Net income in this year’s second quarter (before payment in lieu of tax) was $56.0 million, down 8.6 per cent from last year.
Net loans (including securitized mortgages) were up 13.1 per cent over last year’s second quarter to $23.7 billion, while retail deposits increased 5.2 per cent to $20.6 billion.
ATB Investor Services saw the funds it manages grow 17.3 per cent to $4.7 billion.
ATB’s slight drop in net income from last year’s second quarter was prompted mainly by lower interest rates. ATB’s allowance for credit loss expense improved slightly year-over-year, from $13.9 million to $10.3 million.
“The results are solid. Whether it is for a business loan, for retail banking, or for wealth-management expertise and advice, more Albertans than ever are choosing ATB,” said Dave Mowat, ATB Financial’s President and CEO.
“But we are not taking anything for granted. The marketplace is still challenging, and economic uncertainty remains. We have to keep working hard to delight our customers, grow our business, and watch our expenses.”
Management's Discussion and Analysis (unaudited)
Net Income
For the first time, ATB has recorded a payment in lieu of tax (PILOT) as a reduction to net income. Although this charge was approved in the current quarter, it is to be applied retroactively based on 23% of ATB’s consolidated net income. As a result, ATB has restated last quarters’ results to reflect a $7.6 million expense. The current quarters’ expense is $12.9 million. For simplicity and comparability, all references to net income in this discussion shall be to net income before PILOT. For more information on this item refer to Note 14 of the unaudited interim consolidated financial statements.
For the second quarter ended September 30, 2009, ATB Financial has reported net income of $56.0 million. This compares favorably to the $33.1 million reported in the previous quarter and the $5.7 million reported in the second quarter last year. The $5.7 million reported in the second quarter last year includes a $55.5 million negative fair value adjustment relative to asset-backed commercial paper (ABCP). Earnings a year ago would have been $61.2 million without the fair value adjustment for ABCP. The current quarter’s net income of $56.0 million is approximately 8.5% below the adjusted performance from a year ago. Unless otherwise indicated, the remainder of this commentary refers to operating results exclusive of the provision for loss (fair value adjustment) on ABCP.
The increase in net income over the prior quarter is driven by an $8.8 million reduction in the provision for credit losses; an $8.4 million increase in net interest income (driven by an increase in net interest spread from 2.61% last quarter to 2.71% in the current quarter); and a $4.9 million reduction with respect to non-interest expenses.
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. In absolute terms, an increase in loans resulted in an increase in net interest income despite lower net interest spreads in the current quarter. However year-over-year decreases in other income and increases in non-interest expense had a negative impact on the current quarter.
Net Interest Income
Net interest income was $172.8 million for the second quarter ended September 30, 2009, an increase of $8.5 million (or 5.2%) compared to the previous quarter and up $6.1 million (or 3.7%) compared to the second quarter last year. The increase in net interest income from last quarter was driven by increased pricing, with the net interest spread increasing from 2.61% to 2.71%. The increase from the prior year was driven by volume (loans increased by $1.8 billion, or 8.8%) and was partially offset by a reduction in net interest spread from 2.78% to 2.71%. ATB expects net interest income to increase over the coming quarters based on continued asset growth and stabilizing net interest spreads caused by continued strength in the base price of loans. Additional information on ATB’s exposure to interest rate risk as at September 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 $48.1 million over the following twelve-month period.
Other Income - excluding ABCP
Other income was $50.9 million for the second quarter ended September 30, 2009, a slight increase of $0.7 million (or 1.4%) compared to the prior quarter, and a $7.5 million (or 12.8%) decrease compared to the second quarter of last year. The decrease over the prior quarter was driven by a $7.5 million reduction in securitization income, offset by an increase of $6.0 million in derivative income. The newly securitized mortgages had lower yields than past securitization pools, resulting in a lower gain on sale. In addition, higher than expected liquidations during the quarter (i.e. mortgages either prepaid in full or restructured) from previous securitization pools had a negative impact on income.
The $7.5 million decrease in other income over the second quarter last year was a result of an $8.6 million reduction in securitization income and a $3.9 reduction in derivative income, partially offset by a $2.5 million increase in credit fees.
Credit Quality
ATB management remains satisfied with the overall credit quality of the portfolio at September 30, 2009, particularly considering the current economic environment and low commodity prices. 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.
The gross impaired loan balance continues to increase. At the end of the quarter it was $128.1 million, up from $114.1 million last quarter and from $61.4 million last year. Although this is a negative trend and is being closely monitored, it remains only a small percentage (less than 1%) of the loan portfolio. Another trend that is being monitored is the amount by which the current credit loss allowance exceeds gross impaired loans. At September 30, 2009, the total current credit loss allowance exceeded gross impaired loans by $82.3 million. This compares to $92.2 million at June 30, 2009 and $117.4 million at March 31, 2009. 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.
Non-Interest Expenses
Total non-interest expenses were $157.5 million for the second quarter ended September 30, 2009. This is $4.9 million (or 3.0%) lower than the expense in the prior quarter and $7.6 million (or 5.0%) higher than the expense in the second quarter of last fiscal year. The reduction over the prior quarter is due to lower salaries and benefits – mainly due to the reduction in employment contribution and benefit expense. The increase over the prior year is due to a combination of increased investment in staff, premises and technology. ATB management remains committed to operating efficiently, but is balancing this commitment with the goal of making key strategic investments in the organization which will have long term benefits and will result in better service to our customers delivered in a more productive manner.
ATB uses the efficiency ratio as one measure of 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 second quarter ended September 30, 2009, ATB’s efficiency ratio was 70.4%. This compares favorably to the 75.7% in the prior quarter but is unfavorable compared to the 66.6% achieved in the second quarter last year. Management expects that the efficiency ratio may worsen as the continued investment in growth initiatives continues – 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 increased this quarter to $27.2 billion, up from $26.5 billion last quarter and $25.2 billion last year. The increase from the prior quarter was driven by cash and liquid investments while the increase from the prior year was a result of loan growth.
Although there has been significant growth in the business loan portfolio over the last year (increasing by $1.0 billion, or 12.7%), this quarter saw a $290.9 million (or 3.2%) reduction. This reduction was driven by decreased loan utilization, as customers either had reduced financing requirements or replaced bank debt with less expensive capital market funding. ATB expects that quarter over quarter business loan growth will remain volatile in the future due to a combination of fluctuating demand for credit and increased competition in the marketplace with the easing of the credit crisis.
Residential mortgages were a source of growth with an increase of $633.3 million (or 7.4%) this quarter and $1.0 billion (or 12.7%) for the year (including securitized mortgages). This growth can be attributed to a special five year mortgage campaign that occurred during June, with the majority of loans funding this quarter.
On the liability side, ATB issued a new deposit product during the quarter. This product was marketed as the Alberta Growth Note and is reflected in the financial statements as a capital investment deposit. This is a five-year non-redeemable note that qualifies as tier 2 capital for capital adequacy purposes. Including this deposit, personal and business deposits increased slightly over the prior quarter to $20.8 billion, up from $20.7 billion last quarter and $19.6 billion last year.
In addition to regular personal and business deposits, ATB can also source funds through the issuance of wholesale deposits through an agreement with the Government of Alberta. The current agreement limits the total volume of such deposits to $4.3 billion. As at September 30, 2009, ATB has $3.6 billion in wholesale deposits. This is up by $610.6 million (or 20.1%) from last quarter and $270.6 million (or 8.0%) from last year. The increase in wholesale deposits was a major source of liquidity during the quarter. ATB is nearing the end of its negotiations with Alberta Finance and Enterprise for an increase in the funding limit for Wholesale Deposits.
Accumulated other comprehensive income decreased from $78.8 million last quarter to $63.2 million in the current quarter, reflecting the net temporary decrease in fair value of certain financial instruments.
Asset Backed Commercial Paper
As at September 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 $627.5 million and an expected maturity of between 4.25 and 7.25 years. This includes $960.6 million ($580.6 million fair value) of third-party-sponsored ABCP and $67.0 million ($46.9 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 continues to be no observable market price for these notes as at the balance sheet date, accordingly, ATB has 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 last quarter resulting in a reduced market discount rate. This would normally result in an increase in the estimated fair value of the notes held, but, as it relates to the MAV1 notes restructured under the Montreal Accord, ATB believes that there is sufficient uncertainty relative to the fair value of these notes that it would not be appropriate to make a significant positive adjustment to the valuation at this time. Although spreads have tightened again this quarter, 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. ATB received a payment of $2.3 million on the traditional notes during the quarter. A valuation gain of $2.5 million resulted in a $0.2 million increase in the quarter end carrying value of this investment, despite the principal payment.
ATB has adjusted the valuation of the other ABCP investments by a total of $3.5 million. This negative adjustment was driven by the downgrade of certain investments by Dominion Bond Rating Service this quarter and additional information on the underlying risk of certain investments.
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, the impact of certain accounting standards (Financial Instruments Standards and Accounting Guideline 4) and the PILOT are included within Other Business Units.
PBFS achieved asset growth of $849.7 million (or 4.8%) during the second quarter and $1.9 billion (or 11.4%) over the last 12 months. This asset growth, in combination with higher margins and lower expenses, resulted in a $5.1 million (or 21.2%) increase in net income over the prior quarter. Despite the growth in assets over the prior year, net income reduced by $11.5 million (or 28.1%). This decrease was driven by lower margins and higher expenses (including higher provisions for credit losses) in the current quarter.
CFS also achieved growth in its asset base over the last 12 months with an increase of $796.1 million (or 18.0%), but a reduction in the utilization of established credit lines by customers resulted in a decrease in assets over the prior quarter of $368.5 million (or 7.0%). Despite this decrease in assets over the prior quarter, CFS was able to increase net income over both the prior quarter and the prior year, with increases of $9.0 million and $30.5 million, respectively.
Investor Services continues to benefit from client growth and increased optimism in the equity markets, increasing assets under management and administration to $4.7 billion. This is an increase of $458.2 million (or 10.9%) from last quarter and $687.9 million (or 17.3%) from a year ago. Although this increase in assets under administration had a positive impact on revenue, Investor Services continues to report losses with a current quarter loss of $3.1 million (compared to $3.6 million last quarter and $1.4 million last year). Investor Services is continuing to invest in order to have capacity in its infrastructure to support a much larger business.
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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