Canadian Western Bank

TSX:CWB

Earnings Call Transcript 2022-Q2

[Operator]

Good morning. My name is Sylvie, and I will be your conference operator today. At this time, I would like to welcome everyone to CWB's Second Quarter 2022 Financial Results Conference Call and Webcast. [Operator Instructions]

Mr. Patrick Gallagher, you may begin your conference.

[Patrick Gallagher, executive]

Thank you, Sylvie. Good morning, and welcome to our Second Quarter 2022 Financial Results Conference Call. My name is Patrick Gallagher, and I'm the Vice President, leading our Strategy and Investor Relations team. I would like to remind listeners and webcast participants that statements [indiscernible] future events made on this call are forward-looking in nature and based on certain assumptions and analysis made by management. Actual results could differ materially from expectations due to various risks and uncertainties associated with CWB's business. Please refer to our forward-looking statement advisory on Slide #2.

The agenda for today's call is on the third slide. Presenting to you today are Chris Fowler, our President and Chief Executive Officer; and Matt Rudd, our Chief Financial Officer. Following their presentations, we'll open the lines for a question-and-answer session.

I'll now turn the call over to Chris, who will begin his discussion on Slide 4.

[Christopher Fowler, executive]

Thank you, Patrick, and good morning.

Q2 results landed below our expectations. Our key focus is to win core business owner clients by providing responsive, well-structured, full-service financial solutions. The timing and winning and funding of these full-service opportunities can be variable based on the length of the sales cycle and unique needs of the client.

Loan and branch-raised deposit growth through the first half of the year was lower than expected, with many of these opportunities having pushed into Q3. We're coming out of the second quarter where we had fewer closings than anticipated but with a robust pipeline of full-service client opportunities that we expect will accelerate our loan and deposit -- branch-raised deposits rates growth in the second half of the year.

Our business leaders are confident in the pipeline. And we have a strong start to Q3 so far. While we've experienced downward pressure on second quarter net interest income, the stronger growth we expect to deliver in a rising interest rate environment over the remainder of the year will provide a significant tailwind as we move into next year. Our expense and strategy in Ontario continues to drive strong results, accounting for 40% of our total loan growth during the quarter.

We expect our strong momentum in the province to continue as we open new banking -- our new banking center in Markham this summer and a new banking center in Toronto's Financial District in 2023 to consolidate our Toronto Wealth Management and downtown banking teams into 1 location. In combination with our expansion in Ontario, our investments in our digital platform will continue to deliver strong growth of branch-raised deposits.

This quarter, we prepared our personal and small business digital banking platforms for a first scale launch this summer. The small business platform will integrate with the Virtual COO solution. And once it is fully launched later this year, it will integrate data and explainable artificial intelligence powered tools to empower our small business owner clients to make informed decisions that accelerate their business growth. We believe the VCOO will be a different [ change ] solution for small business owner clients that once fully deployed, will assist in driving strong client growth in this segment, which is another source of lower cost, high-quality deposits.

We're also pleased to announce that we executed an investment commitment in Portage Ventures third fund, Portage III. Portage, the venture capital arm of multi-asset class alternative investment firm Sagard, is a global fintech-focused investor that partners with some of the world's most innovative financial technology companies. Participation in this fund will provide more avenues to further investigate enhancing our digital client experience and product offering through accessing actionable insights into trends shaping the industry and identifying targeted partnership opportunities that leverage our modern technology infrastructure. Further, we continue to implement enhancements to our AIRB tools and processes and believe approval of our AIRB transition program will make us more competitive, support higher growth and achieve further diversification with an enhanced view of risk.

We also published our inaugural sustainability report in March, which provides details on how our approach to ESG will deliver sustainable value creation for all our stakeholders.

Execution of all our strategic priorities reflects the hard work and commitment of our teams. Remaining a destination for top talent in an evolving and competitive environment is key to our success. So we are proud to be recognized in the top 20 on this year's list of Best Workplaces in Canada. Our continued rise in this list is powered by a people-first culture that supports flexible work, promotes diversity and inclusion and inspires collaboration and innovation to deliver a differentiated experience to our clients and deliver on their strategy priorities. CWB also was recognized with the Global Mail’s 2022 Women Lead Here list, a benchmark that identifies best-in-class executive gender diversity in Canada.

To recognize the unwavering commitment of our teams in April, we celebrated Teal Care Day, which awarded an extra day off for our teams to prioritize their overall well-being. We're pleased with our strategic progress to date with several core investments that support full-service client growth approaching completion. While our investments have put downward pressure on near-term financial results, we significantly transformed and diversified our business and are well positioned to leverage those investments to drive breakout growth and enhance profitability for our investors.

Our credit quality is strong and all key credit metrics remain favorable to pre-pandemic results. We recognize there is some uncertainty on the horizon with respect to economic and geopolitical conditions, but we're well positioned to face that potential volatility. Our teams are poised to capitalize on the opportunity in front of us to expand our market share and deliver very strong growth in full-service clients through the remainder of this year.

I'll now turn the call over to Matt, who will provide greater detail on our second quarter performance and outlook.

[R. Rudd, executive]

Thank you, Chris. Good morning, everyone.

Beginning on Slide 5, our branch-raised deposits are up 10% from the prior year and now represents 58% of our total funding compared to 57% last year. This reflects our continued focus across the organization to expand full-service client relationships, leveraging our expanded product offering and digital capabilities. On a sequential basis, our branch-raised deposits increased 1%, which reflected continued strong growth from CWB Trust Services and in our banking centers. This was partially offset by a continued decline in motive deposits, which was primarily driven by strategic pricing decisions.

On Slide 6, total loans were up 9% in the past year. We delivered 9% growth in the strategically targeted general commercial portfolio and that reflects our focus to increase our full-service client relationships across our national footprint. The 12% growth in commercial mortgages reflected strong new lending volumes in D.C., Ontario and Alberta, with high-quality borrowers and underlying asset classes that remain within our risk appetite.

Personal loans and mortgages were up 12%, driven by growth in both insured mortgages to support our participation in the NHA MBS and CMB programs and uninsured mortgages with an average loan-to-value of 62% at origination. Ontario loans grew 13% over the last year, supported by our increased presence with the Mississauga banking center and now represent 24% of our total loans. 11% growth in BC reflected robust commercial mortgage and general commercial activity and the 6% growth in Alberta was pretty well balanced across all portfolios.

On a sequential basis, total loans were up 2%, with 3% growth in our general commercial portfolio, where we are seeing strong momentum build. Personal loans and mortgages increased 2%, reflecting growth in uninsured mortgages, which benefited from strong new origination volumes. New project starts in BC, Alberta and Ontario have increased which drove the 5% growth in real estate project loans. Growth in equipment financing was 1% and continued to be dampened by supply chain challenges.

Slide 7 shows our common shareholders' net income increased 3% compared to the same quarter last year. Adjusted and diluted EPS were consistent with the same quarter last year. Increased net interest income contributed $0.08, higher noninterest income contributed $0.02, primarily due to higher wealth management fees. Higher noninterest expenses reduced EPS by $0.16, which reflects our continued investment in our people, AIRB tools and processes, digital capabilities and product offering. Pretax pre-provision income decreased 5% as the growth in noninterest expenses exceeded the growth in revenue.

As Chris mentioned earlier, we're making several strategic investments where we expect strong revenue growth in a later period. This puts temporary pressure on our efficiency ratio and operating leverage, but we expect this will drive enhanced returns in future years. A lower total provision for credit losses as a percentage of average loans contributed $0.03 to EPS and reflected a 13 basis point decrease in the impaired loan provision, partially offset by a 7 basis point increase in the performing loan provision. Other items contributed $0.03 and included a lower effective tax rate on a onetime basis this quarter and lower preferred share dividends, and that was partially offset by the isolated impact of the incremental shares issued under our ATM program. During the quarter, we issued $46 million worth of common shares at an average price of $35.32.

Our sequential performance is shown on Slide 8. Common shareholders' net income decreased 15% sequentially, primarily due to the impact of higher noninterest expenses, a higher provision for credit losses and lower revenue. Pretax pre-provision income decreased 13%. Adjusted and diluted EPS each decreased $0.15 compared to the prior quarter. Lower net interest income reduced EPS by $0.06. Higher noninterest expenses decreased EPS by $0.09 and reflects a seasonal increase in employee benefits and continued strategic investment in our people, AIRB tools and processes, digital capabilities and product offerings. The increase in the provision for credit losses reflects small increases in the impaired and performing loan provisions, which reduced EPS by $0.02. Other items contributed $0.02, primarily reflecting the positive impact of a lower effective tax rate on a onetime basis this quarter.

As shown on Slide 9, the 3% sequential decrease in total revenue reflects a 3% decline in net interest income and consistent noninterest income as higher wealth management fees were offset by lower credit-related fees. Net interest income decreased from last quarter driven by 3 fewer interest-earning days and a 5 basis point reduction in net interest margin, partially offset by the impact of 2% sequential loan growth. Net interest income was 4% higher than last year, primarily reflecting the benefit of 9% loan growth, partially offset by an 11-basis point decline in NIM. Noninterest income was up 8%, primarily due to higher wealth management fees.

Our net interest margin was 5 basis points lower than the previous quarter, with the drivers shown on Slide 10. [ Through ] Bank of Canada policy rate increases occurred during the quarter which contributed 2 basis points to NIM as expected. The 25-basis point hike that occurred in March was in effect for approximately 2/3 of the quarter and the 50-basis point hike in mid-April had limited positive contribution to NIM as it was only in effect for approximately half a month during the quarter. We will benefit from a full quarter impact of these hikes in subsequent quarters. Higher levels of liquidity drove an unfavorable asset mix compared to the prior quarter, which decreased NIM by 3 basis points and reflected prudent liquidity levels in the current economic environment held to support strong loan growth in the near term.

Higher funding costs primarily from senior deposit note issuances that occurred in the quarter reduced NIM by 2 basis points. An increase in higher cost broker deposits in our funding mix reduced NIM by 1 basis point. Our strength in NIM over the last several years has been underpinned by strong growth of branch-raised deposits. We expect expansion of our NIM as the year progresses, driven by stronger branch-raised deposit growth, stronger loan growth at expanding spreads and the full quarter impact of the Bank of Canada rate hikes that have occurred along with the expectation for further Bank of Canada rate increases.

Highlighted on Slide 11, our second quarter provision for credit losses on total loans was 14 basis points. Our performing loan provision for credit losses was negligible compared to a 1 basis point recovery last quarter. We recognized an impaired loan provision of 14 basis points compared to 12 basis points in the prior quarter and remains well below our 5-year historical average of 19 basis points. Impaired loans of $187 million are down 12% from last quarter and represent 55 basis points of gross loans, still well below pre-COVID-19 levels.

Our quarterly write-offs of 11 basis points fairly consistent with the 12 basis points in the prior year and remained well below our historical averages. We continue to generate strong resolutions of impaired loans and remain in a very strong credit quality position.

Our capital ratios are shown on Slide 12, calculated using the standardized approach. Our CET1 ratio at 8.9% decreased 10 basis points from last quarter. While organic capital generation and common shares issued under our ATM program more than offset growth of risk-weighted assets, our capital ratios were negatively impacted by an unrealized loss in our debt securities portfolio, recognized and accumulated other comprehensive income.

Our debt securities portfolio is entirely composed of bonds issued or guaranteed by federal and provincial governments and held for liquidity management purposes only. These securities are measured at fair value through OCI and the significant increase in unrealized losses this quarter was driven by a rapid and significant increase in interest rates. We typically hold these securities to maturity and expect that the unrealized losses in this portfolio will lessen as the debt securities approach maturity and reduce the temporary downward pressure on our capital ratios.

Since the inception of our ATM program, we've issued 4.1 million shares for gross proceeds of $148 million. That's reflecting the near full utilization of our existing $150 million ATM facility. In the third quarter, we intend to establish a new $150 million ATM program that will have consistent terms with our existing program and will be used as needed to maintain strong capital levels while supporting elevated loan growth.

As Chris noted, we're making good progress to advance our AIRB transition program, including incorporating changes to support increased precision in the measurement of credit risk, drive efficiencies in the use of our AIRB tools and processes by our teams and incorporate changes to adopt the new CAR 2023 guidelines. We continue to believe that approval will make us more competitive, support higher growth, achieve further diversification with an enhanced view of risk and provide a boost to our regulatory capital ratios due to the more risk-sensitive measurement of risk-weighted assets compared to the standardized approach.

Yesterday, our Board declared a common share dividend of $0.31 per share, which is up $0.02 or 7% from the dividend declared 1 year ago and up $0.01 or 3% from the dividend declared last quarter.

Looking forward on Slide 13. Despite the elevated economic uncertainty, we remain confident that we'll achieve annual double-digit percentage loan and branch-raised deposits growth this year. We expect the Bank of Canada will increase its policy interest rate to 2.25% by the end of this fiscal year. Leveraging the continued rising rate environment and stronger expected growth in loans and branch-raised deposits, we expect our quarterly net interest margin to expand over the remainder of the year and result in an annual net interest margin relatively consistent with the prior year. Later-than-expected timing of loan and branch-raised deposit growth this year puts downward pressure on our annual revenues, with annual percentage revenue growth now expected to approach the high single digits. While we will continue to execute on our strategic priorities as planned and expect to implement wage increases for our entry and mid-level team members next quarter, we'll reduce other expenditures from previously planned levels to reflect lower revenue expectations.

We now expect to deliver annual percentage growth in pretax pre-provision income in the mid-single digits. With a provision for credit losses expected to increase within our normal historical range of 18 to 23 basis points over the remainder of the year, we expect that our fiscal 2022 annual diluted earnings per share will be lower than last year by a percentage in the low to mid-single digits. Our teams have built robust pipelines and opportunities aligned to our strategic focus that are already driving strong quarter growth.

We're confident that our strategic investments will build on our positive momentum and accelerate our growth of full-service clients in the back half of this year and into fiscal 2023.

With that, Sylvie, let's go ahead and open the lines for Q&A.

[Operator]

[Operator Instructions] And your first question will be from Doug Young at Desjardins.

[Doug Young, analyst]

Just on the NIMs. What gives you the confidence that NIMs are going to rebound in the second half and be even with fiscal '21 levels. By my math, I mean, NIMs would have to be at least 2.55% in each of Q3, Q4. I mean that's a big sequential rebound. And thanks on Slide 10, I appreciate the kind of sequential change in NIM kind of breakout. But maybe you can kind of talk about which of these items is going to be the biggest driver of that reversal? And I got a bunch of follow-ups.

[R. Rudd, executive]

Yes. So a few benefits right away going into Q3 just from Bank of Canada rate increases. The full quarter impact of the rate increases we've already seen, we expect to drive a couple of basis points of expansion next quarter. The prime increases we're expecting over the balance of the year, we're expecting 50 basis points in each of June and July, and we expect those will drive about 3 basis points of expansion in Q3. That's a partial quarter impact of those hikes.

The rest of the increase from there, our strength in NIM over the last couple of years has been driven by branch-raised deposits growth and the right type of branch-raised deposit growth, the lower cost funding, cash management-type products. We're expecting strong growth of that into the third quarter and expect that, that will be a driver of NIM. We also expect that our asset mix will improve, both liquidity levels coming down a bit and then thinking about the composition of growth over the back half of the year.

We're seeing very strong growth in the horizon from some of our higher-yielding portfolios, general commercial book, predominantly and starting to see pretty good expansion of spreads in that book as well compared to the first half of the year. So the mix of all those things, Doug, gives us a lot of confidence that this quarter was a blip, and we're seeing a pretty strong turnaround for the rest of the year.

[Doug Young, analyst]

So just like you're banking on just only 3 basis points next quarter for the Bank of Canada. So that's -- is that -- did I get that right?

[R. Rudd, executive]

It'd be 5 in total. So full quarter impact of the hikes that happened this quarter and then a partial quarter impact of hikes that will occur next quarter. And so again, in Q4, you'll get the benefit of a full quarter of the mid-quarter hikes that happened in Q3. And we're expecting, as I mentioned, significant hikes in Q3.

[Doug Young, analyst]

Okay. And then just on the asset mix side, too, like our loan mix side, I think [ I ] saw real estate project loans down 21% quarter-over-quarter. If I recall, that's, I think, one of the highest margin, if not the highest margin product. Can you talk a bit about it, is that one of the areas that you foresee a rebound? I guess the pipeline looking pretty promising in that segment. Maybe you can talk a bit about the outlook.

[R. Rudd, executive]

So on real estate project lending, you'll have to go -- take another look. We actually grew that portfolio in Q2, saw good opportunities that landed there. For the rest of the year, in that portfolio, we're not seeing explosive growth on the horizon. We're seeing just strong and steady growth continuing there through the balance of the year.

[Doug Young, analyst]

Okay. So I was thinking sequentially, but maybe I've got that -- I can follow up. And then on the demand and notice deposit side, I know you mentioned that Matt, like up sequentially 1 percentage point. I get it was up 10% year-over-year. Yet, like what -- can you talk a bit about why -- how things were pushed off into next quarter? Like there was a lot of discussion in your prepared remarks between you and Chris, about things getting pushed to next quarter. Can you talk a bit about what's the dynamic there?

[Christopher Fowler, executive]

Doug, most of the dynamic there is just the origination of new credit. We are focused on that full service offer to that mid-market client and the sales cycle can be long. As we look at coming out of COVID, looking at our teams coming, the deal teams coming to visit the clients. And that's where we're seeing good momentum as we look into Q3 that got pushed from Q2 into Q3.

And when we look to move a company with our full-service financial solutions in place, it's a lot of steps, right? And a lot of opportunity for us to continue to grow that deposit base. But it's not something that happens, it's not transactional, right? It's a relationship-based opportunity, and we really focus on doing that well.

Plus, we're delivering on the launch of the -- that digital front end that's coming into play on the personal and small business side this summer. So we see that, again, as another opportunity for more branch-raised deposit growth. So we're increasing our capability, increasing our product offering. And as we look at the flow of business, we are seeing much of what we anticipated to occur in Q2 to go into Q3.

[Doug Young, analyst]

Okay. And then just lastly, the ATM, you're renewing it. Do you have -- do you foresee having to use the full amount of the new programs? And then I guess, is the ATM still accretive? And then why at the same time, if you're trying to conserve capital, why raise the dividend at the same time? Just curious as the dynamic there.

[R. Rudd, executive]

Yes, 2 things to unpack there. So on use of the new ATM, it will be entirely dependent on level of loan growth we see. If we see other elements that occur that create capital demand for us other than loan growth. So it's there if we need it. Our expectation is not to just simply use it in the normal course. We did use it, if you look back at the last one, from when we launched it to today, we've basically reset our level of CET1 ratio. We worked at kind of from the mid 8s into a 9% level. We're quite happy with it, in or around 9%. I could see us being around that level and not seeing a need to work it up significantly from there. So really, the ATM, it's to manage our flow of capital to hold it in or around current levels and feather it up or down in usage depending on demands for that capital, be it through loan growth or anything else.

On the accretion side of things, yes, I'll be honest with you. The idea of issuing capital not just below book, but below what we view as intrinsic value of the bank, which is obviously above book in our view, is not desirable. But in the pure mechanics of accretion, even at these levels, issuing capital and funding loan growth with it is accretive for our shareholders, accretive to EPS. So those are the things that are swirling as we think about the use of the new ATM program going forward.

[Doug Young, analyst]

And just on the dividend -- like why raise the dividend if capital conservation to some degree? I'm just trying to understand the dynamics between the 2.

[R. Rudd, executive]

Yes. So with the dividend, we've taken the strategy in terms of managing a payout ratio and managing a return of direct capital to our shareholders to be consistent and steady increases. It's not something we're looking to need or rapidly change quarter-to-quarter. We think consistency there is important. We're taking a medium-term view on capital. So you might see some temporary volatility here or there. But it's not -- we don't look at the dividend as number one, a significant lever that generates any meaningful capital in any event and think just consistency and trend there is quite important.

[Operator]

Next question will be from Gabriel Dechaine at National Bank.

[Gabriel Dechaine, analyst]

My question is on expenses. One, you talked about the wage hikes that are going to kick in, in Q3. Can you put some numbers around the impact there? And two, overall expense growth were 15% this quarter. AIRB is driving quite a bit of that. I'm wondering if, a, there's a change to your view that you were sharing earlier in the year, late last year that those costs would start to [ peter out ]. Are we maybe going to have to expect higher AIRB transition costs for longer than expected? And then after that, is there another big project on the horizon because there seems to be a consistent theme there?

[R. Rudd, executive]

So on the inflationary increases, we called it out in our outlook and our comments, not because we look at it as a significant expenditure. But we just wanted to make it abundantly clear that when we think about our outlook for NIEs for this year, it's embedded in that guidance. For a multitude of reasons, we don't want to get into specifics of that program. But it's not something that is a material driver of NIE or something that gives us risk of not hitting our outlook on NIEs.

On AIRB, you're right. We did see a ramp-up in those expenses in Q2. We'd expect that to continue into Q3 and likely into Q4 as well. So I think on a run rate basis of AIRB expenses, it's actually likely going to ramp up a bit going into Q3. Q2 was really the kickoff of some model redevelopment work to incorporate the new CAR guidelines that were finalized in Q1. So got our teams going on that. And Q3 is by far our heaviest lift coming. So we might see a bit of an increase in expenses related to that.

New, big, lumpy projects, [ Gabriel ], if we have some, you'll hear us talking about them. At this point, I mean, there is always opportunities we can look at to improve the offering to improve our capabilities. But what we're really focused on right now in near-term horizon is getting AIRB over the finish line, getting all of our digital platforms implemented over the finish line, roll them out really well. And then beyond that, in terms of big projects, nothing to highlight at this point.

[Gabriel Dechaine, analyst]

So what's driving the change, i.e., higher costs with the AIRB transition that you underestimate, is the regulator going back to you with more requirements that you have to fulfill. What's changing?

[R. Rudd, executive]

Yes. The overall level of expense in AIRB in the fiscal year, I'd say it's consistent with what we expected. What we saw is just a little bit of a difference in timing where Q1 expenditure is a bit lighter than what we would have expected and then all that just kind of spilling into the rest of the year. Really, that was taking a bit more time to fully unpack and understand the CAR guidelines, how those would impact things. I mean that was one of the reasons we took the opportunity to enhance the models prior to resubmission was to reflect those. So -- just wanted to make sure we had a full understanding of those guidelines, how they'd impact the models before we then embarked on the redevelopment work.

[Operator]

Next question will be from Darko Mihelic at RBC Capital Markets.

[Darko Mihelic, analyst]

Just a question on the performing loan allowance. It's at $105 million. And I have 2 questions really. The first one is on that slide where you show -- it's on Slide 11. I'm a little bit surprised that macro forecast remains stable because a lot has changed since the last time we spoke. So I wonder if you can touch on your forward-looking indicators and why they really haven't moved?

And then the second question is, if I take that $105 million, and put it as a proportion of your loan book, call it, a coverage ratio, if you will. It would show me that your coverage is now say, it'd be 31 basis points. That's actually 1 basis point below where you were pre-pandemic. So are we now at a state where really releases are kind of a thing of the past? And we really should be just looking at the impaired provision going forward and maybe a modest build if things get worse, obviously, whatever. But -- so could you just give me an idea if I'm on the right track there with respect to the coverage? And is that how you view your Stage 2 allowance?

[Christopher Fowler, executive]

Bit to unpack there. But broadly, yes, there's not a lot there I disagree with. If we start -- where you started with the macro outlook, I think first reminding that we anchor our base case macroeconomic outlook to an average of the large bank economists to make sure we're consistent. And when we look quarter-over-quarter, I'd say there's puts and takes. Unemployment levels a little bit better in near term. Oil better, obviously. Housing price is softer. Rates higher, GDP about the same in terms of outlook. So it's a bit of a mixed bag on macro. When we look at it, and that is a base case, and we try to calibrate our expert credit judgments around what the model produces relative to that forecast.

It shouldn't come as any surprise that when we look at the forecast, we see more downside risk than upside potential. And that's been a pretty consistent view over the last couple of quarters. When you hear us talking about the expectation of gross impaired loans building and just being in a very benign credit environment and thinking that, that tie turns, our expert credit judgments have reflected that view. So there is some embedded hedge against downside risk embedded in that -- in our performing loan allowance.

So then I guess to your second question, which would be the natural follow-on of [ loan ] and your coverage calculation is pretty similar to the one we do. We look pretty consistently covered compared to pre-pandemic levels. If we look at the last couple of years, I'd say we've been very, very prudent about how we've lent -- we've kind of doubled down on discipline from an underwriting perspective. And just frankly, a lot of the growth we've put up, I mean, it's been a drag on NIM that we've put it up in lower yielding opportunities, lower yielding portfolios. But from a risk perspective, we're quite happy with the risk [ trade ] on that despite the headwind it creates on NIM.

It's the big question on where do we go from here? Where does this ultimately settle? Do we settle at a lower level of performing loan allowance than we did pre-COVID? Portfolio composition points to a positive indicator on that. The bigger factor will be underlying credit performance of our borrowers. Balance sheets of our borrowers look strong. It's been very benign so far. We haven't had really any significant hotspots that give us too much concern.

It's just we -- looking forward, we see, again, consistently that impaired loans and provisions on those impaired loans, we just believe they'll come back to normal, likely not higher than normal levels of the past would be our view right now, but we watch it pretty closely.

So on your last piece, do we expect any performing loan releases? I think that's fair to say no. In our outlook, we do not expect any. We're pretty happy at this level. We have some cushion to absorb a bit of a deterioration from here in the macro, but then our models have to be underpinned to a base case outlook as well. So if that does materially worsen or we see something that we're not expecting in terms of a material increase in the level of default or delinquency in our book, then yes, we'd have to make adjustments from there and look at builds.

[Darko Mihelic, analyst]

Okay. That's a good answer. And also, just wanted to touch on the unrealized losses in [indiscernible]. How quickly do we get the pull to par phenomenon here? And it sounds like you want to run a little less liquidity going forward. So I'm just curious, what's your expectation on 21 basis point hit to capital? Like how quickly it will come back?

[R. Rudd, executive]

Yes. It's a relatively short duration portfolio. Now not all less than in the 6-month space. But there's 2 things that will happen. This is a liquidity book. So it's not 1 that we're speculating or looking to sell any of those positions and actually crystallize any of those losses. What will happen here is that as bonds approach maturity, the fair value calculation will become less punitive relative to their coupon. And then these bonds will mature and run off and when they mature, you obviously mature them at face.

We think just looking at the maturity profile, these over the next couple of quarters. It's a case where if the interest rates didn't change at all, like there was no movement in the curve. You'd see nearly half of the unrealized loss go away just as bonds roll down the maturity curve and mature. So it's not something we look at as a structural use of capital or anything that has us concerned about capital adequacy. It's more of a temporary factor that we just see how this plays out and let these bonds run off in due course.

[Operator]

Next question will be from Meny Grauman at Scotiabank.

[Meny Grauman, analyst]

Just following up on that question on the unrealized loss of OCI. Is there hedging that you use to -- in that book? Is there any hedging at all there?

[R. Rudd, executive]

Yes. When we look at -- so yes, we have in the past and have some hedges on that book. When we're trying to develop hedges with interest rate swaps, really is to do 2 things that are more top of the house. It's managing our interest rate risk in the banking book and overall interest sensitivity. And then, I guess, related to that, we're managing the overall duration of our balance sheet at top of the house. So the actual instruments we designate as the hedged items as part of that strategy, loans, deposits and on occasion securities. So that's how we've been doing it. But yes, there's really no -- in terms of direct hedge against these bonds, we don't have many of them right now.

[Meny Grauman, analyst]

Okay. It just stands out relative to peers in terms of the magnitude of that impact. Second question I wanted to talk about was just related to the discussion of -- or your commentary on later-than-expected timing of current year loan growth. I'm just trying to put it into the bigger picture context. Like if we look at the environment, we're seeing very significant commercial loan growth across the peer group in Canada, very big numbers. And so that kind of timing dynamic doesn't seem to be a factor in a broad sense. And so I'm just wondering what we're seeing here, very company specific. So any clarity there would be helpful.

[Christopher Fowler, executive]

Yes. Meny, it's probably -- there is -- I think our approach could be slightly different than the large banks in that when we're looking at our loan growth, there primarily that's a market share increase where we're winning net new clients from the big banks. And quite often, the big banks, their commercial growth could include increases in lines of credit in different ways that they advance more credit to the same client. So much of our growth is actually net new clients. So as we look at that pipeline as we come into Q3, that sort of push from Q2. These are net new clients that we are onboarding, and that's what that in my comments at the beginning about timing being quite variable. We're very happy with the progress of the teams in terms of securing the opportunity with client growth, and we see both sides of the balance sheet benefiting.

[Operator]

Next question will be from Stephen Boland at Raymond James.

[Stephen Boland, analyst]

Two questions. I guess, just in terms of the new EPS guidance where you're expecting a slight decline, what kind of impact from the ATM is in that guidance, if any?

[R. Rudd, executive]

Yes. So within there, Stephen, we are expecting just when we look at how robust growth is looking for the back half of the year. We are expecting at times and where it makes sense, some continued use of the ATM. So yes, that is embedded in our outlook.

[Stephen Boland, analyst]

Can you give kind of a general number, or you don't want to give that much detail?

[R. Rudd, executive]

Yes, it's a little more detail than we've provided in our public disclosure. So it is embedded. And I suppose if you're trying to solve for how much. I guess I've given a pretty big indicator on that and in our desire to hold our CET1 in or around that 9% level.

[Stephen Boland, analyst]

Okay. I appreciate that. And maybe the second one for Chris. I just want to follow up on Doug's earlier question, like your opening statement said the quarter was below your expectation, but it seems when you're talking about the loan growth and the transactional nature -- the nontransactional nature of that loan growth, bringing on new clients. I mean is -- when you say below expectations, is that -- has that been an issue on the client side that those number of steps are taking longer than expected? Or is it an issue on your execution of those steps or a combination?

[Christopher Fowler, executive]

I think it's a combination of the 2. We certainly are originating and making the relationships with the clients. We have issues like in Alberta, we've got like a 12-week structure with the land titles, for example, it takes -- it's extending some of the closings. But overall, the teams are very focused on that client growth, and they've -- are very positive on us achieving the growth we anticipate in the back half of the year.

[Stephen Boland, analyst]

And so when you say that's a combination, what on your side, can you -- what needs to be improved?

[Christopher Fowler, executive]

Well, it's not necessary to improve. I mean the challenge really is just getting and landing it with -- we've got a very prudent, strong underwriting process internally. Our goal is to be responsive and create a credit structure that is prudent in terms of how we consider risk management. So we're comfortable with our internal processes.

When I say a combination, meaning that in getting to close, it's a number of factors that come into play. We've also had the kind of resumption of more positive marketing that comes from the relaxation of COVID standards, which is very positive, so we can have our lending teams, our cash management teams and our wealth teams meeting with -- to pursue that client opportunity. So I think it's really that focus of just it hasn't happened as quickly as we anticipated. And again, as I mentioned before, these are net new clients. And we -- for that full-service opportunity, we are looking to land all of that business. So it does take that a little bit of extra time.

[R. Rudd, executive]

Yes. The biggest piece there is the cash management suite of products. That is quite disruptive to a business owner to change cash management providers. Our teams are focused on making that as easy as possible. But if you're the controller looking over that business, I mean, it's work to change banking providers. Our teams can help to an extent. And we've been -- we've had great success in moving clients over and getting them to switch cash management providers, but in nailing it down to an exact timing. Clients do sometimes get a bit of slippage on their end with competing priorities as they're running their business as well. So that does introduce a bit of variability in landing, particularly on the deposit side.

[Operator]

Next question will be from Sohrab Movahedi at BMO.

[Sohrab Movahedi, analyst]

Just wanted to drill a bit more on the surprised timing for both, I guess, loan and deposit growth. Can you -- Chris or Matt, I guess can you talk a little bit about -- like are you out elephant hunting? Was there one big account that you were trying to bring over that didn't close? It just seems a bit surprising that on math, stuff that was supposed to come in or you were expecting would come in before April has been pushed out. I'm just trying to better understand maybe the concentration, what types of accounts you're going after? And then are there existing providers fighting hard enough that they may not come in?

[Christopher Fowler, executive]

I would say that our focus is on -- elephant hunting is not really in our game plan. We are truly looking for that core client, that business owner client that we can provide that full-service opportunity to. The challenge of closing and moving forward to go back to Matt's comment about the challenge of when you are moving a mid-market company [ over ] and the cash management is part of that equation, it can stand out.

In Alberta, we've got the issue with the land titles taking a long time to close. We've just -- there's issues that are sort of in the process side of that, that it doesn't undermine your ability to continue to grow and support and win more clients. It's just -- it's a matter of how long that sales cycle and closing cycle is.

So we are very focused on -- we've had many years of very strong growth. We've had many years of very strong credit quality. We are unchanged in our view of how we grow and structure our book, and we bring prudently onboard the right clients. So yes, it is -- we did expect to see more closings in the second quarter than we saw, but they are being pushed into the third quarter. So we are positive on momentum in the third quarter.

[Sohrab Movahedi, analyst]

I mean, Chris, just to drill down a little bit further on this. Was this -- so is it fair to say that what seems to have slipped from this quarter to the next is concentrated in Alberta?

[Christopher Fowler, executive]

Well, it's actually across our footprint, BC, Alberta and Ontario. I mean, Ontario has been a very positive addition for the bank in terms of credit growth, 40% of our credit growth was in Ontario in Q2. So we're very happy with the opportunities. And plus we're adding more capability there with the opening of Markham. Alberta, we're definitely seeing -- it's of top 3 provinces, it had the slower closings compared to BC and Ontario. But we see a very solid platform in Alberta here with energy prices being what they're at today. So good client structures and good opportunity as we look at it. So we're confident in our ability to deliver the growth, and we've said we still intend on landing at double-digit growth for the full fiscal 2022. And again, it's pushed from Q2 to Q3.

[Sohrab Movahedi, analyst]

I'm going to take one more kick at this, Chris. I mean, it seems rather peculiar to me that CWB across the board, at this problem. It must be a [ CW-specific ] problem, no?

[Christopher Fowler, executive]

Well, I think it all depends -- if you're trying to compare us to, say, a large bank, and I can't break down how their commercial growth has occurred. I mean I think that is a question. I mean most of our growth is net new, right? So net new clients that we're onboarding versus companies that would say, as the economic prospects improve and they start to reinvest in their business and look at fleet growth or whatever different CapEx you might be doing that we'd be drawing down on lines of credit that, that would be a way that commercial growth would occur in the large bank -- I can't break that all down. But for us, it is net new growth. It's new market share wins. So we are onboarding these clients from other banks that we are providing a credit structure that they're choosing. And that's why we have always focused our growth, and we'll continue to.

[R. Rudd, executive]

To put a finer point on it, nearly 100% of the net loan growth we put up in Q2 was from new clients. We had virtually no contribution from existing clients in the second quarter.

[Sohrab Movahedi, analyst]

Yes. I mean, I guess it's hard to have comfort, I suppose, having seen what's happened this quarter. I mean, I don't know where you get the comfort that you won't be similarly surprised -- August when you're reporting your third quarter result.

[Christopher Fowler, executive]

Well, we run pipeline, Sohrab, and our goal is to have a line of sight on that, both from a business generation, but also the funding side of that equation, too. Our treasury has to have a really clear view of what's coming. And that's where we have a very, very solid group that looks at how the pipeline is performing and what the expectations are for closings.

[Operator]

Next question will be from Paul Holden at CIBC.

[Paul Holden, analyst]

I'll try to keep this quick. But I want to go back to the NIM waterfall you provided this quarter and sort of try to get some more thinking on how it might be impacted going forward? And I guess specifically on funding cost and funding mix. So the funding costs, should we think about this continuing to be a bit of a drag on NIM as broker-based funding and wholesale funding costs increase with the broad increase in rates?

And then secondly, on funding mix, should we expect that will be neutral to positive going forward given your expectation for branch-based deposit growth? And maybe just am I thinking about that correctly?

[R. Rudd, executive]

Yes, you are. And I guess just to kind of decouple the non-branch rate sources. So broker deposit market, we look at pricing there. And is it at risk of going higher based on market interest rate increases expected? I would [ say ] the pricing there has been very high. And if we look at broker pricing over the last couple of quarters, it was definitely forward-looking in pricing and expected interest rate hikes.

I'd say the broker market was probably the first funding source we saw that moved aggressively in the upward direction. So our ability to drive NIM and it's not a different story than the last couple of years, is to stay out of that broker market. It's one, especially this time of year and peak mortgage season with some of the other parties that access it. It can be quite expensive. And our goal would be to stay out of it as much as possible, and that will be a key driver of NIM in the back half of the year.

On capital markets, I guess, relative stability compared to broker, but there, we've seen credit spreads expanding over the last couple of quarters and are definitely at elevated levels now relative to where they had been perhaps over the last year. It's more of a return to normal than something that is blowing out compared to pre-COVID levels. But if we're thinking year-over-year, in cost of funding, you have the higher market interest rates and higher credit spread relative to last year. So it all comes back to really drive NIM expansion beyond just mechanically what comes with the Bank of Canada hikes and prime rate increases. It comes back to driving the low-cost branch-raised deposit growth. It's absolutely critical. And then the right mix of loan growth going forward as well is the other important factor.

[Operator]

Next question will be from Marcel Mclean at TD Securities.

[Marcel Mclean, analyst]

I'm going to take it 1 step further on the NIM. Just wondering -- so with that mix, assuming you get your rate hikes that you're looking for. What's level of branch-raised deposits growth that you need to hit this guidance for 2022? Is there a certain bogey -- like is 10% enough? Or does it have to be higher than that?

[R. Rudd, executive]

No. The outlook on NIM is consistent and underpinned to our outlook on branch-raised deposit growth. So our ability to drive this NIM is very dependent on achieving that double-digit branch-raised deposit growth on an annual basis. And then if you work the backwards math on what do you need in Q3 and Q4, you'll see like we're expecting pretty robust increases in the trend on branch-raised deposits.

[Marcel Mclean, analyst]

Okay. And then maybe secondly, following up on that. So the NIM outlook that you guys have incorporated into your forecast -- the rate hike forecast, I should say, that you're incorporating in your forecast. I think last quarter was only 75 bps of increases in fiscal 2022. Now we're at 200 bps but you've actually brought the NIM forecast down. Can you maybe just speak a little bit more to -- like it seems like more than what we're seeing there in terms of asset mix and this 1 quarter being a blip. Can you -- do you have any further comments on that?

[R. Rudd, executive]

Yes. Well, it's really a factor of digging a bit of a hole here in Q2 that we weren't expecting to have dug. I mean this was not our expectation on second quarter NIM. And so if you look at our year-to-date NIM, relative to where we thought we would be, it becomes a math problem to get your full year NIM back to that same level we guided to last quarter.

So -- yes, we're definitely starting third quarter a bit on our heels in terms of asset mix, in terms of our deposit mix. Good actions to reverse those trends as the year progresses. But yes, we're really just starting the third quarter in a different position than we expected to. And that's caused us to revise our outlook on full year NIM.

[Marcel Mclean, analyst]

Okay. And lastly, I know we've talked a lot about loan growth on this call. Just curious, was there -- this delayed timing of loan growth, is this specific to one category? Or has it been pretty bought every category sort of underperformed your expectations this quarter, and it's all related to timing? Is there any [ thing ] specifically pointing you to the equipment finance, the supply chain issues? Is it just the general commercial book, but where is it?

[Christopher Fowler, executive]

So the general commercial book would be the big category because that's the both sides of the balance sheet opportunity that we really focus on. But we have -- we did see a 5% increase in real estate project loans, we saw 12% increase in Optimum residential mortgage growth. equipment finance is still slower based on the supply chain challenges there. But again, portions of that business are growing well. But it -- overall, it's the biggest part of our balance sheet, which is that general commercial, which is the biggest opportunity as we think about both the funding and loan growth side is the one that has the delays to it.

[Operator]

Next question will be from Lemar Persaud at Cormark.

[Lemar Persaud, analyst]

I just had a quick question and then another follow-up here. So circling back to the unrealized losses on the OCI. Would it be fair to suggest that the capital hit is going to get worse before it gets better if we see the Bank of Canada rate hikes play out? Or is the runoff of these bonds to offset the potential further hit from the rate hikes in subsequent quarters?

[R. Rudd, executive]

Yes, that's a great question, and we've done a bit of modeling on this. So the roll down and roll-off impact will be dampened if you see further increases in market interest rate, not necessarily Bank of Canada because a lot of that's embedded in the curve. It's -- will you see shifts in the yield curve as a whole? Like an upward parallel shift in the yield curve, net-net would dampen some of the impact of the roll down, roll-off.

The shape of the curve's important, too. So that could also dampen the impact if the curve flattens out a bit and you don't see declines in longer run bond yields. So -- there's a lot of moving parts there. When we look forward, even thinking about scenarios and just relative to our outlook on Bank of Canada rates, underpinning to that and thinking about how the roll down and roll-off works, we still think we get positive capital benefits here of the net of those 2 factors, even relative to our expectation of Bank of Canada rate increases. But lots of moving parts on that one, Lemar.

[Lemar Persaud, analyst]

Okay. And then my next question, I think the bigger picture in this quarter. I think it's fair to suggest revenue growth, it is well below what you guys were expecting. Some challenges on margins and following [ on just ] being pushed out into the future quarters. I'm wondering, is there any flexibility to manage the expense growth if the revenue growth outlook is going to be tougher than expected? Or is it really the view of the bank that you just need to spend on these initiatives regardlessly you're not going to defer expense even if revenue growth outlook is softer?

[R. Rudd, executive]

Yes. There are certain elements of our expense base that we've targeted and said, it is of strategic importance to land these capabilities to get these projects done. And so we have not touched those projects in terms of deferring or delaying. There are elements within our expense base that are a bit more discretionary, and we've looked at as levers to pull to help calibrate to similar efficiency ratio. That's what we've done and looking forward on our outlook.

Revenue dampened lower than what we expected. We've notched down our expectation on expenses to manage to a pretty consistent level of efficiency ratio compared to our expectations at the start of the year. You can expect us to continue to do that and just work this around the edges to land it there. And we've got levers to pull without delaying our very important strategic projects.

[Operator]

Next question is from Nigel D'Souza at Veritas Investment Research.

[Nigel D'Souza, analyst]

I'll make it quick. I'm more interested in your net interest margin outlook for 2023. Would it be fair to assume that -- I know you can't probably give specific guidance, but would it be fair to assume that your NIM in 2023 can exceed the NIM that you had in 2019, given an improved funding profile and a higher terminal bank account policy rate?

[R. Rudd, executive]

A bit early to make any specific predictions. But you've highlighted the right factors that give us confidence and pretty bullish on NIM looking forward into 2023. A lot of factors to point to that suggests we have pretty significant upside potential there, and you've highlighted the right ones.

[Operator]

And at this time, gentlemen, we have no further questions. Please proceed.

[Christopher Fowler, executive]

We closed the second quarter with robust pipelines of full-service client opportunities that are already driving strong post-quarter growth and give us confidence that we'll achieve double-digit loan and deposit growth this year. Credit metrics are all better than 5-year averages, and our balance sheet is in great shape to handle potential volatility that may be on the horizon.

We look forward to launching our new retail and small business digital platforms this summer and continue our Ontario expansion with the opening of our new banking center in Markham. Delivery on our strategic priorities will drive accelerated growth of full-service clients. This stronger growth delivered in a rising interest rate environment will provide a significant tailwind as we move into next year and will increase value for investors.

Thank you all very much for your continued interest in CWB Financial Group and we look forward to reporting third quarter financial results on August 26.

With that, we wish you all a good day.

[Operator]

Thank you, sir. Ladies and gentlemen, this does indeed conclude your conference call for today. Once again, thank you for attending. At this time, we ask that you please disconnect your lines. Have a good weekend.