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National Bank of Canada
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Good afternoon, ladies and gentlemen. Welcome to the National Bank of Canada Second Quarter 2018 Results Conference Call. I would now like to turn the meeting over to Mrs. Linda Boulanger, Vice President of Investor Relations. Please go ahead, Mrs. Boulanger.
Thank you, and good afternoon, everyone. I would like to welcome you to National Bank's investor presentation for the second quarter 2018. My name is Linda Boulanger, and I'm Vice President of Investor Relations. Presenting to you this afternoon are Louis Vachon, President and CEO; Ghislain Parent, CFO and Executive Vice President, Finance and Treasury; and Bill Bonnell, Executive Vice President, Risk Management. Following their presentations, we will open the call for questions from analysts. Joining us for your questions are Diane Giard, Executive Vice President, P&C and Marketing; Martin Gagnon, Executive Vice President, Wealth Management; Denis Girouard, Executive Vice President, Financial Markets; and Jean Dagenais, Senior Vice President, Finance. Before we begin, and on behalf of those speaking today, I refer you to Slide 2 of your presentation providing National Bank's caution regarding forward-looking statements. With that, let me now turn the call over to Louis Vachon.
Thanks, Linda. Good afternoon, everyone, and thank you for joining us. Today, we are pleased to report another strong quarter by National Bank with net income of $551 million, up 12% from last year. Our performance was driven by solid growth in all business segments, effective cost management and strong credit quality. As in the past several quarters, our continued execution of the bank transformation translated into strong operating leverage across all businesses. During the quarter, the bank delivered a return on equity of 18.7%, one of the highest in our industry on a global basis. We are carefully managing our capital to maintain strong capital levels. Our CET1 ratio was 11.3% at the end of the quarter, providing us with flexibility to invest in business growth and return capital to shareholders. Credit quality remains strong in our overall portfolio, reflecting a prudent approach to lending. We continued to benefit from favorable economic conditions in our core Québec market. After gaining momentum for several years, the Québec economy is in a very good place. The unemployment is at a historical low and now the second lowest of our province in Canada. Looking forward, there's good visibility for sustained growth in the province, supported by tax relief for household and small businesses as well as large-scale government infrastructure projects. Now let me share some highlights of our businesses with -- during the quarter. Our P&C segment delivered good results this quarter with net income at -- up 8% on a comparable basis. Our performance was driven by revenue growth in both Retail and Commercial, increased net interest margin and continued efficiency improvement. In Personal Banking, we are seeing good volume growth. We are maintaining target volume growth of approximately 4% for 2018 as we complete the transition of our distribution model. In Commercial Banking, we have strong momentum, with revenues up 9%, with growth in both lending and deposits. We strive to achieve the right balance between prudent risk management and sustainable growth. Our objective is to position National Bank to perform well throughout this complete cycle. Looking forward, we will maintain our overweight position in our province of Québec as well as in secured loans, which we view as favorable in the current economic environment. Turning to Wealth Management, our strong momentum was sustained in the second quarter with a 19% increase in net income. We are benefiting from the diversification of our business model, with strong performance in every business line, very good cost management and the positive impact of higher interest rates on our margins. Our Wealth Management business is in good shape, and the outlook is positive for the remainder of the year. Our Financial Markets segment had another strong quarter, our second highest after Q1 of this year. Net income was up 11% from last year, driven by solid growth in our trading and lending activities. Our consistent performance from quarter-to-quarter reflects our changed focus, diversified revenue mix, focus on client-driven activities and strong teamwork. It also reflects our flexible approach to balance sheet allocation, providing us with the ability to seize opportunities as markets evolve. Over the past quarters, we have seen attractive opportunities across markets which resulted in strong revenue growth in our securities finance business, both in Canada and outside of Canada. Despite a challenging quarter for capital markets industry-wide, Corporate and investment banking performed well as shown by increased lending revenues and market share gains in equity underwriting. Our fourth business segment, U.S. Specialty Finance and International, delivered an outstanding second quarter with net income of $63 million, up 58% from last year. Credigy is delivering strong results. While we continue to see a strong growth trajectory for Credigy over time, we expect a slower pace of growth for the second half of the year based on current market conditions. ABA's strong performance continues, and net income is well ahead of expectations. ABA Bank is expanding its branch network with the addition of 16 new branches this year. Loans and deposits volume have grown by approximately 50% year-on-year, and we'll continue to see solid growth opportunities for ABA. At this point in time, we are extending our moratorium on significant additional investments in emerging markets until the end of 2020. We are very satisfied with the performance of Credigy and ABA, and we will concentrate our efforts and our capital on those activities. Now let me reconfirm our capital deployment strategy. Our first priority is to maintain strong capital ratios. Our second priority is to invest in business growth in our core markets. Our third is to invest to continue to capture significant efficiency gains and generate operating leverage close to 2%. And our fourth priority is to return capital to our shareholders through sustainable dividend increases and share buybacks while maintaining CET1 ratio above [ 10.5. ] During the second quarter, we repurchased 1.5 million common shares. This morning, we announced a new NCIB program to purchase up to 8 million shares. We also announced a 2% increase in our quarterly dividend to $0.62 per share. To wrap up, I am very pleased with our second quarter results. We delivered solid growth in all our business segments, continued efficiency improvements and strong levels of capital. In the current environment, we are exercising discipline, with a focus on protecting margin and maintaining strong credit quality. Looking forward, we have strong momentum and the operating and economic environments continue to be favorable, especially in Québec. I would like to end my presentation with some acknowledgments. Today marks Diane Giard's last conference call, and I wish to recognize her leadership and great service and performance to the bank since she joined us in 2011. I would also like to thank Lynn Jeanniot, who's retiring after a very successful career, with the last 10 years as EVP, Human Resources and Corporate Affairs, at National Bank. On that, I'll turn things over to Ghislain. Ghislain?
Thank you, Louis, and good afternoon, everyone. My comments today will focus on 2 areas, efficiency and capital, beginning with Page 7 on the slide deck. As Louis mentioned earlier, we reported excellent second quarter results, underpinned by very good performance across all businesses. During the second quarter, we generated strong top line growth of 10%, while keeping strict discipline in managing our costs. This resulted in an all-bank operating leverage of 4.4%, with positive leverage across all business segments. P&C, Wealth Management and Financial Markets delivered strong operating leverage of 3%, 6% and 3% respectively. Our investments in our digital tools and transformation continue according to plan, and we are seeing tangible results. We continue to implement and improve digital solutions for our clients. We also continue to work on many initiatives to increase the automation of our operations and to simplify our internal processes throughout the bank. Together with these transformation initiatives, we are keeping the discipline on cost management, and all of our employees are contributing to this in their day-to-day activities. All of these initiatives are resulting in additional revenues and lower costs and are allowing frontline staff to spend more time with customers. This translates into an improvement of 210 basis points in our efficiency ratio on a year-over-year basis. In the last 2 years, we have showed consistency in our ability to generate positive operating leverage and better efficiency. Looking ahead, we will continue to invest for growth while capturing additional efficiency gains. We are benefiting from a good momentum, and our team is fully committed to deliver a positive operating leverage. Turning to Slide 8 for a capital overview. We ended the first quarter with a strong CET1 ratio of 11.3%, a slight improvement over the last quarter. This was driven largely by strong internal capital generation, which added 40 basis points. It is partly offset by common share buybacks during the quarter and an increase in risk-weighted assets due to business growth and higher volatility. At the end of Q2, the bank's total capital ratio stood at 16.6%. We are pleased with our current capital position, which provides optionality and flexibility to invest in business growth and returning capital to shareholders. On that, I'm turning the call over to Bill for a risk review.
[Foreign Language] Ghislain. Good afternoon, everyone. Credit conditions remain benign in the second quarter, supported by good underlying economic factors, particularly in our home province of Québec. Details of our loan portfolio's performance are provided on Slide 10. Provisions on impaired loans, referred to as Page 3 under IFRS 9 accounting, were $78 million or 23 basis points. Of the $22 million increase from the same quarter last year, $21 million was generated at our Credigy subsidiary. As expected, and as discussed on previous calls, provisions at Credigy rose through the first half of this year following the growth and seasoning in their unsecured loan portfolio. In the second half of the year, we expect Stage 3 provisions to stabilize around this level, while Stage 1 and 2 provisions should decline as the portfolio amortizes. Excluding Credigy, provisions on impaired loans were unchanged year-over-year at 15 basis points, which demonstrates well the stable conditions from which our Canadian loan portfolios are benefiting. Total provisions for credit losses were $91 million or 27 basis points in the quarter. The increase from last quarter was generated by some seasonal impacts in personal lending as well as provisions on performing loans in Corporate and Commercial following continued growth in these portfolios. Looking ahead, we maintain our target total bank PCL range of between 20 to 30 basis points for 2018. While we haven't given specific guidance on Credigy provisions, I want to remind you that the Credigy business is incorporated in this total bank PCL guidance, and I can reconfirm the 3 major points I communicated at the beginning of the year. First, we expected the conditions in our Canadian portfolios to generate low and stable provisions for credit losses during 2018. Second, we expected Credigy's portfolio to generate higher provisions in the first half of the year and lower provisions in the second half of the year. And finally, we guided to the midpoint of the 20 to 30 basis points PCL range, with the potential for some noise from new IFRS 9 accounting. So far this year, credit performance is tracking our expectations and there is no change in our guidance. Turning to Slide 11. Gross impaired loans were stable at $586 million or 42 basis points. Lower formations in Personal and at Credigy were partially offset by higher formations in Commercial. For additional color, the increase in Commercial impaired came from a handful of small files, only one with a balance greater than $8 million, spread amongst a few sectors and regions. Credit quality and performance across the Commercial portfolio remain strong, and we don't see signs of that changing in the near term. Please turn to Slide 12 for a review of our residential mortgage and HELOC portfolio. Good performance continued, with provisions for credit losses declining to 1 basis point during the quarter. Insured loans account for the largest share of this book at 43%, followed by HELOCs at 32% and uninsured mortgages at 25%. The geographic distribution was unchanged, with mortgages from Québec accounting for 55% of the portfolio. We remain very comfortable with our overweight in Québec as underlying strength in the economy and healthy conditions in the housing market continue. The average LTV for our uninsured mortgages and HELOCs was about 59%, and exposure to the GTA and GVA remain modest. With that, I'll turn the call back to the operator for the Q&A.
Operator, we are ready for the Q&A. Operator, are you still listening? We will ask everybody to hold on and we'll try to rectify the situation.[Technical Difficulty]
We're just asking -- this is Louis speaking. We're just asking people to be patient. We're just getting set-up by the operator here. If someone is ready for their first questions, we'll be ready -- we can take the first questions. [Operator Instructions] So is there anyone ready for a first question?
[Operator Instructions] So the first question will be from Steve Theriault from Eight Capital.
Can you hear me okay?
Yes, we're fine, Steve. Apologies to everyone for the little delay. We're conscious that there's another call in 45 minutes. So apologies for that.
Okay. So for me, last -- a question on mortgages. Last quarter, you flagged mortgage growth as you transitioned to your third-party activity to Paradigm suggested that situation would stabilize in Q2. But it looks like mortgage is still -- mortgages are still growing less than 2%. Just wondering, maybe for Diane, are there any issues here in getting the ball rolling more quickly? And how quickly do you think you'll be up to the growth levels you'd like to be at on the mortgage side?
Okay. Thanks, Steve. The situation, in fact, has stabilized in Q2 this year. What we've seen is if we look 12 months back, we had about $1.1 billion less in authorization. That's a 2% hit to our mortgage growth. In Q2 this year, we had a 7% increase in disbursement and if you compare this quarter to the same quarter last year. And these results do include the impact of B20, which we estimated to be at about 4% negative impact on origination this year. So going forward into the rest of the year, we still expect growth to be at nominal GDP, i.e. in the 4%, or 5% range if you include the mortgages done in Wealth Management. The negative impact of B20 will be offset by the introduction of 240 mortgage specialists that we put in our branches as well as the addition of 40 mobile development managers that we've added in Q1 this year. So the productivity level of these new officers is continuously improving and should reach their full potential by year-end. So we are continuing with the same forecast, and we continue to favor, as I said many times before, a very disciplined approach in our growth strategy by balancing market share gains, margin improvements as well as risk management.
And sorry, you said the mortgage specialists, they were in the seat around Q1 of this year?
Yes. What we did, in fact, is we converted 240 generalists to mortgage specialists. And on top of that, we added 40 new officers in the field. So in total today, we have about 570 employees that are 100% dedicated to secured lending.
Okay. One other one, turning to Credigy. It sounds -- it, certainly, in listening to Louis and listening to Bill, and this would be consistent with your message this year, that Credigy losses, peaking in the first half of the year, Louis, you said expect a slower pace of growth in the second half of the year. So I guess the question is, without -- are there any new agreements in the hopper? And without any new agreements, do you still think you can grow -- or do you think you can grow the Credigy earnings in the back half of the year? Or does peak credit losses also coincide with maybe peak earnings for Credigy as well?
Thanks, Steve. It is obviously dependent on -- for further acquisitions to make up for the peak portfolio at Lending Club. But from what we see from the team and the feedback we get from them, I think that we're confident that we'll still be able to generate earnings growth in the second half of 2018 but obviously at a lower pace than what we've seen over the last 6 to 9 to 12 months. That's why we're not forecasting strong double-digit earnings growth. I think we'll be able to maintain the same level and grow at a lower pace than what we've seen in the last 6 to 12 months.
The next question is from Gabriel Dechaine from NBF.
I have a couple numbers questions, more than a couple actually. And just to confirm, Diane, when you said disbursement up 7% for the quarter, you mean originations in uninsured mortgages up year-over-year 7%?
7% in originations in total mortgages.
What about uninsured, specifically?
I don't have that in front of me. I'm sorry.
Well, we'll get back to you on that, Gabriel, yes.
But probably positive because the trend in insured has been generally negative across the industry or...
But I know that generally -- I don't know specifically for the last 3 -- the last quarter, but I know that, in fact, the total originations in the last 12 months were actually higher in uninsured than insured.
Okay. Then, well, happy retirement, I'll move on to capital markets. I just wanted -- the trading business, the -- great quarter. That's not the point of my question here. It's that the makeup of the revenues have shifted quite a bit. If I go back over the past 4 quarters, it's predominantly trading other income, smaller amount of trading NII. If I go back several years, it's the opposite, like the trading NII was multiples of the other trading revenue. Maybe you can walk through, if there's an accounting thing going on there, or just the nature of the trading operations have changed, just to give a little bit of context.
Gabriel, it's Denis, thank you. But that's...
You want Jean? That's an accounting question...
It's not really accounting. It's -- what I was told by the business line, Gabriel, is that with the increases in the interest rates, especially in the U.S. rates, it's cost more to fund assets. And usually, the revenue on these assets goes into other income when they're swapped or a thing like that, so the revenues go into other income, while the funding of those assets are part of the net interest income. So with the increase of funding cost, we see a reduction in net interest income and an increase in other income.
Okay, all right. That maybe worth a more in-depth discussion on a later date. Then the International/Credigy business, a couple of things here. The margin, we've seen that go from sub-5%, we're now pushing 7%. I assume that's probably driven by Cambodia. How high can that go? And then, the change in the extension of the moratorium on M&A, I get that -- how much of that is you've got enough, I guess, capital allocation to fund the organic growth of Credigy and Cambodia, in particular, versus you just want to stay on the conservative side of things?
Yes. So on margins, yes, I think it is related to ABA. What's happening there is ABA is generating more and more transactional deposits, checking account deposits, and those are costing 0. So that's leading -- very normally, the assets are growing, but our transactional deposits are growing. So that's -- there's margin expansion on that front from there. And so I -- where the limit is, I'm not sure. I think we still have some momentum on that. But obviously, at some point, there will be a limit to that expansion. On the other question is, I think we're quite clear. I think we had a target to get to about 10%, and we're roughly there right now. And so we have 2 assets that are doing very well, namely Credigy and ABA. We're at 10%, and that's why I think we're -- we achieved our objective of diversifying a little bit our activities in Canada with 2 operations. We're doing very well. That's why, going forward, at least until the end of 2020, we don't see the need to do anything else, to do more acquisitions. We're quite happy with just operating these 2 assets and making sure that the performance continues to be as good as it's been in the last 2 years. So that's why we're basically reconfirming that we're on pause for at least the next 2 years.
The next question is from Doug Young from Desjardins Capital.
Just on regulatory capital, just looking at your supplement, and just a few moving pieces, hoping to get a bit of color on. On your credit risk-weighted assets, it looked like book quality improved, and that added a nice 25, 30 basis points to CET-1. And on the flip side, your market risk, risk-weighted assets kind of jumped quite nicely, and again, that ties in with your trading revenue increase in general. So I mean, I just wanted to get some color around that, and is this a conscious effort to maybe pull away from risk on the credit side and put on a little more risk on the market risk side? Or any color around that would be helpful.
On the credit side -- this is Jean. On the credit side, it's mostly hedging of risk that we have done during the quarter. So it reduced, obviously, the risk on the credit side. As far as the market side, it's the volatility that has increased in the market, so increasing the VAR and having an impact on the capital.
But on your second point, Doug, no, there's no conscious decision to reduce. We're being prudent in our increase in allocating credit, but we still -- I think we're being selective, but we still think we'll be generating some increase in risk-weighted assets, particularly in Commercial and Corporate Banking, as we have done in the last few quarters. We think that's going to continue. And then on the -- as Jean mentioned, on the trading side, it depends on volatility. So the VAR, the way the VAR methodology works, if you have higher volatility, at some point, it will reflect into higher risk-weighted assets. And that's why we're keeping a little bit of buffer there because it's especially when you have volatility that you want to be able to deploy balance sheet and capital.
I mean, it just seems, on the equity trading, in particular, just to pick on that one, but it looks like your growth was quite significant. I mean, when I look across your peer group, you're head and shoulders above everybody else in terms of growth. Can you unpack in terms of what really drove that this quarter?
Sure. Denis will pick up that question.
Yes, in equity trading, it's mainly really our ETF and option business that we're doing through the volatility of the period. It was quite volatile in the end of February and beginning of March. And those 2 activities, ETF trading market-making and option book, with our clients were very, very active, and this is why you see a good jump in revenue there.
Fair to say, I mean, volatility has come back a bit here. So I mean, this is going to jump around. But with volatility down, are we fair to assume that this comes down in the back half?
Not really because right now, the way we're pushing ourselves is that we're very long volatility, a very long [ VAGO ]. And in the market, when the volatility is going up, [ VAGO ] is going up, then we're making money and you see underwriting revenue going down, then one is to supplement the other one. And when the volatility is going down and you see underwriting revenue going up, then this is why we have that kind of ways to look at the market. We have an insurance policy when markets are getting volatile, but when it's not, we have the underwriting that's picking up, and you know, that in Canada, we're quite strong in underwriting.
Yes. Okay. And then just lastly, on Credigy, a decent bump in noninterest income sequentially. I think it went from $3 million to $16 million. I'm just hoping to understand, was there anything unusual in there? What really drove that?
Ghislain will answer that question, Doug.
Hi, Doug. So Credigy's other revenues, it varies from quarter-to-quarter as shown in the previous quarter. You may see it in 2017. So it depends on the portfolio's performance and fees that we receive. So honestly, there was nothing special with Credigy this quarter, only normal activities.
There were no sales. I know, in the past, Doug, we sold portfolios, like we sold Puerto Rico in the late '15, '15 to '16. There were no sales of portfolio that created a special gain.
The next question is from Robert Sedran from CIBC Capital Markets.
Louis, I want to take you back to ABA for a second. I mean, can we get a little bit of color on what is driving 40% volume growth? I mean, for a Canadian bank analyst, these numbers are pretty big. So any color you can give us in terms of what they're doing and why you think it's going to continue, as you said, for a while. I'm assuming there's some pretty significant market share gains in there as well.
Yes, first of all, you're dealing with a market that has -- that's growing at double digit every year. So the average of the market, given the fact that, still today, I think only about 25% of the population in Cambodia has a bank account. And the economy, as you know, has been growing -- this year is still growing, but in the last few years, have been growing steadily at 7% real GDP. So when you combine that with low -- an increasing level of utilization of banking products, you have a general environment that's very, very positive. So that's one. Two, yes, they have been gaining market share. When we took our first investments, we had about a 4% to 5% market share in retail banking in Cambodia. They're -- today, 3.5 years later or 4 years later, they're getting closer to 8% in terms of market share, both in terms of deposits and lending, and where they have been growing very nicely, as I mentioned on the call earlier, is because their branch system has been expanding. And frankly, they have what we think and they think is the best mobile banking application in the country. They have been getting a lot of transactional deposits and checking account deposits. And so they have been driving that business forward on that, and so it's been a good combination. So, so far, Rob, it looks like a very good purchase on our side. We're very happy with the results. But ultimately, we want to see, as I said in previous calls, we want to see a complete business cycle before we give the final verdict. But so far, I think it looks good.
And how active are you in the management of this bank? I'm thinking specifically on the systems and support side because I would imagine that this level of growth would put quite a level of strain on back office, middle office and all of that as well.
Yes. The areas where they're most involved with are, obviously, governance. We have people in compliance from Canada in the region, and we have people from technology also from Canada in the region. So you're right, that's where we have some expats, and we're applying daily supervision to these levels.
Okay. And just a quick numbers question. I know everybody probably calculates it differently, but the consolidated net interest margin seemed to be up pretty meaningfully this quarter. Is that some treasury activity? Or is there something else going on in there that you can explain? And I understand if this one has to go offline.
I'm looking at Jean to see whether he can give you...
Well, what we have looked -- when you sent the question to Linda, we have looked at it. One improvement is obviously Corporate Banking, has seen its margin increase and the volume also, which increased that interest income. We have more net interest income, as you can see from Cambodia, also which is good; and some of it is from treasury. And also, you have deposit, that improved our margin in Wealth and everywhere else. So all...
So it's mostly just business activity that just translates into the segment levels as well?
Exactly...
There was nothing special in terms of the -- there was nothing special around that we can point to.
The next question is from Sumit Malhotra from Scotia Capital.
First, a couple of numbers questions to get started. First one is on your trading revenue breakdown. You give us in your supplement the usual product breakdown of equities, interest rates and then FX and commodities. I'm just looking for it here. And then there's a piece that gets allocated to Other for trading that's outside of Financial Markets. Could you just remind me what that piece relates to?
I think it's treasury numbers.
Exactly. That's just treasury mostly. There's other business that could have some trading activities, like insurance, but the biggest portion is treasury.
It's treasury...
And does that not go through the Financial Markets segment. It goes through like the Other segment?
Yes, Other segment.
Okay. And I think I probably had that somewhere. I just wanted a reminder. And then on Credigy, I believe at the Investor Day, you had mentioned that now more than 90% of the assets were U.S. dollar-related. So this is probably going to be pretty self-explanatory, but I just want to confirm. Tax rate was materially lower in Credigy this quarter. I'm assuming that's tax reform benefit, and that's the new run rate number going forward?
I'm looking at Jean.
Yes, correct. Yes.
Okay. And I thought so. I just wanted to confirm that. Let me go to my real questions. First, on capital, so you finished the 6 million share NCIB, and you're -- you've increased it now to 8. Just running some quick numbers. It looks like that would be about a 70 basis point allocation of capital over the next year. Still leaves you at a pretty healthy level, and obviously you're going to generate more going forward. So what are you thinking here, Louis, in terms of what the opportunities are available to the bank, ex of the buyback itself? It certainly seems like your RWA growth is picking up. And is that the most obvious use we should think of? Is that as more of the business goes towards business lending as opposed to mortgages, we're just going to see more capital required in normal course operations from an RWA perspective?
Yes. That part, so the commercial and corporate lending. And the other one, as I said, we always keep a little bit of a buffer on the -- on market risk-related RWA because that's especially when volatility goes up, VAR goes up, capital requirements goes up, that you have the better opportunities. So we keep ourselves a little bit of buffer to have room like we did in the second quarter to take advantage of opportunities when that exists. So that's essentially what it is. On the acquisition front, I think we're quite specific. And on the International side, we're on pause for the next 2 years and, frankly, maybe longer. I think if we -- if everything turns out the way it's turning out with Credigy and ABA, I think that maybe [ delays ] long-term structure of our International division for a longer period of time. And then the rest, we don't see -- frankly, there's not much in the market right now giving valuations that excites us in North America. So that's about where we are.
So 70-ish to the buyback if it gets completed and [inorganic ] growth is where we should expect the rest to go. So clean and quiet on capital.
Yes, and as you know, just we still have 1 million to go on our 6 million, and then we'll see. We'll -- I think what we wanted to signal is that we'll, I think, at some point, move from 1.5 million a quarter to 2 million a quarter and then see what's going on, on risk WA. And then, from there, we'll decide what's the pace of returning capital to shareholders.
And last one for me is around the topic of operating leverage and efficiency. I think it was in one of Jean's slides. There was a number there that talked about 2% operating leverage. Just to confirm, is that more the aspirational run rate goal? Because, obviously, in the first half of the year, your numbers were more like 4.5%. So let me ask that first. That target operating leverage that you have on Slide 7, that close to 2% is for what time period?
Well, Sumit, this is Ghislain. Well, the 2% target is really the midterm objective for the operating leverage. Well, at this stage of the year, it is reasonable to think that we will exceed the 2% with the results of the first part of the year.
I'm sorry, Ghislain, I meant your slides when I said that. And that's where I want to wrap this up. I think, Louis, the focus on efficiency and operating leverage across the sector has certainly become a bigger part of the story in the last couple of years, at least compared to my time earlier in the seat. And it feels like after a bank takes a restructuring charge like you did at the end of 2016, you go through a period where the operating leverage looks very sizable. And you've had now 1.5 years of that, coupled with a good revenue environment. As you look forward, has some of the initial benefit of the restructuring initiatives run its course and now you're going to return closer to that run rate level? Or is there still more remaining in terms of cost containment or expense growth containment that we're going to see heading into 2019?
I think we -- as I said, we don't expect any major big restructuring charges going forward. That being said, controlling costs and being efficient, I think, is something we want to do long-term. Some of that will be just requestioning the way [ we're ] engineering some of the business is, i.e. looking at cost savings without involving technology. And then there's still -- we're still in the middle of a significant investment in technology, which, by themselves, will bring further productivity improvement. So yes, we want to continue to work on this. Diane, anything to add before you move on to retirement?
Yes, I think what you need to know is that the strategy is -- still is to -- for us to save time for our advisers by eliminating, centralizing, automating and digitalizing our forms, reports and processes. We've said that and we haven't completed our work. You need to know that we still have close to 25% of our branch personnel that is responsible for mid- or back-office work. While we don't expect to eliminate all of the administrative tasks in the branches, we're continuing to work on these initiatives to reduce them going forward. Now it won't all be done in 2018, but we do have work for '19 and '20. Also, for our operations department, we do have a target for automation and also digitalization. Now in terms of automation, they're halfway there. And in terms of digitalization, they're about 2/3 there. And the plan is to hit the target for '20 or '21. So as you see, we still have room to grow in terms of efficiency -- well -- or decrease our costs because of the fact that we will simplify our processes, we will reduce the number of products that we have and also originate products online and et cetera.
And Diane, best of luck in your retirement.
Thanks.
The next question is from Mario Mendonca from TD Securities.
First, a quick question, going back to a comment made earlier on the bank being long volatility. I want to make sure I understand what you're getting to -- getting at. Are you suggesting that the bank benefits because of greater client activity during periods of higher volatility, or that, in fact, the bank has a proprietary position that benefits from higher volatility?
I think we -- I'll pick it up, and then Denis will add. I think it's -- I think if you look at -- I'll start with the first part of that question. On a strategic basis, Mario, and I think you've been covering us long enough, I think the way we're structured strategically in terms of business mix, we tend to do pretty well in more volatile periods. So strategically, we're positioned for that. And then on the second part, on the technical front, yes, I think we are -- we tend to run, because of our equity-driven business. Denis, over to you.
Yes, you know what, those questions of volatility are generated by the structure product that we're selling to clients, and we'll decide consciously that we don't want to sell that volatility that we have on hand. And in fact, not selling it, that means less revenue, but it's kind of you have an insurance policy against a volatile market. And because volatility was quite low in the last, I would say, 2 years, 2.5 years, we decided not to sell it, then we capture the money when the volatility is coming back. That's essentially that. We're not doing pro-trading basically. We just inherit those positions when we're selling those structure products to the retail group people. Then we're very close to home in terms of not market-making, but hedging positions. We don't want to take any risk in the market, okay? We're really client-driven in our daily business, and everything we're trying to do, we're hedging yourselves. And all the position that we have, it's hedging, and then we play against the hedge. And the hedge, it is what it is. When markets are getting volatile, you have an opportunity to change your hedge, and this is where you pick up revenue, when you understand what the market is doing and then you can change your hedge and then you're making money, which is, I suppose, that. But we're not taking a position in the market as maybe others are doing.
Aren't you implicitly or explicitly taking a market position by not selling the volatility to the client?
Yes. Because by doing so, we are not capturing the money that we can have by selling that. But at the level that the volatility is right now, it's not a lot of money that we are leaving on the table.
Okay. So let me just cut to the -- I'll cut to the point of the question then. Do you see any outsized risk for the bank here either from an earnings or a capital perspective if we were to get a real spike in volatility in a given period or just a long stretch of very low volatility? Do you see any risk here to the bank earnings or capital?
No, because I think we've -- that -- what we just described, both strategically and tactically, Mario, we've had that for many, many years. So that's -- there's nothing new to that, and as we said before, we don't see that -- we see that as hedging our other activities because when volatility is low, you have -- usually underwriting picks up and other form of activities picks up. The one thing we don't want to be, we can be flat vol, we don't want to be short a lot of vol. That's when you can have significant problems.
Yes. No doubt. And I think the reason why we're asking the question this way is the bank's equity trading numbers are so different from your peers that there's clearly something else going on here for National that we don't see at your peers. And I think that's why we're asking the questions the way we are.
Yes. I think the other thing I think we pointed out in the past is our ETF trading, and that's -- I think we're getting share. I think we're -- our share has continued to increase in ETF trading. And again, that tends to be positive, related -- positively related to volatility, i.e. spreads increase when volatility goes up.
And then a quick question -- sorry. Just a couple of questions for Bill then. Were you suggesting that we might see performing loan recoveries in the second half by virtue of a decline in the Lending Club portfolio?
I think you have seen that already this quarter. And yes, we think the total provisions at Credigy will -- are expected to go down.
Now I'll be more clear. I meant on a total bank basis, could recoveries on the Lending Club portfolio actually drive recoveries overall?
I'm not so sure about that.
Okay, that's fine. And then a final different type of question. How would you respond to the notion that with this very strong growth we've seen in ABA, similar to what happened -- what's happening now at Lending Club, at some point, the PCLs emerge and then the benefit of the loan growth you've already had, the PCLs emerge, and then you start to see the real profitability of the business. Is that a possibility, or would you would say that IFRS 9 and the forward-looking nature of IFRS 9 is appropriately capturing that?
I think in most scenarios that we look at, Mario, the growth of the business should continue to allow us to grow earnings even when there's more maturity within the loan portfolio. That being said, that's why, Mario, look at the transcript, every time I talk about ABA, I said, looks good for now. We want to see the complete business cycle before we give the final verdict on that business. So we are conscious that we're dealing -- everybody looks good when the economy is growing at a 7% real, as you know. So let's have a slowdown, and then we'll see. I think, from what we see so far, if they were serious issues, we've been in that business for 4 years. I think on some of the cohorts -- some of the oldest cohorts, we would see issues in terms of credit, and we're not seeing that. But I think we'll reserve complete judgment when we see an economic slowdown.
The next question is from Meny Grauman from Cormark Securities.
You continue to emphasize strengths of the Québec economy, and it actually seems like it keeps getting better. And just wondering if you feel like you're fully taking advantage of this environment and given the regional skew, sort of an advantage that you have. And I want to suggest, maybe in the credit card business, that growth could be stronger given the macro outlook. But I'm curious to hear your thoughts if there's any area of the business that you feel are -- you'd like to see more from, given the economic backdrop in your province specifically.
I'll start, and then maybe I'll pass it to Diane afterwards. I think, yes, generally, I think we're very happy. If you look at our performance in Wealth Management, that suggests we're benefiting from greater wealth in Québec, I think we're doing that. In credit cards, I think we're growing double-digit [annually. ] So for us, we -- in my 11 years as CEO, we did not always grow at double digit in credit cards, so I think we're seeing some benefit. I think the one area that I think we want to pick up a little bit is on mortgages, and I think we -- Diane will explain that part. The rest, I think, we're quite happy with.
Hi, Meny. Credit cards is actually up 12% year-over-year, and that's due really to an increase in active customers. That's 4% up in the number of active customers, which is not insignificant. Then we had also an important increase in purchase volume. That's about 12% up, which also drove, obviously, the interchange, up 9%, and the average loan portfolio is up 3%. So all KPIs around credit cards are actually looking quite good. So I think -- and we don't expect this to go down. We continue -- we expect this to continue at the same momentum throughout the year. I did explain what we're -- what's happening on the mortgage front, and we do have the vast majority of our mortgages coming from Québec and that also is still continuing. And also, our Commercial book is growing healthy and with healthy results in Québec.
The next question is from Nigel D'Souza from Veritas Investment.
I just wanted to follow up on a point you made earlier on the new mortgage specialists. I believe you mentioned about 240 of your employees were converted from generalists to specialists. And I was wondering if you could provide some color on whether their compensation structure would change as well with that. Would they go from salary base plus variable, to 100% variable commission structure?
Yes. Hi, Nigel. Actually, we did, and now we're transitioning them into full-fledged commission-based officers, much like our mobile officers. But we're transitioning this slowly, and we'll see how the results will be. And we won't -- we're not expecting our cost structure to go up with that as well.
Right. So I guess the reason I asked that question was because that likely has a benefit to your noninterest expense and it should help you reach your operating leverage target. So is there any way you could maybe quantify how transitioning more of your workforce from base plus variable to more of the 100% commission might contribute to -- towards your efficiency targets.
Yes, we haven't factored that in, so -- because all of that is slowly transitioning and we'll see what the results that we have. So currently, that hasn't really impacted our cost structure, not for this year anyway, and we'll see how that evolves. And as productivity increases, we will be working towards a more commission base, but making sure that, obviously, there is some benefits to all of the stakeholders involved.
The next question is from Sohrab Movahedi from BMO Capital Markets.
I'll try and be quick. Just going back to trading, maybe can you quantify how much of the trading revenue would have benefited from the collapse in the inverse vol funds early in the quarter?
Pretty tough to answer that. But on the trading also, we have to be -- we spoke a lot about volatility, but also on the trading, we have what we call our securities funding business that is there, that is also very meaningful in terms of revenue and catching up. It has nothing to do with the market, really. It's really secured funding.
And we certainly did when that occurred, but over the quarter, I think we'll have to get back to you on that one, Sohrab, because...
Okay. Let me just quickly -- Louis, maybe very quickly for Diane or -- I mean, are you keeping pace with the growth in the Commercial business in Québec? Or does it feel like there's intrusion from competition now?
No, I think we're comfortable that we're keeping pace. You have to look at -- when we look at -- when I -- and I think I mentioned that to you before, Sohrab. I think I look -- because of the way we're segmenting between Commercial and Corporate, and we probably have, in our Corporate segment, we probably have quite a bit of clients that would meet the commercial definition in our competitors, I always look at business loans on a combined basis. And that's why, when I look at that on a combined basis, I think we're doing very well. And you'll get to meet Stéphane Achard and Lucie Blanchet over the next few months, and I think you'll be as optimistic as I am about our capacity to grow that franchise going forward.
Okay. And then just one last one for me. I mean, I think, Louis, you've been, I think, crystal clear about being very selective about the type of risk you want to take on as an organization. And I think you even mentioned being a more secured lender and what-have-you. So can I -- do you have a sense of where you believe your mix of business is in aggregate right now, between secured and unsecured, so we could keep track of that over time?
Yes. I think, Bill -- I'm looking at Bill right now. I think we certainly keep track of that. Bill?
Yes, Sohrab, I think on Slide 20, you'll see this effect. So when we talk about being underweight-secured, if you look at our -- in our retail lending, 91% of the lending is secured.
Okay. So when you're talking, Louis, about being a secured lender, you mean in the context of retail only?
Correct, correct. I think the way business is done in Canada on the commercial side, I think we tend to be secured lenders. That's pretty much a tradition here. So I am looking very much at the retail side.
Okay. And so will that mean that -- I mean, Diane, just to come back to the P&C then, I mean, there's been 3 quarters, I think, of relatively stable but flat margin. So does that mean that the more skew you have to secured, the larger the overhang, if you will, on the NIM?
Yes, pretty much. We're expecting flat towards the second half of the year.
The next question is from a participant. [Operator Instructions]
Scott of Canaccord Genuity. Just on Page 5 of the supplemental. I've noticed a significant increase quarter-over-quarter in terms of the employees outside Canada, and I just want to maybe go back to what Louis, what you said at the opening remarks. Does that relate to the 16 branches that you're opening at ABA, or is there something else in that?
It is 100% ABA because I think Credigy is flat in terms of headcount, so it is 100% ABA.
And the 16 new branches help you keep the volume growth that you're doing? Yes?
Yes, yes. I mean, even -- I think a good mobile banking application is important, but what we find, at least in Cambodia, is that the physical location still matters. The street corner locations, street -- still matters. And there were a number of provinces of Cambodia that we were not present, and now with the new branches, many of them will be in Phnom Penh, the capital, but I think by the time we're done, at the end of this year, we'll cover -- we'll have at least one branch in every province in Cambodia. So we'll have a complete national coverage for the country, and then we'll -- we're opening branches, obviously, in areas where we see the fastest growth.
Okay. And just quickly, how many branches do you have right now there, just to get a relative impact approximately?
65.
There are no further questions registered at this time.
Thank you, everyone. And sorry, again, for the delay in answering your questions, and talk to you next quarter. Thank you very much.
Thank you. The conference has now ended. Please disconnect your lines at this time, and we thank you for your participation.