Canadian Western Bank Q2 2023 Earnings Call Transcript

Quartr
Provided by Quartr
May 26, 2023

There are 12 speakers on the call.

Operator

Good day. My name is Michelle, and I will be your conference operator today. At this time, I would like to welcome everyone to the CWB's Second Quarter 2023 Financial Results Conference Call and Results Conference Call and Webcast. All lines are being placed on mute to prevent any background noise. Financials.

Operator

Thank you. I will now the call over to Chris Williams, Assistant Vice President, Investor Relations. Please go ahead, Chris.

Speaker 1

Good morning, and welcome to our 2nd quarter Financial Results Conference Call. We'll begin this morning's presentation with opening remarks from Chris Fowler, President and Financial Officer followed by Matt Rudd, Chief Financial Officer and Karolina Parra, Chief Risk Officer. Financial results. Also present today are Stephen Murphy, Group Head Commercial, Personal and Wealth and Jeff Wright, Group Head Financial Services. After our prepared remarks, they will all be available to take your questions.

Speaker 1

Financial results. As noted on Slide 2, statements may be made on this call that are forward looking in nature, which involve assumptions that have inherent risks financial results could differ materially from these statements. I would also remind listeners financial measures to arrive at adjusted results. Management measures performance on a reported and adjusted basis and considers both to be useful in assessing underlying business performance. I will now turn the call over to Chris Fowler, who will begin his discussion on Slide 4.

Speaker 2

Thank you, Chris, and good morning, everybody. Before I begin my prepared remarks, I'd like to say that our thoughts are with the thousands of people who have been displaced and affected by the wildfires in Western Canada. Financials. Our clients and communities have proven their resilience to navigate similar challenges in the past and we remain ready to provide support to financials. We reported adjusted EPS of $0.74 per share, which was down 27% or $0.28 financials.

Speaker 2

The previous quarter included a $0.13 benefit from the reversal of a previously recognized impaired loan write off. Financial results. The current quarter also reflected 3 fewer interest earning days and a provision for credit losses that move towards a more normal level financials from the very low provisions recognized over the previous 2 years. We continue to build meaningful strength and resilience in our organization with a consistent and disciplined risk appetite, which has enabled us to navigate the significant disruption that we've observed in the banking industry during this quarter. We grew total loans by 2% compared to the prior quarter with increases across our national footprint financials and very strong growth in our general commercial loans of 4%, primarily reflecting growth in Ontario that was supported by our Mississauga and Markham Banking Centres.

Speaker 2

We delivered another quarter of low credit losses supported by the secured nature of our loan portfolio with conservative loan to value ratios to support the right growth opportunities through the business cycle. As Carolina will discuss in a moment, we're starting to see credit performance returning to more normal levels compared to the very benign conditions over the last 2 years. The normalization of credit is expected along with credit losses that remain within our normal historical range through the remainder of the year. Our regulatory capital ratio strengthened during the quarter without the use of our aftermarket equity distribution program. Equity, which provides lower risk weights for many of our lending portfolios.

Speaker 2

Matt will speak to this further in a moment. Financial results. Our branch raised deposits declined by 2% this quarter, with the entire decline occurring prior to the global banking industry volatility that escalated financials. Following these events, we delivered growth of branch financials. These changes were made to better respond to increased competition for deposits that arose during the quarter.

Speaker 2

We exited the quarter with a positive trend of branch raised deposit growth that we expect to continue through the balance of the year. As we look forward, we're now targeting lower annual loan growth than previously expected. With the change in our forward view, we'll be vigilant with expense growth financials against revenue to position ourselves to deliver positive operating leverage through the remainder of the year. With interest rates to remain elevated, We continue to expect that our net interest margin will expand in the second half of the year, but at a slower pace than previously anticipated, primarily due to higher funding costs from elevated competition. We'll continue to drive selective growth in our risk adjusted loan yields to deliver stronger net interest margin performance in the second half of fiscal twenty twenty three.

Speaker 2

Our teams are focused financials. We are pleased to announce that we are on

Speaker 3

track to deliver our business to adjust to lower

Speaker 2

loan growth expectations and keep us positioned to finish the year financials with adjusted ROE within our financial scorecard range of 10% to 11%. Our forecast is to deliver stronger financial results results. We remain well positioned to drive accelerated growth when economic conditions improve as we have through prior cycles. Financial results. I'll now turn the call over to Matt, who'll provide greater detail on our Q2 financial performance.

Speaker 4

Thanks, Chris. Good morning, everyone. Financial results. We begin on Slide 6. Our branch raised deposits were up 3% from last year, reflected 25% growth in our fixed term deposits, partially offset by a 5% decline in demand in notice deposits.

Speaker 4

In the elevated interest rate environment, clients continue to favor fixed term deposits. 2% decrease in both branch raised demand and notice as well as term deposits. Demand and notice deposits were down as we intentionally exited select higher cost non full service client relationships early in the quarter. We grew demand and notice deposits through the second half of the quarter, partly supported by strategic pricing adjustments to respond to the elevated competitive environment. The 2% decrease in branch raised fixed term deposits reflected our choice to replace select maturities with broker term deposits at a lower relative cost.

Speaker 4

Capital market deposits decreased by 6% from last quarter due to a senior deposit note maturity that we also elected to replace with broker term deposits at a lower relative cost. Maturities between 1 5 years that are predominantly insured deposits. Our conservative approach to liquidity management ensures we maintain strong levels of liquidity well in excess of the regulatory requirements and we continue to hold a liquidity coverage ratio that's higher than the current levels of the large Canadian banks. Turning to Slide 7, our total loans were up 9% in the past year. Our focus to increase full service client relationships across our national footprint drove very strong 16% growth in the strategically targeted general commercial portfolio.

Speaker 4

Annual growth in commercial mortgages of 5 financials. The increase in personal lending of 7% was driven by solid new credit scores. Both the commercial mortgage and personal lending portfolios remain relatively flat compared to the previous quarter as new lending volumes that met our risk adjusted return expectations were offset by scheduled repayments. Our sequential earnings performance is shown on Slide 8. Common shareholders net income decreased 26% sequentially, primarily driven by 21 basis point increase in the provision for credit losses and a 3% decline in revenue.

Speaker 4

Pretax pre provision income decreased 8%. Compared to the prior quarter, adjusted EPS decreased $0.28 In the Q1, we benefited $0.13 from the reversal of a previously recognized impaired loan write off, which reflected the combined impacts Within the quarter, higher non interest income increased EPS by $0.03 Excluding the benefit received in Q1 From the reversal of previously recognized write offs, lower net interest income reduced EPS by $0.06 mostly driven by 3 fewer interest earning days this quarter financial results and a 3 basis point decline in net interest margin, again, net of the impaired loan interest recovery in the previous quarter. Higher non interest expenses reduced EPS by $0.01 primarily driven by seasonal increase in statutory employee benefits, while our discretionary expenses were well contained. Financial results. Excluding the impact in Q1 from the reversal of the previously recognized impaired loan write off, the increase in the provision for credit losses reduced EPS by $0.14 financial results.

Speaker 4

EPS reductions also included $0.02 from the impact of a higher effective tax rate reflecting one time true ups financial results and a $0.01 impact from higher LRCN distributions. As shown on Slide 9, total revenue decreased 3% on a sequential basis. Income, which was driven by a strengthening U. S. Dollar in the quarter.

Speaker 4

Net interest income decreased by 5% as 2% sequential loan growth was more than offset by 3 fewer interest earning days and a 6 basis point decrease in net interest margin. As shown on Slide 10, our NIM decreased 6 basis financials this quarter with half of the impact related to the non recurring 3 basis point interest income recovery recorded in the prior quarter. NIM benefited 1 basis point this quarter from the full quarter impact of a 25 basis point Bank of Canada policy rate increase made at the end of January, impact in our floating rate loan yields, net of floating rate deposit costs. Fixed rate asset yields continue to increase, but were partially offset by lower loan related fees financial results for a net contribution of 17 basis points to our NIM this quarter. Higher fixed term deposit costs had a negative 16 basis point impact.

Speaker 4

As expected, the benefit from group pricing fixed rate loans at higher market interest rates closed the gap this quarter to the slowing impact from higher fixed rate deposit costs. As I discussed previously, we made strategic pricing adjustments to certain administered rate deposit products during the quarter, which benefited deposit growth late in the quarter, but reduced NIM by 5 basis points. Changes to our asset mix and funding mix had no significant impact to NIM this quarter. Our capital ratios are calculated using the standardized approach and the drivers of our CET1 improvement are shown on Slide 11. Our CET1 ratio increased 22 basis points to 9.3% this quarter.

Speaker 4

Guidance. The improvement from last quarter primarily reflects a 15 basis point increase associated with the adoption of CAR 2023 guidelines in the quarter, retained earnings growth financial results and a decrease in accumulated unrealized losses on our debt securities. This was partially offset by risk weighted asset growth. No common shares were issued under the ATM program this quarter. The impact of the lower loan growth outlook that Chris discussed earlier results in moderate growth of our financials from its current level throughout the rest of the year, which we believe is appropriate based on the potential volatility and economic conditions and provides us with capacity to support future accelerated growth when prudent.

Speaker 4

Yesterday, our Board declared a common share dividend of $0.33 per share, guidance range, up $0.01 from last quarter and up $0.02 or 6% from last year. I'll now turn the call over to Carolina, who will speak further on our credit performance.

Speaker 3

Thank you, Matt, and good morning, everyone. Beginning on Slide 13, total gross impaired loans represented 68 basis points of gross loans, in support of lending exposures. Our strong credit risk management framework, including well established underwriting standards, financials. The secured nature of our lending portfolio with conservative loan to value ratios and a proactive approach to work with clients through difficult periods continues to be an effective approach to minimize realized losses on the resolution of impaired loans. This is demonstrated by a history of low write offs as a percentage of total loans, including through past periods of economic volatility.

Speaker 3

I would also note that we do not have any material exposure to unsecured personal lending, including no exposure to personal credit cards. As part of our prudent risk management framework, the overall loan portfolios review regularly to provide early identification of possible adverse trends. Turning to Slide 14, I will discuss our commercial real estate portfolio. We are an experienced and specialized and our strong risk management framework has consistently delivered high credit quality with low credit losses. Financial results, along with disciplined project selection to withstand credit slowdown.

Speaker 3

We focus on prudent risk underwriting, structuring using risk policies and lending standards, sensitivity analysis and ongoing monitoring of our portfolio. Financial results. Our conservative approach has created a portfolio with strong credit profile that combined with a strategic decision to focus on selective risk financial returns has resulted in growth of roughly half the rate that our larger peers have grown their total commercial real estate portfolios. Financials. Our total commercial real estate portfolio represents 29% of total loans, which is down from 33% 5 years ago.

Speaker 3

Real estate project loans now represent 9% of our total loans, down from 16% 5 years ago. Financials. Our commercial real estate portfolio is diversified and residential construction exposures represent over 40% of the portfolio. Real estate exposure is multifamily residential and the remaining portion represents development and construction of single family residential. 9% of our commercial real estate portfolio relates to office space, which is primarily includes exposures for low rise buildings that are located outside large downtown centers.

Speaker 3

We are proactive in our loan management and have completed a review of our office exposure. We recognized impairments in this portfolio this quarter with prudent provisions for credit losses added as we worked with our financials. Turning to Slide 15, financial results. Despite elevated interest rates continue to work their way through the Canadian economy, our provision for credit losses was 12 basis points this quarter and remained below our 5 year average of 17 basis points. The performing loan allowance was consistent with the financials.

Speaker 3

And reflected relatively stable default rates and updated macroeconomic forecast with slight improved housing price growth outlook financial results and a softer near term outlook for gross domestic product growth. As we mentioned last quarter, we continue to expect that the impact We continue to recognize the current economic environment and feel confident of how we're managing the portfolio through the financial outlook.

Speaker 2

Thank you, Carolina. Turning to Slide 16. The result of lower loan growth expectations in the current environment financials. We are pleased to announce that our quarterly results are in the Q1 of 2019. We are pleased to announce that our earnings release will

Speaker 5

be

Speaker 2

continue to target growth in our risk adjusted loan yields to help support stronger net interest margin performance in the second half of fiscal twenty twenty three. Financial results. We'll also manage our discretionary expense growth to adjust to the lower growth environment to position ourselves to deliver positive operating leverage through the second half of this year. As Carolina noted previously, we continue to expect provisions for credit losses to remain within our normal historical range financial results, reflecting the strong credit quality and secured nature of our loan portfolio. Through these actions and supported by the strength of our credit performance, we expect to drive annual adjusted earnings for fiscal 2023 in the range financials of $3.50 to $3.60 and adjusted return on equity in line with our 2023 scorecard targets.

Speaker 2

As we look forward, the combination of our robust balance sheet and capital position, our experienced and specialized financials. We are pleased to announce that our teams in the markets we operate across Canada and our prudent approach to how we grow have us well prepared to navigate the potential economic volatility that may unfold. As we have in past periods of economic volatility, we will remain well positioned to capitalize on opportunities to accelerate growth when conditions improve. Financials. Their collective efforts have earned national recognition as the Business Lender of the Year by the Canadian Lenders Association.

Speaker 2

I'm also extremely proud that for the 2nd consecutive year, CWB placed within the top 25 on this year's best workplaces in Canada, recognition for our commitment to a people first culture. I'll now turn the call back to the operator for the Q and A portion of this call.

Operator

Your first question comes from financials. Doug Young of Desjardins. Please go ahead.

Speaker 5

Hi, good morning. Maybe Matt, if we can start with NIMs. Maybe I'll kind of take this in 2 parts. First part, like if you repriced your balance sheet today, what would NIMs be? And how long will it take to get there?

Speaker 5

Because I know there's a difference in the duration and how the funding cost is moving versus your asset yields. Maybe I'll start there and I just got

Speaker 6

to follow-up on them too.

Speaker 4

Yes. So on the trend, just mechanics of the book, Doug, I'd point to, I'd say, a trend we signaled last quarter that we expected to start in the Q2, and that's precisely what we've seen. If you recall last quarter sequentially, we saw an increase in fixed asset yields at 17 basis points or so. Funding costs, they had increased $29,000,000 So that was an unfavorable gap, but that gap has started to close in Q1. And I made the prediction that in Q2, we see that gap close.

Speaker 4

And I think you can see from the slide we put up, our asset yields and funding costs were up on a pretty equivalent basis this quarter, in fact assets maybe one basis point of benefit. So that's an encouraging trend and that's Exactly what we expected and just looking at how that book was structured and the churn. If we play that forward, there's likely About another year or so of this continuing trend where asset yields continue to tick up. And then just structurally fixed term funding costs, We don't expect them to go up much further just if you're looking at market GIC rates. They feel a bit at peak levels, especially at the shorter term lengths.

Speaker 4

So we'll continue to benefit and get a NIM lift from just those mechanics over the next year. Structurally, what does that mean? Financials. There's lots of other puts and takes in our NIM, funding mix, asset mix, those are important, competitive pricing dynamics in the market, that's important. But if all else was held equal and we just looked at how the book churned, mechanically you'd be thinking about a NIM in the mid-250s With of course many puts and takes.

Speaker 5

And that takes about 2 years to fully get to that. Is that a fair assumption?

Speaker 4

Well, the differential in duration between kind of average assets and average liabilities, our assets sort of being in that high 2 year range in liabilities in that low 1 year range. You kind of have a year, year and a half of delta between those two lengths. So that's about what it would take for the portfolio to fully churn. And we're basically we've turned the corner this quarter and we're starting to see it.

Speaker 5

And then the negative on that would be as if you had to raise funding costs like administrative rate funding costs again Because of competitive pressures, like that would be the biggest other delta that would go against that repricing on the asset yield Is that correct?

Speaker 4

Yes. I mean that would be something you'd look at as a potential headwind. I mean we did make an adjustment this quarter. The adjustment we made and we've been very careful on our administered rate deposit costs really through the first half of the year and over the last several quarters. The reason why is when you increase pricing there, you effectively reprice that whole product.

Speaker 4

And so the impact on NIM, adjustments. We like to be in line with the competitive data set and where others are pricing this product. We had fallen outside of that band position through looking through the rest of the year, especially one where if you think about market interest rates moderating, holding the line on the rates we have on these deposits feels like a pretty strong competitive position. And so I don't know, I'd circle this financials. A big risk to our NIM looking forward.

Speaker 4

We made an adjustment this quarter in response to what we saw south of the border. Fortunately, none of that hit us up here. There was no impact that we saw on our deposit base. So it ended up being a conservative pricing adjustment and tactic we took. The benefit going forward is it's driven a pretty strong trajectory of growth in those products that will serve us well as the year progresses.

Speaker 4

So we're feeling like we're pretty well positioned at this point, Doug.

Speaker 5

And then just last on NIMs, like what is so if it's not

Speaker 4

Well, the big drivers of NIM, if you thought if you highlighted funding mix, obviously, Skewing to a lower funding cost mix would be beneficial to NIM, obviously. Asset mix is important. So if we're looking forward And we're not out looking for growth to necessarily maximize spread on an absolute basis. Anytime we're thinking about spread, It's in relation to risk adjusted returns. So spread relative to the risk, composition of our growth years, there are certain categories of lending that would have had higher yields, higher spread relative to others.

Speaker 4

We just didn't like the risk return trade. And so we got into lending that had a lower absolute spread, but higher average credit quality, low credit risk. And so you don't like the dynamics on your NIM, but looking forward in terms of credit loss performance, it's one of the things that gives us confidence that our credit will be well contained and well controlled looking forward. So those are things obviously market pricing on GICs, financials. Broker GIC pricing, capital market deposit pricing, those are things that can impact your NIM, but those are tools and levers and options we'll look at and continue to place funding and where we think the most cost effective place is.

Speaker 4

We just like having that optionality and we'll use it wisely as the year progresses.

Speaker 5

It takes me to my second question and Chris, maybe this is for you or Matt. With that in mind, you obviously are slowing your loan growth down, because you don't like the risk return characteristics. Does this have implications on NIM that we should be thinking about because of Matt what you just said.

Speaker 4

When we look forward, I'll start and then Chris can give Bill and the strategic part of it, but just the mechanics of it. If we're looking at loan growth in a lower growth environment, We are even more we're always focused on risk adjusted returns, but in this sort of an environment, you look to set the bar higher. So when I look at the likely composition of growth through the remainder of the year, I don't think it will be a headwind on NIM relative to We've been growing over the last year. We've been operating very prudently and targeted and how we've been lending in the normal course here. So it's I wouldn't expect a big calibration or big shift in asset mix that I'd point to as a NIM headwind, but I'll throw it to Chris to just lay out just strategically how we're thinking about portfolio allocation, which portfolios we favor in this sort of an environment, but I wouldn't highlight it as a NIM headwind, Doug.

Speaker 2

Yes, agreed. And thanks, Matt. As we think about if you see that the growth that we have posted has had higher on the general commercial side. And that general commercial So those are the opportunities that we think are very positive that higher yielding books that have not grown at the pace we historically did grow them at Real Estate Project Lending and Equipment Finance, the specific reasons for that as we think about the environment that we're in. Equipment Finance, of course, the headline there or the finance remains a very attractive market for us and we will continue to work with that to grow it and really support it.

Speaker 2

And project lending, we could be very specific on where we participate very targeted on the type of client we take on and the projects in which we finance. So we're very focused on that allocation perspective and thinking about how we really continue to very proactively build the bank in a very positive way.

Speaker 5

Okay. Is that Is it general commercial you expect to continue to grow? It's real like which category is where you're more going to curtail the growth

Speaker 7

Is what I'm going to be

Speaker 5

trying to figure out.

Speaker 2

Right. Well, I would say that you would see less growth in commercial mortgages, real estate project lending.

Speaker 4

The other portfolio I'd highlight, which is no different than anyone else, Doug, would be residential mortgages and that's a low spread book as well. So that's I'd expect limited growth.

Speaker 5

Okay. I've got a few more, but I'll requeue for now. Thank you very much.

Speaker 2

Okay. Thank you.

Operator

Thank you. The next question comes from Darko of RBC. Please go ahead.

Speaker 8

Hi, good morning. Thank you. I wanted to just follow-up on this discussion. Low spread. Is that to say that there is less demand for this product or is it that you're actually going to Probably avoid it a little bit because it is low spread.

Speaker 4

Yes. And low spread, it would be low relative to other opportunities we have on the commercial side. Yes, I think it's a case of 1, expecting really strong risk adjusted returns in that sort of a portfolio and this sort of an environment, but certainly on the demand side, I think we're seeing that start to slow as well. So it's kind of 2 factors hitting that 1 Darko.

Speaker 8

Okay. So I just want to be very clear on the mortgage you're seeing, it looks like very strong growth here when I'm looking at slide. And you're saying that you're seeing it slow in demand. I think that there's another dynamic here that I just want to make sure that I understand very well is the funding side. So when I look at what you've put together on the slide, which is helpful by the way, Thank you very much for it.

Speaker 8

But you do mention that you've exited some sort of relationships or some deposits that were not full service demand and notice. Can you just maybe Describe the nature of those deposits?

Speaker 4

Sure. So why don't we get Jeff to step in and Just kind of outline the strategic way we've looked at deposit profitability. And obviously, with the pressure just in dynamics of our book, Assets versus liability repricing, we've been very mindful of this and making sure we're being as profitable as we And within prudent limits obviously on our liability base, I'll throw it to Jeff.

Speaker 9

Thanks, Matt. Good morning, Dorco. As we've talked about, the bulk of our deposit book is driven by our full service relationships and that continues to have positive growth through the year. And on those, we really look at the cost closely compared to other funding sources and made some trades, particularly early in the quarter that we liked other funding sources better, and decided to exit a few of those relationships.

Speaker 8

Okay. So tying them both together, the reason why I'm asking these questions in a very odd manner is When I look at the broker market today for GICs, which looks like you've been favoring and growing In view of these other deposit relationships that seemingly are non core, if I were to just compare Where you are today versus, let's say, the beginning of March 1 before we had any disruption. In the 1, 2 and 3 year tenure of GIC deposits in the broker market, you're about in the 1 year, you're about 35 basis points Higher than a large bank. In the 2 year, you're 72 basis points higher. And in the 3 year, you're 76 basis points higher than a large bank.

Speaker 8

And in March 1, you were 17 basis points, 22 in 2017. So there's been a fairly significant jump. And that's why I was very interested in the nature of the other deposit that you're exiting This is fairly significant. And the reason why I asked about mortgages was because when I look at the brokered mortgage deposit market, The competition will come from some subprime mortgage providers or nearprime mortgage providers. They are Only today about 2 basis points higher than you.

Speaker 8

So I suppose where I'm going with all of this And the option going forward really is in the GIC brokered market. You're really competing against a couple of very specific firms that are pushing up their pricing versus bank. And so the question is, specifically within financials. When you think about those competitors, they have been pushing higher and I've been watching this closely over the past quarter. Financing.

Speaker 8

And is there any reason to believe that they will stop pushing that GIC term funding cost higher for you because that's who you're ultimately competing against?

Speaker 4

Financials. Yes. So a few things on this. First, just thinking about the rest of the year and how we think about funding. I mean, you heard me reference optionality and I mean, that's What we've set up for the back half of the year.

Speaker 4

Our branch raised deposit trend through the quarter overall was negative. We exited on an up swing and we're seeing that momentum continue. And so I mean that's the first channel you look at on a cost effective basis to drive growth. And if you think about a lower loan growth environment in the back half of the year, it creates a pretty comfortable funding profile relative to the momentum we're seeing in branch raised deposits. But the trade you ultimately look at and this is the trade we've been looking at through the first half of the year and it really intensified, you're right, since coming basically since March.

Speaker 4

We've seen the large banks And you've probably seen this in looking at pricing, not be overly aggressive in that brokered GIC market, although We have actually done some volume there. And at times, you see them move up the leaderboard. Where they have been especially aggressive and we have seen pricing at times 50 to 75 basis points higher than what we can ultimately pay in the broker GIC market, would be on larger kind of non core GICs that when we look at Our preference in that trade would obviously be the lower cost, but you're also obtaining smaller deposits. You can think about the maturity ladder of Stack them how you need to stack them more bite sized at a lower cost for us. It makes our headline branch raised deposit number, I suppose, look financials, a bit worse, but on a relative trade from liquidity management, funding profile, relative cost, financials.

Speaker 4

We favored that trade and that's something we'll continue to be mindful of. And you basically look at relative pricing of the various options, be that broker, be that be that the debt capital markets, be that tactics you can deploy in your branches, either promotions, marketing campaigns or pricing to drive that channel. You do the economics and you take your best option based on what's presented to you.

Speaker 8

Okay. But to be clear, have you sort of finished that? Are there still pockets So these non full service fixed term deposit maturities that you think you should be replacing here at these prices? Or are you kind of done there? And will we need the source of funding going forward really come from the term GIC broker market?

Speaker 4

We'll have some decisions to make. No real big ones coming through, Darko, but we'll have some that when they come up for maturity, we'll take a look at the relative options and we expect to continue to use the broker GIC market just not to the same volume and extent we did through the first half of the year. I think you'll see us our volumes there taper off.

Speaker 8

Okay, fair enough. All right. Thank you very much for taking the questions.

Operator

Financials. Thank you. The next question comes from Marcel MacLean of TD. Please go ahead.

Speaker 7

Okay. Good morning. Thanks for taking my question. I'm going to start on expenses. Just wanted to get A little bit more information on where you intend to cut expenses because given the revised efficiency ratio outlook of Approximately 51%, and we're at 54% year to date.

Speaker 7

So over the next two quarters, doing the math that implies a fair bit of expense cut. This quarter, it obviously came down a fair bit, and that's trending in the right direction. But to get to that 51%, I think I would still imply and still pretty meaningful cuts in the second half. So just wondering where you see those expenses coming out?

Speaker 4

Financials. Yes. Fair enough. And let's start with just maybe the Q2 expenses as if we anchor to that and just think from Q2, where do these trend through the back half of the year, what are we thinking about? I mean, you start at salaries and benefits, it's 2 thirds of our NIE.

Speaker 4

So that's the financials. We've been managing tightly there, whether that's salary increases. I think if you do some back of the envelope math, you'll see we've been Pretty well contained, although of course, we've had to make inflationary adjustments, but not to the same extent as others. It's been very well managed. The way we'll manage that looking forward, obviously, it's a lower growth environment.

Speaker 4

Financials. We'll have attrition as the year progresses and we'll just be very mindful on how we ultimately backfill those roles. Do we go Person for person, role for role, do we take that headcount and deploy it elsewhere? Do we let that level of headcount rundown a bit. These are the sort of levers and options we'll think about as the year progresses, but we will be laser focused financials.

Speaker 4

Every single headcount we add will have a high degree of scrutiny and we'll need to have strategic value in making that addition. So That's one where we will be tight and sharp on that. Within the Q2 number, I mean, you see that We had a bit of a tick up and that was due to some sales incentives based on growth delivered kind of on a trailing basis. If you think looking forward, just organically, we'll get a bit of relief on that number looking forward as well. On the premises and equipment, I think Q2 is a reasonable run rate.

Speaker 4

I think we'll see that tick up a little bit financials. Just as we get digital kind of continue working and over the finish line, but it'll be a pretty close run rate through the rest of the year. And then if you go down to that category of other expenses, on the discretionary expenses overall, I'd expect us to hold the line on those levels through the first kind of the Q3 and Q4. We'll look for opportunities to nip and tuck financials. Where that makes sense and where prudent.

Speaker 4

Usually in Q4, we see an uptick in that bucket of other and those discretionary expenses Particularly, our intention this year would be to basically hold the line on the trend through Q3. And then within that bucket, if we look specifically at the Q2 number I wouldn't expect them to reoccur for instance in filing our GST returns which is an annual activity. There was a bit of a true up needed there. Our normal run rate for these other expenses should be more like $3,000,000 not the $5,000,000 that was recognized this quarter. So we'll get some benefit there.

Speaker 4

Financials. I think if you take that recipe I just laid out and put it together, it should help you square the math on how we're thinking about expenses for the back half of the year, financing it very tightly.

Speaker 7

Okay. Thanks. I appreciate that color. And then my second question is on the CRE quarter. Significantly larger proportion of the bank's overall loan book compared to larger peers, obviously, given your more commercial posture.

Speaker 6

Just wondering if you could

Speaker 7

speak to the reserve levels you're holding against those loans specifically and how that compares to maybe say a year or Or more ago, how that's trended in terms of conservatism. And any other metrics you wish to provide or highlight like

Speaker 2

Thanks, Marcel. Yes, we've participated in the CRE market for our entire history and it's A very disciplined approach that we do take both on the construction side and on the commercial mortgage side in terms of on the construction side, Thinking about who the border is, location, how we structure all of that with respect to presales and financials that go into place there. When we look at the commercial mortgage side, we lend to the rent rolls, thinking about mortgage ability, financials. Looking really across industrial, commercial, retail and office and offices of the smallest of all the sectors we lend into. We did impairments in that office sector this quarter.

Speaker 2

And we're really looking at how we measure and Set up the provision there. We want to be very conservative. We always are conservatives when we think about setting up provisions because we want to make sure it's one hit. And then we work to resolve them. We've got a strong team that we've always had on that credit resolution side or special asset management team And really focus on resolution of these loans, working with the board and guarantors to those loans to resolve them.

Speaker 2

So it's really Carolina, if you want to add anything further?

Speaker 3

Absolutely. So thank you, Chris. So when we look at the impairment this quarter and the provision, the PCL financials. We did a conservative review of the portfolio and that's what took that approach in terms of level of provisioning this quarter. When we look a little bit at the loan to volume levels on our commercial real estate, we have Only about 20% of it below 65% loan to value.

Speaker 3

So it's like we have really strong loan to values. We have sorry, we have less than 25% above 65%. So it's a good trend. We continue to We're closely and looking at our relative values of the property and we have a diversified look on the properties we hold with only 9% in the office space, with very selective asset classifications as well financing and looking at offices outside of downtown centers, smaller, low rise offices that have better marketability and and our ACR as well and we're following close to vacancies as well.

Speaker 7

Okay. Thanks. I appreciate that context. I did have one follow-up on that and Kristen, if I had you on the mic, I'm not sure if you want to take this one. But you'd mentioned I think I heard you earlier on the call say that We expect the relative proportion of CRE to continue to trend down and in the slide it's highlighted that it has come down over the past 5 years.

Speaker 7

I was just wondering the thinking over the last 5 years because really theory has only become financial issue in the last sort of 12 to 24 months. So, reporting what the thinking was in sort of bringing that portfolio down? And if there is a level you're targeting that you feel is Appropriate for your bank, what this ultimately makes up?

Speaker 2

Yes. So the reason That has occurred and you'll have seen that in our numbers obviously is the fact that it is the most competitive area of on the commercial mortgage side. So the commercial mortgage side is the most competitive area. Every bank is involved in it, credit unions, There's often pension funds, life quotes. So there's a lot of players in that market.

Speaker 2

And what we always try to do is really look at the risk return. And what we really found in this last couple of years in particular is very strong competition in there. And we've grown at a much slower rate financing. And it's really been that risk return measurement where we've looked at and said, we're just not seeing these and quite often They're not necessary that full service client. They are an opportunity for a sound asset that we look to continue to find if the risk return works, we're happy with But we're not going to go and lean out just to take on more exposure just with deficient returns.

Speaker 2

So we're really we want to be picky in that market and choose the structures, locations and borrower profiles that we're comfortable with.

Speaker 7

Okay. Thank you. I appreciate taking my question.

Speaker 2

Thank you, Marcel.

Operator

Thank you. The next question comes from Gabriel Dechaine of National Bank Financial. Please go ahead.

Speaker 10

Hi, good morning. A couple of questions here. With The loan categories that you listed that are going to be slower growth and slower loan growth overall. Can you Give me a sense of what the ATM usage will be, if any, going forward because you didn't use any this quarter, obviously. And then the second question I have has to

Speaker 4

Yes. So on the ATM usage, I mean, last quarter, I laid out The conditions under which we wouldn't use it. We basically looked at adopting new standardized capital guidelines, but lined up very nicely actually to how we think about lending and got some risk weighted asset density relief and basically a capital base that can support higher levels of growth based on how we target growth and the prudent approach we take to risk. It lined up nicely and gave us some target. So that's been a positive.

Speaker 4

The second piece I lined out was the unrealized losses in the debt securities portfolio. I know that was quite topical this quarter, south of the border. I think I feel like I've been talking to you guys about this for the better part of a year. But we're just seeing that continue to perform as we expect. Those bonds, they're short dated as they're maturing, rolling off, that unrealized loss in that portfolio is ticking down.

Speaker 4

And again, as you know, for our entire debt securities portfolio, we hold dollar for dollar capital against those unrealized losses. So as that occurs, that puts wind in our sails. And then just thinking about mid single digit loan growth. I mean, that's obviously a quite comfortable level of growth if you thought about it from a capital perspective. It's not the driver, but the outcome is that we see our CET1 just organically building from these levels, which I suppose in this sort of an environment, not a bad idea to have dry powder and ready to be opportunistic when you kind of get through the cycle and things start trending

Speaker 10

So mid single digit loan growth, you don't need to use the ATM?

Speaker 4

To accommodate that level of growth, no. We can accommodate that level growth in our organic capital generation, the ATM then it's just it's there if something unusual occurs and we need it, but we would expect to not.

Speaker 10

Got it. Now credit, loan losses were lower and we saw the impaired loans balance go down about 10% from last quarter. But within the GIL balance, I saw $70,000,000 increase in commercial mortgage impaired loans. And that's been moving higher pretty steadily for the past year. Classification, whatever, and what your loss expectations are.

Speaker 3

So hi, Gabe. Yes. So as we mentioned, the The impairments this quarter and as you see was related to various properties, commercial mortgages properties Across different asset classes, some of them on the office space, mostly suburban office space properties that We took that impairment. So what we're seeing is, as expected and as we've been saying since last quarter, we do expect It's an increase in our provisions going forward. There will be trending towards what we see our average range of 13% to 18% basis points.

Speaker 3

And we will see that probably consequently growing in the next month, couple of quarters, but it's quite aligned with what we've seen historically from a trend as well.

Speaker 10

So of the $70 plus 1,000,000 how many properties and where were they?

Speaker 3

It was various properties across the impaired loan that we took as well, the loans. And most of them were in Western Canada.

Speaker 10

Okay. And how much of that was office?

Speaker 3

Yes, it was mostly suburban offices. I would say I don't know the specific of the Mounts, but it was mostly suburban offices.

Speaker 10

Okay. All right. That's it for me. Thanks.

Speaker 2

Thanks, Gabe.

Operator

Thank you. The next question comes from Paul Holden of CIBC. Please go ahead.

Speaker 11

Thank you. Good morning.

Speaker 7

I want to ask a question

Speaker 11

regarding the Branch raise deposits, obviously, a departure from plan this quarter and for financials. Some reasons that impacted, I'd say, all banks. If I go back to your Investor Day presentation, you had An interesting time series just showing the magnitude of branch raised deposit growth for Canadian Western Bank versus The big six and there was just this huge increase in sort of the 2020, 2021 type timeframe. Financing. Is it possible that some of that growth was simply a benefit of industry dynamics and a build in excess savings for commercial customers generally and now that's unwinding as is for the industry.

Speaker 11

And I guess my basic question is, is there continued risk that maybe you have a hard time meeting your deposit deposit objectives at the near term because of the normalization in deposit amounts and how would you view sort of the need for core savings versus excess savings with your existing customers?

Speaker 4

Yes. So I'll start and then Jeff can fill in the blanks just strategically how we thought about deposit growth just over really the last year. But yes, I mean we thought about support and stimulus being flooded into the economy. Of course, that resulted in an uptick in deposits. And I wouldn't point to anything Specific on our end that would have had us have a different trend or a outsized benefit relative to the large banks.

Speaker 4

I think the whole economy and the whole system benefited significantly. And perhaps one thing I could point to anecdotally, And I'd have to really dig into some data to support this. But with us, we have a larger commercial base, financials. Larger banks obviously having the retail base. Where I look at where most of the stimulus and support went, I think it went into the retail wallet rather than that commercial client's bank account.

Speaker 4

But let's say we benefited about the same proportion. I think we've all seen similar dynamics and how this has ultimately been used up, whether that by retail customers and their spending or businesses financing and running the operation of their business. We've seen this really occurring over the last year or so. And so So we thought about deposit growth for this year. Yes, we were thinking about that churn and trend.

Speaker 4

And I wouldn't point to that as something being beyond what we expected or anything Surprising there. Where are we positioned today? What's left to occur? When we look at kind of average financials. It's starting to look fairly close to back to normal, at least for commercial customers.

Speaker 4

On the retail side, there might be a little bit of excess still to churn through, which I think will be a different trend perhaps for the large banks going forward versus us. But I think those are the dynamics and so nothing surprising there, Paul. And I think what you laid out is very logical and exactly what we've been seeing. I just Not sure I agree with that. We would have benefited more than the large banks.

Speaker 4

I think we all benefited. But I'll throw it to Jeff just to talk about financing. The pricing tactics, the strategy, because this is something that as debt from a headline number perspective, we've made some trades on that branch raised deposit headline number because we've had other options.

Speaker 9

Yes. So I agree with what Matt said. And I think the other bit I'd just add in on the macroeconomic How much environment is as high as interest rates are. We have some clients that are choosing to pay down debt instead of holding deposits. And so that's also a bit of a headwind for the industry in When you look at our numbers in particular, we talked last quarter about through the 1st part of the year, we made a choice to prioritize NIM at the cost of some of our deposit growth.

Speaker 9

With the events down in the U. S, while we saw No deposit runoff following what happened there. We decided the right thing to do was to build our liquidity.

Speaker 4

Plan. Yes. And it's a bit of a math problem, Paul, when you think about the rest of the year, like you look at the financials. Headline guidance, I guess, of single digit growth on a full year basis. And that doesn't look overly robust, but you really have to break the year into 2 halves.

Speaker 4

Financials. To get to that low single digit deposit growth on a full year basis, you look at negative growth through the first half of the year, financials. We're seeing and we're projecting it to continue through the back half of the year, very solid, pretty strong financials. And so you think about dollar amount of deposit growth in the back half of the year against dollar amount of the lending we put up. Kind of our base case expectation is branch raised deposits fund the vast majority of that growth.

Speaker 4

And that's sort of the base case and how you think about a funding plan. And then you have the optionality though to continue looking at other potential sources we could tap into if we thought it was a better position on a more cost effective basis relative financials. The tactics you take in the branch rates channel to continue to drive growth. We like the optionality and that's a theme that will continue through the rest of the year.

Speaker 11

Okay. That's a very detailed and helpful answer. Thank you. And then I'll just throw in one more. So I heard some commentary around pulling back your appetite for loan growth based on where Risk adjusted margins fit and fully appreciate that and would agree with the view you're taking.

Speaker 11

But then just trying to reconcile that against The PCL expectation of going back to the normal band like if risk is a little bit elevated and maybe it's more of a price dynamic and you can clarify that. The risk is a little bit elevated. Should we expect PCLs to also be maybe a little bit elevated versus the financials.

Speaker 4

You think about risk in 2 buckets, I'd say. So there's risk you see out that financials. When you look forward, you see an element of risk and you compare that against the pricing you're seeing in the market and you can take a position that you just don't like those economics. Well, at the same time, looking at that level of risk and saying, it's elevated, but not so elevated compared to the strength of our existing credit portfolio that we think our losses get away from us here. So for sure in the way you framed it is a pricing and a returns relative to the risk rather than something we're trying to do because we're worried about the underlying credit quality of our portfolio.

Speaker 4

Financials. From that perspective, we're feeling solid and our provisions, we've been building them up really over the last three quarters. And we're feeling very comfortable with where we sit relative to a deep look at the current portfolio. This is more about forward looking and pricing relative risk on the lending we're seeing out there. It's just it's not squaring for us at the moment, maybe it is for others.

Speaker 4

But I mean, that's how we're thinking about this in 2 pieces.

Speaker 11

Understand. That makes sense. Thank you. I'll leave it there.

Operator

Thank you. The next question comes from Jo Ho Kim of Credit Suisse. Please go ahead.

Speaker 6

Hi, good morning and thanks for taking my question. I just had a couple of quick ones. Maybe first on mortgages.

Operator

Sure. Just ask.

Speaker 6

And I appreciate that your mortgage book is a bit different than what you and what we see from your bigger peers. But could you give us a sense on what you're seeing from your borrowers, whether you are seeing any changes in activities perhaps on the payment rates and curious what you're also seeing from your borrowers from the What you're seeing upon the renewal of the mortgages?

Speaker 9

Thanks. Sure. I presume you're talking personal mortgages. Yes. So when we look at our book, certainly we have a number of renewals coming up at much higher interest rates than they were initially booked.

Speaker 9

The B-twenty stress test certainly helps, because as we did these mortgages, they all qualified, recognizing they could do 2% higher than whatever their rate was at inception. And so we watch our book closely. We have a pretty good idea as renewals Which clients may have a bit of a challenge and we work with them directly. It's a pretty small percentage of our book, frankly, that's having those challenges. But there's tools that we can work within the structure to help them through this.

Speaker 9

And then in the background, frankly, we have fairly low LTVs that give us comfort if we do run into a challenge.

Speaker 3

If I can just add to that, The tenure of our book, it's shorter compared to other participants in the market. And so we've had already just over 20% of our book that has been renewed at already higher rates. And when we look at the delinquency and performance of the portfolio, it's still financials. So even at the higher rates, we're seeing our clients in a position to continue making the payments. And as Jeff said, financials.

Speaker 3

So we're feeling very comfortable with the state of our mortgage book.

Speaker 6

Thank And maybe just a follow-up, is there any way you can size the borrowers that may be having trouble maybe

Speaker 9

I think the best thing you would probably look at is our delinquency rate, which although it has ticked up from abnormally low rates

Operator

financials of Veritas Investment Research. Please go ahead.

Speaker 6

Thank you. Good morning. I wanted to circle back on deposits again. Just a couple follow-up questions. First, could you elaborate on the pricing differential spread between your branch rate deposits and the brokerage.

Speaker 6

I'm just trying to get a sense of That's a moderate. Does it also mean that you won't have to compete on pricing as aggressively financials against competitors and in the broker channel. And is that what you see as and do you see that as a tailwind for NIM?

Speaker 4

Yes. I mean, it's something that could be helpful to NIM. I mean, we'll obviously pick our spots. And I think what you've heard us say is that our spots, we're defining as something that have really strong risk adjusted returns. All in all, and then a lower growth allows us to just be really leverage all the options available to us financials to fund that growth and target lowest costs.

Speaker 4

So yes, it becomes easier to manage your NIM upwards under those conditions, certainly. You thought about kind of branch raised deposit pricing relative to broker pricing. I guess it depends on what sort of product. So if we thought pound for pound retail GIC raised in the branch channel relative to a GIC raised in the broker channel. You're immediately saving a commission about 25 bps if you raise it through your branches.

Speaker 4

We're also some deposits are raising through that channel would be at equivalent rates to broker, others you could get away with a lower rate. So you might have some overall savings there, but that's how you think about it on a term basis. We thought about it on the basis Call it that demand and notice as an overall bucket, it would be considerably cheaper for most deposits in that channel than broker. So I mean that would be The preference, if you thought about it just from pure NIM perspective. But when you're raising funding, you're also, as we always do, you're always thinking about liquidity profile of those deposits.

Speaker 4

When we think about profitability of deposits, we're factoring in the liquidity we'd hold against those deposits. And so we're pretty conservative

Speaker 11

when we

Speaker 4

think about demand deposits in particular of how much liquidity we put up against holding those deposits. So that can impact your economics as well. So it's hard to do just a pure rate comparison because there's a few other factors involved when you're thinking about demand versus term funding.

Speaker 6

Okay. That's helpful. And then on the dividend increase, just trying to understand the rationale there. Why not maintain the dividend build with more dry powder given where we are in the cycle and then So the balance sheet or to buyback shares to offset the ATM issuance. Just trying to understand on the rationale We are at a point cycle where maybe excess capital could be useful coming out of it.

Speaker 4

Yes. You thought about The dividend increase, a penny, I mean, that's about one basis point of CET1. So I wouldn't look at that as a material driver of capital. Financials. When we look at the dividend increase, obviously, we're looking to provide a good return, but also trying to manage to what we think is a very reasonable payout ratio.

Speaker 4

With the increase, I mean, we're basically in the mid-30s, which for us is Obviously, very comfortable. And it's about looking at the forward trend of earnings is if we don't financials. Yes. I think when we look at a dividend increase and why we're comfortable with it, I mean, we see despite lower growth, a lot of levers that are available for us call to really increase the earnings power and earnings efficiency of this bank relative to that lower growth. So I take that as a vote of confidence in that earnings outlook as well.

Speaker 6

Okay. That's helpful. That's it for me. Thanks.

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Earnings Conference Call
Canadian Western Bank Q2 2023
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