message to shareholders
In last year's Annual Report, I noted that we had embarked on a strategy to reinvent our Bank to capitalize on its strengths and to adapt to the new economic realities that the liquidity crisis had presented. The key elements of this strategy were to find new revenue sources, new lower cost sources of deposits and to insulate our Bank's capital against the negative effect of external factors. I am pleased to tell you that in 2012 we made significant progress with this re-invention strategy.
Earlier on in 2011, we launched a Bulk Financing Program to provide our Bank with a new source of low risk loans and leases. We have now signed up a large number of loan and lease vendors and we expect this attractive asset class will grow steadily to a substantial size.
On January 2nd, 2012 we successfully launched a new credit card for Home Hardware's customers and received a tremendous response from Home Hardware's dealer network. Home Hardware has approximately 1,075 dealers that operate throughout Canada and we are very pleased to be working with these dealers to provide them with a high quality credit card financing service. Credit card numbers and balances are growing steadily and we expect by early summer we will have sufficient revenue to allow this new division to breakeven and start making a profit.
On April 2, we launched a new custom banking software for trustees in the bankruptcy industry. There are approximately 900 trustees in bankruptcy operating throughout Canada with deposits that fluctuate around $2 billion. After completing a successful pilot program with MNP LLP and BDO Canada, two of the largest insolvency firms in the country, our Bank began offering its unique banking solution to trustees across Canada. The trustee industry is enthusiastically receiving this new product and we expect balances of this low cost deposit product to grow steadily in the coming months, reducing our Bank's cost of funds and diversifying its deposit base away from expensive GICs.
Adapting to the New Economy
During the liquidity crisis, our Bank's regulatory capital was negatively affected by a rapid decline in the Bank's portfolio of other financial institutions' preferred shares. In 2012, we completed the sale of these securities and recovered the losses previously booked.
During the liquidity crisis, the historically high correlation between the yield on banker's acceptances and that of our same term GICs was significantly reduced giving rise to a substantial loss on interest rate swaps we were using to hedge our longer term loans. During 2012, we were able to raise sufficient longer term deposits to naturally hedge our loans and eliminate the need to use swaps and thereby eliminate the significant basis risk they presented.
2012 Objectives and Achievements:
Improve profitability by increasing net interest income and spread through loan growth in established markets and expansion of the bulk lease finance program.
I am pleased to tell you that our Bank's net interest income grew by 16% from $16.9 million to $19.6
million and total revenue grew by 12% from $28.9 million to $32.4 million. However, non-interest expenses in our Bank grew by 37% from $17.7 million to $24.3 million and by 14% from $21.2 to $24.1 in our consolidated group. In 2011, most of the development expenses associated with the bulk finance, credit card and trustee deposit programs were not born by our Bank, but rather were absorbed by the group. However, now that these programs are all running, the ongoing expenses are born directly by the Bank. As a percentage of assets, our group's expenses have increased significantly over the past few years. Some of this increase can be attributable to the additional expense associated with responding to the elevated amount of regulatory oversight our industry now faces since the liquidity crisis and some can be attributed to the new programs we initiated. With respect to the former, I believe that the "new normal" is that it now costs more to run a bank than it did in the past and with respect to the latter, I believe that the additional expenses associated with running our new programs will be more than offset this year and in the future by the additional revenues they are generating and will generate. However, you can rest assured that we are always looking for ways to operate more efficiently, and this year is no exception. We are reviewing all our operating costs with a view to reducing them wherever possible. Overall, our Bank earned $3.8 million down from the previous year of $7.6 million, with most of the reduction attributable to start-up costs associated with the new programs and an additional $1.9 million income tax provision. Please see our MD&A for a full discussion about this provision. The total group incurred a loss of $5.1 million down from the previous year's loss of $8.2 million. The group has additional interest expense over and above what our Bank incurs of $7.6 million and also makes additional tax provisions. This additional interest expense is associated with its Preference B shares dividend, which is accounted for as interest expense and the net interest paid to its Series C note holders. The majority of this additional interest expense was incurred by issuing Preference B shares and additional Series C notes in order to provide additional regulatory capital to our Bank during the liquidity crisis.
Maintain high credit quality by continuing the Bank's strict disciplined approach to financing and management of its lending portfolios.
The highly disciplined approach we have taken to credit risk management has resulted in two decades of
industry leading statistics. This is particularly impressive, considering our primary target market over this time frame has been commercial real estate, a market that has proven difficult for other lenders to manage. In 2012, our gross impaired loans to asset ratio was 0.10% versus our peer group as shown in CDIC's 2012 Annual Report of 4.0% and the total CDIC membership of 0.50%. This has always been a strength of Pacific & Western's and we are continuing to improve upon it to ensure that it remains that way.
Successfully launch a private label credit card program bringing additional revenues to the corporation and diversity to the lending portfolio.
On January 2nd, we successfully launched the Home Hardware private label credit card and now have
over 28,000 new credit card customers. I expect these numbers will continue to grow so that this program will begin contributing to our Bank's profits early in the summer months.
Successfully launch a new banking software package for trustees in the Bankruptcy industry, thereby reducing our Bank's cost of funds and bringing further diversity to its deposit gathering network.
On April 2nd, we successfully launched this new software platform and are now marketing it throughout
Canada. It is being enthusiastically received by the industry and I expect it will eventually result in our Bank's cost of funds being more comparable to the larger banks that have low interest chequing accounts.
Poised for the Future:
Increase our Bank's regulatory capital ratios to be consistent with those of its peers in the banking industry.
On January 1, 2013 Canadian banks adopted a Canadian version of a new method of determining what
amount and form of capital is adequate for a bank given its risk profile. The driving force behind the creation of this new method was to make very large banks too safe to fail, so that governments would not have to bail them out. This new method of determining capital is included in the new Basel III capital requirements. Unfortunately, very few countries adopted these new requirements as they were originally proposed. Most countries chose to "water down" the requirements. Canada, on the other hand, faithfully implemented Basel III and is referring to its requirements as "gold plated" capital requirements. Although our Bank is one of the smallest banks in the world it has also achieved these "gold plated" capital ratios. On January 1, 2013 our Bank met the new Canadian Basel III capital requirements, but it is clear to us that in order for our Bank to grow and prosper under these new rules, we will have to make some structural changes. Accordingly, on January 28, 2013 we announced our plans to list our Bank on the TSX and strip it of most of its expensive subordinate debt capital. Listing the Bank on the TSX will give it direct access to the public markets so that it can raise additional capital to support growth as the need arises and stripping it of most of its expensive subordinate debt will significantly increase its profitability. Our Bank is a very valuable asset, and I am sure you will agree that, we as its owner should do what we can to ensure it always meets "the gold plated" capital requirements and has access to sufficient capital to grow and prosper.
A New Role for PWC
A second part of this strategy is for PWC (the Bank's parent) to once again invest in commercial real estate. Those of you who have been owners of PWC for a long time will recall that it once held a subsidiary called PacWest Ventures (PWV). PWV was incorporated to capitalize on our considerable knowledge of commercial real estate and earn profit by investing in this area. In 2002, while we were converting our trust company to a Schedule I bank we chose to amalgamate PWV with PWC. It now appears like a very good time to re-activate this idea especially considering that PWC has approximately $35 million in tax losses available. I will be speaking much more about this plan in future press releases and at our annual shareholder meeting.
I think our Bank has now been re-invented to grow and prosper in the "new normal" economic and regulatory environments. The investments we have made to diversify its revenue streams and its deposit base will soon start to pay significant dividends. The plan to list the Bank as a separate entity will no doubt make it much easier for investors to see its true worth. This certainly ought to have a positive effect on the value of our shares in PWC. Secondly, our plan to make well considered investments in commercial real estate will allow us to further capitalize on our expertise in this area and earn additional tax sheltered income.
I have been a significant shareholder of PWC for over 20 years and I know some of you have been with me that long. We have experienced the rough times of recessions and most recently the liquidity crisis along with the heady times of the dot com days when our shares traded for $17 at an enormous price earnings ratio of over 50 times. As they say "what doesn't kill you makes you stronger" and I believe PWC has emerged from the challenge of the liquidity crisis and the aftermath of regulatory change much stronger. We are blessed with a knowledgeable and dedicated board, talented and committed staff, state of the art systems and products ideally suited for our niche markets. I am keenly engaged in returning our shares back to a reasonable value and very much appreciate your support.