Laurentian Bank of Canada

TSX:LB

Earnings Call Analysis

Earnings Call Transcript 2023-Q3

[Operator]

Welcome to the Laurentian Bank Quarterly Financial Results Call. Please note that this call is being recorded. I would now like to turn the meeting over to Andrew Chornenky, Vice President, Investor Relations. Please go ahead, Andrew.

[Andrew Chornenky, Vice President, Investor Relations]

Good morning and thank you for joining us. 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 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 under the Investor Center.

I’d like to remind you that during this conference call, forward-looking statements maybe 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 Llewellyn will be referring to adjusted results in their remarks unless otherwise noted as reported.

I will now turn the call over to Rania.

[Rania Llewellyn, President and Chief Executive Officer]

Thank you, Andrew and thank you all for joining us today. This morning, we announced solid Q3 results and I am extremely pleased with the progress we continue to make on our fiscal year 2023 priorities. On behalf of the entire management team, I would like to thank everyone at Laurentian Bank for their resilience and focus on executing against our plan.

Before providing an overview of our third quarter, I would like to address our recently announced business update. On July 11, the bank announced that our Board of Directors and management team are conducting a review of strategic options to maximize shareholder and stakeholder value. The review is still underway and we do not intend on disclosing further developments until it concludes.

During this time, we remain committed to executing on the bank’s strategy and our fiscal 2023 priorities with the full support and confidence of the Board. Over the past 2.5 years, the bank’s renewed senior leadership team and Board have been focused on building up the bank for sustained growth and profitability. Since the launch of our plan in December 2021, we exceeded all our financial targets against the backdrop of an increasingly challenging macroeconomic environment and market volatility.

Quarter after quarter, we have been delivering on key milestones as set out in our plan and exceeded market expectations in 11 of the past 12 quarters, including today. We have closed our customers’ top 5 digital pain points, including the launches of our mobile app, digital account opening solution and reimagined Visa experience. And we grew our key specializations within commercial banking. We continue to maintain a strong capital and liquidity position and our funding and deposit base remains strong, stable and diversified. The rest of this call will focus on Q3 progress and results. To reiterate, we will not be providing any further details about the strategic review during the Q&A portion.

Turning now to our financial results. Top line revenue for the quarter was $261 million, up 1% compared to last quarter and relatively in line with last year. EPS was $1.22 or up 5% quarter-over-quarter and relatively in line compared to last year.

A few additional highlights include: a sequential improvement of 120 basis points in our efficiency ratio to 68.5%, an increase of 10 basis points in our ROE to 8.2%. NIM was up 4 basis points, in line with our previous guidance. PCLs this quarter were 14 basis points, down 4 basis points year-over-year and sequentially due to the seasonal reduction in utilization rates in inventory financing. We continue to be prudent with our reserves and remain adequately provisioned.

Commercial loan growth was up on a year-over-year basis, but down sequentially as our inventory financing portfolio continues to normalize in line with pre-pandemic behavior. Utilization rates this quarter were 49%, down from 58% in Q2. The third quarter is typically a period of seasonal volume reduction caused by dealers experiencing strong sales due to good consumer demand. We expect utilization to increase in Q4 as dealers begin restocking their inventory. We are closely monitoring turnover of the product, which remains healthy and is a key performance indicator.

In commercial real estate, while demand for new housing remains high, there has been a general slowdown in activity across the sector. Projects in progress continue to be developed. However, we are hearing from some of our customers that they are waiting for inflationary and interest rate pressures to cool before launching new projects.

Our unfunded pipeline continues to be strong and we remain comfortable with our portfolio given our focus in the multi-residential sector and the continued demand for housing in Canada. I am pleased to share that our capital position was further strengthened as a result of internal capital generation and the seasonal volume reduction in inventory financing. We ended the quarter at 9.8%, up 50 basis points on a sequential basis. Looking forward, we will continue to drive results in line with our strategic plan. For fiscal 2023, we identified three priority areas to stimulate growth; first, deliver excellent customer service; second, deposits and optimizing our funding structure; and third, drive efficiencies through simplification.

I will now cover key achievements under each priority, beginning with customer experience. We said at the beginning of the year that we will continue our focus on delivering excellent customer service and removing pain points by leveraging data from our net promoter score or NPS program. This concentrated effort is helping us gain a deeper understanding of what drives customer satisfaction and dissatisfaction, allowing us to implement targeted solutions. Last quarter, we announced that Personal Banking saw a significant improvement in their NPS scores. This quarter, we launched a new Customer Experience Council, which brings together cross-functional groups to align on enhancements to the customer experience. I am pleased to announce the following improvements in our NPS scores.

Private Banking has achieved an excellent NPS rating, which is a score above 50 points. Branch NPS increased by 3 points sequentially and 19 points since the beginning of the year. And our Loyalty Team NPS was up 4 points sequentially or 16 points since the beginning of the year. This is a testament to our continued focus on the customer and putting them at the center of all our actions.

In Q1 2023, we announced the launch of a mortgage financing center to improve the customer experience by handling all mortgage acquisition and refinancing solutions for our retail branches. As a result of this group’s high degree of specialization, we have achieved a first-time right score of 96% for mortgages, up from 90% last year. And have successfully reduced the time to yes to less than 2 days, in line with industry standards and exceeding our 3-year target of less than 3 days.

One final point on customer experience is that now we have migrated more than 70% of our public website to the new modernized look and feel. This is providing a consistent brand experience for our customers and improves navigation on our website. The second priority we identified this year was a focus on deposits and optimizing our funding structure. We are committed to maintaining a diverse, stable and strong balance sheet that supports loan growth.

Following the launch last quarter of our digital account opening solution to the public, I am pleased to announce that 66% of customers being onboarded through this channel are new to the bank and more than 40% are from outside of Quebec. This is in line with our strategy to acquire additional net new customers as well as grow our customer base outside of our traditional branch footprint. Following a recent marketing effort on deposit campaigns with a particular focus on our high interest savings account, we have seen a 50% increase in checking account openings and 125x increase in high interest savings accounts opened on a year-to-date basis.

Finally, we have launched a new virtual first pilot to enhance the customer experience by serving customers where and how they want, while still maintaining a presence in our communities. This pilot will also enable us to offer additional products and services to our recently acquired customers from across Canada through an advice-based model.

Our third priority is to drive efficiencies through simplification. We remain committed to reducing our efficiency ratio over the medium term by further streamlining our internal processes and operations. As part of our drive to enhance efficiencies, we launched a business efficiency program within Personal Banking at the beginning of this year. This program was established to identify key initiatives that will support the bank in meeting its medium-term efficiency target.

So far this year, we have identified and achieved 93% of our 2023 target in annual recurring savings. Three key initiatives include: first, we are relocating branches with expiring leases to smaller, modernized and more convenient locations for our customers improving the customer experience and reducing costs. Second, we are harmonizing contracts for physical paper storage and reducing unnecessary licenses. And third, we are digitizing documents and checks across 9 remote branches, which will reduce expenses by replacing internal mail with a digital document exchange.

Culture and ESG also remain a significant priority with culture as the driving force of our strategic plan, which is underpinned by our commitment to ESG. This year marked our third annual employee survey. Over the last 3 years, we have put a heavy emphasis on everyone’s work life experience. As a result, since the first survey in 2021, our overall response rate has gone up from 66% to 85%.

I am particularly pleased that our overall engagement has gone up from 74% to 80%, which is higher than the industry benchmark of 78% and achieves our fiscal year 2024 target 1 year early. I would like to thank everyone at Laurentian Bank for their focus on creating a better employee experience. Two other highlights under culture and ESG that I would like to mention include: an improvement to our Sustainalytics ESG score, which maintained our low ESG risk rating and launched our third annual Laurentian Bank in the community giving campaign allocating more than $150,000 to community-based charities and not-for-profit chosen by our frontline team members.

I will now turn the call over to Yvan.

[Yvan Deschamps]

I would like to begin by turning to Slide 13, which highlights the bank’s financial performance for the third quarter. Total revenue in the third quarter was $260.8 million, relatively in line with last year and up 1% on a sequential basis. Higher net interest income year-over-year from commercial loans was offset by higher funding costs and a lower contribution from financial markets related revenue, which continues to be impacted by sustained unfavorable financial market conditions. On a reported basis, net income in the third quarter was $49.3 million and EPS was $1.03. The Adjusting items for the quarter amounted to $8.4 million after tax or $0.19 per share and are related to restructuring charges from the rightsizing of the bank’s capital markets franchise announced last quarter, strategic review related charges and the amortization of acquisition-related intangible assets.

Details of these items are shown on Slide 29. The remainder of my comments will be on an adjusted basis. Growth in net interest income, cost discipline and lower loan losses drove this quarter’s solid results. EPS of $1.22 was up 5% quarter-over-quarter and down 2% year-over-year. Net income of $57.6 million was up 12% compared to last year and down 1% compared to – sorry, 1% last quarter. The efficiency ratio improved by 120 basis points quarter-over-quarter to 68.5% despite continued investments in key strategic priorities. ROE was up 10 basis points sequentially to 8.2%. This quarter also included in RCN interest payment, which negatively impacted EPS by $0.06.

The Slide 14 shows net interest income, up by $3.6 million or 2% year-over-year, mainly due to higher net interest income from commercial loans, partly offset by higher funding costs and lower mortgage prepayment penalties. On a sequential basis, the increase of $7.9 million or 4%, mainly reflects the positive impact of 3 additional days in the quarter and sequentially higher mortgage prepayment penalties. Net interest margin was up 4 basis points sequentially to 1.84%. This is mostly due to improved funding costs and higher mortgage prepayment penalties.

Slide 15 highlights our diversified sources of funding and the bank’s liquidity position. Year-over-year, total funding increased by $800 million through cost effective partnership deposits of $1 billion and retail deposits of $300 million, which were offset by a planned decrease in wholesale deposits. On a sequential basis, total funding was relatively flat. We saw a continued transition of deposits to term from demand accounts. The bank maintained a lot a strong liquidity coverage ratio through the quarter.

Slide 16 presents other income, which decreased by 4% compared to last year. Because of unfavorable market conditions impacting financial markets-related revenue, including fees and securities brokerage commissions, income from mutual funds and income from financial instruments. On a sequential basis, other income was down 6% or $4.3 million, mainly for the same reasons.

Slide 17 shows non-interest expenses, up by 2% compared to last year, mainly due to higher technology, depreciation and amortization costs as the bank continues to invest in its strategic priorities to improve the customer experience and support growth. On a sequential basis, Non-interest expenses were slightly lower due to performance-based compensation.

Turning to Slide 18. Our CET1 ratio was up 50 basis points to 9.8%, mostly due to internal capital generation and the seasonal inventory financing loan reduction.

Slide 19 highlights our commercial loan portfolio, which was up by $400 million or 3% year-over-year. As guided in Q2, on a quarter-over-quarter basis, the portfolio was down $800 million or 4% due to a reduction in inventory financing, which saw a normal seasonal portfolio reduction with utilization rates and behavior, more in line with pre-pandemic patterns. Consumer goods acquisitions from dealers last quarter showed strong resilience despite the uncertain economic environment. Dealers begin restocking in Q4, and therefore, utilization rates are expected to increase next quarter.

Slide 20 provides details of our inventory financing portfolio, where key performance indicators, such as the age of inventories and turnover rates are monitored closely. Credit line utilization rates are back to pre-COVID levels for this quarter currently standing at 49%. Given the current economic environment, we are monitoring the portfolio closely and continues to perform well with a high level of dealer sales as previously mentioned.

In commercial real estate, homebuilding continues to meet the demand of rising immigration levels in Canada. However, some developers are being prudent in delaying the start of some projects until inflationary pressures and interest rates ease. As seen on Slide 21, the majority of our portfolio is in multi-residential housing and only around 3% of our commercial loan portfolio is in office.

Our office portfolio consists of Class A or B assets and financial recourse to strong and experienced sponsors. As we said last quarter, the majority of the portfolio is in multi-tenanted properties with limited exposure to single tenanted buildings.

Slide 22 presents the bank’s residential mortgage portfolio. Residential mortgage loans were up 4% year-over-year and flat on a sequential basis. We maintain prudent underwriting standards and are confident in the quality of our portfolio. As evidenced by the high proportion of insurance mortgages at 58% and low LTV of 48% on the uninsured portion. It is also worth noting that more than 80% of our residential mortgage portfolio is in fixed rate, of which almost 80% will mature in 2025 or later.

Allowances for credit losses on Slide 23, totaled $217.1 million, up $23.9 million compared to last year. Mostly as a result of higher provisions on commercial loans related to volume growth and macroeconomic uncertainty. Allowances for credit losses were up $5.5 million sequentially, mostly as a result of higher provisions on commercial loans.

Turning to Slide 24. The provision for credit losses was $13.3 million, an improvement of $3.3 million from a year ago, reflecting lower provisions on performing loans, partly offset by higher provisions on impaired loans. PCLs were down $2.8 million compared to last year, mostly for the same reasons.

Slide 25 provides an overview of impaired loans. On a year-over-year basis, gross impaired loans increased by $43.1 million and were up $18 million sequentially. We continue to manage our risk with a prudent and disciplined approach and remain adequately provisioned.

Last quarter, we provide detailed guidance for the remainder of 2023 and I would like to note a few key points. We expect a slightly higher efficiency ratio in Q4 with lower NII due to the recent seasonal inventory financing loan reduction. Unfavorable financial market conditions and higher expenses mostly related to costs associated with transitioning our current Visa customers to the new Brim platform.

We expect relatively muted loan growth in Q4 as macroeconomic conditions impact business and consumer spending. Despite an increase in inventory financing as dealers start restocking inventory and utilization rates increase. NIM is expected to remain relatively stable but may be impacted by central bank rate decisions. PCLs remain difficult to predict given the uncertain macroeconomic environment, but are expected to be in mid to high teens. Capital is expected to remain strong.

I will now turn the call back to the operator.

[Operator]

Thank you. [Operator Instructions] Your first question comes from Meny Grauman with Scotiabank. Please go ahead.

[Meny Grauman, Scotiabank]

Hi, good morning. Rania, I appreciate you can’t comment on the strategic review you were clear, but I’m just curious if investors should be prepared for some financial impact from the strategic review as it goes on? Like is there anything that we should be prepared to see in terms of slowdown on the revenue side, maybe elevated expenses as maybe decision-making gets slowed down or maybe some type of client attrition in this period of uncertainties, so anything there that you can offer a perspective on?

[Rania Llewellyn, President and Chief Executive Officer]

Yes. So thanks, Meny. As I said in my remarks, and I’ll just kind of reiterate it, I won’t be providing any comments until the review is completed entirely. And so it’s currently ongoing. But what I can say is that our Q4 guidance, which are in both my comments as well as Yvan, is really what you should be guided with. And so – we are focused on our fiscal 2023 priorities. We’re delivering against them, and we’re committed to our 3-year strategic plan. So it’s business as usual. And once the review is completed, that’s when we’ll be providing additional comments.

[Meny Grauman, Scotiabank]

Fair enough. And then just a question on credit better than expected. There’s an interesting chart on Slide 24 in terms of the PCL ratio comparing the Laurentian to peers, and it looks like that gap is definitely widening. And I’m wondering how investors should interpret that? Like is this a function of business mix here? How do we understand such a better PCL ratio relative to the peer group? And it appears to be widening as well. So just curious about that.

[Liam Mason, Chief Risk Officer]

Meny, good morning. And thank you for the question. It’s Liam Mason, Chief Risk Officer. We’ve been very disciplined in setting our reserves. You may recall some time ago, after the pandemic, others were releasing, we were prudent and measured and maintained our ACLs through that period. This quarter, it’s really driven by a couple of factors. First off, as both Rania and Yvan noted, our ACLs are coming down due to a drop in volumes in inventory finance, and that’s one of the major factors. The other is that we’re seeing lower write-off levels. So overall, given the strength of our underwriting standards and prudent approach, we’re very comfortable with our PCLs and ours ACLs, and we expect going forward to get to around mid to high teens as Raina indicated.

[Meny Grauman, Scotiabank]

Thanks, Liam.

[Operator]

Your next question comes from Paul Holden with CIBC. Please go ahead.

[Paul Holden, CIBC]

Thank you. Good morning. A couple of questions on capital to start. So looking at sort of the waterfall leading us to the Q-over-Q increase in Q3. I would assume some reversal of that RWA benefit next quarter, but it sounds now like despite inventory finance going back up overall loan growth is expected to be muted. So just trying to figure out what the implication is for CET1 given typical seasonality, but slowing demand in loans?

[Yvan Deschamps]

Thank you, Paul, for your question. This is Yvan. So this quarter, the 50 bps, in fact, 10 of that came from internal capital generation. Most of it, as you mentioned, came from RWA variations, mostly related to the inventory fining reduction, seasonal impact that we’ve seen. So going forward, we expect the inventory financing to go back to normal behavior that we have pre-COVID environment. So Q4 should see a start of an increase with Q1 being usually where they restock most of their equipment. So we will definitely probably use that for those two quarters, but we also have internal capital generation that will absorb a portion of that. So overall, for the next quarter, we expect the capital to remain pretty strong.

[Paul Holden, CIBC]

Okay. And I guess my follow-up question, and you expect capital to remain strong. Maybe just a reminder on what your target CET1 is. But then, let’s say, loan growth is kind of slower than normal because of the cycle. Are there other alternative uses of capital that you would think about executing on near-term? Or would you more likely keep that capital in your back pocket for when economic conditions improve?

[Yvan Deschamps]

Yes. Thank you. So I would say at this point, we’re happy and comfortable with the level of capital that we have in the current economic environment. It’s a good position to be – we always said that the internal growth is our key focus in terms of capital deployment. We had mentioned that we wanted to be above 9% this year. So we’re healthy right now in terms of capital base and really prudent in the environment. But that remains really our key strategic priority is to deploy that internally with growth. But as mentioned many times in my comments, very happy with the level we have right now.

[Paul Holden, CIBC]

Okay. Got it. And then this will be my last question. So given that – does that suggest then there might be opportunities to grow market share with respect to loan growth? And if yes, where would you say are your best opportunities today to grow share?

[Rania Llewellyn, President and Chief Executive Officer]

Yes. So maybe I’ll take this one, Paul, just in terms of – again, we would be assessing things against the current market conditions, our risk appetite in areas where we can win. Ultimately, our goal is to deploy capital where we can maximize shareholder return and earn the largest risk adjusted risk-weighted adjusted return, right? So wherever we can deploy it most efficiently and get the biggest return. So that’s part of our ongoing day-to-day operations is to maximize the return in terms of how we deploy our capital. But as Yvan said, I think everyone on the street, everyone is trying to be prudent because markets are quite uncertain right now. And so we’re comfortable where with that from a capital position, and we’ll continue to review it on a regular basis.

[Paul Holden, CIBC]

Okay. Thanks for that.

[Rania Llewellyn, President and Chief Executive Officer]

Thanks, Paul.

[Operator]

Your next question comes from Darko Mihelic with RBC Capital Markets. Please go ahead.

[Darko Mihelic, RBC Capital Markets]

Hi, thank you. Good morning. I just wanted to go back to the discussion on the restocking of inventory and your expectations. And we’ve received, I don’t know, the last couple of days, very reduced expectations next year, in particular for Marine. I mean, MasterCraft has really lowered its expectations Polaris, Malibu Boats, all of them suggesting that there’s both sitting on dealer lots, prices are declining, the interest rate environment is affecting demand. And this is all about recreational, very discretionary type of spend really coming down next year in the U.S. So I would assume ATVs and things like that would also be off quite a bit. And when I look at your Slide 20, I look at marine and recreational vehicle as being a very big component. And so I’m really surprised. So Yvan, is there something that I’m missing? Or is there – you’re expecting very big demand in manufactured housing or other – or is it clear that maybe your customers or the borrowers that you’re servicing there are very different from the broader market. Any help on that would be – because my expectation would have been that you would not see significant restocking. And in fact, you’d probably be significantly weaker lending volumes into next year?

[Eric Provost, Head, Commercial Banking]

Darko, it’s Eric Provost, Head of Commercial here. I’m going to take this one, if you don’t mind. Actually, right now, for sure, it’s more difficult to predict the level of restocking we’re going to see. So I don’t think Yvan mentioned significant restocking. I think that we will see throughout the Q4 and Q1 our dealers approach next season. And for sure, with the interest rate, they will be prudent – but let’s not forget, like in times like these, sometimes OEM will put out special programs. They will try to structure to facilitate the dealers to actually onboard the new year product. So it is expected that our dealer base will restart for sure in Marine and RV for the next season, but also need to be noted, and we’ve highlighted that in the previous calls, we’re also aiming our inventory financing towards a diversified approach. So we are growing ag, we’re growing construction. We’re growing our IT dealer base as well. And from there, we do expect some good momentum as well going towards 2024.

[Darko Mihelic, RBC Capital Markets]

Okay. Great, that’s helpful. Thank you very much.

[Operator]

Your next question comes from Sohrab Movahedi with BMO Capital Markets. Please go ahead.

[Sohrab Movahedi, BMO Capital Markets]

Okay. Thank you. I appreciate the strategic reviews on ongoing and you don’t want to talk about the outcome of it. But can I just ask you to maybe validate some of the time lines that were mentioned in some of the press articles. And specifically, whether or not the Board engaged in a strategic review almost immediately or coincidental with when you had your Investor Day. Am I understanding that time line correctly?

[Rania Llewellyn, President and Chief Executive Officer]

Yes. So Sohrab, I can’t really comment on what’s in the press. All I can kind of comment on is what we released in our press release and the comments that I’ve been disclosing on this call. Which is listen, we’re 2 years into a 3-year strategic plan. And the obligations of management and the Board is to continuously be looking at various strategic alternatives and options and to ensure that we’re constantly maximizing the shareholder value. So it’s the optimal time to take a longer-term view. And so again, the review is currently ongoing and we’ll comment in terms of what are the next steps once it’s completed.

[Sohrab Movahedi, BMO Capital Markets]

Okay. And Yvan, I appreciate the some of the outlook commentary you offered, looking ahead into the fourth quarter. One of them was where you expect the expense to revenue ratio to probably settle in unfavorable, I guess, revenue environment and some – it sounds like some of that decided costs, holding things back a little bit relative to expectations. But – what should we be thinking about next year as far as this expense to revenue target and ratio?

[Yvan Deschamps]

Thank you, Sohrab. So maybe I can explain a little bit more on Q4 to start with. So we mentioned – I mentioned in my comments that due to the loan reduction, there’s going to be a slight reduction in NII. So that does put pressure on the efficiency ratio. The other key element is that we mentioned is the visa migration of our existing customers, which is currently ongoing. So most of that – in fact, all of that is expected to be done by the end of the calendar day. So there is clear pressure on the expenses coming from that element. In terms of ‘24, we are currently working in budget and reviewing our plans, as you know. So I would keep and get back to you in Q4 with more details on that.

[Rania Llewellyn, President and Chief Executive Officer]

Just to add to that, Sohrab, I think the only thing that we are – we can continue to say is that we are committed to reducing our efficiency ratio. We’re highly focused on expenses. But yes, stay tuned for Q4 as we work through our budget in terms of further guidance.

[Sohrab Movahedi, BMO Capital Markets]

Thanks for taking my question.

[Operator]

Your next question comes from Gabriel Dechaine with National Bank Financial. Please go ahead.

[Gabriel Dechaine, National Bank Financial]

Good morning. First question about the NIM, and I heard you say and it’s in the slides about – talk about mortgage prepayment penalties. I am just a bit surprised to see that being an influencing factor this quarter. I don’t think people are paying down their mortgages and refinancing because of higher rates. Maybe I am thinking about it the wrong way, and you can clarify?

[Yvan Deschamps]

Yes. Thank you, Gabriel. This is Yvan. So, the mortgage prepayment penalties is also something that is seasonal. You would see more houses being sold in the spring, beginning of the summer, and things like that. So, there is some influence getting there. Definitely, there is less prepayment penalties than what we had a few years ago while the rates were lower. So, your assumption is good but if we compare with last quarter, the rates were – last quarter and this quarter, it’s mostly seasonally related to activity.

[Gabriel Dechaine, National Bank Financial]

Okay. Just like – I got it. It’s not – it’s probably down from last year, I would imagine as well.

[Yvan Deschamps]

It’s down from last year. It’s up from last quarter.

[Gabriel Dechaine, National Bank Financial]

Okay, cool. Now with North Point, I know the revenue contribution. I know the loan – percentage of loans represents – unless I am missing it, which is possible, but I don’t know the profit contribution. Could you clarify how much North Point contributes to your profits?

[Yvan Deschamps]

Yes. Thank you for your question, Gabriel. But unfortunately, we don’t disclose product level profits and contribution. So, that’s not something that we disclose.

[Gabriel Dechaine, National Bank Financial]

Well, could you tell me that my assumption that it’s disproportionate contributor to profit, so it may be whatever, 15%, 20% of revenue, but in terms of earnings, it could be more than that because if I just look at the loan mix, mortgages are a big chunk, but they are not that profitable.

[Yvan Deschamps]

Unfortunately, we don’t disclose product level contribution. So, I cannot confirm or infirm your – what you are saying. We just don’t disclose the product profitability.

[Gabriel Dechaine, National Bank Financial]

Alright. Thanks. Enjoy long weekend.

[Yvan Deschamps]

Thank you.

[Operator]

Your next question comes from Doug Young with Desjardins. Please go ahead.

[Doug Young, Desjardins]

Hi. Good morning. Maybe sticking with the NIMs, was there anything else unusual in the quarter? And when you are talking about for Q4 stable NIMs, I assume that’s relative to the 184 in Q3, just wanted to confirm that.

[Yvan Deschamps]

Yes. Thanks for your question, Doug. I will take that one. So, for the NIM, the first settlement this quarter, which is interesting is that we have improved funding costs. And the way it works is that despite potentially higher, by example, GIC rates versus what you would have last year, the spread versus the swap rates are lower than they were. So, what we do is that when we get, for example, fixed term GICs for our funding, we would translate that – or sorry, hedge that and convert that to variable rates. So, the spread versus the swap rate is a key component that impacts the profitability. And those spreads reduced versus last quarter, and it did contribute to the profitability of the bank. And definitely, as I have mentioned with Gabriel a few months ago, the fact we are higher in terms of prepayment penalties, that goes in the margin as well. So, maybe a bp, up to 1 bp a bp less than 1 bp came from prepaid prepayment penalty, and most of it came from lower funding costs.

[Doug Young, Desjardins]

So, your assumption on those funding costs are essentially the same, but if there is a movement that positive or negative, that could swing a few basis points in Q4. Is that a fair assumption?

[Yvan Deschamps]

Yes. It’s a good assumption, Doug, at this point. When we say relatively stable, it all depends on spreads. It depends on where the central banks will be going. There is a lot of factors impacting the bank margin. But at this point, if I assume most of the conditions remaining about the same, the margin should be relatively close.

[Doug Young, Desjardins]

Okay. And then second, just on the PCL discussion. The release of performing loan PCLs is very different than what we have seen from others. And I get that the inventory financing was a contributor to that. Was there any other changes in your forward-looking indicators or your weightings between the different scenarios that resulted in the release of performing loan allowances, or was this all attributed to the inventory financing?

[Liam Mason, Chief Risk Officer]

Yes, Doug, Liam, CRO, it was all related to inventory financing variation. Indeed, we have maintained our strong reserves against other parts of the portfolio and very happy with where we are at all inventory financing.

[Doug Young, Desjardins]

Okay. And then just lastly, on expenses, the strategic review is costing money. Is this a level that we are seeing, or can you give us a sense of how much this is going to cost when we build into our models? And I get it that it’s backed out of cash, but it does impact reported and capital and whatnot, just trying to get a sense of the ongoing costs related to this.

[Yvan Deschamps]

Yes. And thank you for your question, Doug. But the level that we have in Q3, you should expect we are getting worse still in the strategic review. So definitely, there is going to be cost, but we will get back to you if there is big movements there. But at this point, you should expect something relatively around the same number, but something like that. So, it’s a relatively small amount at this point.

[Doug Young, Desjardins]

Okay. Good. Thank you.

[Operator]

Your next question comes from Lemar Persaud with Cormak. Please go ahead.

[Lemar Persaud, Cormak]

Yes. Thanks. For Yvan, what is the expectation for stable NIMs next quarter if we are going to see inventory finance volumes come back on? And this quarter, you saw some improved funding costs. Like what am I missing here? Are you just being conservative? Because I would think that with inventory financing coming back on, that would be accretive to NIMs, or maybe if the answer is that you are going to offer more promotions on the inventory finance business to facilitate growth in response to an earlier question, like help me square that one up.

[Yvan Deschamps]

Yes. No problem, Lemar. One thing that is important is the NIM is impacted by the average volume of a quarter, right. So, there has been a big decrease or $700 million related to inventory financing in Q3. So technically, despite the fact that it can go up in Q4, it’s really the average of the quarter that will impact it. So, at this point there is no benefit that we expect from inventory financing. In fact there is potentially a small negative impact on the margin because of the volume reduction and the level of the margin of inventory financing. So, think added really from an average order asset-based perspective.

[Lemar Persaud, Cormak]

Okay. So, if I understand it correctly then, the return of those volumes will be more of a Q1 margin story. Is that fair to say?

[Yvan Deschamps]

Exactly, so what you are going to see in Q4 will impact Q1, as you mentioned, and the increase we are going to see in Q1 will gradually impact Q1 and Q2. So, there is always a small lag related to the average balances of those quarters.

[Lemar Persaud, Cormak]

Very helpful. And then my next question for Rania. I know you can’t talk about the strategic review process. But I just want to be clear because you did throw it out there, are the Investor Day targets still valid despite the strategic review process? Is that the way to think about it?

[Rania Llewellyn, President and Chief Executive Officer]

Yes. So, as I have said in my comments, and yes, I will reiterate it, we are focused on our 3-year strategic plan. We have been delivering against it. We are finalizing the second year of the third year. So, the targets at this point continue to be the targets that we are all collectively as a management team and as a bank working towards.

[Lemar Persaud, Cormak]

Okay. I appreciate that. And then my final question, just a modeling-related question. Would it be fair to suggest that there is some improvement in capital markets related revenues into Q4? Just any comment on that would be helpful.

[Yvan Deschamps]

I guess the markets are really – I am sorry, at this point, so it’s really difficult to expect. But seasonally as well, the summer is currently – has been impacting Q3 as it does every year. So, we would expect a slight improvement, but this is all depending on the financial market conditional loan...

[Karine Abgrall-Teslyk, Head, Personal Banking]

Yes. I will jump in, it’s Karine Abgrall-Teslyk here. Like we are expecting to see a resumption of sort of the activity that we would characterize as a more normal run rate for capital markets, keep in mind, our business is heavily focused on fixed income. Already in the first quarter, we have seen some decent activity on the DCM side, and we have been participating in that. So, we are cautiously optimistic that we will see a resumption to more normal run rate market – capital market run rate revenue numbers.

[Lemar Persaud, Cormak]

Thanks. Appreciate the time guys.

[Operator]

Your next question comes from Nigel D'Souza with Veritas Investment. Please go ahead.

[Nigel D'Souza, Veritas Investment]

Thank you and good morning. I wanted to follow-up on credit losses. And when I look at the gross impaired loans, there is uptick quarter-over-quarter, particularly in commercial, but you are not seeing that necessarily show up in credit losses proportionately. So, wondering if you could elaborate on the expected loss rates in commercial and what were the specific exposures in commercial that can be for [ph] this quarter?

[Liam Mason, Chief Risk Officer]

Yes. Hi Nigel, it’s Liam Mason. We are very, very disciplined in terms of our approach to impaired loans. You will see that by the time they get to fully impaired, generally, we have very, very or appropriately prudent reserves against them. We have a disciplined workout process. It does take some time. But overall, there is nothing new here other than variations commensurate with the macroeconomic environment. So, I will just reiterate the expectations that Rania and Yvan laid out that we expect mid to high teens in terms of the aggregate portfolio and comfortable with our processes and the reserves at this time.

[Yvan Deschamps]

And just to be very mathematical, Nigel, I will give a simple example. If you move a $10 million loan to impair, it’s very highly collateralized what we have. So, it means that the PCL potential impact could be very minimal. It’s just that, that loan is moved to impaired loans, but may trigger very minimal losses at the end of the day.

[Liam Mason, Chief Risk Officer]

Just to give color on that, more than 94% of our lending portfolio has a degree of collateral against it.

[Nigel D'Souza, Veritas Investment]

Yes. I appreciate it. I guess that’s what I was getting to in terms of the collateral values of what’s becoming in par. Could you elaborate on what that collateral is? And what your outlook is for collateral values as we go through the cycle because that’s what’s going to mitigate your loan losses?

[Liam Mason, Chief Risk Officer]

There are challenges within the real estate market and impact on valuations from the higher rates. And – but we have – are generally first lien, we have strong underwriting standards, and we are taking loan-to-value attachment points that are very, very conservative. So, even if there is an impact on valuation on some of those commercial real estate properties, generally, given our attachment points, we are well protected. And we have less than – the big pressures right now as were outweighed by the number of competitors are in the office space, we are less than 4% of that. It’s really our emphasis on purpose-built multifamily construction. And we are also within this environment, very conscious of contingencies appropriate debt service reserves to ensure that the properties remain stable and current.

[Nigel D'Souza, Veritas Investment]

Okay. That’s helpful. And I know you can’t comment to the review, but just wondering if you can comment on the specifics of the review, but just the timeline of – or when you would expect the next update on it or anything in terms of just timing?

[Rania Llewellyn, President and Chief Executive Officer]

Yes. So, Nigel, from a timing perspective, it will – the update will be provided once the review is finalized. So, that’s all I can comment on at this point in time.

[Nigel D'Souza, Veritas Investment]

Okay. That’s it for me. Thank you.

[Operator]

Your next question comes from Joo Ho Kim with Credit Suisse. Please go ahead.

[Joo Ho Kim, Credit Suisse]

Hi. Good morning and thanks for taking my questions. I wanted to ask on residential mortgages. And if you can talk about whether you see any difference in client behavior, whether that’s on the payment side or renewals between your Alt-A book and the prime book. I am just trying to get a sense of whether there are different levels of stress on the different sort of types of borrowers given the higher rate environment.

[Karine Abgrall-Teslyk, Head, Personal Banking]

Thank you, Joo. Thank you for your question. It’s Karine here. So, as you know, like we are seeing some direct for some customers and working with them on an individual basis. But when we look at our Alt-A mortgage, it is really a strong portfolio and governance in terms of our risk assessment. We approve it using the same stress methodology and our other mortgages. So, there is no other key differences, and so really, when we look at our Alt, its a small percentage of our overall portfolio, it’s only 12% of our mortgages and less than 5% of our total loan mortgages. And our Alt-A portfolio also has very low LTV, so less than 65%, and 55% or even less than 50%.

[Liam Mason, Chief Risk Officer]

Yes. Just to add to that, the average LTV on our Alt-A book is 49%, you hope. So, very, very strong from a collateral coverage standpoint and we are not seeing any variation relative to the conventional book.

[Joo Ho Kim, Credit Suisse]

Got it. Thanks for that. And I guess when the renewals are expected to happen in 2025 and beyond, how do you think about your borrowers capacity to handle the higher rates, I guess especially given that your book seems to be a bit more geared towards the fixed rate mortgages?

[Liam Mason, Chief Risk Officer]

We are very disciplined in terms of our underwriting standards with our mortgage customers. We do recognize that they will see an impact to the debt service in post 2025 to 2026. But as Karen outlined, we stress the customer capacity to absorb rate increases at the outset. And at this time, we are very comfortable with the reserves against those exposures. There will be an impact for those customers in terms of the debt service with the higher rates, but we are comfortable from a credit standpoint given the valuation, given the reserves and given our forward expectations.

[Joo Ho Kim, Credit Suisse]

Got it. Thank you.

[Operator]

Your last question comes from Stephen Boland with Raymond James. Please go ahead.

[Stephen Boland, Raymond James]

Appreciate you fit me in. Just a follow-up on Darko’s question on the inventory finance. We are hearing from some of your peers that due to higher interest costs, a lot of dealers are paring down their demand for inventory on their lots and things like that. Are you seeing any similar discussions with your dealer groups? Like is that a possibility in your segments?

[Eric Provost, Head, Commercial Banking]

Hi Stephen, it’s Eric. Just again, like right now, summer is not even over. So, we are still seeing at the dealer level, some good foot traffic. We are seeing some demand for the products. So, I think that we will know more walking into Q4, once the restocking season begins and when the shows actually from the OEM are kicked off in all the various industries we cover. So, it’s still early. It’s still difficult to presume for next season. And of course, dealers will be prudent, and it’s something we want to see actually because they – it’s the right approach for them. So, we expect restocking. But again, to what level it is to be seen in the coming quarters.

[Stephen Boland, Raymond James]

And just on the dealer level, are you still seeing – are you still in a dealer add mode, like are you still out there recruiting to get more dealers on your books?

[Eric Provost, Head, Commercial Banking]

Yes. And actually, as I mentioned with Darko’s question, we are still acquiring. We have acquired about – we increased our dealer base about 10% year-over-year, and we are diversifying our book. So, to try to reduce that seasonality impact, we started originating into the construction to the IT sector, which will provide diversified sources of assets as well as diversified the seasonality of the book.

[Stephen Boland, Raymond James]

Alright. Thanks for taking my questions.

[Yvan Deschamps]

Just one last comment, Stephen, thank you for taking coverage on the bank and welcome to the quarterly calls.

[Stephen Boland, Raymond James]

Thank you very much. The timing has been interesting for sure.

[Operator]

Thank you. That’s all the time we have for questions. I would now like to turn the meeting over to Rania.

[Rania Llewellyn, President and Chief Executive Officer]

Thank you for your questions today. We remain focused on our strategic plan and delivering against our three core priorities for this year. Customer experience is top of mind, and I am pleased with the improvements we have made in personal banking. Deposits and an optimized funding structure remain a priority. Our digital account opening solution is supporting this objective by gathering cost-efficient deposits from retail customers across the country. We will continue to take the necessary actions to simplify and automate processes to reduce our efficiency ratio, which will further improve once we complete the conversion of all current Visa customers onto the new card platform. We take a prudent approach to credit and we will manage capital to support growth.

Thank you again for joining the call.

[Operator]

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