2016-17 First Quarter Financial Results
Given the dreary news coming out of the commercial real estate market in Alberta this week, ATB’s earnings were a surprise on the upside. ATB earned $25 million which represented nearly Budget 2016’s full year estimate of earnings ($27 million) predicted on April 14th. The optimistic news in ATB’s first quarter report contrasts starkly with news from commercial real estate REIT, Dream Office, that wrote down 45 per cent of its Alberta office portfolio. [See Commercial Real Estate for more details.]
What was positive about the first quarter was, in part, results were not as bad as the final quarter of 2015-16. The issues facing ATB include: a hostile economic environment; challenges in raising deposits; narrowing interest spreads that form the core of revenue; and rising (or the potential for) provisions for credit losses. On top of all that is the continuing lack of disclosure on the commercial loan portfolio which is, at present, the main source of rising loan loss provisions.
On the deposit front, ATB’s Corporate Financial Services group were active during the quarter in raising $800 million “in business retail deposits (in CFS) as a result of two large amortizing deposits this quarter.” Wholesale deposits declined with the maturing of $750 million in deposits. “Business retail” deposits tend to be more rate sensitive than retail deposits and therefore more volatile. These are also more sensitive to the deposit guarantee offered.
Net loans grew marginally driven by residential mortgages, independent business
loans with an emphasis on real estate and accommodation and food services. During the quarter commercial loans fell by $266 million. The absence of loan growth is in marked contrast to previous years where ATB’s loan book advanced at double digit levels. ATB’s net interest income (the difference between what the institution pays for its funding and what it earns on its interest bearing assets). For June 30, 2016 quarter, net interest spread was 2.44%, lower than the 2.49% attained last quarter and the 2.63% when compared with the June 2015 quarter. The decline was due to falling rates on loan products (consistent with Bank of Canada policy) and “slight increases in yields on both our demand and fixed term deposits resulting from the competitive marketplace.”
A recent ad in the Edmonton Journal illustrates how ATB is competing and paying up for deposits. The advertised rate is 1.65 per cent for a 27 month “Choose Alberta GIC” “plus a BONUS when Alberta employment rate improves.” This innovative teaser rate is above existing rates for the major chartered banks. The ATB website provides an illustrative example. The depositor receives a bonus if Alberta’s unemployment rate improves which should be beneficial to both ATB and the economic well-being of most Albertans.
ALBERTA UNEMPLOYMENT RATE AT MATURITY ONE-TIME BONUS RATE
4.5% or less 0.75%
Over 12.0% 0.00%
ATB Financial GIC ad10-8-16 EJ
Reflecting the weak economy, gross impaired loans continued to climb reaching $690 million compared to $592 million three months earlier. As expected the business loan book took the biggest hit. Perhaps most distressing about accounting entry is the significant rise in gross impaired residential mortgages from $51 million to $63 million over the past three months.
During the quarter, ATB increased its largest single industry segment loan exposure (commercial real estate) from $4.7 billion to $5 billion over the quarter. ATB reported this “represents no more than 26.5% (March 31, 2016: 24.7%) of total gross business loans.” There is no breakdown geographically for these commercial real estate nor the nature of the security taken. ATB disclosed that the “single largest borrower” was $97 million or 0.24% of the total gross loan portfolio.
2015-16 Financial Results
According to ATB’s annual report “The good news is that we actually did more business than we did in 2015, and 2015 was the best year in ATB’s history…Unfortunately, the good news is dampened by a dramatic increase in loan loss provisions- a direct result of the downturn of Alberta’s economy. Those provisions, while not actual losses, certainly overshadow what would otherwise have been a very good year.” Indeed income before loan loss provisions, at $453 million outpaced 2015 by nearly $40 million, and was trumpeted at the annual public meeting on 27 May as the important metric. Unfortunately loan loss provisions are an ordinary expense incurred by financial institutions, in spite of “economic downturns.” Still, credit ATB’s staff, the provincial agency still earned $108 million and took home an undisclosed amount of variable pay with the top 11 executives recording $5.4 million in short-term and long-term variable pay.
Before the fall
From 2011 to 2015, performing loans at ATB have grown from $25.1 billion to $40.4 billion or by 61 per cent. In 2014-15, over two-thirds of ATB’s profits were derived from its commercial lending and deposit operations. From 2011 to 2015, commercial lending at ATB has more than doubled. But not this year, as the Corporate Financial Services earned $29 million , down from $214 million the previous year.
Before the start of its 2015-16 fiscal year ATB projected a profit of $283 million. In its financial report for the nine months ending December 31, 2015, ATB profits fell by $102 million or nearly 40 per cent as the provision for credit losses increased from $20 million to $197 million. On 24 February 2016, the Province’s third quarter fiscal update reported a new estimate of $208 million. In Budget 2016, tabled on 21 April, it was revealed that ATB’s estimated profit for the full fiscal year would be $82 million, down $126 million in just seven weeks. More alarming was the estimate for 2016-17 at just $27 million. With a decline in oil prices, it remains to be seen how current strategies will impact its government owner- an owner that has a huge exposure to changes in the price of oil.
Absence of information
While chartered banks report their loan portfolios on a sectoral basis, since 2009 ATB has not provided any detail on how much of the commercial, or overall, loan book is concentrated in, for example, oil and gas, hospitality, commercial real estate or other key sectors of Alberta’s economy. Strong risk management practices require that not only management, the board, deposit guarantor, and regulator know about the portfolio concentrations in the commercial loan book, but also that the “market,” such as bank and ratings analysts. know through quarterly public disclosures. This is especially essential for regional financial institutions like ATB which are limited to the Alberta marketplace for loans. Since ATB does not have to raise capital in the public markets (its capital is either provided by the Government via wholesale deposits, a deposit guarantee or self-generated), providers of capital look to the AA guarantee by the province for assurance.
The recent annual report shows that commercial real estate is the single largest exposure of $4.7 billion or more than 10 per cent of ATB’s net loans. When examining the Royal Bank’s quarterly information, its business credit portfolio is broken down into more than a dozen segments, with details on total exposure, undrawn commitments, derivatives, and amounts outstanding. Regrettably, the public does not know ATB’s exposure to Alberta’s largest industry – oil and gas. It is probable that oil and gas would be the second largest exposure of ATB’s commercial loan book but no one knows. From receiver reports we know that ATB had loaned over $80 million to Sanjel Corporation (recently in creditor protection) and $5 million to Redwater Resources, also under creditor protection.
Another lacunae of information is executive compensation. Bank disclosure usually is 30-50 pages with details on compensation philosophy; detailed metrics to explain how the board arrived at its pay decisions, and details on contracts of executives. For ATB, two pages of generality is provided in the Management Discussion and Analysis.
Provision for loan losses
In footnote 8 of its financial statements, the provision for loan losses increased by $305 million, $258 million of which was in the business portfolio. Provisions also increased on personal and credit card loans but nothing like the magnitude of the commercial book. Of the $4.7 billion in commercial real estate loans, we know nothing of what percentage of that segment has provisions attached.
Weak deposit growth- additional liquidity required
A final concern about ATB’s performance is its weak deposit growth. Only $300 million in additional deposits were brought in against a target of five to seven per cent. In the October 2105 provincial budget the government directed ATB to expand its lending to small and medium sized businesses and advanced $1.5 billion in capital to fund the program. According to the annual report, “competition for available deposits continues to be significant.” This challenge was due to significant declines in deposit balances from oil and gas corporations who, with lower payrolls and capital expenditure programs, no longer maintain large commercial deposits. ATB was able to finance its loan growth through an increase of $2 billion in its wholesale borrowing through the province. $980 million of the increase in the wholesale borrowing is counted as Tier 2 capital.