Check Point Software Technologies Q1 2024 Earnings Call Transcript

Quartr
Provided by Quartr
March 1, 2024

There are 13 speakers on the call.

Operator

Good morning. My name is Judy, and I will be your conference operator today. At this time, I would like to welcome everyone to CWB's First Quarter 2024 Financial Results Conference Call and Webcast. 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 of Investor Relations. Please go ahead, Chris.

Speaker 1

Good morning, and welcome to our Q1 2024 financial results conference call. We'll begin this morning's presentation with opening remarks from Chris Fowler, President and Chief Executive Officer followed by Matt Rudd, Chief Financial Officer and Carolina Parra, Chief Risk Officer. Also present today Stephen Murphy, Group Head Commercial, Personal and Wealth and Jeff Wright,

Speaker 2

Group

Speaker 1

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. Actual results could differ materially from these statements. I would also remind listeners that the bank uses non GAAP financial measures to arrive at adjusted results.

Speaker 1

Management measures performance on a reported and adjusted basis

Speaker 2

and

Speaker 1

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. CWB's focused performance continued in the Q1 with positive operating leverage driven by disciplined expense management while targeting new lending opportunities that met our risk adjusted return expectations. As expected, growth in the Canadian economy remained muted as elevated interest rates continued to slow consumer spending and reduce inflation. In this environment, our team's focus remained on executing our strategy and winning full service clients within our disciplined risk adjusted pricing criteria while providing exceptional service to our clients. Our people take the time to understand our clients and their businesses and we work as United team to provide holistic solutions and advice for them.

Speaker 2

This differentiates us from the competition and along with our strong balance sheet has us well positioned to capitalize on the growth opportunities in front of us with an economy that we expect to gradually strengthen in the back half of the year. As shown on Slide 5, our loan growth has been strategically targeted in the general commercial portfolio. Clients in this category include a broad section of Canadian economy that's underserved by the other banks and they represent a significant opportunity for CWB to provide a full suite of lending and business banking services deepening our relationship with the client and our returns for our investors. In the last year, we delivered 8% general commercial loan growth. We've taken a highly disciplined approach to lending in the current environment, focused on appropriate financial returns relative to the underlying risk in a higher interest rate environment.

Speaker 2

This has lowered origination volumes across our commercial real estate portfolios. The credit performance of these portfolios has been strong and our overall balance of commercial real estate exposures has been reduced by scheduled repayments and payouts at project completions. Our prudent risk appetite and underwriting standards reflects a consistent and long history of strong credit performance. We remain comfortable with our current exposures while weakening while the economy the weakening economy has returned us to historic provisioning levels. We've driven strong growth in Ontario with support of Mississauga and Markham Banking Centres, especially in the strategically targeted general commercial portfolio, which we've grown by 11% over the last year.

Speaker 2

Brand opening of our new Banking Centre in Toronto's Financial District in January is creating greater awareness of CWB in the GTA and we look forward to continued growth momentum with the opening of our Kitchener branch later this year. I'll now turn the call over to Matt who'll provide greater detail on our Q1 financial performance. Thanks, Chris.

Speaker 1

Good morning, everyone. I'm starting on Slide 7. We delivered stronger growth in franchise deposits than we expected this quarter, and that was especially in demand in notice deposits, which increased 2% sequentially that reflected growth from both new and existing clients. We also delivered growth in term deposits of 4% compared to last quarter, reflected a continued preference for term deposits in the current interest rate environment. Stronger than expected franchise deposit growth has resulted in a temporary bulge in our liquidity levels and we expect liquidity to normalize over the next quarter as we'll deploy to new lending opportunities that meet our risk adjusted return expectations.

Speaker 1

Compared to the prior year, franchise deposits increased 3% as a 12% increase in fixed term franchise deposits was partially offset by a 2% decline in demand and notice. Lower demand and notice deposits primarily reflected a reduction in account balances as clients utilized excess savings over the past year and also converted into term deposits. We commenced the initial launch of our new commercial digital cat and cash management platform and plan to roll it out to customers in a phased approach starting next quarter. We expect the rollout to dampen franchise deposit growth in the near term as we focus on transitioning existing commercial clients onto the new platform before mobilizing our sales force to onboard new clients. We expect positive momentum in franchise deposit growth in the back half of the year and continue to expect to deliver mid single digit percentage growth on an annual basis.

Speaker 1

Our performance compared to the same quarter last year is shown on Slide 8. In Q1 of last year, we recognized a large impaired loan recovery that provided a boost to net interest income and drove the unusual provision for credit losses being in a recovery rather than an expense position. So our provision for credit losses returning to normal within our normal range this year. Our common shareholders' net income decreased by 7% and diluted EPS decreased by $0.08 compared to last year. Our focused operating performance delivered pretax pre provision income growth of 14% compared to last year.

Speaker 1

Adjusted EPS decreased by $0.09 from the same quarter last year. In the prior year, we benefited $0.13 from the reversal of a previously recognized impaired loan write off, which reflected the combined impacts of a reduction in the impaired loan provision for credit losses of $0.10 and increased net interest income of $0.03 Excluding these impacts, higher net interest income increased EPS by $0.16 primarily reflecting the benefit of an 8 basis point increase in net interest margin. Higher provision for credit losses decreased EPS by $0.11 as our provision for credit losses has now returned to being within our normal historical range from the unusually low levels in the prior year. As shown on Slide 9, our common shareholders net income increased 14% and diluted EPS increased $0.11 compared to Q4. Pre tax pre provision income increased 3% on a sequential basis.

Speaker 1

We incurred reorganization costs primarily in the prior quarter that reduced EPS by $0.12 compared to the current quarter. Our reorganization activities are now complete and these costs have been removed from our adjusted performance metrics in bulk periods. Adjusted EPS decreased by $0.01 from the prior quarter. Lower adjusted non interest expenses contributed $0.05 to EPS, primarily due to lower people costs and lower spend due to the timing of ongoing strategic activities. Higher net interest income increased EPS by 0 point 0 $2 and a decrease in non interest income reduced EPS by $0.04 The provision for credit losses this quarter reduced EPS by $0.06 reflecting a return to within our normal historical range as expected.

Speaker 1

As shown on Slide 10, total revenue decreased 1% on a sequential basis. Net interest income increased 1%, primarily driven by an increase in average interest bearing assets. The 13% decrease in non interest income was primarily due to lower foreign exchange revenue due to a weakening U. S. Dollar this quarter compared to a strengthening U.

Speaker 1

S. Dollar in the prior quarter. Turning to Slide 11, our NIM was consistent with the prior quarter. Profitability of our assets grew as expected as the growth in asset yields strongly outpaced the increase in funding costs, which drove 70 basis points of NIM benefit. Stronger than expected franchise deposit growth caused a bulge in liquidity, and that reduced NIM by 5 basis points and our funding mix reduced NIM by 2 basis points from last quarter.

Speaker 1

We continue to anticipate a relatively stable policy interest rate in fiscal 2024 with the potential for interest rate reductions in the latter part of the year. We continue to expect our net interest margin to gradually increase over the remainder of the year and reflect the benefits of normalized liquidity levels, growth in fixed term asset yields continuing to outpace growth in funding costs and loan growth that's targeted to optimize risk adjusted returns. Our capital ratios and the drivers of our CET1 improvement are shown on Slide 12. Our CET1 ratio increased 30 basis points to 10% this quarter, primarily reflecting retained earnings growth, a reduction in accumulated other comprehensive losses associated with an increase in the fair value of our debt securities and a decrease in risk weighted assets. No common shares were issued under the ATM program again this quarter and we do not expect any further issuances under our ATM program.

Speaker 1

Our Board declared a common share dividend yesterday of $0.34 per share, which is consistent with the dividend declared 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 3

Thank you, Matt, and good morning, everyone. Turning to Slide 15. Total gross impaired loans increased $43,000,000 or 16% from prior year and represented 86 basis points of gross loans, 11 basis points higher than prior year. As you know, gross impaired loans can fluctuate and this quarter they increased 19% sequentially after declining 6% sequentially last quarter. The increase in gross impaired loans this quarter was in line with our expectations given the economic backdrop and reflects the impact of higher interest rates pressuring the cash flow of our general commercial borrowers, partially offset by resolutions.

Speaker 3

Ingrid commercial real estate loans were relatively stable compared to the previous quarter. 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 our clients through different cloth periods continues to be an effective in minimizing realized losses on the resolution of impaired loans. This is demonstrated by a history of loan write offs as a percentage of total loans, including some past periods of economic volatility. We also continue to have minimal exposure to unsecured personal lending or credit cards. We expect the total balance of gross impaired loans to continue to fluctuate as the overall loan portfolios review regularly with credit decisions undertaken on a case by case basis to provide early identification of possible adverse trends.

Speaker 3

As shown on slide 16, the performing loan allowance was relatively consistent with the prior quarters as increased downside risk reflected in our economic outlook was offset by a decline in total loans. And the outperforming loan provision was 3 basis points lower than last quarter. Our provision for credit losses on impaired loans increased to $17,000,000 or 19 basis points compared to a charge of $7,000,000 last quarter and a large recovery last year. Looking forward, the sustained impact of higher interest rates is expected to continue to result in elevated borrower default rates and impaired loans over the remainder of the year. Consistent with our experience in prior periods of economic volatility, our prudent lending approach supports our expectations

Speaker 4

that our

Speaker 3

provision for credit losses will remain within our historical ballpark range of 18 to 23 basis points on an annual basis. I will turn the call back to Chris Fowler for his closing remarks and outlook.

Speaker 2

Thank you, Carolina. Turning to Slide 16. We've maintained our focus to open the year with solid results supported by large positive operating leverage. Our balance sheet is strong and the differentiated client experience that our team provides supports the continued delivery of solid results. Our teams remain focused on executing our strategy and winning full service clients within our risk adjusted pricing criteria and we anticipate our momentum will build as the year progresses.

Speaker 2

While we continue to execute our strategic priorities as planned, we will carefully monitor and manage our expenditures and deliver a differentiated experience to Canadian business owners. Our financial outlook for 2024 is unchanged and we're well positioned to create value for our investors in the year ahead. With that, operator, let's open the line for Q and A.

Operator

Thank you. And ladies and gentlemen, we will now begin the question and answer Your first question comes from the line of Doug Young from the Jordan Capital Markets. Your line is open.

Speaker 5

Hi, good morning. Maybe we can just start on credit. And I guess, two questions. Like the increase in new impaired loan formations, and I guess they can be volatile and maybe not lead to actual losses. But can you provide detail in which buckets where you're seeing that impairments or those impairments come through?

Speaker 3

Absolutely, Thil. Good morning. Yes, so the new formations were mostly in our general commercial portfolio. And we're not seeing any impact on specific industries. It was well diversified and we're not really concerned with any specific market, but overall, the general commercial with the pressure from the interest rate increases.

Speaker 5

Was it in any particular geography or

Speaker 3

No. We don't have any significant geography. We saw a little bit of an increase in Alberta, as you saw, but it was a very functional borrower, very idiosyncratic case that does not really cause any impact or any concern from the Alberta market either.

Speaker 5

Okay. And then just on the I just want to confirm the provision for credit loss range of 18 to 23 basis points. Is that on an impaired or total and has that changed?

Speaker 1

It was on a total basis, Doug, and primarily weighted more to the impaired loan rather than performing, And we have not changed our outlook on either.

Speaker 4

Okay. I just

Speaker 3

wanted to

Speaker 5

confirm that. Okay. And Matt, well, I guess I have you NIMs as the topic de jure. And I just want to get an idea of the evolution of NIMS. And again, it's one metric and but it's one that people are absolutely focused on.

Speaker 5

Is this more you see a gradual improvement coming through? Is it more back end weighted? Can you talk about what you're seeing so far in the Q2? And you did have a decline sequentially in capital market deposits by decent amount. I assume those are higher cost deposits, but there wasn't really didn't seem like there was a big impact on NIMs this quarter or is that more of a second quarter item that would come through?

Speaker 1

Yes, actually so NIM, the primary driver there would be the spreads we're getting on our assets. And we actually saw pretty good tick upwards this quarter in that. So what we saw in loan profitability, what we saw in our securities portfolio just rolling over and issuing new securities at the higher rates, everything there was as expected. Overall cost of deposits, a bit lower than what we were expecting actually. So that's 7 basis points I highlighted of just asset yields relative to funding costs, that would have exceeded forecast I would have had last quarter.

Speaker 1

Couple of reasons for that. I think we were very selective on the deposits we originated. You're right, we did have a decline in capital market deposits, but we did do an issuance. It was a smaller issuance to offset a larger maturity. And the reason why we did it, it was at a time where it was basically at parity, in fact, maybe even a little bit cheaper than broker deposits at the time.

Speaker 1

It was just a very opportunistic trade. And I think you'll see us be very disciplined on deposits and managing that cost. So happy with the torque we're seeing in asset spreads where I'd say we had the pressure on NIM this quarter that brought us back to neutral. I mean that was a liquidity story. It was a good news, bad news.

Speaker 1

The good news is that we had more franchise deposit growth than what we expected. And where we were surprised there, which would be a reversion of the trend we've been seeing is that demand in notice deposits grew and it grew from existing clients in addition to new. That's not something we were expecting. On new liquidity coming in, you'll look at our financial disclosure from year end and see when we bring in liquidity and we invested in securities temporarily before it gets into loan growth, securities yield quite a bit less than loans. We don't take on any credit risk in that securities portfolio.

Speaker 1

It's basically federal and provincial bonds. So when we reinvest that into loan growth, it's a pretty significant amount of yield increase and that gives us torque to the NIM. So that's why we're very constructive on net interest margin into the 2nd quarter. I'd expect growth there. Likely more growth in the second quarter than what we'd see maybe in Q3 and Q4, But we'd expect to see continued growth through the year.

Speaker 1

But I'd look at Q2 and I'm quite constructive.

Speaker 5

And are you seeing that so far? And I don't

Speaker 6

know if you want to comment on

Speaker 5

that, but it's like you've got good visibility, I would say daily, weekly on that particular metric. Is that fair to say?

Speaker 1

Yes. I guess the catalyst of do we see more significant NIM expansion or is it in the neighborhood of something smaller like in a couple of basis points, The big driver of that's going to be the strength of our loan growth and bringing down that liquidity level and redeploying it to loans. With loans, pipeline looks good and strong in 2nd quarter. So if we execute well and deliver the growth that we believe is in front of us and achievable, then NIM will be a positive story in Q2.

Speaker 5

And I guess that's where I was going next is like what are you seeing in terms of loan growth? Is it similar to what you're seeing what you saw and what you had in Q1? And how is that deposit to loan growth ratio kind of unfolding so far in Q2?

Speaker 1

Ewen, do you want to touch on growth and what you're seeing? I'll circle back to loan to deposit ratio.

Speaker 4

Sure. We're pretty much seeing what we expected to see. So we had talked about that it was going to be a gradual build through the year. And what we see through the activity to date and in the pipeline, that's what we're seeing. So we knew it was going to build throughout the year and that the growth was going to start in the Q2 and that's consistent with what we're seeing.

Speaker 4

So as we look at it was probably a little bit slower start to the year than we were expecting on the lending side, but we expect to be in line with the guidance that we had previously issued.

Speaker 1

Yes. And then on loan to deposit ratio, I mean, this quarter we saw a notch downwards, again, that we wouldn't have expected and we weren't necessarily structurally planning for. So I wouldn't expect the ratio you compute this quarter to be a running range. We'd expect for next quarter stronger loan growth and lower deposit growth in this quarter would be our base case expectation.

Speaker 6

Appreciate the color. Thank you.

Operator

Your next question comes from the line of Limor Persaud from Cormark. Your line is open.

Speaker 7

Yes, thanks. I want to start off with an answer on the previous set of questions there just on credit. Matt or Carolina, Maybe you could clarify, maybe I heard this wrong, but the PCL guidance, that 18 to 23 basis point guidance, did you say that's total or impaired? I guess your Slide 15 suggests that's impaired, but then your Slide 16 seems like it could be total. So just want to make sure.

Speaker 1

Yes. Just for absolute clarity, it's total. But I guess the majority of it, we expect to be impaired.

Speaker 7

Okay. And then performing with that kind of follow balance growth? Is that kind of the

Speaker 1

way we should think about that? All else being equal, yes, barring from the future shift in economic forecast.

Speaker 7

Okay. And then one of the things that some of the banks have been suggesting throughout this earning season on credit is that, you could possibly see PCLs kind of bump up in the first half of the year and then some relief in the second half of the year. So is it possible just given the step up in impaired that we saw this quarter, it sounds like they could probably move up in the near term and then maybe that could drive PCLs even above that 18% to 23% and then relief in the back half of the year. So maybe Carolina, talk about the path of how you get to that 18% to 23% that would be helpful.

Speaker 3

So we expect to continue to see a trend as we're seeing as we continue to work with our clients. The PCLs, of course, are lagging from when we get the in Paris and as they reflect the impact of the interest rates and inflation. So we do think the first half of the year would be where we start to see a little bit of an increase. But we're getting resolutions at the same time as we're putting in the TCL. So I think the net effect will be definitely lower, and we do not expect to just go well outside of that range what we're seeing.

Speaker 3

And overall, at the end of the year, we are very confident we will be within the thresholds that we're mentioning.

Speaker 7

Okay. So it's not that we should expect like something like 25% and then a move down, like nothing like that.

Speaker 3

We don't expect that.

Speaker 7

Okay. Okay. No, that's fair. And then I guess I've covered the stock for a couple of years and I know you guys typically have better insights into your loans loan growth outlook. Like what gives you the confidence in the ramp of that loan growth starting in Q2 and for the balance half balance of the year like how you guys meet that mid single digit percentage growth?

Speaker 4

Yes. Well, we have pretty good line of sight into our loan pipeline. And we also when you look at the numbers, we have pretty good forecasting. If you look at the net effect of growth in the quarter, you've got to look at the commercial real estate side and some of the repositioning we've had in that portfolio as we've been selective on that side. And so we can predict as things renew or projects are in the pipeline on the construction side, where those because that's been a drag on the net growth.

Speaker 4

And then we can see all of the new activity that's in there and that we're booking for funding looking out. So we've got pretty good line of sight on that. It can kind of in a particular month, you might have things move around a bit depending on what's happening in the market, but we can see the trend line and we feel good about our expectations playing out the way that we thought for the year and the way

Speaker 2

we've previously talked about it.

Speaker 7

Okay. And are some of your commercial borrowers, I'm thinking more on the commercial side, are they just kind of waiting to see how this rates evolve? Is that why there's some hesitation right now? Or is it just more so when these projects come online? So just timing rather than concern around the path of rates.

Speaker 4

Yes. Particularly, if you look at construction lending, like that's absolutely happening. And generally, I'd say, look at we see that we can see as we look forward to the rest of the year things playing out the way that we thought. But that's a fair point.

Speaker 1

Okay. Thanks. And then the final one

Speaker 7

for me just on expenses. I'm okay when I see the

Speaker 5

bank's slow expense relative to

Speaker 7

even the low to mid single digit range. But when it tips into negative territory, I start to ask myself the question, is the bank under investing in growth and basically trading off the future to put up good earnings today. I suspect you're going to tell me that's not what's going on here at CWB. So just tell me why that's not the right way to look at this very low expense growth?

Speaker 8

So a couple of things.

Speaker 1

When we talked about expense trajectory last quarter and the reorganization we did, I mean, it really was to give us a lot of optionality. It was first the reduction of the expense run rate, but it absolutely was meant to be predominantly a reinvestment of those costs. But the timing of when we make those investments is within our control and something we wanted to time with when we wanted to start really driving the revenue growth and make sure that we made good on our commitment to positive operating leverage. So just structurally, that's how we thought about the year. We talked about mid single digit growth of expenses and I'd say that outlook remains consistent.

Speaker 1

And the other weird thing about Q1 typically for us perhaps with others too, it's a lower level of expenses usually relative to the rest of the year. A lot of you don't have CPPEI on your employees, just activity levels usually a bit lower. And when you look back at our historical trend from Q1 to Q2 in terms of structural expense growth, you can always see a bit of an uptick. Last year was a bit of an anomaly. So if you look at Q1 NIEs last year, we would have had double digit NIE growth.

Speaker 1

In the Q2, that is when we started talking about and enact the expense containment actions because the growth outlook started to soften. So we took early action there. Our trajectory pretty rapidly went from double digit expense growth to mid single digit. So that's what we're lapping in Q2. So it's a bit of an easier comp here in Q1 as well to deliver the reduction.

Speaker 1

So I would not expect us to continue to reduce NIEs, as tempting as it is, if you put into my accountant's hat on. It's not realistic and not how we want to run the business. And we'll be back, I'd say, on that mid single digit expense trajectory next quarter.

Speaker 5

Thanks guys.

Operator

Your next question comes from the line of Gabriel Dechaine from National Bank Financial. Your line is open.

Speaker 9

Thank you and good morning. What are we going to say here? Capital, I'll start with that one. You're on the silver lining to flat or negative loan growth as your core Tier 1 ratio goes up and you're at 10% now. I know you're not a big buyback story, whatever you want to call it.

Speaker 9

But given your excess capital position and given the loan growth picture, which you sound optimistic, but it's probably going to be weaker than the typical years you target. Why wouldn't you consider buying back some stock here, especially trading below book value?

Speaker 1

Yes. Again, if I put on my financial hat, it's awfully tempting. The economics on that, look very compelling actually. Our preference in deploying capital, if we get to the point where it's time to start deploying and we have good look through the economic cycle, our preference and we've been consistent on this is to grow the franchise, organic and we've got lots of opportunity in front of us. And coming out of cycles, you can look back historically and see we do quite well.

Speaker 1

When it's time to put the foot on the gas and grow, we generally outperform in those sorts of environments. So having the dry powder to support that, we like that optionality. Inorganics, an option too. And I mean, obviously, we continue to look at things, but that would be our second preference. And then yes, you're right, Gabe.

Speaker 1

Like if we don't have compelling good risk adjusted return opportunities on those first two, then we're looking at other ways to engineer returns for our shareholders. But our preference is obviously grow and support the franchise first.

Speaker 9

No, I get it. It's just I know the ATM was a bit of a sore spot for some $0.50 But yes, next question would be on loan growth. And I do want to delve into that a little bit more. You do sound more optimistic. What was holding back loan growth?

Speaker 9

Because I've seen this from the bank before where you load up on excess liquidity and then there's just a timing issue that the loans didn't actually get advanced and might be just the next day into the new quarter and things that are back to normal spreads, if you will. What was the factor holding back loan growth just from a timing standpoint? Or was there something else going on? And underlying that question too, how much is how much are heights depressing loan growth? I got to imagine there's some borrowers that are just sitting on the sidelines expecting like many of us that rates are going to be lower by the end of the year.

Speaker 1

Yes. So I'll start and then throw to Stephen. I guess the maybe the difference this quarter compared to the other previous times where we found ourselves on excess liquidity, loans weren't necessarily the largest component of that. I mean, we went into this quarter, we weren't expecting robust loan growth for a number of reasons, economic backdrop, just what we're seeing in commercial real estate and our focus there. It was a branch raised deposit story where we just had more growth there than what we were expecting.

Speaker 1

So that's the one difference I wanted to highlight. I think that's important. But then just for loan growth and more commentary, Terry there, I'll throw it to Steven.

Speaker 4

Yes. I think typically the Q1 is a slower quarter for us anyway. But I think as Matt said, there's a lot of other factors going on impacting that. But we had expected it to be kind of a curve of growth through the year kind of getting us to our full year guidance. And we're seeing what we see in our pipeline is consistent with that kind of building growth throughout the year.

Speaker 9

Okay. Then TCL, I just want to revisit that one. You said like the big driver of the impaired one specific account. You can't tell us the industry. I know there was a transportation sector trend, if you will, across that hit a few banks.

Speaker 9

Is it related to that at all or just something else entirely?

Speaker 3

No. I just want to make sure. So it was not one specific kind of what I said. It was idiosyncratic things, not just general things happening in specific industry. I think it's quite diversified.

Speaker 3

And so it's not just one account that caused like the big increase. I think it's just quite diversified across various industries.

Speaker 9

Okay. Then lastly yes, sorry, go ahead.

Speaker 3

General commercial, sorry.

Speaker 9

Okay. Then lastly on I don't know, I think all of us are going to be kind of thinking the same thing here and I say us, the people asking the question today. You have negative growth in the Q1 year over year. You're targeting mid single digits over the course of the year. That's a fairly broad term range.

Speaker 9

But the thinking kind of goes in the direction while there's going to be a bit of a ramp up over the next 3 quarters that gets you to the mid single digits sort of the makeup for the drop we saw in Q1? Is that so we could be upper end to mid single digits or something like that?

Speaker 1

Yes. If we see the growth in revenue that we expect, then we'll Okay. If we do not and something knocks the revenue off that track, then you would see us be a bit tighter with expenses. So that's the way we wanted to manage the year is, I mean, we made a commitment to positive operating leverage. We've left ourselves a lot of levers to pull to make good on that commitment.

Speaker 9

Okay, great. Have a great weekend, everyone.

Operator

Thank you. And your next question comes from the line of Suraj Movahedi from BMO Capital Markets. Your line is open.

Speaker 8

Okay. Thanks for taking my questions. Maybe I can just start on that OPLEV commentary. I assume as a management team, when you say we're committed to OPLEV, you're thinking about it on a, I don't know, full year basis, not necessarily quarter in quarter out. Is that accurate what I'm saying?

Speaker 1

Correct. You definitely can have a bit of ebbs and flows in a quarter like the 7% we put up this quarter. I would not look at that as sustainable obviously for reasons we discussed today. But I mean that's our goal going into a quarter is we want to structurally going into it have really a high degree of confidence that we're structured for positive leverage. And then whether you end up neutral to moderately positive or significantly positive depends on how the quarter plays out.

Speaker 1

But on a full year basis, you're right. I mean, that's structurally the way we set up the year end, I guess, for abundant clarity, it was not to deliver 7% operating leverage, but just good solid positive operating leverage with a lot of different ways we can deliver it.

Speaker 8

Yes. No, I understand. I mean, I think operating leverage is probably more of a full year target anyway because of the seasonality and expenses and revenue recognition and the like. On the loan growth, I just wanted to better understand, is the environment such that growth is available but not fitting your risk appetite? Or is that a governor on the kind of growth rates we're looking at?

Speaker 8

Or was it there was just nothing available, period?

Speaker 2

Well, I'll start with that. Thanks, Saurabh. I would say that what we've done is look at in the different buckets. We've got, say, our commercial mortgage portfolio, which is still very competitive with other FIs. And what we've chosen to do there is be very specific on which loans we choose to renew or look to underwrite based on risk adjusted returns.

Speaker 2

So that book then has declined slightly. The real estate project lending success there is that loans pay out. And we have we did see payouts occur there. What we're not seeing is a big rush to the table with new projects, but we are seeing some. So we do see that happening as the interest rate environment is evaluated, housing supply is being tested in terms of different markets.

Speaker 2

So more product we expect to come online there. And then on the general commercial side, that's our opportunity really for capturing market share. And we do look to cherry pick clients from the large banks as being ones that really meet our risk appetite, meet our industries that we're looking to focus on. And so that again is an open opportunity for us as we look to the future. And equipment finance typically has a bit of a seasonal slowdown in the Q1 and picks up in Q2, Q3.

Speaker 2

So as we think about loan growth, it's we are focused. That's the big driver of our business. And we make sure that we think about a very disciplined approach to underwriting and focused on those markets that we know very well.

Speaker 8

Okay. I mean, maybe if I come at it a little bit differently, can anyone talk a little bit about what the competitive dynamics are like? And when the growth you pick the sector general commercial, commercial real estate, whatever, when those types of opportunities are present, do you are you finding it as competitive as ever, even more competitive? And I just want to kind of I just want to get a feel for when we think about the net interest margin outlook. Are we factoring in asset yields that are likely to come down?

Speaker 8

That's what I'm just trying to kind of get a sense for.

Speaker 4

Yes. I would say the market is a little bit slower. And so that would create more competitiveness, particularly in the stronger risks. And so and of course, we are looking to be selective. But I'd say, in our model, people that are choosing us are generally choosing us as an alternative to the other banks for how we bring our service and advice to them.

Speaker 4

And so in cases like that, it's not necessarily a bidding war kind of situation. So we see depending on how much activity is happening out there, you can see competitive dynamics. But I don't think in our model at our size and with as we project growth out kind of looking to take business away from our competitors, we're not as quite as sensitive to that in the kinds of business that we're taking on.

Speaker 8

Okay. And so, I mean, Chris, in the years that I've paid attention to your stock and your business, I can't think of any time you would have compromised on your underwriting standards for growth. Is there any reason why that may be different this time around?

Speaker 2

Well, we have no intention of compromising on our underwriting standards for growth. I mean, we like the markets we operate in and we've generated great expertise in the different verticals. And our view is just to continue to execute in our very structured approach for underwriting, loan management and stress testing.

Speaker 8

And continued secured underwriting such that like any other previous cycle, gross impaired may look large, but net impaired will be de minimis?

Speaker 2

100%. That is our focus, yes.

Speaker 8

Thank you very much. That's all my questions.

Operator

Your next question comes from the line of Paul Holden from CIBC. Your line is open.

Speaker 10

Thank you. Good morning. I want to ask a couple more questions on the impaired loans, I guess to give people more comfort around the risk there. So first question is, can you give us a sense of provisions and asset recovery expectations around the loans that that went impaired this quarter?

Speaker 3

So yes, from a provision perspective, so what in the new formations we've had, we had certain loans that in which we had provisions come in. However, we manage in general terms very strong loan to value. So when we look at our asset valuations, the provisions are not significant. At the same time, there were quite a few important recoveries as we work with our clients as a payment, but also support the work that we're doing and the prudent management and collateral management we have of our impaired portfolio.

Speaker 10

Okay. So I think that's an important point with respect to an offset specific to this quarter. You're seeing some recoveries on previously impaired loans that helped offset the need to increase provisions for the Q1 impaired loans, correct?

Speaker 1

That's correct.

Speaker 10

Yes. Okay. Okay. That's helpful. And then continuous line of questioning.

Speaker 10

I mean, you mentioned that impaired loans are expected to be what you think gills might do next quarter or 2, again, just to avoid any negative surprises like we saw this quarter, and you did mention that you expected impaired to go higher this quarter. So what do you expect again next quarter, next couple of quarters? Is there visibility any visibility there?

Speaker 3

Well, I think given the economic backdrop, we do expect these events to continue to increase. I don't think we have reached the peak. And of course, because it's lagging from when the impacts take place. So we expected that within the next quarter or 2 to continue to increase before we start seeing some of it tilt down again.

Speaker 10

Okay. And given that's within your expectations, I'm assuming you've already provisioned or partly provisioned for that expectation?

Speaker 3

Right. So as you've seen over the last 7 quarters, we've increased our performing loan allowance, just taking understanding what we expect the portfolio to perform. And so even though this quarter the performing loan allowance did not increase significantly over the last 6 quarters, we had built quite a bit of it and we think we have good coverage as well as those loans become impaired to do and just transition that into impaired provisions as well.

Speaker 1

Yes. The only unusual thing we saw relative to what our models would have otherwise predicted was really through last year impaired loans remaining so benign and credit losses remaining so benign like relative to economic conditions and what we would have expected like that was the unusual piece. Whereas now it's looking a lot more aligned with what our models might have predicted for this sort of environment. So nothing that we're seeing is

Speaker 10

Yes, understood. That's all for you. Very helpful. Thank you for that. And last question, Matt, I'm going to jump in, I'll continue with you.

Speaker 10

Going back to sort of Gabe's line of questioning on share buybacks versus organic growth. I think we can all do the math based on current ROE and price to book sort of what the economics look like on the buyback. Maybe you can help us with the economics on organic growth And obviously, it implies something higher than your current ROE. What are sort of your ROE expectations as you layer on organic growth? Thank you.

Speaker 1

Yes. So if you're thinking what sort of return relative to the risk do we need to see to put the foot down and really accelerate growth. Like we're looking for things that are accretive to ROE relative to current levels. So if you're seeing us accelerate growth and really start consuming capital and throwing capital against growth, We want to do that on the basis of expanding our ROE and we laid out a path that obviously there was a different backdrop. But at our Investor Day, we laid out all sorts of ways that we could contribute to higher ROE.

Speaker 1

Loan growth in the right portfolios with the right capital against it and spreads returning back to more normal levels was a key ingredient in that recipe. And we think there's more torque in doing that than buybacks on pound for pound, dollar for dollar capital basis.

Speaker 10

Okay. Thank you. That's it for me. Thanks for your time.

Operator

Your next question comes from the line of Darko Mihelic from RBC Capital Markets. Your line is open.

Speaker 6

Hi. Thank you. Good morning. I hate to be that guy. I'm going to ask a bunch of detailed sort of individual questions, Matt.

Speaker 6

I hope you don't mind. But before I get there, just following up on the question, Carolina, with respect to your response in terms of sort of near term visibility. You mentioned economic backdrop, you spoke about models. But I'm more curious about what is the watch list telling you? And did anything sort of get impaired this quarter that wasn't on your watch list last quarter?

Speaker 3

So, as expected, our watch list has been increasing and we're managing it actually to maintain it flat. So new coming in and a lot of other solutions coming out as well, both going back into the business with good restructurings. And so anything that came into impaired outside of Watts West, there's very little. Like we try to keep a very tight outlook. I look into our portfolio with a lot of conversation with the business line to just make sure those are moved into watch list and into our Savneo, a special asset management unit to be managed properly.

Speaker 3

And so that transition and that communication is really strong in the back end and that's what help us really to move ahead and be able to manage the accounts promptly and that helps us of course with First Solutions and Recoveries.

Speaker 6

Okay. Okay. That's helpful. And so but I did hear in there that your watch list is growing. Is that a fair characterization?

Speaker 3

So we got new accounts coming in, but we also have like a good chunk of accounts coming out. So relatively flat, I would say. But of course, new formations seem to watch are happening.

Speaker 6

Okay. Okay. Thank you. And then just with respect to recoveries, are there any surprises there with respect to, I don't know, the value of assets backing loans, a process? Is there anything happening on that end that would lead to maybe a thought that the loss on impaired might change going forward?

Speaker 3

So far, we've seen really good trend of recoveries, very similar to what we've had in the past. When we look at some of the valuations, while some values might be coming down, it's not a significant impact on what we're seeing. And we have pretty strong loan to value when we originate. And as we manage with through them, we're not seeing that really reflected in shortfalls when we look at security coverage. So overall, the story is still positive, and we continue to manage it like that.

Speaker 3

I think prompt movement into dealing with our clients is what really help us get the best out in the recoveries. Okay.

Speaker 6

Thank you. That's very helpful. Thank you. So just now getting to my little detailed questions, sorry for Matt for these, but I want to dive into it a little bit. When I look at you mentioned that the quarter had elevated or sorry, a drop in FX, prior quarter had an elevated sort of FX.

Speaker 6

And so when I look at your supplemental and I look at I'm looking specifically at page 5 or the 5 on the bottom of

Speaker 4

the page, I guess 6 in

Speaker 6

the PDF file. Is that in the other line there? Is that what I'm seeing the FX is that where the FX is rolling through?

Speaker 1

Yes, exactly. It's in the other category of non interest income. What you should see in that each quarter, like if you had no change in U. S. Dollar exchange rate, you should see somewhere between $500,000 to $1,000,000 of other fees in there.

Speaker 1

It's the foreign exchange on our we have a net asset position in the U. S. Dollar balance sheet, not a big one, but that's why you've seen that shift from last quarter to this quarter. You went from strengthening U. S.

Speaker 1

Dollar to weakening U. S. Dollar and that's what drove the swing.

Speaker 6

And so all that bouncing around that I see in that line item from quarter to quarter is all FX, would that be a fair characterization?

Speaker 1

It is predominantly FX.

Speaker 6

Okay. And so then following along that line where you mentioned the balance sheet, if I go up one page, so looking at now Page 4, the interest rate sensitive GAAP reversed in the quarter. Can you what does that practically mean? And how should we think about that with respect to your interest rate positioning?

Speaker 1

Yes. I wouldn't look too far into that. It's nothing structural we were trying to do. We weren't trying to make a big bet on interest rates decreasing. Really, we had an increase we weren't expecting in notice and demand deposits.

Speaker 1

Those are predominantly time linked. So directly like 100% interest rate sensitive. And that's what caused that positioning to change. I'd expect that to revert back looking a bit more like normal as early as next quarter.

Speaker 6

Okay. Okay. And then so sticking with that discussion on deposits, I'm going to ask you a weird question. In your slide deck, it seems as though you're now referring to them as franchise deposits. In the past, I think you called them.

Speaker 6

Is there actually a difference? So if you maybe expanded conceptually the type of deposits that you're targeting, so you're now calling them franchise or is the new wording just, I don't know, cooler sounding or something? Can you give me an idea?

Speaker 1

It'd be the first time in my professional career I've been accused of making something sound cooler. No change in what's in it. It was a complete wording change only. Two reasons for it. One, we don't call them branches anymore, they're banking centers.

Speaker 1

And 2, with the launch of the digital cash management platform, we'll have clients that may not necessarily be clients of a banking center or have a banking center accumulate the deposit. It may come through that platform in a geography outside of our banking center footprint. So it was just time to broaden out the definition, but it was a pure wording change and that's why.

Speaker 6

Okay, great. Thank you. And then last question, again, one of these pesky ones. Just looking back at your supplemental and again sticking with page well, I'm going to flip it back and forth, Page 4. When I look at the Wealth Management assets under admin, assets under advisement, they're showing good growth.

Speaker 6

But then when I look at the actual underlying revenues, it's not tied. It's not growing at the same pace. Is there any I realize it's not a huge part of the income statement. I'm just curious as to what's going on there.

Speaker 1

Yes. Sometimes a bit of a lag there. So you'll have the asset growth 1 month and then the fees come the next month. And a big chunk of the asset growth was market driven. And on that, where you have clients with larger positions, it does attract a lower fee intensity on growth in that fee line

Speaker 2

for sure.

Speaker 6

Okay, great. Thanks for entertaining my questions. Have a great weekend.

Speaker 9

That's all.

Operator

And your next question comes from the line of Meny Grauman from Scotiabank. Your line is open.

Speaker 11

Hi, good morning. Just wanted to go back to credit, which is a popular topic this morning. The guidance range you're providing of 18 to 23 basis points, so that's a historic normal range. So really the question is what gives you confidence that we're in this normalized range and not something more negative, I would say, given the speed of the ramp up in the impairments quarter over quarter. What are you seeing beyond maybe obviously, we have rate cut expectations still built in to some extent, but anything in your business that you're seeing that you could highlight that gives you confidence that really what we're seeing here is normalization and not something more negative potentially?

Speaker 2

The approach that we've always taken in underwriting is to have a disciplined structure that in which we have cash flow value or in assets we understand. And really, when you think about it was unusually low. So, as we look at our the macro environment on our clients, we do see a return to what we think 23 basis points would drive and potentially where the losses went by. So it's really just coming through the underwriting structures into the mix of assets and where the funding is going.

Speaker 1

I think

Speaker 3

it's the matter of just our prudent reflection, but also it's the good security coverage we have. And coming from a very, very low base of both impaired and PCL. So I think we're very comfortable with that range as an outlook.

Speaker 11

Sounds like it's I mean, it's more a function really of your underwriting and how you make your loans and the type of loans you make rather than really a commentary about the macro environment. And so maybe there what I'm wondering is as you speak to your clients and what you're seeing more broadly, like is that consistent with a recession? What are you hearing on the ground in terms of just how significant the pressure is on the clients, even if it maybe doesn't necessarily lead to losses in your book, if you could comment on that, give us some perspective from what you're seeing?

Speaker 2

I think the macro environment is always a factor, of course, right, in terms of generation of sales, maintenance of costs and then of costs, of course, are impacted by the higher interest rate environment we're in. So when we look at our accounts that we have seen more challenges with, we're not seeing anything systemic. So it's not like in focus in one particular area. It's just a number of different issues that have arisen. So to what Carolina said, it's very idiosyncratic to individual business models and individual clients.

Speaker 2

And we will continue to work on that. But we as I say, we have come into these credits with a very disciplined underwriting structure that we have in place with secured lending. So we look to find ways to resolve. We've got a very strong team that works on that. Our goal is to be very active in that resolution structure.

Speaker 2

And as Karleen also said, we do we are seeing a lot of resolutions occurring, both as loans that have come into the watch list, but also on the impaired loan side. So it's an ongoing, highly managed process that we undertake to make sure that we manage this very effectively.

Operator

Thank you. And your next question comes from the line of Nigel D'Souza from Veritas Investment Research. Your line is open.

Speaker 12

Good morning. Thank you for taking my question. Two quick ones for you. First, your comment on an expectation for liquidity normalization next quarter, just want to confirm, does that imply that you're expecting that buildup that you saw in deposits this quarter to reverse next quarter? Or is it purely an asset side function where you expect loan growth to increase next quarter?

Speaker 1

Yes, it's loan growth driven. It's how we want to use that liquidity. That's our intent. That's what it's there for. But I think on franchise deposit growth, for all the reasons we mentioned, we do see that moderating next quarter as well.

Speaker 1

So it's really the combination of those two things. And I think the other thing, if we're going into a quarter with an excess liquidity position, there's I mean outside of our branches as well as our lending opportunities, we have other external sources of funding that we'll manage appropriately as well. So you may see us, for instance, take down broker deposits quarter over quarter as well to again, as a way to reduce deposits if we do see another quarter of unexpected strength in deposit growth from our franchise.

Speaker 6

Okay. That makes sense.

Speaker 12

And the last question I had was on the CEVA repayment that we saw the deadline come into force this year. So did that have any impact on credit experience for your portfolio? Do you expect it to have any impact on credit experience or our CEVA repayment is really not an issue here?

Speaker 3

No, Nigel. We haven't had any impact from CEVA repayments on our portfolio.

Operator

Thank you. And ladies and gentlemen, our Q and A session has now ended. I will now turn the call back to Chris Fowler, President and Chief Executive for closing comments.

Speaker 2

Thank you, Lee. Thank you all for joining us today and to our shareholders for their continued commitment and support. We look forward to reporting our Q2 financial results in May. Have a great day. Thank you.

Operator

Thank you. And ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.

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Earnings Conference Call
Check Point Software Technologies Q1 2024
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