National Bank of Canada

TSX:NA

Earnings Call Transcript 2023-Q2

[Operator]

Good afternoon, ladies and gentlemen and welcome to the National Bank of Canada’s Second Quarter Results Conference Call. I would now like to turn the meeting over to Ms. Linda Boulanger, Senior Vice President of Investor Relations. Please go ahead, Ms. Boulanger.

[Linda Boulanger, Senior Vice President, Investor Relations]

Thank you, operator. Good afternoon, everyone and welcome to our second quarter presentation. Presenting this afternoon are Laurent Ferreira, President and CEO of the Bank; Marie Chantal Gingras, Chief Financial Officer; and Bill Bonnell, Chief Risk Officer. Also joining us for the Q&A session are Lucie Blanchet and Stephane Achard for Personal & Commercial Banking. Stephane is also now responsible for our international activities, namely ABA Bank. Denis Girouard, Head of Wealth Management and Etienne Dubuc, Head of Financial Markets and now responsible for Credigy.

Before we begin, I refer you to Slide 2 of our presentation providing National Bank’s caution regarding forward-looking statements. With that, let me now turn the call over to Laurent.

[Laurent Ferreira, President and Chief Executive Officer]

Merci, Linda and thank you everyone for joining us. This morning, National Bank reported solid results for the second quarter, with earnings per share of $2.38. We generated a return on equity of 17.5%, reflecting our highly accretive business model. This performance underscores the strength of our franchise and diversity of our earnings streams. In the face of macroeconomic uncertainty and the U.S. banking turmoil, we remain very comfortable with our strategic positioning and defensive posture.

First, our capital position is strong. With a CET1 ratio of 13.3%, we have flexibility to invest in organic growth across our businesses and a buffer against potential headwinds. Second, our liquidity position is robust and the bank benefits from a diversified funding profile. And third, our credit portfolios remain – continue to perform well, although our impaired PCLs are low. Given the uncertainty macroeconomic outlook, we continue to build reserves consistent with our conservative approach.

On capital deployment, our strategy has always been guided by prudence and discipline and that remains unchanged. We are focused on maintaining strong capital ratios providing us with the flexibility to invest in business growth and to return capital to shareholders when appropriate. To that end, we announced a 5% dividend increase, raising the quarterly dividend to $1.02 per share. The payout ratio is now at the low end of our target range of 40% to 50%, which is where we want it to be.

I will now review our business segments. Personal and Commercial Banking delivered strong performance in the second quarter. PTPP earnings increased by 22% from last year, mainly reflecting margin expansion and balance sheet growth. As anticipated, we continue to see a slowdown in mortgage growth. As such, in the context of higher rates, we remain very disciplined in managing net interest income. In Commercial Banking, we continue to see strong momentum with loan growth of 3% sequentially. For the second half of the year, we expect commercial loan growth to remain healthy, but to decelerate as businesses continue to adjust to higher borrowing costs.

Wealth Management also performed well. Again, this quarter, we generated strong year-over-year earnings growth, supported by our diversified business mix, our large deposit base and higher interest rates. We also delivered strong asset growth, up 7% from last year, demonstrating the breadth of our franchise.

Financial Markets delivered strong second quarter results and what has been a challenging environment. Corporate and Investment Banking showed strength driven by M&A and strong lending activity. Global Markets also delivered strong performance. Results in equities were robust, albeit lower than last year’s record level. We are also pleased with the continued momentum in FICC and securities finance. The performance of our Financial Markets franchise demonstrates its resiliency, earnings diversification, and ability to quickly adapt to market conditions.

Turning to our International segment. ABA Bank’s results reflect continued momentum in balance sheet growth with loans and deposits up more than 25%. Over time, we have been strategically investing to support strong business growth and network expansion. Our investments are paying off as our client base has grown by 40% over the past year. ABA’s revenue growth in the second quarter decelerated, primarily reflecting current pressure on the deposit margin resulting from higher rates, migration to term and a more competitive market for deposits. Looking forward, we continue to expect double-digit balance sheet growth for fiscal 2023. Based on what we are seeing today, margin pressure should ease over the next few quarters. Longer term, the outlook for ABA Bank remains very attractive, based on Cambodia’s strong fundamentals and the reopening for tourism.

I would now like to step back and provide a broader perspective on Credigy’s business model. Our franchise has demonstrated a proven ability to execute in any macro environment and have shown consistent risk reward discipline. Our portfolio is high quality, well-diversified and accretive to the bank’s NIM and ROE. Credigy’s opportunity set is driven by liquidity disruptions as much as by credit cycles. During the second quarter, the Fed intervened to address concerns about systemic risks in the U.S. banking system by injecting liquidity, thereby greatly reducing the liquidity disruption. As a result, Credigy’s second quarter asset growth was modest.

On the revenue side, the year-over-year decline reflects the asset mix evolution, which is now more secured, longer duration and has lower LTVs. This is in line with our defensive positioning given the current landscape. Regarding the outlook for Credigy, we are pleased with the asset growth delivered in the first half of the year, which supports our double-digit growth target for fiscal 2023. Credigy has a long track record of success and we remain confident in our ability to continue to generate high-quality earnings in the years to come.

Moving to the macroeconomic environment, the economy is adjusting to a higher rate environment and much uncertainty remains around the path of interest rates and inflation. Nonetheless, Canada, where the vast majority of our activities are focused, is structurally strong and well-positioned to weather an economic slowdown. Notably, the recent turmoil in the global banking industry underscores the strength and resiliency of the Canadian banking system. Our labor market remains robust, and Canada’s population growth fueled by immigration is the highest among the G7 countries and can contribute to sustainable growth.

To wrap up, the bank delivered a solid performance and superior ROE in the second quarter amidst a challenging environment. Our strategic choices and our defensive posture with a strong balance sheet and prudent reserves will continue to support profitable growth and help us navigate the uncertainty.

With that, I will pass it over to Marie Chantal.

[Marie Gingras, Chief Financial Officer]

Thank you, Laurent, and good afternoon, everyone. My comments will start on Slide 7. The bank delivered solid financial results in Q2 despite a less constructive backdrop. Revenues increased 5% year-over-year. In particular, we generated solid revenue growth in P&C Banking and Wealth Management as well as strong performance from Corporate and Investment Banking.

Expenses increased 6% year-over-year. A significant proportion of our expense growth was driven by last year’s FTE growth and wage inflation. Over the past few quarters, we have been prudently managing new hires and job vacancy. Also contributing to the increase in expenses were passed in new technology investments to deliver value for client experience and efficiency. These investments reflect a greater proportion of OpEx within the expense mix. Higher cost for advertising, business development and occupancy accounted for the remainder of the increase. Variable compensation was lower in the current quarter as last year’s results included a compensation adjustment reflecting the bank’s strong performance.

Our long-standing dynamic approach to balancing business growth and investments as demonstrated by our highly efficient businesses, continue to generate a strong all-bank efficiency ratio of 52.6%. As anticipated and discussed on our last call, operating leverage was negative in Q2, and we expect pressure to persist in Q3. We continue to be strategic and selective in managing expenses, notably related to headcount technology investments and discretionary spending.

While achieving positive operating leverage for fiscal 2023 remains challenging, we continue to target positive operating leverage in Q4. With respect to PTPP earnings, we expect growth in fiscal 2023 to be closer to the lower end of our mid- to high single-digit target. In a challenging environment, our disciplined approach to cost management contributes to the resiliency of the bank.

Now turning to Slide 8. Total net interest income, excluding trading, increased by 18% from last year with strong contributions from most businesses. For P&C Banking, net interest income was up by 20% year-over-year, mainly driven by deposit margin expansion and balance sheet growth. Wealth Management continued to benefit from higher interest rates and a strong deposit base of $40 billion, resulting from the diversification of our underlying businesses. This led to a 50% increase in net interest income compared to last year.

For Corporate Banking, we continue to experience strong growth in net interest income year-over-year, in part driven by strong lending activity. For USSF&I, net interest income decreased by 3% year-over-year as balance sheet growth was more than offset by lower margins, as discussed by Laurent earlier. The all-bank NIM, excluding trading, was 2.09% in Q2.

When looking at NIM sequentially, recall that there were 4 basis points of nonrecurring items that positively impacted Q1 NIM, including $20 million of prepayment revenue at Credigy and an interest recovery on a previously impaired loan in Corporate Banking. Second, Treasury’s performance in Q1 benefited from positive seasonal effects, which accounted for a difference of about 6 basis points of NIM between Q1 and Q2.

Excluding these items, total bank NIM ex trading remained relatively stable sequentially. Based on what we are seeing today, we also expect NIM to remain relatively stable in Q3. In addition, we expect NII to continue to grow compared to last year, albeit at a slower pace than in previous quarters. As always, we remain disciplined on both sides of the balance sheet, balancing growth, margins and credit quality.

Slide 9 highlights our balance sheet. Loans grew by 11% year-over-year. Growth was broad-based with particular strength in Corporate Banking, reflecting growing working capital needs, acquisition financing and capital markets disruption. Commercial loans grew by 11% year-over-year, in part driven by continued opportunities in the residential insured segment.

As anticipated, growth in personal mortgages is decelerating, driven by housing market conditions. Sequentially, loans grew by 3% at the all-bank level. Deposits, excluding wholesale funding, grew 17% year-over-year and 1.4% quarter-over-quarter, demonstrating again the strength of our diversified model and focus on growing our deposit base across all business segments.

Personal deposits are up 19% year-over-year and 2.4% quarter-over-quarter. Demand deposits in our retail channels, which include Wealth Management, are down approximately 1% sequentially as we experienced some migration notably from brokerage accounts to high-interest savings accounts in GIC. Term deposits continued to grow in Q2, but at a slower pace than previous quarters. Non-retail deposits increased by approximately 16% year-over-year and 1% quarter-over-quarter, with all segments contributing to the growth.

Slide 10 presents our strong liquidity position and sound funding profile. Our core banking activities are well funded through diversified and resilient sources. The bank has a comprehensive view on deposits, which involves all business lines, and we remain disciplined around funding costs. This strategy contributes to a well-diversified deposit base and to the bank’s strong overall performance. With an objective of maintaining prudent liquidity metrics, the bank consistently operates at levels that are well above regulatory minimum requirements. We ended Q2 with a liquidity coverage ratio of 155% and a net stable funding ratio of 118%.

Now turning to capital on Slide 11. Our CET1 ratio improved by 76 basis points to reach 13.3%. Second quarter earnings net of dividends contributed 40 basis points to our ratio, underscoring our strong internal capital generation capacity. In addition, Basel III reforms contributed 44 basis points to our ratio and a reduction in market risk RWA contributed 10 basis points.

Excluding Basel III reforms and market risk, RWA increased by approximately $1.7 billion, representing 18 basis points of CET1 ratio. Continued asset growth in Corporate and Commercial Banking books accounted for 12 basis points, while unfavorable rating migration in non-retail portfolios accounted for 6 basis points. Our capital position is strong. It provides us with flexibility to deploy capital across our segments to support growth and return capital to shareholders.

In conclusion, the bank delivered solid Q2 results, supported by organic growth across our businesses, industry-leading ROE, solid balance sheet growth and good margins. Despite continued macro uncertainty with a resilient business model and our disciplined approach to cost capital and risk management, we are well positioned for the second half of the year and beyond.

I will now turn the call over to Bill.

[Bill Bonnell, Chief Risk Officer]

Merci, Marie Chantal, and good afternoon all. Although events in the U.S. banking sector generated higher levels of uncertainty during the last quarter, the performance in our credit portfolios remain strong and continue to follow the trends we discussed on the last call. Strong employment and savings levels continue to help or adjust to the impacts of higher interest rates. This is particularly true in our home province of Quebec where the unemployment rate remains near historical lows and consumer resiliency is strengthened by a greater proportion of two-income households and lower debt levels.

These factors continue to support the solid credit performance you see on Slide 13. In the second quarter, impaired PCLs rose to $52 million or 10 basis points. Across our domestic retail and non-retail portfolios, slow normalization generated impaired PCL levels that remain well below pre-pandemic levels. At Credigy impaired provisions were stable and driven by the normal seasoning of portfolios, and that ABA performance continues to match our expectations with provisions well below the peak experienced in the second half of last year. In light of ongoing macro uncertainty, we prudently built additional reserves on performing loans in the quarter. Updates to our scenarios, portfolio growth and some migration generated $27 million or 5 basis points of performing provisions with the majority of these taken in the non-retail portfolios. Looking ahead, we believe that credit performance will continue to normalize, and we expect impaired PCLs to rise over the coming quarters and into next year. However, based on the strong credit performance we’ve experienced year-to-date, and on current trends and delinquencies, we have lowered our full year impaired PCL target to 10 to 20 basis points and currently expect to end up in the bottom half of that range.

Turning to Slide 14. Total allowances for credit losses increased by 4% to over $1.2 billion. Performing ACLs grew to $975 million, which is just 8% below its pandemic peak.

On Slide 29 in the appendix, you’ll find details of our allowance coverage ratios. In these uncertain times, we are very comfortable with this prudent level of allowances as well as with our defensive geographic and business mix.

Turning to Slide 15. Our gross impaired loans ratio was stable at 38 basis points and remains below pre-pandemic levels. Net formations rose sequentially from last quarter, which had benefited from some repayments, and show ongoing slow normalization trends in our domestic portfolios. Net formations in the International segment continued to match our expectations.

On Slides 16 and 17, we present the highlights of our Canadian RESL portfolio. The mix remained stable with Quebec accounting for 54% and insured mortgages accounting for 29% of total RESL. Average LTVs increased slightly to 58% on uninsured mortgages and 53% on HELOCs, and average credit scores and delinquency rates were stable. Looking at the tail end of the distribution, we find that less than 50 basis points of the RESL portfolio is to uninsured borrowers with credit bureau scores of less than 650 and LTVs greater than 75.

I’ll make some comments now about our commercial real estate exposure. As you may remember, in the late cycle years prior to the pandemic, we frequently discussed on these calls the fact that we had been restraining growth in the commercial real estate sector. During the pandemic, we continue to restrain growth in the office and retail segments, but we allowed healthy growth in the residential segment, which was primarily related to CMHC insured loans to support the supply of affordable and energy-efficient housing. We have been providing details of the CRE portfolio on a slide in our appendices each quarter since the end of 2020, and you’ll find it this quarter on Slide 30. Our portfolio is Canadian focused with minimal U.S. exposure. The Office segment represents around 1% of total loans and benefits from the strong underwriting practices and meaningful recourse that are typical in the Canadian market.

The Retail segment is focused on essential services tenants and has decreased in size over the past 5 years. Our comfort in growing the Residential segment comes from both the strong demographic trends in Canada, supporting consistent demand for rental lodging as well as the high proportion of insured lending in this segment. Overall, we remain very comfortable with the size, quality and mix of our CRE portfolio.

Now before closing, I’ll summarize by saying that we are pleased with the credit performance again this quarter and remain very comfortable with our defensive positioning, our resilient mix and our prudent level of allowances.

And with that, I will turn it back to the operator for the Q&A.

[Operator]

Thank you. [Operator Instructions] Our first question is from Meny Grauman from Scotiabank. Please go ahead.

[Meny Grauman, Scotiabank]

Hi, good afternoon. First question is on ABA, trying to better understand the margin dynamics, what happened this quarter and the outlook going forward. Laurent, you talked about margin pressure easing as you look ahead through the rest of the year. And I’m just trying to understand, first, to clarify that you still see margin pressure, but just less margin pressure going forward? And that’s the first question. Maybe I leave it there just as the first question.

[Stephane Achard, Head, Personal Banking]

Thanks, Meny. Good question. It’s Stephane. So you’re right. So Laurent alluded very clearly to the fact there was this pressure. And at the beginning of the year, we saw some banks fight and be more competitive on deposit and that raised pricing on deposits. And we were fortunate. You saw our deposits grew by 28% or 27% is very strong. there is been migration as well of people going to the term deposit side. So it’s increasing. It’s now up to 30% of our deposits with our term deposits are not typically very long deposits months, but it’s increasing. So that put a pressure on the margin itself. On a year-over-year basis, it will stabilize over the next, I’d say, three quarters, but we probably have still pressure for one or two quarters. tough to predict exactly where the term deposit dynamic is going to stop. I’ll just end up by saying that, overall, the margin at ABA is extremely strong when we compare it to Canada and very accretive for National Bank as a whole.

[Meny Grauman, Scotiabank]

So just to understand the outlook going forward, the expectation – I mean you talked about two different factors. So just in terms of the migration, the expectation just that, that will slow as rate hikes slower start…

[Stephane Achard, Head, Personal Banking]

Yes. As we will see a full year-over-year stabilization and the rate hikes, that’s the first element. So we probably have another – at least another quarter perhaps to before that pressure eases off completely.

[Meny Grauman, Scotiabank]

And then just I wanted to better understand the competitive dynamics in the market and maybe just a refresh as well we talked about it it’s been a while in terms of ABA’s market share and where that market share is right now and the outlook in terms of market share, is there still more expectation of significant market share gains in Cambodia right now?

[Stephane Achard, Head, Personal Banking]

Yes. The market is still very underbanked. So there are opportunities for market share increases, and we’ve seen our market share increase. Obviously, we haven’t gotten the 2022 numbers, but the last assessment positions us around the 18% to 20%. And range in terms of market share. And in our case, when we’re growing the book and the customer base by 40% in a year, obviously, I think that is do more market share.

[Meny Grauman, Scotiabank]

Thanks. And then just a question on capital. CET1 of 13.3, Laurent, you talked about in the past – you’ve talked about how you weren’t interested in doing buybacks at a lower capital ratio at 13.3, does that change your outlook on buybacks at all?

[Laurent Ferreira, President and Chief Executive Officer]

Thanks for your question, Meny. Now buybacks are not on the table right now. A couple of things to keep in mind. Obviously, uncertainty, I think we’ve talked a lot about the uncertainty regarding the macroeconomic outlook, inflation, rates, growth. Also Basel III reform was the initial changes were positive and we still have to go through some of the reforms, and there is going to be a slight reduction in CET1 once fully implemented. So look, our intention is very clear. Past couple of quarters, we want to operate above 12. We’re still with that mindset. But at this point in time, given what I just mentioned, buybacks are not on the table.

[Meny Grauman, Scotiabank]

Thank you.

[Operator]

Thank you. The following question is from Scott Chan from Canaccord Genuity. Please go ahead.

[Scott Chan, Canaccord Genuity]

Good afternoon. So just on the Credigy side, you kind of maintained your double-digit loan target for this year, despite slower growth this quarter. Can you maybe talk about the challenges you witnessed in the quarter in terms of liquidity based on U.S. banking crisis? And it sounds like that liquidity is getting better in the back half of the year to remain your target.

[Laurent Ferreira, President and Chief Executive Officer]

Yes. Thanks for the question, Scott. It’s Laurent. So you’re right. We did encounter some challenges in the quarter. And you did see some very modest growth in Q2 after a very healthy growth in – both in Q4 last year and Q1 this year. So – what we saw this quarter is supply, and I think Lucie alluded to it supply being very low following a period of high volatility with a lot of U.S. government support and their wheelhouse is liquidity situations where there are some for sellers and you didn’t have much of that in the market this quarter. Also, I would say that Credigy are fundamentally very conservative in their pricing approach. And I would say that they are more conservative than other participants right now at the moment. So that results in a gap in pricing levels. So we’re picking our spots and remaining very selective in the current context. We won’t sacrifice pricing discipline for asset growth. That said, we believe that, as the market normalizes over the next two quarters, we will return to mid to high single-digit growth for the year in terms of asset growth.

[Scott Chan, Canaccord Genuity]

That’s helpful. And then maybe last question. At this point, can you quantify potential lost revenues on securities from trading with the budget that changes are going to come into play?

[Marie Gingras, Chief Financial Officer]

Hi, Scott, it’s Marie Chantal here. So as you know, some of the elements of the budget have not been included in the Tax Bill yet. So the Tax Bill that’s currently under the third reading. So it’s still hard at this point of time to give a precise number. Any estimates would be rough estimates. As you know, the amount of Canadian dividends has fluctuated over the year based on market activity and client demand for equity product and Canadian shares. So in addition, as I said, final form of the reform not being finalized yet, it’s still early to say. And finally, maybe just a note, historically, any change in whether it’s capital, liquidity, fiscal regulatory rules have tended to impact market conditions and client demand and our franchise tend to adapt well to those changes.

[Scott Chan, Canaccord Genuity]

Okay, thank you very much.

[Marie Gingras, Chief Financial Officer]

Welcome.

[Operator]

Thank you. Following question is from Paul Holden from CIBC. Please go ahead.

[Paul Holden, CIBC]

Thank you. Good afternoon. A couple of questions for Bill. So if you look at your impaired PCL ratio, I mean, coming in lower than I would have expected, and I’m assuming, given the revised guidance lower than you would have expected. So like why is that? What is it that’s trending slower than you would have expected? And then two, to the extent you can, your impaired PCL ratio is well below what we’ve seen from the other Canadian banks. Why do you think that is?

[Bill Bonnell, Chief Risk Officer]

Hi, Paul, thanks for the question. Maybe I’ll tackle the second one first. The – I can’t comment on in detail on the other bank’s portfolios. But just from a macro level on the outside, I think it’s important to understand where we’re overweight, underweight and where we’re not. So I think what we’ve seen from the U.S. bank reporting and then the Canadian Bank reporting in U.S. operations is that the normalization and credit performance is happening maybe more quickly in the U.S. than in Canada. And I guess that should be expected given the liquidity removal was faster in the U.S. And I think the – with the banking sector turmoil last quarter, there is maybe credit conditions are a little bit tighter. So as you know, we’re pretty small in the U.S., so that’s probably one of the relative. And then on the core Canadian portfolios, I think it’s what we’ve been talking about for quite a while in the geographic and product mix. So we did talk last quarter, and we’re continuing to see the trends this quarter that the normalization is happening faster in unsecured consumer lending, cards and such, which, as you know, we’ve got – we’re significantly smaller on a relative basis than peers in that space. And then geographically, Quebec versus outside Quebec, I think I commented on that in my prepared remarks, but the resiliency of the Quebec consumer with lower leverage levels, lower house prices, more dual income and a higher savings rate on the fact – in the back of that with the employment levels that you’ve seen in Quebec still near historic levels and below the national average. So I think that geographic difference as well as the product difference in Canada, I would assume that, that’s probably the difference.

Now on your first question, yes, we did call out at the end of last year when we were giving our sharing expectations for 2023 that we expected normalization of performance and higher impaired PCLs. I would repeat what I said in my prepared remarks that we do expect impaired PCLs to rise in the coming quarters and well into next year. It has been, say, the color this quarter is it’s been slower than we would have expected and particularly in the – in our Quebec portfolios. So just all of those trends, kind of, I think, describes relative and absolute expectations. Does that answer your question, Paul?

[Paul Holden, CIBC]

It does. That’s helpful. Thank you. And then maybe one for Marie Chantal, you gave us some guidance and thoughts around expense management. Maybe you can just dig a little bit deeper there in terms of what you think is required in the next coming quarters to slow loan – sorry, slow expense growth and get back to positive operating leverage?

[Marie Gingras, Chief Financial Officer]

Yes. Hi, Paul, so maybe I’ll go back to some of my remarks in terms of how we manage expenses dynamically with revenues. And I think having operating leverage as the key levers for all of our businesses, has always been in our strategy. So that definitely is an important background of how we do manage expenses. And as I mentioned, it’s been a couple of quarters now that we have been very prudent in managing hiring as well as vacancies and you can see it in our disclosure, if you look at our number of FTEs that have been stable since Q4 last year. So, we have already been in action in order to be – to manage that operating leverage, and we will continue to do so in the next couple of quarters. Of course, we are also managing our investments in technology and discretionary expenses. So, I think that summarizes the actions that we are taking in order to manage our operating leverage positive for Q4.

[Paul Holden, CIBC]

Okay. And so I want to hear that just to drill in. What I am hearing is, obviously, managing the FTE, the flat, not managing – not expecting to manage FTE to lower.

[Marie Gingras, Chief Financial Officer]

Yes.

[Paul Holden, CIBC]

Okay. Got it. Thank you.

[Marie Gingras, Chief Financial Officer]

You’re welcome. Thanks Paul.

[Operator]

[Operator Instructions] Our following question is from Mike Rizvanovic from KBW Research. Please go ahead.

[Mike Rizvanovic, KBW Research]

Hey. Good afternoon. I wanted to ask about mortgage lending in Québec. Obviously, it’s the key market for you. And I do understand that the strategy around protecting your margins that’s been talked about for several quarters now. But I am just looking at the numbers, and it looks like you have lost about 80 basis points over the last couple of years of your share in Québec. So, this is total RESL lending. And as an anchor product, I am just wondering how sustainable, like how long can you protect the margin and not maybe be more competitive on pricing? Obviously, some of your peers are a lot more aggressive in your neck of the woods. What’s the outlook on your strategy? Do you care about market share at or maybe I am exaggerating the impact here, but wondering how sustainable market share losses in RESL would be for National in Québec going forward?

[Lucie Blanchet, Head, Commercial Banking]

Yes, it’s Lucie. Thank you for that question. Obviously, it’s not our strategy to buy market share, and we have been very, very disciplined on that, and we continue to be very disciplined on that. If we look at the, let’s say, the environment right now, the Q4 and Q1 were probably the worst in terms of competitiveness. We saw better position in Q2. But as we look forward, with the current environment, we see competitiveness to continue and even to increase in the – let’s say, at least for Q3 with the current conditions. So, we are disciplined, we are strategic. We anchor our decision on our customer strategy, where we want to engage and make sure we get the full banking relationship from the mortgage business customers. And we see the benefit of that as the revenue per customers for the core customers, let’s say, the ones that have started banking relationship with us. Their revenue is much higher with the mortgage relationship. So, this is kind of how we approach it. I don’t know if that infers your question?

[Mike Rizvanovic, KBW Research]

No, that’s helpful. I am just wondering, so looking ahead, you did mention you expect it to be competitive going forward. What does your margin in Canadian P&C banking potentially?

[Lucie Blanchet, Head, Commercial Banking]

I don’t think it’s just a matter of mortgage. I think it’s a matter of overall of business mix and you have the commercial growth going there. You have the deposits going there. So, is you question about the overall margin or just…?

[Mike Rizvanovic, KBW Research]

Yes, just a competitive mortgage market, I don’t know what spreads are doing in that line of business. But if it’s going to be very competitive going forward, does that impact your margin much in the segment?

[Lucie Blanchet, Head, Commercial Banking]

I would say, overall, no, because if you look not just the Québec market, but overall, our position in terms of mortgage growth, we have made strategic decisions to decelerate the growth in our third-party channels where the margins have really been close to none, I would say, in the current context. So, that those third-party channels are important in terms of portfolio, but they did not contribute much in terms of growth, and it has impacted overall our mortgage growth, and we are comfortable with that.

[Mike Rizvanovic, KBW Research]

Okay. Thanks for that. And then just really quickly for Laurent, maybe excess capital. Are you thinking about deploying outside of Canada potentially? I know that there has been a moratorium on that for quite some time now. Is that on your radar screen at all? Sorry if you answered this already earlier in your prepared remarks, I may have missed it, but any thoughts on capital deployment, just given the strong CET1 and what your target might eventually…?

[Laurent Ferreira, President and Chief Executive Officer]

Thank you for your question. The only thing that we would consider as capital deployment through Credigy, financial markets, so very niche, ROE accretive, but no bank acquisitions or anything like that anywhere in the world right now.

[Mike Rizvanovic, KBW Research]

Okay. Appreciate that. Thanks very much.

[Operator]

Thank you. Our following question is from Sohrab Movahedi from BMO Capital Markets. Please go ahead.

[Sohrab Movahedi, BMO Capital Markets]

Okay. Thank you. Maybe I will just start just there for a second. Laurent, you mentioned several times, I think in your prepared remarks about the prudent reserve levels and the defensive posture. But you are open to deploying opportunistically, I suppose capital and you said in support of growth in financial markets and Credigy. What I am trying to kind of understand is what’s your risk posture right now? Are you looking to take on risk, or are you still looking to shy away from risk right now?

[Laurent Ferreira, President and Chief Executive Officer]

Well, we never said that we would shy away from risk. Our approach is defensive, but we are not slowing down growth. But we have to be a little bit more opportunistic, I think at this moment in time, given the uncertainty and certain turmoil in the market. But rest assured that we are obviously following closely where those pockets of opportunities are, and we will be ready to jump on it. Our focus is and remains on growth across Canada. We see opportunity to take on market share in commercial. And it’s not just about balance sheet deployment. Wealth is also a growing franchise for us. So, that’s another area that we are going to keep focusing on. But market conditions are such that there is disruption right now. Invest in various areas, as you know it. So, the idea is to be ready when these opportunities are going to be at the right price, at the right risk profile. So, that’s the approach we have, but I don’t know if this helps you.

[Sohrab Movahedi, BMO Capital Markets]

No, that’s very helpful. So, is it safe to say that, I guess if everyone is going to see slower activity, you expect to see slower activity, but less than others because you are better positioned, I guess to be more opportunistic. Is that how you are – is that the way to think about it?

[Laurent Ferreira, President and Chief Executive Officer]

It’s the way we think about it. I mean we expect, obviously and you have heard it on the call, the remarks as well, we expect normalization in mortgage, depending on the path of interest rate and inflation, we could see also a normalization in commercial loan growth. Having said that, we are – we do see opportunities across the country to take on market share, and that’s where we are right now. That’s going to be the focus of the team.

[Sohrab Movahedi, BMO Capital Markets]

Okay. Maybe I can just ask Bill then. I mean Bill, this credit cycle, seems to be kind of evolving a little bit different than the last couple or few that we remember anyway, where it doesn’t look like there is going to be a clean peak to the PCL for any bank in any one quarter. And that’s my words not yours, but it may actually be a little bit more of a drawn out flat top type of a trend. Is that how you are seeing it evolve based on your experience, or do you think that there will be, I will call it, a bit of moment where there will be a quarter where we actually see a peak, a well-defined peak with then kind of, I don’t know, reversals and the like following it?

[Bill Bonnell, Chief Risk Officer]

Thanks Sohrab. I think another way to ask that question would be, will the central banks be able to pull off a soft landing, mild recession, will there be other disruptions in the context of heightened geopolitical, heightened uncertainties and where will interest rates be in 2 years’ time. So, I think it does highlight there is pretty significant uncertainty. And there is various paths which I think you and I could have lots of great discussion on what could lead to any of those paths, but it is really hard to predict. The – my confidence with predicting business cycles, the last one before the pandemic was the longest in history, and we had a pandemic cycle, which we hadn’t seen in 100 years. What this next one will be is hard to know given all the factors. But what I can – what I do feel very confident in is because of our – the positioning that we have talked about for quite a while now, geographical products, capital allowances, I think that we are confident in our ability to perform well regardless of which of those paths come relatively well as well as which of those paths come in. That’s probably the point that I can be most certain about or confident about, not less confident about predicting which path will be the one that will actually be experienced. I don’t think they don’t know if that helps you, Sohrab, but I think it’s the best I have got.

[Sohrab Movahedi, BMO Capital Markets]

Okay. But it’s not your risk like there isn’t growth there that if you were willing to just loosen your risk appetite a little bit that you could pick up. In other words, at the margin, is there a growth that you could pick up if you were willing to actually still deliver on impaired 15 to 25 for this year?

[Bill Bonnell, Chief Risk Officer]

Yes. I think about it a little differently. I think that our discipline is consistent and has been consistent. I think our confidence in the nature of our franchise to seize opportunities quickly where they arise. I am very, very confident in that. And that predicting, it certainly doesn’t feel like a 2009 where all pricing risk on was a lot easier and returns followed. Now, it’s a little more selective and it’s based on the uncertainties that we talked about the future path. But – so very confident that we have a franchise which is nimble and agile and the setup and their positioning with capital and balance sheet and liquidity and allowances will allow the franchise to execute very, very well.

[Operator]

Thank you. Following question is from Darko Mihelic from RBC Capital Markets. Please go ahead.

[Darko Mihelic, RBC Capital Markets]

Hi. Thank you. Just a few questions to follow-up, and it’s been a little bit difficult to get some views on this. So, I am going to ask you and hoping that you can provide maybe some ideas. I mean what we saw in the quarter was maybe better than expected help from the Basel reforms. But as I listen to other bank conference calls, I got this uneasy feeling that the next set of Basel reforms might actually be punitive. The fundamental review of the trading book and then the floor, and I was surprised to see some banks hit the floor. So, do you have any early views on these other hits? And is this something that, in particular, the FRTB might be a bit of an issue for National Bank?

[Marie Gingras, Chief Financial Officer]

Hi Darko, it’s Marie Chantal. Thanks for the questions. And I think, Laurent, alluded to it very briefly a little bit earlier. And we are very – of course, the first phase of the Basel impact was quite positive for us with 44 basis points, and we do anticipate that the next phase will be negative. There is still a moving part. So, it’s not a good time now to give you any estimates, but definitely, it will be negative for the next phase.

[Darko Mihelic, RBC Capital Markets]

Okay. I guess what I was hoping for was some sort of magnitude and/or whether or not it changes your – it might even impact your business model. So, it’s just too early to tell, I suppose. Is that the best…?

[Laurent Ferreira, President and Chief Executive Officer]

Darko, it’s Laurent. Maybe I could jump in. It does not impact our business model at all. And this is over the next 2 years. And we believe in the accretive capital generation of our franchise to be able to manage it. So, it’s not an issue whatsoever. And we are in a very strong capital position, as you know it. And you heard my remarks in terms of how we want to manage through this. So, rest assured, it is not an issue for us.

[Darko Mihelic, RBC Capital Markets]

Okay. Thank you for that. And I am looking – my second question is, I am looking at Page 9 of your investor presentation. And I was just hoping for a little bit of clarity or a little bit of – just a few ideas on your non-retail deposits. We have been noticing for some time that this is a very broad classification. And we have been noticing that even within Canada, you are kind of going against the trend on some of these deposits. So, I am just curious if you can maybe give us a flavor for what you may be doing differently with respect to these non-retail deposits? Why you may be seeing growth, especially in the non-interest bearing ones, whereas we are seeing more terming out and less growth at the other banks. And whether or not this is a fleeting kind of scenario and/or maybe what would make these rather sticky for you given that they are commercial kind of deposits? Thank you.

[Marie Gingras, Chief Financial Officer]

Hi Darko. I will take our first part of your question. So, maybe I would go back to our – first, our diversified model where we grow deposits across all of our businesses. And when you look at our non-retail deposits for this quarter, which were up by 0.9% quarter-over-quarter and 16% year-over-year, it really came from all of our businesses. So, it’s very much well diversified. So, I think that’s what maybe supports the growth that you are seeing in our non-retail deposits.

[Darko Mihelic, RBC Capital Markets]

I guess what I was hoping for though is, I mean most commercial deposits everywhere else are actually declining, suggesting that operating – so either your customers are somehow different or you are doing something different. So, I am just curious as to what might be – like in all commercial and corporate, generally speaking, are down and corporates and commercials are actually using their operating and using their deposits, what might be different for you if it’s not interest rates. I mean if it’s rates, that’s a great answer. But is there something else that you could point to that would suggest that, for some reason, your corporate commercial customers are behaving differently?

[Stephane Achard, Head, Personal Banking]

So Darko, it’s Stephane. So, you are reading as to the behavior of our commercial clients is correct. And we have seen a shrinking in the working capital of the Canadian businesses. And it’s shown in the reduction of the operating line drawings and a bit in the deposits as well, particularly this quarter, but you have got to take into account that we have a large governmental base quantities of deposits, which are going to be more lumpy when it comes tax – receipt of taxes on residential housing and property taxes and so forth. And those tend to be – while their demand, they tend to be very sticky as well. So, that is an important difference, I would say, in the movement of our deposits.

[Darko Mihelic, RBC Capital Markets]

Okay. Great. That’s very helpful. Thank you very much.

[Operator]

Thank you. We will now take our last question from Sohrab Movahedi. Please go ahead.

[Sohrab Movahedi, BMO Capital Markets]

Actually, I just wanted to apologize. I dropped off. I wanted to apologize. I don’t know what happened to my phone there. Bill, I will follow-up with you with any other follow-up questions, but that was a technical matter. Sorry about that.

[Bill Bonnell, Chief Risk Officer]

It wasn’t something I have said with you, Sohrab.

[Sohrab Movahedi, BMO Capital Markets]

Not yet anyway.

[Bill Bonnell, Chief Risk Officer]

Okay. Happy to follow-up with you later.

[Operator]

Thank you. We have no further questions registered at this time. I would now like to turn the meeting back over to Mr. Ferreira.

[Laurent Ferreira, President and Chief Executive Officer]

Well, thank you very much and we will see you at the end of the summer. We will talk to you at the end of the summer. Thank you.

[Operator]

Thank you. The conference has now ended. Please disconnect your lines at this time and we thank you for your participation.