Canadian Western Bank

TSX:CWB

Earnings Call Transcript 2021-Q3

[Operator]

Good morning. My name is Colin, and I'll be your conference operator today. At this time, I'd like to welcome everyone to CWB's Third Quarter Financial Results Conference Call and Webcast. [Operator Instructions] Thank you. Mr. Patrick Gallagher, you may begin your conference.

[Patrick Gallagher, Vice President of Strategy & Investor Relations]

Good morning, and welcome to our third quarter 2021 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 about 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 Executive Vice President and Chief Financial Officer. Following their presentations, we'll open the lines for the question-and-answer session. I'll now turn the call over to Chris, who will begin his discussion on Slide 4.

[Christopher H. Fowler, President, CEO & Director]

Thank you, Patrick, and good morning. The strong results we reported today reflect the momentum our teams have created in recent years as we continue to deliver on our winning strategy, uniquely focused on meeting the full-service needs of business owners in Canada. Clients choose CWB for a proactive, personalized service and the specialized advice, tools and financial solutions we provide. We're very encouraged by the results our strategic investments are delivering. We will continue to enhance our capabilities and product offerings to accelerate our growth and further diversify our business. We delivered very strong results again this quarter. Compared to the same quarter last year, our pretax pre-provision income increased 15%. Adjusted earnings per share was up 36% and ROE increased 300 basis points. I'm very pleased with this level of performance as it reflects the significant improvements, we've made to diversify our funding sources, our portfolio composition as well as improving our revenue mix through our growing wealth management business we provide to business owners and their families. Driven by the strategic focus on growth-enabling activities, our revenue has increased 16% from the strong momentum our teams have generated. This quarter, our client-centric teams produced sequential growth of full-service clients relationships with 4% growth in lower-cost branch-raised deposits and 3% growth of specifically targeted lending. The quarterly results are at the strongest growth levels in our history. The highest growth this quarter was recorded in the commercial mortgage and general commercial portfolios, driven by both supporting existing clients and onboarding new full-service clients. Our geographic diversification is producing a strong pipeline with 10% year-to-date loan growth in Ontario. We expect our strong growth momentum to continue as we enhance our full-service client experience through investments in our in-person and digital channels. Our digital client offering is advancing well. And we're on track to release our enhanced digital banking platform for personal and small business clients, including a limited initial rollout of our Virtual COO solution later this year. The Virtual COO is a differentiated solution for our small business owner clients that once fully deployed, will assist in driving strong client growth in this segment. Once fully operational, we expect our enhanced and targeted digital capabilities will enable us to continue to grow and diversify our business across Canada by winning new clients, both within and outside our banking center footprint while further broadening our access to stable, lower-cost funding. There's no question our people are core to our success. Our strong growth is supported by our positive and inclusive culture. We remain a clear destination for top talent as our employee experience creates value. Our unwavering commitment to advance our people-first culture was recognized again during the quarter by Great Place to Work as one of the Best Workplaces in Alberta, and we're also very pleased to be recognized nationally as one of the Best Workplaces for Mental Wellness in 2021. As Matt will discuss in a moment, we supported our robust loan growth this quarter with active usage of our at-the-market equity distribution program. This program allows us to support strong loan growth while dynamically managing our capital in light of the current economic volatility and providing attractive, sustainable returns to our investors. We're also continuing to use our AIRB tools to assess and manage credit risk. And as we noted last quarter, we're working on components of our tools and processes that we have determined can be improved. Work on these enhancements will make our tools more efficient for our teams to use increased precision in the measurement of credit risk and incorporate the changes required to adopt OSFI's capital advocacy guidelines for the Basel III revisions in Canada. We remain confident our work will obtain approval for us to transition to the AIRB approach. We will provide further updates on our progress once we finalize the timeframe to resubmit our application while considering all relevant stakeholders. I'll now turn the call over to Matt, who will provide greater detail on our third quarter performance and improved outlook as we close fiscal 2021.

[Robin Matthew Rudd, Executive VP & CFO]

Thanks, Chris, and good morning, everyone. So if we turn to Slide 5. Compared to last year, branch-raised deposits grew 17% and now represents 57% of our total funding. Our focus to expand full-service relationships with existing and new clients supported a 31% increase in low-cost demand and notice deposits compared to last year. We also continue to build on the strength of our capital markets program, with a $500 million floating rate note issuance during the quarter at an attractive spread. Our efforts to grow and diversify our funding sources drove a reduction in the outstanding balance of broker deposits again this quarter, and they now represent only 20% of our total funding compared to 26% at this time last year. Looking at Slide 6. Our total loans were up 9% in the past year with positive momentum across our national footprint. The 13% growth in our strategically targeted general commercial portfolio reflected our focus to increase full-service client relationships. We also delivered 21% growth in commercial mortgages, and that reflects strong new lending volumes in D.C., Alberta and Ontario with high-quality borrowers that remain within our risk appetite. Total loans in Ontario grew 10% compared to last year and now represent 23% of our total loans. On a sequential basis, we delivered 4% growth in commercial mortgages, but the majority of that growth generated from strong existing CWB clients, including providing the commercial mortgage on completed real estate project lending. Our general commercial growth of 3% this quarter was well balanced across numerous industries with strong credit profiles. Personal loan and mortgages grew 3% this quarter and represents a strong improvement in the performance of this portfolio compared to the previous several quarters. As Slide 7 shows, we delivered another very strong quarter of profitability. Common shareholders' net income increased 39% and pretax pre-provision income increased 15% compared to last year. And that reflects the benefit of 9% annual loan growth and an 11-basis point increase in net interest margin despite the continued low interest rate environment. Adjusted and diluted EPS each increased by $0.26 from the same quarter last year. Higher net interest income contributed $0.25 and reflects strong loan growth and higher net interest margin. We had a $0.13 contribution from a lower total provision for credit losses, primarily driven by a net performing loan recovery of $7 million compared to a charge of $8 million last year. Higher noninterest income, excluding the wealth acquisition, contributed $0.03 and primarily reflects higher credit-related fees, driven by strong annual loan growth. $0.01 was contributed by the wealth acquisition, which we owned for only 2 months in the same quarter last year. Excluding the wealth acquisition, higher noninterest expenses reduced EPS by $0.13, which reflected our continued investments in our people and technology infrastructure to support our strategic execution and costs associated with operating and enhancing our AIRB tools and processes. This quarter also included a partial coupon payment on our Series 2 limited recourse capital notes that were issued in this March, which reduced EPS by $0.02. Our sequential performance shown on Slide 8 reflects 7% growth in revenue and a decline in the provision for credit losses, that more than offset a 4% sequential increase in noninterest expenses. Common shareholders' net income increased 20% and pretax pre-provision income increased 9% compared to last quarter. Diluted EPS increased $0.16 primarily due to higher net interest income that contributed $0.11 and a lower PCL that added $0.05. Higher noninterest income contributed $0.03 and lower LRCN coupon payments added an additional $0.02. Higher NIEs had a $0.05 negative impact and that was due to increased performance-based compensation costs, annual salary increments, continued investment in our technology infrastructure to support our strategic execution and costs associated with enhancing our AIRB tools and processes. As shown on Slide 9, our revenue has continued to build each quarter over the last year despite no change in the prime interest rates over that same period. Revenue has been driven with very strong NIM performance due to very careful management of our funding cost, supported by very strong growth of branch-raised deposits and continued progress in enhancing the diversity of our funding channels. On a sequential basis, our interest income increased as the benefit of 3 additional interest-earning days and 3% sequential loan growth, more than offset the impact of a 2-basis point decline in net interest margin. Our net interest margin in the prior quarter did include a onetime 2 basis point benefit associated with adjusting certain balance sheet management activities in response to a shift in our funding mix. So if we excluded this onetime item, our NIM was essentially flat compared to the previous quarter. On Slide 10, we highlight our delivery of another quarter of strong credit performance, with low write-offs and low provisions for credit losses and a decline in impaired loans, reflective of our conservative credit risk management. Our third quarter provision for credit losses on total loans of 11 basis points was down 9 basis points from last quarter. Our performing loan provision for credit losses was a recovery of 9 basis points compared to a 7-basis point recovery last quarter. Compared to the same quarter last year, the total provision for credit losses was 22 basis points lower, largely driven by a 20 basis point decrease in the performing loan provision for credit losses and that reflected continued improvements in the near-term economic forecast, lower loan default rates and a continued migration of loans from Stage 1 back to stage -- or from Stage 2 back to Stage 1. We continue to maintain an appropriate level of performing loan allowance for credit losses based on the current volatile economic conditions. Our allowance for credit losses on performing loans totaled $113 million. That was a decrease of $7 million compared to the previous quarter. The forecast used in our estimation of the performing loan allowance this quarter was more optimistic than last quarter and loan default rates continue to trend lower. Ongoing shifts in macroeconomic factors, changes in the level of portfolio defaults or changes in the risk ratings of our loans, will continue to impact the performing loan allowance in future quarters. At 20 basis points, our provision for credit losses on impaired loans was 7 basis points lower than last quarter and 2 basis points lower than the same quarter last year. Gross impaired loans were 86 basis points as a percentage of total loans, down from 95 basis points last quarter and last year. New formations of gross impaired loans were down around 30% compared to last year and last quarter with resolutions of previously impaired loans up 40% compared to last year and up 34% compared to last year. Our realized write-offs remain low, which has been consistent with our historical experience even through periods of elevated levels of gross impaired loan formation. Our solid credit performance reflects our prudent underwriting, the secured nature of our lending portfolio and our disciplined management of impaired loans through the resolution while limiting realized loan losses. Based on our current outlook for the Canadian economy, as described further in our MD&A, we expect our fourth quarter provision for credit losses to increase to within a mid-20 basis point range as a percentage of average loans. Calculated using the standardized approach, both our Tier 1 and total capital ratios increased from the prior year due to our 2 limited recourse capital note issuances, partially offset by the redemption of our Series 7 preferred shares on July 31. Our common equity Tier 1 ratio was consistent with last year at 8.8% and 10 basis points higher than last quarter as the combined benefit of retained earnings growth and approximately $30 million of common shares issued under our ATM program, more than offset the impact of strong risk-weighted asset growth. Our ATM program is an effective tool to dynamically manage our capital ratios. We expect to continue to use common shares issued under our ATM to support strong loan growth. We will balance our use of the ATM to support ongoing returns for our investors while ensuring that our capital levels appropriately reflect the potential for near-term volatility in the economic reopening currently underway, and the spread of more infectious variants of COVID-19. Yesterday, our Board declared a common share dividend of $0.29 per share, consistent with the dividends declared last year and last quarter. Looking ahead on Slide 12. We've delivered a very strong earnings growth on a year-to-date basis. That sets us up really well for strong full year performance. We continue to expect annual percentage loan growth in the high single digits in fiscal 2021 were prudent. While we expect that the origination of new branch-raised deposits will remain strong, we believe that this growth may be offset by declines due to increased business and consumer spending through the economic recovery currently underway. Assuming continued stability in our funding costs, we expect our fourth quarter net interest margin to be roughly consistent with the current quarter. On an annual basis, we expect an efficiency ratio of approximately 49%. Noninterest expenses are expected to increase in the fourth quarter due to the continued planned investments in our strategic priorities, which includes ongoing development of our digital client offering, incremental expenditures associated with our AIRB parallel run and typical seasonal increases in certain expenses. Our outlook on profitability has improved from the expectations we provided last quarter based on our strong third quarter performance. We now expect to deliver full year 2021 growth of adjusted earnings per share that exceeds 20%. With that, Colin, let's go ahead and open the lines for Q&A.

[Operator]

[Operator Instructions] Your first question comes from Doug Young from Desjardins.

[Doug Young, Diversified Financials and Insurance Analyst]

Just several questions here. First, Matt, on the 31% increase in new branch-raised demand and notice deposits, can you quantify how much of that came from new clients versus existing clients? And as well, you mentioned in the release that you did some proactive deposit pricing changes, hoping you can just elaborate a little bit on that.

[Robin Matthew Rudd, Executive VP & CFO]

Yes. Sure, Doug. So on the first one, it's been a pretty consistent theme pretty much all through COVID- that -- the majority of our deposit increases have come from either new client relationships to CWB or the conversion of a lending-only relationship to full service. And with that comes deposits. That's been a long-term strategic focus in building capabilities to drive that outcome, and we're seeing really good momentum. What that's allowed us to do with that robust volume coming in, and we think a large chunk of that is very sticky, we've been able to critically analyze the pricing of certain deposit products and really taken our foot off the gas from a competitive perspective on them. And that's allowed us to put a bit of NIM in our back pocket actually. The other big benefit it's given us that strong branch-raised deposit growth is reliance on wholesale funding channels has been significantly reduced. So where we have tapped into, say, the broker market on occasion or in looking at capital market issuances, we've been very selective when we've tapped into those sources. We do it when we see pricing that looks compelling. But we're not in a position where we feel like it's a requirement. It's just given us a lot of levers to pull to really reduce our funding costs as low as we possibly can. And that's been a big driver year-over-year. If you look at our NIM, Q3 last year to Q3 this year, we've improved it by 11 basis points. That's a very different trend than what we've seen in the market from others. And just our focus on that branch-raised deposit growth is paying dividends, and that's with -- put the tools in our toolkit that's allowed us to generate that growth in NIM despite really no help from market interest rates. So very pleased with the progress there.

[Doug Young, Diversified Financials and Insurance Analyst]

So if I wanted to quantify how much is coming from new clients, would it be fair to say 60%, 70%? And then on the NIM expansion is the other place I did want to go to. So thanks for that lead. And -- like, again, as you mentioned, very different message and quantitatively very different from what we're seeing from the big 6. Is this all as a result of deposits growth in the branch-raised deposit growth? Or is there other items that have factored into that?

[Robin Matthew Rudd, Executive VP & CFO]

Yes. So on the first question, we've been kind of bouncing between as low as 50%, as high as 70%, depending on the quarter in terms of contribution from new-to-bank clients or conversion from lending-only to full service. I mean on the second one, yes, it has been entirely funding cost. We have not had really any help on asset yields. Asset mix year-over-year has actually been a bit of a headwind. You'd note that our overall levels of liquidity have actually increased year-over-year. So on a more normalized basis, there's likely some incremental NIM that might have come if we lowered our levels of liquidity. I mean, we're carrying a prudent amount right now and appropriate for the conditions. But it just highlights just how much torque we've had with really focusing on funding cost. It's -- to say it's been an organizational focus would probably be an understatement. We study our deposit pricing. We study our access to funding channels very carefully on a very frequent basis and in a very strategic way. So good to see that, that focus has been paying off.

[Doug Young, Diversified Financials and Insurance Analyst]

And then just second, on noninterest expense ratio, 49%, for fiscal '21. I mean, you've signaled that there is strategic spend coming in Q4, and I get all that. But my math suggests, I mean, in Q4, we'd be looking at a NIX ratio in the 53% range, which is much higher than what we've seen in the past. Do I have that messaging number a bit right?

[Robin Matthew Rudd, Executive VP & CFO]

Yes. Your math is pretty good, pretty close. If you look at last Q4, it was a similar result as well. I mean fourth quarter, just based on the seasonality of certain expenses typically is a bit of a tick up in the NIX ratio. What we're seeing this quarter, and if you did your backwards math, you'd likely see sequential NIE growth kind of in that -- just hitting in the double digits. If I were to break that down into 3 pieces, about 1/3 of that is just the normal seasonal increases we typically see in things like marketing and things like training. About 1/3 of that comes from the costs we're incurring to enhance our AIRB tools and processes, as we've discussed. And then 1/3 of that is just strategic execution, predominantly our big push on digital. You would have seen in the release, we're pushing really hard to get 2 tools launched later this year. That's our VCOO and our small and midsized commercial digital offerings. So it's just a big push on those that drives the NIX up a bit higher in Q4. But a couple of those big things are heavily strategic focused items that we think will drive us pretty strong growth in the future. So worth making the big push to continue moving those along.

[Doug Young, Diversified Financials and Insurance Analyst]

And then just lastly for me. Lastly, on the PCL, you're signaling mid-20 basis point range for Q4 versus 11 basis points this quarter. Essentially, is the message that we shouldn't expect any release in performing loan PCLs and impaired PCLs probably stay roughly where they were this quarter, maybe a little bit higher. Is that really what the messaging is?

[Robin Matthew Rudd, Executive VP & CFO]

Yes. That would be our base case. And I mean, that has been our base case. When we look at the macroeconomic forecast that underpins our performing loan allowance, when we're thinking about no releases from this quarter to next its stability in that forecast and stability in default rates. What we've been continually surprised by, I suppose, each quarter, is that the macro economy continues to improve, and default rates continue to tick down. So if we saw that continue to occur in fourth quarter, then there is some allowance that could be released on the performing loans side, although not our base case, but I suppose we've been continued to be surprised to the upside all year. So we'll see how that plays out.

[Operator]

Your next question comes from Paul Holden from CIBC.

[Paul David Holden]

Also have a few questions. The one I want to start with is continuing with this growth in NIE. I imagine when you take on these types of projects, you run some kind of financial analysis and have certain hurdle rates in mind. I think it would be helpful for us just kind of understand maybe what those types of hurdle rates are? How we should think about future return on the investments we're seeing flow through into the P&L today?

[Robin Matthew Rudd, Executive VP & CFO]

Yes. You're absolutely right. I mean when we're taking on these projects -- and some of these are capital intensive. Some of these hit us directly in noninterest expenses right away, which is what we're seeing on a couple of the projects. But we consider it as a use of capital rate up against using that capital for loan growth, acquisitions, et cetera. So yes, I mean, it has to make sense on a return on capital basis compared to the other ways we could deploy and use that capital. So you would not see us incurring these investments if we did not believe that the returns were there in the long term. In terms of when we see them, I mean digital is a big one. There's a few different components working together there that we believe are essential to continue the strong momentum we've had on branch-raised deposit growth. You've seen what the investments we've made in the past have done for us in terms of just the momentum it's driven for branch-raised deposit growth. And then how that shakes out into how we can manage the NIM and drive some really profitable and accretive outcomes without any help really from the market. So that's a trend we expect to continue and keep producing as a result of these investments we're making, just as one example.

[Paul David Holden]

And roughly, what would your return on capital hurdle be, somewhere around 12%?

[Robin Matthew Rudd, Executive VP & CFO]

We don't publish it, but I would suggest your gut would not be too far off. I think I understand how you're getting there, and it wouldn't be completely out of line.

[Paul David Holden]

Okay. That's helpful. And then just continuing with the investments in digital, the federal government put something out roughly a month ago on open banking. Just wondering how your digital offering fits with an open banking type of world. Like is it designed or at least partly designed to be able to take advantage of that data portability?

[Christopher H. Fowler, President, CEO & Director]

Absolutely. Yes, Paul, it's Chris. Absolutely. Our investment in our technology platform is really geared to give us the ability to take advantages of what the opportunities open banking provides. And our focus to ensure that we have a digital access to our banking programs and the ability for us to really manage data in a very secure way. So as we think about the opportunities that open banking will provide, given our footprint and our view of really expanding geographically, we see the opportunity of open banking as very positive for us. And to make sure that we can turn it into that opportunity, we have invested very, very specifically in our technology platform to allow us to really to take those steps.

[Paul David Holden]

Okay. Good. And then one final question, and it relates to NIM. So appreciate the guidance specific for next quarter. But as we think further out and the trends, you're seeing in commercial loan growth and the trends you're seeing in branch-based deposit growth, like why shouldn't we expect NIM expansion over the next several quarters? And is there anything in particular to Q4 that's kind of holding back that potential NIM expansion in the near term?

[Robin Matthew Rudd, Executive VP & CFO]

Yes. I mean I'll cover the potential headwinds and tailwinds, and then I think that will help explain Q4 and then maybe some upside that might be there. So yes, I mean, you've hit on a predominant tailwind, growth in commercial lending and our growth in particular. I mean that's something that is accretive to our NIM. The second factor that could be accretive to our NIM as we see how things settle here as we get through a couple, maybe further choppy economic periods is our overall level of liquidity. I mean, part of that is just structural balance sheet composition. Part of that is just being prudent. And so working that down is something that could give us a bit of a tailwind from a NIM perspective. Headwind on NIM, we think of it as a temporary factor. It's this idea that there is some element of the deposit growth we've had that, being honest, we think is just simply excess liquidity being held by our clients that will eventually be put back to work as economy continues to recover, reopen. And that's one where if we're seeing likely our lowest cost of funding, our notice and demand deposits are the ones we think grow off first. If we need to replace them in the near term with a more expensive deposit source, broker deposits or other wholesale opportunities. I mean that's something that could put a little bit of temporary pressure on NIM. But once you get through that, that temporary impact and temporary churn and funding mix, the ongoing momentum will have in branch-raised deposit growth, which we think accelerates and continues when the smoke clears from all this, is something that has NIM look to normalize. The other thing we thought about too is, if you see conditions that have excess deposits being consumed in the economy, that's probably a factor that also results in incremental loan growth. Maybe there's a timing factor there where deposits run first and then the growth comes later on the loan side of things. So maybe that's ultimately a positive in the long run as well. So from a long run perspective, I agree with your thesis. That to me, when I look at the factors, there's a lot more tailwind than headwind. If you get through just maybe a temporary period here of a little bit of volatility, and that's what we're thinking about in Q4. It's one where strong new growth of deposits from the branch rate side of things, we expect to be there. How much of that gets soaked up with runoff if our existing deposits could be a factor that has our NIM looking flattish. If we don't see that runoff come, then you could see some bit of upside there for overdelivering against our current base case.

[Operator]

Your next question comes from Marcel Mclean from TD Securities.

[Marcel Mclean, Associate]

Okay. So I kind of want to go back to PCLs here. Thinking about it maybe beyond just the guidance you provided for next quarter. And specifically on the impaired side, how did you guys see things sort of playing out, thinking about things like Delta variants and the tapering off of government assistance. Do you see the impaired sort of just trending towards a normalized level? Or should we expect maybe to run above historical averages for some period of time? Like how do you see things playing out maybe over the course of the next 12 months? I know it's hard with the amount of uncertainty, but what are your thoughts on that?

[Christopher H. Fowler, President, CEO & Director]

Yes. Thanks, Marcel. Yes, I think the amount of uncertainty is the key part of what you just said. I think as we think about where we sit, we've come through quite an interesting, to say the least, 18 months. And our expectation on how the loan portfolio would perform as all banks took increased provisions. And how we sit here today, and we've really come through with all the stimulus that has been, I think, stabilizing in the economy, we expect to see it just pull off. And then as we think about our clients, what impact does that have. So I think we've had a long period of time for clients to adjust kind of really determine what their revenue profile looks like, how they match their expenses to their revenue. And as we think about that, typically, when we come out of downturns, we do see kind of the ones that have hung on but just don't make it. So we want to be conservative as we think about that gross impaired potential. And as we kind of work through our portfolio and see the different areas that might be impacted, we're conservatively thinking of maintaining that PCLs in the mid-20 basis point level.

[Marcel Mclean, Associate]

Okay. And then I just had one sort of quick one going back to the branch-raised deposit growth. I think I recall you saying last year that there was virtually no runoff in that number, and we could expect branch-raised deposit growth, the pace of it to slow over time. It does look like that has really appeared yet this quarter. I'm just wondering, if there was any runoff included in this quarter's number and sort of the timing, I guess, it's likely to coincide with loan growth, but just your thoughts on how branch-raised deposits evolve from here?

[Robin Matthew Rudd, Executive VP & CFO]

Yes. We did start to see a little bit of runoff in certain products, but certainly not as high as what we might have expected. But we did start to see it occur on a limited basis towards the end of the quarter, but not what I would call a material impact at this point. Not something that, for instance, would have changed our deposit growth in the quarter by, say, 1%. It was a factor much smaller than that. But obviously something we're keeping an eye on, and you can see in our fourth quarter outlook, we are expecting that trend to accelerate a bit, but also, I don't think this is something that will materially impact us from a NIM perspective.

[Operator]

Your next question comes from Meny Grauman from Scotia Bank.

[Meny Grauman]

Curious to follow-up more broadly on how business has changed pre-pandemic to post-pandemic. I mean you talked about the funding structure and the fact that the margin is definitely sort of on a different track before the pandemic. And now in terms of credit and other key drivers, are there any key areas where you'd say, yes, like the business is definitely post-pandemic, we're not going back to pre-pandemic run rates, where have you changed that through this period here? Are there any other notable items you'd highlight there?

[Christopher H. Fowler, President, CEO & Director]

I'll start, Meny, and Matt can step in. Where we sit today is, yes, the pandemic absolutely changed client behavior. We are seeing, obviously, there's a higher deposit levels across the economy and all banks have seen that. But our access to the deposits has fundamentally changed. The execution of our strategic direction really to focus on that full service opportunity with the clients and supported that with an increase in product delivery and increase in the different capabilities we're able to provide our client base and our next move to digital that improves that whole process even further. So for us, yes, we've had a meaningful change in how we engage with our clients, and we see that as, again, a real tailwind for growth. And as we think of diversification that opportunity for us to really push that geographic diversification but also revenue as well. So yes, we see post-pandemic as realizing on the opportunities that we've invested in a strategic direction. Matt, do you want to add?

[Robin Matthew Rudd, Executive VP & CFO]

No. I totally agree. I mean we're exiting the pandemic with a lot more tools in the toolkit to drive growth and exiting the pandemic with the sort of funding profile and funding strength that will allow us to fund that growth on a very efficient and accretive basis. So very happy about how we're positioned. And then, of course, we have what we believe will be a more constructive macroeconomic backdrop for growth as well. So we're quite excited looking forward, Meny.

[Meny Grauman]

And in terms of just the PCL ratio specifically. So obviously, there's still uncertainty. But if we just think wherever that time is post-pandemic, it's behind us, do PCL ratios kind of go back to where they were? Or because the business mix is changing, is there a sense that maybe you'd have a higher PCL ratio in a normal time going forward?

[Christopher H. Fowler, President, CEO & Director]

Yes. We don't anticipate our PCL ratio changing. We've had this 18 to 23 basis points. We haven't changed our underwriting. We're focused on the same core client. We are very disciplined in our underwriting loan management. We think we're just continuing to improve that client experience. And with the improved tools that we are building through the AIRB process that enhances your sort of credit insight on your book. So, no, we don't see any change at all in that outlook.

[Robin Matthew Rudd, Executive VP & CFO]

Now that's been the key theme of our growth, Meny, as we've achieved the growth not by stretching risk appetite. If anything through the pandemic, we might have tightened in a few areas. And so that would mean the composition of the book exiting the pandemic is one that just kind of pound-for-pound, like-for-like, overall, probably a higher credit quality and one that might not cause us to deviate from the historical range and hopefully put us somewhere to the slightly lower end when the smoke clears.

[Meny Grauman]

That's helpful. Just a question on the ATM in terms of how quickly that can be deployed? And how far ahead are you looking? Meaning, should we be surprised if you raise money under the ATM this quarter, the next quarter? Like what kind of -- obviously, it's based on your forecast, but what kind of time range are you looking for here on this current rate?

[Robin Matthew Rudd, Executive VP & CFO]

Yes. Meny, the ATM, it's a great tool. It's dynamic capital management. It allows us to have the right capital for the moment. It's something realistically we're looking at quarter-to-quarter. How much capital we believe we need to support the growth, how much capital we just want to have in our back pocket based on other factors out there that might present potential downside risk as well, strength of pipelines. But it is something we can adjust and calibrate very quickly. And it's not quite the sort of dynamic capital management you'd expect to have as an AIRB bank. But it's one that, it's a bit of an audition here to demonstrate that we do have the focused capabilities, forecasting strength to be able to appropriately dynamically manage our capital through cycles. So pretty pleased with the results so far and how we're using it.

[Meny Grauman]

And just one follow-up. So -- can I think of it as you're kind of steering the CET1, like expect it to be kind of in the 8.8% range for the foreseeable future and until we get to AIRB, I guess, like you're kind of actively managing towards the kind of numbers that we're seeing this past quarter? Would that be the right way to think about it?

[Robin Matthew Rudd, Executive VP & CFO]

Well, it will depend on the quarter and what's in front of us. I think a lot will depend on how Delta variant plays out. Our base case is that we don't expect any significant losses or any big disruption coming from that, but it's an area of uncertainty. So it's one where we'll look at where we sit next quarter with what's in front of us and potential downside and make a call on capital. So you could see us flex it up, you could see us feather it down if we get to a point where we think we're through that uncertainty. The amount of growth we're generating right now that even if we thought we had a little bit extra in our genes as it turns out, we soak it up pretty quickly with growth. So this really is dynamic in the quarter, management of capital and one we can reposition pretty quickly based on the circumstances in front of us.

[Operator]

Your next question comes from Cihan Tuncay from Stifel.

[Cihan Tuncay, Director]

Chris, maybe just if you can elaborate a little bit more on the digital product roll out you've got plan for rest of the -- the end of this year and through next year. If you could give us a little bit more detail on what that product shelf could look like on the -- from both the personal and commercial banking opportunities? And how should we think about the incremental benefit? I mean, is it just the potential incremental reduction in funding costs that you could get from digitally sourced deposits? Or are there anything other projects you're working on that could enhance noninterest income or any revenue opportunities attached to that as well?

[Christopher H. Fowler, President, CEO & Director]

Sure. I'll start on this. Yes, so the initial rollout that we will have in Q4 will deliver the small business and personal online banking and convert those to digital. So that gives us that access to just a better way for clients to navigate within our online banking program. So that, that's a big win. The commercial banking platform will come in Q1, Q2 of fiscal '22, and that will then provide that commercial banking digital platform that will allow again, our clients there to navigate with more ease and single sign-on in terms of managing their daily affairs. And then that also adds into how we can manage payments. And so there are lots of opportunities from that perspective. The other deliverable in this quarter coming up and a full go live as against '22 is the Virtual COO that's targeted a small business client. And the goal there is to provide essentially as a cash management program as well with artificial intelligence that assists in them looking at how they manage their cash. So looking at receivables, payables, payroll and giving them that sort of cues on how they can look at their accounts and provide that extra insight into the cash flows of the company. So the opportunity we see is one for -- clarity for increasing our low-cost deposits as we look to really support that small business client, which are typically net depositors. It also looks to increase our footprint as we -- with the digital delivery, we are less dependent on physical branch interactions with clients. We can do much more online. And then ultimately, that more client base, again, we're focused on that full service, it does translate into more noninterest income as we look at service fees and transaction fees and our ability to just generate more business with that client. So digital is a meaningful impact on how we think about our ability to grow, support our clients and really focus on that geographic diversification as well.

[Cihan Tuncay, Director]

And maybe just a follow-up with -- maybe from your answer, how do you think about now going forward, I mean you've always had new branch openings as it -- they've performed quite well for deposit growth and full-service banking opportunities. But how do you look forward in terms of how do you balance digital growth versus opening new branches? Or has that changed at all? Just maybe an update on the branch rollout as well, please?

[Christopher H. Fowler, President, CEO & Director]

Yes. Well, branches still remain very important for us. We actually are -- we're scheduling a branch opening in Markham in mid-2022, so looking forward to that. So we see that GTA opportunity for us to have a more sort of feet on the ground that also adds on the marketing side. The sort of transactional side of branches, I think we'll see less of that, but really be focused on the advice. And those client meetings that allow us to really provide that special service that we historically have delivered to clients with strong expertise in loan structuring and providing that appropriate financial solutions to the clients. So yes, we expect to also add branches along with digital. So we can really capture that sort of broader geographic footprint but be very targeted where we think we've got from a physical presence, we have good opportunities. And again, that's the GTA opportunity in front of us.

[Cihan Tuncay, Director]

Another update -- sorry, one follow-up and I apologize if I missed this, but for your Q4 guidance, what do you factor in, in terms of ATM usage for that guidance?

[Robin Matthew Rudd, Executive VP & CFO]

Yes. So on that one, it would not be surprising to see us continue to issue a bit on the ATM in fourth quarter as well. I think if you're looking at hitting our EPS growth of in excess of 20%, we have factored some incremental usage of our ATM to drive to that outcome. Not a material amount, not something that would cause our EPS to change by more than $0.01 or $0.02, but we are expecting a bit of continued usage.

[Cihan Tuncay, Director]

And just one last question for me, guys. As we look forward to the removal of capital distribution, shareholder capital distribution restrictions from [ of fee ], how do you balance? Or has there been any change in your thinking of how you look at the dividend? How do you balance the use of the ATM, your growth opportunities, how should we think about the dividend going forward if and when those restrictions are lifted?

[Robin Matthew Rudd, Executive VP & CFO]

Yes. So I mean, dividend, we've always managed within a target for payout ratio prior to the pandemic. I mean you can see by our results, we were typically in the mid-30s in terms of a payout ratio percentage. Consequently, if you took our earnings projection this year and maybe if you normalize PCL to something that was more representative of a midpoint of a historical range. You'd see that our payout ratio is probably landing pretty similarly right now to where we were pre-pandemic. So if we were following that same trajectory, it would suggest that we don't need to see a big boost to the dividend to continue to deliver that same level of payout ratio. It was always a bit of a balance of what we thought was an appropriate direct return to shareholders while also acknowledging that internal retention of capital, we could do some pretty accretive things with it. In fact, the shareholder returns in the long run, retaining capital and deploying it with loan growth and some of the strategic initiatives we're working on actually drives a more favorable outcome. So it's one where you'll continue to see us have that balance as a standardized bank. And certainly, as an AIRB bank in the future, it's how we think about capital allocation as well. Preference is to growth organically and acquisitions that help drive our strategic progress and are accretive. And then when we get through those 2, anything we have left over for a return to shareholders, our preference would be buybacks and then maybe dividends thereafter. And because those last 2, when we model them out, are less accretive to shareholder returns.

[Operator]

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

[Sohrab Movahedi, Analyst]

Okay. Just a couple of -- just clarifying, I think, hopefully, quick ones here for you, Matt. I mean if I think back over the last 3 or 4 quarters in our conversations, it was going to be a bit of a transitional year, I guess, with the addition of the wealth management acquisition, the investments that you've articulated around digital. So the expenses were going to be a little bit, I suppose, uneven from quarter-to-quarter. You've kind of talked a little bit about what next quarter may look like. Is it fair to assume that the guidance around expenses for next quarter benefit from maybe some pulling forward of some of the rollout expenses associated with the future versions that Chris was talking about in Q1, Q2? Or do you think some of what may be implied in next quarter's earnings or expense line, sorry, may continue to trickle into next year?

[Robin Matthew Rudd, Executive VP & CFO]

Yes. I mean, we haven't finalized our budget for next year. But just in terms of broad themes on things that would drive or benefit NIE growth this year compared to next year, investments we'll continue to make in enhancing our AIRB tools. I mean that's something that is impacting our expense growth in Q4, likely something that we see continuing into some period into next year as well. We're working on how long and when we provide our full year guidance, that will be a factor we'll discuss. The push on digital, I mean, it's a big push this quarter to launch the limited rollout of the VCOO. How clients respond to that initial rollout and what enhancements or tweaks we decided to make to it as a result, they could be minor, there could be some incremental build we put on to it as we think about the full rollout of that tool. So that will be a bit of a wait and see. But in terms of the development progress on digital, yes, I mean it's a big push this coming quarter, it's one that should moderate over time. But perhaps in the first half of next year, we might see that trend continuing. But year-over-year, and if we're thinking about '21 versus '20 NIE growth in '22 versus '21 NIE growth, despite not having a finalized budget are all indications point to a bit of a moderating of that trend, but with some factors that may be on a temporary basis don't have it moderate perhaps as much as we'd like.

[Sohrab Movahedi, Analyst]

Okay. That's helpful. And then just looking at the kind of the other income line, the fee income line. Security gains, just looking at your setback, I think over the last 7 quarters have kind of been anywhere from $0 million to $5 million benefit. Can you tell us how much unrealized gains you still have kind of sitting around?

[Robin Matthew Rudd, Executive VP & CFO]

Well, the -- using the gains on securities, it's not something we're necessarily using to drive earnings. It's more of an outcome of balance sheet management activities. Our expectation going forward, and when we thought about Q4 guidance, certainly, that was into an expectation that we wouldn't have any significant realized gains. When we're thinking about movements in the balance sheet quarter-to-quarter, we didn't see anything there that we thought would give rise to us realizing any big gains in the quarter. So I wouldn't expect gains on securities to be continued driver of earnings and certainly not an intentional driver of earnings more of an outcome of the activity in the quarter. So I wouldn't bank on it for next quarter.

[Sohrab Movahedi, Analyst]

Okay. And just one last -- that's very helpful. And then one last question. I mean until you've eventually, hopefully, successfully transitioned over to the AIRB, you are still under the standardize. When you think about this quarter's loan growth, the mix of this quarter's loan growth. You talked about the success in commercial real estate year-over-year. You talked about general, commercial. Do you think this -- where you are having success now and you expect to continue to generate kind of growth in the coming quarters. Is there any reason to believe the capital intensity of the business, not because of the growth, but because of the risk-weighted associated with that growth is going to increase here? In other words, if I think of your RWAs to assets as a proxy, is this -- are we on a bit of an upward trend here?

[Robin Matthew Rudd, Executive VP & CFO]

So commercial lending is a standardized bank. That is our biggest consumer of RWA density. So as long as that growth continues, fair to say that it would cause our RWA density to increase. We're seeing good momentum on personal lending though. And this quarter, pretty good momentum on the insured residential lending, which from an RWA consumption basis, I mean, it's favorable, it's 0%. So it's one that as long as that residential mortgage growth continues. As a proportion basis this quarter, it's kind of held right in there. So that continues. It's one where you probably see stability in RWA density or certainly no material movements. And that's what we'd expect at least into the fourth quarter, perhaps on a longer-term trend. If we saw commercial lending accelerate at a pace beyond residential mortgages, and yes, I mean that's the factor that would increase density as a standardized bank.

[Sohrab Movahedi, Analyst]

Okay. That's -- but I guess that's not -- like when you think about some of the guidance you've shared around, for example, loan loss provisioning next year and so on and so forth. I assume implicit in that is some assumption around the proportionality of that commercial versus, let's say, the insured mortgages that you made reference to. So I assume you're not -- your working assumption is that the proportionality is not going to necessarily change?

[Robin Matthew Rudd, Executive VP & CFO]

Correct. Yes. It would be relatively consistent, would be our view at this point.

[Operator]

Your next question comes from Gabriel Dechaine from National Bank.

[Gabriel Dechaine, Analyst]

Yes. Quick ones here. AIRB transition, is there any change in the timing of your submission? I don't think though, but you got some new language on this, the CAAR 2023 revision you have to integrate?

[Christopher H. Fowler, President, CEO & Director]

Well, we continue to work. Gabe, we've got lots of programs. We've got lots of people that are on it. We're going to give an update as we move along. We've got -- we're seeing lots of opportunities, and we're going to incorporate the final Basel III amendments that will come into play. So we're focused on AIRB. It's a tremendous long-term positive for the bank as we think about particularly our business model with the commercial banking focus. It's a long-term investment that will pay off, and that we're going to ensure that we deliver it appropriately.

[Gabriel Dechaine, Analyst]

Okay. And then the other one, as far as the ATM issuance, how do I -- is it appropriate to measure what you issued this quarter relative to, say, excess loan growth this quarter, so something above 8% annually or whatever? Because it seems like -- or did you wish you more than what was let's just say that by loan growth this quarter as in it's not exactly lining up ATM to what you did that quarter, it's what's coming in the next quarter as well?

[Robin Matthew Rudd, Executive VP & CFO]

Yes. I mean it's -- I mean you would have seen we built our CET1 ratio from last quarter to this one. I mean that's a factor of current growth. That's a factor of strength of pipeline. And then that's a factor of making an assessment of potential downside risk and external factors. A bit of choppiness with the reopening, a bit of Delta variant concern kind of rising quarter-over-quarter. So those are all factors we'll consider each quarter in deciding how much to raise. So not a completely direct linkage to current loan growth, but that would be the primary factor.

[Gabriel Dechaine, Analyst]

Yes. Because if I'm making a few simple assumptions and trying to calculate some accretion, it doesn't -- I mean it may be neutral or maybe slightly accretive compared to the issuance this quarter, but that might not -- that might be understating given that there's more to come, is that kind of the right way to look at it?

[Robin Matthew Rudd, Executive VP & CFO]

It depends on your math on accretion, but -- and the assumptions you're using. But if you were, for instance, using the ATM to fund loan growth and you are maintaining your CET1 ratio. So you weren't looking to build it. You were just looking to perfectly offset loan growth then you might get a level of accretion and using the ATM in that manner in sort of the mid- to high single digits as a percentage of EPS growth. Using the ATM in the manner of this quarter, for instance, of funding the capital needed for the loan growth and putting maybe 10 basis points of CET1 in the back pocket, it's something that would, say, reduce that level of accretion by perhaps 1% or 2%. So still obviously happy with how we're using it to the fact we can still be accretive and put a little capital in our genes for what could be a choppy next couple of quarters. We're pretty happy with that outcome.

[Gabriel Dechaine, Analyst]

Yes. I guess that's my point. I don't want to understate the accretion considering those other factors like you did accrete CET1 and doing this issuance. So anyway, that's -- I'll go offline for this discussion.

[Operator]

Your next question comes from Nigel D'Souza.

[Nigel R. D'Souza, Investment Analyst]

I had a follow-up for you on your Stage 2 loan migration in the quarter. And based on my math, I have your percentage of loans for Stage 2 relative to the whole portfolio going from about 12% last quarter to about 7% this quarter. So first, is my math right there? And on that migration, was that entirely driven by changes to your forward-looking indicators? Or were there any portfolio specific or more specific factors that drove that migration?

[Robin Matthew Rudd, Executive VP & CFO]

Yes. Thanks, Nigel. Your math is right. We did see that level of decline. A little bit of the decline from borrower-specific behavior. Our watch list loans decreased by about $100 million quarter-over-quarter. So that was a small proportion. The larger proportion was model-driven. It's kind of the inverse of the conversation we had when our Stage 2 loan proportion was really running up and running up at a faster rate than what you would have seen in the market. And what we pointed to, was the short duration of our loan book causing some of that volatility. And we talked about at that point, would we see the opposite happen when things start improving with the short duration of your book via benefit? And the answer to that question is yes, and that's what you're seeing this quarter. The assessment of Stage 2 is based on credit risk compared at origination to today. So it's always a relative comparison. And if you think about how quickly our loan book churns, we've originated a fair amount since COVID started. So if you're comparing credit conditions today, to what they would have been at origination, it's certainly been an improvement and certainly not a worsening. So what's happening with Stage 2 is exactly what we expected.

[Nigel R. D'Souza, Investment Analyst]

Okay. And just a really quick clarification there. On the remaining Stage 2 balances, do you see that migration -- further migration and movement lower driven by, again, for specific factors or more applied just to understand what's going to drive the remaining mix of your Stage 2?

[Robin Matthew Rudd, Executive VP & CFO]

Yes. I mean it could be both. Barring no improvement in either underlying default rates or macroeconomic conditions, then it would be borrower-specific that would drive that down. But there is still some ability for our models to continue pushing that down if we continue to see improvements in those 2 key factors, the macro factors and default rates.

[Operator]

There are no further questions at this time. I'll turn it back to Chris for closing remarks.

[Christopher H. Fowler, President, CEO & Director]

Great. Thank you, Colin. Our year-to-date performance has been very strong. Our commitment to our teams and clients over the last 18 months is resonating with business owners in Canada, and we're winning many new desirable full-service relationships. The proactive client-centric experience delivered by our teams is accelerating our growth to capture increased market share across our Western and Central Canadian target markets. Looking forward, we see robust opportunities and our continued focus to invest in our capabilities and product offering will further accelerate our momentum. We're firm in our commitment to advance our strategic direction to deliver long-term profitable growth and provide attractive, sustainable returns to investors. We're also mindful of how we achieve these goals. We're currently undertaking a process to fit sustainability into our strategic direction and our risk management activities. We're also working to deliver an authentic approach that's best from a client, people and investor perspective. We posted our latest corporate social responsibility report to our website this morning and are excited to share our progress as we support Canada's goals of transitioning to a lower carbon economy and a more sustainable future for all our stakeholders. In closing, I'm proud of our team's commitment to achieving our goal to be the best full-service bank for business owners in Canada. And I'd like to say thank you for their efforts to advance our strategic objectives, transform our capabilities and deliver another quarter of strong financial results. To our investors, we appreciate your commitment to CWB as we undertake this transformational journey and deliver strong returns along the way. We look forward to reporting fourth quarter and annual financial results on December 3. With that, we wish you all a great day. Thank you.

[Operator]

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.