Home Capital Group Inc

TSX:HCG

Earnings Call Transcript 2020-Q3

[Operator]

Ladies and gentlemen, thank you for standing by, and welcome to the Home Capital Group Third Quarter Financial Results Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions]I would now like to hand the conference over to your first speaker today, Jill MacRae from Investor Relations. Please go ahead.

[Jill MacRae, Director of Investor Relations]

Thank you. Good morning, and thanks for joining us today. We'll begin the call with remarks from Yousry Bissada, Home Capital's CEO, followed by a presentation by Brad Kotush, our Chief Financial Officer. To answer your questions, Ed Karthaus and Mike Forshee are here from Sales and Underwriting; James Pelletier from Commercial; Benjy Katchen, Chief Digital and Strategy Officer; Victor DiRisio, Chief Information Officer; and David Cluff, Chief Risk Officer.After the formal presentation, we will have a question-and-answer period where we will take questions from investors and analysts. On behalf of those speaking today, I note that this presentation may contain forward-looking statements, and that actual results could differ materially from forecasts, projections or conclusions in these statements. Please refer to our advisory on forward-looking statements on Slide 2 of the presentation.I would also remind listeners that Home Capital uses non-GAAP financial measures to arrive at their adjusted results, and that Yousry and Brad will be referring to both reported and adjusted figures in their presentation. Finally, a link to the slides accompanying this live webcast is available on our website at homecapital.com.With that, I will hand things over to Yousry.

[Yousry Bissada, President, CEO & Non]

Thank you, Jill. Good morning, and thank you for joining us today for our third quarter results conference call. This year, our earnings call is taking place on Remembrance Day. Every year on this day we take time to remember and to honor men and women who have served and continue to serve our country to secure for us all the privileges of freedom and peace. May we all remember to keep a moment of silence at 11:00 a.m. in their honor.I hope you all continue to be in good health and good spirits through these unprecedented times. Home is reporting another quarter of solid results today as we continue to manage through the impact of COVID-19 on our economy and our industry. I will speak with you about some of our accomplishments this quarter, our progress on deferrals and our Ignite Program. Then Brad will take you through the financials in more detail, and we will conclude with a question-and-answer session.As a company, Home Trust has a lot to be proud of this quarter. Our originations reached nearly $2 billion, a meaningful increase over Q3 last year, reflecting strength in both our residential and commercial segments. We delivered a net interest margin of 2.51%, while keeping noninterest expense lower on a sequential basis. Combined with the recovery of provision for credit losses, we reported earnings per share of $1.12 and an increase of 67.2% over the same period last year.We delivered return on equity of 14.7% and increased our industry-leading CET1 ratio sequentially to 19.35%. We concluded the disposition of the point-of-sale component of our retail lending portfolio, and we continue to make progress towards our strategic objectives, including our Ignite project as we prepare the company to be a leader in the financial industry of the future. All of this happened while keeping the health, safety and security of our partners, customers and employees.Our performance this quarter is directly linked to the continuing resilience of the housing market. All our major residential markets are reporting increase in sales volumes and prices. The more time people spend working from home, the more it becomes important to have a home that fits that lifestyle. Instead of choosing a home to -- instead of choosing to live somewhere close to work, people are choosing to live where they can get work done.With the background of the pandemic and recent resurgence in COVID-19 cases, subsequent to the end of the quarter in some of our major markets, having a home as your bubble and your sanctuary takes on an even greater importance. At Home, we recognize the purchase of a home is probably the most important financial decision someone can make. Becoming a homeowner is an enormous commitment and people do not enter into it lightly. It represents an investment of much more than just money. When someone buys a home, they generally do whatever they can to keep it. Our experience with deferrals during this year makes that clear, and I'll provide more details on the next slide.You may remember from earlier calls that we initially allowed lending clients to defer up to 2 months of loan payments beginning in Q1 this year. As of the end of April, 23% of our loans in terms of dollar value were under deferral. By the time we reported Q2, the total has fallen below 8% as of July 31. Today, I report to you that the value of loans is now less than 1% of all our total loans outstanding. The work we have done to find appropriate solutions for our lending clients has successfully helped them through this temporary hardship.Nearly 98% of loans that were previously granted deferrals have either been discharged or resumed regular payments. Borrowers are highly motivated to stay in their homes, if at all possible. At this time, we're not accepting any new pandemic-related deferral requests outside our normal lending practices, and the remaining principal balance is not material to our operations. The deferral program was a coordinated effort by lenders, insurers and regulators to provide support to Canadians affected by the onset of COVID-19 conditions.It was timely, appropriate and effective. I am proud of Home's participation in this program. At the time, as our people were transitioning from home, we were able to move quickly and smoothly to implement a deferral program that conformed to our own risk appetite.Slide 6 gives an update on our Ignite project. We have adapted to remote working conditions, and everyone is working diligently to move this project forward. Significant achievements so far this year include: our deposit automation system for home or DASH, system for straight-through processing of deposits has been launched and rolled out across multiple channels in the company. This improves the customer experience with rapid turnaround of GIC transactions.We implemented several robotic process automation activity throughout the company where repetitive transactions can be automated for efficiency and accuracy. Examples include processing of deferrals, property tax, disbursements and renewals. We created a number of business intelligence dashboards within the company for advanced data analytics and insights. Having access to improved analytical tools makes us more agile, improve our decision-making and supports our sustainable risk culture.We launched a new customer relationship management system for our marketing team, replacing our old legacy marketing information. Ignite represents a multi-year journey for all of us at Home. We have progressed in our implementation time line in spite of the additional demands of managing the deferral program and navigating our pandemic-related disruption. Our digital transformation is delivering the operational and service capabilities we need to grow and thrive in the banking world of the future.I will now invite Brad to discuss our financial results.

[Bradley William Kotush, Executive VP & CFO]

Thanks, Yousry, and good morning, everyone. The presentation continues on Slide 8. We continue to perform well and have seen significant increases in net interest income, net income and return on equity. Our diluted net income per share increased by 67% year-over-year to $1.12 per share. On an adjusted basis, the year-over-year growth in net income per share was 64% to $1.18. The increase in net income resulted primarily from higher net interest income and the release and provision for credit losses.The increase in reported diluted earnings per share reflects the increase in net income and the decrease in the average number of common shares outstanding. The decrease in the average number of common shares resulted from the repurchase of shares under the company's NCIB in Q3 2019 and NCIB and SIB in Q1 2020. Our book value increased to $31.28, and our annualized return on equity was 14.7% for the quarter, 15.5% on an adjusted basis.Our pretax pre-provision income was up by 27% compared with the same quarter last year as total revenue growth of 17% was offset by only 8% growth in our noninterest expenses. Our efficiency ratio was 47.2% on a reported basis and 44.2% on an adjusted basis compared to 51.3% and 47.8% respectively.Slide 9 shows the combined contribution of all these items to our year-over-year growth in net income per share. The most significant contribution to the $0.45 increase was improvement of $0.26 in net interest income through both margin expansion and growth in assets. The reversal of credit provisions contributed $0.15.We had an improved quarter of originations in both residential and commercial portfolios. We continue to build our loan portfolio in a competitive market with growth of 2.6% year-over-year. As at September 30, commercial loans made up 10.9% of our on-balance sheet loans compared with 11.8% in the prior year.The high quality of our loan portfolio is shown on Slide 12, consistent with our risk appetite and prudent underwriting. Within our single-family portfolio, our lending clients had a weighted average FICO score of 726 at the end of Q3. The uninsured portion of our single-family residential portfolio is secured by real estate at a weighted average loan-to-value of 60.1%.Our net interest margin for the quarter was 2.51%, as shown on Slide 13. We continue to pursue a risk-based pricing model on our loan portfolio, while experienced a decline in pricing on our deposit products. Our net cost of funding reflects a balance between offering competitive pricing on our loan and deposit products, while holding a prudent level of lower-yielding liquid assets. Our third quarter net interest margins improved by 11 basis points over Q2 and by 29 basis points over the third quarter of 2019.Consistent with our strategic objective to diversify our funding sources, Home's deposits through our proprietary Oaken channel continue to grow, both on an absolute basis, 18.3% year-over-year and as a share of Home's overall deposit funding from 24.2% to 27.7%, as shown on Slide 14. Oaken share of our total deposit funding has grown every quarter since the end of 2018. Consistent with our prudent approach to liquidity risk management, term funding represents over 80% of deposits gathered through Oaken.The next slide details our credit provisions for the quarter and year-to-date. Provisions for credit losses are calculated using forward-looking economic models sourced through a third-party provider as well as management expectations of future performance. The primary contributors to the $7 million release of provisions related to loans that were repaid during the quarter in the commercial and other consumer retail loan portfolios as well as the impact of an improvement in the forward-looking unemployment rate assumptions used in the estimation of expected credit losses.Our year-to-date provisions are primarily the result of changes in forward-looking macroeconomic data and the probability weightings assigned to different outcomes. As we have said in the past, the forward-looking nature of IFRS 9 means there will be quarter-to-quarter volatility in provisions as economic forecasts and model data are updated. Changes in economic conditions during 2020 have provided an example of that volatility.With the reversal in credit provisions, this quarter's provisions were a negative 16 basis points of gross loans, as seen on Slide 16. This compares to positive 43 basis points in Q2 of this year and 9 basis points 1 year ago. Net write-offs totaled nearly $24 million this quarter and $26.2 million year-to-date. $22.2 million of that or about 93% of the quarterly figure was attributable to the sale of a portfolio of loans within the HVAC rental segment of our other consumer retail loan portfolio. We see this level of write-offs as specific to that counterparty and not representative of the remaining portfolio.Home discontinued originating all HVAC rental financing more than 2 years ago. The remaining gross HVAC rental loans on our balance sheet totaled about $50 million, down from about $116 million at the beginning of the year. Net write-offs in our core residential lending portfolio are in line with historical experience for the quarter and for the year-to-date, while net write-offs in commercial lending are trending better for the same periods.Our allowance for credit losses at the end of the quarter totaled $78 million, with 72% of that attributable to performing loans, Stage 1 and 2 loans. This is a decrease in allowance of roughly $31 million from Q2, of which $7 million is attributable to the reversal in credit provisions and the balance attributable to write-offs. The total allowance is determined through the use of a model which incorporates 3 probability-weighted forward-looking scenarios and include the management overlay.The inputs to those scenarios are provided on Slide 17. The impact of using the 3 scenarios adds almost $10 million to what the allowance would be using just the base case forecast. Our allowance related to performing loans classified as either Stage 1 or Stage 2 totaled $56 million at the end of the quarter, a decrease of $20.2 million from the end of Q2. This is attributable to net write-offs, the assets derecognized or repaid referenced earlier to updated inputs to our economic models. Our performing loan allowance under IFRS 9 will continue to fluctuate as predictions of the impact of COVID-19 on the economy are updated. We consider our loan portfolio to be well-provisioned.Net nonperforming loans on Slide 18 totaled just over $82 million or 47 basis points of gross loans. This compares with 42 basis points as of the end of Q2 of this year and 49 basis points as of Q3 of last year.Our liquidity and capital metrics are on Slide 20. We continue to hold over $1 billion in high-quality liquid assets with access to additional short-term funding as needed. Our CET1 capital ratio of 19.35% at the end of Q3 increased by 87 basis points in the quarter and 171 basis points for the year-to-date. We have a strong capital ratio well in excess of our regulatory minimum and are committed to being prudent stewards of this capital in this period of economic uncertainty. We are confident in our ability to continue to generate solid returns for our shareholders while working towards our strategic objectives.And now I will turn the call back to Yousry for closing remarks.

[Yousry Bissada, President, CEO & Non]

Thank you, Brad. While we are pleased with our results we have reported today, we cannot ignore the continuing uncertainty that our economy is facing as a result of COVID-19. When we entered the lockdown conditions, we had no way of knowing how long they would last. What we have demonstrated today is that we're able to work effectively in any condition. We will continue to do so for as long as necessary until the risk to public health has passed.When the circumstances are favorable to reopen downtown, we will do so with the safety of our stakeholders in mind and in accordance with guidance from health authorities. Until then, we will challenge ourselves to use this time to execute on our strategic priorities, continue along our digital road map, learn from our experiences and build a company that is stronger and more resilient than ever. No matter how long it takes, we have the financial resources, the capability and the resolve to continue our important purpose of helping Canadians own homes.We thank you all for your support. I will now ask the operator to poll for questions.

[Operator]

[Operator Instructions] Our first question this morning comes from Cihan Tuncay from Stifel.

[Cihan Tuncay, Director]

Just a couple of questions for me. Let's start with the NIM, obviously big gains here for the quarter, and I think it's the best NIM performance in a very long time. So with the changes we saw on the yield curve post the election results and the virus vaccine news, do you think this level of NIM around 2.5% -- what do you think -- how comfortable are you with the sustainability of that going forward? And how -- the impact you're seeing on mortgage rates and deposit rates at this time?

[Bradley William Kotush, Executive VP & CFO]

Cihan, it's Brad. So far, we haven't seen a negative impact on NIM, although as you mentioned, some of the forward-looking curves are different. We haven't had a chance to react -- or we will react to those as some of those forward-looking curve items get incorporated in live mortgage or our commitments. But for now, we continue to see higher rate deposits roll off and be replaced with lower rate deposits. And to the extent our underwriting teams are able to price our products at the current spreads, then we may see some slight declines in NIM, but we're also able to -- or have been able to maintain it over the past couple of months.

[Cihan Tuncay, Director]

Okay. And then maybe a question for Yousry. So Yousry, just wondering, have you made -- I didn't hear this, and apologies if you mentioned this in the remarks, but have you -- could you talk about any of the changes you've made to your underwriting standards today versus where you were say at the beginning of Q3? Any changes -- any big changes with respect to that?

[Yousry Bissada, President, CEO & Non]

Sure, Cihan. We did make some changes almost immediately in the early days of the pandemic. And while we still -- virtually still lend where we lend in major urban centers, there were certain pockets that we pulled back the LTV from, let us say in a certain section, we do 80%, we moved it back to 70% or 65% as appropriate. We also in the verification of income, we are always very prudent at verifying income, but even took a harder look in certain industries, industries that require the gathering of people, for instance, we took a harder look on that. We have to be satisfied, and even more than our normal ways.And on the commercial side, very similarly, again, in certain pockets, we looked at, and so where we're comfortable or uncomfortable. And as well on the small commercial side, we again would look at income in a different way, what kind of industry is it, what kind of business is it, does the gathering? So there were a number of things we pulled back on, but I'd say we didn't change geographically just within those geographies, a harder look at income and some LTV differences.

[Cihan Tuncay, Director]

If I could just sneak just one last question in for me. With respect to deferrals, obviously a big decline. Could you talk to at all what the LTV is of the remaining balance that's within deferrals? Are you advising any of these folks to simply sell their home into a strong housing market? How are you looking at the balance that's currently outstanding in deferrals?

[Bradley William Kotush, Executive VP & CFO]

Yes, Cihan, the LTVs are consistent with our overall portfolio, same with FICO scores, maybe slightly lower than average, but we haven't seen any significant issues with that program as you've seen. That number has come down dramatically from its highs. And as Yousry noted, we're very happy that we were able to help our customers through a very trying time, and again, offering assistance to them and trying to organize their financial situation so that they can come back strong in terms of being able to make their payments in their overall credit situation.

[Operator]

Our next question comes from Stephen Boland from Raymond James.

[Stephen Boland, MD & Equity Research Analyst]

Just a couple of big questions -- or couple of questions, sorry. The first one, Yousry, is the other consumer retail loans of HVAC, is the goal to get that down to 0? Like I know you stopped HVAC loans, but any other consumer loans, is the goal just to get that to 0?

[Yousry Bissada, President, CEO & Non]

I'd say over some time, yes. We did sell some of it, that which we have, we're not lending further. We continue to administer the portfolio, and over time, it would go to 0.

[Stephen Boland, MD & Equity Research Analyst]

Okay. And then just the second, I mean your originations in the classic, pretty equal to last year, an improvement over the last quarter. So I mean what's your outlook in terms of housing? There is some concerns that housing prices have risen, even in I would say the suburban market that maybe you guys lend in is a little bit overheated. So just want to get your view for what's going on this quarter and your outlook maybe for the next couple of quarters?

[Yousry Bissada, President, CEO & Non]

Yes. These times, it feels harder than ever to have outlooks. Things seem to change a lot. I don't think any financial institution would have predicted back in April the way the market has shaped this year. So to answer your question, we don't see much evidence in the near future anyway that it's going to be any different. Low interest rates are going to continue. People with jobs seem to be saving more than they planned. They're not traveling. They're not going to restaurants. And people have changed what the definition of a home is.Many have decided that they want a backyard. They don't mind working further because working from home doesn't affect that. So those demand items seem to continue. So I don't know exactly what's going to happen, but it looks like the momentum will continue for a little while yet.

[Operator]

Our next question comes from Graham Ryding from TD Securities.

[Graham Ryding, Research Analyst of Financial Services]

So you flagged that in your provisioning your base case implies I think that you're over-provisioned by almost $10 million. If the world plays out according to what your base case model assumptions are, what is your expectation for the potential for further credit provisions to be released? Is that something that would potentially phase back into your earnings over the next year or so?

[Yousry Bissada, President, CEO & Non]

Thanks. The way to -- I'm going to answer that question in that you asked if the base case persisted. So basically that would mean that we wouldn't have -- absent any portfolio growth, we wouldn't have any further provisions. What may change though are the base case assumptions. So we'll continue to use different probability weighting scenarios. But if the underlying assumptions change and that base case changes as well as any of the other weightings, then there is an opportunity for potential reversals.And as we said, there's -- with the volatility to the extent that things would deteriorate, then we would also be in a position to unfortunately have -- or we're in a position to increase provisions. So again I just want to be clear. So if nothing changes and the portfolio stays the same, then we wouldn't need any further provisions. And yes, if any of the inputs change, and we've seen that they become slightly favorable so far this quarter, then there's an opportunity to see further recoveries absent any increase in the overall portfolio.

[Graham Ryding, Research Analyst of Financial Services]

Okay. Understood. And how about those borrowers that went through that deferral process, then obviously now most of them are off-deferral. Are you expecting any arrears or any pressure from this cohort in particular? Or do you believe that this cohort should perform in line with the rest of your portfolio? Any color there?

[Yousry Bissada, President, CEO & Non]

Yes. As I mentioned, many are either back on repayment or have discharged. There is a small number that have gone into arrears. It's less than maybe I would have imagined back in April, but we're working with them as we would in a normal process. So the good news is most are coming out very, very well, but there is a say small portion. We continue to work with those who have gone from arrears -- a small amount that's gone from arrears into -- sorry, from deferrals into arrears and help them out -- help them as we would with any client who goes in arrears. So surprisingly small size.

[Operator]

[Operator Instructions] Our next question comes from Jaeme Gloyn from National Bank Financial.

[Jaeme Gloyn, Analyst]

First question is related to the commercial mortgage increase in gross impaired loans or impaired loans. I'm not sure if you addressed this on prepared remarks, but can you just give us a little bit more color as to what drove that quarter-over-quarter increase?

[Bradley William Kotush, Executive VP & CFO]

Yes. Sure, Jaeme. We had some loans that we interpret as becoming nonperforming, and as it relates to the current economic circumstances, and we're comfortable that we're well-provisioned on those loans.

[Jaeme Gloyn, Analyst]

Could you -- like, so what is it about that current economic situation, like what changed from Q2 to Q3 if -- were there -- underlying economic assumptions would have improved?

[Bradley William Kotush, Executive VP & CFO]

Well, each individual loan like commercial loans are generally larger than residential. So any one particular circumstance of a commercial loan would result in changes to their staging, and that's how we would approach it.

[Jaeme Gloyn, Analyst]

Okay. Looking at the securitization NIM, big bump in the CMHC-driven net interest margin for securitization portfolio. How sustainable do you think that spread is or that margin is? Is this just a temporary impact and you kind of have to get through the mortgages that were originated a few months ago and are now getting securitized? Or is that something that's sustainable?

[Bradley William Kotush, Executive VP & CFO]

I think short term, yes, meaning we're -- over the next quarter or so and then obviously we'll see where those changes or gap in the future, Jaeme.

[Jaeme Gloyn, Analyst]

Okay. Next one is on the operating expenses. Can you just refresh us on what you're expecting from the Ignite Program spend and where do you think operating expenses ex-the Ignite Program is going to trend here over the next few quarters?

[Bradley William Kotush, Executive VP & CFO]

I think, well, this quarter and the next few quarters are going to be where the majority of our spend will be coming on the SAP implementation. So our current forecasts are that, well, they'll be consistent with this last quarter.

[Jaeme Gloyn, Analyst]

As in both [indiscernible] and Ignite?

[Bradley William Kotush, Executive VP & CFO]

As in -- yes, so the aggregate spend for noninterest expenses will be approximately what it was this last quarter as a run rate.

[Operator]

This concludes the Q&A portion of our call. I now would like to turn it back to Yousry Bissada for final comments.

[Yousry Bissada, President, CEO & Non]

Thank you, everyone, for joining our call. We wish you stay safe and healthy, and we look forward to speaking to you after our Q4 results.

[Operator]

Ladies and gentlemen, this concludes today's conference call. Thank you for participating, and you may now disconnect.