Laurentian Bank of Canada

TSX:LB

Earnings Call Transcript 2022-Q3

[Operator]

Good day, and welcome to the Third Quarter Results 2022 Laurentian Bank Financial Group Conference Call. Today's conference is being recorded.

At this time, I'd like to hand the conference over to Andrew Chornenky, Vice President and Head of Investor Relations. Please go ahead.

[Unknown]

[Foreign Language] Good morning, and thank you for joining us. My name is Andrew Chornenky, and I'm the Head of Investor Relations at Laurentian Bank. Today's opening remarks will be delivered by Rania Llewellyn, President and CEO; and the review of the third quarter financial results will be presented by Yvan Deschamps, Executive Vice President and Chief Financial Officer. After which, we will invite questions from the phone. Also joining us for the question period are several members of the bank's executive leadership team; Liam Mason, Chief Risk Officer; Eric Provost, Head of Commercial Banking; Karine Abgrall-Teslyk, Head of Personal Banking; and Kelsey Gunderson, Head of Capital Markets.

All documents pertaining to the quarter can be found on our website in the Investor Center.

I would like to remind you that during this conference call, forward-looking statements may be made, and it is possible that actual results may differ materially from those projected in such statements. For the complete cautionary note regarding forward-looking statements, please refer to our press release or to Slide 2 of the presentation.

I would also like to remind listeners that the bank assesses its performance on a reported and adjusted basis and considers both to be useful in assessing underlying business performance. Rania and Yvan will be referring to adjusted results in their remarks unless otherwise noted as reported.

I'll now turn the call over to Rania.

[Rania Llewellyn, executive]

[Foreign Language] Good morning, and thank you for joining us. I hope everyone had a nice summer and a chance to recharge. We are pleased with our performance this quarter and remain confident that we will exceed our financial targets for the year.

On behalf of the entire management team, we would like to thank our one winning team for their efforts over the last quarter. They have continuously shown their resilience and commitment to putting our customers first.

The macroeconomic environment continues to be uncertain and volatile and is being weighed down by high inflation, very rapid interest rate increases and geopolitical tensions.

Notwithstanding, our results speak to the strength of our underlying businesses, our prudent approach to credit, disciplined cost management and the progress we are making on executing against our plan.

This quarter, total revenue grew by 2%, and pretax pre-provision income was up 6% year-over-year. Net income for the third quarter was $58.2 million or 2% lower than a year earlier. As a result of higher provisions on performing loans, PCLs increased by $11.2 million or 11 basis points year-over-year to $16.6 million or 18 basis points. Earnings per share were $1.24 compared to $1.25 last year, and ROE was 8.7%, down 20 basis points from a year ago.

Following our record strong second quarter since 2018, revenue was relatively flat quarter-over-quarter, impacted by lower financial market-related noninterest revenues. PCLs increased by $3.6 million or 3 basis points quarter-over-quarter. Pretax pre-provision income and net income were both down by 5% and 6%, respectively, while ROE was down 160 basis points, including the impact of the $3.3 million interest payment on limited recourse capital notes.

Commercial Banking had another strong quarter. Our commercial loan portfolio grew by $3.9 billion or 29% year-over-year and over $600 million or 4% quarter-over-quarter. Personal deposits saw significant growth, up 17% year-over-year and 8% quarter-over-quarter, supporting our solid loan growth.

Last quarter, we said that expenses would be higher in the second half of the year as we continue to deliver on key strategic initiatives, including digital onboarding and our reimagined Visa experience. At 67.1%, our efficiency ratio improved by 130 basis points year-over-year. And at 66.4% year-to-date, we will exceed our fiscal 2022 target of less than 68%.

The bank's CET capital ratio of 9.1% is down from 9.3% last quarter as we continue to redeploy capital in line with our strategic plan to support profitable, sustainable organic growth. Our CET1 ratio remains above our pre-COVID level of 9% and higher than our operating target of 8.5%. As outlined at our December 2021 Investor Day, our business lines play a key role in the success of our strategy. Commercial Banking, our growth engine continued to execute on its proven business model with a focus on its key specializations.

Real estate financing was up by more than $300 million or 3% from last quarter to $9.7 billion. Results were mostly driven by the conversion of our strong unfunded pipeline in the construction portfolio to support the multi-residential segment as developers continue to catch up to the structural supply shortage in certain markets. Inventory financing was up $225 million or 7% from last quarter to $3.6 billion, driven by a more normalized pre-pandemic credit utilization rate of 51%. Equipment financing was up $50 million or 3% from last quarter to $1.5 billion. driven mainly by the transportation and construction segments. As part of our strategy and commitment to diversify our geographic footprint, we now have 21% of our commercial loan portfolio in the U.S., exceeding our medium-term target of 18%.

In Capital Markets, we saw significant volatility this quarter as markets digested various geopolitical risks and aggressive monetary tightening by central banks. In response, we continued to deliver on our focused and aligned strategy. First, in line with our objectives to expand coverage to our top-tier commercial clients, we offered a full suite of advice to our core clients as they navigated current macroeconomic conditions. This led to a strong quarter in FX. Second, we participated in 6 bank issued preferred or limited recourse capital notes issuances as part of our priority to grow our syndicate positions with core corporate issuers. And third, we participated in 4 ESG-themed bonds, including 2 new-to-market issuances by OPG and the municipal financing authority of BC as part of our objective to participate in sustainable bond issuances. In Personal Banking, we are leading with a digital-first approach to reposition the business for growth.

To that end, we are pleased to announce the launch of our digital account opening solution. In partnership with Third Stream, we were able to deploy digital account opening in just 6 months, which aligns with our strategy to partner versus build to get to market faster. Our digital onboarding rollout will focus first on our employees to ensure a seamless customer experience. As the solution is rolled out more broadly, it will allow us to continue acquiring new customers within Quebec beyond our physical footprint and as our launching path to expanding our retail presence across the rest of Canada. Our initial focus will be on checking and deposit products.

To enable the launch of digital account opening, we were able to utilize our recently announced cloud-based API solution in partnership with Kyndryl. With this milestone, we now have a strong and proven foundation to deliver faster, more seamless and innovative digital capabilities for our customers. Along with this key milestone, other digital achievements this quarter include the introduction of self-service password resets, which will help divert more than 5,000 calls per month from our contact center and the launch of our refreshed public website as well as our newly modernized online customer platform, LDC Direct. The new modernized LDC Direct ensures that our digital banking experience is consistent across all devices and improves the overall banking experience for our customers. We said that retention was also a key priority this year, and our recently launched loyalty team continues to make progress.

For instance, our loyalty team's proactive outreach to GIC customers led to a 12% year-over-year increase in retention. In our year of execution, we have now successfully closed the top 5 digital pain points identified by our customers through the launch of contactless TAP debit cards, mobile app, self-service password resets, refreshed web and digital onboarding. Our strategy is also underpinned by a strong culture and a commitment to ESG. With culture as our driving force, we launched a new career path program for our personal bank advisers, participated in pride events across the country and partnered with pride at Work Canada, to bill, up and foster a culture where everyone belongs. In making the better choice, I am proud to announce that Laurentian Bank had the best year-over-year improvement among the big Canadian banks in the Sustainalytics ESG risk rating survey, and we moved into the low-risk category. This reflects the collective enterprise-wide effort to incorporate ESG best practices across all the bank's activities, including implementing a new ED&I policy for the Board and employees.

In wrapping up my remarks, I want to share a progress update with you. On a year-to-date basis, we are exceeding each of our 2022 financial targets. Our EPS growth is up 11%, exceeding our target of greater than 5%. ROE is 9.4%, exceeding our target of greater than 8.5%. The -- our efficiency ratio is 66.4% or 160 basis points better than our target of less than 68%. And our operating leverage is positive at 3.9%. Our team continues to demonstrate their resilience through this volatile economic environment. We are confident and committed to executing on our strategy to deliver long-term sustainable and profitable growth as well as exceeding our financial targets this year.

I would now like to turn the call over to Yvan.

[Yvan Deschamps, executive]

[Foreign Language] I would like to begin by turning to Slide 13, which highlights the bank's financial performance for the third quarter of 2020. Reported EPS was $1.18, and net income was $55.9 million. Adjusting items this quarter amounted to $3.1 million before taxes or $0.06 per share and are related to the amortization of acquisition-related intangible assets. Details of adjusting items are shown on Slide 27. The remainder of my comments will focus on adjusted results. EPS and ROE were $1.24 and 8.7%, a decrease of $0.01 and 20 basis points, respectively, compared to a year ago. The pre-tax pre-provision income or PTPP was $85.5 million, a 6% increase from last year.

Compared to the second quarter of 2022, EPS and ROE decreased by 11% and 160 basis points, respectively, while PTPP decreased by 5%. The key elements of variation this quarter related to the $3.3 million interest payment on LRCM; lower financial market-related noninterest revenues due to volatile market conditions, an increase in PCLs as a result of higher provisions on performing loans due to the less favorable macroeconomic outlook and strategic investments to close key foundational gaps and support growth.

Slide 14 shows the increase of net interest income by 8% year-over-year. On a sequential basis, it increased by 5%, mainly due to the positive impact of 3 additional days in the quarter and higher interest income from commercial loans, partly offset by higher funding costs and liquidity levels. At 1.83%, NIM was down 4 basis points quarter-over-quarter. We made the decision this quarter to prudently carry a higher level of liquidity based on our strong asset growth this year and to reduce funding risk in a period of economic volatility. This, along with the timing lag of assets repricing resulted in the quarter-over-quarter decrease.

Other income, as presented on Slide 15, decreased by 11% compared with the year ago and 10% sequentially. This quarter, the decrease was mainly as a result of the volatile financial markets, unfavorably impacting fees and securities brokerage commissions, commissions on sales of mutual funds and income from financial instruments.

Noninterest expenses, as shown on Slide 16, were flat compared to a year ago despite our strategic investment to close key foundational gaps, improve the customer experience and accelerate business development activities to support growth. These were offset by lower amortization charges and rent expenses. Sequentially, noninterest expenses increased by 3%, mainly due to the aforementioned strategic investments as well as higher professional and advertising fees also to support growth, partly offset by lower performance-based compensation. The increase this quarter was in line with our previous guidance. As a result, the efficiency ratio this quarter was higher by 190 basis points sequentially to 67.1%. However, as Rania mentioned in our remarks, we are seeing sustained improvement year-over-year as we were able to grow revenues and maintain our focus on cost discipline.

Slide 17 presents our diversified sources of funding. Sequentially, deposits increased by 6% or $1.4 billion, while loans grew by 2%. Compared to last year, deposits grew by 15%, while loans grew by 11%. This tracks positively with our objective of growing deposits and loans in line.

Slide 18 highlights our capital position. CET1 capital ratio, which is presented under the standardized approach, stood at 9.1% compared to 9.3% last quarter. This quarter's variation was once again linked to the redeployment of capital accumulated during the pandemic to sustainable, profitable commercial loan growth in line with our strategic plan. Our CET1 ratio remains above our pre-covid level of 9% and higher than our minimal operating level of 8.5%. In line with our disciplined approach to managing capital, the bank is introducing a 2% discount as part of its DRIP program.

Slide 19 highlights the commercial loan portfolio, which delivered strong growth. Loans increased by over $600 million or 4% quarter-over-quarter, driven by growth in real estate financing of over $300 million or 3% and inventory financing of over $225 million or 7%. Our results in real estate were driven by the realization of our strong pipeline, particularly in the construction portfolio for the multi-residential segment. Inventory financing continue to make market share gains and experience normalization and utilization rate.

Slide 20 presents the Penn Canadian residential mortgage loan portfolio. Residential mortgage loans improved by 1%, both year-over-year and sequentially, in line with our objective of portfolio stabilization. The bank's residential mortgage portfolio remains relatively weighted towards insured mortgages at 56% and combined with a low LTV of 44% of the uninsured portfolio continues to reducing the overall risk of this business.

Turning to Slide 21. -- allowances for credit losses totaled $193.2 million, a sequential decrease of $9.6 million, mainly due to write-offs of previously provisioned accounts in the commercial loan portfolio. As shown on Slide 22, the provision for credit losses was $16.6 million in the third quarter of 2020, increasing by $11.2 million from a year ago. This was mainly due to higher provisions on performing loans as a result of volume growth in the commercial loan book and less favorable macroeconomic outlook.

Last year, I also saw a release of provisions on performing loans. Sequentially, the provision for credit losses increased by $3.6 million, mainly for the same reasons. The PCL ratio stood at 18 basis points. Slide 23 highlights the improving trend in gross impaired loans, which decreased by $29.1 million quarter-over-quarter, mainly due to favorable repayment and write-offs of previously provisioned accounts in the commercial loan portfolio.

We continue to manage our risk with a prudent and disciplined approach and remain adequately provisioned. I would now like to offer some thoughts on how we see the remainder of the year development. We anticipate a relatively stable capital level for Q4 as a result of tempering loan growth supported by internal capital generation. We expect modest revenue growth in Q4 on the back of the recent commercial loan growth and early indicators showing a partial rebound in capital markets activity. We are forecasting our NIM to be in the mid-180s for Q4, an increase of a few basis points versus Q3.

For the full year, we expect to be at or slightly above our target of 1.85%. Overall expenses are expected to remain elevated in Q4, slightly above Q3 or the -- sorry, for the year, we will remain below our 2022 efficiency ratio target of less than 68%, leading to a positive operating leverage. The provision for credit losses remains difficult to predict on a quarterly basis given the uncertainty macroeconomic environment. Overall, we expect PTPP to increase slightly in Q4, and we remain confident that we will exceed our 2022 financial targets.

I will now turn the back to Andrew.

[Unknown]

At this point, I would like to turn the call over to the conference operator for the question-and-answer session. Alexandra, we're ready for our first question.

[Operator]

[Operator Instructions] And we'll go ahead and take our first question from Meny Grauman with Scotiabank.

[Meny Grauman, analyst]

I'd like to talk about capital. Yvan, you gave some guidance for the rest of the year, and we've talked about this before. You highlighted moderating loan growth for Q4, keeping the capital ratio relatively stable. If I got that correct. And just on that guidance in terms of moderating loan growth, -- is this something that you're actively doing? Or is this just a broader comment on the market as a whole slowing down? And if that's the case, do you see evidence of that sort of early days in Q4 already?

[Yvan Deschamps, executive]

Yes. Thank you for the question, Meny. I think it's an important one, and I'm really pleased to just add a few comments on that. But if you allow me, I'll just start by doing a step back. And we're currently at 9.1% CET1, which is above the 8.5 minimal range. So we still have a good buffer there. But it's very important to look at the past. So pre-pandemic, we were at 9%. So we're pretty much back to the levels that we have pre-pandemic because the pandemic definitely impacted the fuel portfolio. and we have accumulated capital during that period. And our first priority has always been to redeploy that capital, and we're really pleased with the exceptional growth that we have in commercial growth over the last 12 months pretty much.

So at this point, it's not a question of wanting to slow it down. It's a question of normalization because we did redeploy that capital and the specialty inventory financing is normalizing in terms of market growth at this point. So the utilization rate, as mentioned by Rania now 51%, which is closer to historical level. So that is slowing down, and that's just a reflection of the growth that we had over the last year. So we're still managing prudently the capital and are pleased with the level and expect at this point that the capital generation internally is going to sustain a more normalized growth going forward.

[Rania Llewellyn, executive]

And Meny, just to add to what Yvan was saying, we are constantly proactively managing prudently our capital. And so we did pause the share buyback in Q2. We're reintroducing the 2% DRIP. And given the current macroeconomic conditions, making sure that our growth is profitable, and we're looking at a risk-adjusted return. So it's not growth for the sake of growth, but just being more diligent and proactively managing that growth going forward.

[Meny Grauman, analyst]

I guess where I'm coming from is commercial loan growth just seems remarkably strong. And if I look across the peer group, it doesn't seem like it's slowing in the near term. Certainly, it's come in higher than expected, I think even higher than you had guided to and expected. So the question is in Q4, if it doesn't slow as you expect, what are the implications of that? I'm trying to understand, is it something that you can actively slow? Or do you have other levers that you can use in order to offset that tremendous RWA growth that you're seeing?

[Yvan Deschamps, executive]

Yes. So definitely, I would say an institution, including us, we do have what we call the capital toolkit. So depending on what's happening in the market, we will adjust. Can we slow down some growth? Definitely, we could slow down some growth if we see higher growth in other portfolios. So we're not uncomfortable many at this point with the level of capital that we have. And we feel that we have a few weeks -- but as mentioned by Rania, we're taking proactive actions like we stopped the share buyback last quarter. We reintroduced the DRIP this quarter, which is a reflection of the economy, but it's also a reflection, honestly, of the growth that we have. So we are taking a proactive move, but we definitely have contingency plans in case we would need to address them. But at this point, what we see in our crystal ball, which is hard, it's not a pure science, is that we should be roughly in line with internal capital generation next quarter.

[Operator]

And we'll go ahead and take our next question from Gabriel Dechaine with National Bank Financial.

[Gabriel Dechaine, analyst]

I just want to talk about the margin. A few things here coming to mind. One, I get the idea that you want to make the balance sheet more liquid during volatile times. But from Q2 to Q3, it's not like the world has really gotten dramatically worse, it was volatile in Q2, volatile in Q3. Just wondering what changed the perspective there? And also, to what extent did you maybe get caught off guard by some rapidly increasing cost in the broker channel, where the deposit growth was the highest at the bank. I mean I get that you got to be nimble and all that, but not like the world got dramatically worse this quarter. It's about the same as- i.e. bad as it was in Q2.

[Yvan Deschamps, executive]

Yes. So thank you for your question, Gabriel. I'll take that one. So the level of liquidity is a reflection of 2 items. So definitely, the uncertain times led us to be prudent in the context and gather more liquidity. And what's great is the liquidity, if you look at it, it came from the deposit side, right? So we didn't pull it from the wholesale or something like that. So we're really pleased with the deposit gathering that we had over the last quarter. The second thing is that if you look at the growth, definitely, the growth of commercial was excessively at performance over the last 12 months.

So that leads us to -- or that led us to be more conservative and prudent last quarter because, again, we just wanted to make sure from an equity perspective, we would be careful and manage accordingly. So it did impact the NIM by about 2 basis points. So half of the difference between last quarter and this quarter relates to the level of liquidity. So we've seen a tempering of that, which was exceptional in Q2 was still pretty good in Q3, but lower than it was in Q2.

So the exceptional deposit gathering definitely created an excess of liquidity, but I much prefer being in that position than the reverse. And that will allow us to gradually redeploy those liquidity into loans that will have better margins, which will contribute to this. And I would call that impact transitory because it's going to come back over the next quarters.

[Gabriel Dechaine, analyst]

So loan growth came in faster than anticipated, I guess, so you decided to step on the gas a bit in the deposit channel. But for Q4, you might do less of that because you've got the excess liquidity already on the balance sheet. Can you talk about...

[Yvan Deschamps, executive]

No, I think that's right. So if I -- work for only 1 month -- sorry. Did you want to add something?

[Gabriel Dechaine, analyst]

Like what -- do you have any comments on the increase in funding cost of the broker channel? Or is that not a factor at all?

[Yvan Deschamps, executive]

Yes. There are 2 things. So I'll comment on your first portion, and I'll answer that one after. So we're 1 month in. So I would say with the level of liquidity that we had at the end of the quarter, we slowed down, right, in terms of the deposit gathering at this point. So that's going to help gradually in Q4 and going forward. But the deposits came in very strong in the demand deposits as well as the broker GIC term deposits. And we've been very successful there. It's only playing with rates in that market as you can expect, but also building relationships and deepening the relationship that we have, which also brought more deposits than we expected. So we're really, really pleased with the performance that we had, not only last quarter, but if you look at the 4 years since last year, we grew by 15% at the deposit base, which, for me, has been a real key changer at the bank versus what we had in the previous years.

[Operator]

And we'll go ahead and move on to our next question from Paul Holden with CIBC.

[Paul Holden, analyst]

I want to continue the discussion on NIM and maybe let's put aside sort of the explanations you just provided to Gabe's questions. Because you provided some guidance last quarter, which said that you get more of a NIM benefit from Bank of Canada rates in 2023 versus 2022. So again, kind of putting aside the liquidity explanation, why -- just remind us on why that is? Is that just assets take longer to reprice than deposits?

[Yvan Deschamps, executive]

Yes, it's a very good question. So a few elements there. So the first one that I did not mention yet is really the change in the mortgage retention, which I think is a short-term pain, but a very nice long-term gain. And Karine and her team have been very successful at increasing the retention of the mortgages due to the loyalty activities that we have there, probably partly because of the increasing rate as well, but we're really happy with the retention that we had.

So that created less prepayment penalties this quarter. That means that we're going to keep the customers on a long-term basis, but that did create probably 1 basis -- 1 point of NIM that we did not anticipate, but we're really pleased with the results.

The second one is the liquidity we probably pulled a bit more than we expected in the context of the assets. But I discussed that one, and I think it's really a trend story and it's going to change over time. The last one is really the repricing of the assets, and I know I'm not the only one that mentioned that. So the funding costs always go up in terms of anticipation. The repricing is a question of contracts, and it's also a question of discipline in the market.

So a portion of the lagging in terms of repricing is due to contracts, meaning that the increases need to happen so that we can implement it via the contract that we have with the customers versus the funding will have increased a few months before.

The second element to that is, I would call it, market discipline. So if you look in some products, definitely, the funding costs went way faster than what you would see in the pricing. But it's not only a question of Laurentian, it's a question of market discipline. But again, I'm optimistic and I see that also as transitory and the market discipline should come back over the next quarters.

[Paul Holden, analyst]

Okay. So then a couple of follow-ups to that answer. First, on the contracts. I'm assuming these renew annually, so maybe you can confirm or correct me on that assumption. And then two, does your view on a benefit from Bank of Canada rate increases in 2023, does that still stand?

[Yvan Deschamps, executive]

Yes. And thanks for digging. I think it's good that I had a few comments. So it's not a yearly thing in terms of contracts, but I'll give you an easy example. The funding rates will increase, but the loans that are based on prime will only increase when Bank of Canada should increase. So there's a lag between that funding and the prime increase for the customer. And then some other contracts that we have with the customers as well, the variable rate is based on the prior month. So you may get a few weeks of delay. And in the context where we've seen pretty big increases over the last quarter and frequent increases that creates a lag, but that one is really transitional and it's going to come back relatively quickly.

The only thing I'd be careful is that we still anticipate increases of interest rates over the next 2 quarters or so. So I would expect that, that lag will lag -- will last a little bit longer. But again, as the interest rate increases, stabilize or stop, we will catch up to that element. So I'll reserve my comments on 23, but I would say that we're still positioned to take advantage because of all the elements I discussed as we will reduce the liquidity as we will reprice the variable rate contract that I just mentioned. And as well as we will continue to evolve the portfolio mix, we see that there is still upside on that side.

[Paul Holden, analyst]

Okay. That's very helpful. And one more question from me, if I can. Just you pointed out you're exceeding all of your 2022 financial targets. So that's great. And I guess my question is, does that enable you to accelerate any of the strategic investments you need to make in that business, whether that comes in Q4 or in the following year?

[Yvan Deschamps, executive]

The first thing is definitely it allowed us to sustain the investments that we're doing. We also mentioned last quarter that we would keep an elevated level of expenses for the remainder of 2022. So it definitely did allow us to push and invest a bit more, not only in the strategic investments, but also to support the growth because we had a fantastic growth over the last 12 months. and we need to make sure that we sustain the level of service to the customers. And for us, it's something that we look at it. Customer first is our principle. So definitely, we had to invest there. We continue to invest there. But on the strategic initiatives. In fact, I'll let Rania has comments on it, but she already reflected in our remarks a lot of the adjustments we have sorry, accomplishments we had this quarter. Yes.

[Rania Llewellyn, executive]

So Paul, so thanks for the question. So obviously, it's a dynamic process in terms of us managing our expenses, looking at our projects, the majority of which are strategic, but we do also have some other nonstrategic projects. So it's really important to make sure we have the right balance between investing in the future and having the right cost discipline, particularly in a volatile uncertain macroeconomic environment. So we were -- we've been consistent in terms of what our target is this year. We'll be coming back to -- the Street in Q4 as we finalize kind of our budget and what our strategic plans are for delivery and execution is for next year. We've got lots of levers that we can play around, but making sure that we manage our expenses in line with the growth is also very important. So making sure we have that cost discipline is key. We've always said at Laurentian Bank, we have 2 opportunities here. It's top line revenue growth and efficiency. So there's a number of other efficiencies that we're looking at, and we will continue to invest in that. So we're comfortable with the level of investments at this point.

[Operator]

We'll go ahead and move on to our next question from Sohrab Movahedi with BMO Capital Markets.

[Sohrab Movahedi, analyst]

Just wanted to make sure I heard a few things correctly. I think part of the reason why you mentioned commercial loan growth came in a little bit hotter than you had expected was, I guess, faster normalization in utilization rates. Is that the right way of thinking about it? Yes, it is. ore. So just as a matter of curiosity, how much of it would you say was kind of existing clients drawing down more versus just building the portfolio with new clients.

[Eric Provost, executive]

Yes. Sohrab, it's Eric. Just commenting on that, and thank you for the question. Actually, it's really a mix. The way the team is deployed, we've been able to keep winning market share. So we're up 20% year-over-year in terms of our dealer base. So that is a contributor. But for sure, with the macroeconomic environment, we saw demand for those products normalizing. So that is the big factor in terms of credit line utilization of our existing dealer based in the portfolio. So really a mix of both, like we're successful on boarding new business, but definitely, consumers right now are more tempered in their demand for these types of products.

[Yvan Deschamps, executive]

And maybe to add a bit of color on that. So rather normalizing is a word that is very important. And when we say normalizing, it's not negative. In fact, going back to the normal environment we have precoated, where the dealers will go back to the normal utilization level of their lines within the context where the consumer demand is back to what it was. So if you go back in the covid environment, the demand was too was extremely high from the consumers, and that's why the portfolio reduced. But we're going back to normal level, and we're going to go back to normal level of growth for that portfolio.

[Sohrab Movahedi, analyst]

Okay. But I suppose the normalization was a bit of a surprise to you. Is that the right way to think about it? Do you didn't expect it to normalize as quickly as it did?

[Eric Provost, executive]

Yes, not as quickly, Sohrab, for sure because like preseason ordering for the dealers occur usually in the fall season, early winter. So that was prior to the war prior to interest rate hikes. So like those ordering occurred very strongly again for the 2022 season in anticipation of another strong year. And then the dealers are just coming out of 2 exceptional years. So I just think that they forecasted higher demand. And with the macroeconomic environment, like it's just slowed down consumer to more normal pace. Like utilization right now at 51%. If you go pre-COVID in 2019, during that summer, utilization was at 55%. So we're not even catched up, but definitely, it was quicker than expected.

[Sohrab Movahedi, analyst]

I mean, Eric, every indication is that maybe the economic outlook is going to further slowdown. Do you worry that the normalization may mean a low this cycle on the utilization rates?

[Rania Llewellyn, executive]

Sohrab, maybe if I can just add a little bit of color because it is inventory financing, it's Rania. So when consumer demand actually slows down and the dealers have ordered the unit, it actually improves the utilization for us. So they start drawing down on our facilities, which actually earns us revenue. And so one of the things we're watching out for, and I know our dealers are as well, is the aging of the inventory, making sure that they are slowing down on their orders. So again, just a reminder, in terms of when demand slows down, and they're sitting on inventory, they're actually drawing down on our facilities, which generates revenue for us. And so that's why the pre-pandemic levels of 55%. So I think where the surprise is the supply chain came back very quickly, faster than we anticipated. -- the products are still being sold, and there's really no aging in the inventory. So from a PCL perspective, we're very, very comfortable, and we know that our dealers are being prudent in terms of their ordering season going into this session.

[Sohrab Movahedi, analyst]

I just have 2 -- I just have 2 quick questions. One follow-up to that. I mean, Liam, if your borrowers end up having to sit on inventory because of lack of demand, what ripple effect does that have on your -- what implications does it have on your reserve building requirements?

[Liam Mason;Chief Risk Officer, executive]

Well, first of all, so thank you for the question. We do have a disciplined reserving process against those inventories. I would know we've got sort of 5 layers of protection on that portfolio. We have the collateral itself, which is at wholesale prices. You've got the backing of the dealership. Many of the dealers have personal guarantees on the dealer. Your OEMs, your manufacturers have repurchased arrangements. And then we have a curtailment process where if you're not seeing the turnover. But right now, the liquidation rates are normalizing, as Eric said, we're not seeing a lot from an aged inventory standpoint. This is a very operational business. We're on the ground, doing inspections, looking at the inventory -- but we really don't see any cost for concern given the layers of protection and given our reserving, comfortable with that portfolio at this juncture. It's more of a return to normal than a slowdown or a recessionary impact.

[Sohrab Movahedi, analyst]

Okay. So just for crystal clarity, you will earn higher spreads when dealers are using the facility because of a slowdown in demand without any implications for reserve building. Is that what you're telling me?

[Liam Mason;Chief Risk Officer, executive]

No, no. Just to be clear, as we earn those spreads -- our discipline is to maintain appropriate ACLs against that growth. And indeed, if I might jump in here, sort of one of the big drivers of our increase in ACLs was our prudent measured approach, and we increased reserves commensurate with that volume. That's our discipline. That's how we maintain ensuring that we have the credit protections that we need in addition to the layers of protection, I now...

[Sohrab Movahedi, analyst]

Okay. And on -- I mean, I think to an earlier question, you suggested that the circumstances, let's just say meant being a bit more prudent on reserves -- sorry, liquidity -- higher liquidity levels was prudent, why don't you think you will have to retain a higher liquidity, let's say, for the next couple of quarters because the macro uncertainty is certainly not lessening is intensity.

[Yvan Deschamps, executive]

Yes, it's a good question, Sohrab. And I didn't say that we would let it all go in Q4. To be clear, we're going to look at what's happening in the environment. We're going to look at the growth that we're having as well. We will redeploy some of it in the growth because currently, we did gather a lot in last quarter. So we believe that we're at the point we can use some of it. But definitely, I think we can be accused of being prudent and will probably continue to be prudent for a few quarters. So we may hold a little bit of liquidity for the next few quarters, but I would expect gradually to see that red...

[Operator]

And we'll move on to our next question from Doug Young with Desjardins Capital Markets.

[Doug Young, analyst]

Just on the performing loan build. Just trying to get a sense of -- I believe it was more associated with the commercial side. Is this related to the inventory finance book? Is this across the board? And I do think there was a bit of an uptick in commercial write-offs this quarter. Correct me if I'm wrong, again, was this more related to the inventory being longer dated? Or is this across the board? Just hoping to get a sense of those 2 themes and what segments they relate to?

[Liam Mason;Chief Risk Officer, executive]

So why don't I have my colleague, Eric speak to the growth of the portfolio, and then I'll take the run-off question, Derek.

[Eric Provost, executive]

Yes. Thank you, Doug. Well, the growth was really from all across, but mainly driven by commercial real estate as well as the inventory financing. And then to pinpoint inventory financing, actually, we are at record low aging like coming out from these 2 years, definitely, the dealers and the portfolio there is very healthy. And like Liam just explained, like we are well reserved and protected into this segment, and we feel comfortable there. So Liam maybe more details on the rights of...

[Liam Mason;Chief Risk Officer, executive]

Sure. So Thanks, Eric. You got to be really pleased with that growth. The write-offs are normal ebbs and flows in our commercial cloud management as the files were fully provisioned. And if you look at our deals, I'm actually really pleased our gross repair loans are coming down, down $29 million, and we're seeing with that Jill drop either things returning to performing or getting written off. But these were long-standing files. We have a very client-centric approach to managing workouts and they were fully provisioned. So not indication of any trend or any concentration and certainly not related to inventory finance.

[Yvan Deschamps, executive]

This is Yvan, if I can be extremely crystal clear. The performing loan increase in commercial was due to the macroeconomic factors. It was not related to any particular portfolio. So it's really driven by the environment. And as Liam mentioned, the write-offs is much more clean up than something you right because they were fully provisioned for...

[Liam Mason;Chief Risk Officer, executive]

Yes. Just the other -- just to drive that point on, if you think back to last quarter, we were one of the banks looking at the economic environment, saw sort of the volatility and the weaker economic environment coming, and we updated our economic assumptions and the weightings of our outlook, and that served us very well. And this quarter, given the change in the macroeconomic outlook that's been highlighted by many of the banks and in line with our prudent approach to reserving, we made further adjustments to the assumptions and the weight. And that's really to Yvan's point what's driving it. We continue to be prudent and measured and that's part of our DNA and how we operate.

[Doug Young, analyst]

Okay. Just -- so what we're seeing in the write-offs and the performing loan builds around the commercial side, this isn't anything to do specifically with a particular portfolio like inventory finance. This is more, as you say, clean up across the book and across the different segments.

[Yvan Deschamps, executive]

Yes.

[Liam Mason;Chief Risk Officer, executive]

Yes.

[Doug Young, analyst]

Okay. And then just on the CET1 ratio and the sequential decline, and this might be a simple answer, but I mean, RWA was up 4% quarter-over-quarter. I think the loan book was up 2% quarter-over-quarter. So there's a bit of a difference there. Can you maybe detail a bit of what the driver was? Is this -- are you seeing migration impacting the RWA? I guess it wouldn't be migration, but is this just a portfolio mix? Just trying to get a sense of that.

[Liam Mason;Chief Risk Officer, executive]

Yes. It's really portfolio mix. We're not seeing any adverse migration. You can see that in our stage 1 and stage 2 elements across the commercial book. So it's really portfolio mix.

[Operator]

We'll go ahead and move on to our next question from Nigel D'Souza with Veritas.

[Nigel D'Souza, analyst]

I had a question for you on your interest income sensitivity disclosure. I noticed that the increase in NII over the next 12 months. Last quarter, that was $12 million from a 1% increase in this quarter plus a $1 billion. So just wondering that decrease in NII benefit? Is that mainly on your expectation for [ high quality ] data and color there would be appreciated.

[Yvan Deschamps, executive]

Yes. Thank you for your question, Nigel. So the first thing is we definitely dynamically manage the balance sheet. And that stress test is really the position that you have at one single point in time, which is exactly at the end of the quarter. So if you look at the last few quarters, I think this -- if I run the numbers, we have $1 million this quarter. We had 12 million last quarter. If you look at the one before, we have 3 and the one before we had 15. So I wouldn't see too much in it at this point. We remain positioned to take advantage of increases in the risk rate. And as I mentioned, we're going to see or we expect to see a 2 basis points increase next quarter. And I mentioned already a few drivers of increase in terms of margins in NII coming from reducing gradually the level portfolio mix is going to be an impact as well, and I mentioned the repricing. So I wouldn't read too much in the stress test. It's really a single point in time, and that does fluctuate on the daily basis.

[Nigel D'Souza, analyst]

Okay. And then maybe tying that together with your NIM outlook on Slide 29 for then to exceed 1.9% the medium term. Could you remind me again, that expectation, is that driven by your expectation for margin expansion on the existing portfolio or the change in the loan portfolio mix?

[Yvan Deschamps, executive]

Yes. I would simply just, in fact, repeat what I just mentioned, Nigel, because it's the contribution of various factors. Definitely, the portfolio mix has an impact. So we've seen growth in commercial, and that does contribute reduction that we would expect a little bit on the liquidity side with impact as well. And at one point, the repricing of the assets will have an impact. So it's really all those points, and that's all understanding that the discipline has to be in the market in terms of repricing of the assets also.

[Nigel D'Souza, analyst]

Okay. It sounds like it's a combination of factors. All right. So if I could just switch gears and maybe a broader question. Looking at your SOI, it doesn't look like a recession is your base on area at the moment. But if that does change and the best scenario is one of the recession. Does that impact your strategic road map or your strategic plans going forward? How does that change things?

[Yvan Deschamps, executive]

Yes. I would simply just, in fact, repeat what I just mentioned, Nigel, because it's the contribution of various factors. Definitely, the portfolio mix has an impact. So we've seen growth in commercial, and that does contribute reduction that we would expect a little bit on the liquidity side with impact as well. And at one point, the repricing of the assets will have an impact. So it's really all those points, and that's all understanding that the discipline has to be in the market in terms of repricing of the assets also.

[Nigel D'Souza, analyst]

Okay. It sounds like it's a combination of factors. All right. So if I could just switch gears and maybe a broader question. Looking at your SOI, it doesn't look like a recession is your base on area at the moment. But if that does change and the best scenario is one of the recession. Does that impact your strategic road map or your strategic plans going forward? How does that change things?

[Karine Abgrall-Teslyk, executive]

Why don't I talk about the scenario and then I'll pass it to Rania on the strategic side. We have updated our scenarios as we do every quarter in a regular process and look forward. Our pessimistic scenario does include moving to a lower economic growth pattern, call it recession and how long and prolonged that it depends on how the macroeconomic conditions evolve. I mean you heard from Jackson, the Fed chair you've heard the Bank of Canada indicate they are going to be moving to reduce inflation, and that's going to have a direct impact to the economy, and we factor that in. As I mentioned earlier, we've also adjusted the weightings on our outlook across our economic scenarios, both last quarter and this quarter, support more weight on the weaker scenarios. -- and our reserving will remain prudent, and we'll adjust accordingly. In terms of the strategic implications for that and how the economic profile might affect our strategy, Rania?

[Rania Llewellyn, executive]

Yes. So thanks for that question. What I would say is, as I had mentioned, we delivered on a lot of things this year, right? So we said it's a digital-first approach. We said we were going to grow the commercial book of business. We're going to diversify. So we feel pretty confident that we've built a lot of foundational pieces that should we decide to slow down some other strategic projects, we have enough of a foundation that we can use it as a launching cat or growth acquisition, retention, cross-selling while being very selective as to where else do we want to invest in.

So I think we have the appropriate levers. We feel we're very well positioned at this point, both from a provisioning perspective as well as from an expense management perspective. But it's definitely something that we will come back to you in Q4 to kind of outline what are some of the strategic deliverables we're going to deliver on. But we're very committed to our 3-year strategic plan. We've been executing according to the plan. And so we'll continue to, like I said, dynamically manage where we need to, depending on how the conditions change. Does that answer your question?

[Nigel D'Souza, analyst]

Yes, it did.

[Operator]

And we'll move on to our next question from Marcel McLean with TD Securities.

[Marcel Mclean, analyst]

Two real quick ones for me. Just going back to the capital. You said that you had a toolkit there that you can deploy if loan growth continues to exceed expectations. Just wondered if the -- an ATM is part of that. I don't want your peers has been using it for a number of quarters. And maybe if there's a certain level where that does get implemented, when you dip below this 9%, that was your pre-pandemic level? Or are you comfortable letting it drop to 8.5? Just kind of wondering what your thoughts are on that.

[Yvan Deschamps, executive]

Thank you for your question. That's a good one. I don't want to go too much in the details of my toolkit as you can imagine. But what I can say definitely is ATM is not at the top of that is, right? So at this point, we're pretty comfortable with the level where we stand. And I mentioned pre-pandemic, we're at 9%. So it's not like we're very low. We're just getting back to where we were, which is a normal level for the bank. -- our minimum is 5, so we still have a cushion. So again, I'm going to repeat a bit myself. We started the share buyback. We reintroduced the DRIP. So there's a few things like that we can easily do. But the ATM is not on the forecast for that for now.

[Marcel Mclean, analyst]

Okay. And then secondly, on the NIM. If I'm hearing you correctly, it's actually going to be -- we're going to have to wait until we see a period -- a quarter where we see stability in the Bank of Canada rate before we really start to see an improvement in your NIM, and that's when the improvement might come through more. Am I hearing that correct? Or is there more to it...

[Yvan Deschamps, executive]

Yes, I'll answer with yes and no to that. So the first thing is we mentioned that we're going to see an expansion of the NIM where we expect to see one in Q4, and we'll provide more guidance on '23. And again, I don't want to be too much myself, but liquidity level, asset mix and the lag of repricing. What I'm going to answer you may be right in a certain way is the repricing of the loans because the fact that for the -- part of the loan that I have that has a repricing lag of a month or a few days or something like that, definitely, as the interest rates stop increasing, we're going to catch up fully. So that will have an impact. And the other pricing lag that I discussed is relative to the market, and that one is a bigger question and industry-wide question.

[Operator]

And we'll go ahead and take our last question from Joo Ho Kim with Credit Suisse.

[Joo Ho Kim, analyst]

Just had a couple of quick ones here. Just on the tax rate, it was lower than what we saw in the prior period. So I was wondering if there's anything unusual or onetime in nature? I'm just trying to get a sense of whether that 15% in effective tax rate is appropriate going forward.

[Yvan Deschamps, executive]

Yes. It's a very good question, Joo. And a big portion of that is technical. So this quarter about 16, last quarter 20, about close to half of it is coming from the repayment of the LRCN because the way it's done is the interest payment is done below interest net -- sorry, it's done below the net income, while the tax is impacting the net income. So every time we have the interest payment, it does reduce the tax rate. So you would see that every 6 months because we pay that every 6 months. The rest is a mixed bag depending on the level of profitability of the various elements. So next quarter, just pick something in the middle of that, and you should get closer to what we would expect for Q4.

[Joo Ho Kim, analyst]

And last one for me. Just on your noninterest revenue. When I look at the sort of more traditional retail banking revenue, we saw decrease in lending fee service and sort of card revenue on a year-over-year basis. Just wondering what that year-over-year decline this quarter.

[Operator]

Sorry, if you can just speak up a little louder, it was really hard to hear.

[Joo Ho Kim, analyst]

Sorry, can you hear me better now?

[Operator]

It's still a little staticky, so...

[Joo Ho Kim, analyst]

Sorry, I'll try it again. I just had a question on the noninterest revenue. When I look at the sort of the traditional retail banking revenues, like the card fees and service fees, just -- they were down year-over-year. Just wondering what drove that decline this quarter.

[Yvan Deschamps, executive]

Yes. The key element this quarter relative to that would be card services. So it's lower this quarter because we had a promotion program to increase the velocity and use of the credit cards. So that impact Q3, in fact, by a little bit more than $1 million. So this one is really a onetime. So you would see that being corrected in Q4 in terms of level of revenue. The rest, I would say, is relatively in line versus what you would have seen over the last few quarters. So again, just to be very clear, we would expect the Visa revenue to increase back to pretty much where it was...

[Operator]

And with that, that does conclude our question-and-answer session for today. I would now like to hand the call back over to our CEO, Rania Llewellyn for any additional or closing remarks.

[Rania Llewellyn, executive]

In closing, following a solid Q3, we will continue to execute against our strategy as we head into Q4. Our credit quality is sound, and we are confident in our strong underwriting practices and highly collateralized portfolio. We will continue to apply strong cost discipline across the organization and identify additional cost optimization opportunities. Our one winning team is engaged and continues to show resilience through this period of volatility. We remain confident in our ability to exceed our 2022 financial targets. Thank you for joining the call today.

[Operator]

And with that, that does conclude today's call. Thank you for your participation. You may now disconnect.