & Chief Executive Offi cer, all of the directors are independent. Board meetings generally conclude with a discussion period at which members of management are not in attendance. The Honourable Thomas A. Hockin is the Chairman of the Board.
The Board is responsible for providing stewardship to the Bank, including direction-setting and general oversight of the management and operations of the Bank. The Board’s key responsibilities include the following:
• Establish and review the Bank’s business objectives, and consider and approve the Bank’s business strategy and business plans, in order to assess whether they remain appropriate and prudent in light of the business and economic environment, resources and results of the Bank
• Establish standards of business conduct and ethical behaviour for the Bank’s directors, offi cers, and other personnel, and obtain on a regular basis reasonable assurance that the Bank has an ongoing, appropriate and effective process for ensuring adherence to those standards
• Appoint offi cers, including the Chief Executive Offi cer, and regularly evaluate the effectiveness and performance of such offi cers in managing the Bank’s operations and the risks to which the Bank is exposed
• Identify and review the principal risks of the Bank’s business and operations and implement appropriate systems to effectively manage those risks
• Oversee employee compensation plans and ascertain whether they are consistent with sustainable achievement of business objectives, the prudent management of operations, and the risks to which the Bank is exposed
In order to fully discharge the Board’s responsibilities the Board has delegated certain governance responsibilities to three Board committees, being the Audit Committee, Risk Oversight Committee, and Conduct Review, Governance & HR Committee, each of which is comprised entirely of independent directors. Each of the three Committees reports regularly to the Board.
The Board and its Committees have the authority to engage and compensate outside advisors, as determined to be necessary to permit them to carry out their duties. The Bank’s Management Proxy Circular provides additional information on the Directors, including biographical information, meeting attendance records, and shareholdings.
49 Audit Committee
The Audit Committee is comprised of R.W. (Dick) Carter (Chair), Colin E. Litton and Paul G. Oliver. The Committee’s key responsibilities include the following:
• Concur with the external auditors to be nominated for the purpose of preparing or issuing an audit report or performing other audit, review or attest services, and oversee their work
• Review the audit planning memorandum presented by the external auditor
• Concur with hiring policies regarding partners, employees and former partners and employees of the external auditor
• Review and concur in the appointment, replacement or dismissal of the Internal Auditor
• Review and approve the mandate and audit plan of the Internal Auditor, and follow-up on the Internal Auditor’s material fi ndings and recommendations
• Require management to implement and maintain appropriate internal control procedures
• Recommend policies respecting corporate disclosure
• Concur with the Mandate of the Disclosure Committee
• Review disclosure controls and procedures
• Review the Bank’s disaster and contingency arrangements
• Establish procedures for the receipt, retention and treatment of complaints regarding accounting, internal accounting controls or auditing matters
• Establish procedures for the confi dential, anonymous submission by employees of concerns regarding questionable accounting or auditing matters, and with respect to any instances of management’s overrides of internal controls or policies
• Oversee policies and procedures relating to anti-money laundering and anti-terrorist fi nancing activities
Risk Oversight Committee
The Risk Oversight Committee is comprised of Colin E. Litton (Chair), Robbert-Jan Brabander, and Arnold E. Hillier. The Committee’s key responsibilities include the following:
• Provide oversight of the risk management function of the Bank, including its policies, procedures and practices relating to overall Enterprise Risk Management (ERM), as well as the management of credit, liquidity, market, operational and others types of risks faced by the Bank
• Review and recommend to the Board the Risk Appetite Framework and Risk Appetite Statement
• Provide oversight on enhancements to and development of the Enterprise Risk Management Framework, Risk Magnitude Scale, and Risk Management Processes
• Recommend policies governing management of risks, including credit risk, liquidity risk, market risk, and operational risk, and receive management reports regarding adherence to policies
• Ensure that policies, procedures and controls for managing credit risk, liquidity risk, market risk, and operational risk are in place and are being adhered to
50 • Concur with lending transactions, as required by policy
Conduct Review, Governance & HR Committee
The Conduct Review, Governance & HR Committee is comprised of David A. Bratton (Chair), Arnold E. Hillier, and Susan T. McGovern. The Committee’s key responsibilities include the following:
• Undertake an annual review of the effectiveness of the Related Party Transactions Policy & Procedures and the confl ict of interest section of the Code of Conduct
• Annually review, and receive and review management reports in respect of, the Bank’s policies addressing harassment in the workplace, customer complaints, anonymous employee concerns, and the Code of Conduct
• Develop, review and enhance the Bank’s approach to governance issues
• Set criteria for the selection of directors to ensure that the competencies, skills and personal qualities of the Board members add value
• Recommend to the Board of Directors candidates for election as directors
• Review and make recommendations to the Board of Directors on the structure and membership of committees of the Board
• Review offi cer appointments to ensure that there are experienced and skilled personnel to carry out the business activities in a prudent manner
• Undertake an annual review of the Human Resources Plan and the Management Succession Plan
• In collaboration with the Board, review and set annual objectives for the President & Chief Executive Offi cer, and evaluate the President & Chief Executive Offi cer’s performance and compensation
Ethical Conduct
The Bank has a written Code of Conduct. Among other things, the Code stipulates that in the event that a director has an interest in a material transaction or material contract that the Board is considering, such interest is to be declared. The director is not to be present at a meeting where the transaction or contract is being considered, and is not entitled to vote on the matter. The Conduct Review, Governance & HR Committee monitors compliance with the Code by requiring each director, offi cer and employee to sign an annual certifi cate confi rming that they conform to the Code.
Further, a process has been established for confi dentially receiving concerns regarding questionable accounting or auditing matters, or any other incident of illegal or unethical behaviour.
Corporate Disclosure
The Bank has in place a strong corporate disclosure framework designed to achieve the following objectives: to identify the principles of disclosure of material information, and provide guidance on related disclosure of information and public communication issues; to provide reasonable assurance that material information relating to the Bank is communicated to senior management by others within the Bank; and, to establish a process to ensure that the communications to the public are timely, factual, accurate, and complete, and broadly disseminated in accordance with all legal requirements.
In addition to its Corporate Disclosure Policy, which is reviewed annually by the Board, the Bank
51 has a management Disclosure Committee, as well as detailed Disclosure Controls and Procedures.
Information Regarding Complaints
In accordance with the requirements of the Bank Act, and the accompanying regulations, the Bank confi rms that, for the fi scal 2015 year, it did not receive any complaints from persons having requested or received products or services from the Bank.
Our relationship with our shareholders is maintained through our Transfer Agent and Registrar, Computershare Investor Services Inc. and other fi nancial intermediaries and, in particular, through our shareholders’ meetings. Shareholders may communicate with us by contacting us directly by email at [email protected] or by phone at 1-800-244-1509, or by contacting Computershare.
Additional information regarding the corporate governance framework and practices of Pacifi c & Western Bank of Canada can be found in the Management Proxy Circular relating to its 2016 Annual Shareholders’ Meeting.
52 MANAGEMENT’S RESPONSIBILITY FOR FINANCIAL REPORTING
The consolidated fi nancial statements of Pacifi c & Western Bank of Canada (the “Bank”) and related fi nancial information presented in this annual report have been prepared by management, who are responsible for the integrity and fair presentation of the information presented, which includes the consolidated fi nancial statements, Management’s Discussion and Analysis (MD&A) and other information. The consolidated fi nancial statements were prepared in accordance with International Financial Reporting Standards, including the requirements of the Bank Act (Canada) and related rules and regulations issued by the Offi ce of the Superintendent of Financial Institutions Canada. The MD&A has been prepared in accordance with the requirements of securities regulators, including National Instrument 51-102 of the Canadian Securities Administrators (CSA).
The consolidated fi nancial statements and information in the MD&A necessarily include amounts based on informed judgments and estimates of the expected effects of current events and transactions with appropriate consideration to materiality. The fi nancial information presented throughout the annual report is consistent with that in the consolidated fi nancial statements.
Management has designed the accounting system and related internal controls, and supporting procedures are maintained to provide reasonable assurance that fi nancial records are complete and accurate, assets are safeguarded and the Bank is in compliance with all regulatory requirements. The Bank is a federally regulated bank. The Offi ce of the Superintendent of Financial Institutions Canada examines and enquires into the business affairs of the Bank, to the extent deemed necessary, to satisfy himself that the provisions of the Bank Act (Canada), having reference to the safety of the interests of depositors and creditors of the Bank, are being duly observed and that the Bank is in a sound fi nancial condition.
We, as the Bank’s Chief Executive Offi cer and Chief Financial Offi cer, will certify Pacifi c & Western Bank of Canada’s annual fi lings with the CSA as required by Multilateral Instrument 52-109 (Certifi cation of Disclosure in Issuers’ Annual and Interim Filings).
The system of internal controls is also supported by the Bank’s internal audit department, which carries out periodic inspections of all aspects of the Bank’s operations. The internal auditor has full and free access to the Audit Committee and to the external auditors.
The Audit Committee, appointed by the Board of Directors, is comprised entirely of independent directors who are not offi cers or employees of the Bank. The Audit Committee is responsible for reviewing the consolidated fi nancial statements and MD&A and recommending them to the Board of Directors for approval. Other key responsibilities of the Audit Committee include meeting with management, the internal auditor and the external auditors to discuss the effectiveness of certain internal controls over the fi nancial reporting process and the planning and results of the external audit. The Audit Committee also meets regularly with the internal auditor and the external auditors without management present.
KPMG LLP, independent external auditors appointed by the shareholders of the Bank upon the recommendation of the Audit Committee, has examined the consolidated fi nancial statements and their report follows. The external auditors have full and unrestricted access to the Audit Committee to discuss their audit and related fi ndings as to the integrity of the Bank’s fi nancial reporting and the adequacy of the system of internal controls.
David R. Taylor Barry D. Walter, CPA CA President & Chief Executive Offi cer Senior Vice President & Chief Financial Offi cer
December 2, 2015
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54 55
PACIFIC & WESTERN BANK OF CANADA Consolidated Balance Sheets
As at October 31, 2015 and 2014
(thousands of Canadian dollars) 2015 2014
Assets
Cash and cash equivalents (note 5) $ 127,078 $ 145,140 Securities (note 6) 22,433 48,800 Loans, net of allowance for credit losses (note 7) 1,447,660 1,224,247 Other assets (note 8) 28,635 27,673
$ 1,625,806 $ 1,445,860
Liabilities and Shareholders’ Equity
Deposits (note 10) $ 1,325,828 $ 1,193,797 Subordinated notes payable (note 11) 13,959 13,863 Securitization liabilities (note 12) 43,525 43,466 Other liabilities (note 13) 67,872 42,215 1,451,184 1,293,341
Shareholders’ equity: Share capital (note 14) 171,706 155,993 Retained earnings (deficit) 2,903 (3,493) Accumulated other comprehensive income 13 19 174,622 152,519
$ 1,625,806 $ 1,445,860
The accompanying notes are an integral part of these Consolidated Financial Statements.
On behalf of the Board:
David R. Taylor Hon. Thomas A. Hockin President and Chief Executive Officer Chairman of the Board
56
PACIFIC & WESTERN BANK OF CANADA Consolidated Statements of Income
Years ended October 31, 2015 and 2014
(thousands of Canadian dollars, except per share amounts) 2015 2014
Interest income: Loans $ 62,973 $ 55,278 Securities 1,484 2,883 64,457 58,161
Interest expense: Deposits and other 29,091 28,767 Subordinated notes 1,392 1,520 30,483 30,287
Net interest income 33,974 27,874
Non-interest income (note 16) 1,394 2,633 Total revenue 35,368 30,507
Provision for credit losses (note 7(b)) 1,545 919 33,823 29,588
Non-interest expenses: Salaries and benefits 13,041 11,273 General and administrative 9,648 9,589 Premises and equipment 2,095 2,085 24,784 22,947 Restructuring charges (note 11) – 434 24,784 23,381
Income before income taxes 9,039 6,207
Income tax provision (note 17) 821 531
Net income $ 8,218 $ 5,676
Basic income per common share (note 18) $ 0.33 $ 0.29
Diluted income per common share (note 18) $ 0.33 $ 0.29
Weighted average number of common shares outstanding 19,437,000 19,437,000
The accompanying notes are an integral part of these Consolidated Financial Statements.
57
PACIFIC & WESTERN BANK OF CANADA Consolidated Statements of Comprehensive Income
Years ended October 31, 2015 and 2014
(thousands of Canadian dollars) 2015 2014
Net income $ 8,218 $ 5,676 Other comprehensive loss, net of tax Net unrealized losses on assets held as available-for-sale (1) (6) (5) (6) (5)
Comprehensive income $ 8,212 $ 5,671
(1) Net of income tax benefit of $2 (2014 - $2).
The accompanying notes are an integral part of these Consolidated Financial Statements.
58
PACIFIC & WESTERN BANK OF CANADA Consolidated Statements of Changes in Shareholders’ Equity
Years ended October 31, 2015 and 2014 (thousands of Canadian dollars) 2015 2014
Common shares (note 14):
Balance, beginning and end of year $ 142,224 $ 142,224
Preferred shares (note 14):
Series 1 preferred shares Balance, beginning of year $ 13,647 $ – Issued during the year, net of issue costs and income taxes – 13,647
Balance, end of year $ 13,647 $ 13,647
Series 3 preferred shares Balance, beginning of year $ – $ – Issued during the year, net of issue costs and income taxes 15,690 –
Balance, end of year $ 15,690 $ –
Contributed surplus (note 14):
Balance, beginning of year $ 122 $ 54 Fair value of stock options granted 23 68
Balance, end of year $ 145 $ 122
Total share capital $ 171,706 $ 155,993
Retained earnings (deficit):
Balance, beginning of year $ (3,493) $ (9,169) Net income 8,218 5,676 Dividends paid on preferred shares (1,822) –
Balance, end of year $ 2,903 $ (3,493)
Accumulated other comprehensive income, net of taxes:
Balance, beginning of year $ 19 $ 24 Other comprehensive loss (6) (5)
Balance, end of year $ 13 $ 19
Total shareholders’ equity $ 174,622 $ 152,519
The accompanying notes are an integral part of these Consolidated Financial Statements.
59
PACIFIC & WESTERN BANK OF CANADA Consolidated Statements of Cash Flows
Years ended October 31, 2015 and 2014
(thousands of Canadian dollars) 2015 2014
Cash provided by (used in):
Operations: Net income $ 8,218 $ 5,676 Adjustments to determine net cash flows: Items not involving cash (note 19) (31,192) (26,733) Interest received 63,297 56,949 Interest paid (29,909) (31,277) Income taxes paid – – Change in operating assets and liabilities: Loans (223,565) (64,395) Deposits 131,612 7,647 Change in other assets and liabilities 24,102 23,112 (57,437) (29,021)
Investing: Purchase of securities – (34,894) Proceeds from sale and maturity of securities 25,922 26,443 25,922 (8,451)
Financing: Repayment of subordinated notes payable – (7,000) Proceeds of shares issued, net of costs 15,275 13,289 Dividends paid (1,822) – 13,453 6,289
Decrease in cash and cash equivalents (18,062) (31,183)
Cash and cash equivalents, beginning of year 145,140 176,323
Cash and cash equivalents, end of year (note 5) $ 127,078 $ 145,140
The accompanying notes are an integral part of these Consolidated Financial Statements.
60 PACIFIC & WESTERN BANK OF CANADA Notes to Consolidated Financial Statements
Years ended October 31, 2015 and 2014
1. Reporting entity: Pacific & Western Bank of Canada (the "Bank") operates as a bank under the Bank Act (Canada) and is regulated by the Office of the Superintendent of Financial Institutions (OSFI). The Bank, whose shares trade on the Toronto Stock Exchange, is involved in the business of providing commercial lending services to selected niche markets.
The Bank is incorporated and domiciled in Canada, and maintains its registered office at Suite 2002, 140 Fullarton Street, London, Ontario, Canada, N6A 5P2. It is the principal subsidiary of PWC Capital Inc. (PWC) whose shares also trade on the Toronto Stock Exchange. At October 31, 2015, PWC owned, approximately 68% (2014 – 89%) of the common shares of the Bank.
2. Basis of preparation:
These Consolidated Financial Statements have been prepared in accordance with the Bank Act (Canada). The Superintendent of Financial Institutions Canada (the “Superintendent” or “OSFI”), has instructed that the financial statements are to be prepared in accordance with International Financial Reporting Standards (“IFRS”). The significant accounting policies used in the preparation of these consolidated financial statements, including the accounting requirements of the Superintendent, are summarized below. These accounting policies conform, in all material respects, to IFRS.
a) Statement of compliance: These Consolidated Financial Statements have been prepared in accordance with IFRS as issued by the International Accounting Standards Board (“IASB”).
b) Date authorized for issuance: These Consolidated Financial Statements were approved and authorized for issue by the Board of Directors of the Bank on December 2, 2015.
c) Basis of measurement: These Consolidated Financial Statements have been prepared on the historical cost basis except for securities designated as available-for-sale which are measured at fair value in the Consolidated Balance Sheets.
d) Functional and presentation currency:
These Consolidated Financial Statements are presented in Canadian dollars which is the Bank’s functional currency.
61 PACIFIC & WESTERN BANK OF CANADA Notes to Consolidated Financial Statements
Years ended October 31, 2015 and 2014
2. Basis of preparation – continued:
e) Use of estimates and judgments: In preparing these Consolidated Financial Statements, management has exercised judgment and developed estimates in applying accounting policies and generating reported amounts of assets and liabilities at the date of the financial statements and income and expenses during the reporting periods. Areas where significant judgment was applied were in the assessments of impairment of financial instruments. Estimates were developed in the calculation of the allowance for credit losses and the measurement of deferred income taxes. It is reasonably possible, on the basis of existing knowledge, that actual results may vary from that expected in the generation of these estimates. This could result in material adjustments to the carrying amounts of assets and/or liabilities affected in the future. Estimates and their underlying assumptions are reviewed on an ongoing basis. Revisions to accounting estimates are applied prospectively once they are recognized.
3. Significant accounting policies: The significant accounting policies used in the preparation of these Consolidated Financial Statements were applied consistently to all years presented and are summarized below:
a) Principles of consolidation: The Bank holds 100% of the common shares of Arctic Financial Ltd., PW Capital Inc. and Pacific & Western Public Sector Financing Corp. The Consolidated Financial Statements include the accounts of these subsidiaries. All significant intercompany accounts and transactions have been eliminated.
b) Revenue recognition: Interest income on securities and loans is recognized in net interest income using the effective interest rate method over the expected life of the instrument. Interest income earned but not yet collected on securities and loans is included in the respective securities and loans categories on the Consolidated Balance Sheets. Non-interest income from credit cards is recognized over the expected term of the balance of the card and included in non-interest income. Interest income from credit cards is calculated based on a pre-determined rate and is recognized as earned and included in net interest income.
62 PACIFIC & WESTERN BANK OF CANADA Notes to Consolidated Financial Statements
Years ended October 31, 2015 and 2014
3. Significant accounting policies – continued:
b) Revenue recognition – continued: Interest income is recognized on impaired loans and is accrued using the rate of interest used to discount the future cash flows for purposes of measuring the impairment loss. Loan fees integral to the yield on the loan are amortized to interest income using the effective interest method; otherwise the fees are recorded in non-interest income.
c) Financial instruments: Upon initial recognition, all financial instruments are measured at fair value. Subsequent to initial recognition financial instruments are classified into various categories. The Bank groups all financial assets into one of the following classification categories: held-to-maturity, loans and receivables or available-for-sale. All financial liabilities are measured at amortized cost. Financial assets that are classified as held-to-maturity, loans and receivables and financial liabilities are measured at amortized cost using the effective interest method. Available-for- sale financial assets are measured at fair value with unrealized gains and losses, net of tax, recognized in other comprehensive income. Estimates of fair value are developed using a variety of valuation methods and assumptions. The Bank follows a fair value hierarchy to categorize the inputs used to measure fair value for its financial instruments. The fair value hierarchy is based on quoted prices in active markets (Level 1), models using inputs other than quoted prices but with observable market data (Level 2), or models using inputs that are not based on observable market data (Level 3). Valuation models may require the use of inputs, transaction values derived from models and input assumptions sourced from pricing services. Valuation inputs are either observable or unobservable. The Bank looks to external readily observable market inputs when available and may include certain prices and rates for shorter-dated Canadian yield curves and bankers acceptances. Unobservable inputs may include credit spreads, probability of default and recovery rates.
63 PACIFIC & WESTERN BANK OF CANADA Notes to Consolidated Financial Statements
Years ended October 31, 2015 and 2014
3. Significant accounting policies – continued:
c) Financial instruments – continued: The Bank has no Level 3 financial instruments. Fair value measurements that fall into Level 2 of the fair value hierarchy include term deposits and Canadian municipal debt that are classified as available-for-sale (note 6(d)). For term deposits and Canadian municipal debt, fair value measurement is primarily based on quotes received from brokers that represent transaction prices in markets for identical instruments.
i) Cash and cash equivalents: Cash and cash equivalents are classified as held-to-maturity.
Cash includes deposits with Canadian chartered banks, net of cheques and other items in transit. Cash equivalents include government treasury bills with less than ninety days to maturity from the date of acquisition.
ii) Securities: Securities are either classified as held-to-maturity or available-for-sale (note 6(a)). The Bank holds securities primarily for liquidity purposes and for investment purposes with the intention of holding the securities to maturity or until market conditions render alternative investments more attractive. Settlement date accounting is used for all securities transactions. At the end of each reporting period, the Bank assesses whether or not there is any objective evidence to suggest that a security may be impaired. Objective evidence of impairment results from one or more events that occur after the initial recognition of the security which has an impact that can be reliably estimated on the estimated future cash flows of the security such as financial difficulty of the issuer. An impairment loss is recognized for an equity instrument if the decline in fair value is significant or prolonged, as such circumstances provide objective evidence of impairment. Impairment losses on a held-to-maturity security are recognized in income in the period they are identified. When there is objective evidence of impairment of an available-for-sale security, the cumulative loss that has been recorded in Accumulated Other Comprehensive Income is reclassified to income. For available-for-sale debt securities, if in a subsequent period the impairment loss decreases and the decrease can be related objectively to an event occurring after the impairment was first recognized, then the previously recognized impairment loss is adjusted through income to reflect the net recoverable amount of the impaired security. No adjustments of impairment losses are recognized for available-for- sale equity securities.
64 PACIFIC & WESTERN BANK OF CANADA Notes to Consolidated Financial Statements
Years ended October 31, 2015 and 2014
3. Significant accounting policies – continued:
c) Financial instruments – continued:
iii) Loans: Loans are classified as loans and receivables and are initially measured at fair value plus incremental direct transaction costs. Loans are subsequently measured at amortized cost, net of allowance for credit losses, using the effective interest method. The Bank assesses whether or not there is any objective evidence to suggest that the carrying value of the loans may be impaired. Impairment assessments are facilitated through the identification of loss events and assessments of their impact on the estimated future cash flows of the loans. A loan is classified as impaired when, in management’s opinion, there has been deterioration in credit quality to the extent that there is no longer reasonable assurance as to the timely collection of the full amount of principal and interest. Loans, except credit card receivables, where interest or principal is contractually past due 90 days are automatically recognized as impaired, unless management determines that the loan is fully secured, in the process of collection and the collection efforts are reasonably expected to result in either repayment of the loan or restoring it to current status. All loans, except credit card receivables, are classified as impaired when interest or principal is past due 180 days, except for loans guaranteed or insured by the Canadian government, provinces, territories, or a Canadian government agency, which are classified as impaired when interest or principal is contractually 365 days in arrears. Credit card receivables are written off when payments are 180 days past due, or upon receipt of a bankruptcy notification. As loans are measured at amortized cost, an impairment loss is measured as the difference between the carrying amount and the present value of future cash flows discounted using the effective interest rate computed at initial recognition, if future cash flows can be reasonably estimated. When the amounts and timing of cash flows cannot be reasonably estimated, the carrying amount of the loan is reduced to its estimated net realizable value based on either: i) the fair value of any security underlying the loan, net of expected costs of realization, or,
ii) observable market prices for the loan.
65 PACIFIC & WESTERN BANK OF CANADA Notes to Consolidated Financial Statements
Years ended October 31, 2015 and 2014
3. Significant accounting policies – continued:
c) Financial instruments – continued: Impairment losses are recognized in income. If, in a subsequent period, the impairment loss decreases and the decrease can be related objectively to an event occurring after the impairment was first recognized, then a recovery of a portion or all of the previously recognized impairment loss is adjusted through income to reflect the net recoverable amount of the impaired loan. Real estate held for resale is recorded at the lower of cost and fair value, less costs to sell.
iv) Allowance for credit losses:
The Bank maintains an allowance for credit losses which, in management’s opinion, is adequate to absorb all credit related losses in its loan portfolio. The allowance for credit losses consists of both individual and collective allowances and is reviewed on a monthly basis. The allowance is included in loans on the Consolidated Balance Sheets. The Bank considers evidence of impairment for loans at both an individual asset and collective level. All individually significant loans are assessed for impairment first. All individually significant loans found not to be specifically impaired and all loans which are not individually significant are then collectively assessed for impairment. The collective allowance is determined by separating loans into categories that are considered to have common risk elements and reviewing factors such as current portfolio credit quality trends, exposure at default, probability of default and loss given default rates and business and economic conditions. The collective allowance may also be adjusted by management using its judgment taking into account other observable and unobservable factors.
v) Transaction costs:
Transaction costs are incremental costs that are directly attributable to the acquisition, issue or disposal of a financial asset or liability. Transaction costs related to held-to- maturity securities, loans and receivables, and available-for-sale financial assets, as well as financial liabilities are capitalized and amortized over the expected life of the instrument using the effective interest method. Transaction costs related to financial assets and liabilities at fair value through income are expensed in the Consolidated Statements of Income as incurred.
66 PACIFIC & WESTERN BANK OF CANADA Notes to Consolidated Financial Statements
Years ended October 31, 2015 and 2014
3. Significant accounting policies – continued:
c) Financial instruments – continued:
vi) Securitized mortgages and securitization liabilities: In previous years, the Bank transferred pools of Government of Canada guaranteed residential mortgages to the Canada Housing Trust (“CHT”), a Canada Mortgage and Housing Corporation (“CMHC”) sponsored entity. When the derecognition criteria were not met, these transactions resulted in securitized mortgages being maintained on the Bank’s Consolidated Balance Sheets and in the recognition of securitization liabilities when cash was received from counterparties to the transaction. Securitized mortgages are presented and accounted for as loans on the Consolidated Balance Sheets. Securitization liabilities are presented as a separate line item in the liabilities section on the Consolidated Balance Sheets. Interest income earned on securitized mortgages and interest expense incurred on securitization liabilities are recognized using the effective interest method over the expected life of the underlying instrument.
vii) Embedded derivatives: Certain derivatives embedded in other financial instruments are treated as separate derivatives when their economic characteristics and risk are not closely related to the host contract and the combined contract is not carried at fair value. Identified embedded derivatives are separated from the host contract and are recorded at fair value.
d) Property and equipment: Property and equipment are carried at cost less accumulated amortization and impairment. Amortization on property and equipment is calculated primarily using the straight-line method over the useful life of the equipment which varies between 5 and 20 years. Property and equipment is subject to an impairment review if there are events or changes in circumstances which indicate that the carrying amounts may not be recoverable. Amortization expense and impairment write-downs are included in premises and equipment expense in the Consolidated Statements of Income.
e) Income taxes: Current income taxes are calculated based on taxable income for the reporting period. Taxable income differs from accounting income because of differences in the inclusion and deductibility of certain components of income which are established by Canadian taxation authorities. Current income taxes are measured at the amount expected to be recovered or paid using statutory tax rates at the reporting period end.
67 PACIFIC & WESTERN BANK OF CANADA Notes to Consolidated Financial Statements
Years ended October 31, 2015 and 2014
3. Significant accounting policies – continued:
e) Income taxes – continued: The Bank follows the asset and liability method of accounting for deferred income taxes. Deferred income tax assets and liabilities arise from temporary differences between financial statement carrying values and the respective tax base of those assets and liabilities. Deferred income tax assets and liabilities are measured using enacted or substantively enacted tax rates expected to apply to taxable income in the years when temporary differences are expected to be recovered or settled. Deferred income tax assets are recognized in the consolidated financial statements to the extent that it is probable that the Bank will have sufficient taxable income to enable the benefit of the deferred income tax asset to be realized. Unrecognized deferred income tax assets are reassessed for recoverability at each reporting period end. Current and deferred income taxes are recorded in income for the period, except to the extent that the tax arose from a transaction that is recorded either in other comprehensive income or equity, in which case the income tax on the transaction will also be recorded either in other comprehensive income or equity. Accordingly, current and deferred income taxes are presented in the Consolidated Financial Statements as a component of income, or as a component of Other Comprehensive Income.
f) Employee benefits:
i) Short-term benefits: Short-term employee benefit obligations are recognized as employees render their services and are measured on an undiscounted basis. A liability is recognized for the amount expected to be paid under a short-term cash bonus plan if the Bank has an obligation to make such payments as a result of past service provided by the employee and the obligation can be estimated reliably.
ii) Share-based payment transactions: Equity-settled stock options Employee stock options are measured using the Black-Scholes pricing model which is used to estimate the fair value of the options at the date of grant. Inputs to the Black- Scholes model include the closing share price on the grant date, the exercise price, the expected option life, the expected dividend yield, the expected volatility and the risk-free interest rate. Once the expected option life is determined, it is used in formulating the estimates of expected volatility and the risk-free rate. Expected future volatility is estimated using a historical volatility look-back period that is consistent with the expected life of the option.
68 PACIFIC & WESTERN BANK OF CANADA Notes to Consolidated Financial Statements
Years ended October 31, 2015 and 2014
3. Significant accounting policies – continued:
f) Employee benefits – continued:
The fair value of options which vest immediately are recognized in full as of the grant date, whereas the fair value of options which vest over time are recognized over the vesting period using the graded method which incorporates management’s estimates of the options which are not expected to vest (i.e. forfeitures). The effect of a change in the estimated number of options expected to vest is a change in estimate and the cumulative effect of the change is recognized prospectively once the estimate is revised. The fair value of stock options granted is recorded in salaries and benefits expense in the Consolidated Statements of Income and in share capital as a component of contributed surplus in the Consolidated Balance Sheets. When options are exercised, the consideration received and the estimated fair value previously recorded in contributed surplus is recorded as Share Capital. The Bank’s stock option plan is described in note 15.
g) Share capital:
The Bank’s share capital consists of common shares, preferred shares and contributed surplus.
i) Share issuance costs: Costs directly incurred with raising new share capital are charged against equity. Other costs are expensed as incurred.
ii) Contributed surplus:
Contributed surplus consists of the fair value of stock options granted since inception, less amounts reversed for exercised stock options. If granted options vest and then subsequently expire or are forfeited, no reversal of contributed surplus is recognized.
h) Segment reporting: The Bank does not present segmented information in its financial statements as it has determined that its operations fall into one segment, Banking, and operates in one geographic region, Canada.
69 PACIFIC & WESTERN BANK OF CANADA Notes to Consolidated Financial Statements
Years ended October 31, 2015 and 2014
4. Future changes in accounting policies: There have been a number of standards and amendments that have been issued by the IASB that were not effective for the Bank’s fiscal year end of October 31, 2015 and therefore have not been applied in preparing these consolidated financial statements. The following standard is expected to be applicable to the Bank: Financial Instruments (IFRS 9) In July, 2014, the IASB issued the final revised IFRS 9 standard which addresses classification, measurement and impairment of financial instruments and hedge accounting. IFRS 9 specifies that financial assets be classified into one of three categories: financial assets measured at amortized cost, financial assets measured at fair value through profit or loss or financial assets measured at fair value through other comprehensive income. The standard also includes an expected credit loss model and a general hedging model. IFRS 9 will be mandatorily effective for the Bank’s fiscal year beginning on November 1, 2018, although early adoption is permitted. The Bank has performed preliminary evaluations of the impact of IFRS 9, however the impact on the Bank’s consolidated financial statements cannot be quantified at this time as it is dependent upon the nature and credit quality of financial instruments held by the Bank when IFRS 9 becomes effective. The Bank is of the view that at this time, it will not early adopt IFRS 9.
5. Cash and cash equivalents:
(thousands of dollars) 2015 2014
Deposits with regulated financial institutions $ 39,091 $ 52,539 Treasury bills guaranteed by government 87,987 92,601 $ 127,078 $ 145,140
70 PACIFIC & WESTERN BANK OF CANADA Notes to Consolidated Financial Statements
Years ended October 31, 2015 and 2014
6. Securities:
a) Portfolio analysis:
(thousands of dollars) 2015 2014
Available-for-sale securities Securities issued or guaranteed by: Canadian provincial governments $ 9,607 $ 9,581 Canadian municipal governments 279 554 Term deposits – 26,055 Total available-for-sale securities $ 9,886 $ 36,190
Held-to-maturity security Debt of other financial institutions $ 12,547 $ 12,610 Total securities $ 22,433 $ 48,800
b) Maturities and yields:
(thousands of dollars) 2015 Yield 2014 Yield
Available-for-sale securities Within 3 months $ 9,607 1.37% $ 26,055 1.96% 3 months - 1 year – – 275 3.08% 1 year - 2 years – – 9,581 1.37% 2 years - 5 years 279 2.03% 279 2.08% Total available-for-sale securities $ 9,886 1.38% $ 36,190 1.82%
Held-to-maturity security Floating rate $ 12,547 0.81% $ 12,610 1.28% Total securities $ 22,433 1.06% $ 48,800 1.68%
Average effective yields are based on carrying values and contractual interest adjusted for amortization of premiums and discounts.
71 PACIFIC & WESTERN BANK OF CANADA Notes to Consolidated Financial Statements
Years ended October 31, 2015 and 2014
6. Securities – continued:
c) Unrealized gains and losses on securities:
(thousands of dollars) 2015 2014 Amortized Unrealized Unrealized Fair Amortized Unrealized Unrealized Fair Cost Gains Losses Value Cost Gains Losses Value
Available-for-sale securities Securities issued or guaranteed by: Canadian provinces $ 9,598 $ 9 $ – $ 9,607 $ 9,561 $ 20 $ – $ 9,581 Canadian municipalities 270 9 – 279 548 6 – 554 Term deposits – – – – 26,055 – – 26,055 Total available-for-sale securities $ 9,868 $ 18 $ – $ 9,886 $ 36,164 $ 26 $ – $ 36,190
Held-to-maturity security Debt of other financial institutions $ 12,547 $ – $ (47) $ 12,500 $ 12,610 $ – $ (129) $ 12,481 Total securities $ 22,415 $ 18 $ (47) $ 22,386 $ 48,774 $ 26 $ (129) $ 48,671
There were no impairment charges during the years ended October 31, 2015 and October 31, 2014 related to the Bank’s securities portfolio.
72 PACIFIC & WESTERN BANK OF CANADA Notes to Consolidated Financial Statements
Years ended October 31, 2015 and 2014
6. Securities – continued: d) Fair value hierarchy: Available-for-sale securities measured at fair value are classified into the fair value hierarchy as follows:
(thousands of dollars) 2015 Total Level 1 Level 2 Level 3
Available-for-sale securities Securities issued or guaranteed by: Canadian provincial governments $ 9,607 $ 9,607 $ – $ – Canadian municipal governments 279 – 279 – Total available-for-sale securities $ 9,886 $ 9,607 $ 279 $ –
(thousands of dollars) 2014 Total Level 1 Level 2 Level 3
Available-for-sale securities Securities issued or guaranteed by: Canadian provincial governments $ 9,581 $ 9,581 $ – $ – Canadian municipal governments 554 – 554 – Term deposits 26,055 – 26,055 – Total available-for-sale securities $ 36,190 $ 9,581 $ 26,609 $ –
73 PACIFIC & WESTERN BANK OF CANADA Notes to Consolidated Financial Statements
Years ended October 31, 2015 and 2014
7. Loans: a) Portfolio analysis:
(thousands of dollars) 2015 2014
Government financing $ 72,181 $ 87,332 Residential multi-family mortgages 112,759 122,686 Commercial and consumer loans and leases 783,780 548,240 Commercial mortgages 445,941 432,567 Credit card receivables 27,447 27,972 Other loans 3,721 3,967 1,445,829 1,222,764
Collective allowance (3,212) (2,905) Accrued interest 5,043 4,388
$ 1,447,660 $ 1,224,247
The collective allowance for credit losses relates to the following loan portfolios: (thousands of dollars) 2015 2014
Government financing $ 18 $ 13 Residential multi-family mortgages 30 66 Commercial and consumer loans and leases 624 446 Commercial mortgages 1,475 1,393 Credit card receivables 1,044 962 Other loans 21 25 $ 3,212 $ 2,905
The Bank holds security against the majority of its loans in the form of either mortgage interests over property, other registered securities over assets, guarantees and holdbacks on commercial and consumer loans and leases (note 13).
74 PACIFIC & WESTERN BANK OF CANADA Notes to Consolidated Financial Statements
Years ended October 31, 2015 and 2014
7. Loans – continued: b) Allowance for credit losses:
The allowance for credit losses results from the following:
(thousands of dollars) 2015 2014 Total Total Collective Individual Allowance Allowance
Balance, beginning of year $ 2,905 $ – $ 2,905 $ 3,275 Provision for credit losses 1,545 – 1,545 919 Write-offs (1,238) – (1,238) (1,289)
Balance, end of year $ 3,212 $ – $ 3,212 $ 2,905
c) Maturities and yields:
(thousands of dollars) Within 3 months to 1 year to 2 years to Over 2015 2014 Floating 3 months 1 year 2 years 5 years 5 years Total Total
Total loans $ 427,320 $ 25,429 $ 63,402 $ 195,741 $ 590,480 $ 143,457 $1,445,829 $ 1,222,764 Average effective yield 4.60% 15.31% 3.29% 4.16% 4.13% 3.61% 4.47% 4.64%
Average effective yields are based on book values and contractual interest rates, adjusted for the amortization of any deferred income and expenses.
Credit card receivables are included in the time period that interest starts to accrue. d) Impaired loans:
At October 31, 2015 there were no impaired loans (2014 - $nil).
At October 31, 2015, loans, other than credit card receivables, past due totalled $nil (2014 - $nil). At October 31, 2015, credit card receivables overdue by one day or more totalled $2,773,000 (2014 - $2,999,000).
75 PACIFIC & WESTERN BANK OF CANADA Notes to Consolidated Financial Statements
Years ended October 31, 2015 and 2014
8. Other assets:
(thousands of dollars) 2015 2014
Accounts receivable $ 1,609 $ 1,690 Prepaid expenses and other 13,874 12,992 Property and equipment (note 9) 4,349 4,507 Deferred income tax asset (note 17) 8,803 8,484
$ 28,635 $ 27,673
9. Property and equipment:
(thousands of dollars) 2015 2014
Cost $ 10,656 $ 10,608 Accumulated amortization (6,307) (6,101)
$ 4,349 $ 4,507
None of the Bank’s property and equipment are subject to title restrictions, nor are any pledged as security for the Bank’s liabilities.
Total amortization expense recorded for property and equipment for the year ended October 31, 2015 totalled $393,000 (2014 - $396,000).
10. Deposits:
(thousands of dollars) Demand/ Within 3 months to 1 year to 2 years to Accrued 2015 2014 Floating 3 months 1 year 2 years 5 years Interest Total Total
Total deposits $ 127,623 $ 159,891 $ 413,310 $ 393,073 $ 218,981 $ 12,950 $ 1,325,828 $ 1,193,797
Average effective interest rate 0.16% 1.79% 2.02% 2.28% 2.27% 1.91% 2.02%
Average effective interest rates are based on book values and contractual interest rates.
76 PACIFIC & WESTERN BANK OF CANADA Notes to Consolidated Financial Statements
Years ended October 31, 2015 and 2014
11. Subordinated notes payable:
(thousands of dollars) 2015 2014
Ten year term, unsecured, callable, subordinated notes payable to an unrelated party, maturing between 2019 and 2021, net of note issue costs of $541 (2014 - $637), effective interest of 10.06% (2014 – 10.06%) $ 13,959 $ 13,863
$ 13,959 $ 13,863
During the year ended October 31, 2014, the Bank repaid $7,000,000 in notes payable that had a carrying value of $6,566,000. The difference of $434,000 relating to unamortized note issue costs was included in restructuring charges in the Consolidated Statements of Income.
12. Securitization liabilities: Securitization liabilities include amounts payable to counterparties for cash received upon initiation of securitization transactions, accrued interest on amounts payable to counterparties, and the unamortized balance of deferred costs and discounts which arose upon initiation of the securitization transactions. The amounts payable to counterparties bear interest at rates ranging from 1.97% - 3.95% and mature between 2016 and 2020. Securitized insured mortgages and other assets with a carrying value of $43,370,000 (2014 - $43,349,000) are pledged as collateral for these liabilities.
13. Other liabilities: (thousands of dollars) 2015 2014
Accounts payable and other $ 3,575 $ 2,645 Cash collateral and amounts held in escrow 3,294 2,734 Holdbacks payable on commercial and consumer loans and leases (note 7(a)) 61,003 36,836
$ 67,872 $ 42,215
77 PACIFIC & WESTERN BANK OF CANADA Notes to Consolidated Financial Statements
Years ended October 31, 2015 and 2014
14. Share capital:
a) Authorized:
Common shares:
The Bank is authorized to issue an unlimited number of voting common shares with no par value.
Series 1 Preferred shares:
The Bank is authorized to issue an unlimited number of Series 1 preferred shares, shares with a par value of $10.00. These preferred shares are Basel III-compliant, non-cumulative five year rate reset preferred shares which includes non-viability contingent capital (“NVCC”) provisions which would require the preferred shares to be converted to common shares upon a trigger event (as defined by OSFI).
The holders of the Series 1 preferred shares are entitled to receive a non-cumulative fixed dividend in the amount of $0.70 annually per share, payable quarterly, as and when declared by the Board of Directors for the initial period ending October 31, 2019. The quarterly dividend represents an annual yield of 7.0% based on the stated issue price per share. Thereafter, the dividend rate will reset every five years at a level of 543 basis points over the then five year Government of Canada bond yield.
The Bank maintains the right to redeem, subject to the approval of OSFI, up to all of the outstanding Series 1 preferred shares on October 31, 2019 and on October 31 every five years thereafter at a price of $10.00 per share. Should the Bank choose not to exercise its right to redeem the Series 1 preferred shares, holders of these shares will have the right to convert their shares into an equal number of non-cumulative, floating rate Series 2 preferred shares, subject to certain conditions, on October 31, 2019 and on every October 31 every five years thereafter. Holders of Series 2 preferred shares will be entitled to receive quarterly floating dividends, as and when declared by the Board of Directors, equal to the 90-day Government of Canada Treasury bill rate plus 543 basis points.
Upon the occurrence of a trigger event (as defined by OSFI), each Series 1 or 2 preferred share will be automatically converted, without the consent of the holders, into common shares of the Bank. Conversion to common shares will be determined by dividing the preferred share conversion value ($10.00 per share plus any declared but unpaid dividends) by the common share value (the greater of (i) the floor price of $0.75 and (ii) the current market value price calculated as the volume weighted average trading price for the ten consecutive trading days ending on the day immediately prior to the date of the conversion).
78 PACIFIC & WESTERN BANK OF CANADA Notes to Consolidated Financial Statements
Years ended October 31, 2015 and 2014
14. Share capital (continued):
Series 3 Preferred shares:
The Bank is authorized to issue an unlimited number of preferred shares, including Series 3 preferred shares with a par value of $10.00. These preferred shares are Basel III-compliant, non-cumulative six year rate reset preferred shares which includes non-viability contingent capital (“NVCC”) provisions which would require the preferred shares to be converted to common shares upon a trigger event (as defined by OSFI).
The holders of the Series 3 preferred shares are entitled to receive a non-cumulative fixed dividend in the amount of $0.70 annually per share, payable quarterly, as and when declared by the Board of Directors for the initial period ending April 30, 2021. The quarterly dividend represents an annual yield of 7.0% based on the stated issue price per share. Thereafter, the dividend rate will reset every five years at a level of 569 basis points over the then five year Government of Canada bond yield.
The Bank maintains the right to redeem, subject to the approval of OSFI, up to all of the outstanding Series 3 preferred shares on April 30, 2021 and on April 30 every five years thereafter at a price of $10.00 per share. Should the Bank choose not to exercise its right to redeem the Series 3 preferred shares, holders of these shares will have the right to convert their shares into an equal number of non-cumulative, floating rate Series 4 preferred shares, subject to certain conditions, on April 30, 2021 and on every April 30 every five years thereafter. Holders of Series 4 preferred shares will be entitled to receive quarterly floating dividends, as and when declared by the Board of Directors, equal to the 90-day Government of Canada Treasury bill rate plus 569 basis points.
Upon the occurrence of a trigger event (as defined by OSFI), each Series 3 or 4 preferred share will be automatically converted, without the consent of the holders, into common shares of the Bank. Conversion to common shares will be determined by dividing the preferred share conversion value ($10.00 per share plus any declared but unpaid dividends) by the common share value (the greater of (i) the floor price of $0.75 and (ii) the current market value price calculated as the volume weighted average trading price for the ten consecutive trading days ending on the day immediately prior to the date of the conversion).
The Board of Directors declared the quarterly dividends on the Series 1 and Series 3 preferred shares at the meeting on December 2, 2015.
79 PACIFIC & WESTERN BANK OF CANADA Notes to Consolidated Financial Statements
Years ended October 31, 2015 and 2014
14. Share capital – continued:
b) Issued and outstanding:
(thousands of dollars) 2015 2014 Shares Amount Shares Amount
Common shares: Outstanding, beginning and end of year 19,437,171 $ 142,224 19,437,171 $ 142,224
Series 1 Preferred shares: Outstanding, beginning of year 1,461,460 $ 13,647 – $ – Issued for cash proceeds, net of issue costs and income taxes – – 1,461,460 13,647 Outstanding, end of year 1,461,460 $ 13,647 1,461,460 $ 13,647
Series 3 Preferred shares Outstanding, beginning of year – $ – – $ – Issued for cash proceeds, net of issue costs and income taxes 1,681,320 15,690 – – Outstanding, end of year 1,681,320 $ 15,690 – $ –
Contributed surplus: Balance, beginning of year $ 122 $ 54 Fair value of stock options granted (note 15) 23 68 Balance, end of year $ 145 $ 122
Total share capital $ 171,706 $ 155,993
Issue costs of $1,538,000 (2014- $1,325,000) net of income taxes of $415,000 (2014 - $358,000) have been recorded in share capital.
80 PACIFIC & WESTERN BANK OF CANADA Notes to Consolidated Financial Statements
Years ended October 31, 2015 and 2014
15. Stock-based compensation:
Equity-settled stock options:
The Bank has a stock option plan for its employees and officers. Options are granted at an exercise price set at the closing market price of the Bank’s common shares on the day preceding the date on which the option is granted and are exercisable within ten years of issue. Options are usually granted with graded vesting terms. One third of the grant vests immediately, one third vests on the first anniversary of the grant date, and one third vests on the second anniversary date of the grant date. In limited cases, some options are granted with immediate vesting terms.
For the year ended October 31, 2015, the Bank recognized stock-based compensation expense of $23,000 (2014 - $68,000) related to 40,000 options granted to an officer who is a member of the Bank’s key management personnel. These options are exercisable into common shares at $7.00 per share and expire in 2023. Of the options issued, 40,000 are exercisable at October 31, 2015. The fair value of the options were estimated using the Black-Scholes option pricing model. No stock options were granted during the year ended October 31, 2015 or October 31, 2014.
16. Non-interest income: (thousands of dollars) 2015 2014
Credit card non-interest revenue $ 1,308 $ 1,369 Gain on sale of loans – 1,207 Other income 86 57
$ 1,394 $ 2,633
81 PACIFIC & WESTERN BANK OF CANADA Notes to Consolidated Financial Statements
Years ended October 31, 2015 and 2014
17. Income taxes: Income taxes, including both the current and deferred portions, vary from the amounts that would be computed by applying the aggregated statutory federal and provincial tax rate of 27% (2014 – 27%) to income before income taxes. Income taxes have been computed as follows:
(thousands of dollars) 2015 2014
Income before income taxes $ 9,039 $ 6,207 Income tax rate 27% 27%
Expected income tax provision 2,441 1,676
Adjustment to previously unrecognized deferred income tax asset (1,724) (1,210) Tax rate differential (28) (24) Other permanent differences 132 89
Income tax provision $ 821 $ 531
Movement in current and deferred income tax assets (liabilities) are as follows:
(thousands of dollars) 2015 2014
Current income tax provision $ – $ –
Deferred income tax: Origination and reversal of temporary differences 2,545 1,741 Change in estimate of deferred income tax assets (1,724) (1,210)
Deferred income tax provision $ 821 $ 531
Total income tax provision $ 821 $ 531
82 PACIFIC & WESTERN BANK OF CANADA Notes to Consolidated Financial Statements
Years ended October 31, 2015 and 2014
17. Income taxes – continued:
The components of the recognized deferred income tax assets (liabilities) and related changes, as recognized in net income, equity or accumulated comprehensive income, are as follows:
(thousands of dollars) Accumulated other November 1, Net comprehensive October 31, 2014 income Equity income 2015
Allowance for credit losses $ 776 $ 81 $ – $ – $ 857 Loss carry forwards 7,810 (1,352) 723 2 7,183 Share issue and financing costs 644 (295) 415 – 764 Deposit commissions (809) (81) – – (890) Other 63 826 – – 889 Total deferred income tax assets (liabilities) $ 8,484 $ (821) $ 1,138 $ 2 $ 8,803
(thousands of dollars) Accumulated other November 1, Net comprehensive October 31, 2013 income Equity income 2014
Allowance for credit losses $ 874 $ (98) $ – $ – $ 776 Loss carry forwards 8,384 (576) – 2 7,810 Share issue and financing costs 500 (214) 358 – 644 Deposit commissions (914) 105 – – (809) Other (189) 252 – – 63 Total deferred income tax assets (liabilities) $ 8,655 $ (531) $ 358 $ 2 $ 8,484
The Bank is subject to Part V1.1 tax which is a 40% tax on dividends paid on taxable preferred shares under the Income Tax Act (Canada). The Part V1.1 tax of $723,000 and related deferred tax recovery is recorded through equity.
83 PACIFIC & WESTERN BANK OF CANADA Notes to Consolidated Financial Statements
Years ended October 31, 2015 and 2014
17. Income taxes – continued:
The components of unrecognized deferred income tax assets and related changes, as recognized in net income, are as follows:
(thousands of dollars) November 1, Net October 31, 2014 income 2015
Capital losses $ 935 $ – $ 935 Non-capital losses 1,724 (1,724) – Total unrecognized deferred income tax assets (liabilities) $ 2,659 $ (1,724) $ 935
(thousands of dollars) November 1, Net October 31, 2013 income 2014
Capital losses $ 935 $ – $ 935 Non-capital losses 2,934 (1,210) 1,724 Total unrecognized deferred income tax assets (liabilities) $ 3,869 $ (1,210) $ 2,659
At October 31, 2015, the Bank had income tax losses which can be carried forward to reduce taxable income in future years. These loss carry forwards of the Bank will expire, if unused, as follows:
(thousands of dollars)
2027 $ 318 2028 14,752 2029 2,689 2030 3,066 2031 4,235 2032 662 2033 356 2034 415 2035 410 $ 26,903
In addition the Bank has approximately $7,000,000 (2014 - $7,000,000) of capital loss carry forwards which may be applied against future capital gains.
84 PACIFIC & WESTERN BANK OF CANADA Notes to Consolidated Financial Statements
Years ended October 31, 2015 and 2014
18. Per share amounts: Basic income per common share
(thousands of dollars except per share amounts) 2015 2014
Net income $ 8,218 $ 5,676 Preferred share dividends paid (1,822) – Net income available to common shareholders 6,396 5,676
Average number of common shares outstanding 19,437,000 19,437,000
Basic income per common share $ 0.33 $ 0.29
Diluted income per common share (thousands of dollars except per share amounts) 2015 2014
Net income available to common shareholders $ 6,396 $ 5,676
Average number of common shares outstanding 19,437,000 19,437,000 Dilutive effect of employee stock options – – Average number of common shares outstanding assuming dilution 19,437,000 19,437,000
Diluted income per common share $ 0.33 $ 0.29
Employee stock options do not have a dilutive impact as the exercise price is greater than the average market price. The Series 1 and Series 3 NVCC preferred shares are contingently issuable shares and do not have a dilutive impact. 19. Items not involving cash:
(thousands of dollars) 2015 2014
Provision for credit losses $ 1,545 $ 919 Income tax provision 821 531 Interest income (64,457) (58,161) Interest expense 30,483 30,287 Gain on sale of loans – (1,207) Amortization of property and equipment 393 396 Stock-based compensation 23 68 Restructuring charges – 434
$ (31,192) $ (26,733)
85 PACIFIC & WESTERN BANK OF CANADA Notes to Consolidated Financial Statements
Years ended October 31, 2015 and 2014
20. Nature and extent of risks arising from financial instruments:
Risk management involves the identification, ongoing assessment, managing and monitoring of material risks that could adversely affect the Bank. The Bank is exposed to credit risk, liquidity risk, and market risks.
Senior management is responsible for establishing the framework for identifying risks and developing appropriate risk management policies and framework. The Bank’s Board of Directors, either directly or indirectly through its committees, reviews and approves corporate policies, including specific reporting procedures. This enables them to monitor ongoing compliance with policies, delegate limits and review management’s assessment of risk in its major risk taking activities. An internal auditor is employed to provide a periodic review of policies and procedures to ensure they are appropriate, effective and being followed and that adequate controls are in place in order to mitigate risk to acceptable levels. The internal auditor reports directly to the Audit Committee of the Board of Directors. In addition, the Bank has an ongoing compliance management program with a Compliance Officer who reports directly to the Board of Directors.
Credit Risk
Credit risk is the potential for loss due to the failure of a counterparty or borrower to meet its financial obligations. The Bank is exposed to credit risk primarily as a result of its lending activities but also as a result of investing in securities. The Bank manages its lending activity credit risk using policies that have been recommended by management to the Risk Oversight Committee, which then recommends the policies to the Board of Directors for approval. These policies consist of approval procedures and limits on loan amounts, portfolio concentration, geographic concentration, industry concentration, asset category, loans to any one entity and associated groups, a risk rating policy that provides for risk rating each asset in its total asset portfolio, and early recognition of problem accounts (watch list accounts) with an action plan for each account. The Risk Oversight Committee reviews these policies on an ongoing basis.
The Bank manages its securities credit risk by applying policies that have been recommended by management to the Risk Oversight Committee, which then recommends the policies to the Board of Directors for approval. These policies consist of approval procedures and restrictions in the selection of security dealers, restrictions in the nature of securities selected, and in setting securities portfolio concentration limits. The Risk Oversight Committee reviews these policies on an ongoing basis.
86 PACIFIC & WESTERN BANK OF CANADA Notes to Consolidated Financial Statements
Years ended October 31, 2015 and 2014
20. Nature and extent of risks arising from financial instruments – continued:
The Risk Oversight Committee, comprised entirely of independent directors, performs the following functions related to credit risk: x Recommends policies governing management of credit risks to the Board of Directors for approval and reviews credit risk policies on an ongoing basis to ensure they are prudent and appropriate given possible changes in market conditions and corporate strategy. x Ensures that procedures and controls for managing credit risk are in place. x Concurs with credits exceeding the levels delegated to management, prior to commitment. x Reviews, on a regular basis, watch list accounts, impaired loans and accounts that have gone into arrears.
See note 6 for information relating to credit risk associated with securities and note 7 for information relating to credit risk associated with loans.
There was no material change in the Bank’s processes for managing credit risk during the year.
Liquidity Risk
Liquidity risk is the risk of the Bank being unable to honour all cash outflow obligations as they become due. The Bank is exposed to liquidity risk as a result of timing differences in the cash flows of its lending activities, security investment activities and deposit taking activities. The Bank has established policies to ensure that its cash outflows and inflows are closely matched and that its sources of deposits are diversified between funding sources and over a wide geographic area. The Risk Oversight Committee recommends policies governing management of liquidity risk to the Board for approval and reviews liquidity policies on a ongoing basis. It receives and reviews quarterly securities portfolio reports and liquidity risk reports from management relating to its liquidity position. Additionally, an Asset Liability Committee, consisting of members of senior management, monitors liquidity risk, reviews compliance with policies and discusses strategies in this area.
See note 21 for information relating to liquidity risk associated with the Bank’s asset and liability gaps in maturities.
There was no material change in the Bank’s processes for managing liquidity risk during the year.
Market Risk
Market risk is the risk of a loss resulting from changes in interest rates, and market prices and volatilities that arise from the Bank’s funding and investment activities.
87 PACIFIC & WESTERN BANK OF CANADA Notes to Consolidated Financial Statements
Years ended October 31, 2015 and 2014
20. Nature and extent of risks arising from financial instruments – continued:
The Bank’s principal market risk arises from interest rate risk as the Bank does not undertake foreign exchange or trading activities. The Risk Oversight Committee is charged with recommending policies to the Board of Directors for approval that govern market risk and with reviewing the policies on an ongoing basis.
Interest rate risk is the risk that a movement in interest rates could negatively impact spread, net interest income and the economic value of assets, liabilities and shareholders’ equity. The Bank manages interest rate risk by employing a number of methods including income simulation analysis, interest rate sensitivity gap and duration analysis and on-balance sheet strategies including the raising of longer term deposits and reducing the duration of its assets. Management prepares regular reports to the Board to allow for ongoing monitoring of the Bank’s interest rate risk position. Management of the Bank has an Asset Liability Committee which reviews the results of these analyses on a monthly basis and monitors compliance with limits set by corporate policy.
The management of interest rate risk against interest rate gap limits is supplemented by monitoring the sensitivity of the Bank’s financial assets and liabilities to various standard and non-standard interest rate scenarios. Standard scenarios that are considered include a 100 basis point (bps) parallel fall or rise in all yield curves applicable to the Bank. An analysis of the Bank’s sensitivity to an increase or decrease in market interest rates, assuming no asymmetrical movement in yield curves and a constant balance sheet is as follows:
Interest Rate Position (thousands of dollars) 2015 2014 Increase Decrease Increase Decrease 100 bps 100 bps 100 bps 100 bps
Sensitivity of projected net interest income during a 12 month period $ 3,371 $ (3,114) $ 3,543 $ (3,493) Sensitivity of reported equity during a 60 month period 295 (86) (319) 484
Duration difference between assets and liabilities (months) 0.8 0.2
There was no material change in the Bank’s processes for managing interest rate risk during the year. As at October 31, 2015 and October 31, 2014 the Bank did not have any outstanding contracts to hedge fair value exposure attributed to interest rate risk. The Bank uses on-balance sheet strategies to manage its interest rate risk.
88 PACIFIC & WESTERN BANK OF CANADA Notes to Consolidated Financial Statements
Years ended October 31, 2015 and 2014
21. Interest rate and liquidity risk:
The Bank is exposed to interest rate risk as a consequence of the mismatch, or gap, between assets and liabilities scheduled to mature or reset on particular dates. The gaps, which existed at October 31, 2015 are as follows:
(thousands of dollars) Floating Within 3 months to 1 year to 2 years to Over Non-interest rate 3 months 1 year 2 years 5 years 5 years rate sensitive Total
Assets
Cash resources $ 39,091 $ 87,987 $ $ $ $ $ $ 127,078 Effective yield 0.93% 0.39%
Securities 12,547 9,607 – – 279 – 22,433 Effective yield 0.81% 1.37% 2.03%
Loans 427,320 25,429 63,402 195,741 590,480 143,457 1,831 1,447,660 Effective yield 4.60% 15.31% 3.29% 4.16% 4.13% 3.61%
Other – – – – – – 28,635 28,635
Total assets $ 478,958 $ 123,023 $ 63,402 $ 195,741 $ 590,759 $ 143,457 $ 30,466 $ 1,625,806
Liabilities
Deposits $ 127,623 $ 159,891 $ 413,310 $ 393,073 $ 218,981 $ – $ 12,950 $ 1,325,828 Effective rate 0.16% 1.79% 2.02% 2.28% 2.27%
Subordinated notes – – – – 4,277 9,682 – 13,959 Effective rate 12.93% 8.77%
Securitization liabilities – – – 10,371 – 33,154 – 43,525 Effective rate 1.97% 3.85%
Other 61,003 – – – – – 6,869 67,872 Effective rate 0.70%
Equity – – – – 13,647 15,690 145,285 174,622 Effective rate 7.00% 7.00%
Total liabilities and equity $ 188,626 $ 159,891 $ 413,310 $ 403,444 $ 236,905 $ 58,526 $ 165,104 $ 1,625,806
October 31, 2015 gap $ 290,332 $ (36,868) $ (349,908) $ (207,703) $ 353,854 $ 84,931 $ (134,638) $ – Cumulative $ 290,332 $ 253,464 $ (96,444) $ (304,147) $ 49,707 $ 134,638 $ – $ –
October 31, 2014 gap $ 309,819 $ 18,084 $ (285,059) $ (200,174) $ 195,401 $ 106,569 $ (144,640) $ – Cumulative $ 309,819 $ 327,903 $ 42,844 $ (157,330) $ 38,071 $ 144,640 $ – $ –
89 PACIFIC & WESTERN BANK OF CANADA Notes to Consolidated Financial Statements
Years ended October 31, 2015 and 2014
22. Fair value of financial instruments:
The amounts set out in the table below represent the fair value of the Bank’s financial instruments:
(thousands of dollars) 2015 2014 Fair value Fair value Book of assets Book of assets Value and liabilities value and liabilities
Assets Cash and cash equivalents $ 127,078 $ 127,078 $ 145,140 $ 145,140 Securities 22,433 22,386 48,800 48,671 Loans 1,447,660 1,449,567 1,224,247 1,224,730 Other financial assets 5,887 5,887 5,057 5,057
Liabilities Deposits $ 1,325,828 $ 1,333,366 $ 1,193,797 $ 1,198,530 Subordinated notes payable 13,959 14,500 13,863 14,500 Securitization liabilities 43,525 47,604 43,466 46,732 Other financial liabilities 67,872 67,872 42,215 42,215
Fair values are based on management’s best estimates of market conditions and valuation policies at a certain point in time. The estimates are subjective and involve particular assumptions and matters of judgment and as such, may not be reflective of future fair values. The Bank’s loans and deposits lack an available market as they are not typically exchanged. Therefore, they have been valued as described below and are not necessarily representative of amounts realizable upon immediate settlement.
The fair value amounts have been determined using the following valuation methods and assumptions: x The fair values of securities are determined based on quoted market prices and internal and external valuation models that incorporate observable market data such as interest rates and credit spreads. x The fair value of loans is based on net discounted cash flows using market interest rates and applicable credit spreads for borrowers. x The fair value of deposits is determined based on discounted cash flows using market interest rates adjusted for applicable premiums/discounts. x The fair value of subordinated notes payable are determined by referring to current values for similar debt instruments. x The fair value of securitization liabilities is determined based on discounted cash flows using market interest rates. x The fair value of other financial assets and other financial liabilities is approximately equal to their book value due to the short-term nature of the instruments.
90 PACIFIC & WESTERN BANK OF CANADA Notes to Consolidated Financial Statements
Years ended October 31, 2015 and 2014
23. Related party transactions:
During the year, the Bank paid management and other fees totalling $600,000 (2014 - $980,000) to PWC and a subsidiary of PWC.
The Bank’s and PWC’s Boards of Directors and Senior Executive Officers represent key management personnel.
At October 31, 2015, unsecured loans due from key management personnel totalled $2,303,000 (2014 - $2,298,000).
The interest rates charged on related party loans are similar to that charged in an arms-length transaction. Interest income earned on related party loans for the year ended October 31, 2015 totalled $73,000 (2014 - $81,000). There were no provisions for credit losses related to loans issued to key management personnel (2013 - $nil).
Total compensation expense recognized for key management personnel for the year was $4,563,000 (2014 - $3,779,000).
24. Commitments and contingencies:
a) Credit commitments:
The amount of credit related commitments represents the maximum amount of additional credit that the Bank could be obliged to extend. Under certain circumstances, the Bank may cancel loan commitments at its option. The amount with respect to the letters of credit are not necessarily indicative of credit risk as many of these arrangements are contracted for a limited period of usually less than one year and will expire or terminate without being drawn upon.
91 PACIFIC & WESTERN BANK OF CANADA Notes to Consolidated Financial Statements
Years ended October 31, 2015 and 2014
24. Commitments and contingencies - continued:
(thousands of dollars) 2015 2014
Loan commitments $ 243,252 $ 195,148 Undrawn credit card lines 140,071 159,306 Letters of credit 39,015 43,926
$ 422,338 $ 398,380
b) Lease commitments:
The Bank leases a number of premises under operating leases, with current leasing arrangements expiring between July 30, 2016 and June 30, 2019 with an option to renew the leases after the initial lease period. Lease payments are increased every three to five years to reflect market rates. The Bank does not have any material subleases.
Total operating lease expense recognized for the year ended October 31, 2015 totalled $764,000 (2014 - $703,000)
Minimum future lease commitments are as follows: (thousands of dollars) 2015 2014
Within 1 year $ 841 $ 892 Between 1 and 5 years 2,241 2,745 Greater than 5 years 29 –
Total lease commitments $ 3,111 $ 3,637
c) Pledged assets:
In the ordinary course of business, assets are pledged against the following off-balance sheet items:
(thousands of dollars) 2015 2014
Securitized contracts $ 4,019 $ 3,998 Letters of credit 4,314 6,140
$ 8,333 $ 10,138
92 PACIFIC & WESTERN BANK OF CANADA Notes to Consolidated Financial Statements
Years ended October 31, 2015 and 2014
25. Capital management:
a) Overview
The Bank’s policy is to maintain a strong capital base so as to maintain investor, creditor and market confidence and to sustain future development of the business. The impact of the level of capital on shareholders’ return is also important and the Bank recognizes the need to maintain a balance between the higher returns that might be possible with greater leverage and the advantages and security afforded by a sound capital position.
OSFI sets and monitors capital requirements for the Bank. Capital is managed in accordance with policies and plans that are regularly reviewed and approved by the Board of Directors and take into account forecasted capital needs and conditions in financial markets.
The goal is to maintain adequate regulatory capital to be considered well capitalized, protect consumer deposits and provide capacity for internally generated growth and strategic opportunities that do not otherwise require accessing the public capital markets, all the while providing a satisfactory return to shareholders. The Bank’s regulatory capital is comprised of share capital, retained earnings (deficit) and unrealized gains and losses on available-for-sale securities (Common Equity Tier 1 capital), preferred shares (Additional Tier 1 capital) and the qualifying amount of subordinated notes (Tier 2 capital).
The Bank monitors its capital adequacy and related capital ratios on a daily basis and has policies setting internal maximum and minimum amounts for its capital ratios. These capital ratios consist of the leverage ratio and the risk-based capital ratios.
During the year ended October 31, 2015, there were no material changes in the Bank’s management of capital.
93 PACIFIC & WESTERN BANK OF CANADA Notes to Consolidated Financial Statements
Years ended October 31, 2015 and 2014
25. Capital management – continued:
b) Risk-Based Capital Ratio:
The Basel Committee on Banking Supervision has published the Basel III rules supporting more stringent global standards on capital adequacy and liquidity (Basel III). OSFI requires that all Canadian banks must comply with the Basel III standards on an “all-in” basis that became effective January 1, 2013 for purposes of determining its risk-based capital ratios. Required minimum regulatory capital ratios are a 7.0% Common Equity Tier 1 (CET1) capital ratio and effective January 1, 2014, an 8.5% Tier 1 capital ratio and 10.5% total capital ratio, all of which include a 2.50% capital conservation buffer. The Basel III rules provide for “transitional” adjustments whereby certain aspects of the new rules will be phased in between 2013 and 2019. The only available transition allowed by OSFI for capital ratios is related to the 10 year phase out of non-qualifying capital instruments.
OSFI also requires banks to measure capital adequacy in accordance with guidelines for determining risk adjusted capital and risk-weighted assets including off-balance sheet credit instruments as specified in the Basel III regulations. Based on the deemed credit risk for each type of asset, assets held by the Bank are assigned a weighting of 0% to 150% to determine the risk-based capital ratio.
94 PACIFIC & WESTERN BANK OF CANADA Notes to Consolidated Financial Statements
Years ended October 31, 2015 and 2014
25. Capital management – continued:
b) Risk-Based Capital Ratio – continued:
The Bank’s risk-based capital ratios are calculated as follows:
(thousands of dollars) 2015 2014 “All-in” “Transitional” “All-in” “Transitional”
Common Equity Tier 1 (CET1) capital Directly issued qualifying common share capital $ 142,369 $ 142,369 $ 142,346 $ 142,346 Retained earnings (deficit) 2,903 2,903 (3,493) (3,493) Accumulated other comprehensive income 13 13 19 19 CET1 before regulatory adjustments 145,285 145,285 138,872 138,872 Regulatory adjustments applied to CET1 (9,031) (3,612) (8,693) (1,739) Total Common Equity Tier 1 capital $ 136,254 $ 141,673 $ 130,179 $ 137,133
Additional Tier 1 capital Directly issued qualifying Additional Tier 1 instruments $ 29,337 $ 29,337 $ 13,647 $ 13,647 Total Tier 1 capital $ 165,591 $ 171,010 $ 143,826 $ 150,780
Tier 2 capital Directly issued capital instruments subject to phase out from Tier 2 $ 12,700 $ 12,700 $ 14,500 $ 14,500 Tier 2 capital before regulatory adjustments 12,700 12,700 14,500 14,500 Regulatory adjustments applied to Tier 2 – – – – Total Tier 2 capital $ 12,700 $ 12,700 $ 14,500 $ 14,500 Total capital $ 178,291 $ 183,710 $ 158,326 $ 165,280 Total risk-weighted assets $1,320,158 $ 1,325,576 $1,156,832 $ 1,163,786 Capital ratios CET1 ratio 10.32% 10.69% 11.25% 11.78% Tier 1 capital ratio 12.54% 12.90% 12.43% 12.96% Total capital ratio 13.51% 13.86% 13.69% 14.20%
95 PACIFIC & WESTERN BANK OF CANADA Notes to Consolidated Financial Statements
Years ended October 31, 2015 and 2014
25. Capital management – continued:
c) Leverage ratio:
On January 1, 2015, the assets-to-capital multiple was replaced by the leverage ratio that is prescribed under the Basel III Accord. The leverage ratio is a supplementary measure to the risk-based capital requirements and is defined as the ratio of Tier 1 capital to its total exposures. The Bank is in compliance with its leverage ratio that is calculated as follows:
(thousands of dollars) 2015
On-balance sheet assets $ 1,625,806 Assets amounts deducted in determining the Basel III “all in” Tier 1 capital (9,031) Total on-balance sheet exposures 1,616,775
Off-balance sheet exposure at gross notional amount 422,339 Adjustments for conversion to credit equivalent amount (301,674) Off-balance sheet exposures 120,665
Tier 1 Capital 165,591 Total exposures 1,737,440
Basel III Leverage Ratio 9.53%
96 BOARD OF DIRECTORS
THOMAS A. HOCKIN COLIN LITTON P.C., B.A, M.P.A., Ph.D., ICD.D FCPA, FCA, ICD.D. Chairman of the Board Retired, former partner, KPMG Former President & CEO of the Investment Funds Institute of Canada and the SUSAN T. MCGOVERN Canadian Institute of Financial Planning B.Sc. Vice-President, External Relations ROBBERT-JAN BRABANDER University of Ontario Institute of Technology M.Sc. and B.Sc. (Economics) Former Chief Financial Offi cer & Treasurer of PAUL G. OLIVER General Motors of Canada Limited FCPA, FCA, ICD.D. Retired, former senior partner, DAVID A. BRATTON PricewaterhouseCoopers LLP B.A.(Hons.), M.B.A., CHRP, FCMC President, Bratton Consulting Inc. DAVID R. TAYLOR B.Sc. (Hons.), M.B.A., F.I.C.B. R.W. (DICK) CARTER President and Chief Executive Offi cer, FCPA, FCA, C. Dir Pacifi c & Western Bank of Canada Retired, former President & CEO Crown Investments Corporation of Saskatchewan
ARNOLD E. HILLIER B.Comm., CPA, ACCA Retired, former Chairman, Chief Executive Offi cer and Chief Financial Offi cer, Claude Resources Inc.
97 OFFICERS
DAVID R. TAYLOR MICHAEL DIXON B.Sc. (Hons.), M.B.A., F.I.C.B. B.Comm., M.B.A. President & Chief Executive Offi cer Vice President, Consumer Lending
BARRY D. WALTER STEPHANIE FRANCIS B.Comm., CPA, CA B.Comm., CGA Senior Vice President Vice-President, Finance & Accounting & Chief Financial Offi cer JOANNE JOHNSTON, CPA, CA SHAWN CLARKE Chief Internal Auditor M.Eng., P.Eng., M.B.A. Senior Vice President & Chief Operating ALY LALANI Offi cer B.A., M.B.A., CPA, CA Vice President, Treasurer MAURICE DANIS CFA TEL MATRUNDOLA Senior Vice President, B.A., M.A., Ph.D. Structured & Corporate Finance Vice President, Public & Corporate Affairs
ROSS P. DUGGAN KERRY MCDOWELL Senior Vice President, Lending Vice President, Credit Card Services
NICK KRISTO CAMERON G. MITCHELL B.Comm., M.B.A. B.A., LL.B. Senior Vice President, Vice President, Credit & Chief Risk Offi cer General Counsel & Corporate Secretary
JONATHAN F.P. TAYLOR SCOTT A. MIZZEN B.B.A., CHRP B.A., LL.B. Senior Vice President, Vice President, Real Estate Lending Deposit Services & Human Resources
BRIAN CONLEY Vice President, Credit
98 CORPORATE INFORMATION
SOLICITORS CORPORATE OFFICES
Stikeman Elliott LLP London Offi ce 5300 Commerce Court West Suite 2002 - 140 Fullarton Street 199 Bay Street London, Ontario N6A 5P2 Toronto, Ontario M5L 1B9 Telephone: (519) 645-1919 Toll-free: (866) 979-1919 Fax: (519) 645-2060 AUDITORS
KPMG LLP Saskatoon Offi ce 500-475 2nd Avenue South Suite 950 - 410 22nd Street East Saskatoon, Saskatchewan S7K 1P4 Saskatoon, Saskatchewan S7K 5T6 Telephone: (306) 244-1868 Toll-free: (800) 213-4282 TRANSFER AGENT Fax: (306) 244-4649
Computershare Investor Services Inc. 100 University Avenue Toronto, Ontario M5J 2Y1 Vancouver Offi ce 40733 Perth Drive Garibaldi Highlands, British Columbia V0N 1T0 BANK Telephone: (604) 984-7564 Fax: (604) 898-3442 Royal Bank of Canada Main Branch, 154 1st Avenue South Saskatoon, Saskatchewan S7K 1K2 Waterloo Offi ce Suite 907 – 20 Erb Street West Waterloo, Ontario N2L 1T2 STOCK EXCHANGE LISTING Telephone: (866) 979-1919 Toronto Stock Exchange Trading Symbol: PWB INVESTOR RELATIONS
Toll Free Telephone: (800) 244-1509 Email: [email protected] Web site: www.pwbank.com
99 2015 Annual Report
Pacific & Western Bank of Canada
Suite 2002, 140 Fullarton Street Investor Relations London, Ontario T 800 244 1509 N6A 5P2 E [email protected] T 519 645 1919 www.pwbank.com F 519 645 2060