First Quarter Results
For the quarter ended June 30, 2009
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Message
to Stakeholders
Record loan growth at ATB Financial tempered by substantial ABCP provision
Edmonton - August 18, 2009
ATB Financial (ATB) posted double-digit percentage growth over last year’s first quarter in both loans and deposits, but credit loss provisions and lower interest rates pushed profits down.
Net income in this year's first quarter was $33.1 million, down 41.6 per cent from last year. Loans, including securitized mortgages, were up 15.7 per cent over last year's first quarter to $23.2 billion, while retail deposits increased 10.9 per cent to $20.7 billion.
"Put simply, we're doing more business - and good business. However, interest rates are lower and our margins are tighter, said Dave Mowat, ATB Financial's President and CEO.
"We are active in the marketplace meeting the financial needs of more Albertans than ever, and we're committed to knowing and serving Albertans better than anyone else.
Net income was also impacted by a $10.4-million increase in ATB's allowance for credit loss expense. This increase strengthens ATB's allowance for potential losses based on a continuing economic uncertainty.
Meanwhile, Alberta businesses and investors increasingly sought out ATB as a financial partner. Business loans increased 23.9 per cent to $9.2 billion, while ATB Investor Services' customer base grew and the assets it manages increased to $4.2 billion.
"While some might choose to scale back in times of uncertainty, ATB is strategically re-investing in Alberta," Mowat said. "We're ramping up our capacity to serve strong Alberta businesses, and Alberta investors who want world-class customer service and advice."
Though markets improved in recent months, ATB's estimate of the fair value of its investments in asset-backed commercial paper (ABCP) remains unchanged. ATB does not expect to reflect gains in the fair value of ABCP on its income statement until there is strong evidence that the assets' value has actually increased.
Operational Highlights
Personal and Business Financial Services (PBFS) - ATB's largest line of business includes branches and agencies throughout Alberta. Assets, primarily consisting of loans, grew $1.5 billion, or 9.7 per cent, over the last year. Operating revenue increased by $2.5 million, or 1.6 per cent. PBFS unveiled North America-leading technological and customer service innovations at two Calgary branches; Uptown/17th Avenue and Stampede Station.
Corporate Financial Services (CFS) - This line of business provides services to Alberta's mid- and senior-market companies in three sub-lines -; Energy, Commercial, and Food &; Forestry. CFS's assets grew $1.6 billion, or 38.7 per cent over the last year. Operating revenue increased over last year by $24.3 million, or 87.4 per cent.
ATB Investor Services (IS) - This line of business is responsible for growing and protecting wealth for more than 47,000 customers. At the end of the first quarter, client assets under management and administration reached $4.2 billion, up $105.7 million from last year's first quarter, or 2.6 per cent.
ATB in the Community - ATB's associates and customers celebrated ATB's 10th annual Teddy for a Toonie campaign, which raises money every May for the Stollery and Alberta Children’s Hospital foundations. ATB also supported Alberta cross-country skier Sara Renner with a major Olympic-year partnership.
About ATB Financial - ATB Financial is the largest Alberta-based financial institution, with assets of $26.5 billion. It provides Personal and Business Financial Services, Investor Services, and Corporate Financial Services to more than 670,000 Albertans in 243 communities. It provides service through 164 branches and 132 agencies, telephone and Internet banking, a Customer Contact Centre, and Automated Banking Machines. ATB Financial was established in 1938 and has been a provincial Crown corporation since 1997. It has been named one of Canada's 50 Best Employers by Report on Business Magazine, one of the 75 Best Workplaces in Canada by the Great Place to Work Institute, and one of Alberta's Top 40 Employers by Mediacorp Canada Inc. For more information about ATB Financial, visit www.atb.com
Bob Splane Dave Mowat
Chairman of the Board President & CEO
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Management's Discussion and Analysis (unaudited)
Net Income
For the first quarter ended June 30, 2009, ATB Financial has reported net income of $33.1 million. This compares favourably to the $29.9 million reported in the previous quarter, but is less than the $56.7 million reported in the first quarter last year. In past quarters the provision for loss (or fair value adjustment) on ABCP has had an impact on ATB’s results; this quarter is different in that no valuation adjustment has been recorded. (Refer to “Asset-Backed Commercial Paper” below for additional detail on this topic.) Adjusting for the impact of the provision for loss on ABCP recorded in the prior quarters, the current quarter’s net income compares unfavourably to both the $60.4 million recorded in the prior quarter and the $55.4 million recorded in the same quarter from the prior year. Unless otherwise indicated, the remainder of this commentary refers to operating results exclusive of the provision for loss (fair value adjustment) on ABCP.
Despite an increase in net interest spread (from 2.47% to 2.61%) and a $7.6 million reduction in non-interest expenses, net income reduced by $27.4 million compared to the prior quarter. The decrease was driven by a reduction in other income and an increase in the provision for credit losses. Other income decreased from $85.6 million to $50.2 million due to lower securitization income and a loss on derivatives. The $12.8 million increase in the provision for credit losses is due to the uncertainty in the current economic environment.
Net income is $22.3 million lower than that recorded in the first quarter last year. Consistent with the last few quarters, the current low interest rate environment is having a negative impact on ATB’s year-over-year net interest spread. Consequently, rather than increasing based on asset growth, net interest income declined by $2.7 million compared to the same quarter last year. In addition, non-interest expenses increased by $7.4 million or 4.8% over the first quarter last year as ATB continues to invest in infrastructure and people, and is required to support its continued significant business growth. This increase is lower than previous quarter’s as the impact of constraining expense growth is beginning to take effect. The provision for credit losses increased by $10.4 million compared to the prior year due to the current economic uncertainty. Other income is also negative compared to last year, with a variance of $1.7 million.
Net Interest Income
Net interest income increased by $13.3 million over the prior quarter, from $151.0 million to $164.3 million. Despite growth in loans and deposits over the last year, this is the first increase in net interest income since June 30, 2008. Net interest income has been negatively impacted by the continued reduction in the Canadian prime rate, which has reduced from 4.75% in June 2008 to 2.25% in June 2009. Interest income is more sensitive to rate changes than interest expense, thus when interest rates decrease, as they have over the past year, the result is normally a reduction in net interest income. This current increase in net interest income over the prior quarter is due to increases in loan prices caused by market related liquidity premiums and a shift in the mix of client deposits. ATB expects net interest income to increase over the coming quarters based on continued asset growth and stabilizing net interest spreads caused by continued strengthening in the base pricing of loans.
Compared to the same quarter last year, net interest income reduced from $167.0 million to $164.3 million. This $2.7 million reduction came despite significant growth in loans and deposits and reflects the impact that the reduction in Canadian prime has had on interest margins. The average quarterly Canadian prime rate reduced from 4.87% to 2.31% - which was the prime driver for the reduction in interest spread from 2.9% to 2.6%.
Additional information on ATB’s exposure to interest rate risk as at June 30, 2009 is provided in Note 4 to the unaudited interim consolidated financial statements. Specifically, based on ATB’s current interest rate modeling, it is estimated that a one-percentage point increase in prime would increase ATB’s net interest income by $50 million over the following twelve-month period.
Other Income - excluding ABCP
Other income was $50.2 million for the first quarter ended June 30, 2009, a decrease of $35.4 million (or 41.3%) compared to the prior quarter, and $1.7 million (or 3.4%) compared to the first quarter of last year. The decrease over the prior quarter was driven by a $20.6 million reduction in securitization income and an $11.8 million reduction in derivative income. Securitization income has a number of components – the most significant being the gain on sale on mortgages sold in the period and the fair value adjustment relative to the retained interest in mortgages sold in prior periods. The gain on sale was less this quarter due to a reduction in both the balance of mortgages sold and in the spread at which they were sold. The fair value of the retained interest was negatively impacted by the prepayment of a significant number of mortgages – a result of the low interest rate environment. ATB expects that there will be some further negative adjustments to the retained interest as more mortgages prepay over the next one or two quarters. Derivative income went from $4.0 million last quarter to a loss of $7.7 million in the current quarter. This reduction reflects the impact of maturing and ineffective hedge relationships inherent in ATB’s derivative portfolio at the end of the quarter.
The $1.7 million decrease in other income over the first quarter last year was a result of a $7.0 million reduction in derivative income partially offset by increases in credit fees ($2.3 million), card fees (1.2 million), and securitization income ($1.1 million).
Provision and Allowance for Credit Losses
ATB has recorded a $19.0 million net provision for credit losses in the current quarter. This is $12.8 million higher than the provision recorded in the prior quarter and $10.4 million higher than the $8.6 million recorded in the first quarter of the prior year. The net provision consists of both a general and a specific component. The general loan loss provision is management’s best estimate of probable losses not yet specifically identified in the loan portfolio while specific provisions are recorded when loans are identified as impaired.
The general loan loss provision for the quarter was $11.8 million compared to a provision of $1.2 million last quarter and $6.2 million in the first quarter last year. This increase is the driven by a combination of growth in the loan portfolio and a change in the risk profile of the portfolio. The change in the risk profile can be attributed to the general economic uncertainty and the change in the loan portfolio towards more commercial loans and less residential mortgage loans (due to securitization). Commercial loans are generally deemed to have more risk than residential mortgage loans.
The specific loan loss provision has increased to $7.3 million in the current quarter from $5.0 million in the prior quarter and $2.4 million in the first quarter of last year. This movement is driven by a change in specifically identified impaired loans this quarter compared to prior quarters.
Although the amount currently classified as impaired remains less than 1.0% of the total gross loan portfolio, the actual dollar value of gross impaired loans has increased to $114.1 million from $75.8 million in the prior quarter and from $50.4 million in the first quarter of the prior year. The growth in impaired loans is also in evident when comparing the total credit loss allowance to the gross impaired loan balance. At June 30, 2009, the total current credit loss allowance exceeds gross impaired loans by $92.2 million. This compares to $117.4 million and $118.4 million at March 31, 2009 and June 30, 2008, respectively. The amount impaired does not directly translate into amounts to be written-off as ATB holds security in support of any current credit exposure. The expected write-offs relative to the currently impaired loans are reflected in the specific provisions for credit losses.
While the level of impaired loans is likely to increase further during this current recessionary economic environment, actual losses are expected to remain within the range of acceptable levels. Based on current credit quality, management expects the fiscal 2010 provisions for credit losses will remain in the targeted range of 20 - 30 basis points of average loans.
Non-Interest Expenses
ATB management remains committed to operating efficiently, but is balancing this commitment with the goal of increasing ATB’s operating capacity through the investment in technology, processes, and people. The expectation is that these investments will result in increased operating efficiency in the future. Maintaining this balance has always been a primary focus at ATB, but it has become even more of a focus in the current interest rate environment.
For the first quarter this year non-interest expenses were $162.4 million, $7.6 million (or 4.4%) less than the prior quarter. This decrease was driven by a reduction in the deposit guarantee fee and amortization relative to software and other intangibles. Both of these expenses were higher than normal last quarter due to the requirement for certain one-time adjustments.
Non-interest expenses increased by $7.4 million (or 4.8%) compared to the first quarter last year. This increase was driven by increased salaries and employee benefits, which increased $5.0 million (5.8%), equipment costs, which increased $3.9 million (125.5%), and premises costs, which increased $3.2 million (24.9%). Salaries and employee benefits are higher due to an increase in the number of associates in our retail business, technology and core project team. Increased equipment costs are associated with the core transformation and other ongoing or completed projects at ATB. Premises costs have increased due to the addition of net new branches and increased costs associated with existing branches.
ATB uses the efficiency ratio to measure its effectiveness at generating operating revenue. This is the ratio of non-interest expenses to operating revenue (net interest income before provisions for credit losses, plus other income). A lower ratio indicates greater efficiency at generating income. In the first quarter ended June 30, 2009, ATB’s efficiency ratio was 75.7%. This compares unfavorably to the 71.8% in the prior quarter and the 70.8% achieved in the first quarter last year. Despite a decrease of $7.6 million in Non-Interest Expenses, the efficiency ratio worsened from the prior quarter due to a reduction in operating revenue by $22.1 million or 9.3%. – primarily driven by a reduction in other income (Refer to the other income section of this discussion for details on this decrease). The worsening of this ratio from the prior year is driven by an increase in non-interest expenses ($7.4 million or 4.8%) and a decrease in net interest income ($2.7 million or 1.6%). Management expects that the efficiency ratio may continue to worsen to 79.0 to 82.0% based on the continued investment in growth initiatives – specifically the core transformation initiative. This ratio is expected to decrease significantly once the core transformation is complete and when we begin to see increases in the bank prime rate.
Balance Sheet
Total assets of $26.5 billion remain unchanged from the prior quarter and have increased by $1.9 billion from last year. ATB continues to be focused on “being there for Albertans” even in these uncertain economic times, while maintaining strong credit and underwriting fundamentals. This is evidenced in the increase in total loans, net of allowance for credit losses, of $517.1 million (or 2.4%) over the prior quarter and $2.3 billion (or 11.7%) over the prior year.
This growth has come despite the sale of a portion of ATB’s mortgage portfolio through a securitization program with Canada Housing Trust. Excluding the impact of this securitization (i.e. adding the securitized mortgages back into the loan totals), results in total loan growth of $632.3 million quarter over quarter. This growth is up $90.6 million from the preceding quarter’s growth (of $541.7 million) and $23.4 million from the corresponding first quarter growth figure last year (of $608.9 million).
ATB has two principal sources of deposits through which it can source the funds for growth – personal and business or commercial deposits, primarily sourced through our retail network, and wholesale deposits, which consist primarily of bearer deposit notes and mid-term notes issued on behalf of ATB by the Government of Alberta and sold to other financial institutions. Personal and business deposits decreased by $0.2 billion (or 1.17%) over the prior quarter but increased significantly by $2.0 billion from the prior year. The recent growth in deposits could not have been sustained and this quarter over quarter decrease was not unexpected, although management is working on deposit retention strategies currently. ATB Wholesale deposits are used as a source of funds to supplement retail deposits in supporting lending activities and can fluctuate significantly quarter-to-quarter. The agreement with the Government of Alberta currently limits the total volume of such deposits to $4.3 billion. As at June 30, 2009, ATB has $3.0 billion in wholesale deposits. The balance of wholesale deposits is up $105.5 million (or 3.61%) from the prior quarter and down by $540.3 million (or 15.13%) from the first quarter last year.
Accumulated other comprehensive income decreased from $108.9 million last quarter to $78.8 million in the current quarter, reflecting the net temporary decrease in fair value of certain financial instruments.
Asset Backed Commercial Paper
As at June 30, 2009 ATB held a portfolio of long-term asset-backed commercial paper with a face value of $1.0 billion, a fair value of $630.9 million and an expected maturity of between 4.5 and 7.5 years. This included $966.6 million ($584.5 million fair value) of third-party-sponsored ABCP and $67.0 million ($46.4 million fair value) of bank-sponsored ABCP. For additional details on these notes and the associated risks and obligations refer to Note 8 to the consolidated March 31, 2009 year-end financial statements.
With the exception of the traditional notes, which have been classified as available-for-sale, all of ATB’s investment in ABCP has been classified as held-for-trading. As a consequence it is required to be marked to market each quarter with the resulting valuation adjustment being recorded in the income statement.
There is no observable market prices for the notes as at the balance sheet date, accordingly, ATB estimated the fair value of the ABCP notes using a discounted cash flow methodology. The key assumption in this model is the market discount rate. The market discount rate is based on the various tranches of the CDX.IG index. There was an improvement in the CDX.IG index since March 31, 2009 resulting in a reduced market discount rate this quarter. This would normally result in an increase in the estimated fair value of the notes held, but ATB has not adjusted the valuation of the notes this quarter, as there is not sufficient certainty that the value of the notes has increased in value.
ATB believes that there is sufficient uncertainty relative to the fair value of the notes that it would not be appropriate to make a positive adjustment to the valuation at this time. Although spreads have tightened since March 31, 2009, thereby reducing the probability of collateral calls after the moratorium period ends, the credit risk still remains. The first 18 to 24 months post restructuring are the period of greatest credit risk. As time passes the spread-loss triggers continue to widen – making collateral calls less likely. In addition, with the passage of time the risk of credit losses is more determinable. ATB will continue to review the valuation of these notes quarterly. Positive valuation adjustments will only be made once there is sufficient certainty that the value of the notes has increased. If the CDX.IG index increases or credit losses occur, ATB will evaluate whether further negative valuation adjustments are necessary.
Consistent with the prior quarter, the valuation of ineligible and traditional notes was based on ATB’s review of the underlying assets. The fair value of the traditional notes decreased by $1.8 million this quarter. This amount was recorded in other comprehensive income.
Segmented Information
ATB has organized its operations and activities around three main business segments: Personal and Business Financial Services (PBFS), Corporate Financial Services (CFS), and Investor Services. A fourth line is designated Other Business Units, which is comprised of business units of a corporate nature, as well as expenses, general allowances, and recoveries not expressly attributed to any line of business. The provision (or fair value adjustment) relative to ABCP and the impact of certain accounting standards (Financial Instruments Standards and Accounting Guideline 4) are included within Other Business Units.
PBFS and CFS continue to achieve growth in their asset base. PBFS increased its total assets by $422.0 million (or 2.5%) during the first quarter and by $1.5 billion (or 9.7%) from a year ago, while CFS achieved quarterly asset growth of $159.1 million (or 2.9%) and annual growth of $1.6 billion (or 38.7%). This increase in assets has resulted in increased net income for PBFS and CFS compared to the prior quarter. Compared to last year though, PBFS actually saw income reduce due to reduced net interest margin and increased provision for credit losses. CFS, on the other hand, has been able to translate the increased assets into increased net income over last year.
Investor Services has benefited from the recent optimism in the equity markets, increasing assets under management and administration to $4.2 billion. This is an increase of $329.3 million (or 8.5%) from last quarter and $105.7 million (or 2.6%) from a year ago. This increase in assets under administration had a positive impact on Investors Services revenue, but increased expenses relative to strategic investments in the business resulted in a $3.6 million loss this quarter. This compares the $4.1 million loss suffered last quarter and the $0.7 million loss achieved in the first quarter last year.
Caution Regarding Forward Looking Statements
This report may include forward-looking statements. ATB Financial from time to time may make
forward-looking statements in other written or verbal communications. These
statements may involve, but are not limited to, comments relating to ATB's
objectives or targets for the short and medium term, strategies or actions
planned to achieve those objectives, targeted and expected financial results
and the outlook for operations or the Alberta economy. Forward-looking
statements typically use the words "anticipate," "believe," "estimate,"
"expect," "intend," "may," "plan," or other similar expressions or future or
conditional verbs such as "could," "should," "would," or "will."
By their very nature,
forward-looking statements require ATB's management to make numerous
assumptions and are subject to inherent risks and uncertainties, both general
and specific. A number of factors could cause actual future results,
conditions, actions, or events to differ materially from the targets,
expectations, estimates, or intentions expressed in the forward-looking
statements. Such factors include, but are not limited to: changes in
legislative or regulatory environment; changes in ATB's markets; technological
changes; changes in general economic conditions, including fluctuations in
interest rates, currency values and liquidity conditions; and other
developments, including the degree to which ATB anticipates and successfully
manages the risks implied by such factors.
ATB cautions readers
that the aforementioned list is not exhaustive. Anyone reading and relying on
forward-looking statements should carefully consider these and other factors
that could potentially have an adverse affect on ATB's future results, as there
is a significant risk that forward-looking statements will not prove to be
accurate.
Readers should not place undue reliance on forward-looking statements, as actual
results may differ materially from plans, objectives and expectations.
ATB does not undertake to update any forward-looking statement contained in
this report.
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Highlights