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Pacific & Western: A Canadian bank stock for the brave investor

Investing in Canadian banks can be so boring. Record earnings, dividend hike, blah blah blah.

Instead, spice it up a little by considering Pacific & Western Bank of Canada, the newest and cheapest of this country's publicly traded banking concerns.

In contrast to the giants of the industry with their lucrative, established business models, Pacific & Western is completing a reshaping of the company that, it hopes, will deliver increasing profits and greater returns to its shareholders – and maybe, eventually, a dividend, which Pacific & Western is alone among Canadian banks in failing to provide.

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If that's not risky enough for you, there's also the bank's parent, Pacific & Western Credit Corp., which trades separately on the Toronto Stock Exchange – at a fraction of the value of the bank itself.

Chief executive David Taylor started the business more than a decade ago with the idea of using technology to have a branchless bank, raising deposits through brokers and eschewing most consumer loans in favour of narrowly targeted lines of lending.

One area of concentration: loans to hospitals and school boards. By 2008, Mr. Taylor told The Globe and Mail he hoped his bank's new business – buying up mortgage portfolios – could put $10-billion onto the bank's balance sheet.

Things did not continue on plan. Pacific & Western Credit Corp. had to take out tens of millions of dollars of high-priced debt to shore up the bank as credit markets continued to deteriorate in the months after the bank embarked on its mortgage plans.

The bank is smaller today than five years ago. It allowed many of those lower-yielding loans to the public sector expire. It dumped a portfolio of preferred shares it held in other financial institutions because of the negative effect they would have on the bank's capital. Return on average assets for the nine months ended in July was 0.18 per cent, which is underwhelming, to be polite.

It doesn't seem like the ideal circumstance to do a bank IPO, but that's exactly what Pacific & Western Bank did in August, completing an $11-million offering. It doesn't sound like an ideal bank to invest in, either. But upon closer examination, both ideas make a little more sense.

First, the IPO: The bank, trading under the ticker PWB on the Toronto exchange, now has a market capitalization of just less than $134-million. Pacific & Western Credit Corp., trading under PWC, owns 90 per cent of the bank, yet has a market cap of less than $40-million.

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This is because of that aforementioned debt, with nearly all of the company's $82.7-million in notes bearing interest rates of close to 11 per cent, plus more than $40-million of preferred stock that costs the company even more. All of these securities may make more interesting investments than the common shares, which are way down in the capital structure.

The IPO, however, provides an interesting out for the holding company: The holders of nearly $60-million of the notes have agreed to accept the PWB shares the company holds in lieu of cash interest.

Is that a good idea? Well, it's fair to say a number of things are heading in the right direction at Pacific & Western Bank. The net interest margin – the difference between what it pays for deposits and the amount it makes on its loans – has increased for five consecutive quarters and stood at 1.91 per cent in the most recent quarter. Its capital levels easily exceed the new, tougher requirements from the Office of the Superintendent of Financial Institutions.

Mortgages and loans to the construction industry now make up two-thirds of the bank's portfolio. (The bank's investment in uninsured residential mortgages is, somewhat distressingly, six times the size of its insured portfolio, although Mr. Taylor points to low loss numbers in recent years as evidence of its asset quality).

The bank has also ventured into "bulk financing," where it buys small loans and leases made by finance companies to small businesses and consumers.

A nascent attempt at consumer credit-card lending through a partnership with the Home Hardware chain has so far been unprofitable. In an environment where Canada's six biggest banks trade for at least two times their tangible book value – tangible assets minus liabilities – Pacific & Western Bank can be had for a price-to-book multiple of just one. Its price reflects the gamble investors must take on its mixed recent track record, and what may be a rocky path to greater profitability.

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An investment in the parent company, Pacific & Western Credit, is even riskier; Mr. Taylor notes the shares' price may be highly volatile, depending on how the bank does, and may not be for the traditional bank investor who's looking for dividends.

At this time, the same could be said for Pacific & Western Bank. But it also seems to offer the only current chance for outsized gains in the Canadian banking

industry.

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About the Author
Business and investing reporter and columnist

A business journalist since 1994, David Milstead began writing for The Globe and Mail in 2009. During eight years at the Rocky Mountain News in Denver, Colo., he individually or jointly won nine national awards from SABEW, the Society of American Business Editors and Writers. He has also worked at the Wall Street Journal. More

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