Bank of Nova Scotia

TSX:BNS

Earnings Call Transcript 2022-Q2

[John McCartney, executive]

Good morning, and welcome to Scotiabank's 2022 Second Quarter Results Presentation. My name is John McCartney, and I'm Head of Investor Relations here at Scotiabank. Presenting to you this morning are Brian Porter, Scotiabank's President and Chief Executive Officer; Raj Viswanathan, our Chief Financial Officer; and Phil Thomas, our Chief Risk Officer. [Operator Instructions]

Also present to take questions are the following Scotiabank executives: Dan Rees from Canadian Banking; Glen Gowland from Global Wealth Management; Nacho Deschamps from International Banking; and Jake Lawrence from Global Banking and Markets. Before we start and on behalf of those speaking today, I'll refer you to Slide 2 of our presentation, which contains Scotiabank's caution regarding forward-looking statements.

With that, I will now turn the call over to Brian.

[Brian Porter, executive]

Thank you, John, and good morning, everyone. This morning, we announced our second quarter earnings of $2.8 billion, or $2.18 per share, representing a very strong 15% year-over-year increase in earnings per share. The results reflect net income growth of 12% and a return on equity of 16.4%. Continued loan growth of 13% and improving net interest margin, strong customer balance sheets combined with prudent expense management, positions the bank very well to grow its earnings.

The macroeconomic backdrop for our key geographies remains positive, supported by the rise in commodity prices and the underlying strength of businesses and households. The bank is proving resilient, delivering on all our commitments in terms of earnings growth, return on equity and expense control while maintaining a strong balance sheet. Continued momentum in Canadian Banking and the strong recovery in our International Banking segment contributed to solid year-over-year revenue growth across our operating business lines. These segments delivered positive operating leverage despite the expense pressures of the current operating environment. Global Wealth Management delivered another impressive quarter of growth and positive operating leverage through a period of volatility and broad market declines and Global Banking and Markets showed resilience in a period of heightened volatility and muted customer activity in our trading and origination businesses.

Credit trends remain favorable, a result of our high-quality portfolio supported by strong consumer balance sheets and prudent customer spending behaviors. Phil Thomas will discuss these factors in more detail later in the call.

Our common equity Tier 1 capital ratio ended the quarter 11.6%, as we deployed capital in line with our plans to grow the bank organically, while returning capital to our shareholders. This morning, we also announced a 3% increase to our quarterly dividend to $1.03 per share, reflecting our confidence in our earnings outlook. We expect to continue to deploy internally generated capital in future quarters to support strong loan demand. The organic lending RWA growth of over $27 billion or 62 basis points of capital in the past 2 quarters will support strong revenue growth in future quarters. We remain focused on initiatives at each of our business lines that deepen our customer relationships based on convenience, connectivity, breadth of product offering and best advice.

In Canadian Banking, we're focused on driving multiproduct relationships with our customers, improving customer retention metrics and increasing customer satisfaction scores across our domestic retail business.

The relaunch of our Scotia Plus and Scotia Rewards combined loyalty program is showing great results to date since January, Scene+ added 200,000 new members. Transactions and redemptions are up considerably and digital engagement has been very strong, with over 3 million log-ins between mobile and online channel since our launch with $2.6 million through the Scene+ app. We continue to leverage Tangerine's digital banking lead and customer satisfaction to deepen client penetration in both credit and investment products. Tangerine remains an important driver of deposit growth for our bank.

In Canadian Wealth Management, we continue to build momentum in advice delivery and investment sales. Scotia Smart Investor, our digital hybrid advice platform launched earlier this year jointly with Canadian Banking, has already seen 38,000 accounts opened and customer balances in excess of $1.4 billion. This past quarter, MD Financial and Scotiabank also announced Medicus, a unique multiemployer pension plan designed specifically for Canadian incorporated physicians to access predictable lifetime retirement income. International Banking continues to benefit from loan growth by the quick turnaround in the Pacific Alliance economies.

The segment continues to grow with the corporate and commercial and retail lending books in line with our risk appetite. This will contribute to stable high-quality earnings growth in future quarters. Digital continues to drive customer experience and efficiencies across our international footprint with adoption reaching 55% driven by a strong 20% growth in mobile banking users. In Q2, we also closed the previously announced acquisition of the remaining 16.8% minority interest in Scotiabank Chile from our local partner, adding approximately $30 million of quarterly earnings.

Global Banking end markets experienced double-digit loan growth in the quarter as clients access capital to grow their businesses, financing larger inventories in face of supply chain challenges and strategically investing in near-shoring plant and equipment. We anticipate continued momentum in business banking with loan pipelines higher across all our key markets, complemented by a strong M&A pipeline. In order to enhance our cash management offering to corporate clients, GBM recently completed the launch of payments as a service, enabling real-time customer interaction, allowing for real-time payments, request for payment and account validation.

In the advisory businesses, GBM's leading sustainable finance practice had strong participation in global ESG bond markets and is the top-ranked Canadian dealer in 2022 year-to-date. Enterprise-wide, our efforts to create more diverse and inclusive employment opportunities as well as support the communities in which we operate continues to gain traction and recognition. We recently increased our commitment to $10 billion in capital for women-owned and women-led businesses here in Canada through the Scotiabank Women Initiatives. We were also recognized as one of the best places to work in Canada for the third consecutive year by the Great Place to Work Institute. And just last week, Scotiabank was the only Canadian bank recognized with a global award from Global Finance for outstanding leadership and sustainability, transparency and identified as best in Canada for our sustainable finance initiatives. Despite the macroeconomic and geopolitical uncertainties in recent months, we are encouraged by the resilience of our businesses and the progress of our organic growth initiatives aimed at enhancing customer experience, operating efficiency and future growth for the bank.

And with that, I'll turn the call over to Raj for a more detailed financial report.

[Rajagopal Viswanathan, executive]

Thank you, Brian, and good morning, everyone. Before I begin, I'd like to note that all my comments on the bank and business line results are on an adjusted basis. I'll start the review of the performance for the quarter on Slide 5. The bank reported another strong quarter with earnings of $2.8 billion and diluted EPS of $2.18, an increase in EPS of 15% year-over-year. All 4 business lines reported strong results again this quarter, reinforcing the strength of our diversified platform. Return on equity improved to 16.4% this quarter, while pretax pre-provision earnings increased 2% year-over-year. Revenues were up 3% year-over-year, driven by strong loan growth. Net interest income was up 7% year-over-year and up 3% compared to the prior quarter, once again driven by strong loan growth. All bank net interest margins expanded 7 basis points quarter-over-quarter, driven by a 3 basis point expansion in Canadian Banking and a 10 basis point expansion in the International Banking as detailed in the slide in the appendix.

Canadian banking NIMs were supported by higher deposit spreads and the impact of the Bank of Canada rate increases, while International Banking net interest margin expanded due to spreads and business mix changes. Year-over-year noninterest income was down 3% due to lower investment gains trading revenues and underwriting and advisory fees, while banking and wealth management revenues grew a strong 7%.

The PCL ratio was 13 basis points for the quarter. Year-over-year adjusted expenses were up a modest 3% driven by higher personnel and share-based compensation, professional fees, advertising and technology-related costs to support business growth. The productivity ratio was 52.1% this quarter, while operating revenue was slightly negative at 0.5% year-to-date.

On Slide 6, we provide an evolution of our common equity Tier 1 ratio over the quarter as well as changes in risk-weighted assets. The bank reported a common equity Tier 1 ratio of 11.6%, down from 12% last quarter, primarily related to strong organic growth and repurchase of shares. This represents approximately $2.6 billion of excess capital over the 11% level. Strong internal capital generation of 31 basis points was offset by 33 basis points of growth in risk-weighted assets of $15.2 billion.

During the quarter, the bank repurchased approximately 13.9 million shares using 28 basis points of capital. Year-to-date, the bank has repurchased 26.3 million shares using 53 basis points of capital. As previously mentioned, the closing of the additional stake of our Chilean operations accounted for 11 basis points.

Turning now to the business line results beginning on Slide 7. Canadian Banking reported very strong earnings of $1.2 billion, up 27% year-over-year. Pretax pre-provision earnings grew 13% year-over-year, driven by strong revenue growth. Net interest income growth of 11% was driven by another strong quarter of loan growth, up 14% year-over-year, including 16% growth in mortgages and 19% growth in business loans. Compared to the prior quarter, mortgages grew 3%, while business loans grew 6%. Broad-based strength in commercial banking reflects our efforts to build share in Quebec and British Columbia and growing focus sectors such as agriculture, transportation and manufacturing. Net interest margin increased by 3 basis points quarter-over-quarter benefiting from higher deposit spreads and the impact of the Bank of Canada rate increase, partially offset by lower asset spreads.

The strong noninterest income year-over-year increase of 10% was driven by higher banking revenue, foreign exchange and mutual fund distribution fees. Expenses increased 8% year-over-year, driven by higher technology, personnel and advertising costs to support business growth. The segment generated positive operating leverage for the sixth consecutive quarter, which was at positive 2.8% in Q2. The PCL ratio was a net reversal of 1 basis point.

Turning now to Global Wealth Management on Slide 8. Earnings of $413 million were up 9% year-over-year. Revenue grew 4%, underpinned by higher investment fund fees, net interest income and fee-based revenues, partly offset by lower discount brokerage revenues due to moderating trading volumes. Expenses continue to be well controlled and were flat year-over-year, driven by lower volume-driven expenses and lower discretionary spend, partly offset by investments in product innovation, sales force expansion, technology and digitization. The division generated positive operating leverage of 360 basis points. Productivity ratio this quarter was 58.5%, which is down 210 basis points from last year.

Growth this quarter was broad based with strong results across our asset management, advisory and Pacific Alliance Wealth businesses.

We continue to see strong volume growth in our Private Banking business with double-digit loan and deposit growth, along with a solid pipeline for the second half. Assets under management decreased a modest 1% to $326 billion, while assets under administration increased 4% to $591 billion compared to last year, as higher net sales were partly offset by market depreciation. In Canada, assets under management was up 1% as net sales offset the impact of market appreciation.

Referring to Slide 9. Global Banking and Markets generated earnings of $488 million this quarter, down 6%. Pretax pre-provision income decreased a modest 2%. Revenue was in line with the prior year with strong growth in business banking, driven by continued loan growth while capital markets were down, reflecting challenging market conditions. As Brian mentioned, given volatile debt markets during Q2, we saw more corporate clients accessing bank debt to grow these businesses. GBM's loan balances grew 13% year-over-year and 3% quarter-over-quarter. This was driven by a focus on our growth in the U.S. market. The growth in loans to existing and new clients grew 13% year-over-year.

On the other side of the balance sheet, average deposit balances in GBM grew 2% year-over-year and showed good momentum with 10% annual growth on a spot basis. Expenses were up 3% year-over-year due mainly to technology costs to support business development. GBM Latin America, which is reported as part of International Banking, had another strong quarter with $185 million of earnings, up 9% year-over-year, reflecting strong top line revenue growth of 13%. GBM LatAm's performance reflects strong and growing results from our business banking franchise, which represents the majority of GBM LatAm's revenue.

Slide 10 shows the International Banking results. My comments that follow are on an adjusted and constant dollar basis. International Banking reported net income of $613 million, up 49% year-over-year and 10% quarter-over-quarter. Pretax pre-provision grew 9% year-over-year driven by a strong 11% increase in the Pacific Alliance, which was well above pre-COVID levels. Pretax pre-provision earnings in the Caribbean and Central America was also up a strong 11% year-over-year. The segment's net earnings continued to grow in line with economic recovery and have steadily delivered improving results for the last 7 quarters. Year-over-year loans grew 9% with commercial loans up 10% and mortgages up a strong 14%. Compared to the prior quarter, residential mortgages grew 4%; commercial loans grew 3%; while personal loans and credit cards grew 2%.

Revenue was up 4% year-over-year driven by higher net interest income and noninterest income. Quarter-over-quarter net interest margin increased a healthy 10 basis points to 386 basis points, driven by changes in business mix and the positive impact of higher Central Bank rates. Net interest margin expanded in the Pacific Alliance by 9 basis points, while Caribbean and Central America increased by 13 basis points. Noninterest revenue was up 4% year-over-year. Net fees and commissions were up 7%, mainly from strong banking fees in the combined Pacific Alliance and Caribbean and Central America regions. Provision for credit loss ratio declined year-over-year by 41 basis points to 77 basis points. Noninterest expenses were in line with the prior year as expenses related to business growth and inflationary impact were offset by efficiency initiatives and the benefits from the 2021 restructuring charge, coupled with strong digital progress. The segment has generated positive operating leverage of 2.5% year-to-date.

On Slide 11, I'd like to highlight the aggregate performance of the 4 business lines that reflects our strong operating results. Significantly lower investment gains this year [ used ] the impact of these strong metrics at the all-bank level. Total revenues for the 4 business lines together grew 5% year-over-year, while expenses grew a modest 2%. Strong loan growth, robust lending pipeline and expected growth in net interest margin positions the business lines for higher net interest income in future quarters. Free tax free provision earnings grew 8% year-over-year, while operating leverage was positive 2.5% for the quarter. These metrics demonstrate the steady positive growth that we are realizing from our investments in strategic initiatives across all our business lines and demonstrates the strength, resilience and diversified earnings potential of our key operating segments.

Now turning to the other segment on Slide 12. We reported a modest adjusted net loss of $10 million as compared to a loss of $67 million in the prior quarter and net income of $130 million in the prior year. Year-over-year, the change was a result of significantly lower investment gains, higher noninterest expenses that was partly offset by a higher contribution from asset liability management activities. The higher contribution from asset liability management was the driver of the significant change from the prior quarter as well.

With that, I'll turn the call over to Phil to discuss this.

[Philip Thomas, executive]

Thank you, Raj. Good morning, everyone. I will first highlight the key themes from a credit perspective before moving into the details of the quarter. The bank's credit performance remained strong, driven by lower net write-offs and a favorable business mix. We experienced positive performance across our portfolios, given the resilience shown by our retail and business banking customers despite an uncertain macroeconomic outlook.

Our key portfolios across our footprint are stronger than ever, highlighted by the following: Canadian consumer balance sheets have significantly improved. Average customer loan balances have fallen by 3% since the start of the pandemic, while customer deposits and investable assets have grown by 13% over the same period. Asset quality is strong, and FICO scores continue to improve. 28% of our Canadian mortgage portfolio is insured. Of the uninsured balances, the average loan-to-value of this portfolio is down to 47% from 55% in 2019.

In International Banking Retail, more than 95% of originations are of high quality, up from 77% pre-pandemic, as we continue to focus on the affluent segment. And finally, in business banking, credit quality remains strong with a high investment grade that is well diversified by geography and industry. Approximately 90% of our corporate portfolio has the probability of default of less than 1%. While we are cognizant of the current economic challenges posed by the elevated inflationary forces such as wage growth due to labor shortages and persistent supply chain issues, we remain optimistic about the overall financial health of our customers. The last 2 years have highlighted the bank's ability to effectively manage risk through unforeseen economic challenges, and we continue to be proactive in supporting our customers where needed.

Turning to Slide 14. The overall credit quality of our portfolio continues to improve. The bank's gross impaired loans ratio improved by 4 basis points to 64 basis points since peaking in Q1 of 2021 at 84 basis points. We continue to see a positive trend with lower formations. Our net write-off ratio continued to decline quarter-over-quarter to 25 basis points, down 2 basis points from the prior quarter. We also saw $422 million of write-offs in retail, down 8% from last quarter as we continue to see lower trends across our footprint. We ended the quarter with allowances for credit losses of $5.4 billion, down approximately $200 million from the prior quarter. This level of allowances and lower ACL ratio of 75 basis points is reflective of broad improvements across the bank's portfolios and a shift towards secured retail. Our Canadian and international retail portfolios are now 95% and 71% secured, respectively. Impaired ACLs decreased $19 million from last quarter due to improvements mainly across retail and GBM.

Turning to Slide 16. I will now review the PCL performance for the quarter. All bank PCLs are $219 million or 13 basis points driven by a net reversal from performing loans, loan PCLs in Canadian Banking and Global Banking and Markets. Strong loan growth and a less favorable macroeconomic forecast were offset by continued improvement in credit performance. In performing PCLs, we had a net reversal of $187 million in Q2. The reversal was mainly due to improving credit performance, net of growth of our Canadian retail portfolio and reversals in GBM related to improved credit metrics. Impaired PCLs are $406 million in Q2, flat to last quarter, driven by continued lower net write-offs in international retail, offset by lower releases in Canadian retail.

Before I turn the call back to Brian, I would like to wrap up with a few highlights. We've reached the floor this quarter for PCLs and expect provisions to gradually increase in the latter half of the year. PCL growth was largely driven by lower releases and quality asset growth, offset by a favorable shift in business mix to retail secured lending and stable net write-offs. We are cognizant of the uncertain macroeconomic and geopolitical environment, and we continue to see strength and resilience across our portfolios. Improving origination trends continue to give us confidence that our portfolios are well positioned.

And I will now turn the call back to Brian for closing remarks.

[Brian Porter, executive]

Thank you, Phil. We are very pleased with our performance in the first half of 2022. The bank is reflecting the full earnings power of the organization despite the increased volatility and global macroeconomic developments. As such, we remain confident in our ability to continue to grow the bank and deliver against our key medium-term financial objectives. Growth to date in our core geographies has been resilient, which we expect to continue given healthy consumer balance sheets and the positive economic impact of higher commodity prices. Throughout our footprint, lending pipelines remain strong across corporate, commercial and secured retail businesses.

Our investments in wealth have added diversification and enhanced our ability to consistently deliver high-quality sustainable earnings. The bank has delivered strong performance in periods of macroeconomic uncertainty in the past, and we feel very well positioned to deal with the challenges of the current environment. Strong year-to-date organic RWA growth of $27 billion or 62 basis points and an improving net interest margin will produce higher net interest income supported by a stable credit environment. We will continue to manage expenses prudently to generate positive operating leverage for the balance of the year. We remain highly confident that our diversification of our business model, coupled with prudent risk management and a focus on delivering for our customers, especially through times of uncertainty, will yield strong long-term results for all our stakeholders.

With that, I will pass the call over to John for Q&A.

[John McCartney, executive]

Thank you, Brian. We will now be pleased to take your questions. [Operator Instructions] Operator, can we have the first question on the call?

[Operator]

The first question is from Ebrahim Poonawala from Bank of America.

[Ebrahim Poonawala, analyst]

I guess a question on expenses. So adjusted expenses year-over-year up 3%. Just talk to us as you think through like there's been so much discussion around inflationary pressures, wage growth. Have you been surprised by how these have impacted your expenses year-to-date? And as we look forward, maybe on a consolidated basis or on a segment basis, just talk to us around the outlook for expense growth and how you think about what the core expense run rate should be as we think about this kind of a macro backdrop? And then remind us if there are any opportunities for savings across segments that would mitigate that.

[Rajagopal Viswanathan, executive]

Sure, Ebrahim. I will start and any of my colleagues may pitch in, if they speak to the business line. From a bank's perspective, we talked about it. Prudent current expense management is part of our day-to-day operations, and we consider it a cornerstone of how we run this bank. We said in previous calls we manage it in line with revenue growth. That's kind of the philosophy while continuing to invest in people, cost and technology. So expense growth, yes, this quarter was 3% year-over-year, really good outcome. Really for the first half of the year, Ebrahim, it's like 1.7%. But some of it is helped by FX, which is favorable to our numbers as we look back with over the last 6 months. But looking forward, we know expenses will go up compared to the 1.7% in the first half of the year. It could go up to something higher than that, but we still think it's going to be in the low single digit rates than we indicated in our call in November. So there's no change to that from our perspective.

Salaries and benefits will go up, inflation is high. There are certain expenses that will go up naturally because of what's happening around us. But we have a number of levers that we use in this bank, Ebrahim. A lot of it is discretionary costs, whether it's project related or just professional services, for example, as one category. Lots of opportunity over there. And on the management team, we talk about it a lot, not just across the various business lines, but very specifically across the bank to see how we can find offsets underway. I'll call it real estate as one. We've been working on it for a long time, not recently, continuing to densify our footprint and so on. That's giving us a lot of benefits. Some of it is already in the numbers, but there's move to come. So there are many, many lines that we think there are opportunities to offset those lines, which we know expenses will go up. But it's a balance between investing for the future while continuing to manage expense -- manage our expense growth prudently. Like Brian said, we expect to generate positive operating leverage for this year. It's a small negative at 0.05% at this time. We're quite confident that the second half of the year with the elevated expense load, we should see positive operating leverage for fiscal 2022.

[Ebrahim Poonawala, analyst]

Got it. And just a quick follow-up on that. Implied productivity ratio around 52% first half, that's probably drifting lower, maybe closer to 50% as we think about margin expansion on the other side. Is that kind of the right way to think about it?

[Rajagopal Viswanathan, executive]

Yes. I don't think we'll get to 50% for the year, just to be clear. Our target has always been to get to 50%. Yes, you should see it trending lower as well, yes.

[Operator]

The next question is from Gabriel Dechaine from National Bank Financial.

[Gabriel Dechaine, analyst]

My question is on credit net. I mean I'm trying to interpret your comments there. It doesn't sound like you're too concerned. I'm just wondering, between the end of April, which marks the end of this quarter, and today, where maybe the econ forecasts have gotten worse, would you be doing something with regards to your performing provision inputs like put more weighting on a worst-case scenario or anything of that nature? I mean, conceptually, I know you can't give too much guidance there, but yes, let's leave it there and see what you come up with.

[Philip Thomas, executive]

Thanks, Gabe. Appreciate the question. Maybe let me add some color to the comments I made in the -- in my opening remarks. We're really focused on the quality of the Canadian consumer right now. And as I mentioned earlier, we're seeing people paying down loans over the last 2-year period of 3%. We've seen investable assets increase in our Canadian portfolio -- Canadian consumer portfolio, about 13%. And so we also look at things like FICO scores. We've had improvements in our FICO scores of our customers over the last couple of years on average within our credit book from 720 to 750, in our mortgage book from 750 to 790. So all this sort of gives us really good confidence in terms of in terms of what we're seeing with our customers. I would also like to point out, if you have a look at our net write-offs, we've been seeing good stability within those. We've seen a decrease this quarter from 27 basis points to 25 basis points, which should also give you some confidence in terms of how customers are paying off their loans with us and how sort of the Canadian consumer is healthy. And lastly, maybe just if you look at our mortgage portfolio, we've seen LTVs improve over the last 2 years. The average LTV in our portfolio is now 47%. So despite -- and we are conscious and we are thoughtful about macroeconomic headwinds. We're very confident in the health of the Canadian consumer at this point.

[Gabriel Dechaine, analyst]

No, I get that. I mean -- but a lot of what we're looking at, let's say, loan information, they're rearview-looking indicators. I'm thinking more about the forward-looking indicators and deterioration thereof and maybe just more conservatism that you want to establish just to be cautious. Is there anything like that crossing your mind?

[Philip Thomas, executive]

Yes. I mean, listen, we've hit a trough this quarter in terms of our PCLs. And we will continue to build over the course of the year as we look at the FLIs and how things are happening in the economy.

[Brian Porter, executive]

Yes. Gabe, it's Brian. It's -- Phil's given a good update on the status of the portfolios. But we run rigorous stress tests here in the bank of all our portfolios in Canada, international, corporate and commercial. And obviously, given the macroeconomic environment, we run stress tests that would have more harsh inputs today than we would have possibly a year ago. So that's a rigorous process. We run 100s of them during the course of a week, and it's important to do that for obvious reasons.

[Gabriel Dechaine, analyst]

I'm not saying anything about Scotia. I think I'd have the same question for every bank.

[Operator]

The next question is from Paul Holden from CIBC.

[Paul Holden, analyst]

Just a quick question in terms of deposit mix and managing liquidity in light of, I guess, both higher interest rates, how that's impacting deposit mix and then also quantitative tightening and how that might be impacting availability and growth in deposits.

[Rajagopal Viswanathan, executive]

Yes. I'll start, Paul, at the all-bank level again. Deposit growth and deposit initiatives are key to us. We run a very tight operation, particularly in the P&C business to see how we can be self-funded in many respects, but the loan growth has been fairly strong and deposits have been really good through the pandemic, moderating to more normal levels of what we would see. Deposit strategies are different when it gets to the Canadian bank and as it gets to the international bank. So I won't get it into the details, so I'll pass it on to the 2 of them. But in reality, liquidity is something that we manage very closely. Externally, we have put LCR ratios. We doubled NSFR ratios and so on. So there's a lot of metrics that is used externally and there's numerous metrics that we use internally to manage both sides of the balance sheet, so to speak, and ensure that our funding is appropriately in place to support the strong loan growth that we are seeing. So that's at a very high level from the all-bank perspective.

How about I pass it on to Dan? He can talk about the Canadian bank and then maybe Nacho about the international bank, please?

[Daniel Rees, executive]

Sure. Thanks, Raj. Look, I was very pleased with the quarter-over-quarter growth in deposits in Canadian Banking that you've seen at 1.5% on the average and closer to 3% in spot. If you compare that to loan expansion, which has been significant this quarter, those 2 on a spot basis are almost in balance in Q2, and we haven't seen that at any point during the last 2 years. Of the 3 businesses, recall that we've been intentionally growing the business bank, that's self-funds. So deposits larger and growing faster than loans -- sorry, larger than loans, pardon me. And they had the best quarter in sequential balanced growth in deposits in the last 3 years. Tangerine had a tremendous improvement, as you would expect, in deposits and also in the retail [ Red Bank ], where we were softer last quarter in retail term. We made very good progress as consumers repositioned out of savings into GIC. So from a liquidity management standpoint, as Phil said, consumers and businesses are in good shape and the portfolio saw better deposit growth this quarter than last quarter.

[Ignachio Deschamps, executive]

Thank you. Dan, following on international, we also had a strong quarter in deposits. Our Q-over-Q deposit grew 3% in international in line with loan growth, and this is a key priority, similar to Canadian Banking, in all business lines. On the retail side, we have been providing a much faster account opening on deposits. 75% of all deposit accounts in the Pacific country -- Alliance countries are open end-to-end digital. So this is providing us much more productivity. And in wholesale banking, we have a stronger cash management business in Chile, Peru. We're scaling up our technology in Mexico and Colombia as well. So definitely a high priority for us as well.

[Paul Holden, analyst]

Okay. That's great. So it sounds like no need for increased wholesale deposits, everything is going well in terms of consumer and business deposit growth?

[Rajagopal Viswanathan, executive]

Yes, I think so, Paul. I think that's a good summary, yes.

[Operator]

The next question is from Scott Chan from Canaccord Genuity.

[Scott Chan, analyst]

You spoke a lot about the Canadian consumer, but just curious on the international side, specifically with the Pacific Alliance. You kind of guided a couple of quarters ago to a total PCL ratio of 95 bps in '22, well below pre-pandemic level. So maybe an update on the COVID situation in the Pacific Alliance. And any change or thought process we should think about in terms of your past guidance?

[Philip Thomas, executive]

Thanks, Scott, for the question. I'll start, maybe hand it over to Nacho to add a little bit more color to the comments. But we're very happy with how the -- from a risk perspective and how the international portfolios are performing. We've seen a shift from 66% secured to 71% secured in that portfolio. And not only that, we've seen great work done on our affluent strategy, which is really up-tiering the quality of the portfolio, both from new originations and as we look at the portfolio altogether. And that's why we've been quite confident with our outlook in terms of the international retail PCL ratios.

[Ignachio Deschamps, executive]

Thank you, Phil. Let me follow up, give you a little bit more color on our -- on the markets in the Pacific Alliance countries. We are seeing a very strong recovery on the back of a strong 10% GDP growth last year and expected 3% this quarter, and this is reflected in our growth. Our loan growth this quarter was 3% Q-over-Q for the third consecutive quarter and it was strong in commercial. It was strong in mortgages. And it was also -- it also grew, as Raj mentioned, in personal loans and credit cards, 2% Q-over-Q. We are seeing also positive impacts of interest rate increases and business mix in NIM with a 10 bps increase in the quarter. PTPP continues also to perform better, 9% year-over-year, 11% in the Pacific Alliance countries, specifically. And we delivered a strong operating leverage, 300 bps. I have to say that it's very -- it's remarkable that our expenses are flat year-over-year even when inflation in these countries is around 8% driven by strong digital progress and the execution of the restructuring charge. Credit quality, as Phil mentioned, have also a balance sheet of households and companies are strong, and we're seeing this momentum to continue in the second half of the year.

[Operator]

The next question is from Mario Mendonca from TD Securities.

[Mario Mendonca, analyst]

Just a broad question on capital to start. So the capital ratio, 11.6%, on an absolute basis, obviously, good. Do you -- maybe this is for Raj and Brian. Do you believe that the bank's capital level is sufficient to both absorb the organic growth -- the strong organic growth that's starting to emerge in international and certainly in commercial, and at the same time, be able to absorb some increased risk density as the environment may perhaps deteriorate and then, finally, also have the capital flexibility to buy back stock or do inorganic things with the capital? Is 11.6% enough to get it all done? That's the broad question I'm looking at.

[Rajagopal Viswanathan, executive]

Thanks, Mario. I will start and maybe Brian will have some comments to add to my thoughts. I think the short answer is yes. We work a lot in this bank when we talk about optimal capital. Towards optimal capital, at this time, it's about 11.5%, where we'd like to operate. We want to operate a little bit north of it. You've seen it. We generate 30 to 32 basis points of capital every quarter after dividends. And we have multiple opportunities, like you said, organic RWA growth, buyback of stock, which has been quite high in the first half of the year. I think that's going to moderate in the second half of the year. I doubt we're going to buy back another 27 million shares. As we see it today, we have an ability to buy back another 8 million shares based on the approvals we have in place, and we think we'll execute on that. So that should be a tailwind to what you've seen in the first half how we deploy capital.

And organic growth has been very strong, as you mentioned, across all our businesses. We think Q3 will continue to be strong, but there will be some level of moderation at least on the mortgages in the Canadian bank side where this should be probably the high end of what we would see as capital consumption. But finally, what I'd say is capital is something that we manage very closely. Even at today's level, I've made a comment at 11%, it gives us $2.6 billion of capital cushion to look at RWA density, any sort of migration that might happen that could absorb capital pretty quickly. And I'll probably double down on what Brian said before. A lot of the stress scenarios we run does not get us anywhere close to that to saying that this capital could be used up quickly based on macroeconomics of how the portfolio might move. So I feel like for the rest of the year, the capital will be north of 11.5% for sure after executing all the [ cash ]. Brian?

[Brian Porter, executive]

Yes. The only thing -- that's a good question, Mario, and one we discuss here, and obviously, management -- a key part of management's job is capital allocation and returning capital to shareholders. So we spend a lot of time and focus on this and it's about balance. And we've been executing that in terms of buying shares back, increasing dividend and investing in our businesses organically. But if you were to look at it in a time of stress, I'd refer you to our reg cap supplementary where you can see that for our corporate -- commercial portfolios, we're at the high end of the market vis-a-vis all our competitors in terms of credit quality. So -- and that's by design. That's what we do here in terms of allocating capital to our customers. So in summary, we've been talking about optimal capital at this bank for a long period of time. The arms raise on capital is over. You see the U.S. banks operating in and around the same level we are 11.4%, 11.5%, 11.6%. We think that's more than appropriate given the environment and what we see coming at us in the future.

[Mario Mendonca, analyst]

Yes. And then just one quick detailed question. The share-based payments options and others dropped to 0 this quarter. Was there some sort of change in accounting? Or is that just the quarter-to-quarter volatility we might see in this line?

[Rajagopal Viswanathan, executive]

No, there's no change in accounting, Mario. It's just quarter-to-quarter and Q1 tends to be seasonally high because you have the eligibility to retire that gets picked up at the beginning of the year. So you'll see that every year. This year was a little higher because of the mark-to-market of the share-based performance will impact quarter-over-quarter.

[Operator]

The next question is from Lemar Persaud from Cormark Securities.

[Lemar Persaud, analyst]

I just want to come back to Phil on credit. Just wanted to revisit the all-bank guidance from Q4. Just given that the macroeconomic backdrop today is admittedly very different than when you provided the guidance in Q4. Does it feel like the mid-30 basis [indiscernible] at the all-bank level still makes sense?

[Philip Thomas, executive]

Thanks, Lemar. We're not going to give guidance of 2023 or restate guidance today. But I would just point you back to some of the core underlying comments I made earlier about the quality of the portfolio, how net write-offs are trending. We really like the positioning of the portfolio right now in terms of where it is with the ratio between secured and unsecured. And we feel that we're in a good position should we have any headwinds come down. As Brian mentioned, earlier, I mean, we stressed the portfolio. Not only do we stress the portfolio, but we stress how our customers will behave. And under a big stress scenario, we leverage advanced analytics to be able to look at identifying really vulnerable customers. And we did the same during the pandemic and we had identified 30,000. We do the same run now under stress and we see about 14,000. So if you look at that and you combine it to the fact that we're still up to where we were in our collections capacity, we're leveraging loss mitigation tools now to proactively reach out to customers. So we feel like we're in really good shape. And I would just maybe use that in terms of how you're thinking about your guidance for next year.

[Lemar Persaud, analyst]

Okay. That's fair. And then maybe for Dan on Canadian Banking. Solid mortgage growth in Q2. But kind of given the backdrop of materially higher rates, the discussion about a higher probability of a recession, can you talk about how you see that evolving for the balance of the year? And then are there certain overheated markets that you're looking to pull back on? And are you guys making any changes to underwriting standards in light of some of the higher credit risk?

[Daniel Rees, executive]

Yes. Thank you. Look, we're very pleased with the performance in the quarter. 16% is the result of investments we've been making over several years, both in terms of expanding our sales capacity in our proprietary channel, our online offering was positive again this quarter, and retention, we now stand well over 90%. So the front-end and the back-end piece of the mortgage business performed as expected based on those investments, and we're pleased with our presumed market position there, including in BC and Quebec, where I've been signaling for some time were undersized. You have seen some slowing in the mortgage growth. So sequentially this is -- you see that as opposed to year-over-year. I think we're 2.5% sequentially. We do not anticipate making credit adjudication adjustments at this point. There are some markets which are -- have obviously grown more in the buyers' favor, let's say, based on softening, but we don't plan to be adjusting our sales or credit stance at this point. We believe that the mortgage is a key part of the retail strategy. If we want to own a home, we need to own a mortgage. Our cross-sell ratios continue to improve, in particular, our deposits on takeup. So we're pleased with the performance to date. In terms of outlook, it is slowly slowing. So we will be unlikely at the 16% next quarter, but we do expect to see quarter-over-quarter Q3 and Q4 perhaps at the high single-digit loan growth rates versus prior quarter -- versus the prior year. So slowly slowing and we're pleased with how we stand.

[Operator]

The next question is from Mike Rizvanovic from Stifel.

[Mehmed Rizvanovic, analyst]

Wanted to stick with Dan on that same line of discussion. So just on the residential real estate sector. So it's not just the mortgage itself, but I'm just looking at your real estate and construction category, also up 30% year-over-year. So some pretty good volume growth in both of those books of business. I'm just wondering, at what point are you maybe starting to get a bit concerned? You mentioned not changing credit judication at this point in time. But just the rate environment, the way it looks right now, you're going to have a pretty significant step-up in the cost of carry on existing mortgage balances. Are you not starting to get a bit concerned on where this is heading? Because looks like we're potentially going to have both the variable and fixed rate mortgages at a pretty steep level relative to the lows that we saw in 2021 in the next few months.

[Daniel Rees, executive]

Look, I would just repeat part what I mentioned, Mike, which is you are seeing a relative deceleration in the expansion of real estate lending through the residential side. On the side of commercial, I would just reemphasize, we believe that there is a structural imbalance in Canada, and that supply is short. And so to see growth rates on the construction side higher than residential is our way of supporting more supply coming to the market, which will increase the balance in the market and the health of real estate in Canada over the medium and long term. This quarter, last quarter and the prior quarter, so 3 quarters in a row, you're seeing better industry balance across the commercial loan growth. So we saw tremendous improvements in agriculture. This quarter, we've moved from the #4 position up to the #3 position in terms of market share and could be #2. We're expecting to see a relative performance in technology, in health care, in transportation and logistics, all grow at podium-level rates. So we're less reliant on the real estate now than we would have been a year or 2 ago. And in speaking with clients and the majority of the growth is from long-term top-tier clients, they're taking a long-term view. So they're either pausing on bringing product to market or they're picking up land because they know that the immigration wave is continuing and the population in Canada will grow substantially from here. So we acknowledge there are questions in the marketplace around real estate prices. We support the expansion of supply and some moderation is a good thing for better balance.

[Mehmed Rizvanovic, analyst]

Got it. So no real change in terms of your strategy, that you are going to continue to try to gain share at the expense of your peers. Is that fair?

[Daniel Rees, executive]

Yes. I mean I would -- in broad -- yes, that's correct. And the 2 loan portfolios that are the largest and growing the fastest are the lowest risk. So the PD in residential mortgages and the PD in real estate lending is extremely low. So we're also derisking the book by growing those 2 large portfolios. And bear in mind, in real estate, deposits come along for the ride based on the consumer. So we're very pleased with our credit position in those 2 portfolios.

[Operator]

The next question is from Doug Young from Desjardin Capital Markets.

[Doug Young, analyst]

Just a question on International Banking. Just want to dig in and I look at Peru, pretax pre-provision earnings seems to [ stall ] out quarter-over-quarter. I think that might be due to capital market activity. And if that's right, can you give a little bit more context to that or quantify what that impact was? And then maybe a bit of an outlook.

And then Nacho, I think you've talked about NIM outlook for International Banking in the [ 3 80 to 3 90 ]. You're at, I think, the midpoint right now. Like is that still what you foresee as achievable? Or is there room to kind of push that up a little bit?

[Ignachio Deschamps, executive]

Thank you for your question. And you are right. I think PTPP in Peru declined slightly in the quarter is driven by a very strong capital markets revenue in Q1 in Peru. When you exclude that capital markets revenue, PTPP was flat despite a shorter quarter. And the trends are quite positive in terms of the recovery in Peru for our business following a very strong economic recovery as well. Loan growth was 4% Q-over-Q, both strong in retail and commercial, margin expansion of 5 bps. And Peru has done an excellent job in terms of digital progress. 60% of all new originations in retail are digital. And the restructuring charge execution, the combination of both is allowing us to reduce expenses 5% year-over-year in Peru, and operating leverage is 200 bps. Credit quality retrends remain positive. So you will continue to see improved results in Peru sequentially in the second half of the year.

And margin expansion, we are very pleased to see 10 bps increase this quarter, 7 bps last quarter. We still see an upside in future quarters. So we would expect net interest margin to continue to be positive. Of course, it will depend on market conditions, on competition, on the steepness of the curve and so on. But I would say we are positive about NIM expansion in International Banking.

[Operator]

The next question is from Darko Mihelic from RBC Capital Markets.

[Darko Mihelic, analyst]

My question is for Dan. I just wanted to follow up on some of the line of questioning from Mike on mortgages and real estate in particular. You guys do have a mortgage -- a variable rate mortgage with a unique feature in which the payment goes up when rates go up. So is that a significant part of the mortgage portfolio today? And is it a significant part of the go forward? I mean is it a product right now that is overwhelmingly the choice of product for customers in Canada? And I realize you probably stress test this portfolio and that's all good, but I am just very curious the behavior of this portfolio in a situation of rapidly rising rates.

[Daniel Rees, executive]

Yes. Thanks, Darko. We're not worried about the credit portfolio, the VRM book. 2/3 of the book is fixed. The conversion rate out of variable into fixed has been accelerating over the last number of months as prices have been rising. That's a trend we've anticipated. We do think -- and we believe very strongly that a variable mortgage should have a payment that varies. We think that's good for customers. And as Phil was saying, when we stress test the book, it's tens of thousands of customers that we proactively reach out to who might be vulnerable to an adjustment in their monthly payment amount.

Let me put that in perspective. The average balance on a VRM mortgage is $400,000, and I'm rounding up. And the adjustments to the monthly mortgage, should rates rise 100 basis points from here, is about $250 on an expense base of a household over $5,000. This is not a significant adjustment. Prices have already gone up 75 basis points. We've seen no change in 31-plus or 91-plus delinquency rates, and the FICO scores are higher on the VRM product. The income levels are higher and customers that tend to choose that product have been doing so for a long time because the payment levels are lower. And so this is a sophisticated customer taking our advice and are converting to fixed as anticipated. So this is a product we've had for 20 years. We think it's transparent to the customer. It does not have extra credit risk attached to it, and we've been proactive with Phil's team on supporting those who need to make the modest transition to date.

[Darko Mihelic, analyst]

And just a mechanical question. Are they -- I mean when rates move on them, is it just taken out of their account? Or is there some sort of communication that, hey, your mortgage rate is going up and mortgage payments going up?

[Daniel Rees, executive]

When there's a rate change to prime, the VRM customer receives a proactive written notice informing them of the change and the payment comes out of their account. And from a design standpoint, we receive positive feedback from the regulator in that respect.

[Darko Mihelic, analyst]

And Dan, is it the mortgage of choice today?

[Daniel Rees, executive]

It has changed significantly in the last 3 months. And the swing out of variable in the fixed has been changing during that period. The stock is 2/3 fixed. The flow is more VRM today based on the price differential between variable and fixed. As that narrows, the conversion happens very quickly. And as I've been saying for some time now, when you want to own a home, the ability to cross-sell when the VRM customer comes in for retention is meaningful, and we've been doing a better and better job of that at each time.

[Rajagopal Viswanathan, executive]

Thank you, everyone, for participating in our call today. We're very pleased with the strong start to the year with earnings momentum across all our businesses. On behalf of the entire management team, I want to thank everyone for participating in our call today and look forward to speaking with you again at our Q3 2022 call in August. This concludes our second quarter results call. Have a great day.

[Operator]

Thank you. The conference has ended. Please disconnect your lines, and we thank you for your participation.