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Canadian Western Bank
Earnings Call Analysis
Q3-2023 Analysis
Canadian Western Bank
In a time of economic uncertainty, the company emerges with robust third-quarter financial results, reassuring stakeholders with its disciplined fiscal strategies. While acknowledging the pressures of a heightened interest rate environment and weakened economic growth, the company remains poised to leverage full-service relationships and strategic growth opportunities. Staying true to rigorous underwriting criteria, conservative risk management, and prudent expense controls, they maintain an admirable commitment toward achieving positive operating leverage in the upcoming quarter.
Credit risk remains a focal point as total gross impaired loans rose by 12%, marking a slight uptick in potential risk exposure. However, the effective credit risk framework, solid underwriting standards, significant security against loans, and minimal exposure to unsecured lending fortify the company's defense against economic volatility. Even with a cautious view on future borrower defaults influenced by rate increases, the company is confident its provisions for credit losses will stay within the historical norm. Their resilient credit management instills confidence in delivering stable and predictable returns.
Shareholders have reason to smile as the Common Equity Tier 1 (CET1) ratio gently increased by 10 basis points to 9.4%, reflecting a sound accumulation of retained earnings without the dilutive effects of issuing new shares. The Board's decision to maintain a steady quarterly dividend with a modest increase from the previous year signifies a commitment to consistent and growing shareholder returns, a hallmark of a company with a steadfast financial footing.
The company exhibits sharp fiscal acumen by holding expenditure levels steady and optimally allocating resources. Although not fully realizing positive operating leverage this quarter, the stride towards this goal was significant and sets a confident stage for achieving it in the next quarter. By diligently aligning expenses to their highest and best uses, the company keeps its eyes firmly on sustainable growth and operational efficiency.
Facing an interest rate-sensitive environment, the organization has effectively balanced its floating assets and liabilities, mitigating the impact of Prime rate fluctuations. However, the quick rise in rates towards the quarter's end signals a smaller margin benefit anticipated in the coming quarter. As rates stabilize and work their way through the portfolio, a delayed but positive margin expansion is likely to follow, bolstering future financial resilience.
In a drive to increase market competitiveness and client retention, the company is not resting on its laurels but rather enhancing its product offerings. Improved services and expansions of operational geography underscore an ambition to win over full-service clients, thus enriching the company's financial ecosystem. Such incremental but strategic enhancements hint at a brighter horizon of customer acquisition and retention.
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Good morning. My name is Sylvie, and I will be your conference operator today. At this time, I would like to welcome everyone to CWB's Third Quarter 2023 Financial Results Conference Call and Webcast. Note that all lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] Thank you.
I will now turn the call over to Chris Williams, Assistant Vice President, Investor Relations. Please go ahead, Chris.
Good morning, and welcome to our third quarter financial results conference call. We'll begin this morning's presentation with the opening remarks from Chris Fowler, President and Chief Executive Officer, followed by Matt Rudd, Chief Financial Officer, and Carolina Parra, Chief Risk Officer. Also present today 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 will 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.
Thank you, Chris, and good morning, everyone. Before I begin my remarks, I'd like to say that our thoughts are with the thousands of people who have been displaced and affected by the wildfires in British Columbia and Northwest territories. We remain committed to support our local CWB team members and clients as they navigate this challenging time. Through the focused performance of our teams, we delivered strong financial results in line with our guidance.
Our Q3 adjusted EPS of $0.88 per share, increased 19% from the previous quarter and was supported by improved revenues, continued low levels of credit losses and disciplined management of our expenses. Our ongoing efforts to expand our full service client relationships, combined with the proactive deposit pricing adjustments we made in the previous quarter, resulted in 3% sequential branch raised deposit growth. We're also targeting lending opportunities that meet our expectations for risk adjusted returns as the current uncertain economic environment demands maintaining our prudent risk appetite.
We focused on growth within the strategically important general commercial portfolio In addition, asset repricing outpaced the rise in deposit costs and as expected, we delivered a significant improvement in our net interest margin. which was a key driver of our revenue growth compared to the prior quarter. The disruptions in the global banking industry in the prior quarter didn't impact our financial position or performance in the third quarter. However, the impact of elevated interest rates will continue to work their way through the economy and weakened economic growth in the remainder of the year and into next year.
We're focused on the resilience of our balance sheet and maintaining our disciplined approach to risk management. We expect that the sustained impact of higher market rates will drive increases in consumer and business defaults and as Carolina will discuss in a moment, we expect our secured lending model, prudent underwriting practices and proactive loan management will support provisions for credit losses that remain within our historical range.
Our earnings this quarter were further supported by management's continued actions to contain expense growth. Non-interest expenses were held flat with the prior quarter and increased only 4% from the prior year. As Matt will discuss in a moment, we will continue to prudently manage our expenses and be positioned to deliver positive operating leverage next quarter. Our approach is to proactively navigate the economic and market volatility by maintaining focus on our differentiated offering with unrivalled client experience. We create value for our clients and deliver strategically targeted growth on both sides of our balance sheet. Along with discipline management of our operating and financial performance, the focus of our teams has been to support resilience in our financial position and deliver the strong financial performance that we expected this quarter.
I'll now turn the call over to Matt, who'll provide greater detail on our third quarter financial performance.
Thanks, Chris. Good morning, everyone. I'll start on Slide 6. As Chris noted, our continued efforts to expand our full service client relationships drove a 3% increase in our branch-raised deposits and that supported a 2% decline in our broker sourced deposits. Capital markets remained consistent with the prior quarter. Despite lower usage this quarter, the broker deposit channels [deep liquid source] (ph) to raise fixed term funding with maturities between one and five years and they are predominantly insured deposits.
Compared to the prior year, branch-raised deposits were up also 3%. This increase reflects 15% growth in fixed term deposits partially offset by a 2% decline in demand and notice deposits. Branch-raised demand and notice deposits declined as growth from net new full service client additions was more than offset by our intentional exit of select higher cost non-full service client relationships earlier this year. We've also seen a market shift client deposits from demand to term deposits over the past year, but this trend has started to slow as the year has progressed. This quarter, our sequential growth in demand deposits exceeded the growth in term deposits for the first time in over a year.
Turning to slide 7, as Chris mentioned, our teams have targeted lending opportunities that are aligned to driving full service client growth, while providing strong returns within a prudent risk appetite. This focus drove a 3% sequential increase in our general commercial portfolio with a very strong 13% annual increase. Our equipment financing and leasing portfolio also increased 3% this quarter 6% over the last year. Our equipment portfolio delivers a combination of strong lending yields, comparatively lower capital requirements, and the strength of the underlying security of this portfolio has supported a long history of solid credit performance through economic cycles.
Our conservative approach to commercial real estate over many years has created a portfolio of a strong credit profile and we continue to lend within a disciplined risk appetite. Our focus on risk-adjusted returns in the current environment limited origination volumes across our commercial real estate portfolio. Real estate project loans increased 1% both this quarter and over the last year as we selectively financed new project starts predominantly in BC with top tier borrowers. Commercial mortgages declined 3% this quarter and declined 2% over the last year as low new lending volumes were more than offset by scheduled repayments.
Residential mortgages also declined sequentially, but are up 4% over the last year, reflecting new origination volumes with prudent loan-to-value ratios and strong average beacon scores with lower payouts compared to the prior year. Consistent with the continued execution of our geographic diversification strategy, Ontario loans grew 1% sequentially, and were up 11% over the last year. Ontario loan growth contributed to approximately half of the current quarter loan growth. BC and Alberta loans were roughly consistent with the prior quarter as strong growth in the general commercial portfolio was offset by declines in commercial mortgages in both provinces.
Our sequential earnings performance is shown on Slide 8. Common shareholders net income increased 19% as higher net interest income and prudent expense management more than offset higher provisions for credit losses. Pretax pre provision income increased 16%. Compared to the prior quarter, adjusted earnings per share increased $0.14. Higher net interest income increased EPS by $0.17 with the increase in net interest margin providing a large portion of that benefit with some support provided from the impact of three additional interest earning days. Lower non-interest income reduced EPS by $0.02, and increase in the performing loan allowance, primarily reflecting the uncertainty of the current economic environment, reduced EPS by $0.04. EPS benefited $0.01 from lower LRCN distributions and $0.01 from the impact of a lower effective tax rate, as we recognized one-time true ups that increased our tax expense in the prior quarter.
As shown on Slide 9, total revenue increased 7% on a sequential basis. Net interest income increased 9% due to significantly higher net interest margin, three interest earning days and 1% sequential loan growth. The 8% decrease in non-interest income was primarily due to lower foreign exchange revenue, reflective of a weaker US dollar in quarter, partially offset by higher wealth management fees.
As shown on slide 10, our NIM benefited 4 basis points from the repricing of fixed rate assets at higher market interest rates, which had a larger impact than the increase in deposit costs this quarter. Our focus on optimizing risk adjusted returns of our lending activities was the primary driver in the favorable shift in our loan mix that also contributed 4 basis points to NIM. Loan related fees added 2 basis points to net interest margin. Liquidity levels were consistent with the prior quarter, and did not contribute to the sequential increase in net interest margin. The impact of the 50 basis point Bank of Canada policy interest rate increases made during the quarter had a nominal impact to net interest margin. We continue to expect that net interest margin will expand sequentially in Q4, albeit at a smaller magnitude than the current quarter as the continued positive impact of fixed asset repricing will be partially offset by the impact of higher funding costs also impacted by the recent interest rate increases.
On Slide 11, our non-interest expenses reflect the inflationary pressures in the economy, but against those pressures, we've managed our annual NIE growth to just 4%. Our expenditures were held roughly flat to the previous quarter as we expected. Salaries and employee benefits cost was consistent with last quarter through managing the fill rate of vacant positions. Reductions in certain discretionary expenditures were offset by the continued investment our digital capabilities and other strategic priorities. Our capital ratios are calculated using the standardized approach and the drivers of our CET1 improvement are shown on Slide 12.
Our CET1 ratio increased around 10 basis points to 9.4% this quarter. Our growth in retained earnings this quarter more than offset the impact of risk weighted asset growth. No common shares were issued under the ATM program this quarter. Yesterday, our Board declared a common share dividend of $0.33 per share, consistent with last quarter and up $0.02 from the dividend declared last year.
I'll now turn the call over to Carolina, who will speak further on our credit performance.
Thank you, Matt, and good morning, everyone. Beginning on Slide 14, as expected, we saw borrower defaults and impaired loans increase to normalized [level] (ph) from sustained impact of higher market interest rates. Total gross impaired loans increased $29 million or 12% from last quarter and represented 75 basis points of gross loans, up from 68 basis points last quarter. The increase is primarily related to new formations in general commercial portfolio, with a net increase of $23 million in the quarter. Commercial mortgages classified as impaired, increased $5 million, primarily due to increases in Alberta and partially offset by decreases in BC.
Impaired and equipment financing loans increased $4 million, primarily in Ontario. The level of gross impaired loans fluctuates as loan become impaired and are subsequently resolved and does not directly reflect the lower value of expected write-offs given the intangible security health in support of lending [indiscernible]. Our strong credit risk management framework, including well established underwriting standards, the secured nature of our lending portfolio with conservative loan to value ratios and a proactive approach to working with clients through difficult periods continues to be effective in minimizing realized losses on the resolution of impaired loans. I would also note that we have minimal exposure to unsecured personal lending or credit cards. This is demonstrated by our historic low write-offs as a percentage of total loans, including through past periods of economic volatility. As Chris and Matt have noted, we have taken a targeted approach to lending with a focus on acceptable risk adjusted returns in the current environment, which has supported the resilience of our strong credit profile.
Turning to Slide 15, reflecting on the uncertainty of our current economic environment, we recognized a performing loan provision for credit losses of 6 basis points in the quarter compared to a new provision in the prior quarter. Our provision for credit losses and impaired loans was $10 million, equivalent to 10 basis points this quarter, below our five-year average of 19 basis points. Looking forward, we expect that sustained impact of higher market interest rates will continue to drive increases in borrower defaults and impaired loans. Consistent with our experience in prior periods of elevated borrower defaults, our prudent lending approach supports our expectations that our provisions for credit losses will be within our historical normal range of 18 basis points to 23 basis points next quarter.
I will turn the call back to Chris Fowler for his closing remarks and outlook.
Thank you, Carolina. Turning to Slide 15. We delivered the strong third quarter financial results we expected through the focused performance of our teams. As interest rates continue to work their way through the economy, expected economic growth weakens, you can expect that we will remain focused on growing full service relationships, continue targeting strategic growth opportunities within our strict underwriting and risk adjusted pricing criteria, maintain our conservative and secured risk management approach and continue to prudently manage expenses to be positioned for positive operating leverage next quarter.
The current year has been more volatile than we predicted and we have navigated through the multiple interest rate hikes and significant disruptions in the global banking industry. We have a resilient financial position and the focused performance of our teams supports our expectation of delivering an annual adjusted return on equity in line with the scorecard target that was set at the start of this year.
With that, operator, let's open the lines for Q&A.
[Operator Instructions] And your first question will be from Doug Young at Desjardins Capital Markets. Please go ahead.
Hi. Good morning. Maybe I'll start, Matt, in the past, I think you've talked about if you repriced your balance sheet, NIMs would be in the 2.50% range, and it would take you, maybe up towards of two years to kind of move in that direction. I know this is a kind of a fluid situation and that was a static comment, but any updates to that guidepost, any thoughts on the outlook? If you did reprice the balance sheet, how long it would take you to get there? Maybe I'll start there.
Yeah. Thanks, Doug. Obviously, a lot of moving parts to that answer, but I'll keep it very simple. I think you look at the structure of our balance sheet today, you have all the ingredients for that to continue to hold true. What we're focused on though if you thought over the next year or two, really the same focus and discipline you've seen us exhibit in the last quarter here, is when we focus our lending activities, we're thinking about strongest risk adjusted returns, best use of capital. That's something you saw the benefit quarter, the impact that had to NIM from a better lending mix. So there are opportunities to continue to do that to help support NIM. Conversely on the other side of the balance sheet, we're targeting full service client growth. With that, comes more demand in notice deposits. That's favorable pricing compared to other funding sources. The other benefit that these demand and notice deposits give us, a large proportion of them are at floating interest rates. The remainder are administered deposit rates that are at our discretion. But both of those, if you thought about interest rates declining over a period of time, you get a lot of support and stability in NIM from having these deposits that either directly float or will gradually move with market interest rates. So lots of things we can do to support NIM, lots within our control and you'll see us continue to be very focused on that.
And can you put numbers to the percentage of your demand to notice that’s floating and percentage that's at NIM?
It's a reasonably equal proportion. we've seen just in branch-raised deposits generally, if you went back over several years, we've seen a fairly decent increase in demand and notice and a large proportion of that increase has been in deposits that directly float. That's why when we went through the early days of COVID and interest rates really went down, you saw a lot of stability in our net interest margin. I think we surprised a lot of people with how stable our margin was on the way down in rates. And that larger proportion with deposits that float was definitely a key factor that supported that stability.
Okay. And then just maybe two questions on credit. What are you seeing performance wise within your CRE commercial real estate portfolio? You mentioned a little bit, but I just wanted to maybe get a little bit more information. And then the second part is, can you talk specifically what drove the performing loan ECL [build] (ph) this quarter? Like, what variable was it and what variable really is kind of be the key factor that really swings that performing loan, PCL and ACL?
Yeah. On the CRE side, that that book is one that we have noticeably slowed our growth in. That started in fiscal '22 and continued in fiscal '23. So we've been very selective in the categories in which we land within CRE. It's obviously a broad category, different types of product in there, and geography and focus on who those particular borrowers are. So very, very specific in how we approach that. So really cut that back a bit. And as we think about the opportunity for management of that book, pass over to Carolina with some comments.
Yeah. Thank you, Chris. Yes. That that portfolio, we, as part of the normal monetary we did a deep dive on the portfolio. We feel very comfortable with the position we are right now in there, very closely followed and with the very low exposure to one of the asset categories that has the higher risk, which is the office exposure. So we're feeling comfortable from that perspective. And, we will continue to manage accordingly.
On the performing loan allowance, Doug, if you look at the macro forecast this quarter versus last, you won't see a lot of big changes. You'll see obviously a shift upward in interest rate predictions without in itself, wouldn't have been a big component directly coming out of the models. But that's the base case forecast. When we're looking at performing loan allowances, we're also thinking about upside, I suppose, but also downside risk relative to that base case forecast. So in an environment where it looked like at the date of the balance sheet, where interest rates were looking higher for longer in our judgment, that introduced greater uncertainty and maybe a bit more weighting to downside risk relative to that forecast, and we'll see how it evolves. But coming out of the quarter, we're feeling very prudently reserved on the performing allowance.
So it’s more of weighting of the scenarios than actually a change in the metrics, the FLI then?
Yes, that's the right way to look at it.
Got it. And then on the -- just Carolina, the office and the CRE portfolio, can you talk about the LTV on that?
So we have very good LTVs in the office portfolio. And on the construction side, we're really following up on the trends as well. So it is a very strong, prudent to manage portfolio, not just the office but across, and we continue to maintain that prudency throughout this cycle as well.
But you don't have a number you could share? Or I can just follow up if it's easier?
Yeah. Well, we just don't -- we will -- can follow up on that specific data. Yeah, Doug.
Okay. And then lastly, Matt, just on expenses, anything big coming in Q4 expense-wise?
Our goal that we set out, I talked about, I think, coming out of Q2 is we looked at that level of expense and said we thought that was a pretty good run rate to hold for the rest of the year. Now that's a very high-level headline underneath the [Congress] (ph) of that are a lot of decisions on prioritization and making sure we're allocating expenses to highest and best use, all with the goal of driving positive operating leverage. Pretty down close this quarter, it didn't get all the way there, but we were close but set up quite well into the next quarter, thinking about positive operating leverage. That is our goal and focus.
Okay. Thank you.
Thank you. Next question will be from Marcel McLean at TD Securities.
Okay. Thank you. Well, I just want to [clarify] (ph) a finer point on Doug's initial question on the net interest margin for next quarter. You're seeing an increase but less than this quarter, that's a pretty wide range of something less than 11 basis points. I was wondering if you could size the magnitude any more precisely than that?
Yeah. Sure. I can give some help there. And going back to, I believe it was in the first quarter. And the world has changed quite a bit since then, but the way I look at net interest margin surprisingly hasn't changed much. We talked about coming off of Q1, exiting the year in the 2.40s. When we look at where we are coming out of the third quarter, I think about a lot of different puts and takes in fourth quarter, but net interest margin that may be just snuck into that range, I think we have the recipe to do that based on what I see in front of us. Is there much more upside than that? What's cooled my outlook on getting deep into that range is obviously the higher interest rates and how they'll churn through funding costs just generally in the market. So hopefully, that helps to try to narrow that range a bit for you.
Yeah, it does. I believe those comments were directed at Q4. And kind of -- I don't want to front run the 2024 outlook and I know it can be unpredictable that far out. But I think what I heard is that there still is upside -- it’ll slowly creep up, I guess, throughout 2024 towards that 2.50% range? Is that a fair assumption? Or too much at this time to tell?
There's quite a lot of moving parts there, but let's assume that interest rates didn't change at all, and the shape of the curve was roughly consistent. What you'd see play out, and this is no different than what you saw as rates worked their way up last time is that our deposits were more responsive to those interest rate increases than our assets were. So in fourth quarter, you'll see more pressure on deposit costs, less benefit on the asset yields. But then as you work your way that, asset yields will overtake that impact. And that gives a lot of embedded strength in margin on a go-forward basis that gets masked temporarily in sort of the early days following those increases. So that's one dynamic. And like I was talking to Doug about, there are a lot of other things we can do to optimize and deliver that result, but that's just kind of the structural way these higher rates churn their way through our portfolio, all else being equal.
Okay, thanks for that one, Matt. Then I had a second question on this slowdown in loan growth or loan demand generally across the industry, coincidentally came at the same time that [Car 23] (ph) was implemented. Now under the previous capital regime, in the past, you guys have given a bulk of roughly 8% loan growth was where you started to consume capital based on your mix at the time. Giving your outlook for your new mix, when we do see that loan growth resume, are you able to put that sort of level of growth? Like, would that move up to sort of, like, a 9% or 10% level, or are you able to help me out with, anything on that from when we do see loan growth come back?
Yeah, it naturally creates more capacity. And the reason why we're a commercial lender strategically targeted in the mid market. Under the old capital rules, you know, those were risk weighted at 100%. Under the new capital guidelines, they're risk weighted at 85%. So for that portfolio, which is important to us strategically and where we can be differentiated, we also get the benefit of a lower capital amount, a little bit closer to the actual credit risk. We're quite prudent there. It gets us part of the way there, but, still very conservative relative to how we underrate and lend into that portfolio. But it permits a higher rate of growth than before in that portfolio, specifically. So you're right, if you thought about our lending mix today, we are targeting opportunities within that new capital framework, but they just happen to align quite nicely to our mid market commercial focus.
Okay. And with that new -- with the new capital rule, has [indiscernible] because it sort of narrows that gap? And I'm thinking about this in the context that you sort of managing your discretionary expenses, would that fall into that category or no, it's still sort of full steam ahead behind the scenes on [ARB] (ph)?
Well, we're still focused on making sure that the risk management structure we have internally is supporting our growth story, our ability to manage risk returns. And the elements of ARB certainly are a really big part of that and we continue to focus on how we deliver effective risk ratings and investing and making sure we are able to do that very effectively.
Okay. Thanks so much. That's all for me.
Thank you.
Next question will be from Gabriel Dechaine at National Bank Financial.
Couple of questions here. One on credit and then one strategy one. So on credit, I heard, Chris, and, well, both of you talk about the higher rates and how that's going to push defaults higher. I get that. I'm just wondering where do you see that playing out in your portfolio, on the commercial side, mortgage side -- residential mortgage side, perhaps, like, where do you see the vulnerability being the highest?
Well, I can start, and I'll pass it over to Carolina. I think we -- I think it's a general slowing argument. I think we just saw the number up today GDP contracted 0.2%. I think there is the transmission of monetary policy does create more challenges to businesses as they have to navigate higher interest rates and business models have to be able to respond to that. So you kind of look at all the different lending categories. And revenues are X and expenses are Y and expenses include the cost of borrowing. And if Y goes out more than X does being the revenue side, then it is a challenge. So we want to be very focused on at the inception of the loan, how we underwrote how we structured and then as we look at loan management, making sure we're really on top of those. So predicting which portfolio has more volatility is difficult. We have seen that last quarter, we had more in CRE, this quarter a little bit more in the general commercial. Residential, or personal lending has been very, very strong. So we continue to just be on it in terms of confident in the manner under which we have underwritten and looking at how we continue to manage our existing loans.
Maybe a question -- well, actually, I can refine that question for Carolina. And you touched upon it, the increase in formations we've seen in the past few quarters, would you say that's primarily the result of the rate environment?
Yes, it is. It's something that we were expecting, Gabe. And when we see where they're formed, like we don't have specific niches like Chris mentioned, it's across industries. And at the end, while we have the formation increases given the secure nature of the portfolio, does not translate directly on to same level of losses, right? So we're very comfortable from the position where we're starting right now.
I'm not suggesting any major concerns, I know you guys are good at lending, I’m just finding this commentary overall interesting. Now as far as the strategy question goes, I know the environment is playing a role here and loan demand is maybe declining. But historically, on a handful of occasions, I've seen Canadian Western Bank report a quarter where loan growth is shy of your typical target to be close to the double digits, but then margins go up, capital ratio holds in or increases. And most importantly, stock moves quite a bit higher. I'm just wondering if -- maybe since we've seen this before and having made that observation, it might make you think about your balance sheet management a little bit differently. Such that maybe you're willing to sacrifice on loan growth a bit more in order to get -- generate the other two positive outcomes there, three actually.
Well, thank you for that observation. As we think about our different areas of business that we zero in on our targeted client being that business owner client, we are very focused on risk adjusted returns. And as we sit here today, no question, the kind of the structural change in the balance sheet with, as Matt spoke, to fixed price on the asset side responding and slower, faster than the increased deposits. So we are seeing it tick up in net interest margin improvement in revenue. And as we kind of zero in on how we've been very focused on expense management, we see EPS work, and we're very positive on the outcomes of where we're at today. But it really is that whole idea of how do we think about ecosystem, how do we think about what that means for our different borrowers, how are we looking at risk-adjusted returns. And we just kind of take it all into context and make sure that we are really allocating our capital in the areas we're most comfortable with.
Okay, well, enjoy the long weekend.
Thank you.
Next question will be from Sohrab Movahedi at BMO Capital Markets.
Okay. Thank you for taking my questions. I was a little bit late coming on. So I apologize if you've addressed this earlier in the call. But Matt, I heard you talk a bit about the trend or the expected kind of trend and the evolution of the net interest margin into next quarter and maybe even into next year with lots of puts and takes, no doubt. And I hear Carolina to talk a little bit about the credit normalization, I suppose, is the best way to think about it. So what I'm trying to kind of figure out is how much of that anticipated benefited in net interest margins may get eroded away just because of the PCL is normalizing. So if I think about a risk-adjusted margin here, kind of coincidental NIM, less your PCLs, where do you think that may kind of stabilize relative to pre-COVID?
Two interesting pieces there. If you look at our outlook for this year and the level of PCL we're predicting, it would be well below what we would consider a normal range. If we thought about just the dynamic of our provision for credit losses increasing to -- within our normal range, which I would think would be a very reasonable outcome and reasonable expectation, you're right, that would offset and dampen some of the lift we expect, just structurally from net interest margin and things we can do to shape that result and drive that result, obviously. Our goal, though, there's a few other levers we can look at, where we grow, how we grow, supporting the deposit side of the balance sheet, prudently managing our expenses and how we allocate them. A lot of the themes we're talking about going into fourth quarter and targeting and focused on driving positive operating leverage. That will not be a temporary focus. That's something we want to sustain looking year. And that, for us, is the lever we look at to. You're correct, fight against the headwind of provisions for credit losses returning to normal. That's how we look at driving earnings growth for next year, just that really focused performance. Controlling what we can control and confidence that the way we've lent through the cycle keeps our credit losses within normal range.
Okay. So just to kind of touch on, I guess, an earlier point then. So within your control, obviously, our expenses but also, I suppose, to some extent, loan growth and risk appetite. And you did not or haven't used the ATM for a couple of quarters. What's your -- what -- how should we think about stuff within your control and whether or not the prolonged growth is going to be done within existing resources, so to speak, as opposed to tapping the market to the extent there was loan growth that you wanted to accelerate to?
Yeah. No, it's an interesting consideration. For us, when we look reasonably within a pipeline of opportunities that meet our risk-adjusted return expectations, we believe our organic capital generation is sufficient. For us to think about using an ATM to augment that growth, we would need to see premium risk-adjusted returns to offset the dilutive impact of those shares. And looking at the pipeline right now, we would be moving up a risk curve to a level that, to us, doesn't make sense relative to the price at this point, but it's something we’d continually look at as we work our way through the cycle. But as of right now, Sohrab, that would seem to me to be a lower probability area of the playbook.
Okay. And then maybe just one last thing on that. I appreciate that. That's helpful. But I suppose equally low probability that you're focused on getting your share count back to pre-ATM introduction, 8 to 10 quarters ago.
Yes, I think we're in early part of the cycle to be thinking about those sorts of activities. But I mean, you're right, there will come a point here where perhaps there is some capital to deploy. If we get through a cycle and the economy achieves the soft landing that our policymakers are attempting to engineer. Yeah, I mean you have coming out of the cycle, potentially some dry powder to deploy. And for us, we have a pretty established history of doing quite well, emerging from cycles based on how we've looked after clients through a cycle. We generally do quite well and see pretty strong growth opportunities to increase our market share and target more of those mid-market commercial clients we're after. It seemed to be a lot of opportunities when cycles turn. And so that would be on our minds as well, for sure.
I appreciate the color. Thank you very much.
Thanks, Sohrab.
Next question will be from Meny Grauman at Scotiabank. Please go ahead.
Hi, good morning. Matt, you talked about how rate hikes this quarter only had a nominal impact on margin. And I'm curious to understand why that is, it seems like it's definitely a different dynamic than what we've seen over the past few quarters. If we think about 50 basis points of rate hikes from the [BOC] (ph) this past quarter, part of that not really expected. Just curious, the dynamics there and how that's changed in terms of the sensitivity of your margin to rate in.
Yes, we thought about just the very front end of the curve, so floating rates directly. We're at the point where our floating rate assets are almost equivalent dollars to our floating rate liabilities. We’re pretty closely matched. So I know historically, we've had a wider gap, and that's why you've seen a greater sensitivity to prime interest rate increases and decreases frankly in past years. Right now, we're much less sensitive. So what you would have seen, if you look back in previous quarters where we did have those rate hikes, you'd see maybe for every 25 basis points of Bank of Canada policy change, you’d get an immediate lift of maybe a basis point of margin on a full quarter basis from that hike, and that just reflects the fairly tight spread between floating assets and liabilities. So we will get some lift on the immediate reprice. We would have had a partial quarter impact of that this quarter. And next quarter, we'd get the full quarter impact, it would help, but I wouldn't look at it as a material driver of net interest margin.
Okay. And then just -- I mean, you highlighted the fires in BC. Just wanted to confirm that you don't really expect any impact on your business from that. So I just wanted to check on that.
That's correct, Meny. We've had some indirect impact as everybody had from just suspended operations and some but not significantly impacting clients that have come to us with us for release or anything like that. So we're comfortable from that perspective as well.
Okay. That’s it for me. Thank you.
The next question will be from Lemar Persaud at Cormark. Please go ahead.
Yeah. Thanks. I want to go back to your Slide 10 and that waterfall to what’s the change and obviously solid margin expansion this quarter and your guide is for a smaller magnitude increase or a smaller rate of expansion before. I want to talk about in the context of what you presented in this waterfall here. So you've called out, the continued positive impact of fixed rate asset repricing and higher funding costs. So I think that means the asset versus liability repricing, you present this waterfall next quarter it's going to go down. So not that 4 basis points lift that we saw this quarter. Help me -- is that correct, first of all? And then help me understand how these other three factors [indiscernible] and getting it to just around, I guess, 2.4% next quarter, like I think the loan mix that we saw sequentially this quarter, that seems like it's going to persist. So the loan-related fee mix that's going to tail off and others are going to trail off. Help me understand why we're not going to see this level of expansion in Q4?
Yeah. So on the asset versus liability repricing, you'll see that slow down next quarter and that just reflects. Coming into Q3, we had a relatively stable interest rate environment going into the quarter and through most of the quarter, and then it really ticked up as the quarter closed. So we'll feel a lot of that impact in fourth quarter. So on a temporary basis, just reflecting how much rates move that quickly, I'd expect that factor to be much smaller. Potentially, eating into a positive position, but I wouldn't expect much contribution in fourth quarter. I'd expect that contribution in later quarters as that churns through our portfolio, no different than what you saw with the previous rate hike impacts.
Loan mix, you're right. We did target what turned out to be a more favorable mix that supported NIM this quarter. There's a bit more work we can continue doing on that. But you're right, not to the same extent. On the fees, a piece of that, I'd say is some of our yield related is returning to more normal levels. Others like prepayment penalties continue to be below what we would have seen maybe compared to a year ago. And some one-offs that maybe would represent half of that 2 basis point lift that I'm not sure would persist. So I'm not sure we'll see unless something unexpected happens, I don't know that we'll get increased contribution from fees next quarter, that dynamic keeping prepayment penalties low, I don't see that resolving next quarter, just thinking about how clients would behave to even higher interest rates.
And then that piece we bucketed in other. I mean, part of that's the very minor lift this quarter from the Bank of Canada rate changes. Part of it's a very minor benefit from a slightly more favorable deposit mix. So a couple of minor items in there. So all that wrapped together, that's the broader explanation as to why we believe there's room to continue to expand margin, but why it perhaps stays a bit depressed in Q1 or Q4, I mean, compared to, if you thought about the potential of that churning its way all the way through our balance sheet over time, you'll see the lift come later.
Okay. That's very helpful. Moving on, apologies to pick income statement line item here, but other income. Was it probably a bit more negative than we've seen in the past because it was negative $1.9 million. And you guys are calling out weaker FX revenue. But even then, I would expect it to be closer to zero rather than a loss. So can you help me understand what's driving that loss, that negative $1.9 million and other income this quarter?
Yeah. I gave the math. I can't remember if it was last quarter or the quarter previous. Just based on the size of our US dollar balance sheet, for about every $0.01 weakening of the US dollar, it drove about $1 million of decline in the other income line. So if you look at end of last quarter to the end of this quarter, it was about a $0.03 move in FX, about a $3 million decline then in that other income line, offset by normal course, you'd expect transactional fees maybe in or around $1 million a quarter is kind of a reasonable level. So that's how it washes to a $2 million negative impact you see there. Obviously not something we'd expect to persist next quarter, but depending on what happens to the US dollar. One word of caution too, as you're modeling, if you're looking at Q4 over Q4, recall that in Q4 of last year, we saw a pretty material strengthening of the US dollar in the fourth quarter. And that's why when you see Q4 last year, you see a big number in that other income line. Without a similar strengthening of the US dollar, that wouldn't be in the cards for this quarter again this year.
That's helpful. And that's exactly [Technical Difficulty] to be honest. Can you also, I guess, next question, can you talk about the competitive environment for deposits and your outlook moving forward? Some of the banks refer to elevated competition looking forward. I'm just trying to understand if you feel as though you can continue to grow branch-raised deposits or even gain some momentum, looking forward to 2024 in spite of the competitive forces.
Yeah. Thanks, Lemar. Yeah, we are very focused on that branch-raised deposit story. We've got -- as you saw, the general commercial growth we have, that includes our core target client, that business owner and 13% growth over the last year. And really the win there is to really [juiced up] (ph) and really create that as a solid low-cost funding source. I'll pass it over to Stephen to add more comments.
Yes. And I think we've got a lot of things that we're executing right now that are enhancing our capabilities to add those full-service clients so we had a number of deliverables even within the quarter about enhanced products and services that we delivered to our clients, and we've got more coming in the very near term that improve our competitiveness in that space. And we’re also expanding our addressable market with a couple of new openings happening in Ontario next year. And so we've got continued momentum just in terms of our competitive positioning and our service proposition for business owners, but we are delivering around enhancements that continue to improve our competitiveness.
Okay. So bottom line, you feel like you can kind of -- can you accelerate from here despite the competitive forces just on the back of these new products, new geographies? Or like how should we think about that?
Yes, I think that we absolutely can, that we feel very strongly about the improvements to our offering that we're bringing and what that does for our batting average and ability to win full-service clients. And so I don't know that that's over the weekend kind of thing, but we are continuing to deliver, particularly over the course of the next couple of quarters, enhancements that are going to, I think, give us the ability to increase that for sure.
Yeah. And I'd say -- I'd just add, it's the way we think about lending, too. We don't just grow for growth sake. We're focused on profitability of deposits. So while we like what we're winning in terms of new to bank, full service, profitable deposits. That inflow gives us some latitude when we look in our existing deposit portfolio. Maybe there are deposits that have a lower level of probability that we can then adjust the pricing with the confidence that we have enough coming in that if those deposits do fall out, we can absorb it. You've seen us take that tactic throughout this year, and it's been a factor that's helped support NIM performance.
Appreciate it.
Thank you. Next question is from Paul Holden at CIBC. Please go ahead.
Thanks for taking the time to squeeze me in here. So two questions to kind of help me think about potential scenarios in 2024. First one, with respect to NIM and the, I think, high probability the Bank of Canada cuts rates at some point next year. So, Matt, you gave some helpful context on how you're now ALM matched on the short end of the curve. Should we take that as well if the Bank of Canada cuts rates next year, that sort of the longer end of the curve sticks where it is, should be no impact on NIM. Is that a fair conclusion?
Yeah. I mean that's how we're structured. I do think even in that scenario, you do see some continued build-in in NIM. Just from that continued repricing of the assets with liabilities quicker to reflect the lower market interest rates, you'll have this dynamic occurring where liabilities are coming on at the lower rates more rapidly than assets that eventually churn their way off and reflect the higher interest rates, even with some rate cuts next year. We'll have coming off our balance sheet at much lower yields than new assets coming on even with some cuts. So there'll be some embedded strength in there that I think you wouldn't normally expect to see if you thought about interest rates declining off maybe a more stable starting point, we'll still continue to have some of this churn and that's a factor we look at and thinking about the stability and strength of our net interest margin moving forward.
Good. That's helpful. And then second question is with respect to expense management. So your guidance for the efficiency ratio this year is 52%. Your target is still below 50%. But I think what you're messaging with Q2 being the right run rate going forward, is that the efficiency ratio is expected to go down on revenue growth. So correct me if I'm wrong there. And the second part of the question, I guess, would be, well, what happens if revenue growth isn't as good as expected in '24 because of the macroeconomic challenges, right, that you've talked about on this call, would you consider taking more expense action or just going to take longer to get to the sub-50% efficiency ratio?
So for us, that's how we look at driving positive operating leverage. I mean we're thinking about revenue growth, but also giving some consideration to potential volatility and making sure when we plan out our level of expenses that we have some wiggle room moving forward and ways we can think about prioritization. So that's -- when we think about trying to create a forecast or an operating model that produces operating leverage positively, it's not just eking into positive. We want to give ourselves a good buffer just in light of the volatile economic environment, that would be our goal and focus. To what extent are we committed to that? I think you've seen us take pretty significant action and pretty disciplined approach this year. There are elements, though, of our strategic offering, that we believe are so critical to just thinking about the ongoing strength of our franchise, client offering, et cetera, that we'll continue to do and continue to prioritize. While we've taken a hard look at discretionary expenses this year, we have not sacrificed our strategic projects. That's why you saw efficiency ratio drift up a bit relative to our expectations, reflecting maybe some volatility in FX, a bit of volatility in market rates. We didn't want to take any severe action related to what we think are highly strategic and important projects. Those are continuing as planned.
Got it. Okay. And then just last one from me. There was an increase in commercial mortgage impaired last quarter. You talked about some suburban office space they're accounting for that. The impaired amount was relatively unchanged quarter-over-quarter, not a surprise, but just wondering if you can give us any kind of update on that file. It sounds like expectations for full asset recovery remain intact, I would guess, based on the numbers, but any update there would be appreciated.
So on that, Paul, we're working well on recovery for those assets. Values that we have on file have been holding up, and there's been some good resolutions on that portfolio as well that we're working towards. So that file just continues to evolve and we're working towards getting the resolution as soon as possible with the right values in place.
Okay. As soon as is possible, could you put a time frame behind that or?
No, unfortunately, I wish I could.
Okay. Fair enough. That's it for me then. Thank you.
Thanks, Paul.
Next question will be from Nigel D'Souza at Veritas Investment Research. Please go ahead.
Thank you. Good morning. A couple of questions for you. First, on your macroeconomic variable assumption. When I look at the disclosure, there's a disclosure for the three-month treasury bill rate forecast. And it’s at 3.7%. So just trying to understand if I'm interpreting this data point correctly because that would imply rate cut expectations over the next year. And I'm trying to understand how that fits in with our expectations for rate to remain elevated and lead to higher debt servicing costs. I just want to make sure I understand the outlook correctly and what’s baked into your assumptions.
Yeah. So just as a reminder, when we do the macroeconomic forecast, it's at a point in time. We try to get it as close to the balance sheet date as possible, but also recognizing it takes time to run these macro assumptions through a model. Where we do update for maybe updates to macro factors, like if from the date you started your modeling to eventually you get your balance sheet date, if market interest rate expectations have moved. And as a result, your expert judgment as a management team is for rates to be higher for longer perhaps than was put into the models. That's where we supplemented with expert credit judgment to reflect the evolution of those macro factors and the impact we believe it could have on credit losses when we get to the balance sheet date. So that's why, despite when you look at our macro forecast, it looks pretty consistent, I bet, quarter-over-quarter. That's why you saw us build the allowance this quarter, just reflecting that evolution of interest rate assumptions.
Okay. So, can I interpret that it’s fair to say that your performing allowances already reflect the higher, longer rate environment and there's some high probability, you might take additional provisions. And related to that, Carolina's guidance for 23 basis points in Q4. Is that unimpaired or is that the total [ECL] (ph) ratio?
We would be thinking predominantly impaired. We'd be thinking about that within a range of normal, so 18 to 23. We'll see where we land within that range. And as you know, impaired loan provisions and impaired loans themselves. It's case by case, very specific assessment of each file and the security we have. But that -- you're right, Nigel. That's why we wouldn't expect much volatility from here in the performing of loan allowance we have, and that's why we believe it's prudent. It reflects an up-to-date assessment of the interest rate environment.
And just to squeeze a real quick one in on your net interest margin. When you cite higher funding costs, I assume you're referring to on a year-over-year basis, my understanding would be that, that shift you are seeing from broker deposits, the branch-raised deposits is actually lowering your funding costs. So I just want to make sure first to understand that correctly that sequentially, if that continues, it actually benefits your margins? And then on loan mix, I just want to clarify what category drove that benefit? Was it equipment financing in the third quarter?
Yeah. So on funding costs, we're thinking like-for-like. If we thought about broker or branch-raised GICs as an example, you would have seen bond yields through the quarter increase by, depending on the tenure, I think somewhere as high as 100 basis points of shift upwards in yield curves, started to taper off since then a bit. But that's what we'd be thinking about. That is a direct drive into GIC costs, which is a direct drive into an element of our funding, both through broker channels as well as branch. You're right, the shift into branch notice and demand. Over time, that will be quite beneficial to NIM. Right now with how inverted the curve still is, the impact is a bit more muted and you'd see the benefit over time as rates come down.
And [it’s around] (ph) loan mix, is the equipment financing was [indiscernible].
Yes. So strong growth in general, commercial and equipment finance, both would be a much stronger yield spread and risk return dynamic compared to commercial mortgages. Much tighter spreads, especially relative to current risk. That portfolio contracted versus growth in the other two. So that's what drove the benefit to NIM.
Okay. That’s it for me. Thank you.
Thank you, Nigel.
Thank you. Next question will be from Joo Ho Kim at Credit Suisse. Please go ahead.
Hi, good morning, and thanks for squeezing me in here. Just a couple of quick ones. Maybe a question on the loan mix, but more from capital perspective. If we see this trend of decline, say, in commercial mortgages and personal loans continue but increase obviously, in general commercial loans and equipment financing, maybe talk to us how that would impact your capital. Presumably, it will be accretive, but curious if that's -- curious if that could be a meaningful impact to capital, especially under the new capital regime?
Yeah, you're right. There's more risk sensitivity there, but it's not risk based on the borrower's risk kind of to the portfolio and more to the structure. On commercial mortgages, the loans we do are focused on the lower loan to values, those attract a lower risk weight under the new standardized approach compared to previous. So it does mute some of the benefit. It's still a slightly higher risk weight than we look at for general commercial lending in the mid-market. That would be slightly lower risk weight. Bill for equipment, our small ticket equipment and leasing would be at a slightly lower risk-weighted asset density yet. But our larger ticket, kind of to larger borrowers, that would actually be a slightly higher risk weight compared to low loan-to-value commercial mortgages. So it really depends. I wouldn't point to that in itself as a key driver of the lower RWA density or I guess, more lending for the same amount of capital. Really, our biggest opportunity in that shift is relative to before our mid-market commercial dropping from 100% to 85% risk weight. And then elements of real estate project lending, particularly for commercial construction, that has very punitive risk weights under the new standardized approach, significantly higher than those other portfolios we've been talking about. So that's the opportunity for more bang for the buck on our lending.
Got it. Thanks for that. And maybe last one for me. Just wanted to ask about funding. And when I look at your loan-to-deposit ratio, it's at the higher end of the historical range now, I believe. And so if we do get into an environment in the near term where loan growth remains muted, but still at a reasonable pace, how should we think about CWB's funding for that type of growth? Or I guess, which part of the funding profile do you expect and support that type of growth environment?
We like having a lot of levers available. We think about funding the balance sheet for us, our preference, it's the most favorable cost would be branch-raised deposit growth, obviously, and we like the client relationship aspect and fee generation capabilities from that deposit source, so that's the priority. So if you had really strong growth there, what would you dial down? Our other funding channels we look at would be broker GIC deposits. So that would be an equal trade dollar for deposits, so that wouldn't shift at all the loan-to-deposit ratio. The other sources of funding, though would, we do securitize as a funding source, a couple of our asset classes. Usually, that's had a reasonably favorable cost of funds relative to other sources. So we'd look at that source versus broker versus, I suppose, raising a senior deposit note in the capital markets. What we ultimately decided to do wouldn't be driven by trying to manage a loan-to-deposit ratio. We would be thinking about liquidity characteristics of the deposits, profitability and obviously, that preference to full-service client deposits.
Got it. Thank you. That’s it from me.
Thank you. And at this time, we have no further questions. I would like to turn the call back over to Chris Fowler for closing.
Thank you, Sylvie. The entire CWB team has supported the strong results we reported today and I thank them for all their continued efforts. Together, we've built meaningful strength and resilience in our organization with high satisfaction from our clients. Our strategic focus to meet the full-service financial needs of businesses and their owners differentiates us from the market and will continue to create value for mid-market commercial businesses and our shareholders. Thank you for your continued interest in CWB Financial Group and we look forward to fourth quarter financial results on December 8. Thank you very much, and have a great long weekend.
Thank you, sir. Ladies and gentlemen, this does indeed conclude your conference call for today. Once again, thank you for attending. And at this time, we do ask that you please disconnect your lines.