Canadian Western Bank
Annual Report 1999

Plain-text annual report

C a n a d i a n We s t e r n B a n k { A N N UA L R E P O RT 1 9 9 9 e m e r g i n g TA B L E O F C O N T E N T S P a g e P a g e P a g e 2 5 9 P a g e 2 1 P a g e 4 3 P a g e 4 7 P a g e 5 3 P a g e 6 5 P a g e 6 6 P a g e 6 7 { { { { { { { { { { Highlights Message to Shareholders Corporate Overview Management’s Analysis of Operations and Financial Condition Corporate Governance Financial Statements Notes to Consolidated Financial Statements Executive Officers Board of Directors and Shareholder Information Banking Offices t h e e m e r g i n g a c c e p t a n c e ... of Canadian Western Bank as a strong, regional provider of financial services is a testament to our strategy. We balance the traditional banking relationships that our customers enjoy with a widening complement of services designed to meet the full scope of their financial needs. FINANCIAL • total assets increased by 13% to $2.7 billion • achieved record net earnings of $19.9 million, up 5% over last year • assets under administration and management increased 13% to $959 million • in accordance with industry-wide guidance provided by OSFI, the Bank increased its general allowance for credit risk by $11.7 million to $21.5 million via a one-time charge to retained earnings on April 30, 1999; our general allowance now represents over $2.00 per share • loan growth was very strong, particularly in the fourth quarter when the annualized growth rate exceeded 20% • changed to a semi-annual dividend policy in the third quarter; last annual dividend of $0.32 paid in January 1999 and first semi-annual dividend of $0.16 paid in July 1999 • Alberta and Saskatchewan announced reductions in capital tax rates effective fiscal 2000 • on November 30, 1999 the remaining $11.7 million of 6.75% convertible debentures converted to 925,200 shares, which strengthened our Tier 1 capital ratio and reduced the dilution of earnings per share going forward • the number of shares outstanding increased by almost 8% in the year h i g h l i g h t s f o r t h e y e a r OPERATIONAL • launched sales of mutual funds in 8 branches • relocated and expanded our branches in downtown Vancouver (to Park Place) and in Kelowna, British Columbia • opened a new branch in Langley, British Columbia • expanded our RSP product line with an equity-linked GIC • enhanced service to merchant accounts by adding an automated flow process for credit card receipts • Canadian Western Trust launched CWeb – a direct internet-based link to customer accounts for financial planners • completed all Y2K preparations on schedule P a g e 2 C W B ’9 9 { Five Year Financial Summary ($ thousands, except per share amounts) Results of Operations Total interest income Net interest income Provision for credit losses Other income Net income Return on common shareholders’ equity Return on average total assets Per Common Share Average common shares outstanding (thousands) Earnings per share basic fully diluted Dividends* Book value Market Price High Low Closing market value Balance Sheet and Off-balance Sheet Summary Assets Cash resources and securities Loans Deposits Debentures Shareholders’ equity Assets under administration and management Capital Adequacy Ratios Tier 1 Total Other Information Net interest margin** Net impaired loans as a percentage of total loans Productivity ratio*** Number of full time equivalent staff Number of branches FINANCIAL SUMMARY 1999 1998 1997 1996 1995 $ $ $ 177,504 62,436 3,750 19,795 19,853 12.82% 0.81% 10,153 1.96 1.79 0.48 15.68 24.25 17.30 17.60 $ $ $ 158,338 56,266 4,150 17,491 19,012 13.97% 0.87% 9,421 2.02 1.77 0.30 15.39 27.00 14.75 17.15 $ $ $ 131,917 45,414 4,000 11,520 15,837 13.12% 0.85% 9,322 1.70 1.55 0.25 13.70 22.10 12.20 20.25 $ $ $ 133,399 40,731 4,073 10,466 12,822 13.27% 0.81% 8,116 1.58 1.45 0.15 12.61 13.00 9.25 12.80 $ $ $ 113,413 33,973 3,403 6,876 10,808 13.36% 0.88% 7,420 1.46 1.33 0.10 11.37 11.38 9.13 10.13 $ 2,692,382 375,182 2,253,598 2,371,075 78,691 159,550 959,262 $ 2,386,478 320,405 1,989,656 2,059,545 87,091 145,268 845,614 $ 2,022,951 271,883 1,710,007 1,817,512 37,116 128,533 395,486 $ 1,754,072 247,614 1,478,392 1,585,855 26,000 102,554 371,798 $ 1,330,596 174,670 1,135,173 1,192,663 8,000 92,299 – 7.4% 11.8% 2.58% 0.5% 68.1% 555 24 7.8% 11.9% 2.60% 0.7% 66.7% 522 23 8.4% 11.0% 2.48% 0.5% 64.4% 388 22 8.1% 10.2% 2.59% 1.0% 64.8% 359 20 10.3% 11.1% 2.78% 1.8% 64.4% 314 20 * During the third quarter of 1999 the dividend policy was amended to be semi-annual instead of annual. Hence, the dividend rate for fiscal 1999 will appear unusually high as it includes a dividend of $0.32 paid annually in the first quarter (as in past years) and the first semi-annual dividend of $0.16 paid in the third quarter. ** Net interest income divided by average assets. *** Non-interest expenses expressed as a percentage of net interest income and other income. Total Assets ($millions) 2,692} 2,386} 2,023} 1,754} 1,331} Fully Diluted Earnings Per Common Share $1.79} $1.77} $1.55} $1.45} $1.33} 1995 1996 1997 1998 1999 1995 1996 1997 1998 1999 C W B ’9 9} P a g e 3 o u r MESSAGE TO SHAREHOLDERS Your Bank earned record net profit for the year ended October 31, 1999 in the amount of $19.9 million compared to $19.0 million last year. This is our 8th consecutive year of record earnings. Fully diluted earnings per share for the year stand at $1.79 compared to $1.77 last year. During the year, debenture conversions by holders increased the number of shares outstanding by almost 8% which gave rise to the decline in basic earnings per share to $1.96 compared to $2.02 last year.Total assets grew to approximately $2.7 billion, up 12.8% from the prior year end. Return on equity was 12.82% compared to 13.97% last year. In 1998, we further extended our financial services product line into the wealth management area by becoming the majority shareholder in Canadian Western Capital Limited. It has gone through a substantial restructuring but has not achieved the financial results we had expected. On December 21, 1999, subsequent to our year end, we announced an intended sale of this operation which we expect will have closed by publication date of this report. Removing the negative impact of this subsidiary’s operations (which amounted to $0.28 per share; $0.22 fully diluted compared to $0.17 per share; $0.12 fully diluted in 1998), income from our core banking operations (bank and trust) totalled $22.7 million, up 10% compared to $20.6 million last year.This is confirmation of the steady progress being made in our established operations. Further illustration comes in the fact that total assets grew 5% in the last quarter alone and our actual loan losses incurred have averaged .16% over the last 5 years – an enviably low ratio. m e s s a g e It is also in our core banking operation that we continue to see our longer term strategy affirmed by customer acceptance.We concentrate on a well defined geographic market and we provide professional and friendly personal service. It is our conviction that the competitive edge this strategy gives us will become more and more obvious as larger banks turn their attention to foreign markets and strive to improve earnings through cost cutting – and inevitably reductions in the levels of personal service.The opportunities for us include new customers, well-trained and qualified banking personnel seeking rewarding careers, and greater choice in prospective branch locations. Canadian Western Bank’s branch business model and product mix have a different focus than the “big bank” retail branch and we expect our differences will benefit us even more going forward. C W B ’9 9} P a g e 5 The regulatory environment for banks is also evolving and we are impacted by these changes. During the year, we responded to the industry-wide guidance provided by the Office of the Superintendent of Financial Institutions (“OSFI”) to materially increase the levels of the general allowances for credit risk in the industry. As a result, our general allowance now stands at almost 1% of risk- weighted assets; the equivalent of over $2.00 per share.This year’s operating results were not affected by this increase as it was taken as a one-time charge to retained earnings, the treatment OSFI specified when the change was significant (see Note 19 to the consolidated financial statements). In June, the federal Finance Minister announced policy reforms to the financial services sector. Included in these proposals was the stated intention to change ownership rules and open the door to single ownership of smaller banks such as Canadian Western Bank.The status quo – calling for a maximum 10% ownership by any one entity – would remain in place unless your Board of Directors determined it would be in the best interests of the Bank and its stakeholders to consider a change.The good news is that this proposal would broaden our options for forming beneficial alliances in the future. Another proposal in the Minister’s package with possible implications for your Bank is the introduction of a holding company concept.While it is premature to predict how this might be brought into effect, it could provide more alternatives for effective structuring of future strategic initiatives. Whether or not these proposals ultimately result in adjustments to your Bank’s structure, it is important that we continue to expand and build on our proven model.This year we added a branch in Langley and we moved our main Vancouver business to the ground floor of one of that city’s premiere downtown office towers – Park Place.We also took larger premises in Kelowna.These highly visible locations are expected to attract increased activity from both individuals and businesses.We augmented our service to retail merchants by putting into place arrangements for them to accept credit card receipts – and have the funds flow directly to their accounts with us. And our trust arm implemented an internet-based connection allowing financial planners to view their clients’ accounts with us. We have invested a considerable amount of time and effort in this fiscal year on computer-related issues.The most obvious of these is the Y2K project, but we have also been very involved in the selection of a more efficient platform on which to run our banking software. Both of these projects will be completed within the coming year making available more resources for further enhancement and development of products and services. P a g e 6 C W B ’9 9 { Our objective going forward is to concentrate on our business plan while striving for improvements to operating ratios through scale. Our expectation is for another record year ahead.We have well-trained people who are focused on success, the economic outlook is positive, and the environment is favorable for much greater acceptance of our brand of retail and commercial banking in western Canada. We entered this past decade with approximately $300 million in assets and we will exit with $2.7 billion, a nine-fold increase. Our earnings have grown some fourteen times, staff positions are up 400% and market capitalization has increased twelve times from what it was.Through the nineties we accessed the public markets three times and in so doing contributed to the growth in our regulatory capital base from $40 million to over $250 million today. We have emerged from this decade well equipped and motivated to meet the challenges of the next century. q u e s t i o n a n s w e r Q A { { Q A { { Q A { { Q A { { Q A { { How do you manage to achieve competitive rate spreads when your deposit rates are normally higher than others? First of all, our loan losses are lower and have been for 10 years. We also target commercial loans as a heavier weighting in the portfolio and they have better yields overall. It is also noteworthy that we achieve comparable spreads while maintaining a very attractive productivity ratio – our costs of operating are low. What ever happened to the small American bank you invested in? It is alive and well, growing in its market in Washington. The experience we have gained there is excellent. Do you plan to move further east with your branch network? We have no plans to move east with bricks and mortar. We do accept deposits from many eastern Canadians through our deposit agent network. Can you explain the large drop in share price? When you look at all of the banks in Canada, the drop in our share price has followed roughly the same pattern as theirs. For unknown reasons, the industry generally is less popular with investors right now. Is internet banking coming soon? We provide CWBDirect® today – business customers can get information directly on their accounts, and we plan to extend that. But we want to make sure our systems efficiencies augment and not replace our high quality personal service. C W B ’9 9} P a g e 7 e x p a n d i n g Mission { To provide competitive full service commercial and consumer banking to western Canadians. In doing so we aim to provide our shareholders with a sound and profitable return on their investment. There are two principal lines of business within the Canadian Western organization. Canadian Western Bank is the parent entity and the traditional banking operation.The only Schedule I bank headquartered in western Canada, it offers its services through 24 branches in all major centres across the four western provinces.The Bank is predominantly a commercial lender with specific expertise in commercial financing, energy lending, construction and real estate project financing, and industrial equipment financing. As well, a fully competitive range of deposit and retail services, residential mortgages and personal loans are offered. Canadian Western Trust Company specializes in the provision of trust and administrative services to financial planners in western Canada. It is also a mortgage lender and is broadening its trust service capabilities. o u r s c o p e A chronological summary of our growth follows: { { { { { 1982 Western & Pacific Bank of Canada chartered 1983 1988 Bank of Alberta chartered The two aforementioned banks are amalgamated as Canadian Western Bank 1993 Western Canadian branches of Metropolitan Trust acquired 1994 Canadian Western Bank and North West Trust Company amalgamated as Canadian Western Bank 1996 { Aetna Trust Company purchased and renamed Canadian Western Trust Company C W B ’9 9} P a g e 9 e x t e n d i n g CANADIAN WESTERN BANK The steady growth at Canadian Western Bank (”CWB“) is often attributed to its style of service. Whether personal or business customers, each one is served the way they want to be served.The most common desire we find people have is to deal face to face, which is being lost in the increasingly impersonal banking service delivery promoted by our larger competitors. There are exciting developments in banking technology and CWB provides automated services when requested to do so.The difference, though, is that innovative delivery methods and products are developed to react to customer needs. Even as these are brought on stream, our friendly people will continue to be in branches to tend to customers’ needs face to face. o u r r e a c h Western Canada continues to provide a positive and growing environment in which to grow our business along with our customers.And the Bank continues to present a positive image to its customers and prospective customers. As our customer base has continued to evolve in both size and sophistication, we have added capability to meet their requirements. An example is Canadian Western Trust… Jack Wright Vice President & Regional Manager “Customers repeatedly comment on how refreshing it is to talk to a real person, and not to have to leave a voice mail.” C W B ’9 9} P a g e 1 1 b u i l d i n g CANADIAN WESTERN TRUST COMPANY Canadian Western Trust (”CWT”) serves a different element of our market while offering the same individualized service. Since it joined the CWB family in 1996 it has emerged as one of only a few suppliers who provide trust products regionally to financial planners and companies in western Canada. This year CWT launched its interactive internet-based connection system under the name CWeb.This enables financial planners to connect directly into our database and gain online access to the detailed records of their clients at any time. Financial planners often don’t work regular hours; now they can still meet with their customers knowing they can answer any detailed question which may arise relating to their portfolio. o n s t r e n g t h s We recognize that some of the Bank’s customer base will be prospective users of the RSP and RIF trustee and administrative services provided by CWT and find this can complement the Bank’s overall financial service package nicely. An increased emphasis will begin in the upcoming year on corporate trust services.This will enable companies in western Canada to arrange for such services as escrow agent and bond trusteeship services through local people who are committed to the Specialty Service – Western Hospitality style of service. Adrian Baker General Manager, Canadian Western Trust “Consolidation in financial services has resulted in western Canada being underserved on the trust side. We’re filling that gap.” C W B ’9 9} P a g e 1 3 c o m b i n i n g The specific markets served by the Bank and the Trust, while different, frequently overlap. The thread that holds them together is the commitment to professional service delivered in a typical friendly western style. A team which includes representatives from each has been brought together to ensure we are in fact taking advantage of the opportunities presented by the combination of our individual strengths. o u r a b i l i t i e s This initiative is not limited to the marketing opportunities each may find in the others’ business spheres, but also the efficiencies that may be realized in consolidating resources in communications, computer technology, and marketing capability, to cite just a few examples. A team of professionals whose style of business appeals to western Canadians is here now. More and more westerners are recognizing the benefits of our team’s expanding capacity and focused approach to our chosen markets. As a result we are emerging as a credible alternative to larger institutions in the financial services industry. Doug Dalgetty Executive Vice President “Keeping up with technology advances doesn’t have to mean abandoning good customer service practices” C W B ’9 9} P a g e 1 5 p l a y i n g ENCOURAGING GROWTH Your Bank continues to be an integral part of the community through its support of care-giving, educational and artistic entities across western Canada. An example of this is the creation this year, in partnership with the University of Alberta, of a 10 year, $100,000 scholarship aimed at encouraging and supporting aboriginal students who want to enter U of A’s commerce faculty. We don’t see it as enough, though, to direct dollars alone to these various community needs. Our employees are consistently involved in such things as competing with other banks in a blood donor drive, organizing United Way participation by staff members, or volunteering their time to serve other various organizations. It is a further reinforcement that getting involved personally is an enriching and rewarding experience. important roles Our staff are also encouraged to put their personal knowledge and experience to work in improving the way the Bank operates. Our staff can make suggestions through our SPICE (Staff Participating In Creative Excellence) program. On an ongoing and regular basis suggestions are reviewed and implemented where appropriate. Two examples of this program in action were adopted this year. Adele Carson of our Systems department developed a way to improve daily audit routines by isolating exceptions in reporting. And Yasmin Kassamali of our Finance department identified an area where our fee income could be significantly improved while remaining fully competitive. Uve Knaak Senior AVP, Human Resources “We’re in a people business. Our people care about their customers and their communities.” C W B ’9 9} P a g e 1 7 INVITING INNOVATION Some staff members go beyond our expectations in the way they approach their responsibilities. For many years now we have recognized these people through President’s and Chairman’s awards. Nominations for recognition are made by their peers.This year’s award recipients are as follows: Chairman’s Awards Marie Barwick, Edmonton Southside Branch Esther Edwards, Corporate Office Christine Spence, Canadian Western Trust President’s Awards Gillian Bell, Chinook Branch, Calgary Clara Ho, CAP Department,Vancouver Marilyn Kruger, Main Branch, Calgary Shirley Maglalang, Finance Department Bret Pollard, Systems Department Anita Smith, Nanaimo Branch P a g e 1 8 C W B ’9 9 { f i n a n c i a l r e p o r t P a g e 2 1 P a g e 2 1 P a g e 2 2 P a g e 2 3 P a g e 2 4 P a g e 2 5 P a g e 2 6 P a g e 2 7 P a g e 2 8 P a g e 3 0 P a g e 4 2 { { { { { { { { { { { P a g e 4 3 P a g e 4 3 P a g e 4 3 P a g e 4 4 P a g e 4 5 P a g e 4 5 P a g e 4 6 P a g e 4 6 P a g e 4 6 P a g e 4 7 P a g e 4 7 P a g e 4 8 P a g e 4 9 P a g e 5 0 P a g e 5 1 P a g e 5 2 P a g e 5 3 { { { { { { { { { { { { { { { { { Management’s Analysis of Operations and Financial Condition Overview of 1999 Net Interest Income Other Income Non-interest Expenses Taxes Loans Deposits Capital Funds and Adequacy Risk Management Off-balance Sheet Financial Instruments Including Derivatives Corporate Governance Introduction The Board and Board Committees Audit Committee Conduct Review Committee Corporate Governance & Human Resources Committee Loans Committee Other Areas of Consideration Conclusion Financial Statements Management’s Report Auditors’ Report Consolidated Balance Sheet Consolidated Statement of Income Consolidated Statement of Changes in Shareholders’ Equity Consolidated Statement of Cash Flow Notes to Consolidated Financial Statements P a g e 5 C W B ’9 9 { C W B ’9 9} P a g e 5 MANAGEMENT’S ANALYSIS OF OPERATIONS AND FINANCIAL CONDITION Key Performance Indicators Net income ($ thousands) Net income per common share basic fully diluted Productivity ratio(1) (expenses as a percentage of total revenue) Return on common shareholders’ equity Return on average total assets 1999 $ 19,853 $ $ 1.96 1.79 59.84% 12.82% 0.81% 1998 $ 19,012 $ $ 2.02 1.77 60.65% 13.97% 0.87% 1999/1998 Increase (decrease) $ 841 $ (0.06) $ 0.02 (0.81)% (1.15)% (0.06)% (1) Excluding the operations of Canadian Western Capital due to its intended sale described below. The consolidated ratio was 68.09% (1998 – 66.72%). A decrease in the ratio reflects improved productivity. OVERVIEW OF 1999 Consolidated net income for the year ended October 31, 1999 was $19.9 million, an increase of 5% from $19.0 million reported in 1998. Fully diluted earnings per share were $1.79 compared to $1.77.The average number of shares outstanding increased by 732,000 during the year, primarily as a result of debenture conversions by holders, which gave rise to the decline in basic earnings per share to $1.96 from $2.02 last year. Subsequent to year end, the remaining 6.75% debentures were converted to common shares (as discussed in the Capital Funds and Adequacy section).This will impact basic earnings per share in fiscal 2000, due to the increased number of shares, and further narrow the difference between basic and fully diluted earnings per share. Return on common shareholders’ equity and return on assets for the year ended October 31, 1999 were 12.82% and 0.81% respectively, compared to 13.97% and 0.87% last year. Total assets increased by 13% from one year ago to reach $2.69 billion. Loans increased by $264 million, providing 86% of the total asset growth.The total capital adequacy ratio at October 31, 1999 was 11.8% (1998 – 11.9%) with a Tier 1 component of 7.4% (1998 – 7.8%). Net income for 1999 includes a loss (net of non-controlling interest) of $2.9 million (1998 – $1.6 million) related to Canadian Western Capital Limited (“CWC”), the Bank’s investment dealer subsidiary, which has undergone major restructuring. Excluding the impact of CWC’s results, growth in net income would have been 10% year over year and earnings per share would have been $0.28 greater ($0.22 fully diluted) in fiscal 1999 (1998 – $0.17 and $0.12 respectively). Return on equity and return on assets would have been 14.42% and 0.93% respectively compared to 15.09% and 0.95% last year.While CWC has contributed positively to expansion of non-interest revenues, the improvement in the net operating results anticipated subsequent to the restructuring completed earlier in the year has not materialized. On December 21, 1999, subsequent to the 1999 fiscal year end, the Bank announced that, subject to due diligence, regulatory approvals, execution of a definitive agreement and minority shareholders’ acceptance, it will sell CWC to Goepel McDermid Inc. of Vancouver.The Bank estimates a loss from discontinued operations of between $1.8 million and $3.8 million will be recorded in the first quarter ending January 31, 2000.A continuing relationship within the brokerage industry will be maintained by pursuing mutually advantageous business relationships and strategic alliances where appropriate. Management’s Analysis of Operations and Financial Condition} P a g e 2 1 Table 1 – Net Interest Income ($ thousands) Assets Securities and deposits with NET INTEREST INCOME 1999 1998 Average Balance Mix Interest Interest Rate Average Balance Mix Interest Interest Rate regulated financial institutions $ 262,432 11% $ 13,069 4.98% $ 240,009 11% $ 11,213 4.67% Loans Securities purchased under resale agreements and call loans Residential mortgages Other loans Total loans Total interest bearing assets Other assets Total Assets Liabilities Deposits Demand Notice Fixed term Total deposits Other liabilities Debentures Shareholders’ equity Total Liabilities 28,645 272,868 1,795,917 2,097,430 2,359,862 63,246 1 11 74 86 97 3 1,377 18,618 144,440 164,435 177,504 – 4.81 6.82 8.04 7.84 7.52 0.00 24,895 265,857 1,569,589 1,860,341 2,100,350 60,225 1 12 73 86 97 3 1,177 17,997 127,951 147,125 158,338 – 4.73 6.77 8.15 7.91 7.54 0.00 $ 2,423,108 100% $ 177,504 7.33% $ 2,160,575 100% $ 158,338 7.33% $ 35,447 2% $ – 0.00% $ 33,066 2% $ – 0.00% 192,634 1,878,601 2,106,682 81,867 79,332 155,227 8 77 87 3 3 7 4,676 105,504 110,180 – 4,888 – $ 2,423,108 100% $ 115,068 2.43 5.62 5.23 0.00 6.16 0.00 4.75% 2.58% 186,386 1,662,809 1,882,261 76,697 66,406 135,211 9 76 87 4 3 6 4,393 93,343 97,736 – 4,336 – $ 2,160,575 100% $ 102,072 $ 2,160,575 $ 56,266 2.36 5.61 5.19 0.00 6.53 0.00 4.72% 2.60% Total Assets/Net Interest Income $ 2,423,108 $ 62,436 Net interest income is the difference between interest and dividends earned on assets and interest expensed on deposits and other liabilities, including debentures. Net interest spread, or margin, is net interest income as a percentage of average total assets. In 1999, net interest income increased by $6.2 million or 11%, primarily due to: • increased average interest bearing assets of $260 million (12%). Net interest spread was 2.58%, down slightly from 2.60% in 1998.The portfolio mix remained relatively constant year over year and the average prime rate also remained stable at 6.49% in fiscal 1999 compared to 6.44% last year. In 2000 we expect: • • interest rates will remain relatively stable; and the yields on securities and net interest spread will be comparable to 1999. As discussed in the Interest Rate Risk section, the portfolio has a positive gap with maturing assets exceeding maturing liabilities during the one year time frame. If market rates increase this would have a positive impact on spreads. P a g e 2 2 Management’s Analysis of Operations and Financial Condition { Table 2 – Other Income ($ thousands) OTHER INCOME Credit related Underwriting fees and commissions on securities transactions Retail services Trust services Loan administration and other(1) Net gains on securities sales Total Other Income 1999/1998 Increase (decrease) 1999 $ 7,805 1998 $ 6,729 $ $ 1,076 6,778 2,476 1,485 990 261 5,326 1,964 1,165 2,241 66 1,452 512 320 (1,251) 195 $ 19,795 $ 17,491 $ 2,304 % 16% 27 26 27 (56) 295 13% (1) Other includes gains and losses on capital asset disposals, foreign exchange service fees and other miscellaneous non-interest revenues. Other income, which includes all revenues not classified as net interest income, was $19.8 million, an increase of $2.3 million or 13% over 1998.As shown in table 2, almost all categories of other income showed solid growth in 1999. Notable changes include: • increased credit and retail fees of $1.6 million due to loan and deposit growth and increased activity in the retail branches; an increase of $1.5 million in underwriting fees and commissions on securities transactions reflecting a full year of CWC’s operations and growth in their branch network; increased trust services fees in Canadian Western Trust (“CWT”) due to substantial growth (32%) in the number of self-directed RRSP accounts; and • • • decreased loan administration fees because 1998 included a $750,000 one-time contingency fee earned on the collection of an administered loan and also the administered portfolio and related contract fees have declined over the past year. Other income as a percentage of total revenue (net interest income and other income) was 24% in 1999, the same as in 1998. In 2000 total other income is expected to show continued broad based growth (with the exception of underwriting fees and commissions due to the intended sale of CWC) with a focus on increasing other income as a percentage of total revenue. Management’s Analysis of Operations and Financial Condition} P a g e 2 3 Table 3 – Non-interest Expenses and Productivity Ratio ($ thousands) NON-INTEREST EXPENSES 1999/1998 Increase (decrease) 1999 1998 $ $ 26,717 $ 23,295 3,565 30,282 3,057 26,352 4,443 950 918 6,311 1,713 2,088 3,801 2,976 1,695 3,446 1,579 1,239 826 842 932 3,471 818 744 5,033 1,524 1,969 3,493 2,485 2,452 3,016 1,389 1,092 755 737 783 2,062 15,597 1,627 14,336 $ 55,991 $ 49,214 $ 62,436 19,795 $ 82,231 68.1% 59.8% $ 56,266 17,491 $ 73,757 66.7% 60.7% $ 3,422 508 3,930 972 132 174 1,278 189 119 308 491 (757) 430 190 147 71 105 149 435 1,261 $ 6,777 $ 6,170 2,304 $ 8,474 % 14.7% 16.6 14.9 28.0 16.1 23.4 25.4 12.4 6.0 8.8 19.8 (30.9) 14.3 13.7 13.5 9.4 14.2 19.0 26.7 8.8 13.8% 11.0% 13.2 11.5% The productivity ratio increased to 68.1% from 66.7% in 1998 as revenue growth of 11.5% was more than offset by expense growth of 13.8%. CWC’s wealth management operations have an inherently higher productivity ratio which together with the effect of restructuring and building its operations has resulted in the deterioration of the consolidated ratio year over year. Excluding the wealth management segment the productivity ratio improved to 59.8% from 60.7% in 1998. Non-interest expenses as a percentage of average assets was 2.27% in 1999, basically unchanged from 2.28% in 1998. Salaries and Employee Benefits Salaries Employee benefits Total Premises Rent Depreciation Other Total Equipment and Furniture Depreciation Other Total General Capital and business taxes Deposit insurance premiums Professional fees and services Postage and stationery Marketing and business development Travel Banking charges Communications Other Total Total Non-interest Expenses Productivity Ratio Net interest income Other income Total revenue Productivity Ratio (expenses as a percentage of total revenue) Productivity Ratio, excluding the wealth management segment Non-interest expenses increased $6.8 million to $56.0 million in 1999.The increase in non-interest expenses was limited to 4.2% if the following are excluded: • increased expenses in CWC ($3.2 million) due to inclusion of a full year of expenses as well as costs related to restructuring and growth in its branch network; and incremental costs for new branch initiatives ($1.5 million). • These increases were partially offset by a significant reduction in deposit insurance premiums as a result of the new premium rates which took effect May 1, 1999. P a g e 2 4 Management’s Analysis of Operations and Financial Condition { In 2000 we expect: • the full time staff complement will increase by approximately 8% to accommodate growth in volumes and increased activity in branches; and • other increases in non-interest expenses will be primarily attributable to volume increases from growth. Capital expenditures of $4.9 million are budgeted for 2000 and will be funded from general operating revenues. Approximately 80% of this total relates to proposed expenditures on computer hardware and software with the majority allocated to the move of the banking software to a new operating environment.At year end there were specific commitments for approximately $500,000 of these capital expenditures. In November 1999 additional commitments totalling approximately $2.1 million were made regarding the banking software project. Productivity Ratio* 1999 1998 1997 1996 1995 { 59.8% { 60.7% { 64.4% { 64.8% { 64.4% *excluding the wealth management segment (see Table 3) TAXES As a result of the amalgamation with B.C. Bancorp (“BCB”), in fiscal 1997, the Bank assumed approximately $15.0 million in tax loss carryforwards, and $83.0 million in unclaimed tax deductions which are available for deduction in computing net income for tax purposes without time limitation. Of the consideration received by the BCB shareholders, $10.3 million was allocated to a deferred income tax asset which is being amortized to current income tax expense over the same period as the losses and unclaimed deductions are utilized. The current income tax provision represents amortization of acquired unclaimed deductions and tax loss carryforwards of $2.7 million (1998 – $2.5 million) and large corporations tax of $552, 000 (1998 – $533,000). Deferred income taxes arise from current year timing differences related to claiming deductions for income tax purposes on a basis different from accounting and relate primarily to the provision for credit losses.The Bank has reasonable assurance that its net deferred income tax asset will be realized through future reversals of timing differences. Income taxes otherwise payable by the Bank for the year ended October 31, 1999 were eliminated by utilizing approximately $24.8 million (1998 – $23.7 million) of acquired unclaimed deductions and tax loss carryforwards. At October 31, 1999, the Bank has approximately $44.7 million of unclaimed deductions which are available to reduce future years’ income for tax purposes.The Bank’s subsidiaries have $9.0 million of tax loss carryforwards, which expire up to 2006.The tax benefit of these losses has not been recognized in income. Table 4 – Capital Taxes ($ thousands) British Columbia Alberta Saskatchewan Manitoba Total Capital Taxes Capital Tax Rate 1.00% 2.00%(1) 3.25% 3.00% Capital Allocation(2) 41% 51% 5% 3% 1999 $ 787 1,558 305 172 1998 $ 700 1,192 296 143 $ 2,822 $ 2,331 1999/1998 Increase (decrease) $ % $ 87 366 9 29 $ 491 12.4% 30.7 3.0 20.3 21.1% (1) Capital tax for financial institutions headquartered in Alberta is limited to 10% of pre-tax net income allocated to Alberta provided that value is less than Alberta capital taxes otherwise payable. This reduction decreases on a relative basis when a financial institution’s capital base totals more than $100 million and is eliminated when its capital base reaches $200 million. The Bank’s taxable capital base was approximately $166 million at October 31, 1999 (1998 – $140 million). (2) These capital allocation percentages are for the Bank only although total capital tax includes capital taxes paid in British Columbia by subsidiaries. Management’s Analysis of Operations and Financial Condition} P a g e 2 5 Capital tax for 1999 totalled $2.8 million compared to $2.3 million in 1998.The increase is primarily attributable to: • • increased capital due to the retention of earnings; increased profitability, which increased the Alberta capital tax; and a reduction of $196,000 (1998 – $108,000) in the remission amount respecting Alberta capital tax. • In 2000 capital taxes will decrease due to changes introduced to the capital tax structure for financial institutions in the provinces of Alberta and Saskatchewan that take effect in fiscal 2000. In Alberta the capital tax base will now be harmonized with the federal capital base and the tax rate drops from 2.0% to 0.7% on the first $400 million of capital.The lower rate replaces the relief previously provided in the form of a remission calculation for financial institutions headquartered in Alberta. In Saskatchewan the rate was lowered from 3.25% to 0.7% for financial institutions with capital of $400 million or less. The goods and services tax (GST) carries with it a significant cost to the Bank as it does to all financial institutions to the extent that GST paid is not recoverable through increased service charges, increased loan costs or reduced deposit rates. This is because the majority of the Bank’s activities, except leasing, loan administration and trust services, are exempt under GST legislation and thus GST cannot be charged and collected from customers as occurs in the majority of Canadian businesses.As a result, the ability to recover the GST paid on most purchased goods and services is lost. The estimated cost of unrecoverable GST during 1999 was $1.1 million compared to $872,000 in 1998. Table 5 – Outstanding Loans by Portfolio Type and by Provincial Location of Branch LOANS Alberta Saskatchewan Manitoba Total(1) Composition % ($ millions) October 31, 1999 Loans to Individuals Residential mortgages Other Total Loans to Businesses Securities purchased under resale agreements and call loans Commercial Construction and real estate Industrial Energy Total Total Loans Composition % October 31, 1998 Loans to Individuals Residential mortgages Other Total Loans to Businesses Securities purchased under resale agreements and call loans Commercial Construction and real estate Industrial Energy Total Total Loans Composition % British Columbia $ 162 39 201 – 295 469 162 – 926 $ 1,127 $ 91 49 140 41 243 279 201 48 812 $ 952 $ 16 11 27 – 13 44 17 – 74 $ 101 $ 3 4 7 – 13 65 15 – 93 $ 100 $ 272 103 375 41 564 857 395 48 1,905 $ 2,280 50% 42% 4% 4% 100% $ 161 35 196 – 257 408 151 – 816 $ 1,012 $ 89 53 142 29 191 219 175 61 675 $ 817 $ 24 10 34 – 8 26 22 – 56 $ 90 $ 3 4 7 – 15 49 16 – 80 $ 87 $ 277 102 379 29 471 702 364 61 1,627 $ 2,006 51% 41% 4% 4% 100% 12% 4 16 2 25 38 17 2 84 100% 14% 5 19 1 24 35 18 3 81 100% (1) This table does not include an allocation of the allowance for credit losses and deferred revenue and discounts. P a g e 2 6 Management’s Analysis of Operations and Financial Condition { Loans, as reported on the consolidated balance sheet, totalled $2.25 billion at the end of 1999 compared to $1.99 billion at the end of 1998, an increase of 13%. Highlights of the year over year changes are: Portfolio • growth in commercial loans of $93 million (20%) which represents 25% of the portfolio versus 24% one year ago; • • • growth in construction and real estate loans of $155 million (22%) which represents 38% of the portfolio versus 35% a year earlier; an increase in the industrial portfolio of $31 million (9%); a reduction in the energy portfolio, a specialty in our Calgary market, of $13 million (21%); and a marginal decrease in loans to individuals of $4 million (1%) which represents 16% of the portfolio versus 19% a year ago. • Location • loan growth of $115 million (11%) in British Columbia and $159 million (16%) in the prairie provinces; and a relatively constant overall percentage distribution by province. • Loans by Portfolio Construction and real estate Commerical Energy 38%{ { { 25% 2% Industrial 17% Personal 16% Securities purchased under resale agreements and call loans 2% { { { In 2000 the Bank’s business plan focuses on continued growth in all portfolios.Although the market remains competitive, significant overall loan growth is planned for 2000 as the Bank expands its activities. DEPOSITS Table 6 – Deposits ($ thousands) Canadian Currency Personal chequing and savings Business demand and savings Fixed term: Under $100,000 $100,000 and over Registered retirement products Total Foreign Currency (Canadian equivalent) Total Deposits Deposits grew to $2.37 billion, an increase of 15%. The analysis of these deposits is presented in Table 6. Highlights of the year include: • a stable mix of deposit type for this year and anticipated going forward; and increased total deposits raised in our retail branches of almost 16%. • The mix of deposits by source remained relatively consistent with last year: • branches – 47% (1998 – 45%) • deposit agents – 49% (1998 – 50%) • wholesale clients – 4% (1998 – 5%) 1999 1998 Amount % of Total Amount % of Total $ 86,933 172,734 1,289,839 312,203 498,384 2,360,093 10,982 3.7% 7.3 $ 82,740 168,270 54.4 13.1 21.0 99.5 0.5 1,120,740 260,499 417,792 2,050,041 9,504 4.0% 8.2 54.4 12.6 20.3 99.5 0.5 $ 2,371,075 100.0% $ 2,059,545 100.0% CWT, whose portfolio mix is included in the above numbers, does not have retail branches and so gathers most of its deposits through deposit agents, although $30.9 million (1998 – $20.7 million) of CWT’s portfolio was generated through the Bank’s retail branches. Retail branch deposits are generally considered to be more stable and our ongoing objective is to focus growth strategies on this source.Agent deposits are slightly more expensive because a commission is paid, but this added cost is countered by a reduced need for establishment of an extensive branch network. Management’s Analysis of Operations and Financial Condition} P a g e 2 7 Deposits by Source ($ millions) 1999 1998 1997 1996 1995 { { { { { 1108 1176 87 958 1007 95 828 859 131 703 786 97 627 475 91 Branches Agent Wholesale Table 7 – Capital Structure and Regulatory Ratios at Year End ($ thousands) CAPITAL FUNDS AND ADEQUACY Tier 1 Capital Retained earnings Common shares Non-controlling interest in subsidiary Less unamortized goodwill Total Tier 2 Capital (gross) General allowance for credit losses (Tier A)(1) Subordinated debentures (Tier B) Total Total Less regulatory limitation on inclusion of debentures(2) Total Regulatory Capital Regulatory Capital to Risk-weighted Assets Tier 1 capital Tier 2 capital Total Regulatory Capital Adequacy Ratio Assets to Regulatory Capital Multiple(3) 1999 1998 $ 61,066 $ 55,673 98,484 234 (448) 159,336 15,996 78,691 94,687 254,023 – 89,595 331 (520) 145,079 2,767 87,091 89,858 234,937 (14,716) 1999/1998 Increase (decrease) $ 5,393 8,889 (97) 72 14,257 13,229 (8,400) 4,829 19,086 14,716 $ 254,023 $ 220,221 $ 33,802 7.4% 4.4% 11.8% 10.8 7.8% 4.1% 11.9% 11.0 (0.4)% 0.3 % (0.1)% (0.2) (1) Banks are allowed to include their general allowance for credit losses up to a prescribed percentage of risk-weighted assets in Tier 2A capital. The Bank has been granted an inclusion rate of 0.75% (1998 – 0.15%) of risk-weighted assets. (2) The maximum amount of subordinated debentures that can be included in Tier 2B capital for regulatory purposes is 50% of Tier 1 capital. In 1999, there is no excess Tier 2B capital but in 1998 Tier 2B capital was reduced by $14,716 resulting in regulatory Tier 2 capital of $75,142. (3) Total assets plus off-balance sheet credit instruments, such as letters of credit and guarantees, less goodwill divided by total regulatory capital. P a g e 2 8 Management’s Analysis of Operations and Financial Condition { Table 8 – Risk-weighted Assets ($ thousands) Balance Sheet Assets Cash resources Securities Loans Other assets Total Credit Instruments(1) (contract amounts) Guarantees and standby letters of credit Commitments to extend credit(2) Total Derivative Financial Instruments(3) (notional amounts) Interest rate contracts Equity contracts Total Total Risk-weighted Assets (1) See Note 11 to the Consolidated Financial Statements for further details. (2) Greater than one year only. (3) See Note 15 to the Consolidated Financial Statements for further details. The Office of the Superintendent of Financial Institutions (“OSFI”) requires banks to measure capital adequacy in accordance with instructions for determining risk-adjusted capital and risk-weighted assets including off-balance sheet commitments. Based on the deemed credit risk of each type of asset a weighting of 0% to 100% is assigned. Published regulatory guidelines require banks to maintain a minimum ratio of capital to risk-weighted assets and off-balance sheet items of 8%, of which 4% must be core capital (Tier 1) and the remainder supplementary capital (Tier 2). However, OSFI strongly encourages Canadian banks to maintain a minimum total capital adequacy ratio of 10% with a Tier 1 ratio of not less than 7%. In the Bank,Tier 1 capital is comprised of common shareholders’ equity and Tier 2 capital includes subordinated debentures (to the regulatory maximum amount of 50% of Tier 1 capital) and an inclusion of the general allowance for credit losses at a prescribed inclusion rate based on risk-weighted assets. In tandem with the one-time increase in the general allowance for credit risk (see Note 1(d) to the Consolidated Financial Statements), OSFI authorized the inclusion of the general allowance in Tier 2A capital at up to 75 basis points (0.75%) of risk- weighted assets. Previously the inclusion rate was 15 basis points (0.15%).The net effect of the one-time increase in the general was a decrease in the Tier 1 capital ratio (from the charge to retained earnings) but an increase in the total capital ratio (from the higher Tier 2A inclusion rate). 1999 Risk- weighted Balance 33,685 40,287 2,001,990 54,709 Balance $ 169,990 $ 205,192 2,253,598 63,602 1998 Risk- weighted Balance 31,459 28,208 1,713,087 56,063 Balance $ 159,538 $ 160,867 1,989,656 76,417 $ 2,692,382 $ 2,130,671 $ 2,386,478 $ 1,828,817 $ $ $ $ 27,479 843 28,322 269,000 2,200 271,200 $ $ $ $ 17,659 422 18,081 49 35 84 $ $ $ $ 21,457 638 22,095 130,000 – 130,000 $ $ $ $ 18,231 319 18,550 112 – 112 $ 2,148,836 $ 1,847,479 Capital funds are managed in accordance with policies and plans that are regularly reviewed and approved by the Board of Directors and which take into account forecasted capital needs and markets.The goal is to maintain adequate regulatory capital to provide enough support for internally generated growth and strategic opportunities that do not otherwise require accessing the public capital markets, while still improving the return on equity through the most efficient capital mix. At October 31, 1999 the total regulatory capital ratio coverage was 11.8% (1998 – 11.9%) of which 7.4% (1998 – 7.8%) was Tier 1 capital.Total regulatory capital increased $33.8 million over 1998 as a result of: • earnings net of dividends, of $15.0 million; • the increased inclusion rate of the general allowance for credit risk; share capital of $489,000 issued upon the exercise of 68,977 stock options, net of 10,300 shares purchased for cancellation under the normal course issuer bid; offset by charges to retained earnings of: • • $6.5 million which represents the increase in the general allowance for credit risk of $11.7 million, net of deferred income taxes of $5.2 million; and • $3.1 million which represents the consideration paid by the Bank for the conversion option on a debenture redemption. Management’s Analysis of Operations and Financial Condition} P a g e 2 9 Subordinated debentures include both convertible ($65.6 million) and conventional ($13.1 million) debentures. Note 8 to the Consolidated Financial Statements details the terms of the debentures. During the year $8.4 million of the 6.75% convertible debentures were converted by debentureholders into 672,000 shares at a $12.50 per share conversion price which resulted in a transfer from Tier 2 to Tier 1 capital. On October 29, 1999 the Bank provided notice of its intention to convert all of the outstanding 6.75% convertible debentures to common shares on December 1, 1999.As a result of the notice the remaining $11.6 million debentures were converted by debentureholders on November 30, 1999 at a conversion price of $12.50 per share. Had the conversions occurred on October 31, 1999 the total capital ratio would not have been affected but the Tier 1 capital ratio would have strengthened to 8.0%. In July, a $4.0 million 9% convertible debenture with a conversion price of $11.00 was redeemed for $7.1 million with the excess of total consideration paid over the face value of the debenture attributed to the conversion option and charged to retained earnings.A new $4.0 million ten year debenture, convertible at $25.00 was issued at a fixed interest rate of 5.70% for the first five years. During the third quarter of 1999 the Bank’s dividend policy was amended to be semi-annual instead of annual. In January 1999 the annual dividend of $0.32 per share was paid and in July the first semi-annual dividend of $0.16 was paid. Hence the dividend rate for fiscal 1999 appears unusually high. The Bank has share option plans that are provided as an incentive to officers and employees who are in a position to materially impact the longer term financial success of the Bank as measured by shareholder wealth. Note 9 to the Consolidated Financial Statements details the number of shares under option outstanding, the weighted average exercise prices and the amounts exercisable. On November 4, 1998 the Bank implemented a normal course issuer bid for a twelve-month period which allowed the Bank to purchase for cancellation up to 472,036 common shares, or 5% of its outstanding common shares. The bid was implemented because management considered the shares to be undervalued and viewed a repurchase program as an appropriate use of the Bank’s funds. In October 1999 the Bank purchased 10,300 shares for cancellation, at $17.50 per share.The normal course issuer bid expired November 3, 1999. P a g e 3 0 Management’s Analysis of Operations and Financial Condition { Overview RISK MANAGEMENT The Bank’s risk management policies continue to evolve and improve in order to accommodate the new challenges that come with growth, expansion and changes in the regulatory and public domain. Effective risk management is central to the ability to remain strong and profitable and includes identifying, assessing, managing and monitoring all forms of risk.The Bank is primarily exposed to four basic types of risk: • credit risk; • liquidity risk; • market risk; and • operational risk. The most senior executives are responsible for identifying risks and establishing appropriate risk management policies and frameworks.The Board of Directors, either directly or through its committees, reviews and approves the key policies, and implements specific reporting procedures to enable them to monitor ongoing compliance over significant risk areas.At least annually a report on significant internal controls is presented to the Board and the Audit Committee. The Loans Committee of the Board, which maintains a close working relationship with the credit risk management group, is responsible for: • the review and approval of credit risk management policies; loans in excess of delegated limits; the review and monitor of impaired and other less than satisfactory loans; and the recommendation of the adequacy of the allowance for credit losses to the Audit Committee. • • • At the operational level, the Asset Liability Committee (“ALCO”) plays a key role in the management of liquidity and market risk.ALCO is a management committee chaired by the Senior Vice President, Corporate & Strategic Operations with the President and CEO and other senior executives as members and is responsible for: • the establishment and maintenance of policies and programs for liquidity management and control, funding sources, investments, foreign exchange risk, interest rate risk and derivatives; and regular meetings to review compliance and discuss strategy in this area. • Asset liability management policies are approved and reviewed at least annually by the Board with quarterly status reporting provided to the Board. • annual reviews of individual credit facilities (excepting consumer loans and residential mortgages); • diversification of risk by client, geographic area, industry The Operations Committee meets regularly and is made up of experienced bank officers from all areas of operations and is chaired by a member of senior management.This committee is responsible for developing appropriate policies and procedures, including internal controls, respecting day-to-day, routine operations. The internal audit group performs inspections in all areas of the Bank, including CWT and CWC, and reports the results directly to senior management, the President and CEO and the Audit Committee. Credit Risk Management Credit risk is the risk that a financial loss will be incurred due to the failure of a counterparty to discharge its contractual commitment or obligation to the Bank.This risk can relate to balance sheet assets, such as loans, as well as off- balance sheet assets such as guarantees and letters of credit. To diversify the risk, the exposure to a single borrower or associated borrowers is limited to $15 million. In special circumstances, exposure can be increased to an amount not exceeding 10% of capital funds. The Bank employs and is committed to a number of important principles to manage credit exposures which include: • a Loans Committee of the Board whose duties include approval of lending policies, establishment of lending limits for the Bank, the delegation of lending limits and the review of larger credits as well as quarterly reports prepared by management on watch list loans, impaired loans, the adequacy of the allowance for credit losses, environmental risk and diversification of the portfolio; • delegated lending authorities which are clearly communicated to personnel engaged in the credit granting process, a defined approval process for loans in excess of limits and the review of larger credits by a senior management group prior to recommendation to the Loans Committee of the Board; • credit policies, guidelines and directives which are communicated to all branches and officers whose activities and responsibilities include credit granting and risk assessment; appointment of personnel engaged in credit granting who are qualified, experienced bankers; a standardized credit risk rating classification established for all credits and reviewed not less than annually; • • sectors and products; • pricing of credits commensurate with risk to ensure appropriate compensation; • management of growth within quality objectives; • early recognition of problem accounts and immediate implementation of steps to protect the safety of Bank funds; independent annual reviews of credit valuation, risk classification and credit management procedures by the internal audit group which include reporting the results to senior management, the President and CEO and the Audit Committee; and • • detailed quarterly reviews of accounts rated less than satisfactory including a watch list report recording accounts with evidence of weakness, an impaired loan report covering loans which show impairment to the point where a loss is probable, and the establishment of an action plan for each account. Environmental Risk The operations conducted by the Bank do not impose a material effect on the environment. However, losses can be incurred if a borrower is unable to repay loans due to environmental clean up costs, or if the Bank becomes directly liable for clean up costs if it is deemed to have taken control or ownership of a contaminated property. Risk assessment criteria and procedures are in place to manage environmental risks and these are communicated to lending personnel. Reports on environmental inspections and findings are reviewed by senior management and reported upon quarterly to the Board. Portfolio Quality The Bank’s strategy is to continually improve and maintain a quality portfolio. Efforts are directed towards achieving a wide diversification, engaging experienced personnel who provide a hands on approach in credit granting, account management and quick action when problems develop. The lending focus is primarily directed to small and medium-sized businesses and individuals with operations conducted in the four western provinces. Relationship banking and “know your customers” are important tenets of account management.An appropriate financial return on the level of risk is fundamental. Management’s Analysis of Operations and Financial Condition} P a g e 3 1 Table 9 – Change in Gross Impaired Loans ($ thousands) Gross impaired loans, beginning of year Net additions Write-offs Total Gross Impaired Loans as a Percentage of Total Loans Impaired Loans Gross impaired loans increased $11.8 million in 1999 reflecting a general softening in the British Columbia economy.As shown in Table 9, gross impaired loans total $38.2 million representing 1.69% (1998 – 1.32%) of total outstanding loans. Impaired loans net of the allowance for credit losses have decreased over the past year and represent 0.54% (1998 – 0.68%) of net loans outstanding.The impaired loan outlook going forward into 2000 is expected to be favourable as economic conditions are trending positively. Table 10 shows the year over year change to the allocation of the allowance for credit losses to specific provisions by category of impaired loans and to the general allowance for credit risk. 1999 $ 26,345 14,158 (2,314) 1998 $ 21,534 8,841 (4,030) 1999/1998 Increase (decrease) $ 4,811 5,317 1,716 $ 38,189 $ 26,345 $ 11,844 1.69% 1.32% 0.37% Net Impaired Loans as a Percentage of Net Loans Outstanding 1999 1998 1997 1996 1995 { 0.54% { 0.68% { 0.53% { 0.99% { 1.83% Table 10 – Allowance for Credit Losses ($ thousands) Specific Provisions Consumer and personal Real estate Industrial Other General Allowance Total 1998 Adjustment to Ending General Allowance Balance for Credit Risk(1) Write-offs, net of Recoveries(2) Provision for Credit Losses 1999 Ending Balance $ 320 $ $ 475 $ 348 1,587 165 1,445 9,325 $ 12,842 – – – – 11,694 $ 11,694 $ 447 279 151 1,389 – 1,218 1,224 1,004 (171) 2,526 1,238 1,060 20,848 $ 26,020 $ 2,266 $ 3,750 (1) In accordance with the guidance provided by OSFI, as described further below and in Note 1(d) to the Consolidated Financial Statements, the Bank increased its general allowance for credit risk by $11.7 million. Accordingly, retained earnings was reduced by $6.5 million, representing the increase in the general allowance, net of deferred income taxes of $5.2 million. (2) Recoveries in 1999 totalled $48 (1998 – $334). P a g e 3 2 Management’s Analysis of Operations and Financial Condition { OSFI’s revised general allowance criteria were effective for 1999. In accordance with the guidance provided by OSFI, $11.7 million was added to the general allowance in the second quarter, bringing it to $21.5 million at April 30, 1999. Because the increase was significant, OSFI specified that the adjustment be charged to retained earnings with no restatement of prior periods. Consequently, an amount of $6.5 million, representing the $11.7 million adjustment less deferred income taxes of $5.2 million, was charged to retained earnings.At October 31, 1999 the general allowance for credit risk totalled $20.8 million. Considering the amount required to conform to the guidance as well as the accounting treatment specified by OSFI the accounting for the general allowance represents a departure from generally accepted accounting principles in Canada. However, the accounting policies for all other financial statement items do conform, in all material respects, to generally accepted accounting principles as specified in the Auditors’ Report.The level of the general allowance was established by taking into consideration historical trends in the loss experience during a complete economic cycle, the current portfolio profile, estimated credit losses for the current phase of the economic cycle and historical experience in the industry.The impact of the departure from generally accepted accounting principles to conform to the guidance provided by OSFI is as follows. Impact of the Adjustment on Specific Balance Sheet Items the increase in the general allowance for credit risk • changed the following items on the balance sheet at April 30, 1999: ($ thousands) Assets Loans (net of allowances) Other assets – Deferred income taxes Shareholders’ equity Retained earnings Increase (decrease) $ (11,694) $ 5,185 $ (6,509) Allowance for Credit Losses as a Percentage of Gross Impaired Loans 1999 1998 1997 1996 1995 { 68.1% { 48.7% { 57.5% { 47.0% { 32.8% Allowance For Credit Losses The allowance for credit losses consists of $5.2 million in specific provisions and $20.8 million in the general allowance for credit risk with the latter now representing 0.93% of gross outstandings and 1.03% of risk-weighted credit assets. This compares favorably with the Bank’s five year loan loss average of 0.25% which is based on the annual charges to the income statement.The five year loan loss average based only on net new specific provisions (i.e. excluding the annual increase or decrease in the general allowance for credit risk ) is 0.16%.The general allowance is available to cover credit losses inherent in the portfolio which are not currently identifiable on an account by account basis.An assessment of the adequacy of the general allowance is conducted quarterly and measured against the Bank’s five year loan loss average. In addition, a method of applying a progressive (increasing with higher risk) loss ratio range against groups of loans of a common risk rating is utilized to test the general allowance adequacy.The general allowance would be expected to increase in strong economic times and decrease in weaker economic times as provisions are allocated on specific credits. In October 1998 OSFI provided guidance to all deposit- taking institutions on establishing general allowances for credit risk (unallocated loan loss provisions) in their ongoing program to strengthen general allowances and related methodologies.While OSFI did not believe that there was a systemic problem of asset quality in the Canadian system, they felt the need for higher general allowances was supported by, amongst other things, the current position in the economic cycle, growing potential off-balance sheet activity and associated credit risk, and the current levels of allowances of a number of Canadian institutions in relation to historical levels and compared to institutions in other jurisdictions. Management’s Analysis of Operations and Financial Condition} P a g e 3 3 Impact of the Adjustment on Book Value • the adjustment of $6.5 million (i.e. $11.7 million less deferred income taxes) reduced book value by $0.64 per share. Impact of the Adjustment on Return on Common Shareholders’ Equity • the adjustment to the general allowance decreased average shareholders’ equity for the fiscal year ended October 31, 1999, since the adjustment was made in April, thereby increasing the return on common shareholder’s equity by 0.28%; and • in subsequent fiscal years, the impact on common shareholders’ equity will be negligible. Impact of the Adjustment on Capital Ratios • the total capital adequacy ratio increased (Tier 1 decreased) as a result of the adjustment to the general allowance and taking into account the granting of Tier 2A capital treatment for general allowances up to a maximum of 0.75% of risk-weighted assets. The table below shows the impact of this adjustment: ($ thousands) Tier 1 capital Tier 2 capital Total Capital Risk-weighted assets Ratios Tier 1 capital Tier 2 capital Total Before adjustment After adjustment $ $ 165,845 81,891 247,736 $ 2,142,185 7.7% 3.8% 11.5% $ $ 159,336 94,687 254,023 $ 2,148,836 7.4% 4.4% 11.8% Impact of the Adjustment on the Consolidated Statement of Income • the adjustment to the general allowance had no impact on the Consolidated Statement of Income. Impact of the Adjustment on the Consolidated Statement of Cash Flow • the adjustment to the general allowance had no impact on the cash flow presented in the Consolidated Statement of Cash Flow. Provision for Credit Losses as a Percentage of Average Loans Outstanding Provision for Credit Losses For the year ended October 31, 1999, the provision for credit losses represented 0.18% of average loans.As reflected in the graph below the provision for credit losses is trending downward reflecting the strong credit quality of the portfolio. Diversification of Portfolio Total Advances Based on Location of Borrower (also see Table 5) Geographical Distribution of Loans 1999 1998 1997 1996 1995 British Columbia 45% Saskatchewan 6% Manitoba 4% Other 3% Alberta 42% { { { { { { 0.18% { 0.22% { 0.25% { 0.30% { 0.32% P a g e 3 4 Management’s Analysis of Operations and Financial Condition { The following table illustrates the diversification in our lending operations by industry sector. Table 11 – Total Advances Based on Industry Sector (%) October 31 Real estate operations Construction Consumer loans and residential mortgages Transportation and storage Manufacturing Hotel/motel Oil and gas (production) Logging/forestry Other services Wholesale trade Finance and insurance Government guaranteed Other Total Management of the loan portfolio includes the strategy of avoiding high concentrations in one geographic area or industry sector.The Bank’s portfolio is well diversified with a mix of corporate and personal business. Industrial lending units are set up within branches or stand alone operations, while oil and gas lending is conducted by specialists in our Calgary market. In addition to these areas, we also have real estate divisions established in the major centres in which we operate. Liquidity Risk Liquidity risk is the risk that the Bank will not have sufficient cash to meet its obligations as they become due.This risk arises from fluctuations in cash flows from lending, deposit taking, investing, and other activities. Effective liquidity management ensures that adequate cash is available to honour all cash outflow obligations. Maintenance of a prudent liquidity base also provides flexibility to fund loan growth and to react to other market opportunities. The Bank’s liquidity policy includes: • measurement and forecast of cash flows; • maintenance of a high quality pool of liquid assets; • a stable base of core deposits from retail and commercial customers; limits on single deposits and sources of deposits; • • diversification of funding sources; and • an approved contingency plan. 1999 24.5% 20.4 16.5 6.9 4.1 4.0 2.5 3.0 2.7 2.5 3.0 1.1 8.8 1998 22.6% 20.0 18.4 5.7 4.3 3.8 3.6 3.2 3.0 2.9 2.8 2.3 7.4 100.0% 100.0% Key features of liquidity management are: • daily monitoring of expected cash inflows and outflows and tracking and forecasting the liquidity position, including the flows from off-balance sheet items, on a weekly and forward three month rolling basis; • consideration of the term structure of assets and liabilities, with emphasis on deposit maturities, as well as expected loan fundings and other commitments to provide funds when determining required levels of liquidity; and separate management of the liquidity position of the Bank and CWT to ensure compliance with related party and other regulatory tests. • A schedule outlining the consolidated securities portfolio at October 31, 1999 is provided in Note 2 to the Consolidated Financial Statements.A conservative policy is maintained in this area with: • virtually all investments limited to high quality debt securities and short term money market instruments to meet objectives of liquidity management and to provide an appropriate return; specific investment criteria and procedures for purposes of management of the securities portfolio; regular review, monitoring and approval by ALCO of policies regarding these investments and annual review and approval by the Board of Directors; and • • • quarterly reporting to the Board of Directors on the securities portfolio. Management’s Analysis of Operations and Financial Condition} P a g e 3 5 $ 1999 1,562 136,456 31,972 169,990 41,017 63,928 $ 1998 2,246 133,888 23,404 159,538 28,493 58,896 1999/1998 Increase (decrease) $ (684) 2,568 8,568 10,452 12,524 5,032 52,248 32,574 19,674 48,729 38,938 244,860 41,189 27,937 189,089 $ 414,850 $ 348,627 $ 2,692,382 $ 2,386,478 7,540 11,001 55,771 $ 66,223 $ 305,904 15.4% 14.6% 0.8% $ 2,371,075 $ 2,059,545 $ 311,530 17.5% 16.9% 0.6% Also included in liquid assets are securities purchased under resale agreements and call loans.These are short term advances, typically no more than several days in duration, to securities dealers and either require the dealer to repurchase the securities or are secured by treasury bills or other high quality liquid securities. Short term credit facilities have been arranged with a number of financial institutions.The expansion of such facilities will continue to be pursued as an additional liquidity safeguard.The government insured/guaranteed mortgage and loan portfolios also represent a potential source of liquidity. The primary source of new funding is the issuance of deposit instruments.A summary of the deposits by maturity is presented in Tables 13 and 14. Table 12 – Liquid Assets ($ thousands) Cash Deposits with regulated financial institutions Cheques in transit Total Cash Resources Securities purchased under resale agreements and call loans Government of Canada treasury bills Government of Canada and provincial bonds term to maturity 1 year or less Government of Canada and provincial bonds term to maturity over 1 year Other marketable securities Total Securities Purchased Under Resale Agreements/Call Loans and Marketable Securities Total Liquid Assets Total Assets Liquid assets as a percentage of total assets Total Deposit Liabilities Liquid assets as a percentage of total deposit liabilities As shown in Table 12, liquid assets comprised of cash, interbank deposits, items in transit, securities purchased under resale agreements/call loans and marketable securities, totalled $415 million at October 31, 1999, an increase of $66 million from October 31, 1998. Liquid assets represented 15.4% (1998 – 14.6%) of total assets and 17.5% (1998 – 16.9%) of total deposit liabilities at that date. Highlights of the composition of liquid assets at October 31, 1999 follow: • maturities within one year total 86% or $357 million; • Government of Canada treasury bills made up 15% of the book value with other Government of Canada and provincial debt securities accounting for 24% of liquid assets; • highly rated short term commercial paper totalling $30 million is included in other marketable securities; and • deposits with regulated financial institutions including bankers acceptances were 33% of liquid assets. P a g e 3 6 Management’s Analysis of Operations and Financial Condition { Table 13 – Deposit Maturities Within One Year ($ millions) At October 31, 1999 Demand deposits Notice deposits Deposits payable on a fixed date Total At October 31, 1998 Total Table 14 – Total Deposit Maturities ($ millions) At October 31, 1999 Demand deposits Notice deposits Deposits payable on a fixed date Total At October 31, 1998 Total Within 1 Month $ 45 221 255 $ 521 1 to 3 Months $ – – 152 $ 152 3 Months to 1 Year Cumulative Within 1 Year $ – – 806 $ 806 $ 45 221 1,213 $ 1,479 $ 543 $ 179 $ 563 $ 1,285 Within 1 Year $ 45 221 1,213 $ 1,479 $ 1,285 1 to 2 Years $ – – 353 $ 353 $ 256 2 to 3 Years $ – – 229 $ 229 3 to 4 Years $ – – 158 $ 158 4 to 5 Years $ – – 152 $ 152 Total $ 45 221 2,105 $ 2,371 $ 257 $ 125 $ 137 $ 2,060 A breakdown of deposits by source is provided under the heading Deposits.Target limits by source have been established as part of the Bank’s overall liquidity policy and are monitored to ensure an acceptable level of diversification in sources of funding is maintained.The Bank continues to aggressively pursue retail deposits generated through its branch network as a core funding source. However, the total dollar value of agent generated deposits will likely continue to increase even though the goal is to decrease funding from this source as a percentage of total deposit liabilities. CWT continues to raise essentially all of its deposits through agents.The Bank distributes CWT’s deposit products through the Bank’s branch network and at October 31, 1999, $30.9 million (1998 – $20.7 million) of CWT deposits had been raised in this manner. Market Risk Market risk is the impact on earnings resulting from changes in financial market variables such as interest rates and foreign exchange rates. Market risk arises when making loans, taking deposits and making investments.The Bank itself does not undertake trading activities and, therefore, does not have risks related to such activities as market making, arbitrage or proprietary trading.Therefore, the Bank’s material market risks are confined to interest rates and foreign exchange as discussed below. Interest Rate Risk Interest rate risk or sensitivity can be defined as the impact on net interest income, both current and future, resulting from a change in market interest rates.This risk and potential variability in earnings arises when cash flows associated with interest sensitive assets and liabilities have different repricing dates.The differentials, or interest rate gaps, arise as a result of the financial intermediation process and reflect differences in term preferences on the part of borrowers and depositors. A positive interest rate gap exists when interest sensitive assets exceed interest sensitive liabilities for a specific maturity or repricing period.A positive gap will tend to lead to an increase in net interest income when market interest rates rise since assets are repricing earlier than liabilities. The opposite impact will occur when market interest rates fall.A negative gap is the opposite of a positive gap. To manage interest rate risk arising as a result of the financial intermediation process,ALCO establishes policy guidelines for interest rate gap positions and meets regularly to monitor the Bank’s position and decide future strategy.The objective is to manage the interest rate risk within prudent guidelines. Interest rate risk policies are approved and reviewed at least annually by the Board of Directors with quarterly reporting provided to the Board as to the gap position. Management’s Analysis of Operations and Financial Condition} P a g e 3 7 Exposure to interest rate risk is controlled by managing the size of the static gap positions between interest sensitive assets and interest sensitive liabilities for future periods. Gap analysis is supplemented by computer simulation of the asset liability portfolio structure and dollar estimates of net interest income sensitivity for periods of up to one year. The interest rate gap is measured at least monthly. Table 15 – Asset Liability Gap Positions ($ millions) Table 15 shows the consolidated gap position at October 31, 1999 for selected time intervals. Comparative summary figures are given at October 31, 1998. Figures in brackets represent an excess of liabilities over assets or a negative gap position. At October 31, 1999 Assets Cash resources Securities Loans Other assets Off-balance sheet swaps Total Liabilities and Equity Deposits Other liabilities Debentures Shareholders’ equity Off-balance sheet swaps Total Interest Rate Sensitive Gap Cumulative Gap Floating Rate and Within 1 Month 1 to 3 Months 3 Months to 1 Year $ 71 39 972 – – 1,082 521 10 12 – 271 814 268 268 $ $ $ 41 31 $ 72 – 20 164 152 – – – – 9 77 327 – 210 623 806 – – – – 152 $ 12 $ 280 806 $ (183) $ 97 $ Total Within 1 Year 121 147 1,371 – 230 1,869 1,479 10 12 – 271 1,772 97 97 $ $ 1 Year to 5 Years Over 5 Years Non- interest Sensitive $ – 49 905 – 41 995 892 – 67 – – 959 $ 36 $ 133 $ $ – 9 – – – 9 – – – – – – 9 $ 142 $ $ 49 – (23) 64 – 90 – 73 – 159 – 232 $ (142) $ – $ $ Total 170 205 2,253 64 271 2,963 2,371 83 79 159 271 2,963 – – – Cumulative Gap as a Percentage of Total Assets 9.0% 9.4% 3.3% 3.3% 4.5% 4.8% (4.8)% At October 31, 1998 Total assets Total liabilities and equity Interest Rate Sensitive Gap Cumulative Gap $ $ $ 941 678 263 263 $ 161 179 $ (18) $ 245 $ 424 $ 1,526 587 $ (163) $ 82 1,444 82 82 $ $ $ 899 838 $ 61 $ 143 $ $ 2 – 2 $ 145 $ 89 234 $ (145) $ – Cumulative Gap as a Percentage of Total Assets 10.5% 9.7% 3.3% 3.3% 5.7% 5.8% (5.8)% $ 2,516 2,516 $ $ – – – Notes: 1. Accrued interest is excluded in calculating interest sensitive assets and liabilities. 2. Potential prepayments of fixed rate loans and early redemption of redeemable fixed term deposits have not been estimated. Redemptions of fixed term deposits where depositors have this option are not expected to be material. Deposits with a redemption option totalled approximately $34 million as at October 31, 1999. The majority of fixed rate loans, mortgages and leases are either closed or carry prepayment penalties. P a g e 3 8 Management’s Analysis of Operations and Financial Condition { The gap analysis in Table 15 is a static measurement of interest rate sensitive gaps at a specific time.These gaps can change significantly in a short period of time.The impact of changes in market interest rates on earnings will depend upon the magnitude and rate of change in interest rates as well as the size and maturity structure of the cumulative interest rate gap position and management of those positions over time. Of the $1.21 billion in fixed term deposit liabilities maturing within one year from October 31, 1999, approximately $178 million (7.5% of total deposit liabilities) are fixed term registered retirement product deposits maturing between December 1, 1999 and April 30, 2000. The term in which these deposits and other maturing deposits are retained will have an impact on the future asset liability structure and hence interest rate sensitivity. During the year: • the one year and under cumulative gap remained unchanged at 3.3%; the one month and under gap decreased from 10.5% to 9.0%; and the five year and under cumulative gap decreased from 5.7% to 4.5%. • • The effective interest rates for each class of financial asset and liability, including off-balance sheet instruments, are shown in Table 16. Table 16 – Weighted Average Effective Interest Rates (%) Floating Rate and Within 1 Month 1 to 3 Months 3 Months to 1 Year Total Within 1 Year 1 Year to 5 Years Over 5 Years Total At October 31, 1999 Assets Cash resources Securities Loans Off-balance sheet swaps Total Liabilities Deposits Debentures Off-balance sheet swaps Total 4.8 7.2 – 6.9 3.3 6.8 4.7 3.8 Interest Rate Sensitive Gap 3.1% At October 31, 1998 Total assets Total liabilities Interest Rate Sensitive Gap 7.6% 4.1 3.5% 4.4% 5.0% 4.9% 4.7% –% –% 4.7% 4.8 7.8 5.1 6.2 5.1 – – 5.1 1.1% 6.4% 5.0 1.4% 5.2 7.9 5.3 6.6 5.5 – – 5.5 1.1% 7.0% 5.5 1.5% 5.0 7.4 5.3 6.8 4.7 6.8 4.7 4.7 2.0% 7.3% 4.8 2.5% 5.5 7.7 5.6 7.5 5.7 5.7 – 5.7 1.9% 7.7% 6.0 1.7% 5.5 – – 5.5 – – – – 5.5% 7.0% – 7.0% 5.1 7.5 5.3 7.0 5.1 5.9 4.7 5.0 2.0% 7.4% 5.2 2.2% The interest sensitivity of the portfolio increased in both absolute dollar terms and as a percentage of estimated future net interest income during the year, but remained well within policy guidelines. The estimated sensitivity of net interest income to a change in interest rates is presented in Table 17.The amounts represent the estimated change in net interest income over the time period shown resulting from a one percentage point change in interest rates. If rates increase, the effect would be an increase in net interest income while the opposite would occur if rates decrease.The estimates are based on a number of assumptions/factors, which include: • • a constant structure in the asset liability portfolio; interest rate changes affect interest sensitive assets and liabilities by the same amount and are applied at the appropriate repricing dates; and • no early redemptions. Management’s Analysis of Operations and Financial Condition} P a g e 3 9 Table 17 – Estimated Sensitivity of Net Interest Income As a Result of a One Percentage Point Change in Interest Rates ($ thousands) Period 90 days 1 year 1 year percentage change It is management’s intention to continue to manage the asset liability structure and interest rate sensitivity through pricing and product policies to attract appropriate assets and liabilities as well as through the use of interest rate swaps or other appropriate hedging techniques (see discussion under Off-balance Sheet Financial Instruments Including Derivatives).Assets and liabilities having a term to maturity in excess of five years are subject to specific review and control and with the exception of debentures, as outlined in Note 8 to the Consolidated Financial Statements, such items were not material as at October 31, 1999. Foreign Exchange Risk In providing financial services to its customers, the Bank has assets and liabilities denominated in United States (U.S.) dollars.At October 31, 1999, assets denominated in U.S. dollars were 0.4% of total assets and U.S. dollar liabilities were 0.4% of total liabilities.The comparable percentages at October 31, 1998 were 0.4% and 0.4% for assets and liabilities. Currencies other than U.S. dollars are not bought or sold other than to meet specific customer needs and therefore, the Bank has virtually no exposure to currencies other than U.S. dollars. Foreign exchange risk arises when there is a difference between assets and liabilities denominated in U.S. dollars. Policy is established setting a limit on the difference between U.S. dollar assets and liabilities.The difference is measured daily and managed by use of U.S. dollar contracts or other means. Policy respecting foreign exchange exposure is reviewed and approved at least annually by the Board of Directors, and deviations from policy are reported to the Board and ALCO. P a g e 4 0 Management’s Analysis of Operations and Financial Condition { 1999 $ 601 1,938 1998 $ 585 2,152 3.3% 3.5% Operational Risk Operational risk is the potential for loss as a result of a failure in communication, information or transaction processing due to system or procedural failures, errors, natural disasters or fraudulent activities.The financial measure of operational risk is actual losses incurred. No material losses occurred in 1999 or 1998. • These risks can never be completely eliminated but the Bank’s strategy to minimize operational risk includes: • a knowledgeable and experienced management team that is committed to the Bank’s risk management policies; regular meetings of the Operations Committee, a management committee made up of supervisory and management personnel from all operational areas and chaired by a member of senior management, which is responsible for the development and recommendation of policies and procedures regarding day to day, routine operations; • communication of the importance of effective risk • management to all levels of staff through training and policy implementation; regular inspections for compliance and the effectiveness of procedural controls by a strong, independent internal audit team; implementation of policies and procedural controls appropriate to address identified risks and which include segregation of duties and built-in checks and balances; • use of technology via automated systems with built-in • controls; • continual review and upgrade of systems and procedures; and • updated and tested procedures and contingency plans for disaster recovery and business continuity. In addition, the external auditors report annually on the efficiency and effectiveness of internal controls over significant risk areas and provide their report to the Audit Committee.The Bank also maintains appropriate insurance coverage through a financial institution bond policy. Year 2000 Update The “Year 2000 issue” is a general term used to refer to certain business implications of the arrival of the new millenium.These implications arise primarily because it has been normal practice for computer hardware and software to use only two digits rather than four to record the year in date fields. Date sensitive computer and electronic systems may not interpret dates in the next century accurately, possibly resulting in calculation errors and/or system failures.Without appropriate modifications, the Bank’s ability to carry out normal activities could be compromised. The Bank adopted the Office of the Superintendent of Financial Institutions Canada Year 2000 Project – Best Practices guideline as the basis for managing the Year 2000 issue.A Year 2000 project team was established in 1997 to manage the overall process and includes representatives from CWT and CWC.A standard methodology was adopted by all companies within the Bank’s corporate family. Participation in the Canadian Bankers Association Year 2000 Interbank Working Group was also undertaken. Awareness of the Year 2000 issue is high within the Bank. Quarterly reporting has been provided by management to the Board, and Internal Audit has presented an independent quarterly report to the Audit Committee on the status of the project. In late 1998, an independent party was engaged to review progress toward becoming Year 2000 ready. Items identified by management for follow up have been completed. Modifications, implementation and testing of all internal systems as well as testing wih critical external parties has been completed. Internal testing has included a roll-over from 1999 to 2000 and running in a Year 2000 timeframe where appropriate.A freeze on system modifications is in effect to ensure that systems remain Year 2000 compliant. Third parties are relied on for important services such as telecommunications, payment system clearing services and switching access to Interac® and other electronic networks. Year 2000 readiness of these service providers is actively monitored, and it is believed the third party service providers are ready to continue to provide services to the Bank and its customers. Certain steps have also been taken to review the Year 2000 readiness of major borrowers. Based on this review, no material credit risk concerns have been identified. However, due to the general uncertainty inherent in the Year 2000 issue, it is not possible at this time to estimate any provisions for credit losses that may be required in the future. The business continuity plan has been reinforced with specific contingency plans for Year 2000 transition issues. These contingency plans cover operational capability in the event of systems failures, failures by third party service providers and potentially higher than usual customer activity toward the end of 1999 and into early 2000. However, while the Bank believes that it is taking all required and prudent actions, there can be no assurance that the contingency planning will fully mitigate the risks and uncertainties associated with the transition to the Year 2000. The Bank has guaranteed that customers’ money will be safe in their Canadian Western Bank and Canadian Western Trust accounts, and financial records will be fully protected before, on and after January 1, 2000. Incremental Year 2000 related costs for the Year 2000 project to date have totalled approximately $584,000. Of this amount, approximately $382,000 has been expensed as incurred.The balance of the costs have been capitalized according to existing policies and would have been incurred over the next two years in any event as part of the Bank’s normal ongoing systems maintenance and replacement program. The effects of the Year 2000 issue may be experienced before, on, or after January 1, 2000, and, if not addressed, the impact on operations and financial reporting may range from minor errors to significant systems failures which could affect an entity’s ability to conduct normal business operations. It is not possible to be certain that all aspects of the Year 2000 issue affecting the entity, including those related to the efforts of customers, suppliers, or other third parties will be fully resolved. Management’s Analysis of Operations and Financial Condition} P a g e 4 1 OFF-BALANCE SHEET FINANCIAL INSTRUMENTS INCLUDING DERIVATIVES Table 18 – Off-balance Sheet Financial Instruments ($ thousands) Credit Instruments Guarantees and standby letters of credit(1) Commitments to extend credit(2) Total Derivative Financial Instruments (notional amounts) Interest rate contracts(3) Equity contracts(4) Total Assets Under Administration and Management Assets under administration Assets under management Total 1999 1998 $ 27,479 366,229 $ 393,708 $ 21,457 282,150 $ 303,607 $ 269,000 $ 130,000 2,200 – $ 271,200 $ 130,000 $ 559,978 399,284 $ 959,262 $ 453,058 392,556 $ 845,614 (1) Letters of credit and guarantees are issued on behalf of clients to third party beneficiaries as part of normal business operations. (2) Commitments to extend credit to customers arise in the normal course of business. Includes undrawn availability authorized under lines of credit and commercial operating loans of $150 million (1998 – $122 million) and recently authorized but unfunded loan commitments of $216 million (1998 – $122 million). (3) Interest rate swaps are used as hedging devices to control interest rate risk. The outstanding swaps mature between January 2000 and July 2004. The total gross positive replacement cost of interest rate swaps was a positive $227 (1998 – $437). This market value represents an unrealized gain, or the payment the Bank would receive if these contracts were unwound and settled at that date. (4) Equity contracts are used to offset the return paid to depositors on certain deposit products where the return is linked to a stock index. The two outstanding contracts mature in March and June 2004. The total gross positive replacement cost is $17. (5) U.S. dollar foreign exchange contracts are used from time to time to manage the difference between U.S. dollar assets and liabilities. At October 31, 1999 and 1998 there were no forward foreign exchange contracts outstanding. Trust assets under administration, administered by CWT, totalled approximately $560 million at October 31, 1999 (1998 – $453 million).These assets are primarily in self- directed RRSPs and RRIFs (registered retirement income fund).Assets under administration, and the related fee income, are expected to increase in 2000.Assets under management totalled approximately $399 million (1998 – $393 million) and are managed by CWC. Subsequent to year end, the Bank announced its intended sale of CWC. More detailed information on the nature of the Bank’s off-balance sheet financial instruments is shown in Notes 11, 12 and 15 to the Consolidated Financial Statements. Continued use of interest rate swaps or other off-balance sheet hedging instruments is expected in the future for the purpose of asset liability structuring and management of interest rate risk.The Bank only enters into these off-balance sheet derivative financial instruments for its own account and does not act as an intermediary in this market. Transactions are entered into on the basis of industry standard contracts with approved counterparties subject to periodic and at least annual review. Policies regarding the use of off-balance sheet financial instruments are approved, reviewed, and monitored on a regular basis by ALCO and reviewed and approved by the Board of Directors at least annually. P a g e 4 2 Management’s Analysis of Operations and Financial Condition { CORPORATE GOVERNANCE INTRODUCTION The Board of Directors and management of the Bank are committed to maintaining an effective corporate governance framework which is critical to the effective and efficient management of the Bank’s operations. The Corporate Governance & Human Resources Committee provides direction, monitors compliance and makes recommendations to the Board on the optimum approach to governance issues to enhance corporate performance. THE BOARD AND BOARD COMMITTEES The Bank is a federally regulated Schedule I bank. Pursuant to the Bank Act (the “Act”), no one shareholder, or shareholders acting in concert, can own more than ten percent of any class of shares of a Schedule I bank. Therefore, the Bank has no significant shareholders. The Board is comprised of twelve members.The number of directors reflects the desire to have the members represent the geographical jurisdictions in which the Bank operates and the need to fill the memberships of the two required committees, the Audit and Conduct Review Committees, and the other board committees which are the Loans Committee and the Corporate Governance & Human Resources Committee.The Board has reviewed the status of each of its directors and determined if they are “affiliated” (as defined by the affiliation rules set forth in the Act) or “unrelated”, as defined in the TSE guidelines on corporate governance.As a result of this review, the Board has determined that two of the directors are affiliated (the President and CEO and Executive Vice President); they are also the only inside directors.All other directors are “unrelated”. At the time of appointment to the Board, at least 75 percent of the board members must be resident Canadians and no more than four members may be employees of the Bank. The Chairman is an independent director and is appointed annually by the members of the Board. Responsibilities not delegated to senior management or to a committee of the Board remain those of the full Board.The Board expects all significant risks and internal controls to be identified and reported upon by senior management to the Board and/or its committees. The Board holds four regular meetings each year, as well as additional meetings as required. Most committees meet quarterly and all meet annually at a minimum.A meeting agenda matrix is issued to ensure meetings of the Board and its committees are efficient and complete. The Board of Directors as a whole has expressly assumed responsibility for developing the Bank’s approach to governance issues although the Corporate Governance & Human Resources Committee plays a key role by recommending and reporting on governance issues to the Board. In addition, certain governance issues have been delegated to other committees of the Board. The Act contains several sections dealing with the governance of a bank through its board of directors. These sections prescribe matters such as limitations on the number of directors who can be affiliated or non-resident, certain powers that must be transacted by the full Board, and requirements to establish both an audit committee and a conduct review committee.The Act also prescribes certain minimum benchmarks for board and committee member- ship, quorums and the transaction of business by the Board. The three encompassing duties in the Act that form the basis for the Board’s mandate are: • to manage or supervise the management of the business and affairs of the Bank; to act honestly and in good faith with a view to the best interests of the Bank and exercise the care, diligence and skill that a reasonably prudent person would exercise in similar circumstances; and to comply with the Act, the regulations, the Bank’s incorporating instrument and its by-laws. • • The mandate of the Board also includes references to compliance with the Canada Deposit Insurance Corporation’s (“CDIC”) Standards of Sound Business and Financial Practices. Generally speaking, these practices and related standards cover all major risk areas of a bank and call for the Board at least annually to approve the policies and review the management programs associated with: • • • • • capital management; internal organizational and procedural controls; • • real estate appraisals; and • credit risk management. interest rate risk management; securities portfolio management; liquidity and funding management; foreign exchange risk management; The areas of real estate appraisals and credit risk management have been delegated to the Loans Committee of the Board. Corporate Governance} P a g e 4 3 AUDIT COMMITTEE This committee is comprised of four outside directors and its mandate is summarized as follows: • review the annual statement and report thereon to the directors before approval is given; review such returns as required by OSFI and report thereon to the directors before approval is given; require management to implement and maintain appropriate internal control procedures and review, evaluate and approve those procedures; review such investments and transactions of the Bank, that could adversely affect its well-being, as are brought to the committee’s attention by the auditors, or an officer of the Bank or other committee of the Board; review the annual statement and any specified return or other transactions with the Bank’s auditors, ensuring any items of concern are duly considered; • • • • • • • discuss the adequacy/effectiveness of the internal control procedures with the Vice President and Chief Inspector and review any significant findings with senior management; review the interim unaudited statements, as well as other related public information, before public disclosure; review a report from the Loans Committee of the Board, including recommendations on the adequacy of loan loss provisions and write-offs; review the CDIC Standards Assessment and Reporting Program (SARP) annually and report thereon to the directors before approval is given; review the terms of the auditors’ engagement, their level of compensation, the audit plan, any proposed changes in accounting policies, their presentation and input concerning significant risks and key estimates and judgements of management; and • • • meet regularly with the internal and external auditors without management present. The mandate of the Board also specifically includes other matters which are not necessarily stated in the Act or in the CDIC standards and they are summarized as follows: approve the annual statement and specified returns, • prior to release to the public or submission to OSFI; review and approve the annual strategic business plan and accompanying capital plan and financial operating budget, including capital expenditures; • • declare dividends; • outline the content and frequency of management • • • reports on financial operations; review and ratify the employment, appointment, grade levels and compensation of the top five executive employees and approve all senior officer appointments; review succession plans; review any recommendations from regulators or external auditors respecting their assessment of the effectiveness of the internal controls that come to their attention in the conduct of their work; • ensure an independent audit/inspection function is in place to monitor the effectiveness of organizational and procedural controls; review and accept reports from the Audit, Conduct Review and Corporate Governance & Human Resources Committees; and approve loan write-offs. • • P a g e 4 4 { Corporate Governance CONDUCT REVIEW COMMITTEE • hire appropriate consultants, or request management This committee is comprised of four outside directors and its mandate is summarized as follows: • establish procedures to ensure disclosure of transactions with specified related parties of the Bank and, further, to review any such transactions to ensure compliance with the Act, either approving or declining the transactions, as required; review and approve internal policies for credit arrangements and financial services available to employees of the Bank under the regulations concerning officers and associated parties; • • monitor aggregate transactions of the Bank with directors as well as officers and their interests to ensure continued compliance with the Act with excesses brought to the Board for consideration; review the conduct policy on an annual basis to ensure relevance and completeness in regard to legislative requirements; • • monitor procedures for conflicts of interest, confidential information, disclosure of information and handling of customer complaints, and be satisfied that the procedures are being adhered to; • ensure every employee, officer and Board member agrees to comply, in writing, with annual acknowledgement, with the Bank’s conduct policy; and after each meeting provide a report to the directors on all transactions and other matters reviewed by the committee. • CORPORATE GOVERNANCE & HUMAN RESOURCES COMMITTEE This committee is comprised of five outside directors and its mandate is summarized as follows: • recommend to the Board appropriate structure and process required to address governance issues and maintain compliance with all corporate governance guidelines; review and monitor compliance with corporate governance guidelines and follow any issues noted by the members or as reported to them by management or other directors from time to time; • • no less than annually, report to the Board on corporate governance issues and any instances of non-compliance, together with appropriate recommendations; • • to perform studies and to furnish other information as required; to review such information and take such actions based thereon as appropriate; review and recommend to the Board the employment and appointment of the top five executive employees, to establish their grade levels and compensation, as well as to determine promotions and to make changes in the level of compensation and grade of incumbent executive employees and officers; review the position descriptions for the top five executive employees, ensuring they remain current and accurate and further, to also ensure position descriptions are in place for all other executive officers; • establish an executive compensation structure to compensate all levels of executive employees and, within such compensation structure as may at that time be in effect, to make adjustments and annual revisions as necessary; • ensure an annual performance appraisal is completed for the President and CEO and that it is reviewed with him by the Chairman of the Board; • establish, amend and, where appropriate, terminate: – programs and other personal benefits granted to executive employees; – incentive compensation plans and other bonus arrangements, to administer such plans and to make appropriate interpretations and determinations as required; – share incentive plans and similar arrangements involving the grant of share options, or other benefits to employees attendant upon the issuance of securities, and, in addition, to make grants of options under any share incentive plan and generally to administer such plans, subject to necessary regulatory and shareholder approval; and – annuity, pension, and retirement programs for executive employees; • • review the human resource succession plan as prepared by senior management for all officers and any other senior position considered critical to operations; seek and recommend individuals to be considered for Board membership, as required by the Board, and forward their recommendations with written rationale, compared against published terms of reference, to the Board for their consideration; Corporate Governance} P a g e 4 5 • review, monitor, and make recommendations regarding new director orientation and the ongoing development of existing Board members; • evaluate, at least bi-annually, Board membership (including composition and size) and the involvement/performance of the membership with concerns recorded, and brought to the attention of the committee chair, who, in conjunction with the committee, determines if further action is required; review and recommend to the Board the fees and other benefits to be paid to directors; and • • make recommendations to the Board regarding revisions or additions to the Board of Directors Manual. LOANS COMMITTEE This committee is comprised of eight directors, six of whom are unrelated.The President and CEO and the Executive Vice President, who are affiliated, inside directors, are also members. Its mandate is summarized as follows: • review and approve a lending limit for the Bank and the President and CEO within the limits established by the Board and review such limits at least annually; review, approve and/or decline all credit applications for amounts in excess of delegated limits up to the limit established, not to exceed ten percent of capital; recommend for approval of the full Board, any loan proposals in excess of the Bank’s limit; recommend for approval of the full Board loan proposals to directors, related entities and Bank subsidiaries; annually review and approve the credit risk management program and policies, including management’s real estate appraisal policies and procedures, to ensure they are sound, prudent and in accordance with CDIC standards; review and recommend acceptance of management’s recommendations for loan loss provisions and loan write-offs to the Audit Committee for their presentation to the Board; and review and approve action plans, as required, on loans reported by management to be less than satisfactory. • • • • • • OTHER AREAS OF CONSIDERATION The Bank has not adopted a formalized process of orientation for new Board members although all directors are provided with a Directors’ Manual, outlining key governance information and reference material. It is worthy of note that seven out of the ten outside directors have served on the Board for ten years or more.There is also a Board and member review and assessment program whereby every second year directors complete a formal assessment of the operations and effectiveness of the Board and its committees. Every other year, directors may complete a formal assessment on individual directors’ effectiveness. In order to carry out its responsibilities the Board must have timely access to information which is available via discussions with the Bank’s senior management and through a comprehensive information package sent out prior to each board meeting which includes the agenda, minutes of previous meetings and supporting documentation for specific agenda items. The Bank is also committed to ensuring quality and timely information is available to all shareholders. Inquiries and requests for information from shareholders and potential investors receive prompt attention from an appropriate officer.The President and CEO and other members of senior management also meet periodically with financial analysts and institutional investors. Also, the Board has put in place a policy providing for individual directors to engage outside advisors if the circumstances are warranted. The Bank has engaged an independent Ombudsman to receive complaints from banking clients who are unable to obtain satisfaction from the Bank’s internal complaint handling mechanism. CONCLUSION The Bank’s corporate governance approach is in compliance with the TSE guidelines. It will continue to develop over time with the Corporate Governance & Human Resources Committee playing a key role in monitoring, developing and recommending to the Board on governance issues as warranted. P a g e 4 6 { Corporate Governance FINANCIAL STATEMENTS MANAGEMENT’S REPORT The consolidated financial statements of Canadian Western Bank and related financial information presented elsewhere in this annual report have been prepared by management, who are responsible for the integrity, objectivity and reliability of the data presented.The consolidated financial statements were prepared in accordance with generally accepted accounting principles other than the accounting for the general allowance for credit risk which is in accordance with the accounting requirements of the Superintendent of Financial Institutions Canada under the Bank Act, as described in Note 1.The consolidated financial statements and related financial information reflect amounts which must, of necessity, be based on informed estimates and judgements of management with appropriate consideration to materiality.The financial information presented elsewhere in this annual report is consistent with that in the consolidated financial statements. The Bank’s accounting system and related internal controls are designed, and supporting procedures are maintained, to provide reasonable assurance that financial records are complete and accurate, that assets are safeguarded and that the Bank is in compliance with all regulatory requirements. These supporting procedures include the careful selection and training of qualified staff, defined division of responsibilities and accountability for performance, and the written communication of policies and guidelines of business conduct and risk management throughout the Bank. The system of internal controls is also supported by the internal audit division which carries out periodic inspections of all aspects of the Bank’s operations.The Chief Inspector has full and free access to the Audit Committee and to the shareholders’ auditors. The Audit Committee, appointed by the Board of Directors, is composed of directors who are not officers or employees of the Bank.The committee is responsible for reviewing the financial statements and annual report and recommending them to the Board of Directors for approval.Their responsibilities also include meeting with management, the Chief Inspector and the shareholders’ auditors to discuss the effectiveness of internal controls over the financial reporting process, and the planning and results of the external audit. The Conduct Review Committee, appointed by the Board of Directors, is composed of directors who are not officers or employees of the Bank.Their responsibilities include reviewing related party transactions, and reporting to the Board of Directors, those transactions which may have a material impact on the Bank. The Superintendent of Financial Institutions Canada, at least once a year, makes such examination and enquiry into the affairs of the Bank as he may deem necessary or expedient to satisfy himself that the provisions of the Bank Act, having reference to the safety of the creditors and shareholders of the Bank, are being duly observed and that the Bank is in a sound financial condition. Deloitte & Touche LLP, the shareholders’ auditors, are appointed by the shareholders of the Bank.They have full and free access to, and meet periodically with, the Audit Committee to discuss their audit and matters arising therefrom. “Larry M. Pollock” Larry M. Pollock President and Chief Executive Officer “Tracey C. Ball” Tracey C. Ball, C.A. Vice President and Chief Financial Officer December 3, 1999 Financial Statements} P a g e 4 7 AUDITORS’ REPORT To The Shareholders of Canadian Western Bank We have audited the Consolidated Balance Sheet of Canadian Western Bank as at October 31, 1999 and 1998 and the Consolidated Statements of Income, Changes in Shareholders’ Equity and Cash Flow for the years then ended.These financial statements are the responsibility of the Bank’s management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with generally accepted auditing standards.Those standards require that we plan and perform an audit to obtain reasonable assurance whether the financial statements are free of material misstatement.An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements.An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. In our opinion, these consolidated financial statements present fairly, in all material respects, the financial position of the Bank as at October 31, 1999 and 1998 and the results of its operations and its cash flow for the years then ended in accordance with generally accepted accounting principles, other than the accounting for the general allowance for credit risk which is in accordance with the accounting requirements of the Superintendent of Financial Institutions Canada under the Bank Act, as described in Note 1. “Deloitte & Touche LLP” Deloitte & Touche LLP Chartered Accountants Edmonton,Alberta December 3, 1999 P a g e 4 8 { Financial Statements As at October 31 ($ thousands) Assets Cash Resources Cash Deposits with regulated financial institutions Cheques and other items in transit, net Securities Issued or guaranteed by Canada Issued or guaranteed by a province Other securities CONSOLIDATED BALANCE SHEET (Note 2) Loans (net of allowance for credit losses) (Notes 3 & 4) Securities purchased under resale agreements and call loans Residential mortgages Other Other Land, buildings and equipment Other assets Total Assets Liabilities and Shareholders’ Equity Deposits Payable on demand Payable after notice Payable on a fixed date Other Other liabilities Subordinated Debentures Conventional Convertible Shareholders’ Equity Capital stock Retained earnings (Note 5) (Note 6) (Note 7) (Note 8) (Note 9) 1999 1998 $ 1,562 $ 2,246 136,456 31,972 169,990 112,826 52,079 40,287 205,192 41,017 272,428 1,940,153 2,253,598 13,218 50,384 63,602 133,888 23,404 159,538 98,481 34,178 28,208 160,867 28,493 277,415 1,683,748 1,989,656 12,760 63,657 76,417 $ 2,692,382 $ 2,386,478 $ 45,043 $ 49,325 221,456 2,104,576 2,371,075 83,066 13,126 65,565 78,691 98,484 61,066 159,550 208,551 1,801,669 2,059,545 94,574 13,126 73,965 87,091 89,595 55,673 145,268 Total Liabilities and Shareholders’ Equity $ 2,692,382 $ 2,386,478 ”Jack C. Donald“ Jack C. Donald Chairman ”Larry M. Pollock“ Larry M. Pollock President and Chief Executive Officer Financial Statements} P a g e 4 9 1999 1998 $ 164,435 $ 147,125 9,543 3,526 177,504 110,180 4,888 115,068 62,436 3,750 58,686 7,805 6,778 2,476 1,485 990 261 19,795 78,481 30,282 10,112 12,775 2,822 55,991 22,490 3,516 18,974 879 19,853 10,153,378 1.96 1.79 $ $ $ 7,718 3,495 158,338 97,736 4,336 102,072 56,266 4,150 52,116 6,729 5,326 1,964 1,165 2,241 66 17,491 69,607 26,352 8,526 11,989 2,347 49,214 20,393 1,958 18,435 577 19,012 9,421,196 2.02 1.77 $ $ $ (Note 4) (Note 10) (Note 1(j)) CONSOLIDATED STATEMENT OF INCOME For the year ended October 31 ($ thousands, except per share amounts) Interest Income Loans Securities Deposits with regulated financial institutions Interest Expense Deposits Debentures Net Interest Income Provision for credit losses Net Interest Income after Provision for Credit Losses Other Income Credit related Underwriting fees and commissions on securities transactions Retail services Trust services Loan administration and other Net gains on securities sales Net Interest and Other Income Non-interest Expenses Salaries and employee benefits Premises and equipment Other expenses Provincial capital taxes Net Income before Provision for Income Taxes Provision for income taxes Net Income before Non-controlling Interest in Subsidiary Non-controlling interest in net loss of subsidiary Net Income Average number of common shares outstanding Earnings per common share basic fully diluted P a g e 5 0 { Financial Statements CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY For the year ended October 31 ($ thousands) Capital Stock Balance at beginning of year Common shares issued Common shares purchased for cancellation Balance at end of year Retained Earnings Balance at beginning of year Net income Dividends Adjustment to general allowance for credit risk, net of income taxes of $5,185 Redemption of debenture Balance at end of year Total Shareholders’ Equity $ (Note 9) (Note 9) (Note 4) (Note 8) 1999 89,595 9,069 (180) 98,484 55,673 19,853 (4,860) (6,509) (3,091) 61,066 1998 $ 89,057 538 – 89,595 39,476 19,012 (2,815) – – 55,673 $ 159,550 $ 145,268 Financial Statements} P a g e 5 1 CONSOLIDATED STATEMENT OF CASH FLOW For the year ended October 31 ($ thousands) Cash Flows from Operating Activities Net income Adjustments to determine net cash flows: Provision for credit losses Depreciation and amortization Deferred income taxes, net Gain on sale of securities, net Change in accrued interest receivable and payable, net Other items, net Cash Flows from Financing Activities Deposits, net Dividends Redemption of subordinated debentures Issue of subordinated debentures Common shares issued, net of issue costs Common shares purchased for cancellation Cash Flows Used in Investing Activities Loans, net Securities, net (Note 8) (Note 8) (Note 9) (Note 9) Interest bearing deposits with regulated financial institutions, net Land, buildings and equipment, net Acquisition of controlling interest in Canadian Western Capital Limited (Note 17) Increase (Decrease) in Cash and Cash Equivalents Cash and Cash Equivalents at Beginning of Year Cash and Cash Equivalents at End of Year* * Represented by: Cash and cash equivalents per Consolidated Balance Sheet Less non-operating, interest bearing deposits with regulated financial institutions Cash and Cash Equivalents at End of Year Supplemental Disclosure of Cash Flow Information Amount of interest paid in the year Amount of income taxes paid in the year 1999 1998 $ 19,853 $ 19,012 3,750 2,753 2,964 (261) 5,714 (1,940) 32,833 311,530 (4,860) (7,091) 4,000 669 (180) 304,068 (279,386) (43,954) 9,521 (3,109) – (316,928) 19,973 27,296 47,269 169,990 122,721 47,269 $ $ $ 4,150 2,613 1,425 (66) 6,135 2,990 36,259 242,033 (2,815) – 50,000 513 – 289,731 (283,799) (14,044) (22,740) (3,995) (5,600) (330,178) (4,188) 31,484 27,296 159,538 132,242 27,296 $ $ $ $ 108, 703 $ 751 $ 94,994 $ 409 P a g e 5 2 { Financial Statements NOTES TO CONSOLIDATED FINANCIAL STATEMENTS October 31, 1999 ($ thousands, unless otherwise stated) 1. Significant Accounting Policies These consolidated financial statements have been prepared in accordance with subsection 308 (4) of the Bank Act which states that, except as otherwise specified by the Office of the Superintendent of Financial Institutions Canada (“OSFI”), the financial statements are to be prepared in accordance with generally accepted accounting principles. The significant accounting policies used in the preparation of these financial statements, including the accounting requirements of OSFI, are summarized below. Of necessity, management must make estimates and assumptions that affect the reported amount of assets and liabilities at the date of the financial statements and income and expenses during the year. Actual results could differ from those estimates. OSFI has specified an accounting treatment for the general allowance for credit risk which does not conform to generally accepted accounting principles. The accounting for all other financial statement items conform, in all material respects, to generally accepted accounting principles. a) Basis of Consolidation The consolidated financial statements include the assets, liabilities and results of operations of the Bank and all of its subsidiaries, after the elimination of intercompany transactions and balances. Subsidiaries are defined as corporations whose operations are controlled by the Bank and are corporations in which the Bank owns more than 50 percent of the voting shares. One of the subsidiaries, Canadian Western Capital Limited, has a September 30 year end. See Note 20 for details of the subsidiaries. Business acquisitions are accounted for using the purchase method. The difference between the acquisition cost of an investment and the fair value of the net identifiable assets acquired represents goodwill or other identifiable intangibles. This excess amount is deferred and amortized to income over the anticipated period of benefit, not to exceed 20 years. The unamortized balance is recorded in other assets. The carrying value of goodwill and other identifiable intangibles is evaluated regularly by reviewing the expected cash flows generated by the acquired subsidiary or asset. Any permanent impairment in value is written off to the Consolidated Statement of Income. b) Securities Securities are held in either the investment account or the trading account. Investment account securities are purchased with the original intention to hold the securities to maturity or until market conditions render alternative investments more attractive. Equity securities are stated at cost or, if the value is permanently impaired, at net realizable value and debt securities at amortized cost. Gains and losses on disposal of securities and adjustments to record any permanent impairment in value are included in other income in the period of realization. Amortization of premiums and discounts are reported in interest income from securities in the Consolidated Statement of Income. Trading account securities, which are purchased for resale over a short period of time, are carried at estimated current market value. Gains and losses realized on disposal and adjustments to market value are reported in other income in the Consolidated Statement of Income in the period during which they occur. c) Loans Loans are stated net of unearned income and an allowance for credit losses (Note 1(d)). Interest income is recorded on the accrual basis except for loans classified as impaired. Loans are determined to be impaired when interest is contractually past due 90 days, or where the Bank has taken realization proceedings, or where the Bank’s management is of the opinion that the loan should be regarded as impaired. An exception may be made where management determines that the loan is well secured and in the process of collection and the collection efforts are reasonably expected to result in either repayment of the loan or restoring it to a current status within 180 days from the date the payment went in arrears. All loans are classified as impaired when a payment is 180 days in arrears other than loans guaranteed or insured for both principal and interest by the Canadian government, the provinces or a Canadian government agency. These loans are classified as impaired when payment is 365 days in arrears. Impairment is measured as the difference between the carrying value of the loan at the time it is classified as impaired and the present value of the expected cash flows (estimated realizable amount), using the interest rate inherent in the loan at the date the loan is classified as impaired. When the amounts and timing of future cash flows cannot be reliably estimated, either the fair value of the security underlying the loan, net of any expected realization costs, or the current market price for the loan may be used to measure the estimated realizable amount. At the time a loan is classified as impaired, interest income will cease to be recognized in accordance with the loan agreement, and any uncollected but accrued interest will be added to the carrying value of the loan together with any unamortized premiums, discounts or loan fees. Subsequent payments received on an impaired loan are recorded as a reduction of the recorded investment in the loan. Impaired loans are returned to performing status when the timely collection of both principal and interest is reasonably assured and all delinquent principal and interest payments are brought current and all charges for loan impairment have been reversed. d) Allowance for Credit Losses The Bank maintains an allowance for credit losses, the purpose of which is to keep an adequate balance sufficient to absorb credit related losses in its loan portfolio. The allowance for credit losses is deducted from the related asset category. The balance in the account consists of specific provisions and the general allowance for credit risk. Specific provisions include all the accumulated provisions for losses on particular impaired loans required to reduce the carrying value of those loans to their estimated realizable amount. In October 1998 OSFI provided guidance to all deposit-taking institutions on establishing general allowances for credit risk. The general allowance for credit risk should include provisions for losses relating to individual loans or groups of loans in the existing portfolio which are not yet specifically identified as impaired. The general allowance for credit risk was established by taking into consideration historical trends in the loss experience during an economic cycle, the current portfolio profile, estimated losses for the current phase of the economic cycle and historical experience in the industry. In compliance with the guidance provided by OSFI, any significant adjustment to the general allowance for credit risk, net of income taxes, was treated as a one-time charge to retained earnings, with no adjustment to opening retained earnings. (See Note 19) Notes to Consolidated Financial Statements} P a g e 5 3 Actual write-offs, net of recoveries, are deducted from the allowance for credit losses. The provision for credit losses in the Consolidated Statement of Income is charged with an amount sufficient to keep the balance in the allowance for credit losses adequate to absorb all credit related losses. e) Land, Buildings and Equipment Land is carried at cost. Buildings, equipment and furniture, and lease- hold improvements are carried at cost less accumulated depreciation and amortization. Depreciation and amortization are calculated primarily using the straight-line method over the estimated useful life of the asset as follows: buildings – 20 years, equipment and furniture – 3 to 5 years, and leasehold improvements – term of lease. Gains and losses on disposal are recorded in other income in the Consolidated Statement of Income in the year of disposal. f) Translation of Foreign Currencies Assets and liabilities denominated in foreign currencies are translated into Canadian dollars at rates prevailing at the balance sheet date. Revenues and expenses in foreign currencies are translated at the average exchange rates prevailing during the year. Realized and unrealized gains and losses on foreign currency positions are included in other income in the Consolidated Statement of Income. g) Loan Fees Loan fees, net of directly related costs, are amortized to interest income over the expected term of the loan when such fees are considered to be an integral part of the return earned on the particular loan. Loans are stated net of unamortized fees. h) Income Taxes The Bank follows the tax allocation method of accounting for income taxes whereby income taxes are based on transactions recognized for accounting purposes regardless of when they are recognized for tax purposes. The cumulative timing differences between tax calculated on this basis and taxes currently payable result in deferred income taxes which are recorded in other assets. Total income taxes include the provision for income taxes in the Consolidated Statement of Income and income taxes applicable to items charged or credited directly to retained earnings. i) Derivative Financial Instruments Interest rate, foreign exchange and equity contracts such as futures, options and swaps are entered into for asset/liability management purposes. These contracts are designated and function as hedges and are accounted for on the accrual basis. Net accrued interest receivable/payable and deferred gains/losses are recorded in other assets or other liabilities, as appropriate. Interest income/expense and gains/losses are recognized as interest income or interest expense, as appropriate, over the hedged period. j) Earnings per Common Share Basic earnings per common share is calculated based on the average number of common shares outstanding during the year. Fully diluted earnings per share includes the effect of all potential dilutive factors on earnings per common share. k) Stock Option Plans The Bank has stock option plans which are described in Note 9. No expense is recognized for these plans when the stock options are issued to the employees. Any consideration paid by employees on exercise of stock options is credited to share capital. 2. Securities The analysis of securities at carrying value, by type and maturity is as follows: Within 1 Year $ 88,720 27,455 – 29,969 – Maturities Over 1 to 3 Years $ 24,106 14,903 – – – Over 3 to 5 Years $ – 9,721 – – – Over 5 Years 1999 Total Book Value 1998 Total Book Value $ – – $ 112,826 $ 98,481 52,079 34,178 1,000 – 9,318(2) 1,000 29,969 9,318 1,000 25,905 1,303 $ 146,144 $ 39,009 $ 9,721 $ 10,318 $ 205,192 $ 160,867 Securities Issued or Guaranteed by: Canada A province Other Debt Securities Floating rate notes Corporate debt Equity Securities Total(1) (1) All securities are held in the investment account. (2) These securities have no specific maturity. P a g e 5 4 { Notes to Consolidated Financial Statements The analysis of unrealized gains and losses on investment securities is as follows: 1999 1998 Gross Unrealized Gains Gross Unrealized Losses Estimated Market Value Book Value Gross Unrealized Gains Gross Unrealized Losses Estimated Market Value Book Value Securities Issued or Guaranteed by: Canada A province Other Debt Securities Floating rate notes Corporate debt Equity Securities Total 3. Impaired Loans $ 112,826 $ 52,079 1,000 29,969 9,318 $ 205,192 1 8 – – 106 $ 115 $ 207 399 – 1 410 $ 112,620 $ 98,481 51,688 34,178 $ 290 315 1,000 29,968 9,014 1,000 25,905 1,303 – 1 39 $ 3 $ 98,768 3 – 1 – 34,490 1,000 25,905 1,342 $ 1,017 $ 204,290 $ 160,867 $ 645 $ 7 $ 161,505 Impaired loans and the related allowance for credit losses are as follows: Consumer and personal Real estate Industrial Other Gross Amount $ 3,209 22,862 7,973 4,145 38,189 Specific Provisions $ 348 2,526 1,238 1,060 5,172 1999 Carrying Amount $ 2,861 20,336 6,735 3,085 33,017 General allowance for credit risk(1) Total(2) (1) The general allowance for credit risk is available for the total loan portfolio. (2) Impaired loans include foreclosed real estate assets held for sale with a gross carrying value of $6,866 (1998 – $5,257) and a related specific allowance of $1,606 (1998 – $1,577). $ 38,189 $ 26,020 $ 12,169 (20,848) 20,848 – 1998 Carrying Amount $ 2,391 12,392 2,039 6,006 22,828 (9,325) $ 13,503 At October 31, 1999 other past due loans totalled $249 (1998 – $nil). Other past due loans are loans where payment of interest or principal is contractually 90-180 days in arrears but are not classified as impaired because they are well secured and considered fully collectible. During the year interest recognized as income on impaired loans totalled $579 (1998 – $341). 4. Allowance for Credit Losses The following table shows the changes in the allowance for credit losses during the year. 1999 General Allowance for Credit Risk $ 9,325 11,694 (171) – – Specific Provisions $ 3,517 – 3,921 (2,314) 48 1998 General Allowance for Credit Risk $ 7,476 – 1,849 – – Specific Provisions $ 4,911 – 2,301 (4,029) 334 Total $ 12,842 11,694 3,750 (2,314) 48 Total $ 12,387 – 4,150 (4,029) 334 Balance at beginning of year Adjustment to general allowance for credit risk(1) Provision for credit losses Write-offs Recoveries Balance at end of year $ 5,172 $ 20,848 $ 26,020 $ 3,517 $ 9,325 $ 12,842 (1) In accordance with the guidance provided by OSFI as described in Note 1(d), the Bank increased its general allowance for credit risk by $11,694. Accordingly, retained earnings was reduced by $6,509, representing the increase in the general allowance, net of deferred income taxes of $5,185. The Bank has virtually no loans booked outside of Canada and therefore has no country risk provisions. Notes to Consolidated Financial Statements} P a g e 5 5 5. Land, Buildings and Equipment Land Buildings Equipment and furniture Leasehold improvements Total Accumulated Depreciation and Amortization $ – 1,571 8,291 2,468 Cost $ 2,753 3,099 13,474 6,222 1999 Net Book Value $ 2,753 1,528 5,183 3,754 1998 Net Book Value $ 2,753 1,689 4,934 3,384 $ 25,548 $ 12,330 $ 13,218 $ 12,760 Depreciation and amortization for the year, in respect of the above buildings, equipment and furniture, and leasehold improvements amounted to $2,680 (1998 – $2,358). 6. Other Assets Due from clients and brokers Deferred income tax asset Accrued interest receivable Prepaid expenses Goodwill and other identifiable intangibles(1) Deferred financing costs(2) Other Total (Note 10) (1) Amortization of goodwill and other identifiable intangibles included in other expenses in the Consolidated Statement of Income is $493 (1998 – $397). (2) Amortization of deferred financing costs included in other expenses in the Consolidated Statement of Income is $250 (1998 – $182). 7. Other Liabilities Accrued interest payable Due to clients and brokers Accounts payable Deferred revenue Non-controlling interest in subsidiary Other Total 1999 $ 14,670 12,335 10,822 5,817 2,031 1,861 2,848 1998 $ 31,943 9,827 10,170 5,199 2,584 2,111 1,823 $ 50,384 $ 63,657 1999 $ 47,430 29,070 4,961 628 234 743 1998 $ 41,064 44,656 6,034 1,119 331 1,370 $ 83,066 $ 94,574 P a g e 5 6 { Notes to Consolidated Financial Statements 8. Subordinated Debentures Each of the following qualifies as a bank debenture under the Bank Act and is subordinate in right of payment to all deposit liabilities. All redemptions are subject to the approval of OSFI. The convertible debentures are financial instruments which have both debt and equity components. The recommendation issued by the Canadian Institute of Chartered Accountants to account for these components separately was considered but the value assignable to the conversion option at the date of issue was deemed to be immaterial in each case. Conventional(1) The Province of Alberta CIC Industrial Interests Inc. (an agency of the Province of Saskatchewan) CLIC Investments (Canada) Inc. Convertible 5.50% convertible debentures(2) 6.75% convertible debentures(3) Crown Life Insurance Company(4) Crown Life Insurance Company(5) Total Interest Rate Maturity Date 1999 1998 6.660% 6.590% 6.415% March 31, 2007 June 30, 2007 July 31, 2007 5.500% 6.750% 5.700% 9.000% March 31, 2008 April 15, 2006 July 31, 2009 July 31, 2004 $ 5,000 $ 5,000 3,126 5,000 13,126 50,000 11,565 4,000 – 65,565 3,126 5,000 13,126 50,000 19,965 – 4,000 73,965 $ 78,691 $ 87,091 (1) Each of the conventional debentures has a ten year term with a fixed interest rate for the first five years. Thereafter, if not redeemed by the Bank, interest will be payable at a rate equal to the Canadian Dollar CDOR 90 day Bankers Acceptance Rate plus 1%. (2) These debentures are convertible into common shares at the option of the holder at any time prior to maturity, or the date specified for conversion by the Bank, whichever is earlier, at a conversion price of $30.50 per share. At any time after March 31, 2003 the debentures are convertible by the Bank. (3) These debentures are convertible into common shares at the option of the holder at any time prior to maturity, or the date specified for conversion by the Bank, whichever is earlier, at a conversion price of $12.50 per share. The debentures were not convertible by the Bank prior to April 15, 1999. From April 15, 1999 to April 14, 2001, provided certain market conditions exist, the debentures are convertible by the Bank. In 1999, $8,400 (1998 – $25) of the debentures were converted by holders. On October 29, 1999 the Bank provided notice of its intention to convert all of the outstanding 6.75% convertible debentures to common shares on December 1, 1999. As a result of the notice the remaining $11,565 of the original $20,000 issued were converted by debentureholders on November 30, 1999 at a conversion price of $12.50 per share. (4) On July 28, 1999 the Bank issued a subordinated debenture to Crown Life Insurance Company for $4,000. This debenture is convertible into common shares, at the option of the holder, at any time prior to maturity. The Bank may redeem the debenture after July 31, 2004. The number of shares issued at conversion will be determined based on a $25.00 per share conversion price. (5) On July 6, 1994 the Bank issued a $4,000 subordinated debenture to Crown Life Insurance Company. The debenture was convertible into common shares of the Bank, at the option of the holder, at a conversion price of $11.00 per share. On July 28, 1999, the Bank completed negotiations with the holder for the redemption of the debenture and the related conversion option for aggregate consideration of $7,091 based upon the current market value of the underlying common shares. The excess of the total consideration paid over the face value of the debenture has been attributed to the conversion option and charged to retained earnings. There was no income tax effect. 9. Capital Stock Authorized: An unlimited number of common shares without nominal or par value 33,964,324 Class A shares without nominal or par value 25,000,000 First Preferred shares without nominal or par value, issuable in series Issued and fully paid: Common shares Outstanding at beginning of year Issued on exercise of options and conversion of debentures(1) Shares purchased for cancellation Outstanding at End of Year 1999 1998 Number of Shares 9,441,520 740,977 (10,300) 10,172,197 Amount $ 89,595 9,069 (180) Number of Shares 9,380,778 60,742 – Amount $ 89,057 538 – $ 98,484 9,441,520 $ 89,595 (1) In 1999, 68,977 (1998 – 58,742) options were exercised, at a weighted average exercise price of $9.70 (1998 – $8.73) and $8,400 (1998 – $25) of the 6.75% debentures were converted into 672,000 (1998 – 2,000) shares. Notes to Consolidated Financial Statements} P a g e 5 7 On November 4, 1998 the Bank implemented a normal course issuer bid for a twelve month period which allowed the Bank to purchase for cancellation up to 472,036 common shares, or 5% of its outstanding common shares. The amounts and timing of repurchases were at the Bank’s discretion and could be made up to November 3, 1999 at prevailing market prices. In October 1999 10,300 common shares were purchased for cancellation at $17.50 per share. The Bank has subordinated debentures which are convertible to common shares of the Bank as more fully described in Note 8. Subsequent to year end the debentureholders converted all of the outstanding 6.75% convertible debentures, which totalled $11,565, to common shares resulting in the issuance of 925,200 common shares and a charge to retained earnings of $384 for share issue expenses, net of deferred income taxes. The Bank also has authorized 1,226,831(1) common shares (1998 – 1,145,808) for issuance under option plans. Of the amount authorized, options exercisable into 1,177,096 shares are issued and outstanding (1998 – 1,101,723) and all expire within ten years of date of grant. The options are exercisable at a fixed price equal to the average of the market price on the day of and the four days preceding the grant. Outstanding options have exercise prices ranging from $8.73 to $20.31. Their weighted average remaining contractual life is 4.8 years and they expire on dates ranging from June 2000 to December 2007. The details of and changes in the issued and outstanding options follow: Options Balance at beginning of year Granted Exercised Forfeited Balance at end of year Exercisable at end of year 1999 1998 Number of Options 1,101,723 158,050(1) (68,977) (13,700) 1,177,096 363,305 Weighted Average Exercise Price $ 13.02 18.83 9.70 16.29 $ 13.96 $ 14.13 Number of Options 894,965 268,200 (58,742) (2,700) 1,101,723 157,312 Weighted Average Exercise Price $ 10.93 19.11 8.73 19.11 $ 13.02 $ 9.08 (1) Of this amount, 137,650 options granted (150,000 authorized) are subject to shareholder and Toronto Stock Exchange approval. 10. Income Taxes The provision for income taxes consists of the following: Current Deferred Total The effective income tax rate of the Bank is 45.2%. However, income taxes otherwise payable for the year have been eliminated by utilizing approximately $24, 801 (1998 – $23,660) of acquired unclaimed deductions and tax loss carryforwards. The current income tax provision represents amortization of acquired unclaimed deductions and tax loss carryforwards of $2,708 (1998 – $2,494) and large corporations tax of $552 (1998 – $533). The deferred income tax asset, included in other assets, primarily represents the net unamortized balance of the acquired unclaimed deductions plus accumulated timing differences relating to claiming deductions for income tax purposes on a basis different from accounting and relate mainly to the provision for credit losses. The Bank has reasonable assurance that its net deferred income tax asset will be realized through future operations and reversals of timing differences. 1999 $ 3,260 256 $ 3,516 1998 $ 3,027 (1,069) $ 1,958 At October 31, 1999, the Bank has approximately $44,733 of unclaimed deductions which are available to reduce future years’ income for tax purposes. The Bank’s subsidiaries have approximately $8,990 in tax loss carryforwards which are available to reduce future years’ income for tax purposes and expire up to 2006. In addition, $6,966 (1998 – $6,315) of capital losses are available to apply against future capital gains and have no expiry date. The tax benefit of these losses has not been recognized in income. P a g e 5 8 { Notes to Consolidated Financial Statements 11. Contingent Liabilities and Commitments a) Off-balance Sheet Instruments In the normal course of business, the Bank enters into various commitments and has contingent liabilities which are not reflected in the Consolidated Balance Sheet. These items are reported below and are expressed in terms of the contractual amount of the related commitment. Credit Instruments Guarantees and standby letters of credit Commitments to extend credit Total Guarantees and standby letters of credit are issued on behalf of clients to third party beneficiaries as part of normal business operations. In the event of a call on any of these instruments, the Bank has recourse against its client. Issuance of guarantees and standby letters of credit is subject to the same credit assessment, approval, monitoring and control procedures as the extension of direct loans. Losses, if any, resulting from these transactions are not expected to be material. Commitments to extend credit to customers also arise in the normal course of business and include recently authorized credit facilities not yet drawn down or credit facilities available on a revolving basis. In the majority of instances, availability of undrawn commercial commitments is subject to the borrower meeting specified financial tests or other covenants regarding completion or satisfaction of certain conditions precedent. It is also usual practice to include the right to review and withhold funding in the event of a material adverse change in the financial condition of the borrower. Given that undrawn credit authorizations arise out of approvals granted through the normal credit assessment process, such commitments bear virtually the same credit risk as fully advanced loan assets. From a liquidity perspective, undrawn credit authorizations will be funded over time with draws in many cases extending over a period of months. In some instances authorizations are never advanced or may be reduced because of changing requirements. The balance of commitments to extend credit shown in the table above does not account for principal drawdowns or paybacks that occur in the normal course of operations. Revolving credit authorizations are subject to repayment which on a pooled basis also decreases liquidity risk. 1999 1998 $ 27,479 366,229 $ 393,708 $ 21,457 282,150 $ 303,607 b) Lease Commitments The Bank has obligations under long-term non-cancellable leases for the rental of premises and office equipment. Minimum future lease commitments for each of the five succeeding years and thereafter are as follows: 2000 2001 2002 2003 2004 2005 and thereafter Total $ 3,377 3,415 3,358 3,237 2,915 10,884 $ 27,186 c) Uncertainty Due to the Year 2000 Issue The Year 2000 Issue arises because many computerized systems use two digits rather than four to identify a year. Date-sensitive systems may recognize the year 2000 as 1900 or some other date, resulting in errors when information using year 2000 dates is processed. In addition, similar problems may arise in some systems which use certain dates in 1999 to represent something other than a date. The effects of the Year 2000 Issue may be experienced before, on, or after January 1, 2000, and, if not addressed, the impact on operations and financial reporting may range from minor errors to significant systems failure which could affect an entity’s ability to conduct normal business operations. It is not possible to be certain that all aspects of the Year 2000 Issue affecting the entity, including those related to the efforts of customers, suppliers, or other third parties, will be fully resolved. 12. Assets Under Administration and Management These are assets administered and/or managed by subsidiaries of the Bank. The assets are beneficially owned by clients and are kept separate from the subsidiaries’ own assets. Therefore they are not reported on the Consolidated Balance Sheet. Assets under administration Assets under management Total 1999 $ 559,978 399,284 $ 959,262 1998 $ 453,058 392,556 $ 845,614 Notes to Consolidated Financial Statements} P a g e 5 9 13. Related Party Transactions The Bank makes loans, primarily residential mortgages, to its officers and employees at various preferred rates and terms. The total amounts outstanding for these type of loans are $17,429 (1998 – $15,401). 14. Fair Value of Financial Instruments Fair value represents the estimated consideration that would be agreed upon in a current transaction between knowledgeable, willing parties who are under no compulsion to act. The best evidence of fair value is a quoted market price. However, most of the Bank’s financial instruments lack an available trading market as they are not typically exchanged. Therefore, these instruments have been valued assuming they will not be sold, using present value or other suitable techniques and are not necessarily representative of the amounts realizable in an immediate settlement of the instrument. Changes in interest rates are the main cause of changes in the fair value of the Bank’s financial instruments. The carrying value of the majority of the financial instruments is not adjusted to reflect increases or decreases in fair value due to interest rate changes as the Bank’s intention is to realize their value over time by holding them to maturity. The carrying value of financial instruments held for trading purposes would be continually adjusted to reflect fair value. At October 31, 1999 and 1998 there were no financial instruments held for trading purposes. The table below sets out the fair values of on-balance sheet financial instruments and derivative instruments using the valuation methods and assumptions referred to below the table. Assets Cash resources Securities (Note 2) Loans Other assets(1) Liabilities Deposits Other liabilities Subordinated debentures Off-balance Sheet Derivative Financial Instruments Net asset (Note 15) 1999 1998 Book Value Fair Value Fair Value Over(Under) Book Value Book Value Fair Value Fair Value Over(Under) Book Value $ 169,990 $ 169,990 $ 205,192 2,253,598 37,601 204,290 2,232,876 37,601 2,371,075 2,353,937 83,066 78,691 83,066 77,548 – (902) (20,722) – (17,138) – (1,143) $ 159,538 $ 159,538 $ 160,867 1,989,656 52,677 161,505 1,992,486 52,677 2,059,545 2,087,722 94,574 87,091 94,574 88,737 – 638 2,830 – 28,177 – 1,646 $ (569) $ 333 The table does not include assets and liabilities that are not considered financial instruments, such as land, buildings and equipment. (1) Other assets exclude goodwill and deferred income tax assets which are not financial instruments. (2) For further commentary on interest rates associated with financial assets and liabilities, including off-balance sheet instruments, refer to the Market Risk section of Management’s Analysis of Operations and Financial Condition which includes the asset liability gap position and effective interest rates. The methods and assumptions used to estimate the fair values of on-balance sheet financial instruments are as follows: • • • cash resources, other assets and other liabilities are assumed to approximate their carrying values, due to their short-term nature; securities are assumed to be equal to the estimated market value of securities provided in Note 2. These values are based on quoted market prices, if available. Where a quoted market price is not readily available, other valuation techniques are used to estimate fair value; loans reflect changes in the general level of interest rates which have occurred since the loans were originated and are net of the allowance for credit losses. For floating rate loans, fair value is assumed to be equal to book value as the interest rates on these loans automatically reprice to market. For all other loans, fair value is estimated by discounting the expected future cash flows of these loans at current market rates for loans with similar terms and risks; • • deposits with no stated maturity are assumed to be equal to their carrying values. The estimated fair values of fixed rate deposits are determined by discounting the contractual cash flows at current market rates for deposits of similar original terms; and the fair values of subordinated debentures and liabilities of subsidiaries, other than deposits included in other liabilities are determined by reference to current market prices for debt with similar terms and risks. Fair values are based on management’s best estimates based on market conditions and pricing policies at a certain point in time. The estimates are subjective and involve particular assumptions and matters of judgement and as such may not be reflective of future fair values. P a g e 6 0 { Notes to Consolidated Financial Statements 15. Derivative Financial Instruments The Bank enters into derivative financial instruments for risk management purposes. Interest rate swaps and interest rate floors (or caps) are used as hedging devices to control interest rate risk. The Bank only enters into these interest rate derivative instruments for its own account and does not act as an intermediary in this market. The credit risk is limited to the amount of any adverse change in interest rates applied on the notional contract amount should the counterparty default. Equity contracts are used to offset the return paid to depositors on certain deposit products where the return is linked to a stock index. The credit risk is limited to the average return on an equity index applied on the notional contract amount should the counterparty default. The principal amounts are not exchanged and hence are not at risk. Approved counterparties and maximum notional limits are established and monitored by the Asset Liability Committee of the Bank. At the present time it is policy to undertake foreign exchange trans- actions only for the purposes of meeting needs of clients and of day to day business. Foreign exchange markets are not speculated in by taking a trading position in currencies. Maximum exposure limits are established and monitored by the Asset Liability Committee and are defined by allowable unhedged amounts. The position is managed within the allowable target range by spot and forward transactions or other hedging techniques. Exposure to foreign exchange risk is not material to the Bank’s overall position. The following table summarizes the off-balance sheet financial instrument portfolio and the related credit risk. Notional amounts represent the amount to which a rate or price is applied in order to calculate the exchange of cash flows. The notional amounts are not recorded on the Consolidated Balance Sheet. They represent the volume of outstanding transactions and do not represent the potential gain or loss associated with the market risk or credit risk of such instruments. The replacement cost represents the cost of replacing, at current market rates, all contracts with a positive fair value. The future credit exposure represents the potential for future changes in value and is based on a formula prescribed by OSFI. The credit risk equivalent is the sum of the future credit exposure and the replacement cost. The risk-weighted balance represents the credit risk equivalent weighted according to the credit worthiness of the counterparty as prescribed by OSFI. Notional Amount Replace- ment Cost 1999 Future Credit Credit Risk- Risk weighted Balance Notional Amount Replace- ment Cost Exposure Equivalent 1998 Future Credit Credit Risk- Risk weighted Balance Exposure Equivalent Interest Rate Contracts Interest rate swaps Equity Contracts Total $ 269,000 $ 227 $ 170 $ 397 2,200 17 176 193 $ 271,200 $ 244 $ 346 $ 590 $ 49 35 $ 84 $ 130,000 $ 437 $ 125 $ 562 $ 112 – – – – – $ 130,000 $ 437 $ 125 $ 562 $ 112 The following table shows the off-balance sheet financial instruments split between those contracts that have a positive fair value (favourable contracts) and those that have a negative fair value (unfavourable contracts). 1999 1998 Favourable Contracts (Assets) Unfavourable Contracts (Liabilities) Favourable Contracts (Assets) Unfavourable Contracts (Liabilities) Notional Amount Fair Value Notional Amount $ 155,000 $ 227 $ 114,000 1,200 17 1,000 $ 156,200 $ 244 $ 115,000 Fair Value $ 735 78 $ 813 Notional Amount Fair Value Notional Amount $ 85,000 $ 437 $ 45,000 – – – $ 85,000 $ 437 $ 45,000 Fair Value $ 104 – $ 104 Interest Rate Contracts Interest rate swaps Equity Contracts Total The aggregate contractual or notional amount of the off-balance sheet financial instruments on hand, the extent to which instruments are favourable or unfavourable and, thus, the aggregate fair values of these financial assets and liabilities can fluctuate significantly from time to time. The average fair values of the off-balance sheet financial instruments on hand during the year are set out in the following table. Favourable off-balance sheet financial instruments (assets) Unfavourable off-balance sheet financial instruments (liabilities) 1999 $ 299 $ 338 1998 $ 131 $ 267 Notes to Consolidated Financial Statements} P a g e 6 1 The following table summarizes maturities of off-balance sheet financial instruments and weighted average interest rates paid and received on interest rate contracts. 1999 Maturity 1998 Maturity 1 year or less Over 1 to 5 years 1 year or less Over 1 to 5 years Notional Amount Contractual Interest Rate Notional Amount Contractual Interest Rate Notional Amount Contractual Interest Rate Notional Amount Contractual Interest Rate Interest Rate Contracts Interest rate (fixed/floating) swaps Receive fixed amounts(1) Equity Contracts(1) (2) Total $ 230,000 5.27% $ 39,000 5.67% $ 105,000 5.18% $ 25,000 5.50% – $ 230,000 2,200 $ 41,200 – $ 105,000 – $ 25,000 (1) The Bank pays (floating) interest amounts based on the one month (30 day) Canadian bankers’ acceptance rate. (2) The contractual interest rate is not meaningful for equity contracts. The Bank receives amounts based on the increase in an equity index. 16. Risk Management 17. Acquisition of Canadian Western Capital Limited As part of the Bank’s risk management practices, the risks that are significant to our business are identified, monitored and controlled. These risks include credit risk, liquidity risk, market risk, and operational risk. Descriptions of the nature of these risks and how they are managed is provided in the commentary on pages 30 to 41 of Management’s Analysis of Operations and Financial Condition. Information on specific measures of risk included in the consolidated financial statements is included in these notes for the allowance for credit losses, derivative financial instruments and fair value of financial instruments. Additional information on interest rate sensitivity and the effective interest rates on financial instruments is provided on pages 37 to 40 of Management’s Analysis of Operations and Financial Condition. On January 16, 1998 the Bank invested an additional $3,000 to acquire a 73% interest in the common shares of Canadian Western Capital Limited for a total cash investment of $3,724. The acquisition was accounted for using the purchase method. At the effective date of acquisition there were assets and liabilities of: Assets Acquired Cash and securities Other assets Liabilities Assumed Other liabilities Net Assets Less non-controlling interest Net Assets Acquired $ 13,985 25,022 39,007 34,375 4,632 908 $ 3,724 Included in other assets is an allocation of $1,301 of the total cash investment which represents values assigned to regulatory licenses and tax loss carryforwards at the time of acquisition. On October 31, 1998 the Bank invested an additional $2,600 as a result of a further recapitalization of the company which increased the Bank’s interest to 80%. During the year ended October 31, 1999 the Bank’s interest was reduced to 72% due to additional capital investment by subsidiary employees. P a g e 6 2 { Notes to Consolidated Financial Statements 18. Segmented Information The Bank operates principally in two industry segments – personal and commercial banking and wealth management. Previously the Bank’s financial results were reported on the basis of one industry segment – the financial services industry. These two segments differ in products and services but are both within the same geographic region. Personal and commercial banking includes the operations of the Bank and its trust subsidiary which provides a wide range of banking and trust services to retail and personal clients and small to medium-size commercial business clients primarily in western Canada. The wealth management segment provides retail brokerage, wealth management and corporate finance services in western Canada through a subsidiary company. Net income for each industry segment is detailed in the following table: Net interest income Provision for credit losses Other income Non-interest expenses Provision for income taxes Non-controlling interest in net loss of subsidiary Net Income (Loss) Average Total Assets Wealth Management Personal and Commercial Banking 1999 1998 $ 61,729 $ 55,751 $ (3,750) 13,017 (44,726) (3,516) (4,150) 12,165 (41,192) (1,958) – – 1999 707 – 6,778 (11,265) – 879 $ 22,754 $ 20,616 $ 2,435,217 $ 2,159,044 $ (2,901) $ 34,459 $ 1998 515 – 5,326 (8,022) – Total 1999 1998 $ 62,436 $ 56,266 (3,750) 19,795 (55,991) (3,516) (4,150) 17,491 (49,214) (1,958) 577 879 577 $ (1,604) $ 19,853 $ 19,012 $ 38,881 $ 2,469,676 $ 2,197,925 19. Difference from Generally Accepted Accounting Principles The consolidated financial statements of the Bank are prepared in accordance with generally accepted accounting principles (“GAAP”), other than the accounting for the general allowance for credit risk which is in accordance with the accounting requirements of OSFI. The impact of the departure from GAAP to conform to the guidance provided by OSFI is described below. Consolidated Balance Sheet As described in Note 4, the Bank increased its general allowance for credit risk. In accordance with the guidance provided by OSFI, this one- time adjustment was applied to retained earnings. The adjustment does not comply with GAAP. However, had the Bank not departed from GAAP to conform to the guidance provided by OSFI, loans would have increased by $11,694, deferred income taxes included in “Other assets” would have declined by $5,185 and retained earnings would have increased by $6,509. The comparative balances for 1998 were not affected. Consolidated Statement of Income There was no impact on the Consolidated Statement of Income as reported, compared with GAAP. Consolidated Statement of Changes in Shareholders’ Equity Except for the decrease in shareholders’ equity of $6,509, there was no impact on the Consolidated Statement of Changes in Shareholders’ Equity as reported, compared with GAAP. Consolidated Statement of Cash Flow There was no impact on the Consolidated Statement of Cash Flow as reported, compared with GAAP. Notes to Consolidated Financial Statements} P a g e 6 3 20. Subsidiaries Canadian Western Bank Subsidiaries (annexed in accordance with subsection 308 (3) of the Bank Act) October 31, 1999 Canadian Western Trust Company Canadian Western Capital Limited CWB Canadian Western Financial Ltd. CWC Life Insurance Services Ltd. Address of Head Office 666 Burrard Street Vancouver, British Columbia 666 Burrard Street Vancouver, British Columbia 10303 Jasper Avenue Edmonton, Alberta 666 Burrard Street Vancouver, British Columbia (1) The carrying value of voting shares is stated at the Bank’s equity in the investments. Carrying Value of Voting Shares Owned by the Bank(1) $ 18,633 $ 1,808 $ $ – 26 Percentage of Issued and Outstanding Voting Shares Owned by the Bank 100% 72% 100% 72% 21. Comparative Figures Certain comparative figures have been reclassified to conform with the current year presentation. P a g e 6 4 { Notes to Consolidated Financial Statements CHAIRMAN Jack C. Donald OFFICE OF THE CHIEF EXECUTIVE OFFICER Larry M. Pollock President and Chief Executive Officer Douglas R. Dalgetty Executive Vice President CREDIT RISK MANAGEMENT Donald C. Kemp Vice President Chris H. Fowler Senior Assistant Vice President Wally N. Streit Senior Assistant Vice President Dennis M. Crough Assistant Vice President, Retail Credit A. Wayne MacInnes Assistant Vice President Ken W. Stewart Assistant Vice President CORPORATE & STRATEGIC OPERATIONS William J. Addington Senior Vice President Erwin Granson Assistant Vice President, Asset Management Ed E. Rudzitis Assistant Vice President TREASURY & OPERATIONS Allister J. McPherson Senior Vice President Ricki L. Moffat Senior Assistant Vice President, Treasury and Agent Administration Michael Vos Senior Assistant Vice President, Systems M. Wayne Bond Assistant Vice President, Corporate Administration Roger J. Pogue Assistant Vice President, Operations EXECUTIVE OFFICERS FINANCE Tracey C. Ball, C.A. Vice President and Chief Financial Officer COMMERCIAL BANKING NORTHERN ALBERTA REGION REAL ESTATE LENDING VANCOUVER Jack C. Wright Vice President and Regional Manager Raymond L. Young Vice President Diane M. Davies, C.A. Senior Assistant Vice President and Chief Accountant William A. Book Senior Assistant Vice President Main Branch, Edmonton Diane L. Kerley, C.M.A. Assistant Vice President HUMAN RESOURCES Uve Knaak Senior Assistant Vice President INTERNAL AUDIT David R. Gillespie Vice President and Chief Inspector Lars K. Christensen Assistant Vice President MARKETING AND PRODUCT DEVELOPMENT R. Graham J. Gilbert Vice President COMMERCIAL BANKING PRAIRIE REGION S. Wayne Bamford Vice President and Regional Manager Michael N. Halliwell Senior Assistant Vice President Main Branch, Calgary Gus W. Itzek Senior Assistant Vice President, Energy Lending Main Branch, Calgary Robert H. Bean Assistant Vice President Winnipeg Richard Brodeur Assistant Vice President Calgary N.E. Ken R. MacDonald Assistant Vice President Regina Donald J. Odell Assistant Vice President Red Deer Dean F. Rhoden Assistant Vice President Saskatoon Al Steingart Assistant Vice President Chinook Station, Calgary Ron S. Baker Assistant Vice President West Point, Edmonton David M. Castell Assistant Vice President Main Branch, Edmonton Wayne C. Dosman Assistant Vice President, Personal Banking Main Branch, Edmonton Keith F. Garbutt Assistant Vice President Southside, Edmonton Gary R. Mitchell Assistant Vice President 103rd Street, Edmonton Jake G. Muntain Assistant Vice President 103rd Street, Edmonton Garnett J. Way Assistant Vice President, Real Estate Lending Main Branch, Edmonton COMMERCIAL BANKING BRITISH COLUMBIA REGION Rod W. Sorbo Vice President and Regional Manager Richard C. Ward Senior Assistant Vice President Park Place, Vancouver Robert G.P. Berzins Assistant Vice President Granville & 13th, Vancouver Russ M. Burke Assistant Vice President Nanaimo Ian G. Graham Assistant Vice President Kelowna Gerald W. Laliberte Assistant Vice President Victoria Craig Martin Assistant Vice President Langley Robert E. Wigmore Senior Assistant Vice President W. Bruce Gibbard Assistant Vice President Jack B. Harms Assistant Vice President INDUSTRIAL LENDING AND LEASING Donald C. Watson Vice President James O. Burke Assistant Vice President Chinook Station, Calgary Dean G. Cudmore Assistant Vice President Guildford, Surrey James S. Kitchin Assistant Vice President Kelowna David B. Subject Assistant Vice President Nanaimo CANADIAN WESTERN TRUST COMPANY – VANCOUVER Adrian M. Baker General Manager Paul W. Trapp Vice President, Marketing Kenneth C. Tabor Vice President, Mortgage Lending Mario V. Furlan Assistant Vice President, Real Estate Lending Patrick F. Rennison Assistant Vice President, Real Estate Lending OMBUDSMAN W. Paul Lefaivre C W B ’9 9} P a g e 6 5 BOARD OF DIRECTORS CANADIAN WESTERN BANK & TRUST Charles R. Allard2,3 Chairman & Chief Executive Officer WIC Premium Television Ltd. Edmonton, Alberta Albrecht W. A. Bellstedt3,4 Senior Vice President Law & Chief Compliance Officer TransCanada PipeLines Calgary, Alberta Douglas R. Dalgetty2 Executive Vice President Canadian Western Bank Vancouver, British Columbia Jack C. Donald2,4 President Parkland Industries Ltd. Red Deer, Alberta Jordan L. Golding1 Corporate Director and Consultant Retired Partner KPMG Peat Marwick Boston, Massachusetts, USA Allan W. Jackson2,3,4 President ARCI Ltd. Calgary, Alberta Robert A. Manning1,2,4 President Cathton Holdings Ltd. Edmonton, Alberta Gerald A.B. McGavin1,2 President McGavin Properties Ltd. Vancouver, British Columbia Howard E. Pechet2,4 President Mayfield Consulting Inc. La Jolla, California, USA DIRECTORS EMERITUS John Goldberg Arthur G. Hiller Peter M.S. Longcroft Dr. Maurice W. Nicholson Alma M. McConnell Eugene I. Pechet Dr. Maurice M. Pechet Gordon V. Rasmussen Fred Sparrow Robert J. Turnbull Larry M. Pollock2 President and Chief Executive Officer Canadian Western Bank Edmonton, Alberta Alan M. Rowe, C.A.1 Senior Vice President and Chief Financial Officer Crown Life Insurance Company Regina, Saskatchewan Arnold J. Shell2,3 President Arnold J. Shell Consulting Inc. Calgary, Alberta 1 Audit Committee Member 2 Loans Committee Member 3 Conduct Review Committee Member 4 Corporate Governance & Human Resources Committee Member SHAREHOLDER INFORMATION Head Office Suite 2300, Canadian Western Bank Place 10303 Jasper Avenue Edmonton, Alberta T5J 3X6 Telephone: (780) 423-8888 Fax: (780) 423-8897 Website: www.cwbank.com Subsidiary Head Office Canadian Western Trust Company 22nd Floor, 666 Burrard Street Vancouver, B.C. V6C 2X8 Telephone: (604) 669-0081 Fax: (604) 685-9997 Website: www.cwt.ca Stock Exchange Listing The Toronto Stock Exchange Share Symbol: CWB Convertible Debenture Symbol: CWB.DB.A Transfer Agent and Registrar Mailing Address Montreal Trust Concourse Level 10050 Jasper Avenue Edmonton, Alberta T5J 1V7 Telephone: (780) 448-7598 Fax: (780) 426-4032 Corporate Secretary Charles R. Allard WIC Premium Television Ltd. Edmonton, Alberta Inquiries from Shareholders Any notification regarding change of address or change in registration of shares should be directed to the Transfer Agent. Any inquiries other than change of address or change in registration may be directed to the President and Chief Executive Officer. Annual Meeting The annual meeting of the common shareholders of Canadian Western Bank will be held on March 9, 2000 at The Westin (Manitoba Room), 10135 - 100th Street, Edmonton, Alberta at 2:00 p.m. (MST). P a g e 6 6 { C W B ’9 9 ALBERTA Edmonton Edmonton Main Branch 11350 Jasper Avenue Edmonton, Alberta T5K 0L8 (780) 424-4846 Branch Manager – Bill Book 103rd Street Branch Canadian Western Bank Place 10303 Jasper Avenue Edmonton, Alberta T5J 3N6 (780) 423-8801 Branch Manager – Jake Muntain Southside Branch 7933 - 104 Street Edmonton, Alberta T6E 4C9 (780) 433-4286 Branch Manager – Heinz Kleist West Point Branch 17603 - 100 Avenue Edmonton, Alberta T5S 2M1 (780) 484-7407 Branch Manager – Ron Baker RSP Administration/ Agent Processing Centre Suite 2200, 10303 Jasper Avenue Edmonton, Alberta T5J 3X6 (780) 423-8888 Branch Manager – Lina Langford Victoria 1201 Douglas Street Victoria, B.C. V8W 2E6 (250) 383-1206 Branch Manager – Gerry Laliberte Guildford Industrial Lending Centre, Surrey 401, 15127 - 100 Avenue Surrey, B.C. V3R 0N9 (604) 583-7500 Branch Manager – Dean Cudmore SASKATCHEWAN Regina 1881 Scarth Street McCallum Hill Centre II Regina, Saskatchewan S4P 4K9 (306) 757-8888 Branch Manager – Ken MacDonald Saskatoon 244 - 2nd Avenue S. Saskatoon, Saskatchewan S7K 1K9 (306) 477-8888 Branch Manager – Dean Rhoden Yorkton #45, 277 Broadway Street E. Yorkton, Saskatchewan S3N 3G7 (306) 782-1002 Branch Manager – Barb Apps MANITOBA Winnipeg 234 Portage Avenue Winnipeg, Manitoba R3C 0B1 (204) 956-4669 Branch Manager – Robert Bean BANKING OFFICES Calgary Calgary Main Branch 606 - 4th Street S.W. Calgary, Alberta T2P 1T1 (403) 262-8700 Branch Manager – Michael Halliwell Calgary Northeast Branch 2810 - 32nd Avenue N.E. Calgary, Alberta T1Y 5J4 (403) 250-8838 Branch Manager – Richard Brodeur Chinook Station 6606 MacLeod Trail S.W. Calgary, Alberta T2H 0K6 (403) 252-2299 Branch Manager – Al Steingart Camrose 4895 - 50th Street Camrose, Alberta T4V 1P6 (780) 672-7769 Branch Manager – Kevin MacMillen Red Deer 5013 - 49 Avenue Red Deer, Alberta T4N 3X1 (403) 341-4000 Branch Manager – Don Odell Lethbridge 744 - 4th Avenue South Lethbridge, Alberta T1J 0N8 (403) 328-9199 Branch Manager – Donald Grummett Grande Prairie Industrial Lending Centre 5th Floor, 214 Place 9909 - 102 Street Grande Prairie, Alberta T8V 2V4 (780) 831-1888 Branch Manager – Keith MacLellan BRITISH COLUMBIA Vancouver Regional Office 22nd Floor, 666 Burrard Street Vancouver, B.C. V6C 2X8 (604) 669-0081 Granville & 13th Branch 2899 Granville Street Vancouver, B.C. V6H 3J4 (604) 730-8818 Branch Manager – Rob Berzins Park Place Branch Suite 100, 666 Burrard Street Vancouver, B.C. V6C 2X8 (604) 688-8711 Branch Manager – Richard Ward RSP Administration/ Agent Processing Centre 22nd Floor, 666 Burrard Street Vancouver, B.C. V6C 2X8 (604) 443-5175 1-800-663-1000 Branch Manager – Huguette Holmes Courtenay 470 Puntledge Road Courtenay, B.C. V9N 3R1 (250) 334-8888 Branch Manager – Alan Dafoe Kamloops Industrial Lending Centre 2155 Westsyde Road Kamloops, B.C. V2B 7C3 (250) 554-8030 Account Manager – Harold Lavack Kelowna 1674 Bertram Street Kelowna, B.C. V1Y 9G4 (250) 862-8008 Branch Manager – Ian Graham Langley 100, 19915 – 64th Avenue Langley, B.C. V2Y 1G9 (604) 539-5088 Branch Manager – Craig Martin Nanaimo #101, 6475 Metral Drive Nanaimo, B.C. V9T 2L9 (250) 390-0088 Branch Manager – Russ Burke C W B ’9 9} P a g e 6 7 Designed and produced by Vision Design Communications. Illustrations by David Moore. Canadian Western Bank Place Suite 2300 10303 Jasper Avenue Edmonton, Alberta T5J 3X6 

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