Carrier Global Q3 2023 Earnings Call Transcript

Quartr
Provided by Quartr
September 1, 2023

There are 12 speakers on the call.

Operator

Morning. My name is Sylvie, and I will be your conference operator today. At this time, I would like to welcome everyone to CWB's Third Quarter 2023 Financial Results Conference Call and Webcast. Note that all lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session.

Operator

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

Speaker 1

Good morning, and welcome to our Q3 financial results conference call. We'll begin this morning's presentation with the opening remarks from Chris Fowler, President and Chief Executive Officer followed by Matt Rudd, Chief Financial Officer and Kiara Linapara, Chief Risk Officer. Also present today are Stephen Murphy, Group Head, Commercial, Personal and Wealth and Jeff Wright, Group Head, Client Solutions and Specialty Businesses. After our prepared remarks, They will all be available to take your questions. 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 and uncertainties.

Speaker 1

Actual results could differ materially from these statements. I will also remind listeners that the bank uses non GAAP 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, everyone. Before I begin my 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 British Columbia and Northwest Territories. We remain committed to support our local CWB team members and clients as they navigate this challenging time. Through the focused performance of our teams, we delivered strong financial results in line with our guidance. Our Q3 adjusted EPS of $0.88 per share increased 19% from the previous quarter and was supported by improved revenues, continued load levels of credit losses and disciplined management of our expenses.

Speaker 2

Our ongoing efforts to expand our full service client relationships combined with the proactive deposit pricing adjustments we made in the previous quarter, resulted in 3% sequential branch raised deposit growth. We're also targeting lending opportunities that meet our expectations for risk adjusted returns as the current uncertain economic environment demands maintaining our prudent risk appetite. We focused on growth within the strategically important general commercial portfolio. In addition, asset repricing outpaced the rise in deposit costs and as expected, we delivered a significant improvement in our net interest margin, which was a key driver of our revenue growth compared to the prior quarter. The disruptions in the global banking industry in prior quarter didn't impact our financial position or performance in the 3rd quarter.

Speaker 2

However, the impact of elevated Interest rates will continue to work their way through the economy and weaken economic growth in the remainder of the year and into next year. We're focused on the resilience of our balance sheet and maintaining our disciplined approach to risk management. We expect that the sustained impact of higher market rates will drive increases in consumer and business defaults. And as Carolina will discuss in a moment, we expect our Our secured lending model, prudent underwriting practices and proactive loan management will support provisions for credit losses that remain within our historical range. Our earnings this quarter were further supported by management's continued actions to contain expense growth.

Speaker 2

Non interest expenses were held flat with the prior quarter and increased only 4% from the prior year. As Matt will discuss in a moment, We'll continue to prudently manage our expenses and be positioned to deliver positive operating leverage next quarter. Our approach is to proactively navigate the economic and market volatility by maintaining focus on our differentiated offering with unrivaled client experience. We create value for our clients and deliver strategically targeted growth on both sides of our balance sheet. Along with disciplined management of our operating and financial performance, The focus of our teams has been to support resilience in our financial position and deliver the strong financial performance that we expected this quarter.

Speaker 2

I'll now turn the call over to Matt, who'll provide greater detail on our Q3 financial performance.

Speaker 3

Thanks, Chris. I'll start on Slide 6. Chris noted, our continued efforts to expand our full service client relationships drove a 3% increase in our branch raised deposits, and that supported a 2% decline in our broker sourced deposits. Capital Markets remained consistent with the prior quarter. Despite lower usage this quarter, the broker deposit channel is a deep and liquid source to raise fixed term funding with maturities between 1 5 years and they're predominantly insured deposits.

Speaker 3

Compared to the prior year, branch raised deposits were up also 3%. This increase reflects 15% growth in fixed term deposits, partially offset by 2% decline in demand and notice deposits. Brent trade demand and notice deposits declined as growth from net new full service client additions was more than offset by our intentional exit of select higher cost non full service client relationships earlier this year. We've also seen a market shift in client deposits from demand to term deposits over the past year, but this trend has started to slow as the year has progressed. This quarter, our sequential growth in demand deposits exceeded the growth in term deposits for the first time in over a year.

Speaker 2

Turning

Speaker 4

to Slide 7.

Speaker 3

As Chris mentioned, our teams have targeted lending opportunities that are aligned to driving full service client growth, while providing strong returns within a prudent risk appetite. This focus drove a 3% sequential increase in our general commercial portfolio with a very strong 13% annual increase. Our equipment financing and leasing portfolio also increased 3% this quarter and 6% over the last year. Our equipment portfolio delivers combination of strong lending yields, comparatively lower capital requirements and the strength of the underlying security of this portfolio has supported a long history of solid credit performance through economic cycles. Our conservative approach to commercial real estate over many years has created a portfolio with strong credit profile and we continue to lend within a disciplined risk appetite.

Speaker 3

Our focus on risk adjusted returns in the current environment limited origination volumes across our commercial real estate portfolio. Real estate project loans increased 1% both this quarter and over the last year as we selectively finance new project starts predominantly in BC with top tier borrowers. Commercial mortgages declined 3% this quarter and declined 2% over the last year as loan new lending volumes were more than offset by scheduled repayments. Residential mortgages also declined sequentially, but are up 4% over the last year, reflecting new origination volumes with prudent loan to value ratios and strong average Beacon scores with lower payouts compared to the prior year. Consistent with the continued execution of our geographic certification strategy, Ontario loans grew 1% sequentially and were up 11% over the last year.

Speaker 3

Ontario loan growth contributed to approximately half of the current quarter loan growth. BC and Alberta loans were roughly consistent with the prior quarter as strong growth in the general commercial portfolio was offset by declines in commercial mortgages in both provinces. Our sequential earnings performance is shown on Slide 8. Common shareholders net income increased 19% as higher net interest income and prudent expense management more than offset higher provisions for credit losses. Pretax pre provision income increased 16%.

Speaker 3

Compared to the prior quarter, adjusted earnings per share increased $0.14 Higher net interest income increased EPS by $0.17 with the increase in net interest margin providing a large portion of that benefit with some support provided from the impact of 3 additional interest earning days. Lower non interest income reduced EPS by $0.02 An increase in the performing loan allowance, primarily reflecting the uncertainty of the current economic environment, reduced EPS by 0 point 0 $4 EPS benefited $0.01 from lower LRCN distributions and $0.01 from the impact of a lower effective tax rate as we recognized onetime true ups that increased our tax expense in the prior quarter. As shown on Slide 9. Total revenue increased 7% on a sequential basis. Net interest income increased 9% due to significantly higher net interest margin, 3 interest earning days and 1% sequential loan growth.

Speaker 3

The 8% decrease in non interest income was primarily due to lower foreign exchange revenue, reflective of a weaker U. S. Dollar in quarter, partially offset by higher wealth management fees. As shown on Slide 10, our NIM benefited 4 basis points from the repricing of fixed rate assets at higher market interest rates, which had a larger impact than the increase in deposit costs this quarter. Our focus on optimizing risk adjusted returns of our lending activities was the primary driver in the favorable shift in our loan mix that also contributed 4 basis points to NIM.

Speaker 3

Loan related fees added 2 basis points to net interest margin. Liquidity levels were consistent with the prior quarter and did not contribute to the sequential increase in net interest margin. The impact of the 50 basis point Bank of Canada policy interest rate increases made during the quarter had a nominal impact to net interest margin. We continue to expect that net interest margin will expand sequentially in Q4, albeit at a smaller magnitude than the current quarter. As the continued positive impact of fixed asset repricing will be partially offset by the impact of higher funding costs also impacted by the recent interest rate increases.

Speaker 3

On Slide 11, our non interest expenses reflect the inflationary pressures in the economy, but against those pressures, we've managed our annual NIE growth to just 4%. Our expenditures were held roughly flat to the previous quarter as we expected. Salaries and employee benefits cost was consistent with last quarter through managing the fill rate of vacant positions. Reductions in certain discretionary expenditures were offset by the continued investment in our digital capabilities and other strategic priorities. Our capital ratios are calculated using the standardized approach and the drivers of our CET1 improvement are shown on Slide 12.

Speaker 3

Our CET1 ratio increased around 10 basis points to 9.4% this quarter. Our growth in retained earnings this quarter more than offset the impact of risk weighted asset growth. No common shares were issued under the ATM program this quarter. Yesterday, our Board declared a common share dividend of $0.33 per share, consistent with last quarter and up $0.02 from the dividend declared last year. I'll now turn the call over to Carolina, who will speak further on our credit performance.

Speaker 5

Thank you, Matt, and good morning, everyone. Beginning on Slide 14, as expected, we saw borrower defaults and impaired loans increase to normalized letter from sustained impact of higher market interest rates. Total gross impaired loans increased $29,000,000 or 12% from last quarter and represented 75 basis points of gross loans, up from 68 basis points last quarter. The increase is primarily related to new formations in general commercial portfolio with a net increase of $23,000,000 in the quarter. Commercial mortgages classified as impaired increased $5,000,000 primarily due to increases in Alberta and partially offset by decreases in BC.

Speaker 5

Impaired in equipment financing loans increased $4,000,000 primarily in Ontario. The level of gross impaired loans fluctuates as loans become impaired and are subsequently resolved and does not directly reflect the lower value of expected write offs given the intangible security held in support of lending exposures. Our strong credit risk management framework, including well established underwriting standards, the secured nature of our lending portfolio with conservative loan to value ratios and a proactive approach to working with clients through difficult periods continues to be effective in minimizing realized losses on the resolution of impaired loans. I would also note that we have minimal exposure to unsecured personal lending or credit cards. This is demonstrated by our historic low write offs as a percentage of total loans, including through past periods of economic volatility.

Speaker 5

As Chris and Matt have noted, we have taken a targeted approach to lending with a focus on acceptable risk adjusted returns in the current environment, which has supported the resilience of our strong credit profile. Turning to Slide 15. Reflecting on the uncertainty of our current economic environment, We recognized a performing loan provision for credit losses of 6 basis points in the quarter compared to a new provision in the prior quarter. Our provision for credit losses and impaired loans was $10,000,000 equivalent to 10 basis points this quarter, below our 5 year average of 19 basis points. Looking forward, we expect that sustained impact of higher market interest rates will continue to drive increases in borrower defaults and impaired loans.

Speaker 5

Consistent with our experience in prior periods of elevated borrower defaults, Our prudent lending approach supports our expectations that our provisions for credit losses will be within our historical normal range of 18 to 23 basis points next quarter. I will turn the call back to Chris Fowler for his closing remarks and outlook.

Speaker 2

Thank you, Carolina. Turning to Slide 15, we delivered the strong Q3 financial results we expected through the focused performance of our teams. As interest rates continue to work their way through the economy and expected economic growth weakens, you can expect that we will remain focused on growing full service relationships, continue targeting strategic growth opportunities within our strict underwriting and risk adjusted pricing criteria, maintain our conservative and secured risk management approach and continue to prudently manage expenses to be positioned for positive operating leverage next quarter. The current year has been more volatile than we predicted and we have navigated through the multiple interest rate hikes and significant disruptions in the global banking industry. We have a resilient financial position and the focused performance of our teams supports our expectation of delivering an annual adjusted return on equity in line with the scorecard target that was set at the start of this year.

Speaker 2

With that, operator, let's open the lines for Q and A.

Operator

Thank you, sir. You will then hear a 3 tone prompt acknowledging your request. And if you are using your speakerphone, we ask that you please lift the handset before pressing any keys. And your first question will be from Doug Young at Desjardins Capital Markets. Please go ahead.

Speaker 4

Hi, good morning. Maybe I'll start, Matt, in the past, I think you've talked about if you repriced your balance sheet, NIMs would be in the 2.50 range and it would take you maybe afterwards of 2 years to kind of move in that direction. I know this is kind of a fluid situation and that was a static comment, but any updates to that guidepost, any thoughts on outlook. If you did reprice the balance sheet, how long it would take you to get there? Maybe I'll start there.

Speaker 3

Yes. Thanks, Jack. Obviously, a lot of moving parts to that answer, but I'll keep it very simple. I think you look at the structure of our balance sheet today, you have all the ingredients for that to continue to hold true. What we're focused on though, if you thought over the next year or 2, Really the same focus and discipline you've seen us exhibit in the last quarter here is when we focus our lending activities, we're thinking about strongest risk That's something you saw the benefit this quarter, the impact that had to NIM from a better lending mix.

Speaker 3

So there are opportunities to continue to do that to help support NIM. Conversely, on the other side of the balance sheet, we're targeting full service client growth. With that comes more demand in notice deposits. That's Give us a large proportion of them are at floating interest rates. The remainder are administered deposit rates that are at our discretion.

Speaker 3

But both of those, if you thought about interest rates declining over a period of time, you get a lot of support and stability in NIM from having these deposits that either directly float or will gradually move with market interest rates. So lots of things we can do to support NIM, lots within our control and you'll see us continue to be very focused on that. And you'll see us continue to be very focused on that.

Speaker 4

Can you put numbers to the percentage of your demand to notice that's floating and percentage that's at NIM.

Speaker 3

It's a reasonably equal proportion. We've seen Just in branch raised deposits, generally, if you went back over several years, we've seen a fairly decent increase in demand in notice And a large proportion of that increase has been in deposits that directly float. That's why when we went through the early days of COVID and interest Rates really went down. You saw a lot of stability in our net interest margin. I think we surprised a lot of people with how stable our margin was on the way down in rates And that larger proportion with deposits that flow was definitely a key factor that supported that stability.

Speaker 4

Okay. And then just maybe two questions on credit. What do you see in performance wise within your CRE commercial real estate portfolio that you mentioned a little bit, but I just wanted to maybe get a little bit more information. And then the second part is, can you talk Specifically, what drove the performing loan ECL build this quarter? Like what variable was it?

Speaker 4

And what variable really is kind of The key factor that really swings that performing loan PCL and ACL.

Speaker 2

Yes. On the CRE side, that book is one that we have noticeably slowed Our growth in, that started in fiscal 2022 and continued in fiscal 2023. So we've been very selective in In the categories in which we land within CRE, it's obviously a broad category, different types of product in there and geography and focus on who those Bores are. So very specific in how we approach that. So really cut that back a bit.

Speaker 2

And as we think about the opportunity for Management of that book and maybe pass over to Carolina with some comments.

Speaker 5

Yes. Thank you, Chris. Yes, that portfolio, we as part of The normal monetary, we did dive on the portfolio. We feel very comfortable with the position we are right now in there, very closely followed and with the very low exposure to one of the asset categories that has a higher risk, which is the office exposure. So we're feeling comfortable from that perspective and we will continue to manage accordingly.

Speaker 3

On the performing loan allowance, Doug, if you look at the macro forecast this Quarter versus last, you won't see a lot of big changes. You'll see obviously a shift upward in interest rate predictions. But that in itself Wouldn't have been a big component directly coming out of the models, but that's the base case forecast. When we're looking at performing loan allowances, we're also thinking about upside, I suppose, but also downside risk relative to that base case forecast. So in an environment where it looked like at the date of the balance sheet, where interest rates were looking higher for longer, In our judgment that introduced greater uncertainty and maybe a bit more weighting to downside risk relative to that forecast and we'll see how it evolves.

Speaker 3

But Coming out of the quarter, we're feeling very prudently reserved on the performing allowance.

Speaker 4

There was more weighting of the scenarios than actually a change in the Metrics, DFLI then.

Speaker 3

Yes, that's the right way to work

Speaker 6

at it.

Speaker 4

Yes. And then on the just Carolina, the office and the CRE portfolio. Can you talk about the LTV on that?

Speaker 5

So we have very good LTVs in the office portfolio. And on the construction side, we're really following up on the trends as well. So it is a very strong prudence to manage portfolio, not just the office, but across and we continue to maintain that prudency throughout this cycle as well.

Speaker 4

But you don't have a number you could share or I can always follow-up if it's easier?

Speaker 5

Yes. Well, We just don't we can't follow-up on that specific data. Okay.

Speaker 4

And then lastly, Matt, just on expenses, anything Big coming in Q4 expense wise?

Speaker 3

Our goal that we set out, I talked about, I think coming out of Q2 as we looked at that level of expense and said we thought that was a pretty good run rate to hold for the rest of the year. Now that's a very high level headline underneath the covers of that There are a lot of decisions on prioritization and making sure we're allocating expenses to highest and best use, all with the goal of driving positive operating leverage. Pretty damn close this quarter, didn't get all the way there, but we're close but set up quite well into the next quarter. Thinking about positive operating leverage, that is our goal and focus.

Speaker 4

Okay. Thank you.

Operator

Thank you. Next question will be from Marcel MacLean at TD Securities.

Speaker 7

Okay. Thank you. Well, I just want to try to put a finer point on Doug's initial question on the net interest margin for next quarter. You're saying an increase, but Less than this quarter, that's a pretty wide range of something less than 11 basis points. I was wondering if you could size the magnitude any more precisely than that.

Speaker 3

Yes, sure. I can give some help there. And going back to I believe it was in the Q1 And the world has changed quite a bit since then, but the way I look at net interest margin surprisingly hasn't changed much. We talked about coming off of Q1 exiting the year in the 2.40s. When we look at where we are coming out of the Q3, I think about a lot of different puts and takes in Q4, but Net interest margin that maybe just snuck into that range, I think we have the recipe to do that based on what I see in front of us.

Speaker 3

Is there much more upside than that? What's cooled my outlook on getting deep into that range is obviously See the higher interest rates and how they'll churn through funding costs just generally in the market. So hopefully that helps to try to narrow that range a bit for you.

Speaker 7

Yes. It's John. I believe those comments were directed at Q4 and kind of I don't want to front run the 2024 outlook and I know it even It can be unpredictable that far out, but I think what I heard is that there still is upside, like not Like it will fully creep up, I guess throughout 2024 towards that $250,000,000 range. Is that a fair assumption? Or 2 2 months, I don't have the time

Speaker 3

to tell. There's quite a lot of moving parts there, but let's assume that interest rates didn't change at all and the shape of the curve was roughly consistent. What you'd see play out and this is no different than what you saw as rates work their way up last time is that our deposits were more responsive to those interest rate increases than our assets were. So in Q4, you'll see more pressure on deposit costs, less benefit on the asset yields. But then as you work your way through that Asset yields will overtake that impact and that gives a lot of embedded strength in margin on a go forward basis that gets massed temporarily in sort of the early days following those increases.

Speaker 3

So that's one dynamic. And like I was talking to Doug about there are a lot of other things we can do to optimize and deliver that result, but that's just kind of the structural way these higher rates Sure. And their way through our portfolio, all else being equal.

Speaker 8

Okay. Thanks for putting

Speaker 7

that final point on that. Then I have a second question This slowdown in loan growth or loan demand generally across the

Speaker 9

industry, it coincidentally came at

Speaker 7

the same time that CAR 23 was implemented. Now under the previous capital regime, in the past, you guys have given a bulk of roughly 8% loan growth was where you started to consume capital based on your mix at the time. Giving you all up for your new mix, when we do see that loan growth resume, are you able to put that sort of level Of growth, like would that move up to sort of like a 9% or 10% level? Or are you able to help me out with anything on that for when we do see loan growth come back?

Speaker 3

Yes, it naturally creates more capacity. And the reason why we're a commercial lender Strategically targeted in the mid market. Under the old capital rules, those were risk weighted at 100 percent under the new capital guidelines, they're risk weighted at 85%. So for that portfolio, which is important to us Strategically and where we can be differentiated, we also get the benefit of a lower capital amount. A little bit closer to the actual credit risk, And we're quite prudent there.

Speaker 3

It gets us part of the way there, but still very conservative relative to how we underwrite and lend into that portfolio. But it permits A higher rate of growth than before in that portfolio specifically. So you're right, if you thought about our lending mix Today, we are targeting opportunities within that new capital framework, but they just happen to align quite nicely to our mid market commercial focus.

Speaker 7

Okay. And with that new with the new capital rules, has ARB been deprioritized at all Just because it sort of narrowed that gap. And I'm thinking about this in the context of you sort of managing your discretionary expenses, would that fall into that category or no, it's still sort of full steam ahead behind the scenes on ARB?

Speaker 2

Well, we're still focused on making sure that the risk management structure we have internally is supporting Our growth story, our ability to manage risk U. S. Returns and the elements of ARB certainly are really big part of that. And We continue to focus on how we deliver effective risk ratings and investing and making sure we are able to do that very effectively.

Speaker 7

Okay. Thanks so much. That's all for me.

Speaker 2

Thank you.

Operator

Next question will be from Gabriel Deschamps at National Bank Financial.

Speaker 10

Couple of questions here, one on credit and then one strategy one. So on credit, I heard Chris Well, both of you to talk about the higher rates and how that's going to push defaults higher. I get that. I'm just wondering where do you see that playing out in your portfolio on the commercial side, mortgage side or Residential mortgage side perhaps, like where do you see the vulnerability being the highest?

Speaker 2

Well, I can start and I'll pass it over to Carolina. I think we just I think it's a general slowing argument. I think we just saw The numbers of today GDP contracted 0.2%. I think there is the transmission of monetary policy does create more challenges to businesses as they have to navigate higher interest rates and business models Have to be able to respond to that. So you kind of look at all the different lending categories and you brought revenues Expenses are Y and expenses include the cost of borrowing.

Speaker 2

And if Y goes out more than X as being the revenue side, then there's a challenge. So we want to be very focused on At the inception of the loan, how we underwrote, how we structured and then as we look at loan management, making sure we're really on top of those. So Predicting which portfolio has more volatility is difficult. We have seen that last quarter we More in CRE this quarter a little bit more in the general commercial. Residential is our personal lending has been very, very strong.

Speaker 2

So we continue to just be on it In terms of confident in the manner under which we've underwritten and looking at how we continue to manage our existing loans. So

Speaker 10

maybe a question well, actually I can refine that question for Carolina. And you touched upon it, the increase in formations we've seen And then in the past few quarters, would you say that's primarily the result of the rate environment?

Speaker 5

Yes, it is. And it's something that we were expecting, And when we see where they're formed, like we don't have specific niches, like as Chris mentioned, it's across Industries. And at the end, while we have the formations increases given the secure nature of the portfolio, does not translate directly on the same level of losses, right? So we're very comfortable from the position where we're starting right now.

Speaker 10

I'm not suggesting any major concerns. I know you guys are good at lending. I just find this commentary overall interesting. Now as far as the strategy question goes, and I know the environment is playing a role here as loan demand is maybe declining. But Historically and on a handful of occasions, I've seen Canadian Western Bank report a quarter where loan growth is shy of your typical target to be close to the double digits, but then margins go up, capital ratio holds in or increases And most importantly, stock moves quite a bit higher.

Speaker 10

I'm just wondering if maybe since we've seen this before And having made that observation, it might make you think about your balance sheet management a little bit differently, such that Maybe you're willing to sacrifice on loan growth a bit more in order to get a generate the other 2 positive outcomes there, 3 actually.

Speaker 2

Well, thank you for that observation. As we think about are different areas of business that we zero in on our targeted client being that business owner client. We are very focused on risk adjusted returns. And as we sit here today, no question, the kind of the structural change in the balance sheet with, as Matt spoke to, fixed Price on the asset side responding and slower faster than the increased deposit. So we are seeing a tick up in net interest margin improvement in revenue.

Speaker 2

And as we kind of zero in on how we've been very On expense management, we see EPS work and we're very positive on the outcomes of where we're at today. But it really is that whole idea of how do we think about How do we think about what that means for our different borrowers? How are we looking at risk adjusted returns? And we just kind of take it all into context and make sure that we are really allocating our capital in the areas we're most comfortable with.

Speaker 10

Okay. Well, enjoy the long weekend.

Speaker 2

Thanks Gabe.

Operator

Thank you. Next question will be from Saurabh Mavedi at BMO Capital Markets.

Speaker 6

Okay. Thank you for taking my questions. I was a little bit late coming on, so I apologize if you've addressed this earlier in the call. But Matt, I heard you talk a bit about the trend or the expected kind of trend and the evolution of the net interest margin Into next quarter and maybe even into next year with lots of puts and takes, no doubt. And I hear Carolina talk a

Speaker 8

little bit about

Speaker 6

The credit normalization, I suppose, is the best way to think about it. So what I'm trying to kind of figure out Curious, how much of that anticipated benefit in the additions margins may get eroded away just because of the PCLs normalizing? So if I think about a risk Adjusted margin here kind of coincidental NIM less your PCLs. Where do you think that may kind of stabilize relative to pre COVID?

Speaker 3

Two interesting pieces there. If you look at Our outlook for this year and the level of PCL we're predicting, it would be well below what we would consider a normal range. If we thought about just the dynamic of our provision for credit losses increasing to within our normal range, which I would think would be a very reasonable outcome and reasonable expectation. You're right, that would offset and dampen some of the lift we Expect just structurally from net interest margin and things we can do to shape that result and drive that result, obviously. Our goal though, there's a few other levers we can look at, where we grow, how we grow, supporting the deposit side of the balance sheet, prudently managing our expenses and how we allocate them.

Speaker 3

A lot of the themes we're talking about going into Q4 and targeting and focused on driving positive operating leverage, that will not be a temporary focus. That's something we want to Looking into next year and that for us is the lever we look at to, you're correct, fight against the headwind of Provisions for credit losses returning to normal, that's how we look at driving earnings growth for next year. Just that really focused performance, Controlling what we can control and confidence that are the way we've lent through the cycle keeps our credit losses within normal range.

Speaker 6

Okay. So Just to kind of touch on, I guess, an earlier point then. So within your control, obviously, our expenses, but also, I suppose, To some extent, loan growth and risk appetite. And you did not Or haven't used the ATM for a couple of quarters. What's your how should we think about stuff within your control and whether or not the long growth is going to be done within existing resources, so to speak, as opposed to tapping the market to the extent that there was loan growth that you wanted to accelerate on?

Speaker 3

Yes. No, it's an interesting consideration. For us, when we look reasonably within a pipeline of opportunities that meet our risk adjusted return indications, we believe our organic capital generation is sufficient. For us to think about using an ATM to augment That growth, we would need to see premium risk adjusted returns to offset the dilutive impact of those shares. And Looking at the pipeline right now, we would be moving up a risk curve to a level that to us doesn't make sense relative to the price At this point, but it's something we'd continually look at as we work our way through the cycle.

Speaker 3

But as of right now, Saurabh, that would seem to me to be a lower probability area of the playbook.

Speaker 6

Okay. And then maybe just one last thing on that. I appreciate that. That's helpful. But I suppose Equally low probability that you're focused on getting your share count back to pre ATM introduction.

Speaker 6

8 to 10 quarters ago.

Speaker 3

Yes. I think we're in an Early part of the cycle to be thinking about those sorts of activities. But I mean, you're right, there will come a point here where Perhaps there is some capital to deploy if we get through a cycle and the economy achieves the soft landing that Our policymakers are attempting to engineer. Yes, I mean you have coming out of the cycle potentially some dry powder to deploy. And For us, we have a pretty established history of doing quite well emerging from cycles based on how we've looked after clients through a cycle.

Speaker 3

We generally do quite well and see pretty strong growth opportunities to increase our market share and target more of those mid market commercial clients we're after. Seem to be a lot of opportunities when cycles turn. And so that would be on our minds as well for sure.

Speaker 6

I appreciate the color. Thank you very much.

Speaker 2

Thanks, Horeb.

Operator

Next question will be from Meny Grauman at Scotiabank. Please go ahead.

Speaker 8

Hi, good morning. Matt, you talked about how rate hikes this quarter only had a nominal impact On margin and I'm curious to understand why that is. It seems like it's definitely a different dynamic than what we've seen over the past few quarters. Now if we think about 50 basis points of rate hikes from the BOC this past quarter, part of that not really expected. Just curious The dynamics there and how that's changed in terms of the sensitivity of your margin to rate it?

Speaker 3

Yes. If we thought about just the very front end of the curve, so to floating rates directly, we're at the point where our floating rate assets are almost equivalent dollars to our floating rate liabilities were pretty closely matched. So I know historically we've had a wider gap and that's why you've seen a greater Sensitivity to prime interest rate increases and decreases frankly in past years. Right now we're much less So what you would have seen if you look back in previous quarters where we did have those rate hikes, you'd see Maybe for every 25 basis point of Bank of Canada policy change, you'd get an immediate lift of maybe a basis point of margin on a full quarter basis from the hike and that just reflects the fairly tight spread between floating assets and liabilities. So we will get Some lift on the immediate reprice.

Speaker 3

We would have had a partial quarter impact of that this quarter. And next quarter, we'd get the full quarter impact. It would help, but I wouldn't look at it as a material driver net interest margin.

Speaker 8

Okay. And then just, I mean, you highlighted the fires in BC. Just wanted to confirm that you You don't really expect any impact on your business from that. So I just wanted to check on that.

Speaker 5

That's correct, Meny. We've had some indirect impact as everybody has had from just suspended operations and stuff, but not significant impacting clients that have come to us with us for release or anything like that. So we're comfortable from that perspective as well.

Speaker 8

Okay. That's it for me. Thank you.

Operator

Next question will be from Lamar Prasad at Cormark. Please go ahead.

Speaker 4

Yes, thanks. I want to go back to your slide 10 and that waterfall to the question. Obviously, solid margin expansion this quarter and your guidance for a smaller magnitude increase and our smaller rate of expansion in Q4. I want to talk about in the context of what you presented in this waterfall here. So you've called out The continued positive impact of fixed rate asset repricing and higher funding costs.

Speaker 4

So I think that means the asset versus liability repricing. When you present this waterfall next quarter, it's going to go down, so not that 4 basis Point lift that we saw this quarter. Help me is that correct, first of all? And then help me understand how these other three Factor expected to fall in getting in to just around 2 points, I guess 2.4% Next quarter like, I think the loan mix that we saw sequentially this quarter, that seems like it's going to persist. So the loan related fees, I think that's going to trail off and others going to trail off.

Speaker 4

Help me understand why we're not going

Speaker 9

to see this level of expansion?

Speaker 3

Yes. So on the asset versus liability repricing, you'll see that slowdown next quarter and that just reflects. Coming into Q3, we had a relatively stable interest rate environment going into the quarter and through most of the quarter and then it really ticked up as the quarter closed. So we'll feel a lot of that impact in Q4. So on a temporary basis, just reflecting how much rates It's moved that quickly.

Speaker 3

I'd expect that factor to be much smaller. Potentially eking into a positive position, but I wouldn't Expect much contribution in Q4. I'd expect that contribution in later quarters as that churns through our portfolio no different than what you saw with the previous rate hike impacts. Low mix, you're right. We did target what turned out to be a more favorable mix that Reported NIM this quarter.

Speaker 3

There's a bit more work we can continue doing on that, but you're right, not to the same extent. On the fees, a piece of that I'd say is some of our yield related Fees returning to more normal levels, others like prepayment penalties continue to be below what we would have seen maybe compared to a year ago. And some one offs that maybe would represent half of that 2 basis point lift that I'm not sure would persist. So, I'm not sure we'll see unless something unexpected happens. I don't know that we'll get increased contribution from fees next quarter that dynamic keeping prepayment penalties low.

Speaker 3

I don't see that resolving next quarter just thinking about how clients would behave to even higher interest rates. And then that piece we bucketed in other, I mean part of that's the very minor lift this quarter from the Bank of Canada rate changes part of it's a very minor benefit from a slightly more favorable deposit mix. So the couple of minor items in there. So all that wrapped together, that's the broader explanation as to why we believe there's room to continue to expand margin, but why it perhaps stays a bit depressed in Q1 or Q4, I mean, compared to if you thought about the potential of that churning its All the way through our balance sheet over time, you'll see the lift come later.

Speaker 4

Okay. That's very helpful. Moving on, Apologies to pick on income statement and line item here, but other income was probably a bit more negative than Seen in the past that it was negative $1,900,000 and you guys are calling out weaker FX revenue. But Even then, I would expect it to be closer to 0 rather than a lot. So can you help me understand what's driving that loss, that negative $1,900,000 in other income this quarter?

Speaker 4

Yes. I gave the math.

Speaker 3

I can't remember if it was last quarter or the quarter previous. Just based on the size of our U. S. Dollar balance sheet, That for about every $0.01 weakening of the U. S.

Speaker 3

Dollar, it drove about $1,000,000 of decline in that other income line. So if you look at end of last quarter to the end of this quarter, About a $0.03 move in FX, about a $3,000,000 decline then in that other income line, Offset by normal course, you'd expect transactional fees maybe in or around $1,000,000 a quarters of kind of a reasonable level. So that's how it washes to $2,000,000 negative impact you see there. Obviously, not something we'd expect It persists next quarter, but dependent on what happens to the U. S.

Speaker 3

Dollar. One word of caution too, as you're modeling, If you're looking at Q4 over Q4, recall that in Q4 of last year, we saw a pretty material strengthening of the U. S. Dollar in the In the Q4 and that's why you look when you see Q4 last year you see a big number in that other other income line. Without a similar Strengthening of the U.

Speaker 3

S. Dollar that wouldn't be in the cards for this quarter again this year.

Speaker 4

That's helpful. And that's exactly Actually, Amit. You also, I guess, next question, can you talk about the competitive environment for deposits and your outlook moving forward? Some of the banks referenced elevated competition looking forward. I'm just trying to understand if you feel as though you could continue to grow branch rate deposit or even gained some momentum looking forward to 2024 in light of the competitive forces that are

Speaker 2

Yes. Thanks, Lamar. Yes, we are very focused on that branch resource deposit story. We've got as you saw the general commercial growth we have that's included our core target client that business owner and 30% growth over last year. And really the win there is to really Juice up and really create that as a solid low cost funding source.

Speaker 2

I'll pass it over to Stephen to add more comments.

Speaker 4

Yes. And I think we've got a lot of things that we're executing right now that are enhancing our capabilities to add those full service clients. And so we had a number of deliverables even within the quarter about enhanced products and services that we delivered to our clients and we've got more coming in the very near term that improve our competitiveness in that space. And we're also expanding our addressable market with a couple of new openings happening in Ontario next year. And so we've got continued momentum just in terms of our Competitive positioning and our service proposition for business owners, but we are delivering around enhancements that Continue to improve our competitiveness.

Speaker 4

Okay. So bottom line, you like you can kind of

Speaker 3

Can you accelerate from here despite

Speaker 4

the competitive forces just on the back of these new products, new geographies or Like how should we think about that? Yes. I think that we absolutely can. Like we feel very strongly about the improvements to our offering that we're bringing and what that does for our batting average and ability to win full service clients. And so I don't know that that's over the weekend kind of thing, but we are continuing to deliver Particularly over the course of the next couple of quarters, enhancements that are going to, I think give us the ability to increase that For sure.

Speaker 3

Yes. And I'd say I'd just add, I guess, it's the way we think about lending too. We don't just grow for growth sake. We're focused on profitability of deposits. So while we like what we're winning in terms of new to bank full service profitable deposits, That inflow gives us some latitude when we look in our existing deposit portfolio.

Speaker 3

Maybe there are deposits that have a lower level of probability That we can then adjust the pricing with the confidence that we have enough coming in that if those deposits do flow out, we can absorb it. You've seen us take that tactic throughout this year and it's been a factor that's helped support NIM performance.

Speaker 2

Appreciate it.

Operator

Thank you. Next question is from Paul Holden at CIBC. Please go ahead.

Speaker 11

Thanks. Thanks for taking the time to squeeze me in here. So two questions to kind of help me think about potential scenarios in 2024. First one with respect to NIM and the, I think high probability the Bank of Canada cuts rates at some point next year. So Matt, you gave some helpful context on how you're now ALM matched on the short end of the curve.

Speaker 11

Should we take that as well if the Bank of Canada cuts rates next year, but sort of the longer end of the curve Where it is, should be no impact on NIM. Is that a fair conclusion?

Speaker 3

Yes. I mean, that's how we're structured. I do think even in that scenario, you do see some continued build in NIM Just from that continued repricing of the assets with liabilities quicker to reflect the lower market interest rates. You'll have this dynamic occurring where liabilities are coming on at the lower rates more rapidly than Assets that eventually churn their way off and reflect the higher interest rates even with some rate cuts next year. We'll have assets coming off our balance sheet at much lower yields than new assets coming on even with some cuts.

Speaker 3

So There'll be some embedded strength in there that I think you wouldn't normally expect to see if you thought about interest rates Declining off maybe a more stable starting point. We'll still continue to have some of this churn and that's a factor we look at and thinking about the stability and strength of our net interest margin moving forward.

Speaker 11

Good. That's helpful. And then second question is with respect to expense Management, so your guidance for the efficiency ratio this year is 52. Your target is still below 50. But I think what you're messaging with Q2 being the right run rate going forward is that The efficiency ratio is expected to go down on revenue growth.

Speaker 11

So correct me if I'm wrong there. And the second part of the question, I guess, would be, well, what happens if Revenue growth isn't as good as expected in 2024 because of the macroeconomic challenges, right, that you've talked about on this call. Would you consider taking more expense action or just going to take longer to get to the sub-fifty efficiency ratio?

Speaker 3

So for us that's how we look at Driving positive operating leverage. I mean, we're thinking about revenue growth, but also giving some consideration to potential volatility and making sure When we plan out our level of expenses that we have some wiggle room moving forward and ways we can think about prioritization. So that's When we think about trying to create a forecast or an operating model that produces operating leverage positively, it's not just We want to give ourselves a good buffer just in light of the volatile economic environment. That would be our goal and focus. To what extent are we committed to that?

Speaker 3

I think you've seen us take Pretty significant action and pretty disciplined approach this year. There are elements though of our strategic offering that we believe Are so critical to just thinking about the ongoing strength of our franchise, client offering, etcetera, that We'll continue to do and continue to prioritize. While we've taken a hard look at discretionary expenses this year, we have not sacrificed Our strategic projects. That's why you saw efficiency ratio drift up a bit relative to our expectations reflecting maybe some volatility in FX, A bit of volatility in market rates. We didn't want to take any severe action related to what we think Highly strategic and important projects.

Speaker 3

Those are continuing as planned.

Speaker 11

Got it. Okay. And then just last one From me, there was an increase in commercial mortgage impaired last quarter. You talked about some suburban The office space there accounting for that, the impaired amount was relatively unchanged quarter over quarter, not a surprise. But just wondering if you can give Any kind of update on that file?

Speaker 11

It sounds like expectations for full asset recovery remain intact, I would guess, based on the numbers, but Any update there would be appreciated.

Speaker 5

So on that file, we're working well on recovery for those assets. Values that we have on file have been holding up and There's been some good resolutions on that portfolio as well that we're working towards. So that file just continued to evolve and we're working towards getting the resolution as soon as possible with the right values in place.

Speaker 11

Okay. And soon as possible, could you put a timeframe behind that or?

Speaker 5

No, unfortunately, I wish I could.

Speaker 11

Okay, fair enough. That's it for me then. Thank you.

Speaker 2

Thanks, Paul.

Operator

Next question will be from Nigel D'Souza at Veritas Investment Research. Please go ahead.

Speaker 4

Thank you. Good morning. A couple of questions for you. First on your macroeconomic variable assumption. When I look at the disclosure, there is a disclosure for the 3 month treasury bill rate forecast,

Speaker 7

and it's at 3.7%.

Speaker 4

Just trying to understand if I'm interpreting this data point correctly because that would imply rate cut expectations over the next year and trying to understand how that fits in with your expectations for rates to remain elevated and at least the higher debt servicing costs. Just want to make sure I Sandy, I'll look correctly and

Speaker 9

we'll speak into your assumption.

Speaker 3

Yes. So just as a reminder, when we Due to the macroeconomic forecast, it's at a point in time. We try to get it as close to the balance sheet date as possible, but also recognizing It takes time to run these macro assumptions through a model. Where we do update for maybe updates to macro factors, like if you know from the date you started your modeling to eventually you get to your balance sheet date if market interest rate expectations have moved. And as a result, your expert judgment as a management team is for rates to be higher for longer perhaps than was put into the models.

Speaker 3

That's where we supplement it with expert credit judgment to reflect the evolution of those macro factors and the impact we believe it could have on credit losses When we get to the balance sheet date. So that's why despite when you look at our macro forecast, it looks pretty consistent, I bet, quarter over quarter. That's why you saw us build the allowance this quarter just reflecting that evolution of interest rate assumptions.

Speaker 4

Okay. So thanks, Rupert. That's fair to say that your performing allowances already reflect the higher for longer rate environment and There's some high probability they might take additional provisions. And related to that, Carolina's guidance for 23 basis points. In Q4, is that on impaired or is that the total BTL ratio?

Speaker 3

We would be thinking predominantly impaired. We'd be thinking about that within a range of normal. So 18% to 23%, we'll see where we land within that range. As you know, impaired loan provisions and impaired loans themselves, it's case by case, very specific assessment of each file and the security we have. But that you're right, Nigel.

Speaker 3

That's why we wouldn't expect much volatility from here in the performing loan allowance we have, and that's why we believe is prudent, it reflects an up to date assessment of the interest rate environment.

Speaker 4

Okay. And just squeeze a real quick one in on your net interest margin. When you Higher funding costs, I assume you're referring to on a year over year basis. My understanding would be that, that shift you're seeing from broker deposits to branch rate deposits is actually lowering your funding costs. So I just want to make sure first I understand that correctly that sequentially if that continues it's actually benefit to your margins.

Speaker 4

And then on long mix, just want to clarify what category drove that benefit? Was it equipment financing in the

Speaker 3

Yes. So on funding costs, we're thinking like for like. If we thought about broker or branch raised GICs as an example, you would have seen bond yields through the quarter increase by depending on the tenor, I think somewhere as high as 100 basis points of shifts upwards in yield curves, started to taper off since then a bit. But that's what we'd be thinking about. That is a direct drive into GIC costs, Which is a direct drive into an element of our funding, both through broker channels as well as branch.

Speaker 3

You're right, the shift into branch notice and demand. Over time, that will be quite beneficial to NIM. Right now, with How inverted the curve still is, the impact is a bit more muted and you'd see the benefit over time as rates come down.

Speaker 4

And sorry, on loan mix, it's equipment financing,

Speaker 9

what's the difference?

Speaker 3

Yes. So strong growth in general commercial and equipment finance, Both would be a much stronger yield spread and risk return dynamic compared to commercial mortgages, Much tighter spreads, especially relative to current risk. That portfolio contracted versus growth in the other 2, so that's what drove the benefit to NIM.

Speaker 4

Okay. That's it for me. Thank you.

Speaker 2

Thank you, Dantel. Thank

Operator

you. Next question will be from Juho Kim at Credit Suisse. Please go ahead.

Speaker 9

Hi, good morning and thanks for squeezing me in here. Just a couple of quick ones. Maybe a question on the loan mix, but more from capital perspective. If we see this trend of decline, say, in commercial mortgages and personal loans continue, but increase, Obviously, in general commercial loans and equipment financing, maybe talk to us how that would impact Your capital presumably, it will be accretive, but curious if that could be a meaningful impact To capital especially under the new capital regime.

Speaker 3

Yes, you're right. There's a bit more risk sensitivity there, but it's not risk based on the borrower, it's risk kind of to the portfolio and more to the structure. On commercial mortgages, The loans we do are focused on the lower loan to values. Those attract a lower risk weight under the new standardized approach Scott, compared to previous. So it does mute some of the benefit.

Speaker 3

It's still a slightly higher risk weight than we'd book at for general commercial lending in the mid market that would be slightly lower risk weight. Ditto for equipment, our small ticket Equipment and leasing would be at a slightly lower risk weighted asset density yet, but Our larger ticket kind of to larger borrowers, that would actually be a slightly higher risk weight Compared to low loan to value commercial mortgages, so it really depends. I wouldn't point at that in itself as a Key driver of the lower RWA density or I guess more lending for the same amount of capital. Really, our biggest opportunity in that shift is relative to before Our mid market commercial dropping from 100% to 85% risk weight and then elements of real estate project lending, particularly for commercial Construction that has very punitive risk weights under the new standardized approach, significantly higher than those other portfolios we've been talking about. So that's the opportunity for more bang for the buck on our lending.

Speaker 9

Got it. Thanks for that. And Maybe last one for me, just wanted to ask about funding. And when I look at your loan to deposit ratio, it's at the higher end of the Historical range now, I believe. And so if we do get into an environment in the near term where loan growth remains muted, but still at a reasonable pace, How should we think about CWB's funding for that type of growth?

Speaker 9

Or I guess, which part

Speaker 7

of the funding

Speaker 9

profile Do you expect and support that type of growth environment?

Speaker 3

Yes. We like having a lot of levers available. We think about funding the balance sheet for us. Our preference because it's the most favorable cost would be branch And we like the client relationship aspect and fee generation capabilities from that deposit source, so that's the priority. So if you had really strong growth there, what would you dial down?

Speaker 3

Our other funding channels we look at would be broker GIC deposits. So That would be an equal trade dollar for deposit, so that wouldn't shift at all the loan to deposit ratio. The other sources of funding though would. We do securitize as a funding source a couple of our asset classes. Usually, that's at a reasonably favorable cost of funds relative to other sources.

Speaker 3

So we'd look at that source versus broker versus I suppose Raising a senior deposit note in the capital markets. What we ultimately decided to do wouldn't be driven by trying to manage A loan to deposit ratio, we would be thinking about liquidity characteristics of the deposits, profitability and obviously that preference to full service client deposits.

Speaker 9

Got it. Thank you. That's it for me.

Operator

Thank you. And at this time, we have no further questions. I would like to turn the call back over to Chris Fowler for closing.

Speaker 2

Thank you, Sylvie. The entire CWB team has supported the strong results we reported today and I thank them for all their continued efforts. Together, we've built meaningful strength and resilience in our organization with high satisfaction from our clients. Our strategic focus to meet the full service financial needs of businesses and their owners differentiates us from the market and will continue to create value for mid market commercial businesses and our shareholders. Thank you for your continued interest in CWB Financial Group and we look forward to reporting 4th quarter financial results on December 8.

Speaker 2

Thank Thank you very much and have a great long weekend.

Operator

Thank you, sir. Ladies and gentlemen, this does indeed conclude your conference call for today. Once again, thank you for attending. And at this time,

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Carrier Global Q3 2023
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