On Thursday 13 August, ATB Financial issued its financial results for its quarter ending 30 June 2020. The rosy press release “Supporting Alberta’s economic recovery” acknowledged the “triple impact event” of COVID–19, oil price shock, and market volatility, while affirming the results “demonstrate its financial strength while supporting customers.” Buried in the news release was the fact that ATB had lost $114 million in the quarter driven mainly by another $245 million provision for loan loss. This is the second consecutive quarterly loss for ATB which lost $93 million in the previous quarter.
Not to be deterred by persistent negative news, the release boasted:
In the first quarter, ATB delivered solid operating revenue of $424.6 million and continued its focus on expense management. ATB’s results were not immune to the shuttering of the economy and recorded a provision for loan losses of $245.3 million resulting in a net loss of $114.2 million for the quarter. With assets of $55.1 billion ATB continues to be in a strong financial position, both in terms of liquidity and capital.
President and CEO Curtis Stange put a positive spin on the challenges facing the organization declaring:
“A crisis brings home an organization’s purpose like at no other time. With the triple impact event hitting Alberta, we quickly rallied around our customers and team members, reimagined our relief programs and formed new partnerships to help make it possible for Albertans during these uncertain times.”
The press release failed to get picked up in mainstream media like The Globe and Mail or Postmedia outlets. Still, the financial report is worth a read to get a sense of how ATB itself is responding to this triple impact event.
The rest of the release highlighted the acquisition of Grow Technologies as evidence of ATB’s continued leadership in AI capabilities and its quick automation process for the Canada Emergency Business Accounts application process. There was however no mention in the release and financial report of how many ATB customers are receiving various benefits such as loan deferrals, a number reported by Canadian banks in their second quarter results.
First Quarter 2020-21
Economy
According to the financial report, the economic landscape was described as driving a car under abnormal driving conditions – “extremely tough and unpredictable,” with governments “sanding the road ….with unprecedented spending.” The economic analysis continues: “On top of this, the oil-price crash has added a strong wind blowing snow directly into the path of the Alberta economy. The wind has abated somewhat as oil prices have improved, but it continues to freeze out billions in oil patch investment and the jobs that go along with it.” Notably, the economic analysis revealed that sectors as accommodation and food services, arts and entertainment, and retail “hit the ditch harder and sustained more damage.” This interesting analogy suggests that ATB’s loan book will likely be hit harder than its competitors given its central role in lending to Alberta’s small business community.
Financial results
Examining the key determinants of net income, Net Interest Income (NII), the spread earned by the difference between what ATB earns on its loans and investments and pays on its deposits, fell by 17 basis points (one basis point is one one-hundredth of one per cent). This decline in one quarter is a big change. One positive development however was lower expenses due, in part, to a “fair-value adjustment” to ATB Wealth’s achievement notes program in the previous March 2020 quarter. The charge was not repeated but no amount was provided on the adjustment.
Another primary driver of profitability is the efficiency ratio which measures total expenses, excluding provision for loan losses, with total revenue. ATB’s expense ratio improved to 69.1 per cent in the quarter from 71.1 per cent the previous year. ATB’s competitors, CWB and the major banks have efficiency ratios shown in the table below.
| Table 1 | |
| Institution | Expense /Efficiency Ratio (%) |
| ATB Financial |
69.1 |
| BMO | 64.4 |
| BNS | 54.0 |
| CIBC | 57.2 |
| CWB | 47.1 |
| Laurentian | 76.4 |
| National | 53.1 |
| Royal | 57.5 |
| TD Bank | 48.6 |
| Sources: Banks’ Second Quarter 2020 reports to shareholders for quarter ended 30 April 2020 and supplementary financial information; ATB Quarterly Report for quarter ended 30 June 2020. |
ATB’s largest business segments- Everyday Financial Services (EFS) and ATB Business lost $46.7 million and $82.5 million, respectively. ATB Business recorded a drop in provision for credit losses of about $10 million while EFS experienced a rise in provisions to $54 million from $46.5 million the previous quarter. The June 2019 to June 2020 rise in provisioning at ATB Financial was 400 per cent to be expected given the triple impact event.
The paucity of disclosure on industry concentration revealed little change over the past twelve months. Commercial real estate ($5.9 billion), oil and gas ($4.4 billion), and agriculture, forestry, fishing, and hunting ($4.2) collectively account for over 30 per cent of ATB’s gross loans. Unlike the banks, ATB does not break down its provision for loan losses by industry segment. The Alberta public has no idea the quantum of provisions against commercial real estate and oil and gas, two sectors that have been especially hard hit by Alberta’s adverse driving conditions.
As mentioned, ATB’s financial statements and Management Discussion and Analysis provide no details on how many customers have enrolled in the various relief programs for principal and mortgage deferral, nor the principal amount outstanding on re-negotiated loans.
Questions
The Notes to the financial statements continue the fiction that ATB Financial’s capital standards provide a similar level of protection that those of federal institutions. Of ATB’s $5.7 billion total “capital,” $1.9 billion is in the form of “Wholesale borrowings” with $74 million in “notional capital.” How this fiction is allowed to persist by the Auditor General is another question rating agencies might be asking.
One of the curious features of the reporting of Loans Past Due- which is an indicator of the institution’s vulnerability to loan default- is the decline of loans past due. From the end of March, which represented the beginning of the COVID-19 lock-down to the end of June, total loans past due, but not impaired, fell from $684 million to $376 million. How this positive development occurred during a period of acute financial and economic distress, in a province suffering from one of the highest unemployment levels in the country, is a good question. This anomaly could be explained by the introduction of IFRS 9. Another, less benign interpretation might be that loan deferrals might explain the decline. However, the is nothing in the financial reporting that even refers to loan deferrals. The only passing comment to the word deferral is “The fact that borrowers opt to participate in payment-deferral programs does not on its own cause a significant increase in credit risk or trigger a stage migration.” No numbers on how many ATB customers deferred payments or the principal amount. Such information would be helpful to compare ATB with its competitors.
How many businesses will survive is another perspective from which to analyze ATB’s $23 business billion loan book. A recent survey from the Canadian Federation of Independent Business states that nationally 55,000 to 218,000 businesses are at risk of closing- a number that excludes businesses that have already closed. According to the Federation survey, one in seven businesses are at risk of closing, or 158,000 businesses across Canada.
In the case of ATB’s loan book, with its emphasis on commercial real estate, oil and gas ($10.2 billion- total), and unspecified amounts in hospitality and accommodation, a realistic number might be a 25 per cent provision. Twenty five per cent represents an adjustment factor of two times to the national average of one in seven, or 14.3 per cent of Canadian business. Such an adjustment would not seem unreasonable given our economy’s oil and gas and real estate exposure and ATB’s concentrated exposure to Alberta’s economy. Twenty-five per cent of ATB’s $23.6 billion in business loans, $16.2 billion in residential mortgages ($8.9 billion which are uninsured) and $6.8 billion in personal and credit card debt, is a very large number. Of course, the loss to the institution after realization is anywhere between a 100 per cent recovery (common with insured residential mortgages) to zero (Trident, Redwater Resources).
Another question relates to the funding of ATB through its different deposit and borrowing programs. Some significant funding sources emerged in the past 90 days. ATB has more reliance on transaction deposit accounts but less notice deposits which can, in extreme situations require 20 days before withdrawing. In addition, exposure to redeemable fixed date deposits rose by 50 per cent in the April-June quarter. These changes suggest that ATB is experiencing heavier demands for liquidity. This is reflected on the nearly 250 per cent increase in cash or securities lodged with the Bank of Canada to nearly $3.2 billion.
Uncertainty
ATB records allowances for loan losses for all loans by incorporating a forward-looking expected credit loss approach, as required under IFRS 9. This process involves inputs and assumptions requiring a high degree of judgment to assess for forecasts of macroeconomic variables and significant increases in credit risk. For the quarter ending June 30, 2020, our estimates and assumptions consider the economic impact of the COVID-19 pandemic, and we continue to closely monitor the situation and the impacts this has on our customers.
What might be the loss in the event of default for commercial real estate in Alberta? The loan is secured by real property, a hotel, a strip mall, or office tower with a loan-to-value ratio of 60 per cent or less. Again we don’t know details in the case of ATB. This equity requirement gives a lender a considerable margin of safety. So unless there is a worst-case scenario, for instance, a 50% decline in occupancy and rental rates, losses might only be 10% of that portfolio, or $500 million.
Disclosure Issues
The total allowance for business loans currently sits at $739 million but we have no idea how much has been put aside to real estate, let alone the problematic oil and gas portfolio. We do not know where the real estate is secured, other than the property is in Alberta (with some rare exceptions). Unlike the other major banks, ATB does not give a breakdown of the allocation of the specific provisions for credit losses or the allowance for credit losses. Table 2- reports provisions (Panel A) from Scotiabank’s second quarter supplementary financial reporting and allowance for credit losses (Panel B).
Table 2
| Bank of Nova Scotia | 2020(1) | ||
| ($MM) | Q2 | Q1 | |
| Panel A Provision for Credit Losses on impaired loans (Stage 3): | |||
| Residential Mortgages | 23 | 4 | |
| Personal Loans | 415 | 412 | |
| Credit Cards | 283 | 283 | |
| Personal | 721 | 699 | |
| Wholesale and Retail | 23 | 10 | |
| Real Estate and Construction | 20 | 22 | |
| Energy | 22 | 16 | |
| Utilities | 1 | 1 | |
| Health Care | 26 | 7 | |
| Technology and Media | 8 | 3 | |
| Chemicals | 0 | 0 | |
| Food and Beverage | 5 | 9 | |
| Forest Products | 4 | 5 | |
| Other | 18 | 12 | |
| Sovereign | 1 | 0 | |
| Business & Government | 149 | 103 | |
| Provision for Credit Losses – performing (Stage 1 and 2 | |||
| Personal | 701 | -13 | |
| Business & Government | 275 | -18 | |
| Provision for Credit Losses – performing (Stage 1 and 2) | 976 | -31 | |
| Total Provision for Credit Losses | 1846 | 771 | |
| Panel B -Allowance for Credit Losses | 2nd Quarter | ||
| ($MM) | Gross | (Stage 3) | Net |
| Wholesale and Retail | 381 | 188 | 193 |
| Real Estate and Construction | 329 | 78 | 251 |
| Energy | 229 | 25 | 204 |
| Transportation | 102 | 37 | 65 |
| Automotive | 51 | 27 | 24 |
| Agriculture | 268 | 76 | 192 |
| Hospitality and Leisure | 4 | 1 | 3 |
| Mining | 31 | 4 | 27 |
| Metals | 84 | 22 | 62 |
| Utilities | 32 | 19 | 13 |
| Health Care | 101 | 42 | 59 |
| Technology and Media | 38 | 14 | 24 |
| Chemicals | 8 | 3 | 5 |
| Food and Beverage | 133 | 64 | 69 |
| Forest Products | 27 | 11 | 16 |
| Other | 151 | 76 | 75 |
| Sovereign | 255 | 4 | 251 |
| Business & Government | 2267 | 704 | 1563 |
| Source: Bank of Nova Scotia, Supplementary Financial information | |||
For the oil patch, we have little or no idea, except Street rumours, about the nature of ATB’s oil book. We believe, based on bankruptcy proceedings, that ATB has focussed mainly in the junior producer field. This lending market can be lucrative for the high fees and high interest rates, but the income is volatile unless the lender or borrower hedges against potentially significant losses in commodities markets or through credit default swaps. (ATB’s financial statements reveal no credit default swaps have been entered into by ATB). Powers granted by the government in 2008 gave ATB a specific power to hedge residential mortgage exposure. This would enable ATB to swap its credit exposure in ALberta for residential mortgage exposure outside Alberta. There is no evidence ATB has taken advantage of such powers. ATB may also, on behalf of a customer, enter into commodities hedging contracts to offset the impact of falling prices and thereby strengthen the resilience of the company and protect ATB’s lending position.
With the Redwater decision, creditors of companies with large environmental liabilities like Trident will get nothing. So what is ATB’s oil and gas loan book worth? If the portfolio was shopped on the street, the portfolio’s fair market value is likely to 50 to 70 per cent, implying losses of $1.3 billion to $2.2 billion. How much of the $739 million of the allowance for business credit losses is for the oil and gas portfolio? We just don’t know. Even if all that business allowance is for oil and gas, is the provision sufficient given the current economic circumstances?
One positive…but
On a positive note, ATB’s capital adequacy rules, put in place over two decades ago, have served Albertans well. Without the $4 billion cushion of real capital in the form of retained earnings, the rating agencies would be more worried. Nevertheless, the provisioning appears to be on the light side. With so little financial information on this $55 billion publicly-owned institution, as COVID-19 continues, loan deferrals fall off, unemployment remains high, empty storefronts proliferate, and more businesses close, ATB will assume a more pivotal role in agency ratings. More transparency is required from this storied public institution.