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Canadian Western Bank: Higher Risk, Lower Reward

Canadian Western Bank  (TSX:CWB) is one of those tricky stocks to look at from a long-term perspective in the current environment. I’m going to attempt to put this bank’s risk/reward profile into perspective, comparing its dividend yield to the major Canadian banks’.

In my mind, I have segregated Canadian banks into three segments: the “Big Five” Canadian banks, smaller regional banks, and alternative lenders/tertiary banks serving markets that may be underserved by banks in the first two segments.

As part of a well-functioning economy, I agree that the need for these three categories of banks exists. That said, it can be very tricky to place specific banks into a particular bucket, as a bank such as Canadian Western Bank may exhibit attributes of all three categories within its business model, acting as a large bank, regional bank, and alternative lender all at the same time.

One thing is certain: Canadian Western Bank is much riskier than the Big Five Canadian banks, offering a significant percentage of its loans to borrowers in some of the most over-leveraged and economically challenged parts of the country compared to a more diversified portfolio of assets held by larger banks. Traditionally, Canadian Western Bank has made its living serving western Canada, which, for a long time, meant primarily the Albertan market. As the oil market softened and commercial businesses related to the oil industry also took a hit, Canadian Western Bank began increasingly searching for diversified returns across the country.

As I have commented recently, it appears to me that Canadian Western Bank is taking on higher levels of risk with respect to its growing alternative lending portfolio, and yet the bank does not offer investors a sufficient return for taking this risk.

Let’s look at Canadian Western Bank’s dividend yield compared to the “Big Five” banks, as an example:

Bank 5-Year Historical Dividend Yield TTM Dividend Yield
Canadian Imperial Bank of Commerce 4.53% 4.67%
Bank of Montreal 4.16% 3.81%
Bank of Nova Scotia 4.12% 3.81%
Royal Bank of Canada 3.90% 3.56%
Toronto-Dominion Bank 3.40% 3.48%
Canadian Western Bank 2.53% 3.66%

It boggles me why an income-focused investor would consider Canadian Western Bank and the company’s increased risk profile when each of the Big Five Canadian banks posted a substantially higher historical dividend yield and an equivalent or better trailing 12-month yield as well.

Bottom line

Of all the Canadian banks, alternative lenders and regional banks with significant exposure to the Albertan economy or the Toronto/Vancouver housing bubbles are banks I want to avoid. Bubbles are easy to see in hindsight, and while many have considered the Albertan bubble to have already popped, I would argue that harder times are more likely to come than a sustained rebound, given the poor long-term outlook I have for the Canadian oil market overall.

Stay Foolish, my friends.

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

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