Canadian Western Bank Annual Report 2014

Plain-text annual report

C W B G r o u p 2 0 1 4 A n n u a l R e p o r t 2014 Annual Report CWB Group Bank Trust Insurance Wealth Management CWB Group 2014 Annual Report i Five Year Financial Summary ($ thousands, except per share amounts) Results of Operations Net interest income (teb)(3) Less teb adjustment Net interest income per financial statements Other income Total revenues (teb) Total revenues Net income available to common shareholders Return on common shareholders’ equity(4) Return on average total assets(5) Per Common Share IFRS(1) Canadian GAAP(1) 2014 2013(2) 2012 2011 2010 $ 513,196 $ 470,757 $ 443,572 $ 411,452 $ 328,664 7,676 505,520 113,409 626,605 618,929 218,549 14.8% 1.10 8,138 462,619 94,982 565,739 557,601 187,163 9,143 434,429 81,910 525,482 516,339 172,197 11,059 400,393 72,103 483,555 472,496 149,538 14.2% 1.06 15.0% 1.08 14.7% 1.09 11,186 317,478 105,595 434,259 423,073 148,413 17.1% 1.24 Average common shares outstanding (thousands) 80,034 79,147 76,841 72,205 65,757 Earnings per share Basic Diluted Adjusted cash(6) Dividends Book value Market price High Low Close $ $ 2.73 2.70 2.76 0.78 19.52 43.30 32.61 37.75 $ 2.36 2.35 2.39 0.70 17.54 33.75 27.04 33.44 $ 2.24 2.22 2.30 0.62 15.94 30.10 24.62 29.56 $ 2.07 1.95 2.17 0.54 13.87 31.75 24.00 28.50 2.26 2.05 2.09 0.44 14.08 26.59 19.85 25.36 Balance Sheet and Off-Balance Sheet Summary Assets $ 20,608,656 $ 18,513,340 $ 16,873,269 $ 14,849,141 $ 12,701,691 Cash resources, securities and repurchase agreements 2,697,185 2,580,327 2,573,083 2,238,039 Loans Deposits Debt Shareholders’ equity Assets under administration Assets under management Capital Adequacy(7) Common equity Tier 1 ratio Tier 1 ratio Total ratio Other Information Efficiency ratio (teb)(8) Efficiency ratio Net interest margin (teb)(9) Net interest margin Provision for credit losses as a percentage of average loans Net impaired loans as a percentage of total loans Number of full-time equivalent staff Number of bank branches 17,510,099 15,567,440 13,953,686 12,293,282 17,373,014 15,631,040 14,144,837 12,394,689 1,036,990 1,693,527 10,101,698 820,650 1,598,507 8,423,972 634,273 1,464,979 7,171,826 634,877 1,256,613 9,369,589 1,795,975 1,901,146 855,333 816,219 8.0% 9.3 12.8 46.0 46.6 2.59 2.55 0.15 (0.19) 2,094 41 8.0% 9.7 13.9 46.4 47.1 2.66 2.62 0.19 (0.14) 2,037 41 n/a 10.6% 13.8 44.8% 45.6 2.79 2.73 0.19 (0.11) 1,885 41 n/a 11.1% 15.4 44.9% 45.9 2.99 2.91 0.19 0.21 1,796 40 1,876,085 10,496,464 10,812,767 315,000 1,148,043 8,530,716 795,467 n/a 11.3% 14.3 44.1% 45.3 2.74 2.64 0.21 0.62 1,716 39 (1) Financial information prepared under IFRS (2011–2014) and Canadian GAAP (2010) may not be (4) Return on common shareholders’ equity is calculated as net income available to common shareholders directly comparable. divided by average common shareholders’ equity. (2) During 2014, CWB adopted IFRS 10 Consolidated Financial Statements and applied a change (5) Return on assets is calculated as net income available to common shareholders divided by average in accounting policy for indirect leasing costs, both as described in Note 1 of the consolidated financial statements. The 2013 comparative figures reflect the retrospective application of these changes, and 2010–2012 have not been restated. (3) Most banks analyze revenue on a taxable equivalent basis (teb) to permit uniform measurement and comparison of net interest income. Net interest income (as presented in the consolidated statement of income) includes tax-exempt income on certain securities. Since this income is not taxable, the rate of interest or dividend received is significantly lower than would apply to a loan or security of the same amount. The adjustment to taxable equivalent basis increases interest income and the provision for income taxes to what they would have been had the tax- exempt securities been taxed at the statutory rate. The taxable equivalent basis does not have a standardized meaning prescribed by generally accepted accounting principles and, therefore, may not be comparable to similar measures presented by other banks. total assets. (6) Diluted earnings per common share excluding the after-tax amortization of acquisition-related intangible assets and the non-tax deductible change in fair value of contingent consideration. These exclusions represent non-cash charges are not considered to be indicative of ongoing business performance. (7) As of January 1, 2013, the Office of the Superintendent of Financial Institutions Canada (OSFI) adopted a new capital management framework called Basel III and capital is managed and reported in accordance with those requirements. Capital ratios prior to fiscal 2013 have been calculated using the previous framework, Basel II. Capital ratios calculated under Basel III are not directly comparable to the equivalent Basel II measures. (8) Efficiency ratio is calculated as non-interest expenses divided by total revenues excluding the non-tax deductible change in fair value of contingent consideration. (9) Net interest margin is calculated as net interest income divided by average total assets. ii CWB Group 2014 Annual Report Financial Performance Summary(1)(2) Total Loans ($ millions) Total Assets ($ millions) 17,510 15,567 13,953 12,293 10,496 16,873 14,849 12,701 Total Revenues (teb) ($ millions) 626 565 18,513 20,608 525 483 434 2010 2011 2012 2013 2014 2010 2011 2012 2013 2014 2010 2011 2012 2013 2014 GAAP IFRS GAAP IFRS GAAP IFRS Net Income Available to Common Shareholders ($ millions) 218 187 172 148 149 Efficiency Ratio (teb) (expenses to revenues) Provision for Credit Losses ( as a percentage of average loans) 44.1% 44.9% 44.8% 46.4% 46.0% 0.21% 0.19% 0.19% 0.19% 0.15% 2010 2011 2012 2013 2014 2010 2011 2012 2013 2014 2010 2011 2012 2013 2014 GAAP IFRS GAAP IFRS GAAP IFRS (1) As of 2011, financial results are reported under IFRS, as opposed to Canadian GAAP, and may not be directly comparable. (2) During 2014, CWB adopted IFRS 10 Consolidated Financial Statements and applied a change in accounting policy for indirect leasing costs, both as described in Note 1 of the Consolidated Financial Statements. The 2013 comparative figures reflect the retrospective application of these changes and 2010–2012 have not been restated. 2014 Performance Target Ranges(1) Adjusted cash earnings per common share growth Total revenue (teb) growth Loan growth Provision for credit losses as a percentage of average loans Efficiency ratio (teb) Return on common shareholders’ equity Return on assets (1) See page 13 for a discussion of non-IFRS measures. 2014 Target Ranges 12 – 16% 10 – 12 10 – 12 0.18 to 0.23 ≤ 46 14.0 – 15.0 1.05 – 1.15 2014 Performance 15% 11 12 0.15 46.0 14.8 1.10 CWB Group 2014 Annual Report iii About CWB Group Canadian Western Bank (TSX: CWB) offers highly personalized business and personal banking services, primarily across the four western provinces, and is the largest publicly traded Canadian bank headquartered in Western Canada. The Bank, along with its operating affiliates and divisions – National Leasing, Optimum Mortgage, Canadian Direct Financial, Canadian Western Trust, Valiant Trust, Canadian Direct Insurance, Adroit Investment Management, McLean & Partners Wealth Management, and Canadian Western Financial – collectively offer a diversified range of financial services across Canada and are together known as CWB Group. Table of Contents CWB Group ......................................................................... i Five Year Financial Summary ................................................ ii Financial Performance Summary ......................................... iii Introduction ........................................................................ 1 Business Strategy and Lines of Business ............................... 2 Interview with the President and CEO, Chris Fowler ............. 4 Message from the Chair, Allan Jackson ............................... 6 Corporate Governance ........................................................ 8 Management’s Discussion and Analysis ............................. 11 Consolidated Financial Statements .................................... 62 Shareholder Information ................................................. 103 Locations ........................................................................ 104 1 CWB Group 2014 Annual Report Business Strategy Lines of Business Vision To be seen as crucial to our clients’ futures. CWB Group is focused on becoming the trusted financial partner to a growing base of clients by delivering responsive service and sensible solutions, while preserving its fundamental identity as a conservative, growth-oriented organization built on a results-oriented culture. In doing so, management maintains a supportive environment for employees, aims to provide strong long-term returns for shareholders and gives back in the communities where clients and employees work and live. CWB Group’s approach to strategic management recognizes that the development and implementation of strategies cannot be undertaken in isolation, but need to be part of a cross-functional, group-wide process. The intent is to focus on key business drivers that contribute the greatest impact toward the achievement of CWB Group’s vision, and are represented by both financial and non-financial measures. This approach is facilitated through a focus on four inter-dependent pillars within CWB Group’s strategic direction, summarized as follows: People Invest in our people, build lasting relationships and live our values. Support Build funding sources, drive operational excellence, and balance risk and reward. Clients Be responsive, deliver sensible solutions and be the trusted financial partner. Financial Sustain profitable growth, build revenue sources and maintain our efficiency. 2 BANK Canadian Western Bank (CWB) Offers comprehensive business banking services in branches located throughout Western Canada, with specialized expertise in general commercial banking, equipment financing and leasing, commercial real estate financing, real estate construction financing, and energy lending. Complementary full-service personal banking options include chequing and savings accounts, mortgages, personal loans and investment products. National Leasing Delivers small- and mid-ticket equipment leasing solutions with operations across Canada, specializing in four key verticals: general commercial, agriculture, health care, and golf and turf. Optimum Mortgage Specialty lender focused on broker-sourced alternative mortgages across Canada, with the exception of Quebec. Also offers high ratio insured mortgages, conventional “A” mortgages and competitive home equity lines of credit. Canadian Direct Financial (CDF) CWB’s Internet-based division offers personal banking services to clients across Canada, with the exception of Quebec, including chequing, savings and investment products. Select 2014 Highlights • Collectively achieved 12% loan growth, surpassing $17.6 billion of total loans • Generated 15% growth in branch-raised demand and notice deposits • Surpassed $3 billion of total equipment financing loans and leases • Expanded the geographic footprint of Optimum Mortage to include Atlantic Canada, and surpassed $1.4 billion of total mortgages outstanding in this business • Increased the number of CDF clients by 20%, and approached $375 million of total deposits through this channel Opportunities • Profitably support ongoing double-digit loan growth with a focus on optimized funding, lending yields and targeted diversification • Leverage significant investment in technology and employee training to deliver targeted financial solutions based on a strong understanding of client needs • Deepen client relationships and increase products-per-client through successful cross-selling between business and personal banking areas, as well as other CWB Group companies CWB Group 2014 Annual ReportINSURANCE Canadian Direct Insurance (CDI) Offers auto, home, tenant, condominium and travel insurance at highly competitive rates by phone or over the Internet. Select 2014 Highlights • Realized an underwriting profit for the 12th consecutive year, despite the financial impact of severe weather events Opportunities • Optimize home insurance pricing adequacy based on results of comprehensive review of policy coverages and deductibles • Expand online delivery platform to include tenant and condo insurance products • Ongoing development of affinity partnership opportunities • Deepen client relationships by continuing to promote CWB Group’s brand and products TRUST Canadian Western Trust (CWT) Delivers customized pension, trustee and custodial solutions for individuals and businesses through two distinct lines of business: Individual Retirement Investment Services (IRIS) and Corporate and Group Services (CGS). Valiant Trust (Valiant) Offers specialty trust services for public and private corporations, including stock transfer, corporate trust, escrow and employee plan administration. Select 2014 Highlights • Surpassed $10 billion of trust assets under administration • CWT introduced French-language services, both online and by phone • Completed nearly 700 client appointments in Valiant Opportunities • Deepen client relationships by continuing to develop private client partnerships and cross-sell opportunities with other CWB Group companies • Build on CWT’s successes serving clients of Adroit Investment Management to grow CGS market share WEALTH MANAGEMENT Adroit Investment Management Offers discretionary wealth management for high-net-worth individuals, corporations and institutions, with core investments in Canadian equities, non-Canadian equities and fixed income products. McLean & Partners Wealth Management Offers discretionary wealth management for high-net-worth individuals based on distinct strategies that offer balanced trade-offs between risk and reward. Canadian Western Financial (CWF) Offers investment planning services through licensed mutual fund representatives located in CWB branches. Provides access to a full range of investment products from Canada’s leading mutual fund companies. Select 2014 Highlights • Engaged an experienced wealth management executive to refine CWB’s wealth management strategy and provide a clear road map for future expansion and growth • Added regional wealth management specialists in Alberta Opportunities • Align geographic footprint of discretionary wealth management segment with CWB branch network through additional wealth management specialists and ongoing consideration of strategic acquisitions • Invest in tools and training to improve financial planning advice specific to business owners • Deepen client relationships and increase products-per-client through successful cross-selling between CWB Group companies 3 CWB Group 2014 Annual Report Interview with the President and CEO, Chris Fowler CWB Group had a great year in 2014 – what stands out the most for you? What are your primary strategic priorities as CEO and what are your expectations for 2015 and beyond? To achieve record financial performance in a year where few things came easily is very gratifying. Thanks to the collaborative efforts of our tremendous people, our results were in line with or better than each of our financial performance target ranges in spite of ongoing challenges related to very low interest rates and elevated competitive pressures. We have a relatively simple business model and the spread we earn on loans has a big impact on our overall financial results. Our 2014 performance target ranges were underpinned by the expectation that net interest margin would remain stable compared to the second half of 2013. Although this was not the case, we still delivered great results across each of our lines of business. The issuance of $125 million of Series 5 preferred shares in February, and subsequent redemption of $209 million of higher cost Series 3 preferred shares in April, was another highlight. Taken together, these transactions support our strategic focus to optimize regulatory capital while developing a more cost-effective capital structure, which positively impacts earnings per share. It was satisfying to see the very strong market reception for our new preferred shares as it reinforces the recognition we’ve earned within the investment community. This recognition also helps us diversify and enhance our funding mix with cost-effective deposits raised through the capital markets. Exceptional credit quality continues to be a strength for us. This is primarily a function of our secured lending model and disciplined underwriting practices, and it also ties back to strong economic fundamentals within our key markets. There’s a lot of ground to cover here. I’ll begin by saying that at the highest level we continue to focus on delivering exceptional service to our clients, which will ultimately drive CWB Group’s ongoing transition into a larger, diversified financial institution. Our overall strategic direction supports our vision to be seen as crucial to our clients’ futures while preserving our fundamental identity as a conservative, growth-oriented organization built on an entrepreneurial culture. We view the business through four interrelated strategic pillars, beginning with our people. It’s our people who create and evolve our unique culture. We work hard, we’re resilient and we get things done for our clients. In doing so, we ensure we earn an appropriate return for our shareholders while continuing to make a positive difference in the communities where we work and live. Our culture is the foundation of everything we do, but we recognize that culture alone is not enough to attract and retain the most qualified employees. To ensure that we’re staffed with the best available talent amidst a very competitive labour market, especially here in Western Canada, we initiated a formal review of non-executive compensation this year. Changes to the level and structure of total rewards for all non-executive bank employees will increase total compensation expense in 2015, but we know it’s the right thing to do to position us for ongoing success. Our next strategic pillar relates to technology, infrastructure and processes required to maintain and improve our client offerings and service capacity. With respect to physical infrastructure, we relocated our Edmonton Main Branch to significantly expanded premises and broke ground on new premises in Medicine Hat, Alberta. We also plan to open an expanded branch in Prince George, British Columbia, in 2015. 4 CWB Group 2014 Annual ReportWe continue to work toward completion of the most significant technology investment we’ve ever undertaken, deployment of a new core banking system. The new system will allow our teams to spend less time on paperwork and more time focusing on building relationships to meet our clients’ financial needs. Implementation is scheduled for early fiscal 2016 and I’m pleased to say that the project continues to go very well. The next strategic pillar is all about our clients. By delivering responsive service and sensible solutions, we have become the trusted financial partner to a growing base of clients in Western Canada and other select markets. We have lots of room to gain market share within all of our lines of business and we’re excited about our opportunities to attract new clients while becoming more crucial to those we already serve. We’re doing this by leveraging our traditional strengths in commercial lending while continuing to expand and enhance our product and service offerings. We’ve improved our suite of cash management products, for example, making it easier for business owners to manage their day-to- day banking needs. We’ve also enhanced our service offering through an ongoing commitment to employee training and development. Our teams have always provided great service, and we want to augment this strength by ensuring our clients are aware of everything we can do for them. It’s not about pushing products. Instead, it’s about helping our teams discover client needs we can meet with sensible financial solutions. All of these factors contribute to long-term value creation for CWB shareholders, which is our fourth strategic pillar. Our financial performance targets emphasize specific measures that we believe tie directly to shareholder value. This year’s targets reflect our ambitions to build on our long history of double-digit asset growth, stable profitability and strong efficiency, all while maintaining disciplined underwriting practices and strong credit quality. There have been a number of changes to the Executive Committee this year. What were the reasons for these changes and how do you expect them to benefit CWB Group and its stakeholders? A key change was the retirement of Tracey Ball after many years of exceptional leadership as our chief financial officer (CFO). Tracey had an enormous impact on the development and success of CWB Group during her 27-year tenure. Carolyn Graham, our chief accountant since 2006, worked closely with Tracey since joining CWB Group in 2000, and she was appointed our new executive vice president and CFO effective October 1. With her unique combination of leadership, experience, insight, and determination, Carolyn is without question the right person for this job. In addition to welcoming Carolyn into her new role, we further augmented our Executive Committee to ensure we execute on our strategy while continuing to support CWB Group’s ongoing growth. To complement the significant contributions and depth of expertise provided to the Executive Committee by executive vice presidents, Randy Garvey, Greg Sprung and Brian Young, in October 2014, we appointed Kelly Blackett to Executive Vice President, Human Resources. Kelly’s appointment reflects her considerable experience and the important contributions she has made during her time with CWB Group. It is also aligned with our commitment to foster an exceptional culture which emphasizes quality training and unique career development opportunities. In December 2014, we introduced Bogie Ozdemir as Executive Vice President and Chief Risk Officer (CRO). Bogie’s role addresses our objective to take a more integrated approach to risk management across our organization, and to support our strategic focus to optimize regulatory capital, including plans for an eventual transition to an advanced methodology for calculating risk-weighted assets. Are there opportunities for CWB Group to expand further via acquisition? And if so, in what areas are these opportunities most likely to arise? We’ve always taken a patient approach to strategic acquisitions. We’re determined to focus on areas where CWB can foster distinct competitive advantages within our primary geographic and business footprints. We reviewed a number of opportunities in the past year and will continue to do so going forward. Wealth management is an area of particular interest for us as it offers revenue diversification and a natural complement to our core service offerings in business banking, where personal relationships are crucial. We’re also interested in adding scale to our operations in equipment financing and leasing. Through National Leasing, our small ticket equipment leasing company, we’ve acquired three regional equipment brokers in as many years, one in Quebec, another in Saskatchewan and the most recent in New Brunswick. These tuck-in acquisitions were sound from a strategic standpoint, offered strong cultural fits and strengthened our market position in each region. In general, our proven ability to deliver strong organic growth across our lines of business has allowed us to remain conservative in pursuing acquisitions and we don’t see anything changing in that respect. Can you explain what you are currently seeing in your markets as it relates to competition? Competition has always been a challenge within our chosen operating environments. Western Canada is an attractive place to do business, a fact which has certainly not escaped the attention of our competitors. One new wrinkle in the competitive landscape relates to regulation and deposit pricing. With enforcement of Basel III liquidity guidelines due to commence in 2015, regulated financial institutions have taken steps to attract preferred funding sources, creating increased pricing competition for those deposits. Without an offset from loan pricing in a persistently low interest rate environment, lending spreads have been compressed. This was another factor which challenged net interest margin through 2014. We’re confident the steps we’re taking to build and diversify our funding sources, including an ongoing strategic focus on branch-raised deposit growth, will help to mitigate this pressure over time. Western Canada continues to lead the country in economic growth. Could you comment on your business outlook for the coming year? Western Canada remains the strongest economic region of the country. Expansion in the western provinces has brought growth in population, employment and personal income that require support through new housing and infrastructure. The resource sector has been a significant catalyst for this ongoing development. However, this is an international sector, where global market dynamics affect local decisions. We will continue to monitor movements in oil prices and assess the impact on our clients and their businesses. We have built our business around small to mid-market entrepreneurs and have a diverse mix of clients. The large resource companies are not our core clientele; we’re focused on the contractors that work for them and businesses that emerge from the broad range of economic opportunities created by resource-related activity. A sustained period of lower oil prices may impact certain near-term decisions to expand, but the long-term nature of existing oil sands investment requires continued capital expenditures to maintain production levels. The economy in Western Canada has demonstrated impressive resilience in the face of commodity price volatility in the past. We’re encouraged by the recent clarification of the royalty regime in British Columbia and optimistic about the outlook for development of liquefied natural gas infrastructure on the West Coast. Our core geographic footprint will remain an attractive investment jurisdiction for a long time to come. We’re maintaining our bullish outlook for Western Canada and are very excited about CWB Group’s future! 5 CWB Group 2014 Annual Report Message from the Chair, Allan Jackson The CWB Board of Directors remains focused on maintaining an effective governance framework in support of CWB Group’s strategic direction and ongoing growth. The Board believes that its role in supporting a culture of ethical behaviour is just as important as its obligation to ensure the right management team is in place, and works proactively to ensure that key strategic objectives properly balance risk and reward. The Right Culture A well-known Canadian businessman once said that he did not understand why business schools waste a whole year talking about ethics, when all students need to do is understand and obey the law. Although I do not believe this is a widely held viewpoint, one does not have to look far to observe instances where businesses and governments check with their lawyers before embarking on a course of action. While it is essential to obey the law and follow regulations, many activities that are legal are neither right nor ethical. I am proud to say that at CWB Group, one of the first things we confirm is whether a proposed course of action is right, fair and ethical based on a commitment to our strong corporate values. This imperative has always guided CWB Group, and is applied consistently whether the actions involve one of our companies or our people, clients or shareholders. I have no doubt that this ethical standard and commitment to maintaining strong corporate values are foundations supporting CWB Group’s achievement of record financial performance in 2014. The Right People This year, we continued to focus on depth of leadership and planning for succession. The Board worked with our CEO, Chris Fowler, to further strengthen the Executive Committee and appoint three new executive vice presidents (EVP) - two promoted from within and the third recruited externally. Kelly Blackett, EVP, Human Resources, and Carolyn Graham, EVP and Chief Financial Officer, were promoted from their prior key roles, while Bogie Ozdemir joins CWB Group, in a new role for us, as EVP and Chief Risk Officer. Kelly was promoted from her prior position as Senior Vice President, Human Resources, in recognition of the skill she has demonstrated as an executive, the depth of her experience and the valuable contributions she has made to the CWB Group. Carolyn is a well-established leader and succeeds our long-time EVP and CFO, Tracey Ball. The Board thanks Tracey for the very important role she played in the success of CWB Group, and in fostering our unique corporate culture. One of Tracey’s many talents is the ability to find and develop equally talented people, and Carolyn is a reflection of this. The Board came to know Carolyn well in her role as chief accountant, where she consistently demonstrated the unique combination of leadership and insight required of a CFO. Bogie brings a wealth of knowledge and experience in Canadian financial services risk governance and, as our chief risk officer, will play a key role in supporting our growth while facilitating the critical balance of risk and reward. We are very pleased to welcome him. 6 CWB Group 2014 Annual ReportThe Right Board Complement Next year, two long serving directors will retire from the Board. Howard Pechet was one of the founding shareholders of the Bank of Alberta, CWB’s predecessor, and has been a director since 1984. He has been an exceptional director and has significantly influenced CWB Group’s evolution from a small, regional bank to the integrated financial services institution we are today. Wendy Leaney will also retire after 13 years as director. Her knowledge of banking and clarity of thought greatly contributed to the incredible growth we have achieved. During her tenure, she served on each of our board committees and, since the beginning of 2013, chaired our Loans Committee. Our newest director, Sarah Morgan-Silvester, was elected to the Board in March 2014. She is a leader in the Canadian banking industry with particular expertise in personal banking, trust and wealth management, and is a welcome addition to our group. The Board decided many years ago that 12 directors was the appropriate number to most effectively and efficiently provide oversight to CWB Group and, in this year’s assessment of board effectiveness, this conclusion was reaffirmed. Over the past two years, we deliberately increased the size of the Board to provide a smooth transition for anticipated retirements. With two directors not standing for re-election this year, the Board complement will return to 12. The Right Strategy CWB Group continues to make history as the first successful publicly traded Schedule 1 bank headquartered in Western Canada. We are optimistic about the significant potential for future growth in our core lines of business and are taking appropriate steps to realize that potential. We have exceptional, highly motivated people, led by an outstanding management team, and we are confident that we have the right strategy and culture to achieve our collective goals. Sincerely, Allan Jackson Chair of the Board 7 CWB Group 2014 Annual Report Corporate Governance At CWB Group, we strive to earn the trust of our stakeholders through high standards of corporate governance, and have embedded rigorous oversight and governance practices into our business processes. We work continuously to enhance and improve our governance practices with the recognition that this commitment directly contributes to the creation of long-term shareholder value and the sound functioning of our organization. Governance Structure To ensure strong governance in the areas of audit, governance, human resources and loans, committees made up of directors are given specific oversight roles in which they report back to the overall Board. Risk is overseen by the Board as a whole. Full mandates of each committee, as well as the Board mandate, are available in the Corporate Governance section at cwb.com. Board Committees Audit Committee Governance Committee • Discusses and reviews CWB Group’s financial disclosures with management and external auditors • Recommends the external auditor to shareholders • Oversees the organization’s internal controls • Reviews existing governance practices to ensure alignment with legal requirements, regulatory requirements and industry best practices • Works with CWB Group management to foster a culture of ethical conduct • Acts as the conduct review committee and the nominating committee Human Resources Committee • Oversees CWB Group’s human capital and ensures that the organization’s succession plans are adequate • Leads compensation review and recommendation process • Oversees the structure of executive compensation Loans Committee • Establishes lending policies and guidelines for CWB Group • Establishes lending limits for management, and evaluates and approves loan applications above these limits The Board of Directors (the Board) is responsible for the overall stewardship of CWB Group, including the development and monitoring of the organization’s governance structure, review and approval of the risk management framework, and fostering a culture of ethical conduct and accountability. Risk Management The Board plays an integral role in CWB Group’s risk management processes and directly oversees risk management to ensure a comprehensive approach to risk. As part of this oversight, the Board approves the enterprise risk management framework to ensure that policies and procedures are in place to measure and manage material risk exposures. Quarterly updates on the framework and risk observations are provided by CWB Group’s management team. Board Independence and Effectiveness Members of the Board have been carefully selected for their judgment, integrity, leadership ability and general business expertise, as well as their knowledge of financial services and/or key geographic markets and businesses where CWB Group operates. During fiscal 2014, the Board was comprised of fourteen business and community leaders who guided and monitored CWB Group’s strategy and implementation. Thirteen of the fourteen directors are independent, with Mr. Fowler, CWB’s president and CEO, serving as the only non- independent member. It is a regulatory requirement for a bank’s CEO to serve on its board. Because succession planning is integral to the sound functioning of an evolving board, CWB’s directors have developed a skills and competency evaluation process for their team. Results are reviewed annually, and are used to inform the overall Board succession plan. In addition, in alternating years, the effectiveness of the Board and the contributions of individual directors are assessed to ensure the Board maintains an appropriate complement of skills, experiences and qualifications. 8 CWB Group 2014 Annual ReportBoard of Directors from left to right (October 31, 2014): Linda M.O. Hohol; Howard E. Pechet; Andrew J. Bibby; Albrecht W. A. Bellstedt; Alan M. Rowe; Sarah A. Morgan-Silvester; Robert A. Manning; Allan W. Jackson (Chair); Chris H. Fowler; Wendy A. Leaney; H. Sanford Riley; Raymond J. Protti; Robert L. Phillips; and, Ian M. Reid. Ethical Conduct Compensation Programs At CWB Group, ethical conduct is not only a legal and regulatory requirement, but a core value that facilitates the development of strong relationships with clients and other stakeholders in the communities where we operate. Codes of conduct for all directors, officers and employees are in place, and are reviewed and signed off on annually to ensure compliance. A whistleblower policy that allows for the anonymous reporting of complaints and concerns is also in place. All concerns and complaints, however raised, are investigated and appropriate action taken. CWB Group’s director and executive compensation policies are strongly aligned with governance best practices. For the past four years, CWB Group has asked shareholders to vote on the Board’s approach to executive compensation and has received support. To further ensure that compensation is competitive and fair, the Human Resources Committee is authorized to seek the advice of independent compensation advisors. In addition, directors and senior officers are required to maintain a minimum level of share ownership to encourage decision-making that aligns with the interests of shareholders. 9 CWB Group 2014 Annual Report Proactive Approach to Governance CWB Group takes a proactive approach to ensuring best practices in corporate governance, and the Board is committed to continuous improvement of governance policies and procedures. A few best practices recently adopted by the Board include: • introduction of a diversity policy which aims to have at least 25% of both the Board and the Executive Committee consist of female members, and which requires the Board to consider age, gender and ethnic diversity in the nomination of directors and members of the Executive; • introduction of a compensation recoupment policy to discourage short-term decision-making and excessive risk taking; • retention of a compensation consultant to ensure executive compensation is aligned with best practices; and, • the requirement for the Board and each Board committee to have in camera sessions without management present. For More Information To encourage open dialogue with shareholders, the Board can be contacted directly about corporate governance issues by emailing chairoftheboard@cwbank.com. Detailed information about CWB Group’s governance practices is available in the Corporate Governance section at cwb.com. Shareholders are also welcome to attend CWB Group’s annual shareholder meeting on March 5, 2015, to meet with directors and senior management, and hear about CWB Group’s future direction. Shareholders wishing to attend the annual shareholder meeting are encouraged to review CWB Group’s Management Proxy Circular for information on how they can attend and participate. Board of Directors (October 31, 2014) • Albrecht W.A. Bellstedt, Q.C. • Sarah A. Morgan-Silvester President, A.W.A. Bellstedt Professional Corporation • Andrew Bibby CEO and Director, Grosvenor Americas Partners • Chris H. Fowler President and CEO, Canadian Western Bank • Linda M.O. Hohol Corporate Director • Allan W. Jackson (Chair) President and CEO, ARCI Ltd. • Wendy A. Leaney, FICB President, Wyoming Associates Ltd. • Robert A. Manning President, Cathton Investments Ltd. Corporate Director • Howard E. Pechet President, Mayfield Consulting Inc. • Robert L. Phillips, Q.C. President, R.L. Phillips Investments Inc. • Raymond J. Protti, ICD.D Corporate Director • Ian M. Reid Corporate Director • H. Sanford Riley, C.M. President and CEO, Richardson Financial Group Limited • Alan M. Rowe, CPA, CA Partner, Crown Realty Partners CWB Group Executive Committee (October 31, 2014) • Chris Fowler President and Chief Executive Officer • Carolyn Graham, FCA Executive Vice President and Chief Financial Officer • Greg Sprung Executive Vice President, Banking • Kelly Blackett Executive Vice President, Human Resources • Randy Garvey, FCMA, CFA, CDir • Brian J. Young Executive Vice President, Corporate Services Executive Vice President, Canadian Western Bank, and President and CEO, Canadian Direct Insurance 10 CWB Group 2014 Annual ReportManagement’s Discussion and Analysis (MD&A) TABLE OF CONTENTS BUSINESS PROFILE AND STRATEGY 11 FORWARD-LOOKING STATEMENTS TAXABLE EQUIVALENT BASIS (TEB) NON-IFRS MEASURES 12 13 13 GROUP FINANCIAL PERFORMANCE 14 OVERVIEW NET INTEREST INCOME NON-INTEREST INCOME NON-INTEREST EXPENSES AND EFFICIENCY INCOME TAXES COMPREHENSIVE INCOME CASH AND SECURITIES LOANS CREDIT QUALITY ALLOWANCE FOR CREDIT LOSSES DEPOSITS 14 17 18 20 22 22 23 23 27 29 30 OTHER ASSETS AND OTHER LIABILITIES 32 RISK MANAGEMENT LIQUIDITY MANAGEMENT CAPITAL MANAGEMENT FINANCIAL INSTRUMENTS AND OTHER INSTRUMENTS ACQUISITIONS OFF-BALANCE SHEET SUMMARY OF QUARTERLY RESULTS AND FOURTH QUARTER QUARTERLY RESULTS FOURTH QUARTER OF 2014 ACCOUNTING POLICIES AND ESTIMATES CRITICAL ACCOUNTING ESTIMATES CHANGES IN ACCOUNTING POLICIES FUTURE CHANGES IN ACCOUNTING POLICIES 32 35 38 39 39 40 40 41 42 42 44 44 RISK MANAGEMENT OVERVIEW CREDIT RISK MARKET RISK LIQUIDITY AND FUNDING RISK CAPITAL RISK OPERATIONAL RISK REGULATORY RISK TECHNOLOGY RISK PEOPLE RISK REPUTATION RISK INSURANCE RISK OTHER RISK FACTORS UPDATED SHARE INFORMATION CONTROLS AND PROCEDURES 45 45 49 51 53 56 56 58 58 58 59 59 59 61 61 BUSINESS PROFILE AND STRATEGY Canadian Western Bank (TSX:CWB) offers a diverse range of financial services and is the largest publicly traded Schedule I Canadian bank headquartered in Western Canada. The Bank, along with its subsidiaries, National Leasing Group Inc. (National Leasing), Canadian Western Trust Company (CWT), Valiant Trust Company (Valiant), Canadian Direct Insurance Incorporated (CDI), Adroit Investment Management Ltd. (Adroit), McLean & Partners Wealth Management Ltd. (McLean & Partners) and Canadian Western Financial Ltd. (CWF), are together known as Canadian Western Bank Group (CWB or CWB Group). CWB currently operates in the financial services areas of banking, trust, insurance and wealth management. With a focus on mid- market commercial banking, real estate and construction financing, equipment financing and energy lending, the Bank’s strategy is mainly based on building strong client relationships and providing value- added services to businesses and individuals in Western Canada. The Bank also delivers a wide variety of personal financial products and services, including personal loans and mortgages, deposit accounts, investment products and other banking services. Customer access to all banking services is primarily provided through a network of 41 client-focused branches in select locations across the four western provinces. Canadian Direct Financial® (CDF) is an Internet-based division of the Bank that offers a range of deposit and registered savings products directly to customers in all provinces and territories except Quebec. National Leasing specializes in commercial equipment leasing for small- and mid-sized transactions and is represented across all provinces of Canada. CWT provides trustee and custody services to independent financial advisors, corporations, brokerage firms and individuals. Optimum Mortgage (Optimum), a division of CWT, underwrites and administers residential mortgages sourced through an extensive network of mortgage brokers located in Western Canada and select markets in Ontario and Atlantic Canada. Valiant’s operations include stock transfer and corporate trust services. CDI underwrites and delivers personal auto and home insurance policies for customers in British Columbia (BC) and Alberta. Adroit provides discretionary wealth management for individuals, corporations and institutional clients, while McLean & Partners specializes in discretionary wealth management primarily for high net-worth individuals. Third-party mutual funds are offered with financial and investment planning advice in bank branches through CWF, CWB’s mutual fund dealer subsidiary. Vision To be seen as crucial to our clients’ futures. CWB is focused on becoming the trusted financial partner to a growing base of clients by delivering responsive service and sensible solutions, while preserving its fundamental identity as a conservative, growth-oriented organization built on a results-oriented culture. In doing so, management maintains a supportive environment for employees, aims to provide strong long-term returns for shareholders and gives back in the communities where clients and employees work and live. CWB’s approach to strategic management recognizes that the development and implementation of strategies cannot be undertaken in isolation, but need to be part of a cross-functional, group-wide process. The intent is to focus on key business drivers that contribute the greatest impact toward the achievement of CWB’s vision, and are represented by both financial and non-financial measures. 11 CWB Group 2014 Annual Report This approach is facilitated through a focus on four inter-dependent pillars within CWB’s strategic direction, summarized as follows: People Invest in our people, build lasting relationships and live our values. Support Build funding sources, drive operational excellence, and balance risk and reward. Clients Be responsive, deliver sensible solutions and be the trusted financial partner. Financial Sustain profitable growth, build revenue sources and maintain our efficiency. The consolidated financial statements have been prepared in accordance with International Financial Reporting Standards (IFRS) and are presented in Canadian dollars. The following pages contain management’s discussion of the financial performance of CWB and a summary of quarterly results. Additional information relating to CWB, including the Annual Information Form, is available on SEDAR at sedar.com and on CWB’s website at cwb.com. FORWARD-LOOKING STATEMENTS From time to time, CWB makes written and verbal forward-looking statements. Statements of this type are included in the Annual Report and reports to shareholders and may be included in filings with Canadian securities regulators or in other communications such as press releases and corporate presentations. Forward-looking statements include, but are not limited to, statements about CWB’s objectives and strategies, targeted and expected financial results and the outlook for CWB’s businesses or for the Canadian economy. Forward-looking statements are typically identified by the words “believe”, “expect”, “anticipate”, “intend”, “estimate”, “may increase”, “may impact”, “goal”, “focus”, “potential”, “proposed” and other similar expressions, or future or conditional verbs such as “will”, “should”, “would” and “could”. By their very nature, forward-looking statements involve numerous assumptions and are subject to inherent risks and uncertainties, which give rise to the possibility that management’s predictions, forecasts, projections, expectations and conclusions will not prove to be accurate, that its assumptions may not be correct and that its strategic goals will not be achieved. A variety of factors, many of which are beyond CWB’s control, may cause actual results to differ materially from the expectations expressed in the forward-looking statements. These factors include, but are not limited to, general business and economic conditions in Canada, including the volatility and level of liquidity in financial markets, fluctuations in interest rates and currency values, changes in monetary policy, changes in economic and political conditions, legislative and regulatory developments, legal developments, the level of competition, the occurrence of weather-related and other natural catastrophes, changes in accounting standards and policies, the accuracy and completeness of information CWB receives about customers and counterparties, the ability to attract and retain key personnel, the ability to complete and integrate acquisitions, reliance on third parties to provide components of business infrastructure, changes in tax laws, technological developments, unexpected changes in consumer spending and saving habits, timely development and introduction of new products, and management’s ability to anticipate and manage the risks associated with these factors. It is important to note that the preceding list is not exhaustive of possible factors. Additional information about these factors can be found in the Risk Management section of this Management’s Discussion and Analysis (MD&A). These and other factors should be considered carefully, and readers are cautioned not to place undue reliance on these forward-looking statements as a number of important factors could cause CWB’s actual results to differ materially from the expectations expressed in such forward-looking statements. Unless required by securities law, CWB does not undertake to update any forward- looking statement, whether written or verbal, that may be made from time to time by it or on its behalf. Assumptions about the performance of the Canadian economy in 2015 and how it will affect CWB’s businesses are material factors considered when setting organizational objectives and targets. Performance target ranges for fiscal 2015 consider the following management assumptions: • Moderate economic growth in Canada and relatively stronger performance in the four western provinces; • A relatively stable net interest margin compared to the level achieved in the fourth quarter of 2014, primarily attributed to treasury management strategies and shifts in asset mix that help to offset impacts from the very low interest rate environment, a flat interest rate curve and competitive factors; • Sound credit quality with actual losses remaining within CWB’s historical range of acceptable levels. Potential risks that may have a material adverse impact on current economic expectations and forecasts include a sustained period of materially lower energy and other commodity prices compared to average levels observed in fiscal 2014, a slowing rate of economic growth in the United States, a significant and sustained deterioration in Canadian residential real estate prices, or a significant disruption in major global economies. Greater than expected pricing competition and/or disruptions in domestic or global financial markets that meaningfully impact average loan yields and/or the overall costs of deposit funding may also contribute to adverse financial results compared to expectations. 12 CWB Group 2014 Annual ReportTAXABLE EQUIVALENT BASIS (TEB) NON-IFRS MEASURES Most banks analyze revenue on a taxable equivalent basis to permit uniform measurement and comparison of net interest income. Net interest income (as presented in the consolidated statements of income) includes tax-exempt income on certain securities. Since this income is not taxable, the rate of interest or dividends received is significantly lower than would apply to a loan or security of the same amount. The fiscal 2014 adjustment to taxable equivalent basis of $7.7 million (2013 – $8.1 million) increases interest income and the provision for income taxes to what they would have been had the tax-exempt securities been taxed at the statutory rate. The taxable equivalent basis does not have a standardized meaning prescribed by IFRS and, therefore, may not be comparable to similar measures presented by other banks. Total revenues, net interest income and income taxes are discussed on a taxable equivalent basis throughout this MD&A. Taxable equivalent basis, adjusted cash earnings per common share, return on common shareholders’ equity, return on assets, efficiency ratio, net interest margin, common equity Tier 1, Tier 1 and total capital adequacy ratios, and average balances do not have standardized meanings prescribed by IFRS and, therefore, may not be comparable to similar measures presented by other financial institutions. The non-IFRS measures used in this MD&A are calculated as follows: • Taxable equivalent basis – described above. • Adjusted cash earnings per common share – diluted earnings per common share excluding the after-tax amortization of acquisition- related intangible assets and the non-tax deductible change in fair value of contingent consideration. These exclusions represent non- cash charges and are not considered to be indicative of ongoing business performance. • Return on common shareholders’ equity – net income available to common shareholders divided by average common shareholders’ equity. • Return on assets – net income available to common shareholders divided by average total assets. • Efficiency ratio – non-interest expenses divided by total revenues excluding the non-tax deductible charge for the fair value of contingent consideration. • Net interest margin – net interest income divided by average total assets. • Common equity Tier 1, Tier 1 and total capital ratios – in accordance with guidelines issued by the Office of the Superintendent of Financial Institutions Canada (OSFI). • Average balances – average daily balances. Adjusted net income available to common shareholders ($ thousands) Net income available to common shareholders Adjustments: Amortization of acquisition-related intangible assets (after tax) Contingent consideration fair value change 2014 2013 $ 218,549 $ 187,163 3,527 1,000 3,262 – Adjusted net income available to common shareholders $ 223,076 $ 190,425 13 CWB Group 2014 Annual Report GROUP FINANCIAL PERFORMANCE OVERVIEW Highlights of 2014 (compared to 2013) • Record net income available to common shareholders of $218.5 million, up 17%. • Record diluted and adjusted cash earnings per common share • Solid credit quality as evidenced by very low write-offs and a provision for credit losses measured as a percentage of average loans of 15 basis points, down four basis points. of $2.70 and $2.76, respectively, both up 15%. • Efficiency ratio (teb) of 46.0%, an improvement of • Return on common shareholders’ equity of 14.8%, up 60 basis points. • Return on assets of 1.10%, up four basis points. • Strong loan growth of 12%, marking the achievement of double-digit loan growth in 24 of the past 25 years. • Issued $125 million of 4.40% Series 5 preferred shares and redeemed $209 million of 7.25% Series 3 preferred shares, resulting in a more efficient capital structure. • Cash dividends paid to common shareholders of $0.78 per share, up 11%. • Record total revenues (teb) of $626.6 million, up 11%, with net interest margin (teb) of 2.59%, down seven basis points. 40 basis points. • Solid Basel III capital ratios under the Standardized approach for calculating risk-weighted assets of 8.0% common equity Tier 1 (CET1), 9.3% Tier 1, and 12.8% total capital. • Total assets and assets under administration surpassed milestones of $20 billion and $10 billion, respectively. • Following completion of analysis and design phases of CWB’s core banking system implementation, management revised the project’s capital budget to $62 million, from an initial estimate of $50 million, and scheduled deployment for early fiscal 2016. Table 1 – Select Annual Financial Information(1) ($ thousands, except per share amounts) Key Performance Indicators Net income available to common shareholders $ 218,549 $ 187,163 $ 172,197 $ 31,386 17% 2014 2013(2) 2012 $ % Change from 2013 Earnings per share Basic Diluted Adjusted cash(1) Provision for credit losses as a percentage of average loans Net interest margin (teb)(1) Net interest margin Efficiency ratio (teb)(1)(4) Efficiency ratio Return on common shareholders’ equity Return on assets Other Financial Information Total revenues (teb) Total revenues Total assets Debt 2.73 2.70 2.76 2.36 2.35 2.39 2.24 2.22 2.30 0.37 0.35 0.37 16 15 15 0.15% 0.19% 0.19% (4)bp(3) 2.59 2.55 46.0 46.6 14.8 1.10 2.66 2.62 46.4 47.1 14.2 1.06 2.79 2.73 44.8 45.6 15.0 1.08 (7) (7) (40) (50) 60 4 $ 626,605 $ 565,739 $ 525,482 $ 60,866 11% 618,929 557,601 516,339 61,328 20,608,656 18,513,340 16,873,269 2,095,316 1,036,990 820,650 634,273 216,340 11 11 26 11 Dividends per common share 0.78 0.70 0.62 0.08 (1) See page 13 for a discussion of teb and non-IFRS measures. (2) During 2014, CWB adopted IFRS 10 Consolidated Financial Statements and applied a change in accounting policy for internal direct leasing costs, both as described in Note 1 of the consolidated financial statements. The 2013 comparative figures reflect the retrospective application of these changes. (3) bp – basis points. (4) A decrease in the ratio reflects improved efficiency, while an increase reflects deterioration. 14 CWB Group 2014 Annual Report Net income available to common shareholders increased 17% over 2013 to a record $218.5 million, while diluted earnings per common share of $2.70 ($2.73 basic) was up 15% from $2.35 ($2.36 basic). Adjusted cash earnings per share, which is diluted earnings per common share excluding the after-tax amortization of acquisition- related intangible assets and the non-tax deductible change in fair value of contingent consideration, was $2.76, also up 15%. Growth in both net income available to common shareholders and earnings per share reflects the combined benefits of record total revenues (teb) of $626.6 million, lower preferred share dividends and a decrease in the provision for credit losses, partially offset by higher non-interest expenses. Growth in total revenues was based on increases in net interest income (teb) and non-interest income of 9% and 19%, respectively. Growth in net interest income was driven by strong loan growth, partially offset by a seven basis point reduction in net interest margin (teb) to 2.59%. Margin contraction in the year mainly reflected lower yields on loans, partially offset by improved fixed term deposit costs. Lower loan yields primarily resulted from the combined impact of the sustained very low interest rate environment and ongoing competitive pressures. The level of preferred share dividends was reduced following the issuance of $125 million of 4.40% preferred shares in February 2014, and subsequent redemption of $209 million of 7.25% preferred shares in April 2014. Strong credit quality was maintained throughout the year and the provision for credit losses as a percentage of average loans declined four basis points to 15 basis points. The efficiency ratio (teb) – which measures non-interest expenses as a percentage of total revenues (teb) excluding the non-tax deductible charge for the change in fair value of contingent consideration – of 46.0% improved 40 basis points from last year, as growth in total revenues (teb) surpassed growth in non-interest expenses. Growth in non-interest expenses was mainly attributed to investments in additional staff complement, infrastructure and technology to support current and future business growth. Return on common shareholders’ equity of 14.8% was up 60 basis points while return on assets increased four basis points to 1.10%. The increase in return on common shareholders’ equity largely resulted from the same combination of factors driving growth in net income available to common shareholders and earnings per share described above. Total cash dividends paid to common shareholders of $0.78 per share increased 11% from $0.70 per share paid in the prior year, and resulted in a dividend payout ratio of 29% of total net income available to common shareholders. Total assets increased 11% to reach $20,609 million driven by strong loan growth. Total branch-raised deposits increased 11%, while the demand and notice component within branch-raised deposits was up 15%. Strong growth in branch-raised deposits, including the demand and notice component, reflects the success of ongoing strategies to further enhance and diversify core funding sources. Total deposits grew 11% in the year to reach $17,373 million, including an increase in capital markets deposits of $1,011 million to reach 14% of total deposits. The balance of personal fixed rate term deposits raised through the deposit broker network declined by $204 million. Total branch-raised deposits represented 55% of total deposits at October 31, 2014, unchanged from a year earlier. The demand and notice component comprised 33% of total deposits, up from 32% last year. The ratio of total deposits to total loans at October 31, 2014 was effectively 1:1, relatively unchanged from a year earlier. The maintenance of solid capital levels is fundamental to CWB’s objectives to effectively manage risks and support strong growth. The common equity Tier 1 (CET1), Tier 1 and total capital ratios at October 31, 2014 of 8.0%, 9.3% and 12.8%, respectively, were above both internal and regulatory minimums. CWB’s minimum regulatory capital ratios, which include a 250 basis point capital conservation buffer, are 7.0% CET1, 8.5% Tier 1 and 10.5% total capital. 15 CWB Group 2014 Annual Report 2014 Target Ranges 12 – 16% 10 – 12 10 – 12 2014 Performance 15% 11 12 2015 Target Ranges 5 – 8% n/a(2) 10 – 12 0.18 to 0.23 46% or less 14.0 – 15.0 1.05 – 1.15 0.15 0.17 – 0.22 46.0 47% or less 14.8 1.10 14.0 – 15.0 1.07 – 1.12 and 22 basis points of average loans and reflects expectations that overall credit quality will remain sound. In consideration of constrained revenues owing to net interest margin pressure and strategic investment necessary to support CWB’s long-term growth, the 2015 efficiency ratio (teb) target is 47% or less. While this represents an increase from 2014, management remains committed to disciplined management of all discretionary expenses based on total revenue growth, and expects the efficiency ratio will show improvement over the medium term. The most notable incremental expense contributing to the higher 2015 efficiency ratio target relates to changes in non-executive compensation to align the level and structure of CWB’s employee offering with industry benchmarks. Profitability targets measured by the return on common shareholders’ equity and return on assets are consistent with 2014. Ongoing assessment and development of each of CWB Group’s core businesses will remain a key priority, while potential acquisitions continue to be evaluated. With its solid capital position under the more conservative Standardized approach for calculating risk-weighted assets, CWB remains well positioned to support continued growth and manage unforeseen challenges. Management will maintain its focus on creating value for shareholders over the long term. Although the overall outlook for 2015 is positive, a sustained period of materially lower energy and other commodity prices compared to average levels observed in fiscal 2014 could have an adverse impact on economic expectations. Performance Targets and Outlook Table 2 – 2014 and 2015 Performance Target Ranges(1) Adjusted cash earnings per common share growth Total revenue (teb) growth Loan growth Provision for credit losses as a percentage of average loans Efficiency ratio (teb) Return on common shareholders’ equity Return on assets (1) See page 13 for a discussion of teb and non-IFRS measures. (2) n/a – no target range set for 2015. 2014 Performance CWB achieved favourable results compared to all fiscal 2014 performance target ranges. Growth in net income available to common shareholders and earnings per common share was largely driven by strong 12% loan growth, higher contributions from non-interest income, lower preferred share dividends, and a decrease in the provision for credit losses. A seven basis point reduction in net interest margin and a 10% increase in non-interest expenses were constraints on further growth in net income available to common shareholders and more pronounced improvement in the efficiency ratio. Overall credit quality was better than expected with the annual provision for credit losses as a percentage of average loans coming in below the target range at 15 basis points. The return on common shareholders’ equity and return on assets were both within the respective target ranges at 14.8% and 1.10%. The efficiency ratio (teb) of 46.0% met the 2014 target of 46% or less. 2015 Performance Target Ranges Fiscal 2015 performance target ranges, as shown in the table above, are based on expectations for moderate economic growth in Canada and comparatively stronger performance within key western Canadian markets. Achievement of 2015 targets for the important shareholder value metrics of adjusted cash earnings per share growth and profitability ratios will be largely driven by management’s commitment to deliver ongoing strong loan growth, stable credit quality and effective expense management. Lower preferred share dividends compared to 2014 will also benefit earnings and profitability. CWB will maintain its focus on further enhancing its funding base and growing secured loans that offer a fair and profitable return in an environment where net interest margin pressure is expected to persist as a result of very low interest rates, a flat interest rate curve and competitive influences. The provision for credit losses is targeted between 17 16 CWB Group 2014 Annual Report NET INTEREST INCOME Net interest income is the difference between interest and dividends earned on assets, and interest paid on deposits and other liabilities, including debt. Net interest margin is net interest income as a percentage of average total assets. Highlights of 2014 • Net interest income (teb) increased 9% to a record $513.2 million based on 12% growth in average total interest earning assets. • Net interest margin (teb) of 2.59% was down seven basis points mainly reflecting the impact of the persistent very low interest rate environment, a relatively flat interest rate curve and competitive factors. Table 3 – Net Interest Income (teb)(1) ($ thousands) 2014 2013(2) Average Balance Mix Interest Interest Rate Average Balance Mix Interest Interest Rate Assets Cash, securities and deposits with regulated financial institutions $ 2,739,295 14% $ 56,495 2.06% $ 2,506,616 14% $ 54,410 2.17% Securities purchased under resale agreements 43,495 – 419 0.96 29,701 – 289 0.97 Loans Personal Business Total interest bearing assets Other assets Total Assets Liabilities Deposits Personal 2,674,108 13,960,477 16,634,585 19,417,375 384,334 14 70 84 98 2 106,832 693,077 799,909 856,823 – 4.00 4.96 4.81 4.41 0.00 2,371,920 12,410,378 14,782,298 17,318,615 354,812 14 70 84 98 2 94,862 640,542 735,404 790,103 – 4.00 5.16 4.97 4.56 0.00 $ 19,801,709 100% $ 856,823 4.33% $ 17,673,427 100% $ 790,103 4.47% $ 9,926,667 50% $ 204,035 2.06% $ 9,206,767 52% $ 201,170 2.19% Business and government 6,836,427 Other liabilities Debt Shareholders’ equity Non-controlling interests 16,763,094 486,596 887,737 1,663,248 1,034 35 85 3 4 8 – 107,004 311,039 36 32,552 – – 1.57 5,624,044 1.86 14,830,811 0.01 3.67 0.00 0.00 484,286 830,284 1,527,544 502 32 84 3 5 8 – 85,700 286,870 43 32,433 – – Total Liabilities and Equity $ 19,801,709 100% $ 343,627 1.74% $ 17,673,427 100% $ 319,346 Total Assets/Net Interest Income $ 19,801,709 $ 513,196 2.59% $ 17,673,427 $ 470,757 1.52 1.93 0.01 3.91 0.00 0.00 1.81% 2.66% (1) See page 13 for a discussion of teb and non-IFRS measures. (2) During 2014, CWB adopted IFRS 10 Consolidated Financial Statements and applied a change in accounting policy for internal direct leasing costs, both as described in Note 1 of the consolidated financial statements. The 2013 comparative figures reflect the retrospective application of these changes. Net interest income (teb) increased 9% to reach a record $513.2 million driven by 12% growth in average interest earning assets, with the percentage difference reflecting the impact of a seven basis point reduction in net interest margin (teb) to 2.59%. Growth in average interest earning assets resulted from a combination of strong 12% growth in average loans and a 10% increase in average balances of cash and securities. The change in net interest margin mainly resulted from the combined impact of ongoing very low interest rates, a relatively flat yield curve and competitive factors, and is reflected in a 16 basis point lower yield on average loans, partially offset by a seven basis point reduction in average deposit costs. The yield on average cash, securities and deposits with regulated financial institutions was down 11 basis points, primarily reflecting an increase in the proportion of debt securities held compared to higher yielding preferred shares and common equities. Generally, increases in the prime interest rate positively impact net interest margin because prime-based loans reprice more quickly than deposits, which subsequently expands the interest spread earned on CWB’s assets. The prime rate was maintained at 3.00% throughout the year and has been unchanged since the Bank of Canada last increased rates in September 2010. 17 CWB Group 2014 Annual Report Outlook for Net Interest Income Loan growth will continue to have a positive influence on net interest income, but the combination of the persistent very low interest rate environment, a relatively flat yield curve and competitive factors is expected to constrain meaningful improvement in net interest margin from the level of 2.56% realized in the fourth quarter of 2014. The current interest rate environment diminishes the incremental benefit of low and no-cost deposits, as well as deposits that are less interest sensitive. A sustained upward slope in the interest rate curve, and/or an increase in the prime lending interest rate would benefit CWB’s net interest margin. CWB projections for 2015 assume no change in the prime lending interest rate. Competitive factors, particularly in certain business areas, can result in lower overall loan pricing and higher overall deposit costs. CWB does not expect material change in the competitive environment in the near term. Changes in average balances of cash and securities also have an impact on net interest margin, with lower average balances generally enhancing margin, and higher average balances having the opposite effect. Consistent with its liquidity risk appetite CWB will maintain prudent levels of cash and securities while complying with OSFI’s Liquidity Adequacy Requirements Guideline. NON-INTEREST INCOME Highlights of 2014 • Record non-interest income of $113.4 million, up 19%. • Non-interest income represented 18% of total revenues (teb), up from 17% in 2013. Table 4 – Non-Interest Income ($ thousands) Insurance Net earned premiums Commissions and processing fees Net claims and adjustment expenses Policy acquisition costs Net insurance revenues Trust and wealth management services Credit related Gains on securities, net Retail services Other(1) 2014 2013 $ % Change from 2013 $ 130,410 $ 126,825 $ 1,580 (85,997) (25,079) 20,914 33,866 25,014 13,999 11,399 8,217 1,787 (87,008) (25,325) 16,279 24,511 21,685 15,094 10,272 7,141 3,585 (207) 1,011 246 4,635 9,355 3,329 (1,095) 1,127 1,076 3% (12) (1) (1) 28 38 15 (7) 11 15 Total Non-Interest Income $ 113,409 $ 94,982 $ 18,427 19% (1) Includes foreign exchange gains/losses, contingent consideration fair value charges, gains on loan portfolio sales, lease administration services, fair value changes related to derivative financial instruments not accounted for as hedges, gains/losses on land, buildings and equipment disposals, and other miscellaneous non-interest revenues. Non-interest income of $113.4 million was up 19% as the combined benefit of a $9.4 million increase in trust and wealth management revenues, $4.6 million higher net insurance revenues, a $3.3 million increase in credit-related income and continued growth across other categories more than offset lower net gains on securities. Very strong growth in trust and wealth management primarily resulted from the acquisition of McLean & Partners completed in the third quarter of 2013 and was further supported by ongoing solid performance within trust services. Growth in net insurance revenues primarily reflects the positive impact of higher net earned premiums and lower claims expense. Insurance results in both years include claims expense resulting from catastrophic weather events, although the combined impact on claims in 2013 related to southern Alberta floods and severe hailstorms exceeded hail-related claims experienced in 2014. Growth in credit-related and retail services income of 15% and 11%, respectively, was consistent with strong lending and deposit gathering activity. Although net gains on securities remained high at $14.0 million, they were $1.1 million lower than 2013. The 15% increase in ‘other’ non-interest income to $8.2 million mainly resulted from the gain on sale of CWB’s former Edmonton Main Branch location. Non-interest income as a percentage of total revenues (net interest income and other income) was 18%, up from 17% in 2013. 18 CWB Group 2014 Annual Report Outlook for Non-Interest Income Solid growth is expected across most categories of non-interest income, reflecting CWB’s continued focus on enhancing transactional service capabilities and increasing other sources of fee-based revenues. The generation of more transactional business with both new and existing clients, an enhanced market presence, double-digit loan growth and expanded product offerings are key factors contributing to expected growth in banking-related services. While net insurance revenues should increase with a return to more normal claims experience and continued policy growth, volatility in net claims expense could result from severe weather-related events, as was the case in each of the past three years. Net gains on securities are expected to be lower compared to 2014; however, the magnitude and timing of such gains are dependent on market factors that are difficult to predict. Management will continue to realize gains on the sale of non- core residential mortgage portfolios as opportunities become available. Such gains are expected to be a recurring, although periodic, source of non-interest income. Solid growth is expected from trust services in 2015, resulting from increased market share and ongoing business development. Further increases in core wealth management revenues are expected to result from ongoing strong organic growth at McLean & Partners and Adroit, as well as the introduction of discretionary investment services to more CWB banking clients. CWB’s branch-based mutual fund dealer, Canadian Western Financial (CWF), also continues to perform well. The addition of regional wealth management specialists is expected to improve CWF’s ability to attract mutual fund inflows through enhanced delivery of value-added financial and investment planning services. CWB maintains its long-term objective to diversify total revenues and will continue with initiatives to further develop and/or acquire additional sources of complementary non- interest income. 19 CWB Group 2014 Annual Report NON-INTEREST EXPENSES AND EFFICIENCY Highlights of 2014 • The efficiency ratio (teb) of 46.0% improved 40 basis points compared to 2013, reflecting the benefit of positive operating leverage. Table 5 – Non-Interest Expenses and Efficiency Ratio ($ thousands) 2014 2013 $ % Change from 2013 Salaries and Employee Benefits Salaries Employee benefits Premises Rent Depreciation Other Equipment and Furniture Depreciation Other General Professional fees and services Marketing and business development Amortization of acquisition-related intangible assets Banking charges Travel Postage and stationery Regulatory costs Community investment Employee training Communications General insurance Capital and business taxes Other $ 156,885 $ 144,200 $ 30,986 187,871 28,037 172,237 19,667 6,131 3,570 29,368 10,430 9,267 19,697 9,334 7,402 5,125 3,724 2,885 2,971 3,845 2,127 1,819 1,857 1,044 1,004 8,899 52,036 16,359 5,938 3,124 25,421 8,901 8,503 17,404 7,104 6,846 4,627 3,622 2,726 2,680 2,659 2,337 1,908 1,824 1,035 937 9,130 47,435 Total Non-Interest Expenses $ 288,972 $ 262,497 $ 12,685 2,949 15,634 3,308 193 446 3,947 1,529 764 2,293 2,230 556 498 102 159 291 1,186 (210) (89) 33 9 67 (231) 4,601 26,475 Efficiency Ratio (teb)(1)(2) 46.0% 46.4% (1) Non-interest expenses as a percentage of total revenues (net interest income (teb) plus other income) excluding the non-tax deductible change in fair value of contingent consideration. 9% 11 9 20 3 – 16 17 9 13 31 8 11 3 6 11 45 (9) (5) 2 1 7 (3) 10 10% (40)bp(3) See page 13 for a discussion of non-IFRS measures. (2) A decrease in this ratio reflects improved efficiency, while an increase reflects deterioration. (3) bp – basis points. Total non-interest expenses of $289.0 million were up 10% reflecting a 9% increase in salary and benefit costs due to a combination of higher staff complement and annual salary increments. Full-year inclusion of McLean & Partners accounted for 15% of the total increase in non-interest expenses. The number of full-time equivalent employees (FTEs) grew 3% (57 FTEs) in 2014 to meet requirements 20 for added client-facing services, corporate support and other business expansion. Premises and equipment expenses, including depreciation, increased 16%, reflecting the impact of expanded corporate office facilities to support business growth and the relocation of CWB’s Edmonton Main Branch to significantly expanded premises. CWB Group 2014 Annual Report Ongoing investment in technology infrastructure necessary to position CWB for future growth also contributed to the increase in non-interest expenses. General non-interest expenses were up 10% due to increases in most areas, including $2.3 million higher costs for professional fees and services, and a $1.2 million increase in regulatory costs. Higher professional services costs relate to external consultant fees in support of several strategic initiatives, including implementation of a new strategic management framework and a compensation review. The increase in regulatory costs primarily resulted from higher Canada Deposit Insurance Corporation (CDIC) premiums. Figure 1 – Number of Full-time Equivalent Staff The efficiency ratio (teb) – which measures non-interest expenses as a percentage of total revenues (teb) excluding the non-tax deductible charge for the fair value of contingent consideration – was 46.0%, compared to 46.4% last year, reflecting the benefit of positive operating leverage. 2014 +3% 2,094 Outlook for Non-Interest Expenses and Efficiency One of management’s key priorities is to deliver strong long-term growth through strategic investment in people, technology, and infrastructure while maintaining effective control of costs. This strategy is aligned with a commitment to maximize long-term shareholder value and is expected to provide material benefits in future periods. portfolio and client relationship management capabilities and improved turnaround of credit approvals. Certain technology investments, including loan origination systems and the future core banking system, are also key requirements to facilitate an eventual transition to an advanced methodology for calculating risk-weighted assets. A formal review was completed in 2014 to ensure non-executive compensation is competitive within key markets and enables CWB to continue to attract and retain qualified employees who fit the organization’s culture. This review has resulted in changes which will better align the level and structure of total compensation with industry benchmarks, reduce CWB’s issuance of dilutive stock options, and facilitate the alignment of short- term incentive compensation with both individual performance and CWB Group’s strategic objectives. While the net impact is an increase in salary expense in 2015, these changes are relatively cost-neutral in subsequent years. The major program to implement a new core banking system is progressing as planned. Following completion of comprehensive analysis and design phases in 2014, management has confirmed the program scope and established an implementation date supportive of planned training, service continuity objectives and program control requirements. Implementation is scheduled for early fiscal 2016 based on a capital budget of $62 million, revised from an initial estimate of $50 million. The core banking and other technology investments are expected to provide considerable efficiencies in the future, including enhanced data, Relocation of CWB’s Medicine Hat, Alberta branch and expansion of the branch in Prince George, British Columbia are scheduled for completion in 2015. Additional opportunities to upgrade and expand branch infrastructure continue to be reviewed. Compliance with an increasing level of regulatory rules and oversight for all Canadian banks also requires the investment of both time and resources. Anticipated growth in total revenues (teb) should largely offset the impact of increased investment necessary for effective execution of CWB’s strategic plan over the mid to long term. However, in consideration of investment in growth initiatives over the short term, including those discussed above, and expectations for constrained net interest margin in the absence of increases in the prime lending interest rate and/or sustained steepening of the yield curve, the expected efficiency ratio is 47% or better in 2015. While this represents an increase from 2014, management remains committed to disciplined management of all discretionary expenses based on total revenue growth, and expects the efficiency ratio will show improvement over the medium term. 21 CWB Group 2014 Annual Report INCOME TAXES The 2014 effective income tax rate (teb) was 26.0%, unchanged from 2013, while the effective tax rate before the teb adjustment was 24.1%. Deferred tax assets and liabilities represent the cumulative amount of tax applicable to temporary differences between the carrying amount of assets and liabilities, and their values for tax purposes. CWB’s deferred income tax assets and liabilities relate primarily to the collective allowance for credit losses and intangible assets. Deferred tax assets and liabilities are measured using enacted or substantively enacted tax rates anticipated to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Changes in deferred income taxes related to a change in tax rates are recognized as income in the period of the tax rate change. Capital losses of $8.2 million (2013 – $11.1 million) are available to apply against future capital gains and have no expiry date. The tax benefit of these capital losses has not been recognized in the financial statements. Capital losses of $2.9 million carried forward from prior years were applied to the gain resulting on the sale of CWB’s former Edmonton Main Branch location. Outlook for Income Taxes CWB’s expected income tax rate (teb) for fiscal 2015 is approximately 26.0%, or 24.3% before the teb adjustment. COMPREHENSIVE INCOME Comprehensive income is comprised of net income and other comprehensive income (OCI), all net of income taxes. CWB’s OCI includes unrealized gains and losses on available-for-sale cash and securities, and fair value changes for derivative instruments designated as cash flow hedges. The 2014 increase in comprehensive income was driven by 14% ($28.1 million) higher net income, and a $15.4 million increase in fair value, net of tax, of available-for-sale securities. While the combined dollar investment in preferred shares and common equities is relatively small in relation to total liquid assets, it increases the potential for comparatively larger fluctuations in OCI. Table 6 – Comprehensive Income ($ thousands) Net Income Other Comprehensive Income (Loss) Available-for-sale securities Gains (losses) from change in fair value, net of tax Reclassification to net income, net of tax Derivatives designated as cash flow hedges Gains from change in fair value, net of tax Reclassification to net income, net of tax 2014 2013 2013 Change from $ 231,299 $ 203,206 $ 28,093 12,882 (10,287) 2,595 3,372 (3,575) (203) 2,392 (2,553) (11,160) (13,713) 2,332 (1,255) 1,077 (12,636) 15,435 873 16,308 1,040 (2,320) (1,280) 15,028 Total Comprehensive Income $ 233,691 $ 190,570 $ 43,121 22 CWB Group 2014 Annual Report CASH AND SECURITIES Cash, securities and securities purchased under resale agreements totalled $2,697 million at October 31, 2014, compared to $2,580 million one year ago. Total net unrealized losses before tax recorded on the balance sheet at October 31, 2014 were $3.4 million, compared to $7.1 million last year. Net unrealized gains or losses are reflected in Table 7. Table 7 – Unrealized Gains (Losses) on Available-for-Sale Cash and Securities ($ thousands) Deposits with regulated financial institutions Government of Canada Province or municipality Other debt securities Preferred shares Common shares Total 2014 $ 91 $ 347 559 872 (3,834) (1,428) $ (3,393) $ 2013 569 632 161 1,180 (16,301) 6,657 (7,102) The cash and securities portfolio is mainly comprised of high quality debt instruments and a comparatively smaller component of preferred and common shares. Securities are not held for trading purposes and, where applicable, are typically held until maturity. Fluctuations in the value of securities, other than common equities, are generally attributed to changes in interest rates and movements in market credit spreads. Volatility in equity markets causes fluctuations in the value of common shares. Realized net gains on securities remained high at $14.0 million, $1.1 million below those realized in the prior year. Unrealized losses on securities are regularly reviewed and, based on available objective evidence, CWB reflected $1.2 million (2013 – nil) of pre-tax impairment charges in net gains on securities in 2014. Net gains on securities were mainly attributed to the sale of common shares following strong market performance, partially offset by losses realized on the sale of preferred shares. CWB has no direct investment in any non-Canadian sovereign debt or other securities issued outside of Canada or the United States. See Table 25 – Valuation of Financial Instruments of this MD&A for additional information on significant financial assets and liabilities reported at fair value. The balance and mix of cash and securities are managed as part of CWB’s overall liquidity management process; additional information, including management’s outlook for 2015, is included in the Liquidity Management discussion of this MD&A. LOANS Highlights of 2014 • Strong 12% loan growth, largely driven by very strong performance in real estate project loans, equipment financing and leasing, and personal loans and mortgages. • Double-digit loan growth achieved in 24 of the past 25 years (the exception being 2009 when loan growth during the global credit crisis was 7%). Table 8 – Outstanding Loans by Portfolio ($ millions) Commercial mortgages General commercial loans Equipment financing and leasing Real estate project loans Personal loans and mortgages Corporate lending Oil and gas production loans Total Outstanding Loans 2014 2013 $ Change from 2013 $ 3,574 $ 3,311 $ 3,525 3,394 2,871 2,841 1,147 254 3,428 2,932 2,304 2,502 902 274 263 97 462 567 339 245 (20) % 8% 3 16 25 14 27 (7) $ 17,606 $ 15,653 $ 1,953 12% 23 CWB Group 2014 Annual Report Total loans before the allowance for credit losses increased 12% to reach $17,606 million at year end. Measured in dollars and by loan type as shown in Table 8, growth in real estate project loans of 25% represented the strongest source, followed by equipment financing and leasing at 16%, and personal loans and mortgages at 14%. Growth in real estate project loans exceeded expectations as CWB has continued to finance well-capitalized developers on the basis of sound loan structures and acceptable pre-sale/lease levels. Although recent growth in this area has been very strong, total exposure to real estate remains within CWB’s established risk appetite. The balance of loans in equipment financing and leasing includes the Bank’s heavy equipment financing business and the small- and mid-ticket leasing business of National Leasing. Personal loans and mortgages include CWB’s broker-sourced residential mortgage business, Optimum, and lending activity in banking branches. Total loans of $1,470 million in Optimum represented net growth of 20%. Adjusting for $36 million (2013 – $95 million) of residential mortgages sold during the year, Optimum’s annual loan growth was 23%. Net growth was mainly driven by alternative mortgages secured via conventional residential first mortgages carrying a weighted average loan-to-value ratio at initiation of approximately 71%. The book value of alternative mortgages represented approximately 85% of Optimum’s total portfolio at year end. Management remains committed to the ongoing development of this mortgage business, including further expansion in Ontario and Atlantic Canada, as it continues to produce solid returns while maintaining an acceptable risk profile. Corporate lending represents a diversified portfolio that is centrally sourced and administered through designated lending groups. Corporate lending includes participation in select syndications structured and led primarily by the major Canadian banks, but excludes participation in various other syndicated facilities sourced through relationships developed at CWB branches. Syndicated facilities sourced in branches are primarily real estate project loans, and oil and gas production loans, which are both included as separate classifications in Table 8. General commercial loans increased 3%. Based on industry sector as shown in Table 9, general commercial loans include categories such as manufacturing, finance and insurance, and wholesale and retail trade. CWB’s promising pipeline of new commercial loans and a strategic focus on a customized training program for commercial relationship managers support management’s expectations for accelerated growth in this portfolio over time. The balance of oil and gas production loans, which represent a relatively small percentage of the total portfolio, was down 7% driven by a combination of fewer new lending opportunities, payouts and write-offs. The mix of the portfolio (see Figure 2) shifted slightly during the year as strong growth in real estate project loans and corporate lending led to a slight decrease in the proportion of general commercial loans. Based on the location of security (see Figure 3), Alberta and BC represented 41% and 34% of total loans at year end, compared to 42% and 35%, respectively, in 2013, with the shift resulting from strong relative growth in Manitoba and Ontario. Figure 2 – Outstanding Loans by Portfolio (October 31, 2013 in brackets) Oil and Gas Production Loans 2% (2%) Corporate Loans 7% (6%) Real Estate Project Loans 16% (15%) Personal Loans and Mortgages 16% (16%) 24 General Commercial Loans 20% (22%) Commercial Mortgages 20% (20%) Equipment Financing and Leasing 19% (19%) CWB Group 2014 Annual ReportOutlook for Loans While strong competition from domestic banks and other financial services firms is expected to persist, the current overall outlook for generating new business opportunities continues to be positive. CWB expects to maintain double-digit loan growth and has set its fiscal 2015 target range at 10 to 12%. Management believes market share will be gained from the combined positive influences of an expanded market presence, increased brand awareness in core geographic markets, and the effective execution of CWB’s strategic plan focused on targeted client solutions and superior customer service. Growth in Canada’s domestic economy is expected to continue at a moderate pace in 2015, in part due to continued strength in U.S. markets. The western Canadian economy is expected to continue to perform well relative to the rest of Canada, largely reflecting ongoing capital investment and in-migration related to a favourable long-term outlook for commodities, notwithstanding recent oil price declines. However, a prolonged period of materially lower energy and other commodity prices poses a risk to the outlook for economic growth in Canada overall, and within Western Canada in particular. In Alberta, the forecast for 2015 is supported by significant long-term capital investment in the oil sands, as well as a relatively positive long-term outlook for activity related to conventional oil production. Activity related to the resource sector in BC, including forestry, has remained solid due to the ongoing U.S. economic recovery and export opportunities to Pacific Rim countries, including China. Growth in Saskatchewan will be supported by a growing energy sector, increased mining output and potash production, and the potential for improvement in agriculture following constrained output due to flooding in 2014. Manitoba’s economy is diverse with positive economic growth contributions mainly expected from agriculture, mining, energy and non-residential construction related to infrastructure investment. Continued economic strength in the U.S. and a lower Canadian dollar are expected to support an escalation of manufacturing and exporting activity in all provinces. Canadian residential real estate markets have been resilient and affordability in most geographic areas remains within historical ranges, largely reflecting very low interest rates. However, the combination of historically high price levels, elevated levels of Canadian consumer debt and the potential for increasing interest rates in the future could slow construction and other related lending activity over time, particularly in specific areas of Vancouver, Calgary and Toronto. Price volatility and ongoing uncertainty surrounding long-term transportation solutions for both natural gas and heavy oil could lead to moderated growth in capital investment related to natural gas production and oil sands development in the near term. However, recent clarification of the royalty regime in British Columbia is a positive development with respect to the outlook for expansion of liquefied natural gas infrastructure on the west coast, and opportunities related to the maintenance of existing facilities within the resource sector remain abundant. The current overall economic outlook remains supportive of management’s expectations for continued strong loan growth. Potential risks that may have a material adverse impact on current economic expectations and forecasts include a sustained period of materially lower energy and other commodity prices, a slowing rate of economic growth in the United States, a significant and sustained deterioration in Canadian residential real estate prices, or a significant disruption in major global economies. Diversification of Portfolio Total advances based on location of security Figure 3 – Geographical Distribution of Loans (October 31, 2013 in brackets) Manitoba 3% (2%) Saskatchewan 7% (7%) Ontario 12% (11%) Other 3% (3%) British Columbia 34% (35%) Alberta 41% (42%) 25 CWB Group 2014 Annual Report The following table illustrates the diversification in lending operations by standard industry sectors. Table 9 – Total Advances Based on Industry Sector(1) (% at October 31) Real estate operations Construction Consumer loans and residential mortgages(2) Transportation and storage Health and social services Finance and insurance Hotel/motel Oil and gas service Oil and gas production Manufacturing Retail trade Wholesale trade Other services Logging/forestry All other Total 2014 2013 22% 22 15 7 5 5 4 3 2 2 2 2 2 2 5 100% 22% 21 15 6 5 4 5 2 3 2 2 2 2 2 7 100% (1) Table is based on the North American Industry Classification System (NAICS) codes. (2) Residential mortgages in this table include only single-family properties. The loan portfolio is focused on areas of demonstrated lending expertise, while concentrations measured by geographic area and industry sector are managed within specified tolerance levels. The portfolio is well diversified with a mix of business and personal loans. Heavy equipment financing is primarily sourced by specialized lenders within branches or through stand-alone equipment financing centres, while small- and mid-sized leases are offered across Canada through National Leasing. Oil and gas production lending is conducted by specialists located in Calgary. Outlook for Diversification of Portfolio Growth is expected across all lending sectors in 2015. While stronger economic activity in Alberta and increased lending exposure in Ontario and Atlantic Canada are expected to lead to comparatively faster growth in these areas, portfolio diversification by geography will likely remain relatively consistent with October 31, 2014. Based on the current view, management expects higher net growth in areas such as equipment financing and leasing, personal loans and mortgages, and general commercial loans compared to commercial mortgages and real estate project loans. Commercial mortgages are often subject to a higher level of pricing competition compared to other types of lending and Real estate specialists are established in the major centres of Vancouver, Edmonton and Calgary. Optimum Mortgage maintains centralized administration based in Edmonton and sources residential mortgages throughout Western Canada and select regions of Ontario and Atlantic Canada through an established network of mortgage brokers. CWB will remain focused on maintaining this portfolio based on client relationships and adequate returns. Expectations for slower growth in real estate project loans compared to that achieved in 2014 reflect the combined impact of this portfolio’s relatively short duration and forecasted moderation in Canadian residential real estate activity, particularly in certain geographical areas. Within the parameters of its established risk appetite, CWB will continue to finance well- capitalized developers on the basis of sound loan structures and acceptable pre-sale/lease levels as such opportunities arise. 26 CWB Group 2014 Annual Report CREDIT QUALITY Highlights of 2014 • Continued strong credit quality and an acceptable level • The provision for credit losses of $25.1 million represented of write-offs. • Gross impaired loans decreased 3% from the prior year and, as a percentage of total loans, represented 35 basis points, compared to 41 basis points one year ago. 15 basis points of average loans, down from 19 basis points in the prior year, three basis points beneath the low end of the 2014 target range of 18 to 23 basis points. Impaired Loans As shown in the table below, gross impaired loans totalled $62.1 million and represented 0.35% of total loans, compared to $64.2 million or 0.41% at the end of 2013. The ten largest accounts classified as impaired, measured by dollars outstanding, represented Table 10 – Change in Gross Impaired Loans ($ thousands) approximately 50% of total gross impaired loans at year end, down from 55%. New formations of impaired loans totalled $63.8 million, compared to $66.9 million last year. Change from 2013 2014 2013 Gross impaired loans, beginning of period $ 64,211 $ 66,840 $ New formations 63,840 66,883 Reductions, impaired accounts paid down or returned to performing status Write-offs Total, end of period(1) Balance of the ten largest impaired accounts Total number of accounts classified as impaired(2) Total number of accounts classified as impaired under $1 million(2) (48,862) (17,069) $ $ 62,120 31,308 $ $ 120 110 (42,860) (26,652) 64,211 35,619 143 135 $ $ $ (2,629) (3,043) (6,002) 9,583 (2,091) (4,311) (23) (25) % (4) (5) 14 (36) (3) (12) (16) (19) Gross impaired loans as a percentage of total loans(3) 0.35% 0.41% (6)bp(4) (1) Gross impaired loans includes foreclosed assets held for sale with a carrying value of $2,393 (2013 – $12,407). CWB pursues timely realization on foreclosed assets and does not use the assets for its own operations. (2) Total number of accounts excludes National Leasing accounts. (3) Total loans do not include an allocation for credit losses or deferred revenue and premiums. (4) bp – basis point change. The dollar level of gross impaired loans fluctuates as loans become impaired and are subsequently resolved, and does not directly reflect the dollar value of expected write-offs given tangible security held in support of lending exposures. The lower balance of gross impaired loans reflects the success of ongoing loan realization efforts and work-out programs, as well as relatively stable economic conditions in CWB’s core geographic markets. Actual credit losses as a percentage of total loans continue to demonstrate the benefits of secured lending practices and disciplined underwriting. Current estimates of expected write-offs for existing loans classified as impaired are reflected in the specific provisions for credit losses, which totalled $5.5 million at year end, compared to $9.6 million a year earlier. Estimates are established through detailed analyses of both the overall quality and ultimate marketability of the security held against each impaired account. The 2014 dollar provision for credit losses of $25.1 million decreased 10% from the previous year despite 12% loan growth. The provision measured as a percentage of average loans of 15 basis points was lower by four basis points. However, as shown in Figure 4, the collective allowance for credit losses exceeded the balance of impaired loans, net of specific allowances. Growth in the collective allowance of 18% exceeded loan growth despite a decrease in the dollar provision for credit losses. The total allowance for credit losses as a percentage of gross impaired loans (coverage ratio) was 154%, up from 134% in 2013. 27 CWB Group 2014 Annual Report Figure 4 – Net Impaired Loans as a Percentage of Net Loans Outstanding 2014 The overall loan portfolio is reviewed regularly with credit decisions undertaken on a case-by-case basis to provide early identification of possible adverse trends. Loans that have become impaired are monitored closely by a specialized team with regular quarterly, or more frequent, reviews of each loan and its realization plan. An impaired loans report is reviewed quarterly by the Loans Committee of the Board of Directors. Outlook for Impaired Loans The combination of ongoing disciplined underwriting practices, the secured nature of the loan portfolio and expectations for moderate economic growth in Canada with comparatively stronger performance within key western Canadian markets underpins management's view that overall credit quality will remain sound. The level of gross impaired loans will likely increase from the current very low level reflecting normal fluctuations of the credit cycle. Overall lending exposures will continue to be closely monitored and actual losses are expected to remain within CWB’s acceptable range. Management remains confident in the strength, diversity and underwriting structure of the overall loan portfolio. 28 CWB Group 2014 Annual ReportALLOWANCE FOR CREDIT LOSSES The year-over-year change in the allowance for credit losses split between the specific allowance by category of impaired loans and Table 11 – Allowance for Credit Losses ($ thousands) the collective allowance for credit risk is provided in the table below. 2014 Opening Balance Provision for Credit Losses Write-Offs, net of Recoveries(1) 2014 Ending Balance Specific Allowance Commercial Real estate Equipment financing and energy Consumer and personal Collective Allowance Total (1) Recoveries in 2014 totalled $1,824. $ 293 $ 1,140 $ (802) $ 6,349 2,179 748 9,569 76,217 (525) 9,871 713 11,199 13,858 (4,915) (8,585) (943) (15,245) $ 85,786 $ 25,057 $ (15,245) $ 95,598 – 90,075 631 909 3,465 518 5,523 Allowances for credit losses are maintained to absorb both identified and unidentified losses in the loan portfolio and, at October 31, 2014, consisted of $5.5 million (2013 – $9.6 million) of specific allowances and $90.1 million (2013 – $76.2 million) in the collective allowance for credit losses. The specific allowance includes the amount of accumulated provisions for losses required to reduce the carrying value of identified impaired loans to their estimated realizable value. The collective allowance for credit risk includes allowances for losses inherent in the portfolio that are not presently identifiable on an account-by-account basis. Policies and methodology governing the management of the collective allowance are in place. An assessment of the adequacy of the collective allowance for credit losses is conducted quarterly in consideration of: • historical trends in loss experience during economic cycles; • the current portfolio composition and profile; • historical loss experience in portfolios that display similar credit risk characteristics; • the estimated period of time between when the impairment occurs and when the loss is identified; and, • management's judgment as to whether current economic and credit conditions are such that the actual level of inherent losses at the balance sheet date is likely to be greater or less than that suggested by historical experience. The loan portfolio is delineated through the assignment of internal risk ratings to each borrower. The rating is based on assessments of key evaluation factors for the nature of the exposure applied on a consistent basis across the portfolio. The current rating system has twelve levels of risk and ratings are updated at least annually for all loans, with the exception of consumer loans and single-unit residential mortgages. Outlook for Allowance for Credit Losses Specific allowances will continue to be determined on an account-by-account basis and reviewed at least quarterly. Lower levels of specific allowances are expected in strong economic times and higher levels of specific allowances in weaker economic times. The collective allowance is expected to fluctuate as a result of normal portfolio growth. Based on management’s current outlook for credit performance and CWB’s actual historical loss experience, the existing level of the collective allowance is considered sufficient to mitigate losses inherent in the portfolio that are not presently identifiable. 29 CWB Group 2014 Annual Report Provision for Credit Losses The provision for credit losses represented 15 basis points of average loans in 2014 (see Table 12), down four basis points from the previous year. Net new specific provisions represented seven basis points of average loans, compared to 13 basis points in 2013. CWB has a long history of strong credit quality and low loan losses, both of Table 12 – Provision for Credit Losses ($ thousands) which compare very favourably to the Canadian banking industry. Macroeconomic and other external factors that may impact core geographic regions and/or industry sectors in which CWB clients operate are continually analyzed. Provision for credit losses(1) Net new specific provisions (net of recoveries)(2) 2014 0.15% 0.07 IFRS 2013 0.19% 0.13 2012 0.19% 0.14 Canadian GAAP(4) 2011 0.19% 0.20 2010 0.21% 0.27 Collective allowance Coverage ratio(3) $ 90,075 $ 76,217 $ 67,344 $ 61,330 $ 59,603 154% 134% 122% 74% 55% (1) As a percentage of average loans. (2) Portion of the year’s provision for credit losses allocated to specific provisions as a percentage of average loans. (3) Allowance for credit losses as a percentage of gross impaired loans. (4) Canadian GAAP – Canadian Generally Accepted Accounting Principles. Outlook for the Provision for Credit Losses The provision for credit losses in 2015 is expected to represent 17 to 22 basis points of average loans. The expected provision reflects CWB’s current assessment based on assumptions about the economic outlook, the overall quality of the portfolio and its underlying security, and the adequacy of the collective allowance for credit losses. The assessment process is continuous and updated expectations are communicated no less than quarterly. DEPOSITS Highlights of 2014 • Branch-raised demand and notice deposits increased 15%. • Branch-raised deposits were 55% of total deposits, consistent issued in the debt capital markets to a broad range of institutional investors. with 2013. • Funding sources were diversified with the expansion of CWB’s bearer deposit note (BDN) and senior deposit note programs • Capital markets deposits increased to 14% of total deposits by source (2013 – 9%), while higher cost broker deposits decreased to 31% (2013 – 36%). 30 CWB Group 2014 Annual Report Table 13 – Deposits ($ thousands) Demand Notice Term 2014 Total Personal $ 33,060 $ 2,957,970 $ 6,841,639 $ 9,832,669 Business and government 637,025 2,134,295 2,399,068 5,170,388 Capital markets Total Deposits % of Total – – 2,369,957 2,369,957 $ 670,085 $ 5,092,265 $ 11,610,664 $ 17,373,014 4% 29% 67% 100% Demand Notice Term 2013 Total Personal $ 30,337 $ 2,741,951 $ 6,648,466 $ 9,420,754 Business and government 615,166 1,622,400 2,613,691 4,851,257 Capital markets Total Deposits % of Total – – 1,359,029 1,359,029 $ 645,503 $ 4,364,351 $ 10,621,186 $ 15,631,040 4% 28% 68% 100% % of Total 56% 30 14 100% % of Total 60% 31 9 100% Total deposits of $17,373 million increased 11% over 2013 reflecting 7% growth in business and government deposits, 4% growth in personal deposits, which include those issued through the deposit broker network, and a 75% increase in capital markets deposits outstanding. Table 14 – Deposits by Source (as a percentage of total deposits at October 31) Branches Deposit brokers Capital markets Total 2014 55% 31 14 100% 2013 55% 36 9 100% References to branch-raised deposits within this MD&A include all deposits generated through the branch network, as well as those raised via CWT, CDF and Valiant. Increasing the level of branch- raised personal deposits and certain types of business deposits is an ongoing strategic focus for CWB as success in this area provides the most reliable and stable sources of funding. Success in growing these funding sources will become even more important under the Basel III rules governing liquidity beginning in 2015 (see the Liquidity Management section of this MD&A). CWT raises deposits through notice accounts (comprised primarily of cash balances held in self- directed registered accounts), corporate trust deposits and through the Bank’s branch network. CDF, the Internet-based banking division of CWB, currently offers various deposit products to clients in all provinces and territories except Quebec. Client deposits in CDF at October 31, 2014 totalled $371 million, a 29% increase compared to a year earlier. Valiant’s status as a federal deposit-taking institution accounts for CWB’s third CDIC licence and provides an additional channel to raise insured deposits. Valiant deposits are currently offered only in CWB branches. Consistent with CWB’s commercial focus, a considerable portion of branch-raised deposits are generated from corporate clients that tend to hold larger balances compared to personal clients (see the Liquidity Management section of this MD&A). Growth in total branch-raised deposits was 11% in 2014, while the demand and notice component within branch-raised deposits increased 15%. Demand and notice deposits, which include lower cost funding sources, comprised 33% of total deposits at year end, up from 32% in the previous year. Branch-raised deposits comprised 55% of total deposits, unchanged from 2013. The level of growth in demand and notice deposits reflects ongoing execution of strategies to further enhance and diversify CWB’s core sources of funding. Other types of deposits are primarily sourced through a deposit broker network and debt capital markets. Insured deposits raised through deposit brokers remain an efficient source of funding. Although these funds are subject to commissions, this cost is countered by a reduced dependence on a more extensive branch network and the benefit of generating insured fixed term retail deposits over a wide geographic base. Additional sources of funding in 2014 included expansion of CWB’s BDN program to $365 million, issuances of $900 million of senior deposit notes, net of maturities, securitization of $363 million of equipment leases (2013 – $91 million) and whole loan sales of $36 million (2013 – $95 million) of residential mortgages. 31 CWB Group 2014 Annual Report Outlook for Deposits and Funding The strategic focus to increase branch-raised deposits will continue, with particular emphasis on the demand and notice component, which is often lower cost and provides associated transactional fee income. CWB’s growing market presence, which includes the expansion and/or opening of full-service branches, also supports objectives to generate branch-raised deposits. Various strategic initiatives, which include the offering of enhanced cash management products and a competitive business savings account, as well as the creation of a new role in senior management for integrated leadership of business and personal banking, are also intended to further augment growth of desired branch-raised funding. The deposit broker network remains an efficient source for raising insured fixed term retail deposits and has proven to be a reliable and effective way to access funding and liquidity over a wide geographic base. Selectively utilizing the debt capital markets is also part of management’s strategy to further augment and diversify both the long- and short-term funding base over time. National Leasing will continue to utilize securitization channels for a portion of its funding requirements, provided that both related costs and the regulatory capital impact remain satisfactory. Utilizing securitization and/or whole loan sales as added sources of funding for certain other types of portfolios, most notably residential mortgages, will also continue to be evaluated in 2015. Other liabilities totalled $504 million at October 31, 2014 (2013 – $462 million). Insurance-related other liabilities were $166 million (2013 – $168 million) and consisted primarily of provisions for unpaid claims and adjustment expenses and unearned premiums. OTHER ASSETS AND OTHER LIABILITIES Other assets at October 31, 2014 totalled $401 million (2013 – $366 million). Insurance-related other assets were $66 million (2013 – $64 million) and consisted primarily of instalment premiums receivable as well as deferred policy acquisition costs. The amount of goodwill and intangible assets recorded on the balance sheet at October 31, 2014 was $50 million (2013 – $49 million) and $85 million (2013 – $70 million), respectively. The increase in intangible assets primarily relates to investment in CWB’s new banking system. LIQUIDITY MANAGEMENT Highlights of 2014 • Maintained a prudent liquidity position and conservative • CWB expects to be compliant with the new investment profile. OSFI Liquidity Adequacy Requirements Guideline. A schedule outlining the consolidated securities portfolio at October 31, 2014 is provided in Note 4 to the consolidated financial statements. A conservative investment profile is maintained by ensuring: • all investments are high quality and include government debt securities, short-term money market instruments, preferred shares, common shares and other marketable securities; CWB’s liquidity management is a comprehensive process that includes, but is not limited to: • maintaining a pool of high quality liquid assets; • comprehensive liquidity scenario stress testing; • monitoring the quality of the cash and securities portfolio; • monitoring liability diversification and maturity profile; • specific investment criteria and procedures are in place to manage • monitoring deposit behaviour; the securities portfolio; • regular review, monitoring and approval of investment policies is completed by CWB’s Asset Liability Committee (ALCO); and, • quarterly reports are provided to the Board on the composition of the securities portfolio, which is further supported by the Board’s annual review and approval of investment policies. • maintaining access to deposit and capital market funding sources; and, • monitoring microeconomic and macroeconomic factors and early warning indicators. 32 CWB Group 2014 Annual ReportTable 15 – Liquid Assets ($ thousands) 2014 2013 2013 Change from Cash and non-interest bearing deposits with financial institutions $ 13,320 $ 83,856 $ (70,536) Deposits with regulated financial institutions Cheques and other items in transit Total Cash Resources Government of Canada treasury bills Government of Canada, provincial and municipal debt, term to maturity 1 year or less 491,255 258,466 232,789 3,839 5,673 (1,834) 508,414 347,995 160,419 134,383 22,541 448,442 (314,059) 401,950 (379,409) Government of Canada, provincial and municipal debt, term to maturity more than 1 year 1,167,771 487,669 680,102 Other debt securities Preferred shares Common shares Securities purchased under resale agreements Total Securities Purchased Under Resale Agreements and Marketable Securities Total Liquid Assets Total Assets 290,363 321,216 152,931 99,566 367,961 379,141 147,169 – (77,598) (57,925) 5,762 99,566 $ 2,188,771 $ 2,232,332 $ (43,561) $ 2,697,185 $ 2,580,327 $ 116,858 $ 20,608,656 $ 18,513,340 $ 2,095,316 Liquid Assets as a Percentage of Total Assets 13% 14% (100)bp(1) Total Deposit Liabilities $ 17,373,014 $ 15,631,040 $ 1,741,974 Liquid Assets as a Percentage of Total Deposit Liabilities 16% 17% (100)bp Additional sources of liquidity and funding in 2014 included $332 million of equipment leases securitized (2013 – $91 million) and $36 million (2013 – $95 million) of residential mortgages sold via whole loan sales. The primary source of incremental new funding was the issuance of capital markets deposit instruments. A summary of all outstanding deposits by contractual maturity date is presented in Tables 16 and 17. (1) bp – basis points. As shown in Table 15, liquid assets comprised of cash, deposits, securities purchased (or sold) under resale agreements and marketable securities totalled $2,697 million at October 31, 2014, an increase of 5% compared to a year earlier. Liquid assets represented 13% (2013 – 14%) of total assets and 16% (2013 – 17%) of total deposit liabilities at year end. The composition of total liquid assets changed over the course of the year as the book was positioned to comply with new OSFI Liquidity Adequacy Requirements Guideline. The duration of the book was also lengthened to reflect a more neutral interest rate risk position. Key changes in the composition of liquid assets at October 31, 2014 compared to the prior year include: • maturities within one year comprising 17% (2013 – 48%); • Government of Canada, provincial and municipal debt securities decreasing to 49% (2013 – 52%); • deposits with regulated financial institutions increasing to 18% (2013 – 13%); • preferred shares decreasing to 12% (2013 – 15%); and, • other marketable securities decreasing to 16% (2013 – 20%). 33 CWB Group 2014 Annual Report Table 16 – Deposit Maturities Within One Year ($ millions) October 31, 2014 Demand deposits Notice deposits Deposits payable on a fixed date Total October 31, 2013 Total Table 17 – Total Deposit Maturities ($ millions) Within 1 1 to 3 Month Months 3 Months to 1 Year Cumulative Within 1 Year $ 670 $ 5,092 1,157 $ – – – – 1,297 3,754 $ 670 5,092 6,208 $ $ 6,919 $ 1,297 $ 3,754 $ 11,970 6,006 $ 932 $ 4,360 $ 11,298 Within 1 year 1 to 2 Years 2 to 3 Years 3 to 4 Years 4 to 5 Years More than 5 Years Total October 31, 2014 Demand deposits Notice deposits Deposits payable on a fixed date $ 670 $ 5,092 6,208 $ – – $ – – $ – – $ – – 2,375 1,605 843 580 Total $ 11,970 $ 2,375 $ 1,605 $ 843 $ 580 $ October 31, 2013 Total $ 11,298 $ 2,416 $ 887 $ 618 $ 412 $ – – – – – $ 670 5,092 11,611 17,373 15,631 $ $ A breakdown of deposits by source is provided in Table 14. Target limits by source have been established as part of the overall liquidity policy and are monitored regularly to ensure an acceptable level of funding diversification is maintained. Management continues to develop and implement strategies to ensure branch-raised deposits remain the core source of funding. Deposits raised through deposit brokers remain an effective incremental funding source. Senior and bearer deposit notes raised in the capital markets provide a further source of funding and liquidity. Table 18 – Subordinated Debentures Outstanding ($ thousands) In addition to deposit liabilities, CWB has subordinated debentures and debt securities related to the securitization of leases to third parties (refer to Note 17 of the consolidated financial statements for additional information). A summary of subordinated debentures outstanding is presented in the following table: Interest Rate 4.389%(1) 3.463%(2) 5.571%(3) Total Maturity Date Earliest Date Redeemable by CWB at Par As at October 31 2014 As at October 31 2013 November 30, 2020 November 30, 2015 $ 300,000 $ 300,000 December 17, 2024 December 17, 2019 March 21, 2022 March 22, 2017 250,000 75,000 250,000 75,000 $ 625,000 $ 625,000 (1) These conventional debentures have a 10-year term with a fixed interest rate for the first five years. Thereafter, the interest rate will be reset quarterly at the Canadian dollar CDOR 90-day Bankers’ Acceptance rate plus 193 basis points. (2) These conventional debentures have a 12-year term with a fixed interest rate for the first seven years. Thereafter, the interest rate will be reset quarterly at the 90-day Canadian dollar CDOR rate plus 160 basis points. (3) These conventional debentures have a 15-year term with a fixed interest rate for the first 10 years. Thereafter, the interest rate will be reset quarterly at the Canadian dollar CDOR 90-day Bankers’ Acceptance rate plus 180 basis points. 34 CWB Group 2014 Annual Report Outlook for Liquidity Management Internal methodologies for managing liquidity risk are continuously refined. CWB utilizes comprehensive stress testing to manage, measure and monitor liquidity risk to ensure a prudent approach. CWB will maintain prudent liquidity levels in 2015 while complying with OSFI’s Liquidity Adequacy Requirements Guideline. CAPITAL MANAGEMENT Highlights of 2014 • Solid common equity Tier 1, Tier 1 and total capital adequacy ratios of 8.0%, 9.3% and 12.8%, respectively. • Cash dividends of $0.78 per share paid to common • Cash dividends of $0.78 per share paid to common shareholders, up 11%. shareholders, up 11%. • Supported strong loan growth while maintaining a consistent • common equity Tier 1 (CET1) capital ratio. Issued $125 million of Basel III compliant 4.40% 5-year rate • reset preferred shares and redeemed $209 million of 7.25% 5-year rate reset preferred shares. Issued $125 million of Basel III compliant 4.40% 5-year rate reset preferred shares and redeemed $209 million of 7.25% 5-year rate reset preferred shares. Subsequent Highlights • In December 2014, the Board of Directors declared a quarterly cash dividend of $0.21 per common share, an increase of 5% over the prior quarter and 11% over the dividend declared a year earlier. The Board of Directors also declared a quarterly cash dividend of $0.275 per Series 5 Preferred Share. year earlier. The Board of Directors also declared a quarterly cash dividend of $0.275 per Series 5 Preferred Share. Capital is managed in accordance with policies and plans that are regularly reviewed and approved by the Board. Capital management takes into account forecasted capital needs with consideration of anticipated profitability, asset growth, market and economic conditions, regulatory changes, and common and preferred share dividends. The overriding goal is to remain well capitalized in order to protect depositors and policyholders, and provide capacity for internally generated growth and strategic opportunities that do not otherwise require accessing the capital markets, all while providing a satisfactory return for common shareholders. CWB has implemented an Internal Capital Adequacy Assessment Process (ICAAP) to establish target capital levels deemed prudent to effectively manage risks, including potential capital shocks from unexpected macroeconomic and/or CWB-specific events. CWB provides a share incentive plan to officers and employees who are in a position to materially impact the longer term financial success of the organization, as measured by overall profitability, earnings growth, share price appreciation and dividends. Note 19 to the consolidated financial statements details the number of options outstanding, the weighted average exercise price and the amounts exercisable at year end. Holders of CWB common shares and holders of any other class of shares deemed eligible by the Board are offered the choice to direct cash dividends paid toward the purchase of common shares through a dividend reinvestment plan (DRIP). Further details regarding CWB’s DRIP are available at cwb.com/investor-relations. Basel III Capital Adequacy Accord Regulatory capital and capital ratios are calculated in accordance with the requirements of OSFI, and capital is managed and reported in accordance with the requirements of the Basel III Capital Adequacy Accord (Basel III). CWB’s minimum regulatory capital ratios, including a 250 basis point capital conservation buffer, are 7.0% CET1, 8.5% Tier 1 and 10.5% total capital. The Basel III rules provide for transitional adjustments whereby certain aspects of the new rules will be phased in between 2013 and 2019. The only available transition adjustment in the Basel III capital standards permitted by OSFI for Canadian banks relates to the multi-year phase out of non-qualifying capital instruments. CWB currently reports its regulatory capital ratios using the Standardized approach for calculating risk-weighted assets. This approach requires CWB to carry significantly more capital for certain credit exposures compared to requirements under the Advanced Internal Ratings Based (AIRB) methodology used by larger Canadian financial institutions. For this reason, regulatory capital ratios of banks that utilize the Standardized approach versus the AIRB methodology are not directly comparable. CWB complied with all internal and external capital requirements in 2014. 35 CWB Group 2014 Annual Report Table 19 – Capital Structure and Regulatory Ratios at Year End ($ thousands) Regulatory Capital, net of deductions Common equity Tier 1 Tier 1 Total Capital ratios Common equity Tier 1 Tier 1 Total Asset to capital multiple 2014 2013 $ 1,443,841 $ 1,285,692 1,673,996 1,560,801 2,304,108 2,243,654 8.0% 9.3 12.8 8.8x 8% 9.7 13.9 8.1x Changes in the Tier 1 and total capital ratios reflect the 2014 issuance of $125 million of 4.40% 5-year rate reset preferred shares, which qualify as Tier 1 capital under Basel III, and the redemption of $209 million of non-qualifying 7.25% 5-year rate reset preferred shares. The required amortization relating to the phase out of existing, non-qualifying subordinated debentures also contributed to the decrease in the total capital ratio. Table 20 – Regulatory Capital ($ thousands) Common equity Tier 1 capital instruments and reserves 2014 2013 Directly issued qualifying common share capital plus related share-based payment reserve $ 558,377 $ 534,914 Retained earnings Accumulated other comprehensive income and other reserves Common equity Tier 1 capital before regulatory adjustments Regulatory adjustments to Common equity Tier 1(1) Common equity Tier 1 capital Additional Tier 1 capital instruments Directly issued capital instruments qualifying as Additional Tier 1 instruments Directly issued capital instruments subject to phase out from Additional Tier 1(2) Additional Tier 1 instruments issued by subsidiaries and held by third parties Additional Tier 1 capital before regulatory adjustments Regulatory adjustments to Additional Tier 1 capital(3) Additional Tier 1 capital Tier 1 capital Tier 2 capital instruments and allowances 1,011,147 865,087 (2,822) (5,417) 1,566,702 1,394,584 (122,861) (108,892) 1,443,841 1,285,692 125,000 105,000 155 – 283,275 163 230,155 283,438 – 230,155 (8,329) 275,109 1,673,996 1,560,801 Directly issued capital instruments subject to phase out from Tier 2(2) 540,000 607,500 Tier 2 instruments issued by subsidiaries and held by third parties Collective allowance for credit losses Tier 2 capital before regulatory adjustments Regulatory adjustments to Tier 2 capital(4) Tier 2 capital Total capital 37 90,075 630,112 – 38 76,217 683,755 (902) 630,112 682,853 $ 2,304,108 $ 2,243,654 (1) CET1 deductions include goodwill, intangible assets, and non-significant investments in financial institutions above a specific percentage of CET1 capital. (2) Capital balances exclude 20% (2013 – 10%) of non-common equity instruments outstanding at January 1, 2013 that do not include non-viability contingent capital clauses. At October 31, 2014, there was no exclusion from Tier 1 regulatory capital related to the Innovative Tier 1 capital (disclosed in deposits). At October 31, 2013, a combined $31 million of outstanding Innovative Tier 1 capital and preferred shares were excluded from regulatory capital. At October 31, 2014, $85 million of outstanding subordinated debentures (October 31, 2013 – $18 million) were excluded from regulatory capital. (3) Additional Tier 1 deduction includes non-significant investments in financial institutions above a specific percentage of CET1 capital. (4) Tier 2 deduction includes non-significant investments in financial institutions above a specific percentage of CET1 capital. 36 CWB Group 2014 Annual Report Table 21 – Risk-Weighted Assets ($ thousands) Corporate Sovereign Bank Retail residential mortgages Other retail Excluding small business entities Small business entities Equity Undrawn commitments Operational risk Securitization risk Other As at October 31, 2014 As at October 31, 2013 Table 22 – Risk-Weighting Category ($ thousands) Cash, Securities and Resale Agreements Loans Other Items $ 152,027 $ 12,011,130 $ 1,329,179 613,873 – – – 426,769 – – – – 30,968 17,797 2,708,015 201,252 2,204,002 – 415,797 48,558 90,810 2014 Risk- Weighted Total Assets $ 12,163,157 $ 12,073,249 1,360,147 631,670 2,708,015 40,604 200,385 980,774 201,252 144,790 2,204,002 1,680,572 426,769 415,797 78,985 48,558 426,769 406,073 987,317 606,975 478,314 – – – – – – – – – – 78,985 389,077 479,887 $ $ 2,521,848 $ 17,728,329 2,395,060 $ 15,942,099 $ $ 468,062 $ 20,718,239 $ 18,025,822 431,127 $ 18,768,286 $ 16,115,012 0% 20% 35% 50% 75% 100% greater Balance Weighted $ 30,251 $ 31,436 $ – $101,990 $ – $ 11,966,506 $ 32,974 $ 12,163,157 $ 12,073,249 2014 150% and Corporate Sovereign Bank 1,157,125 203,022 – 461,614 – – – 123,988 – – Retail residential mortgages 312,599 – 2,053,594 – 319,224 – 46,068 22,598 – – – 1,360,147 40,604 631,670 200,385 2,708,015 980,774 Other retail Excluding small business entities 7,917 1,374 Small business entities 2,362 707 Equity Undrawn commitments Operational risk Securitization risk – – – – – – – – Other 148,047 16,769 – – – – – – – – – – – – – – 191,181 82 698 201,252 144,790 2,098,118 94,760 8,055 2,204,002 1,680,572 – 426,769 38,898 376,899 – – 426,769 426,769 415,797 406,073 – – – – 78,985 78,985 987,317 48,558 48,558 606,975 16,808 189,917 108,346 479,887 478,314 As at October 31, 2014 $ 1,658,301 $ 714,922 $ 2,053,594 $ 225,978 $ 2,664,229 $ 13,123,599 $ 277,616 $ 20,718,239 $ 18,025,822 As at October 31, 2013 $ 1,771,988 $ 537,057 $ 1,754,275 $ 82,574 $ 2,547,915 $ 11,842,730 $ 231,747 $ 18,768,286 $ 16,115,012 37 CWB Group 2014 Annual Report Outlook for Capital Management CWB will maintain solid capital ratios above its target ICAAP thresholds and OSFI’s required minimums, and is well positioned to manage future business growth and unexpected events. Target capital ratios, including an appropriate capital buffer over the prescribed OSFI minimums, are reconfirmed at least annually through CWB’s comprehensive ICAAP. The ongoing retention of earnings, net of expected common and preferred share dividends, is expected to support capital requirements associated with the anticipated achievement of performance within the 2015 target ranges. OSFI’s stated requirement for banks to maintain a minimum leverage ratio of 3% at all times effective January 2015 is not expected to be a constraint for CWB. FINANCIAL INSTRUMENTS AND OTHER INSTRUMENTS As a financial institution, most of CWB’s balance sheet is comprised of financial instruments and the majority of net income results from revenues, expenses, gains and losses related to the same. Financial instrument assets include cash resources, securities, securities purchased under resale agreements, loans, derivative financial instruments and certain other assets. Financial instrument liabilities include deposits, debt, derivative financial instruments and certain other liabilities. The use of financial instruments exposes CWB to credit, liquidity and market risk. A discussion of how these and other risks are managed can be found in the Risk Management section of this MD&A. Management continues to evaluate alternatives to deploy capital for the long-term benefit of CWB shareholders, which includes the potential for strategic acquisitions. Required resources, costs and potential timelines related to CWB’s possible transition to an AIRB methodology for managing credit risk and calculating risk-weighted assets will continue to be evaluated under the direction of CWB’s newly appointed chief risk officer. Preliminary analysis confirms a multi-year time frame which requires OSFI approval. Implementation of CWB’s new core banking system is scheduled for early fiscal 2016. This new system is a critical component for a number of requirements necessary for AIRB compliance, including the collection of certain types of data. Further information on how the fair value of financial instruments is determined is included in the Financial Instruments Measured at Fair Value discussion in the Critical Accounting Estimates section of this MD&A. Income and expenses are classified as to source, either securities or loans for income, and deposits or borrower funds for expense. Net realized gains (losses) on securities are shown separately in non- interest income. Derivative Financial Instruments More detailed information on the nature of derivative financial instruments is shown in Note 11 to the consolidated financial statements. The notional amounts of derivative financial instruments are not reflected on the consolidated balance sheets. Table 23 – Derivative Financial Instruments ($ thousands) Notional Amounts Interest rate contracts(1) Equity swaps designated as hedges(2) Equity swaps not designated as hedges(3) Foreign exchange contracts(4) Total 2014 2013 $ 1,725,000 $ 800,000 19,205 3,754 1,964 17,470 – 1,235 $ 1,749,923 $ 818,705 (1) Interest rate contracts are used as hedging devices to manage interest rate risk. The outstanding contracts mature between December 2014 and July 2017. (2) Equity swaps designated as hedges mature between June 2015 and June 2017. Equity swaps are used to reduce the earnings volatility from restricted share units linked to CWB’s common share price. (3) Equity swaps not designated as hedges mature in June 2015. Equity swaps are used to reduce the earnings volatility from deferred share units linked to CWB’s common share price. (4) U.S. dollar foreign exchange contracts are used from time to time to manage the difference between U.S. dollar assets and liabilities. Forward foreign exchange contracts outstanding mature between November 2014 and July 2015. 38 CWB Group 2014 Annual Report The active use of interest rate contracts remains an integral component to manage the interest rate gap position. The increase in the volume of outstanding contracts (measured by the notional amount) reflects normal course management of interest rate risk. Derivative financial instruments are entered into only for CWB’s own account. CWB does not act as an intermediary in derivatives markets. Transactions are entered on the basis of industry standard contracts with approved counterparties subject to periodic and at least annual review, including an assessment of the credit worthiness of the counterparty. Policies regarding the use of derivative financial instruments are approved, reviewed and monitored on a regular basis by ALCO, and are reviewed and approved by the Board no less than annually. ACQUISITIONS No material acquisitions were completed in 2014. OFF-BALANCE SHEET Off-balance sheet items include assets under administration and assets under management. Total assets under administration, which are comprised of trust assets under administration and third-party leases under administration, as well as mortgages under service agreements totalled $10,102 million at October 31, 2014, compared to $8,424 million one year ago. Assets under management held within Adroit and McLean & Partners were $1,796 million at year end, compared to $1,901 million last year. Lower assets under management primarily reflect the redemption of a single institutional account at Adroit. Other off-balance sheet items are comprised of standard industry credit instruments (guarantees, standby letters of credit and commitments to extend credit). CWB does not utilize, nor does it have exposure to, collateralized debt obligations or credit default swaps. For additional information regarding other off-balance sheet items, refer to Note 21 of the consolidated financial statements. 39 CWB Group 2014 Annual Report SUMMARY OF QUARTERLY RESULTS AND FOURTH QUARTER QUARTERLY RESULTS The financial results for each of the last eight quarters are summarized in Table 24. In general, CWB’s performance reflects a consistent growth trend, although the second quarter contains three fewer revenue-earning days. Quarterly financial results are subject to some fluctuation due to exposure to property and casualty insurance. Insurance operations, which are primarily reflected in non-interest income, are subject to seasonal weather conditions, cyclical patterns of the industry and natural catastrophes. In the third quarter of 2013, net insurance revenues, reflected in non-interest income, were materially impacted by claims expense resulting from catastrophic floods in southern Alberta. In the fourth quarter of 2014, net insurance revenues were materially impacted by claims expense resulting from severe Alberta hailstorms. Mandatory participation in the Alberta auto risk sharing pools can also result in unpredictable quarterly fluctuations. Table 24 – Quarterly Financial Highlights(1) ($ thousands, except per share amounts) Net gains on securities, reflected in non-interest income, were unusually high in 2013 and 2014. The majority of net gains on securities in these periods resulted from favourable market conditions and the repositioning of investments in preferred shares and common equities. Among other things, quarterly results can also fluctuate from the recognition of periodic income tax items. Detailed management’s discussion and analysis along with unaudited interim consolidated financial statements for each quarter, except for the fourth quarters of fiscal 2013 and 2014, are available for review on SEDAR at sedar.com and on CWB’s website at cwb.com. Copies of the quarterly reports to shareholders can also be obtained, free of charge, by contacting InvestorRelations@cwbank.com. Net interest income (teb) $ 132,479 $ 131,751 $ 123,727 $ 125,239 $ 124,775 $ 121,002 $ 111,929 $ 113,052 2014 2013 Q4 Q3 Q2 Q1 Q4 Q3 Q2 Q1 Less teb adjustment Net interest income 1,709 1,888 1,989 2,090 2,062 2,161 2,000 1,915 per financial statements 130,770 129,863 121,738 123,149 122,713 118,841 109,929 111,137 Non-interest income Total revenues (teb) Total revenues Net income available to 27,057 28,027 29,794 28,531 26,181 23,032 23,390 22,379 159,536 159,778 153,521 153,770 150,956 144,034 135,319 135,431 157,827 157,890 151,532 151,680 148,894 141,873 133,319 133,516 common shareholders 58,150 56,580 51,191 52,628 51,210 47,484 42,988 45,482 Earnings per common share Basic Diluted Adjusted cash Return on common 0.72 0.72 0.73 0.71 0.70 0.71 0.64 0.63 0.65 0.66 0.65 0.67 0.64 0.64 0.65 0.60 0.60 0.61 0.54 0.54 0.55 0.58 0.57 0.58 shareholders’ equity (ROE) 15.0% 14.9% 14.4% 14.8% 14.9% 14.1% 13.5% 14.2% Return on average total assets (ROA) Efficiency ratio (teb) Efficiency ratio Net interest margin (teb) Net interest margin Provision for credit losses as 1.12 47.2 47.7 2.56 2.53 1.11 45.9 46.4 2.58 2.54 1.07 46.0 46.6 2.59 2.55 1.11 45.1 45.7 2.64 2.60 1.11 45.5 46.1 2.72 2.67 1.06 46.5 47.2 2.70 2.65 1.00 47.9 48.6 2.61 2.56 1.06 45.8 46.5 2.62 2.58 a percentage of average loans 0.09 0.16 0.16 0.19 0.19 0.20 0.19 0.18 (1) See page 13 for a discussion of teb and non-IFRS measures. 40 CWB Group 2014 Annual Report FOURTH QUARTER OF 2014 Q4 2014 vs. Q4 2013 ROE and ROA Strong fourth quarter financial performance was marked by record earnings and double-digit loan growth. Record net income available to common shareholders of $58.2 million was up 14% while diluted earnings per common share increased 13% to $0.72. Adjusted cash earnings per common share, which excludes the after-tax amortization of acquisition-related intangible assets and the non-tax deductible change in fair value of contingent consideration, was a record $0.73, up 12%. Earnings growth was based on a 6% increase in total revenues (teb) to $159.5 million, a decrease in preferred share dividends and a lower provision for credit losses, partially offset by higher non-interest expenses. Higher total revenues primarily resulted from the benefit of strong 12% loan growth and 3% higher non- interest income, partially offset by a 16 basis point decrease in net interest margin (teb) to 2.56%. Growth in almost all categories of non-interest income more than offset notable declines in both net insurance revenues and net gains on securities. ‘Other’ non-interest income was $4.5 million higher, primarily due to a gain on the sale of CWB’s former Edmonton Main Branch premises. Credit-related fee income and trust and wealth management fees increased $1.0 million and $0.9 million, respectively, while net insurance revenues were $3.6 million lower due to the impact of claims expense related to severe hailstorms in Alberta. Net gains on securities were $1.8 million lower. Q4 2014 vs. Q3 2014 Net income available to common shareholders increased 3%, mainly due to a lower provision for credit losses and higher ‘other’ non- interest income, partially offset by a $3.6 million decline in net gains on securities, a $2.0 million reduction in net insurance revenues and higher non-interest expenses. Changes in ‘other’ non-interest income and net insurance revenues primarily resulted from the same factors discussed above. Diluted and adjusted cash earnings per common share both increased 3%. The quarterly return on common shareholders’ equity of 15.0% increased 10 basis points from both a year earlier and the prior quarter. Fourth quarter return on assets was 1.12%, compared to 1.11% both last year and in the previous quarter. Efficiency The quarterly efficiency ratio (teb), which measures non-interest expenses as a percentage of total revenues (teb), excluding the non- tax deductible charge for the fair value of contingent consideration, was 47.2%, up from 45.5% a year earlier, primarily reflecting the revenue impact of lower net interest margin. Loan Growth Total loans of $17,606 million grew 2% in the quarter and 12% over the past twelve months. Credit Quality Overall credit quality continued to reflect sound underwriting, secured lending practices and strong economic activity in CWB’s key geographic markets. Gross impaired loans totalled $62.1 million at quarter end, compared to $58.1 million last quarter and $64.2 million a year earlier. The quarterly provision for credit losses represented nine basis points of average loans, compared to 16 basis points in the prior quarter and 19 basis points last year. Despite the sequential decline, the dollar provision for credit losses exceeded net new specific provisions and led to a slight increase in the level of the collective allowance for credit losses compared to last quarter. 41 CWB Group 2014 Annual Report All provisions are periodically reviewed and evaluated in light of emerging claims experience and changing circumstances. Changes in circumstances may cause future assessments of unpaid claims and adjustment expenses to be significantly different than current assessments and may require an increase or decrease in the provision. In estimating the provision for unpaid claims and adjustment expenses, a number of uncertainties are taken into account and assumptions made, which makes it difficult to estimate a range for the provision. Further, as noted above, the provision includes a margin for adverse deviations in assumptions. At October 31, 2014, the provision for unpaid claims and adjustment expenses totalled $85.5 million (2013 – $89.7 million). Additional information on the process and methodology for determining the provision for unpaid claims and adjustment expenses can be found in Note 22 to the consolidated financial statements. Financial Instruments Measured at Fair Value Cash resources, securities, securities purchased (sold) under resale agreements, acquisition contingent consideration and derivative financial instruments are reported on the consolidated balance sheets at fair value. CWB categorizes its fair value measurements of financial instruments recorded on the consolidated balance sheets according to a three-level hierarchy. Level 1 fair value measurements reflect published market prices quoted in active markets. Level 2 fair value measurements were estimated using a valuation technique based on observable market data. Level 3 fair value measurements were determined using a valuation technique based on non-market observable input. ACCOUNTING POLICIES AND ESTIMATES CRITICAL ACCOUNTING ESTIMATES CWB’s significant accounting policies are outlined in Note 1 to the audited consolidated financial statements with related financial note disclosures by major caption. The policies discussed below are considered particularly important, as they require management to make significant estimates or judgments, some of which may relate to matters that are inherently uncertain. Allowance for Credit Losses An allowance for credit losses is maintained to absorb probable credit-related losses in the loan portfolio based on management’s estimate at the balance sheet date. In assessing existing credit losses, management must rely on estimates and exercise judgment regarding matters for which the ultimate outcome is unknown. These matters include economic factors, developments affecting particular industries and specific issues with respect to single borrowers. Changes in circumstances may cause future assessments of credit risk to be significantly different than current assessments and may require an increase or decrease in the allowance for credit losses. Establishing a range for the allowance for credit losses is difficult due to the number of uncertainties involved. The collective allowance for credit losses is intended to address this uncertainty. At October 31, 2014, CWB’s total allowance for credit losses was $95.6 million (2013 – $85.8 million) which included specific allowances of $5.5 million (2013 – $9.6 million) and a collective allowance of $90.1 million (2013 – $76.2 million). Additional information on the process and methodology for determining the allowance for credit losses can be found in the discussion of Credit Quality in this MD&A and in Note 7 to the consolidated financial statements. Provision for Unpaid Insurance Claims and Adjustment Expenses A provision for unpaid claims is maintained, with the provision representing the amounts needed to provide for the estimated ultimate expected cost of settling claims related to insured events (both reported and unreported) that have occurred on or before each balance sheet date. A provision for adjustment expenses is also maintained, which represents the estimated expected costs of investigating, resolving and processing these claims. Estimated recoveries of these costs from reinsurance ceded are included in other assets. The computation of these provisions takes into account the time value of money using discount rates based on projected investment income from the assets supporting the provisions. The process of determining the provision for unpaid claims and adjustment expenses necessarily involves risks that the actual results will deviate from the best estimates made. These risks vary in proportion to the length of the estimation period and the volatility of each component comprising the liabilities. To recognize the uncertainty in establishing these best estimates and to allow for possible deterioration in experience, actuaries are required to include explicit margins for adverse deviation in assumptions for asset defaults, reinvestment risk, claims development and recoverability of reinsurance balances. 42 CWB Group 2014 Annual ReportThe following table summarizes the significant financial assets and liabilities recorded on the consolidated balance sheets at fair value. Table 25 – Valuation of Financial Instruments ($ thousands) As at October 31, 2014 Financial Assets Cash resources Securities Securities purchased under resale agreements Derivative related Total Financial Assets Financial Liabilities Other liability(1) Derivative related Total Financial Liabilities As at October 31, 2013 Financial Assets Cash resources Securities Derivative related Total Financial Assets Financial Liabilities Other liability(1) Derivative related Total Financial Liabilities Fair Value Level 1 Level 2 Level 3 Valuation Technique $ 508,414 $ 471,643 $ 36,771 $ 2,089,205 2,089,205 99,566 5,420 99,566 – 5,420 – – $ 2,702,605 $ 2,660,414 $ 42,191 $ – – – – – $ $ 2,679 $ 386 3,065 $ – – – $ $ – $ 2,679 386 – 386 $ 2,679 Fair Value Level 1 Level 2 Level 3 Valuation Technique $ 347,995 $ 300,995 $ 47,000 $ 2,232,332 2,232,332 4,509 – – 4,509 $ 2,584,836 $ 2,533,327 $ 51,509 $ – – – – $ $ 1,679 $ 36 1,715 $ – – – $ $ – $ 1,679 36 – 36 $ 1,679 (1) Level 3 financial instruments are comprised of the contingent consideration related to the acquisition of McLean & Partners Wealth Management Ltd. Notes 3, 4, 5, 11 and 30 to the consolidated financial statements provide additional information regarding these financial instruments. 43 CWB Group 2014 Annual Report CHANGES IN ACCOUNTING POLICIES FUTURE CHANGES IN ACCOUNTING POLICIES A number of standards and amendments have been issued by the IASB, and the following changes may have an impact on CWB’s future financial statements. CWB is currently reviewing these standards to determine the impact, if any, on the financial statements. IFRS 9 – Financial Instruments During 2014, the IASB issued the complete version of IFRS 9. Under the finalized guidance, IFRS 9 specifies that financial assets be classified into one of three categories: financial assets measured at amortized cost, financial assets measured at fair value through profit or loss, or financial assets measured at fair value through other comprehensive income. IFRS 9 introduces changes to measuring an entity’s own credit risk in the valuation of financial liabilities. The final standard also introduces a new expected credit loss model for calculating impairment, and new general hedge accounting requirements that align more closely with an entity’s risk management model. Compliance with IFRS 9 is mandatory for CWB’s fiscal year beginning on November 1, 2018, and early adoption is permitted. OSFI is currently assessing whether it will require federally regulated Canadian banks, including CWB, to adopt IFRS 9 effective November 1, 2017, in advance of IASB requirements. IFRS 15 – Revenue from Contracts with Customers During 2014, the IASB established principles for reporting about the nature, amount, timing and uncertainty of revenue and cash flows arising from an entity’s contracts with customers. The standard provides a single, principles-based model for revenue recognition to be applied to all contracts with customers. IFRS 15 will be effective for CWB’s fiscal year beginning November 1, 2017, with earlier adoption permitted. CWB continues to monitor IASB ongoing activity and proposed changes to IFRS. Several accounting standards that are in the process of being amended by the IASB (i.e. macro-hedging, leases and insurance) may have a significant impact on CWB’s future consolidated financial statements. A number of standards and amendments have been issued by the International Accounting Standards Board (IASB), and the following changes may have an impact on CWB’s future financial statements. CWB is currently reviewing these standards to determine the impact, if any, on the financial statements. Consolidated Financial Statements Effective November 1, 2013, CWB retrospectively adopted IFRS 10 Consolidated Financial Statements and IFRS 12 Disclosures of Interests in Other Entities, which establish principles for the presentation and preparation of consolidated financial statements when an entity controls one or more other entities, and new disclosure requirements for all forms of interests in other entities. As a result of the application of IFRS 10, CWB has changed its accounting policy for determining whether it has control over its investees and, consequently, has de-consolidated Canadian Western Bank Capital Trust (the Trust) through which certain regulatory capital instruments are issued. In accordance with the transitional provisions, CWB has applied IFRS 10 retrospectively and comparative figures have been restated to reflect the de-consolidation of the Trust. The de-consolidation of the Trust resulted in a $105 million decrease in CWB Capital Trust Capital Securities Series 1 (WesTS) previously classified as non-controlling interest and an increase of $105 million in deposit liabilities, and reclassification of the associated distribution, which totalled $6.7 million for the year ended October 31, 2013, from non-controlling interest to interest expense. The annual disclosures required by IFRS 12 are included in Notes 14, 20 and 33. Accounting for Internal Direct Leasing Costs IAS 17 Leases requires that the lessor capitalize initial direct leasing costs in the initial measurement of the lease, and defines initial direct costs as incremental costs directly attributable to negotiating and arranging a lease. Prior to 2014, CWB capitalized costs of certain employees and other internal costs directly attributable to arranging new leases within initial direct leasing costs on initial measurement of a lease. During 2014, the IFRS Interpretations Committee has issued clarification that certain internal costs do not qualify as incremental costs. As a result, during the year CWB changed its accounting policy to expense, rather than capitalize, non-incremental internal costs for negotiating and arranging new leases as incurred. CWB has applied this accounting policy retrospectively, resulting in a decrease of $9.5 million in loans, an increase in other assets of $2.5 million for deferred income taxes, and a decrease of $6.9 million in retained earnings for all presented comparative periods. This change did not result in a change to the consolidated statements of income. Fair Value Measurement Effective November 1, 2013, CWB adopted IFRS 13 Fair Value Measurement, which applies to other IFRS standards that require or permit fair value measurements or disclosures about fair value measurements, and sets out a framework on how to measure fair value using the assumptions that market participants would use when pricing the asset or liability under current market conditions, including assumptions about risk. In accordance with the transitional provisions of IFRS 13, CWB has applied the new fair value measurement guidance prospectively. This new standard had no impact on the measurement of CWB’s assets and liabilities. Additional disclosures required by IFRS 13 are included in Note 30. 44 CWB Group 2014 Annual ReportRISK MANAGEMENT The shaded areas of this MD&A represent a discussion of risk management policies and procedures relating to credit, market and liquidity risks as required under IFRS, which permits these specific disclosures to be included in the MD&A. Therefore, the shaded areas presented on pages 45 to 54 of this MD&A form an integral part of the audited consolidated financial statements for the year ended October 31, 2014. Highlights of 2014 Several enhancements to CWB’s risk management framework were undertaken in 2014 as part of the ongoing development and implementation of CWB’s risk management processes. Key changes included: • Completion of the CWB Group Risk Appetite Statement; • Inclusion of technology risk as a discrete subset of operational risk in recognition of CWB’s increasing reliance on technology; and, • Recruitment of an executive chief risk officer to take office in fiscal 2015; • Implementation of a group-wide operational risk training initiative. RISK MANAGEMENT OVERVIEW CWB’s risk management processes are designed to complement the organization’s overall size, level of complexity, risk profile and philosophy regarding risk. CWB’s risk management philosophy emphasizes sound controls, effective governance, transparency and accountability. Selectively choosing and managing acceptable risks has been integral to CWB’s ability to grow profitably in both favourable and adverse market conditions. A strong risk culture continues to be a cornerstone of CWB’s approach to risk management. As with all financial institutions, CWB is in the business of managing risk and is therefore exposed to various risk factors that could adversely affect its operating environment, financial condition and financial performance. Exposure to risk may also influence a client’s decision to make deposits and/or an investor’s decision to buy, sell or hold CWB shares or other securities. Each of CWB’s businesses is subject to certain risks that require unique mitigation strategies. CWB has demonstrated its ability to effectively manage risks through conservative management practices based on a strong risk culture and a disciplined risk management approach; however, not all risks are within CWB’s direct control. A description of key external risk factors management considers is included in this risk management discussion. CWB actively evaluates existing and potential risks to develop, implement and continually enhance appropriate risk mitigation strategies. Risk Management Principles The following principles guide the management of risks across all operations and companies of CWB (group-wide): • An effective balance of risk and reward through alignment of business strategy with risk appetite, diversifying risk, pricing appropriately for risk, and mitigating risk through sound preventive and detection controls. • A group-wide view of risk and the acceptance of risks required to build the business with continuous consideration for how those risks may affect CWB’s reputation. • The belief that every employee is accountable to understand the risks inherent in their respective day-to-day activities. • Use of common sense, sound judgment and fulsome risk-based discussions. • Recognition that “knowing your client” reduces risks by ensuring the services provided are suitable for, and understood by, the client. The mandate of CWB’s Group Risk Management function is to enhance existing processes and structure to help identify and appropriately mitigate risks on a group-wide basis. The intent is to provide a suitable framework for CWB to properly balance risk and reward while ensuring risk management practices satisfy regulatory requirements. 45 CWB Group 2014 Annual Report CWB Group Risk Appetite StatementCWB Group’s vision – to be seen as crucial to our clients’ futures – requires continuous consideration, understanding and responsible management of all key risks at both the strategic and operational levels. Our core strategic objective to balance risk and reward requires each of us to make common-sense business decisions by assessing risk and reward trade-offs considering CWB Group strategy, risk appetite and regulatory/legal requirements. Our Risk Appetite Statement considers all risks we manage as we seek to deliver value and growth for each of our key stakeholder groups: clients, shareholders, employees and communities and is summarized as follows:At CWB Group, we consciously accept risks to add value for stakeholders and support the responsible and efficient delivery of products and services provided those risks:• Help us become more crucial to our clients’ futures • Are thoroughly understood and managed within the confines of well-communicated CWB Group risk tolerances, including the highest ethical standards. Risk Management Framework The primary goal of risk management is to ensure that the outcomes of risk taking are consistent with CWB’s business activities, strategies and risk appetite. The group-wide risk management framework provides the foundation for achieving this goal. CWB utilizes the ISO 31000 Standard for Risk Management as a comprehensive framework to help ensure risk is managed effectively and efficiently. This international standard provides principles and guidelines for managing risk in a systematic, transparent and credible manner. The risk framework is subject to continuous evaluation to ensure it meets the challenges and requirements faced by CWB in its operations, including the evaluation of industry best practices and compliance with evolving regulatory standards. CWB’s group-wide risk management framework (Figure 5) is comprised of four main elements: Figure 5 – Risk Management Framework Risk Governance Risk Appetite Framework Principal Risks and Risk Management Processes Strong Risk Culture Risk Culture A strong risk culture emphasizes transparency and accountability. Organizations with a strong risk culture have a consistent and repeatable approach to risk management when making key business decisions, including regular discussions of risk and reviews of risk scenarios that can help management and the Board understand the interrelationships and potential impacts of risks. CWB’s strong risk culture starts with an appropriate “tone at the top” that demonstrates and sends consistent and clear messages throughout the organization. Risk culture is communicated throughout the organization and is emphasized by the actions of senior management and the Board. Principal Risks The ability to identify, measure and monitor risks is a key component of effective group-wide risk management. Certain principal risks have been identified that have the greatest potential to materially impact operations. Following (Figure 6) is a visual representation of CWB’s principal risk exposures by business line: Figure 6 – Principal Risks CWB Liquidity/Funding Risk Market Risk Capital Risk Operational Risk Business and Personal Banking Trust Services Insurance Wealth Management Credit Risk Operational Risk Credit Risk Operational Risk Operational Risk Operational Risk 46 CWB Group 2014 Annual Report Reputational risk is also a principal risk, which arises as a consequence of not managing other risks effectively. Regulatory, technology and people risks are significant subsets of Operational Risk. Important risk factors, including related risk management processes, are described in more detail in the following sections. While each of these risks is described independently, many of the factors and risks discussed may also be interrelated. CWB’s risk management processes incorporate various forms of stress testing to assist in making informed risk management and capital planning decisions, which are developed and managed as part of sound business strategy. Stress testing is performed across key functional areas of CWB and is based on both quantitative and qualitative inputs. Risk Appetite Senior management establishes and recommends CWB’s overall risk appetite, which is ultimately approved by the Board. Risk appetite is the formalization of basic business principles such as making decisions based on risk-reward tradeoffs, understanding potential outcomes of those decisions and deciding whether CWB is comfortable with the risk associated with those decisions. It provides a context to discuss potential risks and reach a shared understanding of appropriate risk thresholds. Setting risk tolerances is dynamic and requires flexible processes, as well as continuous review and guidance from senior management, internal risk committees and the Board. Key attributes of CWB’s formalized risk appetite framework include the following: • A conservative culture that is prevalent throughout CWB, from the Board to senior management to front-line staff. • No direct exposure to wholesale banking businesses (investment banking, brokerage and trading) which are subject to significant earnings volatility and can lead to large unexpected losses compared to typical spread lending. • Careful and diligent management of risks at all levels led by a knowledgeable and experienced management team committed to sound management practices and the promotion of a highly ethical culture. • A relatively flat organizational structure with management close to their respective operations, helping to facilitate effective internal communications and reinforcing an appropriate “tone at the top.” • A continuous commitment and focus on the achievement of high quality, sustainable long-term financial results. • A philosophy of avoiding exposure to risks that are not well understood. Management strives to thoroughly understand the risks of the businesses in which CWB chooses to engage and has extensive knowledge and experience in CWB’s chosen lending sectors, key geographic regions and other complementary business areas. 47 CWB Group 2014 Annual Report Risk Management Governance Structure Management owns the risks CWB takes or is exposed to while conducting its business activities, while the Board approves and monitors the framework under which these risks are managed. This framework places ultimate accountability for the management of risk with the CWB Group Executive Committee. The Executive Committee, with the assistance of the Group Risk Management function, is responsible for establishing the overall risk management framework, identifying risks and developing appropriate risk management policies. Figure 7 – Internal Risk Management Committees The Board, either directly or through its committees, reviews or approves the key policies and implements specific reporting procedures to enable effective monitoring of significant risk areas. At least annually, a report on risks and key risk management policies is presented to the Board and/or Board committees for review, assessment and approval. An overview of the management committee structure and list of key risks for which each committee is responsible follows. CEO Executive Committee Reputational Regulatory Group Credit Risk Committee Group ALCO Group Capital Risk Committee Group Operational Risk Committee Group Disclosure Committee Credit Market Liquidity Funding Capital Operational • Regulatory • Technology • People Group Capital Risk Committee – Responsible for the oversight of capital adequacy, CWB’s regulatory capital plan, ICAAP and stress testing. Group Operational Risk Committee – Reviews the group operational risk management framework, operational loss reporting and business continuity plans. Reviews action plans for mitigating and improving the management of operational risk. Group Disclosure Committee – Supports CEO/CFO certification over public disclosures. Responsible for reviewing CWB’s internal control over financial reports and disclosure controls and procedures to help ensure the accuracy, completeness and timeliness of related public disclosures. Executive Committee – Oversees major risk management processes, provides oversight to internal risk committees and ensures the risk management framework is properly implemented. Provides executive oversight for all principal risks, and recommends the risk appetite and overall risk management framework for Board approval. Group Credit Risk Committee – Approves loans within delegated limits and is responsible for ensuring that appropriate credit policies are in place. Monitors the quality, diversification and exposure of the loan portfolio and recommends actions to ensure adequacy of the provision for credit losses. Group Asset Liability Committee (ALCO) – 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 risk. Oversees diversification of product offerings to ensure alignment with strategy and risk tolerances. 48 CWB Group 2014 Annual ReportAdditional information on these committees is provided below in principal risk governance sections. To support the overall governance structure, CWB has adopted a “three lines of defense” model: Table 26 – Three Lines of Defense First Line Business and Support Areas - Own risk - Identify and manage risk through the establishment of policies and procedures - Ensure activities conform to risk management policies and authorities - Develop and maintain effective internal controls - Monitor and report activities Second Line Oversight Functions Third Line Internal Audit - Establish group-wide frameworks and training for risk management and compliance - Provide oversight and independent challenge to business and support areas - Monitor and report on compliance with risk policies - Provide independent assurance that risk management controls and governance processes are adequate and functioning as intended The following CWB oversight functions provide key support within the group-wide risk management framework: Group Risk Management – Establishes the group-wide risk management framework and provides independent oversight of enterprise risk management. The Chief Risk Officer (CRO) will report functionally to the Board. Regulatory Compliance – Establishes risk-based processes to actively manage known and emerging risks related to applicable regulatory requirements. The General Counsel acts in the capacity of Chief Compliance Officer (CCO) and reports functionally to the Board. Finance – Provides independent oversight of processes to manage financial reporting and capital risk. Provides oversight on financial reporting, capital adequacy, external credit ratings, regulatory reporting, tax and accounting-related functions. The Chief Financial Officer (CFO) reports functionally to the Audit Committee. Internal Audit – Provides independent, objective assurance and consulting services designed to improve CWB’s operations. The scope of work includes determining whether the network of risk management controls and governance processes, as designed and implemented by management, are adequate and functioning in the intended manner. The Chief Internal Auditor (CIA) reports functionally to the Audit Committee. CREDIT RISK Risk Overview The main source of credit risk exposure for CWB results from its focus and expertise in granting loans and leases. CWB’s credit risk management culture reflects the unique combination of policies, practices, experience and management attitudes that support growth within chosen industries and geographic markets. Underwriting standards are designed to ensure an appropriate balance of risk and return, and are supported by established loan exposure limits in areas of demonstrated lending expertise. Concentration is measured against specified tolerance levels by geographic region, industry sector and product type. In order to minimize its potential loss given default, the vast majority of loans are secured by tangible collateral. CWB’s approach to managing credit risk has proven to be very effective, as demonstrated by CWB’s relatively stable provision for credit losses and consistently low write-offs measured as a percentage of total loans. Refer to the Loans and Credit Quality sections of this MD&A for additional information. 49 CWB Group 2014 Annual Report 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 CWB. Risk Governance The credit approval process is centrally controlled, with all significant credit requests submitted to Credit Risk Management for adjudication. Credit Risk Management is independent of the originating business. Requests for credit approval beyond the lending limit of the CEO are referred to the Group Credit Risk Committee or to the Loans Committee of the Board for approval, depending on the size of the exposure. Risk Management CWB is committed to a number of important principles to manage credit exposures, which include: • ongoing development of credit analytics reporting to assess portfolio risks at a granular level; • pricing of credits commensurate with risk to ensure an • oversight provided by the Loans Committee of the Board; appropriate financial return; • delegated lending authorities that are clearly communicated • management of growth while maintaining the quality of loans; to lenders and other personnel engaged in the credit granting process; • credit policies, guidelines and directives which are communicated within all branches, business lines and to officers whose activities and responsibilities include credit granting and risk assessment; • appointment of personnel engaged in credit granting who are both qualified and experienced; • a standard credit risk-rating classification established for all credits; • a review at least annually of credit risk-rating classifications and individual credit facilities (except consumer loans and single-unit residential mortgages); • quarterly review of risk diversification by geographic area, industry sector and product measured against assigned portfolio limits; • early recognition of problem accounts and immediate action to protect the safety of CWB’s capital; • delegation of loans deemed to carry higher risks to a specialized loan workout group that performs an appropriate level of regular monitoring and close management; • independent reviews of credit evaluation, risk classification and credit management procedures by Internal Audit, which includes direct reporting of results to senior management, the CEO and the Audit Committee of the Board; and, • detailed quarterly reviews of accounts rated less than satisfactory. Reviews include a recap of action plans for each less than satisfactory account, the completion of a watch list report recording accounts with evidence of weakness and an impaired report covering loans that show impairment to the point where a loss is possible. A summary report of less than satisfactory accounts is reviewed by the Loans Committee of the Board on a quarterly basis. Credit Risk Concentration Risk diversification is addressed by establishing portfolio limits by geographic area, industry sector and product. The policy is to limit loans to connected corporate borrowers to not more than 10% of CWB’s shareholders’ equity. Generally, CWB’s lending limit is $50 million for a single risk exposure. However, for certain quality connections that confirm debt service capacity and loan security from more than one source, the limit is generally $75 million. CWB clients with larger borrowing requirements can be accommodated through loan syndications with other financial institutions. Environmental Risk Portfolio Quality While the day-to-day operations of CWB do not have a material impact on the environment, environmental risks include the risk of loss given default if a borrower is unable to repay loans due to environmental cleanup costs, and the risk of damage to CWB’s reputation resulting from the same. In order to manage these risks, and to help mitigate CWB’s overall impact on the environment, CWB evaluates potential environmental risks as part of its credit granting process. If potential environmental risks are identified that cannot be resolved to CWB’s satisfaction, the application will be denied. Reports on environmental inspections and findings are provided quarterly to the Board. Where financing is provided, Internal Audit will sample test loan files to ensure environmental studies required as a condition of financing are in place, including review for a transmittal letter from the author of the environmental study indicating that it may be relied upon for financing purposes. CWB’s strategy is to maintain a quality, secured and diversified loan portfolio by engaging experienced personnel who provide a hands-on approach in credit granting, account management and timely action when problems develop. Lending within the Bank is largely directed toward small- and medium-sized businesses operating in the four western provinces, and to individuals. Relationship banking and “knowing your client” are important tenets of effective account management. Earning an appropriate financial return for the level of risk is also fundamental. Geographic diversification of the loan portfolio outside of Western Canada is achieved through participation in syndicated lending facilities primarily led by other Canadian banks, National Leasing’s representation across all provinces of Canada, and residential mortgages underwritten and serviced by Optimum in select regions of Ontario and Atlantic Canada. For additional information, see the Loans and Credit Quality sections of this MD&A. 50 CWB Group 2014 Annual ReportMARKET RISK Risk Overview Risk Governance Market risk arises when making loans, taking deposits and making investments. The most material market risks for CWB are those related to changes in interest rates. CWB does not undertake market activities such as market making, arbitrage or proprietary trading and, therefore, does not have direct risks related to those activities. A diversified cash and securities portfolio is maintained that is primarily comprised of high quality debt instruments, preferred shares and common shares that are subject to price fluctuations based on movements in interest rates and volatility in financial markets. CWB has limited direct exposure to foreign exchange risk. INTEREST RATE RISK The Board annually approves asset liability management policies specifying interest rate and foreign exchange exposure limits, and regularly reviews actual positions against these thresholds. ALCO is responsible for ongoing oversight, and reviews and endorses the asset liability policies at least annually in addition to providing related strategic direction and oversight for Treasury. Treasury actively monitors and manages market risk with strong support from senior management. This risk and the potential for variability in earnings arise primarily when cash flows associated with assets and liabilities have different repricing dates. The differentials, or interest rate gaps, arise as a result of the financial intermediation process and primarily reflect differences in the preferences for term 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. Generally, a positive gap will result in an increase in net interest income when market interest rates rise since assets reprice earlier than liabilities. The opposite impact will generally occur when market interest rates fall; however, the correlation may be disrupted when interest rates approach zero. To manage interest rate risk arising as a result of the financial intermediation process, ALCO works within policy guidelines for interest rate gap positions and meets regularly to monitor CWB’s position and decide future strategy. The objective is to prudently manage interest rate risk within established guidelines. Interest rate risk policies are reviewed and approved by the Board at least annually. The gap position is reported to the Board at least quarterly. 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 stress testing of the asset liability portfolio structure, duration analysis and dollar estimates of net interest income sensitivity for periods of up to one year after Treasury hedging activity. The interest rate gap is measured at least monthly. Note 29 to the consolidated financial statements shows the gap position at October 31, 2014 for select time intervals. The analysis in Note 29 is a static measurement of interest rate sensitivity gaps at a specific point in time, and there is potential for these gaps to change significantly over a short period. The impact on earnings from changes in market interest rates will depend on both the magnitude of and speed with which interest rates change, as well as the size and maturity structure of the cumulative interest rate gap position and the management of those positions over time. The one-year and under cumulative gap represented negative 0.7% of total assets at October 31, 2014, down from 1.2% one year ago, while the one-month and under gap decreased to 2.7%, from 6.7% a year earlier. The estimated sensitivity of net interest income to a change in interest rates is presented in Table 27. 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. The estimates are based on a number of assumptions and factors, which include: • a constant structure in the interest sensitive asset liability portfolio; • floor levels for various deposit liabilities; • interest rate changes affecting interest sensitive assets and liabilities by proportionally the same amount and applied at the appropriate repricing dates; and, • no early redemptions. 51 CWB Group 2014 Annual Report Interest rate risk is the impact on earnings and economic value resulting from changes in interest rates.Interest rate risk is managed to ensure sustainable earnings over time, balancing the impact on current year earnings against changes in economic value at risk over the life of the asset and liability portfolios.Market risk is the impact on earnings resulting from changes in financial market variables such as interest rates and foreign exchange rates.Table 27 – Estimated Sensitivity of Net Interest Income as a Result of One Percentage Point Change in Interest Rates ($ thousands) Impact of 1% increase in interest rates Period 90 days 1 year 1 year percentage change Impact of 1% decrease in interest rates Period 90 days 1 year 1 year percentage change 2014 2013 $ 2,411 $ 4,176 9,185 14,545 2.0% 3.3% 2014 2013 $ (4,889) $ (6,796) (18,221) (23,853) (3.9)% (5.3)% Higher sensitivity to a decrease in rates is due to asymmetry in the impact of falling rates on loans and deposits. A decrease of one- percentage point in rates is assumed to reduce loan yields by an equivalent amount. However, the assumed change in total deposit costs is lower because deposits yielding less than one percent at the beginning of the period are adjusted to zero or an assumed floor if higher than zero. It is estimated that a one-percentage point increase in all interest rates at October 31, 2014 would decrease unrealized gains related to available-for-sale debt securities and the fair value of interest rate swaps designated as hedges, and result in a reduction in other comprehensive income of approximately $36.6 million, net of tax (October 31, 2013 – $14.4 million); it is estimated that a one-percentage point decrease in all interest rates at October 31, 2014 would result in a higher level of unrealized gains related to available-for-sale debt securities and increase the fair value of interest rate swaps designated as hedges, which would increase other comprehensive income by approximately $37.3 million, net of tax (October 31, 2013 – $14.4 million). It is management’s intention to continue to manage the asset liability structure and interest rate sensitivity through pricing and product policies to attract desired assets and liabilities, as well as through the use of interest rate swaps or other appropriate hedging techniques (see discussion under Derivative Financial Instruments section). Assets and liabilities having a term to maturity in excess of five years are subject to specific review and control, and were not material. FOREIGN EXCHANGE RISK Foreign exchange risk is the risk of changes in earnings or economic value arising from changes in foreign exchange rates. This risk arises when various assets and liabilities are denominated in different currencies. In providing financial services to its clients, CWB has assets and liabilities denominated in U.S. dollars. At October 31, 2014, assets denominated in U.S. dollars were 1.0% (2013 – 1.2%) of total assets and U.S. dollar liabilities were 1.1% (2013 – 1.3%) of total liabilities. Currencies other than U.S. dollars are not bought or sold other than to meet specific client needs. CWB has no material exposure to currencies other than U.S. dollars. Policies have been established that include limits on the maximum allowable differences between U.S. dollar assets and liabilities. The difference is measured daily and managed by use of U.S. dollar forward contracts or other means. Policy respecting foreign exchange exposure is reviewed and approved at least annually by the Board. Any deviations from policy are reported regularly to ALCO and quarterly to the Board. 52 CWB Group 2014 Annual Report LIQUIDITY AND FUNDING RISK Risk Overview CWB maintains a sound, prudent and conservative approach to managing exposure to liquidity risk, including targeting a contingency planning horizon under stressed operating conditions that may be caused by company-specific or market-wide stress scenarios. The contingency planning horizon and related liquidity and funding management strategies comprise an integrated liquidity risk management program designed to ensure that CWB manages liquidity risk within an appropriate threshold. CWB’s key risk mitigation strategies include: • broad funding access, including preserving and growing a reliable base of core deposits and continual access to diversified sources of funding; • a comprehensive group-wide liquidity contingency plan that is supported by a pool of unencumbered high quality liquid assets and marketable securities that would provide assured access to liquidity in a crisis; and, • the maintenance of a liquidity position to manage current and future liquidity requirements while also contributing to the flexibility, safety and soundness of CWB under times of stress. • an appropriate balance between the level of risks CWB undertakes and the corresponding cost of risk mitigation that considers the potential impact of extreme but plausible events; Refer to the Liquidity Management section of this MD&A for additional information. Risk Governance Liquidity management is centralized to better facilitate the effective management of liquidity risk. The Board annually approves asset liability management policies and delegates liquidity risk authorities to senior management. The Board is responsible for oversight of the liquidity policies and also reviews, on a regular basis, reporting on the overall liquidity position, status and trends. ALCO annually reviews and endorses the liquidity management policies and provides primary management oversight for the treasury management function. The Treasury department actively measures, monitors and manages liquidity risk with strong support from senior management. 53 CWB Group 2014 Annual Report Liquidity risk is the risk that CWB cannot meet a demand for cash or fund its financial obligations in a cost efficient or timely manner as they become due. These financial obligations can arise from withdrawals of deposits, debt maturities, and commitments to provide credit.Risk Management CWB has comprehensive Asset Liability Management policies that cover key aspects of liquidity risk management. The key elements of managing liquidity risk for CWB include the following: • Policies – Liquidity risk management policies establish targets for minimum liquidity, set the monitoring regime, and define authority levels and responsibilities. Policies are reviewed at a minimum annually by ALCO and the Board. Limit setting establishes acceptable thresholds for liquidity risk; • Monitoring – Trends and behaviours regarding how clients manage their deposits and loans are monitored to determine appropriate liquidity levels. Active monitoring of the external environment is performed using a wide range of sources and economic barometers; • Measurement and modelling – CWB’s liquidity model measures and forecasts cash inflows and outflows, including any cash flows related to applicable off-balance sheet activities over various risk scenarios; • Reporting – Treasury oversight of all significant liquidity risks that support analysis, risk measurement, stress testing, monitoring and reporting to both ALCO and the Board; • Stress testing – CWB performs liquidity stress testing on a regular basis to evaluate the potential effect of both systemic and company-specific (idiosyncratic) disruptions on CWB’s liquidity position. Liquidity stress tests consider the effect of changes in funding assumptions, depositor behaviour and the market behaviour of liquid assets. CWB stress tests liquidity as per guidance from OSFI as described in the Liquidity Adequacy Requirements Guideline. Stress test results are reviewed by ALCO and considered in making liquidity management decisions. Liquidity stress testing has many purposes, including, but not limited to: - helping the Board and senior management understand the potential behaviour of various positions on CWB’s balance sheet in circumstances of stress; and, - facilitating the development of effective funding, risk mitigation and contingency plans. • Contingency planning – A liquidity contingency plan is maintained that defines a liquidity event and specifies the desired approaches for analyzing and responding to actual and potential liquidity events. The plan outlines an appropriate governance structure for the management and monitoring of liquidity events, processes for effective internal and external communication, and identifies potential countermeasures to be considered at various stages of an event; • Funding diversification – CWB actively manages the diversification of its deposit liabilities by source, type of depositor, instrument and term. Supplementary funding sources currently include securitization, capital market issuance and whole loan sales; and, • Core liquidity – CWB maintains a pool of highly liquid, unencumbered assets that can be readily sold, or pledged to secure borrowings, under stressed market conditions or due to company-specific events. OSFI issued the final Liquidity Adequacy Requirements in May 2014, which formalizes many of the regulations issued by the Bank for International Settlements (BIS) in the International Framework for Liquidity Risk, Measurement, Standards and Monitoring. Canadian banks are expected to comply with the Liquidity Coverage Ratio (LCR) in January 2015 while implementation of the Net Stable Funding Ratio (NSFR) is delayed until 2018. OSFI also introduced a monitoring tool called the Net Cumulative Cash Flow. CWB expects to be compliant with the Liquidity Adequacy Requirements Guidelines. 54 CWB Group 2014 Annual ReportContractual Obligations CWB enters into contracts in the normal course of business that give rise to commitments of future minimum payments that affect the liquidity position. In addition to the obligations related to deposits and subordinated debentures discussed in the Deposits and Liquidity Table 28 – Contractual Obligations ($ thousands) Management sections of this MD&A, as well as Notes 13, 17, 21 and 29 of the consolidated financial statements, the following contractual obligations are outstanding at October 31, 2014: Lease commitments $ 12,121 $ 21,751 $ 16,857 $ 46,178 $ 96,907 Within 1 Year 1 to 3 Years 4 to 5 Years More than 5 Years Total Purchase obligations for operating and capital expenditures October 31, 2014 October 31, 2013 Credit Ratings 3,132 15,253 13,019 $ $ 2,856 24,607 25,438 $ $ 2,677 19,534 19,395 $ $ – 46,178 52,599 $ $ 8,665 105,572 110,451 $ $ CWB’s ability to efficiently access capital markets funding on a cost-effective basis is partially dependent upon the maintenance of satisfactory credit ratings. Such credit ratings, accompanied with a stable or positive outlook, increase the breadth of clients and investors able to participate in various deposit and debt offerings, while also lowering CWB’s overall cost of capital. Credit ratings are largely determined by the quality of earnings, the adequacy of capital, the effectiveness of risk management programs and the opinions of rating agencies related to creditworthiness of the financial sector as a whole. There can be no assurance that CWB’s credit ratings and the corresponding outlook will not be changed, potentially resulting in adverse consequences for funding capacity or access to capital markets. Changes in credit ratings may also affect the ability and/or the cost of establishing normal course derivative or hedging transactions. Credit ratings do not consider market price or address the suitability of any financial instrument for a particular investor and are not recommendations to purchase, sell or hold securities. Ratings are subject to revision or withdrawal at any time by the rating organization. The following table summarizes the credit ratings issued for CWB, as well as the corresponding rating agency outlook at October 31, 2014. Table 29 – Credit Ratings The following CWB ratings issued by DBRS, along with the corresponding outlook, were last confirmed on October 21, 2014. Long-term senior debt and deposits Short-term debt Subordinated debentures Preferred shares Outlook DBRS A (low) R-1 (low) BBB (high) Pfd-3 Stable 55 CWB Group 2014 Annual Report CAPITAL RISK Risk Overview CWB follows three main principles to facilitate the effective management of capital risk: • Capital management involves a dynamic and ongoing process to determine, allocate and maintain appropriate amounts of capital. • The optimal amount and composition of capital must consider regulatory and economic capital requirements, as well as the expectation of CWB shareholders and other stakeholders. • The objective of capital management is to ensure: - capital is, and will continue to be, adequate to maintain confidence in the safety and stability of CWB while also complying with required regulatory standards; - CWB has the capability to access appropriate sources of capital in a timely and cost-effective manner; and, - return on capital is sufficient to support projected business growth and satisfy the expectations of investors. responsible for capital risk management. Under the leadership of the CFO, senior representatives within Finance, Group Risk Management, Strategy and Communications, and Credit Analytics comprise the ICAAP core team, which is closely supported by other key departments, including Treasury and Credit Risk Management. Risk Management The following are key elements of capital risk management: • The regulatory capital plan, inclusive of the capital management policy and three-year capital projections, is completed at least annually. • Consolidated forecast models are used to analyze the likely capital impact of projected operations, stress testing and/or significant transactions. • Regulatory capital ratios are reported to senior management and the Board on a monthly basis. Risk Governance • The Board receives a quarterly capital risk update. The Board at least annually approves the regulatory capital plan, Internal Capital Adequacy Assessment Process (ICAAP) and capital management policies. The Group Capital Risk Committee is For additional information, please refer to the Capital Management section of this MD&A. OPERATIONAL RISK Risk Overview Operational risk is inherent in all of CWB’s business activities, including banking, trust, wealth management and insurance operations, and is embedded in processes that support the management of principal risks such as credit, liquidity, market, capital and reputational risk. CWB is exposed to operational risk from internal business activities, external threats and outsourced business activities. Its impact can be financial loss, loss of reputation, loss of competitive position, regulatory penalties, or failure in the management of other risks. While operational risk cannot be completely eliminated, proactive operational risk management is a key strategy to mitigate this risk. The primary financial measure of operational risk is actual losses incurred. CWB incurred no material losses related to operational risk in 2014 or 2013. The regulatory framework requires certain amounts of capital to be allocated to support operational risk. CWB uses the Standardized approach to measure operational risk. CWB has a group-wide Operational Risk Management Framework to ensure that all employees understand their responsibilities with respect to operational risk management. The Operational Risk Management Framework 56 encompasses a common language of risk coupled with programs and methodologies for identification, measurement, control, and management of operational risk. This is supported by specific operational risk training for all staff. Risk Governance Business and support areas are fully accountable for the management and control of operational risks to which they are exposed. The Group Operational Risk Committee has responsibility for operational risk, with oversight by the Board, Executive Committee and senior management. The Group Risk Management function is responsible for the continual enhancement of the Group Operational Risk Management Framework and supporting policies. The Board has ultimate oversight and approves the Group’s Operational Risk Management Framework with support from various Board committees. CWB Group 2014 Annual ReportCapital risk is the risk that CWB has insufficient capital resources, in either quantity or quality, to support strategic initiatives and current or planned operations. Operational risk is the risk of loss resulting from human error, inadequate or failed processes, systems or controls, or external events. There are three subsets of operational risk: regulatory risk, people risk and technology risk. Risk Management Following is a summary of strategies and factors that assist with the effective management of operational risk: Additional key components include: • Flat organizational structure with management close to their respective operations, which helps to facilitate effective internal communication and operational control; • Organizational surveys on employee engagement and corporate culture (including CWB’s ongoing participation in the 50 Best Employers in Canada survey); • Communication of, and specific training related to, the importance of effective operational risk management to all levels; • Management that is very engaged with promoting CWB’s operational risk tolerance and appetite; and, • Ongoing enhancement of group-wide operational risk management processes. Key elements of the Operational Risk Management Framework include: • Common definitions of operational risk - CWB incorporates standard risk terms and certain key operational risk definitions as part of its Group Operational Risk Management framework and supporting policies. • Risk assessments - Risk control self-assessments are utilized throughout CWB with the objective to proactively identify key operational risk exposures and assess whether appropriate risk- mitigating internal controls are in place and operating effectively. Action plans may result where additional strategies are identified to reduce risk exposure. • Operational risk reporting - Loss data monitoring is important to maintain awareness of identified operational risks and to assist management in taking constructive action to reduce exposures to future losses. • implementation of policies and procedural controls appropriate to address identified risks (including segregation of duties and other fundamental checks and balances); • continual enhancements to fraud prevention processes, policies and communication; • established “whistleblower” processes and employee code of conduct; • maintenance of an outsourcing management program; • at least annual assessment and benchmarking of business insurance; • human resource policies and processes to ensure staff are adequately trained for the tasks for which they are responsible and enable retention and recruitment; • a Regulatory Compliance department focused on key regulatory compliance areas such as privacy, anti-money laundering, anti- terrorist financing and consumer regulations; • use of technology that incorporates automated systems with built-in controls and active management of configuration and change management along with information security management programs; • enhanced focus on data quality as an important and strategic asset; • effective project management processes supported by a designated committee comprised of representatives of senior management; and, • continual updating and testing of procedures and contingency plans for disaster recovery and business continuity (including pandemic planning). 57 CWB Group 2014 Annual Report REGULATORY RISK The businesses operated by CWB are highly regulated through laws and regulations that have been put in place by various federal and provincial governments and regulators. Changes to laws and regulations, including changes in their interpretation or implementation, could adversely affect CWB. CWB’s failure to comply with applicable laws, regulations, industry codes or regulatory expectations could result in sanctions, financial penalties and costs associated with litigation that could adversely impact earnings and damage reputation. Although most sources of regulatory risk are outside of management’s direct control, CWB takes what it believes to be reasonable and prudent measures designed to support compliance with governing laws and regulations. Over the past several years the intensity of supervisory oversight of all federally regulated Canadian financial institutions has increased significantly in terms of both regulation and new standards. This includes amplified supervisory activities, an increase in the volume of regulation, more frequent data and information requests from regulators, and shorter implementation time frames for regulatory requirements, including the Basel III capital and liquidity standards. Certain regulations may also impact CWB’s ability to compete against both non-OSFI and other OSFI regulated entities. Effective management of regulatory risk and compliance in the current environment requires, and is expected to continue to require, considerable internal resources and the active involvement of senior management and the Board. Notwithstanding the additional resources, the volume, pace and implementation of new and amended regulations and standards increases the risk of unintended consequences and non-compliance for all regulated entities. TECHNOLOGY RISK CWB is highly dependent upon information technology and supporting infrastructure, such as voice, data and network access. In addition to internal resources, various third parties provide key components of the infrastructure and applications. Disruptions in information technology and infrastructure, whether attributed to internal or external factors, and including potential disruptions in the services provided by various third parties, could adversely affect the ability of CWB to conduct regular business and/or deliver products and services to clients. Ongoing diligence is required to ensure systems are secure from threats. In addition, CWB currently has a number of significant technology projects underway, including the replacement of its core banking system (implementation scheduled for early fiscal 2016), which further increase risk exposure related to information systems and technology. PEOPLE RISK Competition for qualified employees in CWB’s key markets is intense, reflecting the general level of economic activity and the needs of other financial services participants within and outside CWB’s geographic footprint. CWB intends to continually attract and retain sufficient qualified employees to successfully execute against its strategic direction. Inability to maintain an appropriate staff complement would adversely affect CWB’s ability to achieve the organization’s strategic objectives. 58 CWB Group 2014 Annual ReportRegulatory risk is the risk of negative impact to business activities, earnings or capital, regulatory relationships or reputation as a result of non-compliance with applicable regulatory requirements. Technology risk is related to the operational performance, confidentiality, integrity and availability of our information, systems and infrastructure. People risk is the risk that CWB is not able to retain and attract sufficient qualified employees to implement its strategies and/or achieve its objectives. REPUTATION RISK Negative public opinion can result from actual or alleged misconduct in any number of activities, either on the part of employees or external partners, but often involves questions about business ethics and integrity, competence, corporate governance practices, quality and accuracy of financial reporting disclosures, or quality of products and service. Negative public opinion could adversely affect CWB’s ability to attract and retain clients and/or employees and could expose CWB to litigation and/or regulatory action. Responsibility for governance and management of reputation risk falls to all CWB employees, including senior management and the Board. All directors, officers and employees have a responsibility to conduct their activities in accordance with the CWB Group’s personal conduct policies and in a manner that minimizes reputational risk. In addition to members of senior management, the Legal, Strategy and Communications, and Regulatory Compliance departments are particularly involved in the management of reputation risk. INSURANCE RISK CWB is exposed to insurance risk through its wholly owned subsidiary, CDI, which offers home and auto insurance to customers in BC and Alberta. Accordingly, CWB’s operations are subject to uncertainties and fluctuations in earnings based on elements of risk associated with these lines of business. These elements include cyclical patterns in the industry and unpredictable developments, including weather-related and other natural catastrophes. CDI carries reinsurance coverage as part of its strategy to manage these risks. The insurance industry is also impacted by political, regulatory, legal and economic influences. The insurance business involves various types of insurance-related risk; in particular, underwriting risk, pricing risk, claims risk and reinsurance risk. Policies and procedures have been established to manage insurance-related risk, as well as other categories of risk to which CWB is exposed through CDI. The risk that CDI might be exposed to large claims or to an accumulation of claims resulting from a natural catastrophe, such as a weather-related or seismic event, is mitigated by reinsurance treaties that protect it from such risks. Reinsurance risk includes the risk that reinsurance counterparties are not financially strong and that underwriting strategies are inappropriately matched with reinsurance programs. CDI performs financial due diligence on prospective reinsurers and only purchases coverage from a list of reviewed and approved companies. CDI is exposed to regulatory risk as the insurance business is regulated by both federal and provincial authorities. This risk is managed mainly by monitoring current developments and actively participating in relevant bodies and associations in order to contribute CDI’s perspectives on regulations. Level of Competition CWB’s performance is impacted by the intensity of competition in the markets in which it operates. Client retention may be influenced by many factors, including relative service levels, the prices and attributes of products and services, changes in products and services, and actions taken by competitors. OTHER RISK FACTORS In addition to the risks described above, other risk factors, including those below and those identified in the forward-looking statements section, may adversely affect CWB’s businesses and financial results. General Business and Economic Conditions The majority of CWB’s business is conducted in Western Canada. Accordingly, CWB’s overall financial performance is largely impacted by the general business and economic conditions of the four western provinces. Several factors that could impact general business and economic conditions in CWB’s core markets include, but are not limited to, changes in: short-term and long-term interest rates; energy and other commodity prices; real estate prices; adverse global economic events and/or elevated economic uncertainties; inflation; exchange rates; levels of consumer, business and government spending; levels of consumer, business and government debt; and consumer confidence. 59 CWB Group 2014 Annual Report Reputation risk is the consequence of not managing risks effectively and cannot be considered in isolation from other risks. Insurance risk is the risk of financial loss due to actual experience being different from that assumed in insurance product pricing and reserving. Insurance contracts provide financial protection for the insured by transferring risks to the insurer in exchange for premiums. Unfavourable experience could emerge due to adverse fluctuations in timing, size or frequency of claims, or associated expenses. Accuracy and Completeness of Information on Clients and Counterparties CWB depends on the accuracy and completeness of information about customers and counterparties. In deciding whether to extend credit or enter into other transactions with clients and counterparties, CWB may rely on information furnished by them, including financial statements, appraisals, external credit ratings and other financial information. CWB may also rely on the representations of clients and counterparties as to the accuracy and completeness of that information and, with respect to financial statements, on the reports of auditors. CWB’s financial condition and earnings could be negatively impacted to the extent it relies on financial statements that do not comply with standard accounting practices, that are materially misleading, or that do not fairly present, in all material respects, the financial condition and results of operations of the customer or counterparties. Ability to Execute Growth Initiatives As part of its long-term corporate strategy, CWB intends to continue growing its business through a combination of organic growth and strategic acquisitions. The ability to successfully grow its business will be dependent on a number of factors, including identification of accretive new business or acquisition opportunities, negotiation of purchase agreements on satisfactory terms and prices, approval of acquisitions by regulatory authorities, securing satisfactory regulatory capital and financing arrangements, and effective integration of newly acquired operations into the existing business. All of these activities may be more difficult to implement or may take longer to execute than management anticipates. Further, any significant expansion of the business may increase the operating complexity and divert management’s attention away from established or ongoing business activities. Any failure to successfully manage acquisition strategies could have a material adverse impact on CWB’s business, financial condition and results of operations. Adequacy of CWB’s Risk Management Framework The Risk Management Framework is made up of various processes and strategies for managing risk exposure. Given its structure and scope of its operations, CWB is primarily subject to credit, market (mainly interest rate), liquidity, operational, reputation, regulatory, insurance, environmental, and other risks. There can be no assurance that the framework to manage risks, including the framework’s underlying assumptions and models, will be effective under all conditions and circumstances. If the risk management framework proves ineffective, CWB could be materially affected by unexpected financial losses and/ or other harm. Changes in Accounting Standards and Accounting Policies and Estimates The International Accounting Standards Board continues to change the financial accounting and reporting standards that govern the preparation of CWB’s financial statements. These types of changes can be significant and may materially impact how CWB records and reports its financial condition and results of operations. Where CWB is required to retroactively apply a new or revised standard, it may be required to restate prior period financial statements. Other Factors CWB cautions that the above discussion of risk factors is not exhaustive. Other factors beyond CWB’s control that may affect future results include changes in tax laws, technological changes, unexpected changes in consumer spending and saving habits, timely development and introduction of new products, and the anticipation of and success in managing the associated risks. 60 CWB Group 2014 Annual ReportUPDATED SHARE INFORMATION As at November 26, 2014, there were 80,370,001 common shares outstanding. Also outstanding were employee stock options, which are or will be exercisable for up to 4,736,835 common shares for maximum proceeds of $145.7 million. On December 3, 2014, the Board of Directors declared a quarterly cash dividend of $0.21 per common share payable on January 8, 2015, to shareholders of record on December 16, 2014. The Board of Directors also declared a cash dividend of $0.275 per Series 5 preferred share payable on January 31, 2015 to shareholders of record on January 23, 2015. CONTROLS AND PROCEDURES As of October 31, 2014, an evaluation was carried out on the effectiveness of CWB’s disclosure controls and procedures. Based on that evaluation, the CEO and CFO have certified that the design and operating effectiveness of those disclosure controls and procedures were effective. Also at October 31, 2014, an evaluation was carried out on the effectiveness of internal controls over financial reporting to provide reasonable assurance regarding the reliability of financial reporting and financial statement compliance with IFRS. Based on that evaluation, the CEO and CFO have certified that the design and operating effectiveness of internal controls over financial reporting were effective. These evaluations were conducted in accordance with the standards of Internal Control over Financial Reporting – Guidance for Smaller Public Companies, a recognized control model, and the requirements of Multilateral Instrument 52-109 of the Canadian Securities Administrators. A Disclosure Committee, comprised of members of senior management, assists the CEO and CFO in their responsibilities. Management’s evaluation of controls can only provide reasonable, not absolute, assurance that all control issues that may result in material misstatement, if any, have been detected. The Bank’s certifying officers had previously limited the scope of the design of disclosure controls and procedures and internal control over financial reporting to exclude the controls, policies and procedures of McLean & Partners, acquired in the third quarter of 2013. This limitation has now been removed. There were no changes in CWB’s internal controls over financial reporting that occurred during the year ended October 31, 2014 that have materially affected, or are reasonably likely to materially affect, internal controls over financial reporting. This Management’s Discussion and Analysis is dated December 3, 2014. 61 CWB Group 2014 Annual Report Consolidated Financial Statements MANAGEMENT’S RESPONSIBILITY FOR FINANCIAL REPORTING The consolidated financial statements of Canadian Western Bank (CWB) and related financial information presented in this annual report have been prepared by management, who are responsible for the integrity and fair presentation of the information presented, which includes the consolidated financial statements, Management’s Discussion and Analysis (MD&A) and other information. The consolidated financial statements were prepared in accordance with International Financial Reporting Standards, including the requirements of the Bank Act and related rules and regulations issued by the Office of the Superintendent of Financial Institutions Canada. The MD&A has been prepared in accordance with the requirements of securities regulators, including National Instrument 51-102 of the Canadian Securities Administrators (CSA). The consolidated financial statements, MD&A and related financial information reflect amounts which must, of necessity, be based on informed estimates and judgments of management with appropriate consideration to materiality. The financial information represented elsewhere in this annual report is fairly presented and consistent with that in the consolidated financial statements. Management has designed the accounting system and related internal controls, and supporting procedures are maintained to provide reasonable assurance that financial records are complete and accurate, assets are safeguarded and CWB 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 CWB. We, as CWB’s Chief Executive Officer and Chief Financial Officer, will certify CWB’s annual filings with the CSA as required by Multilateral Instrument 52-109 (Certification of Disclosure in Issuers’ Annual and Interim Filings). The system of internal controls is also supported by our internal audit department, which carries out periodic internal audits of all aspects of CWB’s operations. The Chief Internal Auditor has full and free access to the Audit Committee and to the external auditors. The Audit Committee, appointed by the Board of Directors, is comprised entirely of independent directors who are not officers or employees of CWB. The Committee is responsible for reviewing the financial statements and annual report, including the MD&A, and recommending them to the Board of Directors for approval. Other key responsibilities of the Audit Committee include meeting with management, the Chief Internal Auditor and the external auditors to discuss the effectiveness of certain internal controls over the financial reporting process and the planning and results of the external audit. The Committee also meets regularly with the Chief Internal Auditor and the external auditors without management present. The Governance Committee, appointed by the Board of Directors, is comprised of directors who are not officers or employees of CWB. Their responsibilities include reviewing related party transactions and reporting to the Board of Directors those transactions which may have a material impact on CWB. The Office of the Superintendent of Financial Institutions Canada, at least once a year, makes such examination and inquiry into the affairs of CWB and its federally regulated subsidiaries as is deemed necessary or expedient to satisfy themselves that the provisions of the relevant Acts, having reference to the safety of depositors and policyholders, are being duly observed and that CWB is in a sound financial condition. KPMG LLP, the independent auditors appointed by the shareholders of CWB, have performed an audit of the consolidated financial statements and their report follows. The external auditors have full and free access to, and meet periodically with, the Audit Committee to discuss their audit and matters arising therefrom. Chris Fowler President and Chief Executive Officer December 3, 2014 Carolyn J. Graham, FCA Executive Vice President and Chief Financial Officer 62 CWB Group 2014 Annual ReportIndependent Auditors’ Report TO THE SHAREHOLDERS OF CANADIAN WESTERN BANK We have audited the accompanying consolidated financial statements of Canadian Western Bank, which comprise the consolidated balance sheets as at October 31, 2014 and 2013, the consolidated statements of income, comprehensive income, changes in equity and cash flows for the years ended October 31, 2014 and 2013, and notes, comprising a summary of significant accounting policies and other explanatory information. MANAGEMENT’S RESPONSIBILITY FOR THE CONSOLIDATED FINANCIAL STATEMENTS Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with International Financial Reporting Standards, and for such internal control as management determines is necessary to enable the preparation of consolidated financial statements that are free from material misstatement, whether due to fraud or error. AUDITORS’ RESPONSIBILITY Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with Canadian generally accepted auditing standards. Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on our judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, we consider internal control relevant to the entity’s preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that the audit evidence we have obtained in our audits is sufficient and appropriate to provide a basis for our audit opinion. OPINION In our opinion, the consolidated financial statements present fairly, in all material respects, the consolidated financial position of Canadian Western Bank as at October 31, 2014 and 2013, and its consolidated financial performance and its consolidated cash flows for the years ended October 31, 2014 and 2013 in accordance with International Financial Reporting Standards. Chartered Accountants Edmonton, Canada December 3, 2014 63 CWB Group 2014 Annual Report CONSOLIDATED BALANCE SHEETS ($ thousands) Assets Cash Resources Cash and non-interest bearing deposits with financial institutions Interest bearing deposits with regulated financial institutions Cheques and other items in transit Securities Issued or guaranteed by Canada Issued or guaranteed by a province or municipality Other securities Securities Purchased under Resale Agreements Loans Personal Business Allowance for credit losses Other Property and equipment Goodwill Intangible assets Insurance related Derivative related Other assets Total Assets Liabilities and Equity Deposits Personal Business and government Other Cheques and other items in transit Insurance related Derivative related Other liabilities Debt Subordinated debentures Debt securities Equity Preferred shares Common shares Retained earnings Share-based payment reserve Other reserves Total Shareholders’ Equity Non-controlling interests Total Equity Total Liabilities and Equity As at October 31 2014 As at October 31 2013(1) (Note 3) $ 13,320 491,255 3,839 508,414 $ 83,856 258,466 5,673 347,995 (Note 4) (Note 5) (Note 6) (Note 7) (Note 8) (Note 9) (Note 9) (Note 10) (Note 11) (Note 12) (Note 13) (Note 15) (Note 11) (Note 16) (Note 17) (Note 18) (Note 18) (Note 20) 764,213 560,482 764,510 2,089,205 99,566 2,841,154 14,764,543 17,605,697 (95,598) 17,510,099 927,077 410,984 894,271 2,232,332 – 2,502,295 13,150,931 15,653,226 (85,786) 15,567,440 66,257 50,408 85,137 65,764 5,420 128,386 401,372 $ 20,608,656 66,647 49,424 70,197 64,365 4,509 110,431 365,573 $ 18,513,340 $ 9,832,669 7,540,345 17,373,014 $ 9,420,754 6,210,286 15,631,040 54,826 165,903 386 282,944 504,059 625,000 411,990 1,036,990 125,000 533,038 1,011,147 25,339 (997) 1,693,527 1,066 55,290 167,816 36 238,939 462,081 625,000 195,650 820,650 208,815 510,282 858,167 24,632 (3,389) 1,598,507 1,062 1,694,593 $ 20,608,656 1,599,569 $ 18,513,340 (1) During 2014, CWB retrospectively adopted IFRS 10 Consolidated Financial Statements and applied a change in accounting policy for internal direct leasing costs, as described in Note 1. The accompanying notes are an integral part of the consolidated financial statements. Allan W. Jackson Chair of the Board 64 Chris Fowler President and Chief Executive Officer CWB Group 2014 Annual Report CONSOLIDATED STATEMENTS 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 Debt Net Interest Income Provision for Credit Losses Net Interest Income after Provision for Credit Losses Non-Interest Income Trust and wealth management services Credit related Insurance, net Gains on securities, net Retail services Other Net Interest and Non-Interest Income Non-Interest Expenses Salaries and employee benefits Premises and equipment Other expenses Net Income before Income Taxes Income Taxes Net Income Net Income Attributable to Non-Controlling Interests Net Income Attributable to Shareholders of CWB Preferred share dividends Premium paid on purchase of preferred shares for cancellation Net Income Available to Common Shareholders Average number of common shares (in thousands) Average number of diluted common shares (in thousands) Earnings Per Common Share Basic Diluted (1) During 2014, CWB retrospectively adopted IFRS 10 Consolidated Financial Statements, as described in Note 1. The accompanying notes are an integral part of the consolidated financial statements. 2014 2013(1) $ 799,909 $ 735,404 44,096 5,142 44,952 1,609 849,147 781,965 311,075 286,913 32,552 343,627 505,520 25,057 32,433 319,346 462,619 27,846 480,463 434,773 33,866 25,014 20,914 13,999 11,399 8,217 113,409 593,872 24,511 21,685 16,279 15,094 10,272 7,141 94,982 529,755 187,871 172,237 49,065 52,036 288,972 304,900 73,601 42,825 47,435 262,497 267,258 64,052 $ 231,299 $ 203,206 1,240 824 $ 230,059 $ 202,382 11,510 15,183 – 36 $ 218,549 $ 187,163 (Note 7) (Note 22) (Note 25) 80,034 80,955 (Note 26) $ 2.73 $ 2.70 79,147 79,544 2.36 2.35 65 CWB Group 2014 Annual Report CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME For the Year Ended October 31 ($ thousands) Net Income Available-for-sale securities Gains (losses) from change in fair value(2) Reclassification to net income(3) Derivatives designated as cash flow hedges Gains from change in fair value(4) Reclassification to net income(5) Other Comprehensive Income (Loss), Net of Tax, for the Year Comprehensive Income for the Year Comprehensive income for the year attributable to: Shareholders of CWB Non-controlling interests Comprehensive Income for the Year (1) During 2014, CWB retrospectively adopted IFRS 10 Consolidated Financial Statements, as described in Note 1. (2) Net of income tax of $4,697 (2013 – $866). (3) Net of income tax of $3,712 (2013 – $3,934). (4) Net of income tax of $1,139 (2013 – $788). (5) Net of income tax of $1,208 (2013 – $424). 2014 2013(1) $ 231,299 $ 203,206 12,882 (10,287) 2,595 3,372 (3,575) (203) 2,392 (2,553) (11,160) (13,713) 2,332 (1,255) 1,077 (12,636) $ 233,691 $ 190,570 $ 232,451 $ 189,746 1,240 824 $ 233,691 $ 190,570 Items presented in other comprehensive income will be subsequently reclassified to the Consolidated Statements of Income when specific conditions are met. The accompanying notes are an integral part of the consolidated financial statements. 66 CWB Group 2014 Annual Report CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY For the Year Ended October 31 ($ thousands) Retained Earnings Balance at beginning of year Net income attributable to shareholders of CWB Dividends - Preferred shares - Common shares Issuance costs on preferred shares Premium paid on purchase of preferred shares for cancellation Balance at end of year Other Reserves Balance at beginning of year Changes in available-for-sale securities Changes in derivatives designated as cash flow hedges Balance at end of year Preferred Shares Balance at beginning of year Shares issued Shares redeemed Purchased for cancellation Balance at end of year Common Shares Balance at beginning of year Issued under dividend reinvestment plan Transferred from share-based payment reserve on the exercise or exchange of options Issued on exercise of options Balance at end of year Share-Based Payment Reserve Balance at beginning of year Amortization of fair value of options Transferred to common shares on the exercise or exchange of options Balance at end of year Total Shareholders’ Equity Non-Controlling Interests Balance at beginning of year Net income attributable to non-controlling interests Dividends to non-controlling interests Partial ownership increase Business acquisition Balance at end of year Total Equity (Note 18) (Note 18) (Note 18) (Note 18) (Note 19) 2014 2013(1) $ 858,167 $ 726,378 230,059 202,382 (11,510) (62,408) (3,161) – (15,183) (55,374) – (36) 1,011,147 858,167 (3,389) 2,595 (203) (997) 208,815 125,000 (208,815) – 9,247 (13,713) 1,077 (3,389) 209,750 – – (935) 125,000 208,815 510,282 490,218 16,467 5,223 1,066 14,404 3,986 1,674 533,038 510,282 24,632 5,930 (5,223) 25,339 22,468 6,150 (3,986) 24,632 1,693,527 1,598,507 1,062 1,240 (1,139) (97) – 244 824 (322) – 316 1,066 1,062 $ 1,694,593 $ 1,599,569 (1) During 2014, CWB retrospectively adopted IFRS 10 Consolidated Financial Statements and applied a change in accounting policy for internal direct leasing costs, as described in Note 1. The accompanying notes are an integral part of the consolidated financial statements. 67 CWB Group 2014 Annual Report CONSOLIDATED STATEMENTS OF CASH FLOWS 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 Current income taxes receivable and payable Amortization of fair value of employee stock options Accrued interest receivable and payable, net Gain on securities, net Deferred taxes, net Gain on disposal of property and equipment Change in operating assets and liabilities Loans, net Deposits, net Securities purchased under resale agreements, net Securities sold under repurchase agreements, net Other items, net Cash Flows from Financing Activities Common shares issued, net of issuance costs Preferred shares issued, net of issuance costs Preferred shares redeemed Debt securities issued Debt securities repaid Dividends Distributions to non-controlling interests Debentures issued Debentures redeemed Preferred shares purchased for cancellation Cash Flows from Investing Activities Interest bearing deposits with regulated financial institutions, net Securities, purchased Securities, sales proceeds Securities, matured Proceeds on disposal of property and equipment Property, equipment and intangibles Business acquisition Change 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 non-interest bearing deposits with financial institutions Cheques and other items in transit (included in Cash Resources) Cheques and other items in transit (included in Other Liabilities) Cash and Cash Equivalents at End of Year Supplemental Disclosure of Cash Flow Information Interest and dividends received Interest paid Income taxes paid (1) During 2014, CWB retrospectively adopted IFRS 10 Consolidated Financial Statements, as described in Note 1. The accompanying notes are an integral part of the consolidated financial statements. 68 (Note 18) (Note 18) (Note 18) 2014 2013(1) $ 231,299 $ 203,206 25,057 21,685 10,254 5,930 6,604 (13,999) (5,014) (4,698) 27,846 21,572 (7,444) 6,150 2,816 (15,094) 5,507 – (1,967,717) (1,651,053) 1,741,974 1,381,203 (99,566) – – (70,089) 13,327 (34,864) 17,533 121,839 (208,815) 363,187 934 (94,446) 16,078 – – 90,596 (146,848) (104,219) (73,918) (1,139) – – – (70,557) (322) 250,000 (50,000) (971) 71,839 130,605 (232,766) (81,284) (6,779,305) (6,004,062) 4,329,567 3,839,290 2,604,572 2,275,813 7,263 (38,212) – (108,881) (71,906) 34,239 – (27,504) (10,098) (7,845) 28,314 5,925 $ $ (37,667) $ 34,239 13,320 $ 83,856 3,839 (54,826) 5,673 (55,290) $ (37,667) $ 34,239 $ 845,063 $ 785,643 333,479 68,362 313,463 65,989 CWB Group 2014 Annual Report NOTES TO CONSOLIDATED FINANCIAL STATEMENTS For the Years Ended October 31, 2014 and 2013 ($ thousands, except per share amounts) 1. NATURE OF OPERATIONS AND BASIS OF PRESENTATION a) Reporting Entity e) Basis of Consolidation Canadian Western Bank (CWB) is a publicly traded Canadian bank headquartered in Edmonton, Alberta. CWB offers a diversified range of financial services. The consolidated financial statements were authorized for issue by the Board of Directors on December 3, 2014. The consolidated financial statements include the assets, liabilities and results of operations of CWB and all of its subsidiaries, after the elimination of intercompany transactions and balances. Subsidiaries are defined as entities whose operations are controlled by CWB and are corporations in which CWB is the beneficial owner. See Note 33 for details of the subsidiaries. b) Statement of Compliance f) Business Combinations These consolidated financial statements of CWB have been prepared in accordance with International Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board (IASB) and in accordance with subsection 308 (4) of the Bank Act and the accounting requirements of the Office of the Superintendent of Financial Institutions Canada (OSFI). The significant accounting policies used in the preparation of these financial statements, including the accounting requirements of OSFI, are summarized below and in the following notes. c) Use of Estimates and Assumptions The preparation of financial statements in conformity with IFRS requires CWB to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as at the date of the consolidated financial statements as well as the reported amount of revenues and expenses during the period. Key areas of estimation where CWB has made subjective judgments, often as a result of matters that are inherently uncertain, include those relating to the allowance for credit losses, fair value of financial instruments, goodwill and intangible assets, provision for unpaid claims and adjustment expenses, deferred tax assets and liabilities, impairment of available-for-sale securities and fair value of stock options. Therefore, actual results could differ from these estimates. d) Significant Judgments Information on critical judgments in applying accounting policies that has the most significant effect on the amounts recognized in the consolidated financial statements is described in the following notes: • Impairment of loans (Note 6); • Allowance for credit losses (Note 7); and, • Provision for unpaid claims and adjustment expenses (Note 22). Business combinations are accounted for using the acquisition method. The cost of an acquisition is measured at the fair value of the consideration, including contingent consideration, given at the acquisition date. Contingent consideration is considered a financial instrument and, as such, is remeasured each period thereafter with the adjustment recorded to other income. Acquisition-related costs are recognized as an expense in the income statement in the period in which they are incurred. The acquired identifiable assets, liabilities and contingent liabilities are measured at their fair values at the date of acquisition. Goodwill is measured as the excess of the aggregate of the consideration transferred, including any amount of any non- controlling interest in the acquiree, over the net of the recognized amounts of the identifiable assets acquired and the liabilities assumed. CWB elects on a transaction-by-transaction basis whether to measure non-controlling interest at its fair value or at its proportionate share of the recognized amount of the identifiable net assets, at the acquisition date. g) Functional and Foreign Currencies The consolidated financial statements are presented in Canadian dollars, which is CWB’s functional currency. 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 period. Realized and unrealized gains and losses on foreign currency positions are included in other income, except for unrealized foreign exchange gains and losses on available-for-sale equity securities that are included in other comprehensive income. 69 CWB Group 2014 Annual Report h) Specific Accounting Policies The accounting policies set out below have been applied consistently to all periods presented in these consolidated financial statements. To facilitate a better understanding of CWB’s consolidated financial statements, the significant accounting policies are disclosed in the notes, where applicable, with related financial disclosures by major caption: Note 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 Topic Financial instruments Cash resources Securities Securities purchased under resale agreements Loans Allowance for credit losses Property and equipment Goodwill and intangible assets Insurance-related other assets Derivative financial instruments Other assets Deposits Interest in unconsolidated structured entity Insurance-related other liabilities Other liabilities Debt Capital stock Share-based payments Non-controlling interests Contingent liabilities and commitments Insurance operations Disclosures on rate regulation Employee future benefits Income taxes Earnings per common share Assets under administration and management Related party transactions Interest rate sensitivity Fair value of financial instruments Risk management Capital management Subsidiaries Comparative figures i) Changes in Accounting Policies Consolidated Financial Statements Effective November 1, 2013, CWB retrospectively adopted IFRS 10 Consolidated Financial Statements and IFRS 12 Disclosures of Interests in Other Entities, which establish principles for the presentation and preparation of consolidated financial statements when an entity controls one or more other entities, and new disclosure requirements for all forms of interests in other entities. As a result of the application of IFRS 10, CWB has changed its accounting policy for determining whether it has control over its investees and, consequently, has de-consolidated Canadian Western Bank Capital Trust (the Trust) through which certain regulatory capital instruments are issued. In accordance with the transitional provisions, CWB has applied IFRS 10 retrospectively and comparative figures have been restated to reflect the de-consolidation of the Trust. The de-consolidation of the Trust resulted in a $105,000 decrease in CWB Capital Trust Capital Securities Series 1 (WesTS) previously classified as non-controlling 70 interest and an increase of $105,000 in deposit liabilities, and reclassification of the associated distribution, which totalled $6,744 for the year ended October 31, 2013, from non-controlling interest to interest expense. The annual disclosures required by IFRS 12 are included in Notes 14, 20 and 33. Accounting for internal direct leasing costs IAS 17 Leases requires that the lessor capitalize initial direct leasing costs in the initial measurement of the lease, and defines initial direct costs as incremental costs directly attributable to negotiating and arranging a lease. Prior to 2014, CWB capitalized costs of certain employees and other internal costs directly attributable to arranging new leases within initial direct leasing costs on initial measurement of a lease. During 2014, the IFRS Interpretations Committee issued clarification that certain internal costs do not qualify as incremental costs. As a result, during the year CWB changed its accounting policy to expense, rather than capitalize, non-incremental internal costs for negotiating and arranging new leases as incurred. CWB has applied this accounting policy retrospectively, resulting in a decrease of $9,453 in loans, an increase in other assets of $2,533 for deferred income taxes and a decrease of $6,920 in retained earnings for all presented comparative periods. This change did not result in a change to the consolidated statements of income. Fair value measurement Effective November 1, 2013, CWB adopted IFRS 13 Fair Value Measurement, which applies to other IFRS standards that require or permit fair value measurements or disclosures about fair value measurements and sets out a framework on how to measure fair value using the assumptions that market participants would use when pricing the asset or liability under current market conditions, including assumptions about risk. In accordance with the transitional provisions of IFRS 13, CWB has applied the new fair value measurement guidance prospectively. This new standard had no impact on the measurement of CWB’s assets and liabilities. Additional disclosures required by IFRS 13 are included in Note 30. j) Future Accounting Changes A number of standards and amendments have been issued by the IASB, and the following changes may have an impact on CWB’s future financial statements. CWB is currently reviewing these standards to determine the impact on the financial statements. IFRS 9 – Financial Instruments During 2014, the IASB issued the complete version of IFRS 9. Under the finalized guidance, IFRS 9 specifies that financial assets be classified into one of three categories: financial assets measured at amortized cost, financial assets measured at fair value through profit or loss or financial assets measured at fair value through other comprehensive income. IFRS 9 introduces changes to measuring an entity’s own credit risk in the valuation of financial liabilities. The final standard also introduces a new “expected credit loss” model for calculating impairment, and new general hedge accounting requirements that align more closely with an entity’s risk management model. IFRS 9 will be mandatorily effective for CWB’s fiscal year beginning on November 1, 2018, and early adoption is permitted. OSFI is currently assessing whether it will require federally regulated Canadian banks, including CWB, to early adopt IFRS 9 effective November 1, 2017. CWB Group 2014 Annual ReportIFRS 15 – Revenue from Contracts with Customers 4. SECURITIES Securities have been designated as available-for-sale, are accounted for at settlement date and recorded on the consolidated balance sheets at fair value with changes in fair value recorded in other comprehensive income, net of income taxes, until the security is sold or becomes impaired. Interest income from securities, which includes amortization of premiums and discounts, is recognized using the effective interest method in the consolidated statements of income. Dividend income is recognized on the ex-dividend date. Securities are purchased with the original intention to hold the instrument to maturity or until market conditions render alternative investments more attractive. Gains and losses realized on disposal of securities and adjustments to record any impairment in value are included in non-interest income. At each reporting date, CWB assesses whether there is objective evidence that securities designated as available-for-sale are impaired. Objective evidence that a security is impaired can include significant financial difficulty of the issuer, indications that an issuer will enter bankruptcy or the lack of an active market for a security. In addition, for an equity security, a significant or prolonged decline in fair value below amortized cost is objective evidence of impairment. Impairment losses on available-for-sale securities are recognized by reclassifying the cumulative loss recognized in other comprehensive income to the income statement as ‘gains on securities, net’. The reclassified amount is the difference between the amortized cost, net of any principal repayment and amortization, and the fair value, less any impairment previously recognized in net income. If, in a subsequent period, the fair value of an impaired available-for- sale debt security increases and the increase can be objectively related to an event occurring after the impairment loss was recognized in net income, the impairment loss is reversed, with the reversal recognized in net income. However, if, in a subsequent period, the fair value of an impaired available-for-sale equity security increases, the recovery is recognized in other comprehensive income until the equity security is sold or redeemed. During 2014, the IASB established principles for reporting about the nature, amount, timing and uncertainty of revenue and cash flows arising from an entity’s contracts with customers. The standard provides a single, principles based model for revenue recognition to be applied to all contracts with customers. IFRS 15 will be effective for CWB’s fiscal year beginning November 1, 2017, with earlier adoption permitted. CWB continues to monitor IASB ongoing activity and proposed changes to IFRS. Several accounting standards that are in the process of being amended by the IASB (i.e. macro-hedging, leases and insurance) may have a significant impact on CWB’s future consolidated financial statements. 2. FINANCIAL INSTRUMENTS As a financial institution, most of CWB’s balance sheet is comprised of financial instruments and the majority of net income results from gains, losses, income and expenses related to the same. Financial assets include cash resources, securities, securities purchased under resale agreements, loans, derivative financial instruments and certain other assets. Financial liabilities include deposits, derivative financial instruments, debt and certain other liabilities. The use of financial instruments exposes CWB to credit, liquidity and market risk. A discussion of how these are managed can be found in the Risk Management section of the 2014 Annual Report. Income and expenses are classified as to source, either securities or loans for income, and deposits or debt for expense. Gains on the sale of securities, net, and fair value changes in certain derivatives and contingent consideration fair value changes are classified to non- interest income. 3. CASH RESOURCES Cash resources have been designated as available-for-sale and are reported on the consolidated balance sheets at fair value with changes in fair value reported in other comprehensive income, net of income taxes, and include highly liquid investments that are readily convertible to cash and which are subject to an insignificant risk of change in value. Included in deposits with regulated financial institutions are available- for-sale financial instruments reported on the consolidated balance sheets at the fair value of $491,255 (October 31, 2013 – $258,466), which is $91 (October 31, 2013 – $569) higher than amortized cost. 71 CWB Group 2014 Annual Report The analysis of securities at carrying value, by type and maturity, is as follows: Maturities As at As at Within 1 Year 1 to 3 Years 3 to 5 Years Over 5 Years October 31 2014 October 31 2013 Securities issued or guaranteed by Canada $ 140,017 $ 274,565 $ 349,631 $ – $ 764,213 $ 927,077 A province or municipality 16,906 72,370 370,897 100,309 560,482 410,984 Other debt securities Equity securities Preferred shares Common shares(1) Total (1) Common shares have no maturity date. 102,487 154,097 19,978 13,800 290,362 367,961 80,168 106,882 119,916 14,251 321,217 379,141 – – – 152,931 152,931 147,169 $ 339,578 $ 607,914 $ 860,422 $ 281,291 $ 2,089,205 $ 2,232,332 The analysis of unrealized gains and losses on securities reflected on the balance sheet is as follows: As at October 31, 2014 As at October 31, 2013 Amortized Unrealized Unrealized Fair Amortized Unrealized Unrealized Cost Gains Losses Value Cost Gains Losses Fair Value Securities issued or guaranteed by Canada $ 763,866 $ 426 $ 79 $ 764,213 $ 926,445 $ 652 $ 20 $ 927,077 A province or municipality Other debt securities Equity securities Preferred shares Common shares 559,923 289,490 659 949 325,051 154,359 2,222 5,830 100 560,482 410,823 227 66 410,984 77 290,362 366,781 1,284 104 367,961 6,056 321,217 395,442 1,444 17,745 379,141 7,258 152,931 140,512 8,119 1,462 147,169 Total $ 2,092,689 $ 10,086 $ 13,570 $ 2,089,205 $ 2,240,003 $ 11,726 $ 19,397 $ 2,232,332 The securities portfolio is primarily comprised of high quality debt instruments, preferred shares and common shares that are not held for trading purposes and, where applicable, are typically held until maturity. Fluctuations in value are generally attributed to changes in interest rates, market credit spreads and shifts in the interest rate curve. Volatility in equity markets also leads to fluctuations in value, particularly for common shares. For the year ended October 31, 2014, CWB assessed the securities with unrealized losses and, based on available objective evidence, $1,200 (2013 – nil) of pre-tax impairment charges were included in gains on securities, net. 5. SECURITIES PURCHASED UNDER RESALE AGREEMENTS Securities purchased under resale agreements represent a purchase of Government of Canada securities by CWB effected with a simultaneous agreement to sell them back at a specified price on a future date, which is generally short term. The difference between the cost of the purchase and the predetermined proceeds to be received on a resale agreement is recorded as securities interest income. Securities purchased under resale agreements have been designated as available-for-sale and are reported on the consolidated balance sheets at fair value with changes in fair value reported in other comprehensive income, net of income taxes. 72 CWB Group 2014 Annual Report 6. LOANS Loans, including leases, are recorded at amortized cost and stated net of unearned income, unamortized premiums and allowance for credit losses (Note 7). Interest income is recorded using the effective interest method. Loans are determined to be impaired when payments are contractually past due 90 days, or where CWB has commenced realization proceedings, or where CWB is of the opinion that the loan should be regarded as impaired based on objective evidence. Objective evidence that a loan is impaired can include significant financial difficulty of the borrower, default or delinquency of a borrower, breach of loan covenants or conditions, or indications that a borrower will enter bankruptcy. An exception may be made where CWB 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 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, a province 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 original effective interest rate of the loan. 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. Impaired loans are returned to performing status when the timely collection of both principal and interest is reasonably assured, all delinquent principal and interest payments are brought current, and all charges for loan impairment have been reversed. Loan fees integral to the yield on the loan, net of directly related costs, are amortized to interest income using the effective interest method. Premiums paid on the acquisition of loan portfolios are amortized to interest income using the effective interest method. Outstanding gross loans and impaired loans, net of the allowances for credit losses, by loan type, are as follows: As at October 31, 2014 As at October 31, 2013 Gross Amount Impaired Amount(2) Gross Specific Allowance Net Impaired Loans Gross Amount Gross Impaired Amount(2) Specific Allowance Net Impaired Loans $ 2,841,154 $ 15,294 $ 518 $ 14,776 $ 2,502,295 $ 17,052 $ 748 $ 16,304 Personal Business Real estate(1) Commercial 6,810,834 26,058 4,263,501 6,544 909 631 25,149 5,829,225 31,937 6,349 25,588 5,913 4,091,371 4,612 293 4,319 8,431 Equipment financing and energy 3,690,208 14,224 3,465 10,759 3,230,335 10,610 2,179 Total $ 17,605,697 $ 62,120 $ 5,523 56,597 $ 15,653,226 $ 64,211 $ 9,569 54,642 Collective allowance(3) Net impaired loans after collective allowance (90,075) $ (33,478) (76,217) $ (21,575) (1) Multi-family residential mortgages are included in real estate loans. (2) Gross impaired loans include foreclosed assets with a carrying value of $2,393 (October 31, 2013 – $12,407). CWB pursues timely realization on foreclosed assets and does not use the assets for its own operations. (3) The collective allowance for credit loss is not allocated by loan type. During the year, interest recognized as income on impaired loans totalled $1,264 (2013 – $2,582). 73 CWB Group 2014 Annual Report Outstanding impaired loans, net of the allowance for credit losses, by provincial location of security, are as follows: Alberta British Columbia Ontario Saskatchewan Manitoba Other Total As at October 31, 2014 As at October 31, 2013 Gross Impaired Amount Specific Allowance Net Impaired Loans Gross Impaired Amount Specific Allowance Net Impaired Loans $ 17,742 $ 2,508 $ 15,234 $ 38,886 $ 7,475 $ 31,411 32,862 1,039 31,823 17,904 6,336 1,968 1,695 1,517 877 384 152 563 5,459 1,584 1,543 954 2,886 1,861 1,214 1,460 476 728 381 146 363 $ 62,120 $ 5,523 56,597 $ 64,211 $ 9,569 17,428 2,158 1,480 1,068 1,097 54,642 (76,217) $ (21,575) Collective allowance(1) Net impaired loans after collective allowance (1) The collective allowance for credit loss is not allocated by province. (90,075) $ (33,478) Gross impaired loans exclude certain past due loans where payment of interest or principal is contractually in arrears, which are not classified as impaired. Details of such past due loans that have not been included in the gross impaired amount are as follows: As at October 31, 2014 1 - 30 days 31 - 60 days 61 - 90 days 90 days Total More than Personal Business As at October 31, 2013 $ 11,661 $ 13,672 $ 2,363 $ 2,259 $ 29,955 24,190 22,236 2,049 40 48,515 $ $ 35,851 24,710 $ $ 35,908 48,102 $ $ 4,412 2,075 $ $ 2,299 2,400 $ $ 78,470 77,287 The composition of CWB’s loan portfolio by geographic region and industry sector is as follows: October 31, 2014 ($ millions) Personal Business Real estate Commercial Equipment financing and energy(1) Total Loans(2) Composition Percentage October 31, 2014 October 31, 2013 Composition Percentage Oct. 31 Oct. 31 BC AB ON SK MB Other Total 2014 2013 $ 875 $ 1,121 $ 565 $ 178 $ 83 $ 19 $ 2,841 16% 16% 2,960 1,560 2,736 1,887 500 376 605 5,125 1,551 6,174 653 1,529 442 210 336 988 119 145 131 395 54 86 6,811 4,264 414 3,690 554 14,765 39 24 21 84 37 26 21 84 $ 6,000 $ 7,295 $ 2,094 $ 1,166 $ 478 $ 573 $ 17,606 100% 100% 34% 35% 41% 42% 12% 11% 7% 7% 3% 2% 3% 3% 100% 100% (1) Includes securitized leases reported on-balance sheet of $465 (October 31, 2013 – $230). (2) This table does not include an allocation of the allowance for credit losses. 74 CWB Group 2014 Annual Report 7. ALLOWANCE FOR CREDIT LOSSES An allowance for credit losses is maintained which, in CWB’s opinion, is adequate to absorb credit-related impairment losses incurred in its loan portfolio. The allowance for credit losses is calculated on individual loans (specific allowance) and on groups of loans assessed collectively (collective allowance). The adequacy of the allowance for credit losses is reviewed at least quarterly. The allowance for credit losses is deducted from the outstanding loan balance. Losses expected from future events are not recognized. Specific Allowance The specific allowance includes all the accumulated provisions for losses on identified impaired loans required to reduce the carrying value of those loans to their estimated realizable amount. See Note 6 for the identification process of impaired loans. If the amount of an impairment loss decreases in a subsequent period, and the decrease can be objectively related to an event occurring after the impairment was recognized, the specific loan impairment allowance is reduced accordingly. The reversal of impairment is recognized in the consolidated statements of income in provision for credit losses. Collective Allowance The collective allowance for credit risk includes provisions for losses that have been incurred but have not yet been identified on an individual loan or account basis by CWB. As soon as information becomes available which identifies losses on individual loans within the collective group, those loans are removed from the group and assessed on an individual basis for impairment. The collective allowance for credit risk is established by taking into consideration: • historical trends in the loss experience during economic cycles; • the current portfolio profile; • historical loss experience in portfolios of similar credit risk characteristics; • the estimated period between impairment occurring and the loss being identified; and, • CWB’s management judgment as to whether current economic and credit conditions are such that the actual level of inherent losses at the balance sheet date is likely to be greater or less than that suggested by historical experience. The following table shows the changes in the allowance for credit losses during the year: 2014 Specific Allowance Collective Allowance 2013 Specific Collective Total Allowance Allowance Total Balance at beginning of year Provision for credit losses Write-offs Recoveries $ 9,569 $ 76,217 $ 85,786 $ 14,379 $ 67,344 $ 81,723 11,199 13,858 25,057 18,973 8,873 27,846 (17,069) 1,824 – – (17,069) (26,652) 1,824 2,869 – – (26,652) 2,869 Balance at end of year $ 5,523 $ 90,075 $ 95,598 $ 9,569 $ 76,217 $ 85,786 75 CWB Group 2014 Annual Report 8. PROPERTY AND EQUIPMENT Land is carried at cost. Buildings, equipment and furniture, and leasehold improvements are carried at cost less accumulated depreciation and impairment. Depreciation is 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 10 years • Leasehold improvements: over the shorter of the term of the lease and the remaining useful life When components of an item of property and equipment have different useful lives, they are accounted for as separate items. Gains and losses on disposal are recorded in non-interest income in the period of disposal. Property and equipment is subject to an impairment review if there are events or changes in circumstances which indicate that the carrying amount may not be recoverable. Cost Balance at November 1, 2013 $ 62,025 $ 23,748 $ 27,731 $ 34,712 $ 148,216 Leasehold Improvements Land and Buildings Computer Equipment Office Equipment Total Additions Disposals Balance at October 31, 2014 Accumulated depreciation and impairment Balance at November 1, 2013 Depreciation for the year Disposals Balance at October 31, 2014 Net carrying amount at October 31, 2014 Cost Balance at November 1, 2012 Additions Disposals Balance at October 31, 2013 Accumulated depreciation and impairment Balance at November 1, 2012 Depreciation for the year Disposals Balance at October 31, 2013 $ $ 6,975 – 69,000 31,342 5,216 – 36,558 55 (5,264) 18,539 6,308 583 (3,061) 3,830 3,342 – 3,553 (569) 13,925 (5,833) 31,073 37,696 156,308 20,845 2,915 – 23,074 3,036 (207) 23,760 25,903 81,569 11,750 (3,268) 90,051 32,442 $ 14,709 $ 7,313 $ 11,793 $ 66,257 59,172 $ 23,615 $ 24,250 $ 32,518 $ 139,555 2,853 – 62,025 26,373 4,969 – 31,342 133 – 23,748 5,657 651 – 6,308 3,586 (105) 27,731 18,220 2,730 (105) 20,845 2,227 (33) 8,799 (138) 34,712 148,216 20,367 2,740 (33) 23,074 70,617 11,090 (138) 81,569 Net carrying amount at October 31, 2013 $ 30,683 $ 17,440 $ 6,886 $ 11,638 $ 66,647 76 CWB Group 2014 Annual Report 9. GOODWILL AND INTANGIBLE ASSETS Goodwill On the date of acquisition, goodwill arises on the acquisition of subsidiaries and represents the excess of the fair value of the purchase consideration, including any amount of any non-controlling interest in the acquiree, over the net recognized amounts of the identifiable assets, including identifiable intangible assets, and liabilities assumed. For the purposes of calculating goodwill, fair values of acquired assets and liabilities are determined by reference to market values or by discounting expected future cash flows to present value. This discounting is performed using either market rates, or risk-free rates with risk-adjusted expected future cash flows. Goodwill is stated at cost less accumulated impairment losses. Goodwill is reviewed for impairment annually or more frequently if there are indications that impairment may have occurred. Goodwill is allocated to cash-generating units for the purpose of impairment testing considering the business level at which goodwill is monitored for internal management purposes. On this basis, CWB’s cash- generating units with goodwill allocated are: • National Leasing Group Inc. (NL); • Canadian Direct Insurance Incorporated (CDI); • Valiant Trust Company (VTC); • Adroit Investment Management Ltd. (AIM); and, • McLean & Partners Wealth Management Ltd. (M&P). NL CDI VTC AIM M&P Total Balance at November 1, 2013 $ 35,776 $ 3,254 $ 3,679 $ 2,827 $ 3,888 $ 49,424 Business acquisition Goodwill impairment – – – – – – 984 – – – 984 – Balance at October 31, 2014 $ 35,776 $ 3,254 $ 3,679 $ 3,811 $ 3,888 $ 50,408 Balance at November 1, 2012 $ 35,776 $ 3,254 $ 3,679 $ 2,827 $ – $ 45,536 Business acquisition Goodwill impairment – – – – – – – – 3,888 3,888 – – Balance at October 31, 2013 $ 35,776 $ 3,254 $ 3,679 $ 2,827 $ 3,888 $ 49,424 Intangible assets Intangible assets represent identifiable non-monetary assets and are acquired either separately through a business combination, or generated internally. Intangible assets with a finite useful life are recorded at cost less any accumulated amortization and impairment losses. The assets’ useful lives are confirmed at least annually. Certain intangible assets, such as trademarks and trade names, have an indefinite useful life. These indefinite life intangibles are not amortized but are tested for impairment at least annually or more frequently if events or changes in circumstances indicate that impairment may have occurred. Amortization of intangible assets with finite useful lives is reported in other expenses on the consolidated statements of income and provided on a straight-line basis from the date at which it is available for use as follows: • Customer relationships: 10 to 15 years; • Computer software: 3 to 15 years; • Non-competition agreements: 4 to 5 years; and, • Other: 3 to 5 years. 77 CWB Group 2014 Annual Report Business acquisition Additions Balance at October 31, 2014 Accumulated amortization Balance at November 1, 2013 Amortization Customer Relationships Computer Software Non- competition Agreements Trademarks Other Total Cost Balance at November 1, 2013 $ 42,710 $ 65,403 $ 9,719 $ 2,709 $ 3,730 $ 124,271 486 – 43,196 – 23,337 88,740 – – 102 – – 950 588 24,287 9,719 2,811 4,680 149,146 Balance at October 31, 2014 16,235 39,003 13,192 3,043 33,873 5,130 5,231 1,417 6,648 – – – 1,778 345 2,123 54,074 9,935 64,009 Net carrying amount at October 31, 2014 $ 26,961 $ 49,737 $ 3,071 $ 2,811 $ 2,557 $ 85,137 Cost Balance at November 1, 2012 $ 37,515 $ 48,528 $ 5,593 $ 2,191 $ 1,900 $ 95,727 Business acquisition Additions Balance at October 31, 2013 Accumulated amortization Balance at November 1, 2012 Amortization Balance at October 31, 2013 5,195 – 42,710 10,425 2,767 13,192 16,875 65,403 29,805 4,068 33,873 – 4,126 – 518 – 9,719 2,709 3,858 1,373 5,231 – – – – 1,830 3,730 1,680 98 1,778 9,839 18,705 124,271 45,768 8,306 54,074 Net carrying amount at October 31, 2013 $ 29,518 $ 31,530 $ 4,488 $ 2,709 $ 1,952 $ 70,197 Impairment The carrying amounts of CWB’s goodwill and intangible assets with finite useful lives are reviewed at each reporting date to determine whether there is any indication of impairment. If an indication exists, CWB tests for impairment. For goodwill and intangible assets with indefinite useful lives, the impairment tests are performed each year. Impairment testing is performed by comparing the estimated recoverable amount from a cash-generating unit with the carrying amount of its net assets, including attributable goodwill. The recoverable amount of an asset is the higher of its fair value less cost to sell, and its value in use. If the recoverable amount is less than the carrying value, an impairment loss is charged to the consolidated statements of income. The recoverable amounts for CWB’s cash-generating units have been calculated based on their value in use. Value in use for each unit was determined by discounting the future cash flows expected to be generated from the continuing use of the cash-generating unit. Unless indicated otherwise, value in use was determined similarly as in the comparative year. The calculation of the value in use was based on the following key assumptions: • Cash flows were projected based on past experience, actual operating results and the four-year future business plan. Cash flows for a further 16-year period were extrapolated using a constant growth rate of 3%, which is based on the long-term forecast Canadian gross domestic product growth rates. The forecast period is based on CWB’s long-term perspective with respect to the operation of these cash-generating units; and, • A pre-tax discount rate of 8.6% was applied in determining the recoverable amounts, which was comprised of a risk-free interest rate and a market risk premium. The key assumptions described above may change as economic and market conditions change. CWB estimates that reasonable possible changes in these assumptions are not expected to cause the recoverable amounts of the cash-generating units to decline below the carrying amounts. No impairment losses on goodwill or intangible assets were identified during 2014 or 2013. 78 CWB Group 2014 Annual Report 10. INSURANCE-RELATED OTHER ASSETS Instalment premiums receivable Deferred policy acquisition costs Recoverable on unpaid claims Reinsurers’ share of unpaid claims and adjustment expenses Due from reinsurers Total As at October 31 2014 As at October 31 2013 $ 38,622 $ 12,250 9,679 4,587 626 36,615 11,905 8,167 6,760 918 $ 65,764 $ 64,365 11. DERIVATIVE FINANCIAL INSTRUMENTS Interest rate, foreign exchange and equity swaps/contracts such as futures, options, swaps, floors and rate locks are entered into for risk management purposes in accordance with CWB’s asset liability management policies. It is CWB’s policy not to utilize derivative financial instruments for trading or speculative purposes. Interest rate swaps and floors are primarily used to reduce the impact of fluctuating interest rates. Equity swaps are used to reduce the earnings volatility from restricted share units linked to CWB’s common share price. Foreign exchange contracts are only used for the purposes of meeting needs of clients or day-to-day business. Use of Derivatives CWB enters into derivative financial instruments for risk management purposes. Derivative financial instruments are financial contracts whose value is derived from an underlying interest rate, foreign exchange rate, equity or commodity instrument or index. Derivative financial instruments primarily used by CWB include: • interest rate swaps, which are agreements where two counterparties exchange a series of payments based on different interest rates applied to a notional amount; • foreign exchange forwards and futures, which are contractual obligations to exchange one currency for another at a specified price for settlement at a predetermined future date; and, • equity swaps, which are agreements where CWB makes periodic interest payments to a counterparty and receives the capital gain or loss plus dividends of a CWB common share. Interest rate swaps are used as hedging instruments to manage interest rate risk. CWB enters into these interest rate derivative instruments only 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 should the counterparty default. The Asset Liability Committee (ALCO) of CWB establishes and monitors approved counterparties (including an assessment of credit worthiness) and maximum notional limits. Approved counterparties are limited to rated financial institutions or their associated parent/affiliate with a minimum rating of A high or equivalent. Exposure to foreign exchange risk is not material to CWB’s overall financial position. Foreign exchange markets are not speculated in by taking a trading position in currencies. Maximum exposure limits are established and monitored by ALCO 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. Equity swap transactions are used as hedging instruments to manage risk related to the payout of restricted share units and deferred share units that have not yet vested. CWB enters into equity swap instruments only for its own account and does not act as an intermediary in this market. The risk is limited to the amount of an increase in CWB’s share price applied on the notional contract amount should the counterparty default. Designated Hedges CWB designates certain derivative financial instruments as either a hedge of the fair value of recognized assets or liabilities or firm commitments (fair value hedges), or a hedge of highly probable future cash flows attributable to a recognized asset or liability or a forecasted transaction (cash flow hedges). On an ongoing basis, the derivatives used in hedging transactions are assessed to determine whether they are effective in offsetting changes in fair values or cash flows of the hedged items. If a hedging transaction becomes ineffective or if the derivative is not designated as a cash flow hedge, any subsequent change in the fair value of the hedging instrument is recognized in net income. Interest income received or interest expense paid on derivative financial instruments designated as cash flow hedges is accounted for on the accrual basis and recognized as interest expense over the term of the hedge contract. Premiums on purchased contracts are amortized to interest expense over the term of the contract. Accrued interest receivable and payable and deferred gains and losses for these contracts are recorded in other assets or liabilities as appropriate. When a hedging instrument expires or is sold, or when a hedge no longer meets the criteria for hedge accounting, any cumulative gain or loss existing in other comprehensive income at that time is held separately in accumulated other comprehensive income until the forecast transaction is eventually recognized in the income statements. 79 CWB Group 2014 Annual Report When a forecasted transaction is no longer expected to occur, the cumulative gain or loss that was reported in accumulated other comprehensive income is immediately reclassified to the income statements. Embedded Derivatives Certain derivatives embedded in other financial instruments are treated as separate derivatives when their economic characteristics and risk are not closely related to those of the host contract and the combined contract is not carried at fair value. Identified embedded derivatives are separated from the host contract and are recorded at fair value. Fair Value Derivative financial instruments are recorded on the balance sheet at fair value as either other assets or other liabilities with changes in fair value related to the effective portion of cash flow interest rate hedges recorded in other comprehensive income, net of income taxes. Changes in fair value related to the ineffective portion of a designated hedge, a derivative not designated as a hedge and all other derivative financial instruments are reported in non-interest income on the consolidated statements of income. The following table summarizes the derivative 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 sheets. 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. Additional discussion of OSFI’s capital adequacy requirements is provided within the Capital Management section of Management’s Discussion and Analysis. As at October 31, 2014 As at October 31, 2013 Notional Amount Replace- ment Cost Future Credit Exposure Credit Risk Equivalent Risk- Weighted Balance Notional Amount Replace- ment Cost Future Credit Exposure Credit Risk Equivalent Risk- Weighted Balance Interest rate swaps $ 1,725,000 $ 1,612 $ 7,421 $ 9,033 $ 1,807 $ 800,000 $ 367 $ 1,494 $ 1,861 $ Equity swaps 22,959 3,785 50 3,835 767 17,470 4,131 45 4,176 372 835 Foreign exchange contracts 1,964 23 20 43 14 1,235 11 12 23 10 Total $ 1,749,923 $ 5,420 $ 7,491 $ 12,911 $ 2,588 $ 818,705 $ 4,509 $ 1,551 $ 6,060 $ 1,217 The following table shows the derivative financial instruments split between those contracts that have a positive fair value (favourable contracts) and those that have a negative fair value (unfavourable contracts): As at October 31, 2014 As at October 31, 2013 Favourable Contracts Unfavourable Contracts Favourable Contracts Unfavourable Contracts Notional Amount Fair Value Notional Amount Fair Value Notional Amount Fair Value Notional Amount Fair Value Interest rate swaps designated as hedges $ 1,675,000 $ 1,612 $ 50,000 $ (27) $ 675,000 $ 367 $ 125,000 $ (32) Equity swaps designated as hedges Equity swaps not designated as hedges Foreign exchange contracts 9,255 3,785 9,950 (246) 17,470 4,131 – 1,204 – 23 3,754 760 (101) (12) – 784 – 11 – – 451 Total $ 1,685,459 $ 5,420 $ 64,464 $ (386) $ 693,254 $ 4,509 $ 125,451 $ – – (4) (36) 80 CWB Group 2014 Annual Report The aggregate contractual or notional amount of the derivative 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 derivative financial instruments on hand during the year are set out in the following table: Favourable derivative financial instruments (assets) Unfavourable derivative financial instruments (liabilities) 2014 6261 130 $ $ 2013 1,955 76 $ $ The following table summarizes maturities of derivative financial instruments and weighted average interest rates paid and received on contracts: As at October 31, 2014 Maturity As at October 31, 2013 Maturity 1 Year or Less More than 1 Year 1 Year or Less More than 1 Year Notional Amount Contractual Interest Rate Notional Amount Contractual Interest Rate Notional Amount Contractual Interest Rate Notional Amount Contractual Interest Rate Interest rate swaps designated as hedges(1) $ 375,000 1.31% $ 1,350,000 1.40% $ 525,000 1.24% $ 275,000 1.33% Equity swaps designated as hedges(2) 9,201 2.30% 10,004 2.27% 8,215 2.37% 9,255 2.45% Equity swaps not designated as hedges(3) Foreign exchange contracts(4) 3,754 1,964 2.03% – – – – 1,235 – – – – Total $ 389,919 $ 1,360,004 $ 534,450 $ 284,255 (1) CWB receives interest at a fixed contractual rate and pays interest on the one-month (30-day) Canadian Bankers’ Acceptance rate. Interest rate swaps designated as hedges outstanding at October 31, 2014 mature between December 2014 and July 2017. (2) Equity swaps designated as hedges outstanding at October 31, 2014 mature between June 2015 and June 2017. (3) Equity swaps not designated as hedges outstanding at October 31, 2014 mature June 2015. (4) Foreign exchange contracts mature between November 2014 and July 2015. The contractual interest rate is not meaningful for foreign exchange contracts. During the year, $3,372 net unrealized after-tax gains (2013 – $2,332) were recorded in other comprehensive income for changes in fair value of the effective portion of derivatives designated as cash flow hedges, and no amounts (2013 – nil) were recorded in non- interest income for changes in fair value of the ineffective portion of derivatives classified as cash flow hedges. Amounts accumulated in other comprehensive income are reclassified to net income in the same period that the hedged items affect income. During the year, $3,575 of net gains after tax (2013 – $1,255) were reclassified to net income. At October 31, 2014, hedged cash flows are expected to occur and affect profit or loss within the next three years. 81 CWB Group 2014 Annual Report 12. OTHER ASSETS Accrued interest receivable Accounts receivable Deferred tax asset Prepaid expenses Income taxes receivable Financing costs(1) Other Total (1) Amortization for the year amounted to $2,261 (2013 – $2,108). 13. DEPOSITS Deposits are accounted for on an amortized cost basis. Costs relating to the issuance of fixed term deposits are amortized over the expected life of the deposit using the effective interest method. Payable on demand Payable after notice Payable on a fixed date Total Payable on demand Payable after notice Payable on a fixed date Total (Note 25) As at October 31 2014 As at October 31 2013 $ 48,242 $ 44,698 36,856 26,349 8,468 1,336 5,874 1,261 28,358 21,857 7,410 2,011 6,019 78 $ 128,386 $ 110,431 As at October 31, 2014 Individuals Business and Government Total $ 33,060 $ 637,025 $ 670,085 2,957,970 2,134,295 5,092,265 6,841,639 4,769,025 11,610,664 $ 9,832,669 $ 7,540,345 $ 17,373,014 As at October 31, 2013 Individuals Business and Government Total $ 30,337 $ 615,166 $ 645,503 2,741,951 1,622,400 4,364,351 6,648,466 3,972,720 10,621,186 $ 9,420,754 $ 6,210,286 $ 15,631,040 14. INTEREST IN UNCONSOLIDATED STRUCTURED ENTITY In 2006, CWB arranged for the issuance of innovative capital instruments, CWB Capital Trust Capital Securities Series 1 (WesTS), through Canadian Western Bank Capital Trust (CWB Capital Trust), a structured entity with a December 31 year end. CWB Capital Trust, an open-end trust, issued non-voting WesTS and the proceeds were used to purchase a senior deposit note from CWB. The deposit note of $105,000 (2013 – $105,000) is included in Deposits in the consolidated balance sheets. Based on the guidance provided in IFRS 10 Consolidated Financial Statements, CWB has determined that it does not control, and consequently does not consolidate, CWB Capital Trust. However, CWB Capital Trust qualifies as an unconsolidated structured entity under the guidance of IFRS 12 Disclosure of Interests in Other Entities and, accordingly, additional disclosures regarding CWB Capital Trust are provided herein. Holders of WesTS are eligible to receive semi-annual non-cumulative fixed cash distributions. No cash distributions will be payable by CWB Capital Trust on WesTS if CWB fails to declare regular dividends on its preferred shares or, if no preferred shares are outstanding, on its common shares. In this case, the net distributable funds of CWB Capital Trust will be distributed to CWB as holder of the residual interest in CWB Capital Trust. Should CWB Capital Trust fail to pay the semi-annual distributions in full, CWB has contractually agreed not to declare dividends of any kind on any of the preferred or common shares for a specified period of time. 82 CWB Group 2014 Annual Report The following information presents the outstanding WesTS: Issuance date August 31, 2006 Distribution dates June 30, December 31 Annual yield 6.199% Earliest date redeemable at the option of the issuer December 31, 2011 Earliest date exchangeable at the option of the holder Any time Trust capital securities outstanding 105,000 Principal amount $105,000 The significant terms and conditions of the WesTS are: 1) Subject to the approval of OSFI, CWB Capital Trust may, in whole (but not in part), on the redemption date specified above, and on any distribution date thereafter, redeem the WesTS without the consent of the holders. 2) Subject to the approval of OSFI, upon occurrence of a special event as defined, prior to the redemption date specified above, CWB Capital Trust may redeem all, but not part, of the WesTS without the consent of the holders. 3) The WesTS may be redeemed for cash equivalent to (i) the early redemption price if the redemption occurs prior to December 31, 2016 or (ii) the redemption price if the redemption occurs on or after December 31, 2016. Redemption price refers to an amount equal to one thousand dollars plus the unpaid distributions to the redemption date. Early redemption price refers to an amount equal to the greater of (i) the redemption price and (ii) the price calculated to provide an annual yield, equal to the yield on a Government of Canada bond issued on the redemption date with a maturity date of December 31, 2016, plus 0.50%. 15. INSURANCE-RELATED OTHER LIABILITIES Unpaid claims and adjustment expenses Unearned premiums Due to insurance companies and policyholders Unearned commissions Total 4) Holders of WesTS may, at any time, exchange each one thousand dollars of principal for 40 First Preferred Shares Series 1 of CWB. CWB’s First Preferred Shares Series 1 pay semi-annual non- cumulative cash dividends with an annual yield of 4.00% and will be redeemable at the option of CWB, with OSFI approval, on or after December 31, 2011, but not at the option of the holders. This exchange right will be effected through the conversion by CWB Capital Trust of the corresponding amount of the deposit note of CWB. The WesTS exchanged for CWB’s First Preferred Shares Series 1 will be cancelled by CWB Capital Trust. 5) Each WesTS will be exchanged automatically without the consent of the holders for 40 non-cumulative redeemable CWB First Preferred Shares Series 2 upon occurrence of any one of the following events: (i) proceedings are commenced for the winding up of CWB, (ii) OSFI takes control of CWB, (iii) CWB has a Tier 1 capital ratio of less than 5% or Total capital ratio of less than 8%, or (iv) OSFI has directed CWB to increase its capital or provide additional liquidity and CWB elects such automatic exchange or CWB fails to comply with such direction. Following the occurrence of an automatic exchange, CWB would hold all of the Special Trust Securities and all of the WesTS, and the primary asset of CWB Capital Trust would continue to be the senior deposit note. CWB’s First Preferred Shares Series 2 pay semi-annual non-cumulative cash dividends with an annual yield of 5.25% and will be redeemable at the option of CWB, with OSFI approval, on or after December 31, 2011, but not at the option of the holders. 6) For regulatory capital purposes, all of the outstanding WesTS amounts are currently included in Tier 1 capital. 7) The non-cumulative cash distribution on the WesTS will be 6.199% paid semi-annually until December 31, 2016 and, thereafter, at the CDOR 180-day Bankers’ Acceptance rate plus 2.55%. As at October 31 2014 As at October 31 2013 (Note 22) $ 85,526 $ 89,742 77,408 2,378 591 75,481 2,033 560 $ 165,903 $ 167,816 83 CWB Group 2014 Annual Report As at October 31 2014 As at October 31 2013 $ 137,084 $ 112,500 115,014 9,838 11,242 3,507 3,370 2,679 210 104,866 10,360 1,663 3,431 3,840 1,679 600 $ 282,944 $ 238,939 (Note 25) (Note 30) 16. OTHER LIABILITIES Accounts payable Accrued interest payable Deferred tax liability Income taxes payable Deferred revenue Leasehold inducements Acquisition contingent consideration Other Total 17. DEBT a) Subordinated Debentures Financing costs relating to the issuance of subordinated debentures are amortized over the expected life of the related subordinated debenture using the effective interest method. 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. Interest Rate 4.389%(1) 3.463%(2) 5.571%(3) Total Maturity Date Earliest Date Redeemable by CWB at Par As at October 31 2014 As at October 31 2013 November 30, 2020 November 30, 2015 $ 300,000 $ 300,000 December 17, 2024 December 17, 2019 March 21, 2022 March 22, 2017 250,000 75,000 250,000 75,000 $ 625,000 $ 625,000 (1) These conventional debentures have a 10-year term with a fixed interest rate for the first five years. Thereafter, the interest rate will be reset quarterly at the 3-month Canadian dollar CDOR rate plus 193 basis points. (2) These conventional debentures have a 12-year term with a fixed interest rate for the first seven years. Thereafter, the interest rate will be reset quarterly at the 3-month Canadian dollar CDOR rate plus 160 basis points. (3) These conventional debentures have a 15-year term with a fixed interest rate for the first 10 years. Thereafter, the interest rate will be reset quarterly at the Canadian dollar CDOR 90-day Bankers’ Acceptance rate plus 180 basis points. b) Debt Securities CWB securitizes leases to third parties. These securitizations do not qualify for derecognition as CWB continues to be exposed to certain risks associated with the leases, including an obligation to remit contractual cash flow payments regardless of whether the underlying cash flows are collected from lessees and, therefore, has not transferred substantially all of the risk and rewards of ownership. As the leases do not qualify for derecognition, the assets are not removed from the balance sheet and a securitization liability is recognized for the cash proceeds received. The carrying amount of the liability as at October 31, 2014 was $411,990 (October 31, 2013 – $195,650), and the associated carrying amount of the lease assets recorded on the balance sheet was $464,809 (October 31, 2013 – $230,353), which does not include an allocation of the allowance for credit losses. 84 CWB Group 2014 Annual Report 18. 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; and • An unlimited number of first preferred shares, without nominal or par value, issuable in series, provided that the maximum aggregate consideration for all outstanding first preferred shares at any time does not exceed $1,000,000. Issued and fully paid: Preferred Shares - Series 5 Outstanding at beginning of year Issued Outstanding at end of year Preferred Shares - Series 3 Outstanding at beginning of year Redeemed Purchased for cancellation Outstanding at end of year Common Shares 2014 Number of Shares Amount 2013 Number of Shares – $ – 5,000,000 5,000,000 125,000 125,000 $ – – – Amount – – – 8,352,596 208,815 8,390,000 209,750 (8,352,596) (208,815) – – – – – (37,404) – (935) 8,352,596 208,815 Outstanding at beginning of year 79,619,595 510,282 78,742,812 490,218 Issued under dividend reinvestment plan Issued on exercise or exchange of options Transferred from share-based payment reserve on 437,331 312,379 16,467 1,066 509,969 366,814 14,404 1,674 exercise or exchange of options – 5,223 – 3,986 Outstanding at end of year Share Capital 80,369,305 533,038 79,619,595 510,282 $ 658,038 $ 719,097 CWB is prohibited by the Bank Act from declaring any dividends on common shares when CWB is or would be placed, as a result of the declaration, in contravention of the capital adequacy and liquidity regulations or any regulatory directives issued under the Bank Act. In addition, should CWB Capital Trust fail to pay the semi-annual distributions in full on the CWB Capital Trust Securities Series 1 (see Note 14), CWB has contractually agreed to not declare dividends on any of its common and preferred shares for a specified period of time. These limitations do not restrict the current level of dividends. a) Dividends The following dividends were declared by CWB’s Board of Directors and paid by CWB during the year: $0.78 per common share (2013 – $0.70) $0.79 per preferred share – Series 5 $0.91 per preferred share – Series 3 (2013 – $1.81) Total 2014 2013 $ 62,408 $ 55,374 3,940 7,570 – 15,183 $ 73,918 $ 70,557 Subsequent to October 31, 2014, the Board of Directors of CWB declared a dividend of $0.21 per common share payable on January 8, 2015 to shareholders of record on December 16, 2014 and a dividend of $0.275 per Series 5 preferred share payable on January 31, 2015 to shareholders of record on January 23, 2015. With respect to these dividend declarations, no liability was recorded in the balance sheet at October 31, 2014. 85 CWB Group 2014 Annual Report b) Preferred Shares Series 5 Preferred Shares On February 10, 2014, CWB issued five million non-cumulative, five year rate reset First Preferred Shares Series 5 (Series 5 Preferred Shares) at $25.00 per share, for gross proceeds of $125 million. Holders of Series 5 Preferred Shares are entitled to receive a non-cumulative fixed dividend in the amount of $1.10 annually, payable quarterly, as and when declared by the Board of Directors of CWB, for the initial period ending April 30, 2019. The quarterly dividend represents an annual yield of 4.40% based on the stated issue price per share. Thereafter, the dividend rate will reset every five years at a level of 276 basis points over the then five year Government of Canada bond yield. CWB maintains the right to redeem, subject to the approval of OSFI, up to all of the then outstanding Series 5 Preferred Shares on April 30, 2019, and on April 30 every five years thereafter at a price of $25.00 per share. Should CWB choose not to exercise its right to redeem the Series 5 Preferred Shares, holders of these shares will have the right to convert their shares into an equal number of non-cumulative, floating rate First Preferred Shares Series 6 (Series 6 Preferred Shares), subject to certain conditions, on April 30, 2019, and on April 30 every five years thereafter. Holders of the Series 6 Preferred Shares will be entitled to receive quarterly floating dividends, as and when declared by the Board of Directors of CWB, equal to the 90-day Government of Canada Treasury Bill rate plus 276 basis points. Upon the occurrence of a trigger event (as defined by OSFI), each Series 5 or 6 Preferred Share will be automatically converted, without the consent of the holders, into CWB common shares. Conversion to common shares will be determined by dividing the preferred share conversion value ($25.00 per preferred share plus any declared but unpaid dividends) by the common share value (the greater of (i) the floor price of $5.00 and (ii) the current market price calculated as the volume-weighted average trading price for the ten consecutive trading days ending on the day immediately prior to the date of the conversion). Series 3 Preferred Shares On April 30, 2014, CWB redeemed all outstanding Series 3 Preferred Shares at $25.00 per share. Holders of the Series 3 preferred shares were entitled, with OSFI approval, to receive non-cumulative quarterly fixed dividends for the initial five-year period ending April 30, 2014 of 7.25% per annum, payable quarterly, as and when declared by the Board of Directors. c) Dividend Reinvestment Plan Under the dividend reinvestment plan (plan), CWB provides holders of CWB’s common shares and holders of any other class of shares deemed eligible by CWB’s Board of Directors with the opportunity to direct cash dividends paid on any class of their eligible shares towards the purchase of additional common shares. Currently, the Board of Directors has deemed that the holders of CWB’s Series 5 preferred shares are also eligible to participate in the plan. The plan is only open to shareholders residing in Canada. At the option of CWB, the common shares may be issued from CWB’s treasury at an average market price based on the closing prices of a board lot of common shares on the Toronto Stock Exchange (TSX) for the five trading days immediately preceding the dividend payment date, with a discount of between 0% to 5% at CWB’s discretion. CWB also has the option to fund the plan through the open market at market prices. During the year, 437,331 (2013 – 509,969) common shares were issued under the plan from CWB’s treasury at a 2% (2013 – 2%) discount. 86 CWB Group 2014 Annual Report19. SHARE-BASED PAYMENTS a) Stock Options Stock options are accounted for using the fair value method. The estimated value is recognized over the applicable vesting period as an increase to both salary expense and share-based payment reserve. When options are exercised, the proceeds received and the applicable amount in share-based payment reserve are credited to common shares. 4,217,908) are issued and outstanding. The options vest within three years and 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 date. All options expire within five years of date of grant. Outstanding options expire from December 2014 to June 2019. CWB has authorized 6,830,580 common shares (2013 – 5,542,959) for issuance under the share incentive plan. Of the amount authorized, options exercisable into 4,743,277 shares (2013 – The details of, and changes in, the issued and outstanding options follow: Options Balance at beginning of year Granted Exercised or exchanged Expired Forfeited Balance at end of year Exercisable at end of year 2014 2013 Number of Options 4,217,908 $ 1,422,357 (769,865) – (127,123) 4,743,277 469,910 $ $ Weighted Average Exercise Price 26.96 38.58 24.44 – 30.59 30.76 28.76 Number of Options 3,441,100 $ 1,810,899 (824,068) (162,075) (47,948) 4,217,908 501,579 $ $ Weighted Average Exercise Price 24.51 28.30 18.80 31.18 27.64 26.96 20.50 Further details relating to stock options outstanding and exercisable follow: Range of Exercise Prices $22.09 to $23.43 $25.46 to $29.42 $30.76 to $39.42 Total Options Outstanding Options Exercisable Weighted Average Remaining Contractual Life (years) 0.5 $ 2.9 4.0 3.2 $ Weighted Average Exercise Price 23.10 27.43 37.55 30.76 Number of Options 94,034 3,051,399 1,597,844 4,743,277 Number of Options 94,034 $ 164,750 211,126 469,910 $ Weighted Average Exercise Price 23.10 29.42 30.76 28.76 Until March 1, 2014, the terms of the share incentive plan allowed the holders of vested options two alternatives whereby the option holder could either (a) elect to receive shares by delivering cash to CWB in the amount of the option exercise price or (b) elect to receive the number of shares equivalent to the excess of the market value of the shares under option, determined at the exercise date, over the exercise price (cashless settlement). Effective March 1, 2014, all exercised options are settled via cashless settlement. Of the 769,865 (2013 – 824,068) options exercised or exchanged, option holders exchanged the rights to 723,373 (2013 – 737,653) options and received 265,887 (2013 – 280,399) shares in return under the cashless settlement alternative. Salary expense of $5,930 (2013 – $6,150) was recognized relating to the estimated fair value of options granted. The fair value of options granted was estimated using a binomial option pricing model with the following variables and assumptions: (i) risk-free interest rate of 1.5% (2013 – 1.4%), (ii) expected option life of 4.0 (2013 – 4.0) years, (iii) expected volatility of 18% (2013 – 22%), and (iv) expected annual dividends of 2.1% (2013 – 2.5%). Expected volatility is estimated by evaluating historical volatility of the share price over multi-year periods. The weighted average fair value of options granted was estimated at $4.61 (2013 – 3.93) per share. During the year, $5,223 (2013 – $3,986) was transferred from the share-based payment reserve to share capital, representing the estimated fair value recognized for 769,865 (2013 – 824,068) options exercised during the year. 87 CWB Group 2014 Annual Report b) Restricted Share Units Under the Restricted Share Unit (RSU) plan, certain employees are eligible to receive an award in the form of RSUs. Each RSU entitles the holder to receive the cash equivalent of the market value of CWB’s common shares at the vesting date and an amount equivalent to the dividends paid on the common shares during the vesting period. RSUs vest on each anniversary of the grant in equal one-third instalments over a period of three years. Salary expense is recognized over the vesting period except where the employee is eligible to retire prior to the vesting date, in which case the expense is recognized between the grant date and the date the employee is eligible to retire. Number of RSUs Balance at beginning of year Granted Vested and paid out Forfeited Balance at end of year During the year, salary expense of $10,217 (2013 – $9,796) was recognized related to RSUs. As at October 31, 2014, the liability for the RSUs held under this plan was $13,709 (October 31, 2013 – $12,111). At the end of each period, the liability and salary expense are adjusted to reflect changes in the fair value of the RSUs. 2014 650,791 266,561 (142,555) (26,777) 748,020 2013 594,455 354,491 (281,564) (16,591) 650,791 c) Deferred Share Units Under the Deferred Share Unit (DSU) plan, non-employee directors receive at least 50% of their annual retainer in DSUs. The DSUs are not redeemable until the individual is no longer a director and must be redeemed for cash. Common share dividend equivalents accrue to the directors in the form of additional units. The expense related to the DSUs is recorded in the period the award is earned by the director. During the year, other non-interest expenses included $629 (2013 – $745) related to the DSUs. As at October 31, 2014, the liability for DSUs held under this plan was $3,858 (October 31, 2013 – $2,782). At the end of each period, the liability and expense are adjusted to reflect changes in the market value of the DSUs. Number of DSUs Balance at beginning of year Granted Paid out Balance at end of year 2014 83,350 24,236 (10,420) 97,166 2013 78,761 9,059 (4,470) 83,350 d) Performance Share Units During 2014, CWB introduced a Performance Share Unit (PSU) plan, which is offered to certain employees on an annual basis. At the time of a grant, each PSU represents a unit with an underlying value equivalent to the value of a CWB common share. Notional dividends accrue to the holder of the PSU during the life of the PSU. Under the PSU plan, each PSU vests at the end of a three year period and is settled in cash. For PSUs granted in fiscal 2014, at the end of each specified performance period, a multiplier is applied to a portion of the PSUs originally granted and any accrued notional dividends such that the total value of the PSUs may vary from 0% to 200% of the value of an equal number of CWB common shares. The multiplier is determined by comparing the total shareholder return (TSR) of CWB’s common shares against the TSR of comparator companies during various performance periods. Number of PSUs Balance at beginning of year Granted Paid out Balance at end of year 88 2014 – 25,305 – 25,305 2013 – – – – CWB Group 2014 Annual Report20. NON-CONTROLLING INTERESTS Non-controlling interests are comprised of the following: McLean & Partners Wealth Management Ltd. Adroit Investment Management Ltd. Total As at October 31 2014 As at October 31 2013 $ $ 913 $ 153 790 272 1,066 $ 1,062 21. CONTINGENT LIABILITIES AND COMMITMENTS a) Credit Instruments In the normal course of business, CWB enters into various commitments and has contingent liabilities, which are not reflected in the consolidated balance sheets. 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 represent CWB’s obligation to make payments to third parties when a customer is unable to make required payments or meet other contractual obligations. These instruments carry the same credit risk, recourse and collateral security requirements as loans extended to customers and generally have a term that does not exceed one year. 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 undrawn availability under lines of credit and commercial operating loans of $2,526,808 (October 31, 2013 – $2,085,452) and authorized but unfunded loan commitments of $2,084,503 (October 31, 2013 – $1,792,537). In the majority of instances, availability of b) Lease Commitments CWB has obligations under long-term, non-cancellable operating leases for the rental of premises. The leases typically run 10 to 15 years, with an option to renew the lease for an additional five years. Operating leases primarily comprise branch and office premises and As at October 31 2014 As at October 31 2013 $ 407,681 $ 354,083 4,611,311 3,877,989 $ 5,018,992 $ 4,232,072 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. 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. Revolving credit authorizations are subject to repayment which, on a pooled basis, also decreases liquidity risk. are not capitalized. Total costs, including free rent periods and step-rent increases, are expensed on a straight-line basis over the lease term. Minimum future lease commitments for each of the five succeeding years and thereafter are as follows: 2015 2016 2017 2018 2019 2020 and thereafter Total $ 12,121 11,796 9,955 8,799 8,058 46,178 $ 96,907 89 CWB Group 2014 Annual Report c) Guarantees A guarantee is defined as a contract that contingently requires the guarantor to make payments to a third party based on (i) changes in an underlying economic characteristic that is related to an asset, liability or equity security of the guaranteed party, (ii) failure of another party to perform under an obligating agreement, or (iii) failure of another third party to pay indebtedness when due. 22. INSURANCE OPERATIONS Insurance Contracts – Classification Contracts where CWB accepts significant insurance risk from another party by agreeing to compensate the policyholder or other beneficiary if a specified uncertain future event adversely affects the policyholder or other beneficiaries are classified as insurance contracts. Significant guarantees provided to third parties include guarantees and standby letters of credit as discussed above. Premiums Earned and Deferred Policy Acquisition Costs In the ordinary course of business, CWB enters into contractual arrangements under which CWB may agree to indemnify the other party. Under these agreements, CWB may be required to compensate counterparties for costs incurred as a result of various contingencies, such as changes in laws and regulations and litigation claims. A maximum potential liability cannot be identified as the terms of these arrangements vary and generally no predetermined amounts or limits are identified. The likelihood of occurrence of contingent events that would trigger payment under these arrangements is either remote or difficult to predict and, in the past, payments under these arrangements have been insignificant. No amounts are reflected in the consolidated financial statements related to these guarantees and indemnifications. d) Legal and Regulatory Proceedings In the ordinary course of business, CWB and its subsidiaries are party to legal and regulatory proceedings. Based on current knowledge, CWB does not expect the outcome of any of these proceedings to have a material effect on the consolidated financial position or results of operations. Insurance premiums are included in other income on a daily pro rata basis over the terms of the underlying insurance policies. Unearned premiums represent the portion of premiums written that relate to the unexpired term of the policies in force and are included in other liabilities. Insurance premiums are shown before deduction of commissions and are gross of any taxes and dues levied on premiums. Policy acquisition costs are those expenses incurred in the acquisition of insurance business. Acquisition costs comprise advertising and marketing expenses, insurance advisor salaries and benefits, broker commissions, premium taxes and other expenses directly attributable to the production of business. Policy acquisition costs related to unearned premiums are only deferred, and included in other assets, to the extent that they are expected to be recovered from unearned premiums and are amortized to income over the periods in which the premiums are earned. If the unearned premiums are not sufficient to pay expected claims and expenses (including policy maintenance expenses and unamortized policy acquisition costs), a premium deficiency is said to exist. Anticipated investment income is considered in determining whether a premium deficiency exists. Premium deficiencies are recognized by writing down the deferred policy acquisition cost asset. Liability Adequacy Test At the end of each reporting period, liability adequacy tests are performed to ensure the adequacy of the contract liabilities, net of related deferred policy acquisition costs (DPAC). In performing these tests, current best estimates of future contractual cash flows and claims handling and administration expenses, as well as investment income from the assets supporting the provisions, are used. Any deficiency is immediately charged to profit or loss by writing off DPAC and, if required, establishing a provision for losses arising from liability adequacy tests (the premium deficiency). Unpaid Claims and Adjustment Expenses The provision for unpaid claims represents the amounts needed to provide for the estimated ultimate expected cost of settling claims related to insured events (both reported and unreported) that have occurred but not been settled on or before each balance sheet date. The provision for adjustment expenses represents the estimated ultimate expected costs of investigating, resolving and processing these claims. These provisions are included in other liabilities and their computation takes into account the time value of money using discount rates based on projected investment income from the assets supporting the provisions. 90 CWB Group 2014 Annual ReportThe process of determining the provision for unpaid claims and adjustment expenses necessarily involves risks that the actual results will deviate from the best estimates made. These risks vary in proportion to the length of the estimation period and the volatility of each component comprising the liabilities. To recognize the uncertainty in establishing these best estimates and to allow for possible deterioration in experience, actuaries are required to include explicit provisions for adverse deviation in assumptions for asset defaults, reinvestment risk, claims development and recoverability of reinsurance balances. The provisions are periodically reviewed and evaluated in light of emerging claims experience and changing circumstances. The resulting changes in estimates of the ultimate liability are recorded as incurred claims in the current period. Net earned premiums Commissions and processing fees Net claims and adjustment expenses Policy acquisition costs Insurance revenues, net Reinsurance Ceded Earned premiums and claims expenses are recorded net of amounts ceded to, and recoverable from, reinsurers. Estimates of amounts recoverable from reinsurers on unpaid claims and adjustment expenses are recorded in other assets separately from estimated amounts payable to policyholders. Amounts recoverable from reinsurers are estimated in a manner consistent with the liabilities associated with the reinsured policies. These assets consist of short-term balances due from reinsurers, as well as longer term receivables that are dependent on the expected claims and benefits arising under the related reinsured insurance contracts. Amounts recoverable from or due to reinsurers are measured consistently with the amounts associated with the reinsured insurance contracts and in accordance with the terms of each reinsurance contract. Reinsurance liabilities are primarily premiums payable for reinsurance contracts and are recognized as an expense when due. Reinsurance assets are assessed for impairment on an annual basis. If there is objective evidence that the reinsurance asset is impaired, the carrying amount of the reinsurance asset is reduced to its recoverable amount and the impairment loss is recognized in the income statement. Objective evidence that a reinsurance asset is impaired is gathered using observable data about the following criteria: • Significant financial difficulty of the reinsurer; • A breach of contract, such as default or delinquency in payments; and, • Observable data indicating that there is a measurable decrease in the estimated future cash flow from the reinsurance asset since its initial recognition. a) Insurance Revenues, Net Insurance revenues, net, reported in other income on the consolidated statements of income are presented net of claims, adjustment expenses and policy acquisition costs. 2014 2013 $ 130,410 $ 126,825 1,580 (85,997) (25,079) 1,787 (87,008) (25,325) $ 20,914 $ 16,279 91 CWB Group 2014 Annual Report b) Unpaid Claims and Adjustment Expenses Nature of Unpaid Claims The establishment of the provision for unpaid claims and adjustment expenses and the related reinsurers’ share is based on known facts and interpretation of circumstances and is, therefore, a complex and dynamic process influenced by a large variety of factors. These factors include experience with similar cases and historical trends involving claim payment patterns, loss payments, pending levels of unpaid claims, product mix or concentration, claims severity, and claims frequency patterns. Other factors include the continually evolving and changing regulatory and legal environment, actuarial studies, professional experience and expertise of the claims department personnel and independent adjusters retained to handle individual claims, quality of the data used for projection purposes, existing claims management practices, including claims handling and settlement practices, effect of inflationary trends on future claims settlement costs, investment rates of return, court decisions, economic conditions and public attitudes. In addition, time can be a critical part of the provision determination since, the longer the span between the incidence of a loss and the payment or settlement of the claim, the more variable the ultimate Unpaid claims and adjustment expenses, net, beginning of year Claims incurred In the current year In prior periods Claims paid during the year Unpaid claims and adjustment expenses, net, end of year Reinsurers’ share of unpaid claims and adjustment expenses Recoverable on unpaid claims settlement amount can be. Accordingly, short-tailed claims, such as property claims, tend to be more reasonably predictable than long- tailed claims, such as liability claims. Consequently, the establishment of the provision for unpaid claims and adjustment expenses relies on the judgment and opinions of a large number of individuals, on historical precedent and trends, on prevailing legal, economic, social and regulatory trends and on expectations as to future developments. The process of determining the provisions necessarily involves risks that the actual results will deviate, perhaps substantially, from the best estimates made. Provision for Unpaid Claims and Adjustment Expenses An annual evaluation of the adequacy of unpaid claims is completed at the end of each financial year. This evaluation includes a re-estimation of the liability for unpaid claims relating to each preceding financial year compared to the liability that was originally established. The results of this comparison and the changes in the provision for unpaid claims and adjustment expenses follow: 2014 2013 $ 74,815 $ 74,295 87,917 (1,920) (89,552) 71,260 4,587 9,679 86,087 921 (86,488) 74,815 6,760 8,167 Unpaid claims and adjustment expenses, net, end of year $ 85,526 $ 89,742 92 CWB Group 2014 Annual Report The provision for unpaid claims and adjustment expenses and related reinsurance recoveries are discounted using rates based on the projected investment income from the assets supporting the provisions, and reflecting the estimated timing of payments and recoveries. The investment rate of return used for all cash flow periods and all lines of business was 2.47% (2013 – 2.50%). However, that rate was reduced by a 0.50% (2013 – 0.50%) provision for adverse deviation in discounting the provision for unpaid claims and adjustment expenses and related reinsurance recoveries. The impact of this provision for adverse deviation results in an increase of $575 (2013 – $585) in unpaid claims and adjustment expenses and related reinsurance recoveries. Policy balances, included in insurance-related other assets and other liabilities, analyzed by major lines of business are as follows: Unpaid claims and adjustment expenses $ 66,943 $ 18,583 $ 68,532 $ 21,210 Reinsurers’ share of unpaid claims and adjustment expenses Unearned premiums 2,495 50,874 2,092 26,534 4,169 50,500 2,591 24,981 2014 2013 Automobile Home Automobile Home c) Underwriting Policy and Reinsurance Ceded Reinsurance contracts with coverage up to maximum policy limits are entered into to protect against losses in excess of certain amounts that may arise from automobile, personal property and liability claims. Reinsurance with a limit of $320,000 (2013 – $300,000) is obtained to protect against certain catastrophic losses. Retention on catastrophic events is $5,000 (2013 – $5,000), on property per risk events is $1,000 (2013 – $1,000) and on casualty events is $2,000 (2013 – $2,000). For the British Columbia automobile insurance product, retentions are further reduced by the underlying mandatory coverage provided by the provincially governed Crown corporation. Reinsurance coverage is diversified across many reinsurers in order to spread risk and reduce reinsurer concentration risk in the event of a very large loss, such as an earthquake. The reinsurers selected to participate in the program have a minimum rating of A- from Standard & Poor’s or A.M. Best. In addition, reinsurance treaties have a special termination clause allowing CWB to change a reinsurer during the term of the agreement if the reinsurer’s rating falls below a specified level. At October 31, 2014, $4,587 (October 31, 2013 – $6,760) of unpaid claims and adjustment expenses were recorded as recoverable from reinsurers. Failure of a reinsurer to honour its obligation could result in losses. The financial condition of reinsurers is regularly evaluated to minimize the exposure to significant losses from reinsurer insolvency. The amounts shown in other income are net of the following amounts relating to reinsurance ceded to other insurance companies. Premiums earned reduced by Claims incurred reduced by 2014 $ 11,132 $ 3,425 2013 9,976 3,732 23. DISCLOSURES ON RATE REGULATION Canadian Direct Insurance Incorporated (Canadian Direct), a wholly owned subsidiary, is licensed under insurance legislation in the provinces in which it conducts business. Automobile insurance is a compulsory product and is subject to different regulations across the provinces in Canada, including those with respect to rate setting. Rate setting mechanisms vary across the provinces, but they generally fall under three categories: “use and file”, “file and use” and “file and approve”. Under “use and file”, rates are filed following use. Under “file and use”, insurers file their rates with the relevant authorities and wait for a prescribed period of time and then implement the proposed rates. Under “file and approve”, insurers must wait for specific approval of filed rates before they may be used. The authority that regulates automobile insurance rates, in the province in which Canadian Direct is writing that business, is listed below. Automobile direct written premiums in Alberta totalled $47,200 in 2014 (2013 – $46,400) and represented 53% (2013 – 52%) of direct automobile premiums written. Province Alberta Rate Filing File and approve Regulatory Authority Alberta Automobile Insurance Rate Board While regulatory authorities generally approve rates and rate adjustments prospectively, in some circumstances retroactive rate adjustments in respect of historical results may be required, which could result in a regulatory asset or liability for CWB. As at October 31, 2014 and October 31, 2013, CWB had no such regulatory asset or liability. 24. EMPLOYEE FUTURE BENEFITS All employee future benefits related to CWB’s group retirement savings and employee share purchase plans are recognized in the periods during which services are rendered by employees. CWB’s contributions to the group retirement savings plan and employee share purchase plan totalled $12,154 (2013 – $11,685). 93 CWB Group 2014 Annual Report 25. INCOME TAXES CWB follows the deferred method of accounting for income taxes whereby current income taxes are recognized for the estimated income taxes payable for the current period. Deferred tax assets and liabilities represent the cumulative amount of tax applicable to temporary differences between the carrying amount of the assets and liabilities, and their values for tax purposes. Deferred tax assets and liabilities are measured using enacted or substantively enacted The provision for income taxes consists of the following: Consolidated statements of income Current Deferred Other comprehensive income Tax expense related to: Unrealized gains (losses) on available-for-sale securities Gains on derivatives designated as cash flow hedges Total tax rates anticipated to apply to taxable income in the years in which those temporary differences are anticipated to be recovered or settled. Changes in deferred taxes related to a change in tax rates are recognized in income in the period of the tax rate change. All deferred tax assets and liabilities are expected to be realized in the normal course of operations. 2014 2013 $ 78,615 $ 58,545 (5,014) 73,601 5,507 64,052 985 (69) 916 (4,800) 364 (4,436) $ 74,517 $ 59,616 A reconciliation of the statutory tax rates and income tax that would be payable at these rates to the effective income tax rates and provision for income taxes reported in the consolidated statements of income follows: Combined Canadian federal and provincial income taxes and statutory tax rate $ 77,255 25.3% $ 67,884 25.4% 2014 2013 Increase (decrease) arising from: Tax-exempt income Stock-based compensation Other (6,285) 1,495 1,136 (2.1) 0.5 0.4 (6,072) 1,547 693 (2.2) 0.6 0.2 Provision for income taxes and effective tax rate $ 73,601 24.1% $ 64,052 24.0% Deferred tax balances are comprised of the following: Deferred tax assets Allowance for credit losses Deferred loan fees Deferred deposit broker commission Leasing income Other temporary differences Deferred tax liabilities Intangible assets Other temporary differences CWB has approximately $8,234 (2013 – $11,140) of capital losses that are available to apply against future capital gains and have no expiry date. The tax benefit of these losses has not been recognized in the consolidated financial statements. 94 2014 2013 $ 19,978 $ 16,618 10,832 (4,056) (3,335) 2,930 9,357 (3,659) 536 (995) $ 26,349 $ 21,857 $ $ 7,995 $ 9,197 1,843 1,163 9,838 $ 10,360 CWB Group 2014 Annual Report 26. EARNINGS PER COMMON SHARE Basic earnings per common share is calculated based on the weighted average number of common shares outstanding during the period. Diluted earnings per share is calculated based on the treasury stock method, which assumes that any proceeds from in-the-money stock options are used to purchase CWB’s common shares at the average market price during the period. The calculation of earnings per common share follows: Numerator 2014 2013 Net income available to common shareholders $ 218,549 $ 187,163 Denominator Weighted average of common shares outstanding – basic 80,033,646 79,147,496 Dilutive instruments: Stock options(1) Weighted average number of common shares outstanding – diluted Earnings per common share Basic Diluted 921,221 396,532 80,954,867 79,544,028 $ 2.73 $ 2.70 2.36 2.35 (1) At October 31, 2014 and 2013, there were no employee stock options with an average adjusted exercise price, adjusted for unrecognized stock-based compensation, that was greater than the average market price. 27. ASSETS UNDER ADMINISTRATION AND MANAGEMENT Assets under administration of $10,101,698 (October 31, 2013 – $8,423,972) and assets under management of $1,795,975 (October 31, 2013 – $1,901,146) represent the fair value of assets held for personal, corporate and institutional clients as well as third-party leases and residential mortgages subject to service agreements. These assets are kept separate from CWB’s own assets. Assets under administration and management are not reflected in the consolidated balance sheets. 28. RELATED PARTY TRANSACTIONS Transactions with and between subsidiary entities are made at normal market prices and are eliminated on consolidation. Preferred Rates and Terms Key Management Personnel CWB makes loans, primarily residential mortgages, to its officers and employees at various preferred rates and terms. The total amount outstanding for these types of loans is $114,508 (October 31, 2013 – $106,085). CWB offers deposits, primarily fixed term deposits, to its officers and employees and their immediate family at preferred rates. The total amount outstanding for these deposits is $264,936 (October 31, 2013 – $256,136). Compensation of key management personnel is as follows: Salaries, benefits and directors’ compensation Share-based payments (stock options, RSUs and DSUs)(1) Total (1) Share-based payments are based on the estimated fair value on grant date. Loans outstanding with key management personnel totalled $589 as at October 31, 2014 (October 31, 2013 – $146). CWB’s policies preclude lending to CWB’s independent directors. Key management personnel of CWB are those that have authority and responsibility for planning, directing and controlling the activities of CWB and include independent directors of CWB. 2014 $ 5,775 $ 3,219 $ 8,994 $ 2013 6,129 3,644 9,773 95 CWB Group 2014 Annual Report 29. INTEREST RATE SENSITIVITY CWB is exposed to interest rate risk as a result of a difference, or gap, between the maturity or repricing behaviour of interest sensitive assets and liabilities. The interest rate gap is managed by forecasting core balance trends. The repricing profile of these assets and liabilities has Asset Liability Gap Positions ($ millions) been incorporated in the table following showing the gap position at October 31 for select time intervals. Figures in brackets represent an excess of liabilities over assets or a negative gap position. October 31, 2014 Assets Floating Rate and Within 1 Month 1 to 3 Months 3 Months to 1 Year Total Within 1 Year to More than Non – Interest 1 Year 5 Years 5 Years Sensitive Total Cash resources and securities $ 468 $ 758 $ 272 $ 1,498 $ 1,022 $ 173 $ 4 $ 2,697 8,284 897 2,263 11,444 6,025 113 Loans Other assets(2) Derivative financial instruments(1) Total Liabilities and Equity Deposits Other liabilities(2) Debt(3) Equity Derivative financial instruments(1) Total Interest Rate Sensitive Gap Cumulative Gap Cumulative Gap as a 1,748 8,159 593 593 $ $ $ $ $ $ – – – 75 – 313 – 388 8,752 1,730 2,848 13,330 – 1,360 8,407 6,395 1,315 3,838 11,548 5,841 4 12 – 8 24 – – 34 106 – – 46 142 – 1,748 31 895 – – 1,347 $ 3,978 $ 13,484 383 $ (1,130) 976 $ (154) $ $ (154) (154) $ $ $ 6,767 1,640 1,486 $ $ $ (72) 401 2 17,510 401 1,750 – – 286 335 22,358 – 9 – – – 9 277 1,763 $ $ $ (16) 418 – 1,694 2 17,373 504 1,037 1,694 1,750 2,098 $ 22,358 $ $ (1,763) – – – – – – – Percentage of Total Assets 2.7% 4.4% (0.7)% (0.7)% 6.6% 7.9% October 31, 2013 Cumulative Gap Cumulative Gap as a $ 1,289 $ 1,785 $ 240 $ 240 $ 1,499 $ 1,541 $ – $ Percentage of Total Assets 6.7% 9.2% 1.2% 1.2% 7.8% 8.0% – (1) Derivative financial instruments are included in this table at the notional amount. (2) Accrued interest is excluded in calculating interest sensitive assets and liabilities. (3) 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. The majority of fixed rate loans, mortgages and leases are either closed or carry prepayment penalties. 96 CWB Group 2014 Annual Report The effective, weighted average interest rates for each class of financial asset and liability are shown below: Weighted Average Effective Interest Rates (%) October 31, 2014 Total Assets Total Liabilities Interest Rate Sensitive Gap October 31, 2013 Total Assets Total Liabilities Interest Rate Sensitive Gap Floating Rate and Within 1 Month 1 to 3 Months 3 Months to 1 Year 3.7% 1.2 2.5% 3.8% 1.3 2.5% 2.6% 1.7 0.9% 2.3% 1.9 0.4% 4.3% 2.0 2.3% 4.0% 2.0 2.0% Total Within 1 Year 3.7% 1.5 2.2% 3.6% 1.6 2.0% 1 Year to 5 Years More than 5 Years Total 3.9% 2.4 1.5% 4.6% 2.4 2.2% 4.6% – 4.6% 4.8% 3.3 1.5% 3.8% 1.8 2.0% 4.0% 1.9 2.1% Based on the current interest rate gap position, it is estimated that a one percentage point increase in all interest rates would increase net interest income by approximately 2.0% or $9,185 (October 31, 2013 – 3.3% or $14,545) and decrease other comprehensive income $36,578 (October 31, 2013 – $14,418) net of tax, respectively, over the following twelve months. A one percentage point decrease in all interest rates would decrease net interest income by approximately 3.9% or $18,221 (October 31, 2013 – 5.3% or $23,853) and increase other comprehensive income $37,323 (October 31, 2013 – $14,418), net of tax. 30. FAIR VALUE OF FINANCIAL INSTRUMENTS a) Financial Assets and Liabilities by Measurement Basis The fair value of a financial instrument on initial recognition is normally the transaction price (i.e. the value of the consideration given or received). Subsequent to initial recognition, financial instruments measured at fair value that are quoted in active markets are based on bid prices for financial assets and offer prices for financial liabilities. For certain securities and derivative financial instruments where an active market does not exist, fair values are determined using valuation techniques that refer to observable market data, including discounted cash flow analysis, option pricing models and other valuation techniques commonly used by market participants, and non- market observable inputs. Several of CWB’s significant financial instruments, such as loans and deposits, 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 CWB’s financial instruments. The carrying value of loans, deposits and subordinated debentures are not adjusted to reflect increases or decreases in fair value due to interest rate changes as CWB’s intention is to realize their value over time by holding them to maturity. The table below provides the carrying amount of financial instruments by category as defined in IAS 39 – Financial Instruments: Recognition and Measurement and by balance sheet heading. The table sets out the fair values of financial instruments (including derivatives) using the valuation methods and assumptions referred to below the table. The table does not include assets and liabilities that are not considered financial instruments. The table also excludes assets and liabilities which are considered financial instruments, but are not recorded at fair value and for which the carrying amount approximates fair value. 97 CWB Group 2014 Annual Report October 31, 2014 Financial Assets Cash resources Securities Securities purchased under resale agreements Loans(1) Derivative related Total Financial Assets Financial Liabilities Deposits(1) Debt Acquisition contingent consideration Derivative related Loans and Receivables, and Non-trading Liabilities Available- for-sale Total Carrying Amount Fair Value Fair Value Over (Under) Carrying Amount Derivatives (Note 3) $ (Note 4) – $ – – – $ 508,414 $ 508,414 $ 508,414 $ – – 2,089,205 2,089,205 2,089,205 99,566 99,566 99,566 – – – – 17,582,480 5,420 – – – 17,582,480 17,571,250 (11,230) 5,420 5,420 – $ 5,420 $ 17,582,480 $ 2,697,185 $ 20,285,085 $ 20,273,855 $ (11,230) $ – $ 17,388,737 $ – $ 17,388,737 $ 17,414,150 $ 25,413 – – 386 1,036,990 2,679 – – – – 1,036,990 1,056,234 19,244 2,679 386 2,679 386 – – Total Financial Liabilities $ 386 $ 18,428,406 $ – $ 18,428,792 $ 18,473,449 $ 44,657 October 31, 2013 Financial Assets Cash resources Securities Loans(1) Derivative related Total Financial Assets Financial Liabilities Deposits(1) Debt Acquisition contingent consideration Derivative related Loans and Receivables, and Non-trading Derivatives Liabilities Available- for-sale Total Carrying Amount Fair Value Fair Value Over (Under) Carrying Amount (Note 3) $ (Note 4) – $ – – $ 347,995 $ 347,995 $ 347,995 $ – 2,232,322 2,232,322 2,232,322 – – $ $ – 15,629,443 4,509 – – – 15,629,443 15,614,937 (14,506) 4,509 4,509 – 4,509 $ 15,629,443 $ 2,580,317 $ 18,214,269 $ 18,199,763 $ (14,506) – $ 15,541,831 $ – $ 15,541,831 $ 15,553,762 $ 11,931 – – 36 820,650 1,679 – – – – 820,650 835,639 14,989 1,679 1,679 36 36 – – Total Financial Liabilities $ 36 $ 16,364,160 $ – $ 16,364,196 $ 16,391,116 $ 26,920 (1) Loans and deposits exclude deferred premiums and deferred revenue, which are not financial instruments. (2) For further information on interest rates associated with financial assets and liabilities, including derivative instruments, refer to Note 29. The methods and assumptions used to estimate the fair values of financial instruments are as follows: • Cash resources and securities are reported on the consolidated balance sheets at the fair value disclosed in Notes 3 and 4. Securities purchased under resale agreements are reported at the fair value as disclosed on the consolidated balance sheets. These values are based on quoted market prices, if available. Where a quoted market price is not readily available, other valuation techniques are based on observable market rates used to estimate fair value; • Loans reflect changes in the general level of interest rates that 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; • With the exception of derivative financial instruments and acquisition contingent consideration, other assets and other liabilities reported on the consolidated balance sheets are either not considered financial instruments, or are assumed to approximate their carrying value due to their short-term nature. Other assets and other liabilities which are not considered financial instruments include property and equipment, goodwill and other intangible assets, reinsurers’ share of unpaid claims and adjustment expenses, deferred tax asset, prepaid and deferred expenses, financing costs, deferred tax liability, deferred revenue, unearned insurance premiums and other items that are not financial instruments; • For derivative financial instruments where an active market does not exist, fair values are determined using valuation techniques that refer to observable market data, including discounted cash flow analysis, option pricing models and other valuation techniques commonly used by market participants; 98 CWB Group 2014 Annual Report • For the acquisition contingent consideration, included in other liabilities, where an active market does not exist, fair value is determined using valuation techniques that refer to non-market observable inputs; • 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 terms; and, • The fair values of debt 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 judgment and, as such, may not be reflective of future fair values. Fair Value Hierarchy CWB categorizes its fair value measurements of financial instruments according to a three-level hierarchy. Level 1 fair value measurements reflect unadjusted quoted prices in active markets for identical assets and liabilities that CWB can access at the measurement date. Level 2 fair value measurements were estimated using observable inputs, including quoted market prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in inactive markets, and model inputs that are either observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 3 fair value measurements were determined using one or more inputs that are unobservable and significant to the fair value of the asset or liability. Unobservable inputs are used to measure fair value to the extent that observable inputs are not available at the measurement date. As at October 31, 2014 Financial Assets Cash resources Securities Securities purchased under resale agreements Loans Derivative related Total Financial Assets Financial Liabilities Deposits Debt Other liability Derivative related Fair Value Level 1 Level 2 Level 3 Valuation Technique $ 508,414 $ 471,643 $ 36,771 $ 2,089,205 2,089,205 99,566 99,566 – – 17,571,250 5,420 – – 17,571,250 5,420 $ 20,273,855 $ 2,660,414 $ 17,613,441 $ $ 17,414,150 $ 1,056,234 2,679 386 $ 17,414,150 $ 1,056,234 – 386 Total Financial Liabilities $ 18,473,449 $ $ 18,470,770 $ 2,679 Valuation Technique As at October 31, 2013 Fair Value Level 1 Level 2 Level 3 – – – – – – – – 2,679 – – – – – – – – 1,679 – – – – – – – – – – – $ 347,995 $ 300,995 $ 47,000 $ 2,232,332 2,232,332 – 15,614,937 4,509 – – 15,614,937 4,509 $ 18,199,773 $ 2,533,327 $ 15,666,446 $ $ 15,553,762 $ 835,639 1,679 36 $ 15,553,762 $ 835,639 – 36 $ 16,389,437 $ 1,679 99 Financial Assets Cash resources Securities Loans Derivative related Total Financial Assets Financial Liabilities Deposits Debt Other liability Derivative related Total Financial Liabilities $ 16,391,116 $ CWB Group 2014 Annual Report b) Level 3 Financial Instrument The Level 3 financial instrument was comprised of the contingent consideration related to a subsidiary acquisition. The following table shows a reconciliation of the fair value measurements related to the Level 3 valued instrument: Balance at beginning of year Business acquisition Change in fair value charged to non-interest income Balance at end of year 31. RISK MANAGEMENT As part of CWB’s risk management practices, the risks that are significant to the business are identified, monitored and controlled. The most significant risks include credit risk, liquidity risk, market risk, insurance risk, operational risk, and regulatory and legal risk. The nature of these risks and how they are managed is provided in the Risk Management section of Management’s Discussion and Analysis (MD&A). As permitted by the IASB, certain of the risk management disclosure related to risks inherent with financial instruments is included in the MD&A. The relevant MD&A sections are identified by shading within boxes and the content forms an integral part of these audited consolidated financial statements. Information on specific measures of risk, including the allowance for credit losses, derivative financial instruments, interest rate sensitivity, fair value of financial instruments and liability for unpaid claims are included elsewhere in these notes to the consolidated financial statements. 32. CAPITAL MANAGEMENT Capital funds are managed in accordance with policies and plans that are regularly reviewed and approved by the Board of Directors and take into account forecasted capital needs and markets. The goal is to maintain adequate regulatory capital to be considered well capitalized, protect customer deposits and provide capacity for internally generated growth and strategic opportunities that do not otherwise require accessing the public capital markets, all while providing a satisfactory return for shareholders. CWB has a share incentive plan that is provided to officers and employees who are in a position to impact the longer term financial success of CWB as measured by share price appreciation and dividend yield. Note 19 to the consolidated financial statements details the number of shares under options outstanding, the weighted average exercise price and the amounts exercisable at year end. Regulatory capital and capital ratios are calculated in accordance with the requirements of OSFI. Capital is managed and reported in accordance with the requirements of the Basel III Capital Adequacy Accord (Basel III). 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. 2014 $ 1,679 $ – 1,000 2013 – 1,679 – $ 2,679 $ 1,679 Based on the deemed credit risk of each type of asset, a standardized weighting of 0% to 150% is assigned. As an example, a loan that is fully insured by the Canada Mortgage and Housing Corporation (CMHC) is applied a risk weighting of 0% as CWB’s risk of loss is nil, while uninsured commercial loans are assigned a risk weighting of 100% to reflect the higher level of risk associated with this type of asset. The ratio of regulatory capital to risk-weighted assets is calculated and compared to OSFI’s standards for Canadian financial institutions. Off-balance sheet assets, such as the notional amount of derivatives and some credit commitments, are included in the calculation of risk-weighted assets and both the credit risk equivalent and the risk-weighted calculations are prescribed by OSFI. As Canadian Direct Insurance (CDI) is subject to separate OSFI capital requirements specific to insurance companies, CWB’s investment in CDI is consolidated and risk-weighted using the equity accounting method and CDI’s underlying assets are excluded from the calculation of risk- weighted assets. The required minimum regulatory capital ratios for a bank using the Standardized approach for credit risk, including a 250 basis point capital conservation buffer, are 7.0% common equity Tier 1 (CET1), 8.5% Tier 1 and 10.5% total capital. Basel III rules provide for transitional adjustments with certain aspects of the new rules phased in between 2013 and 2019. The only available transition allowance in the Basel III capital standards permitted by OSFI for Canadian banks relates to the multi-year phase out of non-qualifying capital instruments. The 2014 inclusion of non-qualifying capital instruments in non-common Tier 1 (WesTS) and total capital (subordinated debentures) under Basel III are capped at 80% (October 31, 2013 – 90%) of the January 1, 2013 outstanding balances. At October 31, 2014, there was no exclusion from regulatory capital related to the WesTS Tier 1 capital (disclosed in deposits). At October 31, 2013, a combined $30,540 of outstanding WesTS Tier 1 capital and Series 3 preferred shares were excluded from regulatory capital. At October 31, 2014, $85,000 (October 31, 2013 – $17,500) of outstanding subordinated debentures were excluded from regulatory capital. Significant capital transactions during fiscal 2014 include the February 10, 2014 issue of five million Basel III-compliant, non-cumulative, five year rate reset Series 5 Preferred Shares at $25.00 per share for gross proceeds of $125 million, and the April 30, 2014 redemption, with OSFI approval, of all outstanding Series 3 Preferred Shares (see Note 18). 100 CWB Group 2014 Annual Report During the year, CWB complied with all internal and external capital requirements. Capital Structure and Regulatory Ratios Regulatory Capital, net of deductions Common equity Tier 1 Tier 1 Total Capital ratios Common equity Tier 1 Tier 1 Total Asset to capital multiple 33. SUBSIDIARIES Canadian Western Bank Subsidiaries (1) (annexed in accordance with subsection 308 (3) of the Bank Act) October 31, 2014 National Leasing Group Inc. Canadian Direct Insurance Incorporated Canadian Western Trust Company McLean & Partners Wealth Management Ltd. Adroit Investment Management Ltd. Valiant Trust Company Canadian Western Bank Capital Trust Canadian Western Bank Leasing Inc. Canadian Western Financial Ltd. Address of Head Office 1525 Buffalo Place Winnipeg, Manitoba Suite 600, 750 Cambie Street Vancouver, British Columbia Suite 3000, 10303 Jasper Avenue Edmonton, Alberta 801 10th Avenue SW Calgary, Alberta Suite 1250, 10303 Jasper Avenue Edmonton, Alberta Suite 310, 606 4th Street SW Calgary, Alberta Suite 3000, 10303 Jasper Avenue Edmonton, Alberta Suite 3000, 10303 Jasper Avenue Edmonton, Alberta Suite 3000, 10303 Jasper Avenue Edmonton, Alberta (1) CWB owns 100% of the voting shares of each entity, with the exception of Adroit Investment Management Ltd. (84.0% ownership) and McLean & Partners Wealth Management Ltd. (54.6% ownership). (2) The carrying value of voting shares is stated at CWB’s equity in the subsidiaries. 2014 2013 $ 1,443,841 $ 1,285,692 1,673,996 1,560,801 2,304,108 2,243,654 8.0% 8.0% 9.3 12.8 8.8x 9.7 13.9 8.1x Carrying Value of Voting Shares Owned by the Bank(2) $ 134,458 25,766 19,136 11,777 8,449 8,080 1,000 1 1 101 CWB Group 2014 Annual Report 34. COMPARATIVE FIGURES Certain comparative figures have been reclassified to conform to the current period’s presentation. 102 CWB Group 2014 Annual ReportShareholder Information CWB Group Corporate Headquarters Suite 3000, 10303 Jasper Avenue Canadian Western Bank Place Edmonton, Alberta T5J 3X6 Telephone: (780) 423-8888 Fax: (780) 423-8897 Website: cwb.com Transfer Agent and Registrar Valiant Trust Company Suite 310, 606 - 4th Street S.W. Calgary, Alberta T2P 1T1 Telephone: (866) 313-1872 Fax: (403) 233-2857 Website: valianttrust.com Stock Exchange Listings The Toronto Stock Exchange (TSX) Common Shares: CWB Series 5 Preferred Shares: CWB.PR.B Shareholder Administration Valiant Trust Company, with offices in Calgary, Edmonton, Vancouver and Toronto, serves as Transfer Agent and Registrar for the common shares and preferred shares of CWB. For dividend information, change in share registration or address, lost share certificates, tax forms or estate transfers, please write or call the Transfer Agent and Registrar, or email inquiries@valianttrust.com. Duplicated Communications If you receive, but do not require, more than one mailing for the same ownership, please contact the Transfer Agent and Registrar to combine the accounts. Direct Deposit Services Shareholders may choose to have cash dividends paid on CWB common and preferred shares deposited directly into accounts held at their financial institution. To arrange direct deposit service, please contact the Transfer Agent and Registrar. Eligible Dividend Designation CWB designates all common and preferred share dividends paid to Canadian residents as “eligible dividends”, as defined in the Income Tax Act (Canada), unless otherwise noted. Dividend Reinvestment Plan CWB’s dividend reinvestment plan allows common and preferred shareholders to purchase additional common shares by reinvesting their cash dividend without incurring brokerage and commission fees. For information about participation in the plan, please contact the Transfer Agent and Registrar. Investor Relations Shareholders, institutional investors or research analysts who would like additional financial information are asked to contact: Investor Relations Department Canadian Western Bank Suite 3000, 10303 Jasper Avenue Canadian Western Bank Place Edmonton, Alberta T5J 3X6 Telephone: (800) 836-1886 Fax: (780) 969-8326 Email: investorrelations@cwbank.com More comprehensive investor information - including supplemental financial reports, quarterly financial releases, corporate presentations, corporate fact sheets and frequently asked questions - is available in the Investor Relations section at cwb.com. This 2014 Annual Report, along with our Annual Information Form, Notice of Annual Meeting of Shareholders and Proxy Circular, is available on our website. For additional printed copies of these reports, please contact the Investor Relations Department. Complaints or Concerns regarding Accounting, Internal Accounting Controls or Auditing Matters Please contact either: Carolyn J. Graham Executive Vice President and Chief Financial Officer Canadian Western Bank Telephone: (780) 423-8854 Fax: (780) 969-8326 Email: carolyn.graham@cwbank.com or Robert A. Manning Chairman of the Audit Committee c/o 210 – 5324 Calgary Trail Edmonton, Alberta T6H 4J8 Telephone: (780) 438-2626 Fax: (780) 438-2632 Email: rmanning@shawbiz.ca SENIOR OFFICERS Group Executive Officers Chris H. Fowler President and Chief Executive Officer Carolyn J. Graham, FCA Executive Vice President and Chief Financial Officer Kelly S. Blackett Executive Vice President, Human Resources Randy W. Garvey, FCMA Executive Vice President, Corporate Services Gregory J. Sprung Executive Vice President, Banking Filings are available on the Canadian Securities Administrators’ website at sedar.com. Brian J. Young Executive Vice President 2015 Annual Meeting The annual meeting of the common shareholders of Canadian Western Bank will be held in Edmonton, Alberta, on March 5, 2015, at The Fairmont Hotel Macdonald (Empire Ballroom) at 3:00 p.m. MT (5:00 p.m. ET). Senior Corporate Officers Niall Boles Senior Vice President and Treasurer Richard R. Gilpin Senior Vice President, Credit Risk Management Corporate Secretary Gail L. Harding, Q.C. Senior Vice President, General Counsel and Corporate Secretary Canadian Western Bank Suite 3000, 10303 Jasper Avenue Edmonton, Alberta T5J 3X6 Telephone: (780) 969-1525 Fax: (780) 969-1503 Gail L. Harding, Q.C. Senior Vice President, General Counsel and Corporate Secretary Darrell R. Jones, FCMA Senior Vice President and Chief Information Officer Peter K. Morrison Senior Vice President, Business and Personal Banking Allen D. Stephen, CA Vice President and Chief Accountant Commercial and Retail Banking Glen Eastwood Senior Vice President and Regional General Manager, Prairies Michael N. Halliwell Senior Vice President and Regional General Manager, Northern Alberta Mario Furlan Senior Vice President and Regional General Manager, British Columbia National Leasing Tom Pundyk President and Chief Executive Officer Canadian Western Trust Matt Colpitts Vice President and General Manager Valiant Trust Jay Campbell General Manager Canadian Direct Insurance Brian J. Young President and Chief Executive Officer Adroit Investment Management Maria Holowinsky President and Chief Investment Officer McLean & Partners Wealth Management Brent McLean Chief Executive Officer Kevin Dehod President Ombudsman R. Graham Gilbert 103 CWB Group 2014 Annual Report Locations Canadian Western Bank Regional Offices British Columbia 2200, 666 Burrard Street Vancouver (604) 669-0081 Mario Furlan Northern Alberta 3000, 10303 Jasper Avenue Edmonton (780) 423-8888 Michael Halliwell Prairies 606 - 4 Street S.W. Calgary (403) 262-8700 Glen Eastwood Equipment Financing 300, 5222 - 130 Avenue S.E. Calgary (403) 257-8235 Michael Docherty Alberta Edmonton Edmonton Main 100, 12230 Jasper Avenue (780) 424-4846 George Bawden 103 Street 10303 Jasper Avenue (780) 423-8801 Bruce Young Old Strathcona 7933 - 104 Street (780) 433-4286 Donna Austin South Edmonton Common 2142 - 99 Street (780) 988-8607 Robert Ovics West Point 17603 - 100 Avenue (780) 484-7407 David Hardy Calgary Calgary Main 606 - 4 Street S.W. (403) 262-8700 Jeff Bowling Calgary Chinook 6606 MacLeod Trail S.W. (403) 252-2299 Lew Christie Calgary Foothills 6127 Barlow Trail S.E. (403) 269-9882 Dustin Jones 104 Calgary Northeast 2810 - 32 Avenue N.E. (403) 250-8838 June Lavigueur Calgary South Trail Crossing 300, 5222 - 130 Avenue S.E. (403) 257-8235 Rick Vandergraaf Broker Buying Centre 285, 2880 Glenmore Trail S.E. (403) 720-8960 David Miller Calgary Westjet Banking Centre 22 Aerial Place N.W. Westjet Campus (403) 452-5869 Christina French Grande Prairie 11226 - 100 Avenue (780) 831-1888 Todd Kramer Leduc 5407 Discovery Way (780) 986-9858 Michael White Lethbridge 744 - 4 Avenue S (403) 328-9199 Daryn Wenaas Lloydminster C, 6209 - 44 Street (780) 874-9555 Ethan Walker Medicine Hat 102, 1111 Kingsway Avenue S.E. (403) 527-7321 Daniel Kitching Red Deer 4822 - 51 Avenue (403) 341-4000 Don Odell Sherwood Park 251 Palisades Way (780) 449-6699 Arden Vos St. Albert 300 - 700 St. Albert Trail (780) 458-4001 Blair Zahara British Columbia Vancouver Kitsilano 3190 West Broadway (604) 732-4262 Demetra Papaspyros Park Place 100, 666 Burrard Street (604) 688-8711 Brian Korpan Vancouver Real Estate 2200, 666 Burrard Street (604) 669-0081 Scott Weiss West Broadway 110, 1333 West Broadway (604) 730-8818 Jules Mihalyi Abbotsford 100, 2548 Clearbrook Road (604) 855-4941 Hugh Ellis Coquitlam 310, 101 Schoolhouse Street (604) 540-8829 Dave McGregor Courtenay 200, 470 Puntledge Road (250) 334-8888 Jean-Marc Jaquier Cranbrook 202, 828 Baker Street (250) 426-1140 Mike Eckersley Kamloops 101, 1211 Summit Drive (250) 828-1070 Joshua Knaak Kelowna Kelowna 1674 Bertram Street (250) 862-8008 Bob Brown Kelowna Industrial 101, 1505 Harvey Avenue (250) 860-0088 Jim Kruiper Langley 100, 19915 - 64 Avenue (604) 539-5088 Craig Martin Nanaimo 101, 6475 Metral Drive (250) 390-0088 Kevin Wilson Prince George 300 Victoria Street (250) 612-0123 Derek Dougherty Richmond 4991 No. 3 Road (604) 238-2800 Michael Yeung Surrey Panorama Ridge 103, 15230 Highway 10 (604) 575-3783 Greg Noga Strawberry Hill 1, 7548 - 120 Street (604) 591-1898 Bob Duffield Victoria 1201 Douglas Street (250) 383-1206 Bob Granger Saskatchewan Regina 1866 Hamilton Street Hill Tower III (306) 757-8888 Kelly Dennis Saskatoon Saskatoon City Centre 244 - 2 Avenue S (306) 477-8888 Scott Grant Saskatoon North Landing 101, 2803 Faithfull Avenue (306) 244-8008 Byron Eberle Yorkton 5, 259 Hamilton Road (306) 782-1002 Kelly Price Manitoba Winnipeg Winnipeg 230 Portage Avenue (204) 956-4669 Mike McCauley Winnipeg Kenaston 125 Nature Park Way (204) 452-0939 Christopher Voogt Canadian Direct Financial Edmonton 3000, 10303 Jasper Avenue (780) 441-2249 www.canadiandirectfinancial.com Canadian Western Trust Calgary 310, 606 - 4 Street S.W. (403) 717-3145 Edmonton 3000, 10303 Jasper Avenue (780) 969-8332 Toronto 710, 130 King Street West (416) 360-1301 Vancouver 600, 750 Cambie Street (604) 685-2081 Optimum Mortgage Edmonton 3000, 10303 Jasper Avenue (780) 423-9748 (Representation across all provinces in Canada, excluding Quebec) Canadian Direct Insurance Edmonton 500, 10115 - 100A Street (780) 413-5933 Vancouver 600, 750 Cambie Street (604) 699-3678 Valiant Trust Calgary 310, 606 - 4 Street S.W. (403) 233-2801 Edmonton 3000, 10303 Jasper Avenue (780) 441-2267 Toronto 710, 130 King Street West (416) 360-1481 Vancouver 600, 750 Cambie Street (604) 699-4880 Adroit Investment Management Edmonton 1250, 10303 Jasper Avenue (780) 429-3500 McLean & Partners Wealth Management Calgary 801 - 10 Avenue S.W. (403) 234-0005 National Leasing Group Winnipeg 1525 Buffalo Place (204) 954-9000 (Representation across all provinces and territories in Canada) Canadian Western Financial Edmonton 3000, 10303 Jasper Avenue (780) 423-8888 CWB Group 2014 Annual ReportC W B G r o u p 2 0 1 4 A n n u a l R e p o r t cwb.com

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