Canadian Western Bank

TSX:CWB

Earnings Call Analysis

Earnings Call Transcript 2024-Q2

[Operator]

Good morning. My name is Jenny, and I will be your conference operator today. At this time, I would like to welcome everyone to CWB's Second Quarter 2024 Financial Results Conference Call and Webcast. [Operator Instructions]Thank you. I will now turn the call over to Chris Williams, Assistant Vice President, Investor Relations. Please go ahead, Chris.

[Chris Williams, executive]

Good morning, and welcome to our second quarter 2024 financial results conference call. We'll begin this morning's presentation with opening remarks from Chris Fowler, President and Chief Executive Officer; followed by Matt Rudd, Chief Financial Officer; and Caroline Carolina Parra, Chief Risk Officer. Also present today are Stephen Murphy, Group Head, Commercial, Personal & Wealth; and Jeff Wright, Group Head, Client Solutions & Specialty Businesses. After our prepared remarks, they will all be available to take your questions.As noted on Slide 2, statements may be made on this call that are forward-looking in nature, which involve assumptions that have inherent risks and uncertainties. Actual results could differ materially from these statements. I would also remind listeners that the bank uses non-GAAP financial measures to arrive at adjusted results. Management measures performance on a reported and adjusted basis and considers both to be useful in assessing underlying business performance.I will now turn the call over to Chris Fowler, who will begin his discussion on Slide 4.

[Christopher Fowler, executive]

Thank you, Chris, and good morning, everyone. We continue to successfully navigate through a muted economic environment. In the second quarter, we delivered a 15% increase in pre-tax pre-provision income and a 9% increase in adjusted earnings per share compared to last year. Our loan portfolio grew 1% sequentially, following a moderate contraction in the previous quarter.While we saw growth momentum build through the quarter, particularly in our general commercial portfolio that grew 2% sequentially, our total loan growth was below our expectations, which dampened our second quarter net interest income growth. In response, we continued to prudently manage our non-interest expenses and drove 6% positive operating leverage this quarter.Our total provision for credit losses for the first half of fiscal 2024 was 22 basis points, and we expect to remain at the higher end of our provision for credit losses guidance on a full year basis. Our confidence in our secured lending approach, prudent underwriting and proactive loan management supports our continued expectation that total PCLs will remain within our annual expected range of 18 basis points to 23 basis points. Overall financial performance has been strong in response to the current environment, but earnings per share has fallen short of our expectations this quarter. Lower-than-expected loan growth through the first half of the year has also dampened our outlook for revenue and profitability on a full year basis.We see a compelling opportunity to increase our market share and accelerate our loan growth as the economy strengthens. Our balance sheet strength, reorganized operations has us well positioned to capitalize on this opportunity. We have a history of taking market share coming out of disrupted economic times, and our team will execute our winning playbook to drive more growth across our Canadian footprint.We're pleased with the mix of our loan growth in the second quarter, which is shown on Slide 5. We maintained a highly disciplined lending approach with selective origination in our combined commercial real estate portfolios. Commercial mortgages declined 9% from last year as new origination volume was more than offset by scheduled repayments and loan payouts. Real estate project loans decreased 6% as lower-than-usual volume of new project starts from top-tier borrowers was more than offset by payouts associated with project completions. We have started to see lending activity pick up in this sector and delivered 1% sequential growth this quarter.Credit performance in both portfolios remains strong and reflects our prudent risk appetite and underwriting standards that have supported our long history of strong credit performance. In the second quarter, we delivered 6% general commercial loan growth on an annual basis. This performance supports 12% average annual loan growth in this category over the last 5 years. As our teams focus on improving growth in the latter half of the year, we expect general commercial growth will continue to be our strongest growing loan category.General commercial clients represent a significant opportunity for CWB to provide our full suite of our lending and business banking services and increase our revenues through lower cost deposits, transactional service fees and wealth management opportunities. These clients have been an important contributor to our 5-year average growth in franchise deposits of 10%.In the second quarter, we delivered 2% annual franchise deposit growth as we continued the initial launch of our new commercial digital and cash management platform through a phased rollout to existing customers to prepare for a broader launch. We expect growth of franchise deposits to increase once we begin onboarding our pipeline of new cash management clients onto the platform later this year. On an annual basis, we expect to deliver franchise deposit growth of approximately 2%.I'll now turn the call over to Matt, who will provide greater detail on our second quarter financial performance.

[R. Rudd, executive]

Thanks, Chris. Good morning, everyone. I'm starting on Slide 7. In the first quarter, we had especially strong growth of demand and notice deposits. And as you recall, that created a temporary bulge in liquidity. And as we expected, this quarter, our liquidity levels have normalized. Franchise deposits increased 2% sequentially as a 3% increase in term deposits more than offset by a 4% decrease in demand and notice deposits. Lower demand and notice deposits primarily reflected the deployment of excess savings by existing clients, and this included the excess deposits that supported the unexpectedly strong demand and notice deposit growth last quarter.For the clients that retained excess savings, we noted a continued preference for term deposits in the current interest rate environment. On an annual basis, franchise deposit growth of 2% reflects a 17% increase in term deposits, partially offset by a 4% decline in demand and notice deposits.Our performance compared to the same quarter last year is shown on Slide 8. Common shareholders' net income increased 9%. An 8% increase in revenue was partially offset by a 2% increase in adjusted NIEs, delivering 6% positive operating leverage and a 15% increase in pre-tax pre-provision income compared to the prior year. Total provision for credit losses as a percentage of average loans increased from the unusually low levels last year.Diluted EPS increased 8% and adjusted EPS increased by $0.07 from the same quarter last year. Higher net interest income increased EPS by $0.15, primarily due to a 14 basis point increase in net interest margin and 1 additional interest-earning day. Higher non-interest income contributed $0.02. Higher non-interest expenses reduced EPS by $0.03, primarily due to higher expenses associated with the opening of our new Toronto banking center and the phased rollout of our new commercial, digital and cash management platform. Higher provision for credit losses decreased EPS by $0.10. EPS benefited $0.03 from the impact of a lower effective tax rate due to onetime true-ups associated with filing our tax returns disclosures.As shown on Slide 9, compared to the prior quarter, common shareholders' net income and diluted EPS both decreased 13%, and pre-tax pre-provision income decreased 7%. Adjusted EPS decreased $0.12 from the prior quarter. Lower net interest income reduced EPS by $0.07, and non-interest income contributed $0.04. Higher non-interest expenses reduced EPS by $0.05, and this was primarily driven by the seasonal increase in our statutory employee benefits and the timing of continued investments in our strategic priorities. Higher provision for credit losses this quarter reduced EPS by $0.04.As shown on Slide 10, revenue was lower on a sequential basis. Net interest income decreased 4%, primarily due to 2 fewer interest-earning days and a sequential decline in average interest-earning assets. Higher non-interest income was driven by the combined impacts of higher foreign exchange income and higher wealth management fees.Our net interest margin was consistent with the prior quarter. We benefited 1 basis point from an increase in fixed term asset yields, which continued to outpace the increase in deposit costs. An improved asset mix provided a 4 basis point benefit to net interest margin due to the expected decrease in our average liquidity from the excess position we were carrying at the previous quarter. These benefits were offset by lower loan-related fees that reduced NIM by 2 basis points and a 3 basis point impact from the unfavorable shift in our deposit mix, which also included the impact of the $250 million subordinated debenture issuance late in the first quarter. That issuance was done to replace the Series F subordinated debentures, which we'll redeem in the third quarter. In the second half of the year, we expect net interest margin to expand as we benefit from stronger loan growth that we'll target to optimize risk-adjusted returns.The drivers of our sequential CET1 improvement are shown on Slide 11. Our CET1 ratio increased 10 basis points to 10.1% this quarter as retained earnings growth was partially offset by an increase in [ risk-weighted ] assets.Our Board declared a common share dividend yesterday of $0.35 per share, which is up $0.01 from the dividend declared last quarter and up $0.02 from the dividend declared last year.And I'll now turn the call over to Carolina who will speak to our credit performance.

[Carolina Parra, executive]

Thank you, Matt, and good morning, everyone. I will begin my remarks on Slide 13. As we entered the quarter, we anticipated gross impaired loans to continue to increase through the year and for our PCLs to remain in our historic range on an annual basis. The total balance of gross impaired loans continues to fluctuate as the overall loan portfolio is reviewed regularly to provide early identification of possible adverse trends, while we continue to drive timely resolutions of loans that have become impaired.As expected, the uncertain macroeconomic environment and the sustained impact of higher interest rates continues to result in elevated borrower default rates and impaired loans in the second quarter. Total gross impaired loans increased $40 million or 13% higher than prior quarter and represent 96 basis points of gross loans, 10 basis points higher sequentially. This change is primarily driven by equipment and general commercial portfolios and is partially offset by an 11% reduction in impaired loans in commercial real estate. While we expect that gross impaired loans will continue to increase through the back end of our current fiscal year, our strong credit risk management framework continues to be effective in minimizing realized losses on the resolution of impaired loans. This is demonstrated by our historic low write-offs as a percentage of total loans, including through the past periods of economic volatility. We also continue to have minimal exposure to unsecured personal lending and no exposure to personal credit cards.Our provisioning for both impaired and performing loans continues to reflect our well-established underwriting standards to secure [ the nature ] of our lending portfolio with conservative loan to values and a proactive loan management, which are hallmarks of our historic success.As shown on Slide 14, the performing loan allowance increased 2% sequentially, primarily reflecting a marginal deterioration in our macroeconomic forecast and a larger loan balance. The 2 basis point performing loan allowance was 2 basis points higher than last quarter and last year.Provision for credit losses on impaired loans increased to $21 million compared to $17 million last quarter and $10 million last year. The current quarter impaired loan provision for credit losses represented 24 basis points.I will now turn back the call to Chris Fowler for his closing remarks and outlook.

[Christopher Fowler, executive]

Thank you, Carolina. Turning to Slide 15, as I noted in my opening remarks, we see a compelling opportunity to increase our market share and accelerate our loan growth as the economy strengthens. We'll leverage our balance sheet strength and reorganize operations to ensure we're well positioned to capitalize on this opportunity.Our loan growth has been slower to materialize this year than we originally anticipated and has dampened our full year revenue expectations. Accordingly, we have reduced our outlook for annual adjusted earnings per common share to be in the range of $3.50 to $3.60, but continue to expect to deliver positive operating leverage on a full year basis. We have a history of taking market share leading out of disrupted economic times, and our team will execute our winning playbook to drive more growth across our Canadian footprint.With that, Jenny, let's open the lines for Q&A.

[Operator]

[Operator Instructions] Your first question is from Gabriel Dechaine from National Bank.

[Gabriel Dechaine, analyst]

First, on credit, the big pickup in equipment finance impairment, is that the trucking sector or something else?

[Carolina Parra, executive]

Gabe, yes, it is in trucking section. The transportation sector is where we're seeing the larger increase in impairments in that portfolio.

[Gabriel Dechaine, analyst]

And then, is that a specific account such that you're comfortable that the -- that's the end of it in that particular category, and you're provisioned for it sufficiently, so it's not -- is it more of like a blip type thing we're seeing?

[Carolina Parra, executive]

No. So our equipment financing has lower ticket items. It's not a one account. Actually, it's across various borrowers in the industry. We're seeing that trend starting to improve. I think overall, transportation is one of the industries that gets mostly impacted when there's any deterioration in the macroeconomic environment, any distress. So they're the first ones to feel it. And we've done this in the past. We've seen the same kind of trend in the cycle, but there are also some of the ones that pick up and improve faster as well as things start to recover. So we are seeing a little bit of improvement in delinquencies in the most recent weeks and months. But it is part of the whole industry that it's being impacted by the distress.

[Gabriel Dechaine, analyst]

Got it. And do you think, is that the category, or is it others that -- because you said you expect impairments to continue rising to the end of the year. Is that a similar driver or something else?

[Carolina Parra, executive]

Yes, that's what we're seeing as well through the second half of the year to see some impairments increases, as we see the borrowers go through the cycle as well.

[Gabriel Dechaine, analyst]

Okay, got it. Then, on the top line loan growth type of stuff, I heard the explanation for the NIM trajectory this quarter, and that included some reduction in your liquidity levels. Is that -- are you at a point now -- let's say, loan growth suddenly comes back. That would be great to see. Would you need to raise liquidity quite fast? Or do you have sufficient to accommodate the loan growth? Because I'm just going back to Q1, where you raised liquidity levels in anticipation of loan growth that hasn't materialized. So I'm just wondering how much of that excess liquidity you've kind of reduced, and then how much capacity that leaves you at this point.

[R. Rudd, executive]

Yes, Gabe, we want to be well matched in terms of carrying liquidity, not quite in real time. We need to build it a little bit in advance, but we're certainly not trying to build it and hold it for an entire quarter in advance. That would not be conducive to optimizing profitability. If we go back to last quarter, I just want to circle back. The excess liquidity we had was related to stronger-than-expected branch-raised deposit growth, particularly in notice and demand. So we got more deposits than we were expecting. We expected a relatively slow loan growth quarter so that the deposit growth was more of the driver. Our preference going into this quarter would have been to take that liquidity and shift it from securities into incremental loans. That would have been the most accretive to profitability and net interest margin expansion. The loan growth was lower than what we expected this quarter. So rather than continue to hold this liquidity, which is damaging to profitability and NIM, we managed our deposit balances down. That was a combination of broker deposits, just letting that book run down a bit without being as aggressive on replacement. And then, there were pockets within our branch-raised channels that we just simply chose not to be aggressive this quarter because we weren't seeing the loan growth.In terms of where we're positioned exiting the quarter, the amount of liquidity we have this quarter, it's right-sized for the amount of loan growth we see in front of us in the near term. And then, of course, through the quarter, we'll raise funding commensurate with the loan growth we're actually seeing. But it's a case where we're not coming into this quarter skinny. We're prudently provided from a liquidity perspective, and we'll just manage through the quarter.

[Gabriel Dechaine, analyst]

Okay. Great. And then, I guess, the last one. You mentioned loan growth not materializing as quickly as -- or as strongly as you anticipated at the start of the year. I think we all can appreciate why high rates, economic uncertainty. My question is, if next week, the Bank of Canada cuts, we think about it from a credit standpoint, but from a stimulus standpoint, what kind of lag effect would there be -- would it be an immediate bump to your loan growth demand? Or do you have borrowers that are just kind of waiting for that to happen and then they'll start tapping credit lines or whatever? I'm just trying to get a sense for how sensitive the loan growth is to rate cuts specifically, so I kind of manage my expectations here.

[Christopher Fowler, executive]

I think there's always a bit of a lag either way, up or down. I think as we think about our clients, they have been very prudent over the last couple of years with rising rates and have really looked at what they're doing in terms of deploying their own equity, in terms of capital spent, capital expenditures, but clearly, [ have ] an environment where you had a start of declining rates would be positive, and we would see that across our loan portfolio. So we do see that as a positive opportunity for us as we look to the -- well, to whatever starts to hopefully occur next week.

[Gabriel Dechaine, analyst]

And is like a 25 basis point rate cut enough to move the needle or what...

[Christopher Fowler, executive]

I think it affects the kind of perception of the future. And that perception is typically positive, right? When you start to see an environment that becomes more conducive and you see things like the housing market, you see things like real estate project lending, you just have different ways that you look for renewals of loans as they come up in terms of what that means for debt serviceability. So I think it's just a very positive impact on the economy.

[Operator]

Your next question is from Doug Young from Desjardins Capital Markets.

[Doug Young, analyst]

Maybe starting like big picture, looking at your guidance, cash EPS of $3.50 to $3.60 in fiscal '24, if my math serves me correct, it implies an average of $0.89 to $0.93 in each of the next two quarters. And just trying to get a sense what gives you the confidence of getting there from $0.81. And maybe you can talk a bit about the moving pieces that kind of take you sequentially up to that level. And then, can you talk about -- I'm sure you've thought through this too -- what are the risks that may push against you and not let you get to that level?

[R. Rudd, executive]

Yes. So for just going from Q2 to Q3, we get the benefit of more interest-earning days in the third quarter. We were -- and we're coming off a quarter in the second where our average loans, they actually ticked down a bit from the first quarter. So we'd expect our average loans to increase in the third quarter. So the combination of the expanding loans, the more interest-earning days and the loan growth that we're expecting to put up, and this is why -- part of the reason why we're signaling a bit of an uptick from where we're at. We're looking at spreads in the market. And in all portfolios, except for commercial mortgages, which still look a little tight, everything else is looking pretty good and supportive to NIM, if we grow -- like we're targeting to grow over the next quarter. We also think that fuels net interest margin expansion. So from a revenue perspective, we're looking positive from second quarter to third quarter, obviously, and those are the drivers. I would expect to see an uptick in expenses dampening some of that revenue benefit. We're still going to be positive on pre-tax pre-provision income. I don't think we'll be in the teens growth that we've been putting up in the last couple of quarters. I think that's unsustainable through the back of the year, but still positive growth, just more and more modest growth of pre-tax, pre-provision income.And then, offsetting that -- I mean, it's been the same story for the first couple of quarters, but we're lapping against the third quarter last year where our provision for credit losses was below the low end of our historical range. So that will put a bit of pressure on earnings if we get into the high end of our range, which is what we're expecting through next quarter. So those are the puts and takes in third quarter. The ramp in the fourth quarter is actually pretty similar: strong loan growth, continued margin expansion. But again, that tough comp on credit, where I think in fourth quarter -- you'll probably have a spreadsheet in front of you that tells you the exact number, but we would have been 10 basis points or 11 basis points of [indiscernible] in fourth quarter last year. So that's a bit of a tough comp from an earnings perspective. Bu we'll be able to offset a lot of that grind. I think in fourth quarter, we will have a fairly robust and strong pre-tax pre-provision income growth. So that's the setup. And it's really to exit the year on building momentum and set us up really well going into next fiscal.

[Doug Young, analyst]

And then, maybe if I can just kind of dig into a few items here, like [ NIM ], if I look at Slide 10, the asset versus liability re-pricing 1 basis point, if I think of last quarter, it was [ 7 ]. And so, you're seeing the acceleration. That surprised me, so -- but maybe I'm missing something. Can you talk -- like is that -- is this the acceleration going to continue? Or is there something abnormal around the asset versus liability re-pricing this quarter? Is this just the deposit cost kind of trends that you're seeing? And are you doing anything differently in your approach around loan origination that would impact your NIMs differently versus the past?

[R. Rudd, executive]

Yes. I too, Doug, would have expected more expansion of our asset yields relative to deposit costs this quarter. If we were talking a quarter ago, I would have seen a larger number than that, and really 2 reasons. One, stronger loan growth at the sort of spreads we had seen even through the quarter would have expanded asset yields even further. So it's just a case of seeing good spreads in the market, but just not originating enough of those assets compared to what we would have otherwise planned for. The other piece of it is, yes, you are correct, like it was a bit of an uptick in deposit costs. We weren't out there getting aggressive because we just simply weren't seeing the growth on the loans. But even in the deposits we were turning into the book, you would have seen through the quarter, bond yields, overall market interest rates had ticked up actually pretty considerably quarter-over-quarter. It would have been in the magnitude, depending on where you were in the curve, 1 to 2 years, 30 basis points to 40 basis points. I wouldn't have expected that when we were talking a quarter ago. But this interest rate environment continues to surprise, and we continue to pivot to react to it. So those are the 2 big drivers. But I would have expected more. But for me, and when I was talking about net interest margin last quarter, I'd reiterate the same theme this quarter. The expansion of NIM will be led by the acceleration of loan growth because we really like the spreads we're seeing in the market right now and expect those to hold.

[Doug Young, analyst]

Okay. And then, so that -- so it doesn't seem like this quarter, the 1 basis point is really what you're expecting. Can you talk a bit about what you're seeing so far this quarter? And I know we're only part way in, but I know you've got good visibility, I think, on that part of the NIM structures, like what are you seeing so far.

[R. Rudd, executive]

Yes. Well, spreads are performing as we would have expected in terms of what the markets -- has available on new lending opportunities. So, that continues to be very constructive. And so, again, the loan growth expectations for the quarter at those spreads, I would expect a bigger number in terms of the differential between asset yield and deposit cost for next quarter. That would be embedded in our outlook.

[Doug Young, analyst]

Okay. And then, lastly, you talked about negative operating leverage in the third quarter. Is this just turning on the new cash management project, the expenses starting to flow through? What's driving that? And is there a risk that you may not be able to achieve positive operating leverage in fiscal '24?

[R. Rudd, executive]

So for us, we are continuing structurally to target positive operating leverage. I just want to make that explicitly clear that we're not reentering some sort of an investment mode where we're willing to live with negative operating leverage on a sustained basis. We're willing to tolerate it into the third quarter, but we'd be looking to work it back into neutral to moderately positive in the fourth quarter and exit the year. The reason why we'll tolerate it for the third quarter is, you're right, there's a couple of things. One of them is the cash management platform and rolling that out. There's costs associated with that. There are headcount investments associated with getting ready and geared up to really start rolling that out. The other piece, we have a branch in Kitchener, just opened the doors on it. We'll do a formal grand opening on it in the fall, but that is up and running as of basically today. So, that will contribute a bit of the cost increase. And then, the other piece of it, in terms of why the quarter-over-quarter increase in expenses, the levels of headcount we were running through first quarter, and I'd say we ran it again deliberately lower than what we would have otherwise expected in second quarter. This wasn't our intent to continue to run the bank at this level of headcount following our reorganization. It was always meant to be a true reorganization and a reallocation, not headcount for headcount, dollar for dollar, but a good proportion of it was a re-engineering of our headcount to gear ourselves up and be positioned for the stronger growth we saw coming out of this cycle. We hadn't really done much of that through the second quarter. And so, that will continue through the third quarter, just to make sure we're set up for the opportunity in front of us. So it's a bit of a temporary blip, not a sustained trend. We're not changing our stance or expectation for a structural positive operating leverage.

[Operator]

Your next question is from Stephen Boland from Raymond James.

[Stephen Boland, analyst]

I got a bunch of my questions. I'm just going -- sorry, going through the list. I guess, just in terms of the PCLs, when you -- when I think back to last quarter, you kind of -- I'm not sure, did you guide for the whole year in that historic range? Like was there a bit of a surprise here that the PCLs did come up above your historic range? I think that was a little bit of a surprise. Was there something unusual or an unusual file or 2 that created that? I know it's a blip, but certainly a little bit higher than expected.

[Carolina Parra, executive]

Paul, so -- Stephen, sorry, apologies. So yes, we guided last quarter that we will remain within our historic range of 18 basis points to 23 basis points for the full year. And so, while this quarter was slightly above it, I think from a full year perspective, we continue to guide towards that. This year -- this quarter, we had a little bit of an increase on the impairment side, and we continue to build our performing PCL. But it is aligned with what our expectations. And for the full year, we feel confident we will land within that range on the higher end.

[Stephen Boland, analyst]

Okay. And then, I guess my second question, and this -- I don't know if this maybe is for Chris. The slide that you have in there about growth, you're really -- general commercial, commercial mortgage, real estate project loans that you expect to take market share. So I would assume that if the environment improves that everybody is looking at the same kind of time frame that everyone -- your competitors are going to be looking to take market share as well. So what gives you confidence that you can win that business when things do improve?

[Christopher Fowler, executive]

Well, we've historically grown this bank in a high-single low-double digit market. And our opportunity for that is really deploying our teams against those -- the opportunities that come forward to us. We've got an expanded footprint with our expansion in Ontario. We've got solid markets in BC and Alberta. So we see as the market improves that our ability to pick off great clients is very positive. I'll pass it over to Stephen if he wants to add more to that.

[Stephen H. Murphy, executive]

Yes, Stephen, I would also say that we will position ourselves really well for growth. And as you know, we've been very deliberate and selective in recent quarters about which clients we've been choosing. And so, we are trying to cherry pick the strongest clients off our competitors. And this is a pretty unique cycle compared to many, many years. And so, you want to make sure you're pulling off those strong borrowers with the right economics for us. And, yes, we think we've positioned ourselves really well and have line of sight now to really go after those clients. And we know our business model, and what we have to offer those clients is a winning recipe. So we think we're well positioned.

[Stephen Boland, analyst]

That's great. And maybe I'll just sneak one more in. I know that RBC-HSBC is just closed, but I think in past conversations, you talked about like there's an opportunity that some of the HSBC clients may feel dislocated, maybe don't want to go to a large Canadian bank like that. Are you seeing any, I don't know, leads coming out of that, out of HSBC, the legacy business?

[Stephen H. Murphy, executive]

Yes. I think there was a wait-and-see period there where everyone was -- we didn't see a lot of actual movement, and there was a lot of talking, but not so much movement. And I think we're starting to see -- we're at the timing with things happening with competitors in the market, but also kind of getting to the point of the cycle where conversations are translating people making actual decisions on who their banking partner they want for the long term is going to be.

[Operator]

Your next question is from Paul Holden from CIBC.

[Paul Holden, analyst]

I want to go back to the loan growth and sort of the shortfall in Q2 and the expectation for better in Q3 because I would observe that some of the larger banks put up pretty good commercial loan growth in Canada last quarter. So I want to make sure none of this has to do with intensified competition. So maybe you can give some perspective there. You have pointed to good pricing and margins, so that's not indicative of competition. But I want to make sure there's -- not missing anything here in terms of the competitive dynamics.

[Stephen H. Murphy, executive]

Yes. I think for us, like we had signaled to a trajectory of increasing growth through the year, and that's actually what we're seeing. It was a bit slower developing than what we anticipated. But when you look at where we finished the quarter from where we were earlier in the quarter, like we see the curve, it was just a little later developing than we thought. And as Matt talked about, like what we see is confidence in the momentum of the kinds of borrowers we want to bring on at the right pricing to risk. And so, we're comfortable with where things are going, and now we're on the trajectory of the curve, but it was just a little slower developing than we anticipated.

[Paul Holden, analyst]

Okay, Stephen. So I think the answer you're giving is, you see the pipeline, you see the activity. It's just it's not -- the deals aren't closing as quickly as you had expected. Is that what you're telling us?

[Stephen H. Murphy, executive]

I think that's fair. I think for the kind of business that we wanted to do and as we were moving through it, now we're seeing more activity and it's closing and a lot was getting delayed. And now we actually see the trajectory of the momentum, and we see kind of week-to-week how it looks. And so -- and there's an opportunity we can lean into. So we feel good about it.

[Paul Holden, analyst]

Okay. And then, in terms of the deposit growth because you also reduced expectations there for the year, is it the same dynamic where it's just maybe those exactly the same customers where you thought maybe they would close in Q2 and now closing in Q3? Is it same dynamic? Or is there something else going on in the deposit side that's resulted in lower-than-expected growth?

[Jeffrey Wright, executive]

Yes. It's Jeff. I can speak to that. It's a little bit of the same thing because certainly as new clients come on, it's a full balance sheet that comes with them. But the other element here is, we've talked about the introduction of our new cash management platform over the summer. And so, while we're really excited about what it's going to do for us in terms of opening up an opportunity for full-service client growth and deposit growth, right now, it's actually a little bit of a headwind because our focus is on making sure we get the client experience right. And so, when we have a client right now that wants to bring their business over to the bank, we're hesitant to bring them onto our new platform when we know we need to migrate them again in a few months. And so, we actually have a bit of a -- almost a waiting list, as we've been recommending to clients that they wait until that new platform is ready in a few months and move their business then.

[Paul Holden, analyst]

Okay. Last question for me on the discussion on impairments. You referred to particular pressure in the trucking portfolio. And I think what was interesting there is you made a comment that, that tends to be a more cyclical part of the portfolio, which we understand, and tends to feel the economic pain first. That just leads me to a natural question like, well, who comes next then. If trucking is early in the cycle, right, if trucking is early in the cycle, is there potential other books that could be feeling some more pain in the next couple of quarters?

[Carolina Parra, executive]

So, we're not seeing any specific other portfolios going through any significant distress. When we look at overall portfolios, our commercial real estate, residential real estate are performing quite strong, and we feel very comfortable. And in our general commercial, like you know, we have strong borrowers, we have good security as well. And what happens in just [ interacting ] the nature of the portfolio, sometimes you have large loans with very specific issues happening that could trigger that increase in impairments. But overall, there's not any concentration or any specific portfolio where we're seeing deterioration as we're seeing right now relating to transportation.

[Paul Holden, analyst]

Okay. So you feel the factors that have impacted the transportation sector won't impact the rest of the book in the same way?

[Carolina Parra, executive]

Correct.

[Operator]

Your next question is from Sohrab Movahedi from BMO Capital Markets.

[Sohrab Movahedi, analyst]

Carolina, were you surprised by the PCLs this quarter?

[Carolina Parra, executive]

Was I surprised by the PCLs? No, I was not surprised. I think we keep a very close look at how it evolves during the quarter. We are working well with our clients. And when we look at some of the PCLs, we're seeing also very good resolutions on that side. And so, those resolutions really are coming in to offset some of the PCL increase. So, no, it was not a surprise. We continue to really see it evolving as we were expecting through the cycle.

[Sohrab Movahedi, analyst]

Okay. And I think, based on the answer you gave to the last question, if you have degradation, I suppose, in anything other than your transportation and equipment finance, that would be a surprise.

[Carolina Parra, executive]

I would say not a surprise. Like we do expect some deterioration in the portfolio, not like across significant -- or specific industries. But as we go through the cycle, there are borrowers that present higher distrust and they will become impaired. And we will continue to work with them. But what we do not expect is that those all -- those impairments will translate into losses. But we do expect increasing impairments in the second half of the year.

[Sohrab Movahedi, analyst]

What are the chances you may be negatively surprised relative to the guidance given for the full year?

[Carolina Parra, executive]

We're confident on what we're seeing unless there is something significant. But I think overall, we feel our loan to values and our security is holding up pretty strong. So, that would definitely help us maintain and be comfortable with our guidance.

[Sohrab Movahedi, analyst]

Okay. And, Matt, I remember -- I can't remember exactly which quarter. I think a few quarters ago anyway, maybe it was a couple of years ago now, we had a similar situation where in anticipation of loan growth, I think you had kind of built up some liquidity. And I think Stephen had to -- he said, sorry, some things that were supposed to transpire didn't, and they transpired some at a later date. Am I remembering that correctly?

[R. Rudd, executive]

Yes, you are. Different circumstance though. I'd say the difference this time is we identified this trend fairly early, and we're able to work down liquidity. So we protected NIM. The quarter you're referencing, our NIM went backwards as a result. And this quarter, I'd say we were on it and managed our way well through it to protect earnings as best we could with the lower-than-expected loan growth.

[Sohrab Movahedi, analyst]

So if I just can maybe ask a bit of a cynical and unfair question, is Stephen good at building pipelines and giving you the guidance you need to build up liquidity and what have you? Or is he a bit more of a rose-color glass type of guy?

[R. Rudd, executive]

No. To me, I'm getting the detail when I need it to be able to manage liquidity appropriately. And you saw us take -- like I can't do it, turn on a dime. But you can see directionally what we did to manage liquidity down like running off deposits. You can see we did not spend what we expected to spend on NIEs this quarter. I signaled mid-single digits. We were low-single digits. So we were able to react and pivot. So does anyone make a perfect prediction? No. But are we making revisions or early identification of changing trends and giving me the ability to pivot and react? Stephen and team are doing a good job with that.

[Sohrab Movahedi, analyst]

A lot is riding on loan growth rebounding in the second half. We are a month into Q3. Can you quantify where the pipeline is right now, please?

[Stephen H. Murphy, executive]

Yes, Sohrab. So, to be clear, Matt gets madder at me if I do a bunch of lending at crappy prices that don't make money.

[R. Rudd, executive]

That's correct.

[Stephen H. Murphy, executive]

So this is about making sure that we are making the right decisions about which borrowers we bring on, particularly when you're in an edgier part of the cycle. And that's why you're balancing things where we've let a lot of borrowers go well in advance of these kind of cyclical events because as the questions for Carolina, it's like, well, we're getting ahead of those risks. And so, that -- in some cases, you create your own headwind. So what we have seen is, we are anticipating a pipeline, but you can't control where the clients want to borrow the money and what timing that they want. And there's been a lot of kind of caution and wait and see, but we're seeing the activity. And so, as we went late in the quarter, into this quarter, we see the activity and are comfortable with the trajectory and the momentum and sustainability of that trajectory now.

[Sohrab Movahedi, analyst]

Okay. Just 2 more questions quickly. Matt, what is the dollar value of intangibles you have on the balance sheet associated with the AIRB conversion project?

[R. Rudd, executive]

It would be -- so if you look back, we did -- it would have been in the fourth quarter of 2022. We did an accelerated depreciation of the previously developed models, worked them through COVID, got good experience and data through that, and it required a redevelopment of our models, which we've done. In the fourth quarter that year, you would have seen us depreciate. It was in or around, and you'll be able to go back and find the exact number, but in the neighborhood of $17 million or $18 million or so. It's about very close to dollar-for-dollar replacement in terms of what we have on the balance sheet today and use in the business -- currently, Stephen and team are using to evaluate adjudicated credit, monitor risk trends, do risk-adjusted pricing, et cetera. We're using them and happy with what we're seeing.

[Sohrab Movahedi, analyst]

Okay. And one last question. Carolina, these provisions that you're taking, can you talk a little bit about the year of origination for them? Which vintages are these? And are they associated with the period you were issuing equity below book value to grow the loan book?

[Carolina Parra, executive]

So there's -- some of them are longstanding clients, and we've been working with them for a long time. We continue to operate with them. There's not a specific trend on the vintages. When we look at the portfolio for transportation, it is spread across like different years of origination. And that's a portfolio that we manage very, very closely, small ticket items. We have a good collection process in place where we work with our clients and make sure we adjust that we receive our recoveries as we move forward in the cycle. So, no specific vintage of where we're seeing deterioration. As I said, it's very, very spread across longstanding clients and then just [indiscernible] come in, in the later years as well.

[Operator]

Your next question is from Meny Grauman from Scotiabank.

[Meny Grauman, analyst]

Carolina, wondering whether you view Q2 as the high point for your PCL ratio this cycle. Would that be a fair assessment of your view?

[Carolina Parra, executive]

So, for the PCL ratio of the quarter, yes, that's probably at the higher end that we're seeing. We're expecting the full year to be within our guidance, which means we would kind of stay stable or lower into the next 2 quarters as we go through on the PCL ratio.

[Meny Grauman, analyst]

Okay. I just wanted to clarify in terms of the quarterly sort of movement that you're looking for within that guidance. The other question I had was just on -- I noticed professional fees and services definitely moved up a lot sequentially and year-over-year. So I'm just wondering what's driving that. Is that something related to -- well, I'll just leave it open-ended. Wanted to understand...

[R. Rudd, executive]

Yes. That is -- intensity of work effort on finalizing and deploying the digital cash management platform is a driver there. That would be the biggest component.

[Meny Grauman, analyst]

Okay. And then, last one for me is just in terms of your outlook for loan growth. It sounds like when you're talking that a big component of the guidance is based on gaining market share. So maybe there's some macro component here, but it sounds like market share gains is part of the plan. So I'm just wondering if -- do I understand that right? And then, within that question, so what are you doing to get that market share? Is that -- in the past, you've talked about being more selective, given the environment. Are you seeing a changing environment that allows you to be, I'd call it, less selective going forward and that's what's likely to drive market share gains for you?

[Christopher Fowler, executive]

Yes. I would just say it's not necessarily less selective, but I think we're at the point of cycle where our line of sight is better. So this has been quite a disruptive and unique economic period. And so, to have a line of sight to who are the real winners and the really strong companies is a little bit different than maybe what it would have been historically. And so, now, we feel we've got that line of sight so we can be quite focused on which borrowers are the ones we want to take. And like our strategy is always about taking market share. That's where our growth is going to be. And it is -- we're not just riding the economy and taking whatever deals there. We're being quite targeted about taking the optimal kind of clients that will drive our strategy and profitability away from those banks. And it's all about the model and the offering that we bring in terms of our advice and experience of why they choose that they would rather bank with us. But as Jeff mentioned, it's an interesting period for us now, too, where in some cases, we're actually building a relationship, but also kind of get a bit of a headwind of saying, okay, hold on with bringing your full banking over until we've -- we're fully ready with the new platform.

[Operator]

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

[Darko Mihelic, analyst]

Matt, I'm going to ask a couple of questions, and I really apologize if you've already kind of gone over this a little bit. It's end of bank reporting. I guess, sometimes in the fog of war, I miss things. So I'm just going to ask a couple of questions here, and apologies if you've already gone over this. But one of the things that stands out to me is the outlook on the net interest margin. And when I look at Slide 15, you talk about loan growth, but I'm sort of building an expectation here of 100 basis points of reduction in the Bank of Canada rate before the end of the year. So can you weave that in? Because when I look at your sensitivity -- sometimes I don't like to look at sensitivity. It's some sort of across the curve, parallel shift and so on. So I'm very interested and curious into what you've built into your net interest margin sort of expansion expectation with respect to the short end of the curve coming down pretty aggressively here.

[R. Rudd, executive]

Yes. And I don't like looking at the sensitivity disclosure either because it's done on a static balance sheet basis, and you're doing the parallel shock, and both of those things are unrealistic when trying to look at forward expectations. But it gives you a sense of how we're positioned. And yes, like you see, 100 bps parallel shift downwards. Annualized, that's about 1 basis point of NIM pickup. So I think that supports what I've been saying all along is that we're positioned on a fairly neutral basis to -- just structurally in the book to shifts in parallel across the curve. But if you go from a static balance sheet perspective to a growing balance sheet perspective, you become a lot less interest rate sensitive and a lot more spread sensitive. And for us, it is a pretty significant benefit we're seeing from the spreads of the new loans that we're originating and expect to continue to originate on a go-forward basis relative to the spreads of the loans that are rolling off or re-pricing. So that's what's supporting our constructive view on net interest margin. It is really something that will be led by the loan growth as opposed to behind the scenes trying to take a -- or lean into expectations of rate cuts to try to get more juice out of the NIM. That's not how we're managing interest rate risk in the banking book that we're really trying to smooth the edges and how we manage interest rate risk.

[Darko Mihelic, analyst]

Okay. That's helpful. And my next question is pretty straightforward. In the -- sort of as you think about the $3.50 to $3.60 for 2024, what tax rate are you using for the back half of the year?

[R. Rudd, executive]

Yes. A normal tax rate. We had an abnormally low tax rate, which I covered in my opening remarks, just true-ups of filing the returns. On an ongoing basis, we should have an effective rate of tax very similar to our statutory rate of tax, which would be in the high 25%, just eking into 26%, so in or around 26%, maybe high-25s.

[Operator]

Your next question is from Nigel D'Souza from Veritas Investment Research.

[Nigel D'Souza, analyst]

I wanted to follow up on the decline you're seeing in those excess savings and deposit balances in your franchise. We are seeing similar, I guess, speed of decline for other banks. And I'm wondering if that reflects differences in retail and commercial clients where homeowners appear to be holding on to their cash buffers a little bit better. So any more color on what exactly is driving that decline in deposits for your commercial clients? And is it a sign of strain on their cash flows or other type of, I guess, challenges that they're facing?

[Stephen H. Murphy, executive]

Let me take a shot at that, Nigel. I think specific to Q2 and the run-up we saw at the end of Q1, a bunch of that was seasonal. And so, what you see is with the TFSA and RSP season, often a lot of deposits come in and they sit in cash. And then, particularly in this interest rate environment, people are looking at other opportunities and it often flows off balance sheet. And so, that's largely what we saw in Q2 was some more temporary deposits that are being put to work.

[Nigel D'Souza, analyst]

Okay. It sounds like it's not credit related, just some seasonal trends. So if I -- second, if I -- I guess what everyone is getting at here and maybe this would be helpful. In terms of your outlook for loan growth and credit risk, could you just speak to how those could perform in other scenarios, either where rates stay higher for longer or there's more macroeconomic weakness than you expect? Just trying to understand what the growth opportunities are if we have the scenario other than business as usual and rate cuts in the second half of the year.

[R. Rudd, executive]

So I might start on the loan growth side. And I think, as Chris mentioned earlier, it would help from a, I think, confidence and activity in the market perspective, if you see a signal of rates going down because we see that sentiment out in the marketplace. However, like I talked about earlier, I think we feel like we're well positioned with the line of sight to opportunities now that even if that didn't happen that we can drive the growth at the level that we've guided without that tailwind.I'll turn it over maybe to Carolina to talk about -- if you want to talk about on the credit side.

[Carolina Parra, executive]

[indiscernible] a little bit what we expect in terms from a credit and impairment [ PCR ] perspective, Nigel. I don't know if you need any additional clarification on anything.

[Nigel D'Souza, analyst]

Well, if you have any comments on how different scenarios -- I mean, I know this is incorporated into IFRS 9, but the outlook, how much of that is dependent on rate cuts and if we don't get that or we have maybe rate cuts in conjunction with macroeconomic weakness. How does that change your outlook? Or does it change your outlook for credit losses?

[Carolina Parra, executive]

So, of course, the longer the rates stay higher, the more distress we will see on some of our borrowers. But I don't think -- I think from a borrower selection and what we're seeing in the portfolio, unless there is a significant change in the macro outlook and significant deterioration, we don't see that it would cause a material impact on what we're seeing right now in terms of our impairment and overall credit performance of the book.

[Operator]

Thank you. With no further questions, I will now turn the call over to Chris Fowler for his closing remarks.

[Christopher Fowler, executive]

Thank you, Jenny, and thank all of you for joining us today and to our shareholders for their continued commitment and support. We look forward to reporting our third quarter financial results in August. Thank you very much.

[Operator]

Thank you. Ladies and gentlemen, the conference has now ended. Thank you all for joining. You may all disconnect your lines.