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National Bank of Canada
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Good afternoon, ladies and gentlemen, and welcome to National Bank of Canada's Third Quarter Results Conference Call. I would now like to turn the meeting over to Mrs. Linda Boulanger, Senior Vice President of Investor Relations. Please go ahead, Ms. Boulanger.
Thank you, operator. Good afternoon, everyone, and welcome to our third 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 Stephane Achard and Lucie Blanchet, Co-Heads of P&C Banking; Martin Gagnon, Head of Wealth Management; Denis Girouard, Head of Financial Markets; Ghislain Parent, Head of International; and Jean Dagenais, Senior VP, Finance.
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.
Merci, Linda, and thank you, everyone, for joining us. This morning, we released strong third quarter results with pretax pre-provision earnings up 9%, driven by double-digit growth across all business segments. This translated into an industry-leading return on equity of 18%, reflecting our disciplined approach to capital, risk and cost management. We continue to operate in an uncertain and complex environment, dominated by elevated inflation, rising interest rates and heightened geopolitical risks.
While headline inflation recently showed signs of deceleration, it still remains too high. The Bank of Canada is expected to continue to raise rates in September to slow demand and tame inflationary pressures. Given this backdrop, a slowdown in economic growth is expected to persist through the -- through next year. Although the probability of a recession has increased over the past few weeks, it is not our base case. Our economics team is currently calling for a soft landing of the Canadian economy.
In our view, inflation should continue to decelerate and interest rates should normalize this fall to just over 3%. In this scenario, the unemployment rate should stabilize just over 5.5% in 2023. In this context, the bank is on solid footing. Our capital levels are strong with a CET1 ratio of 12.8%. Our credit portfolios continue to perform well. We are maintaining a disciplined and balanced approach in underwriting new deals, and we continue to carry a prudent level of reserves.
Turning now to our business segments. P&C delivered a record quarter with revenues surpassing the $1 billion mark for the first time in its history. Pretax pre-provision earnings were up 18%, supported by strong growth on both sides of the balance sheet as well as expansion of net interest margin. On the retail side, mortgage loans grew 8% year-over-year. Given the rising interest rate environment, we anticipate the demand for real estate secured lending to continue to normalize back to pre-COVID levels.
Several factors continue to support the Canadian housing market, including strong immigration and unemployment at historical lows. We also expect Quebec's housing market to be resilient given better relative housing affordability, consumer savings and debt levels in the province. Commercial loans are up 17% year-over-year, with solid growth across industries and geographies. While clients are being more prudent due to the economic context and higher financing costs, we expect commercial loan demand to remain robust in the coming quarters.
Our Wealth Management franchise delivered a strong performance this quarter. Pretax pre-provision earnings were up 11% year-over-year, highlighting our diversified revenue mix. We saw a significant uplift in net interest income propelled by a large deposit base and rising interest rates. We also delivered strong net sales in all channels, despite challenging market conditions, demonstrating the depth of our franchise.
Financial Markets had another strong quarter with revenues of $611 million, up 14% from last year. Momentum continued in global markets with strong performance across most business lines. Our Corporate and Investment Banking franchise generated good results supported by domestic M&A activity and balance sheet growth. Our performance record -- sorry, our performance track record in Financial Markets speaks to the resilience and diversification of our franchise.
Moving on to our International segment. ABA Bank had another strong quarter, with revenues and net income up 28% and 31%, respectively. This was driven by strong loan and deposit growth. The underlying fundamentals of Cambodia remain strong. The country is underbanked and the benefits -- and benefits from strong demographics. Also, Cambodia is a U.S. dollar-based economy. As a result, they are experiencing a level of inflation in line with Western countries.
Turning now to our U.S. Specialty Finance business. Credigy's results continue to reflect strong underlying performance across asset classes. Rising interest rates impacted revenues from assets at fair value this quarter. Nonetheless, assets were up 2% on a sequential basis, driven by higher utilization, new deals and extensions. In the current environment, Credigy remains highly selective, and we'll continue to pursue a disciplined investment approach.
To conclude, there are several scenarios on the table as to the path of the economy. Despite potential headwinds ahead, the bank is well positioned. Our third quarter performance reaffirms the resiliency of our franchise, our business mix and our strategic choices. We have a defensive positioning with strong capital levels, resilient balance sheet and prudent credit allowances. This provides us with flexibility to grow our business and a buffer in an uncertain environment.
Our businesses are positioned to continue to perform well and generate attractive growth. Our Personal and Commercial franchise has an overweight position in secured lending and a disciplined approach to volume growth, margins and credit quality. Financial Markets has proven its resiliency with consistent performance over time with a focused domestic strategy. Our Wealth franchise is demonstrating the strength of its earning power through the cycle. And finally, our International businesses remain well positioned to deliver strong growth and high return over time.
Looking ahead, we will maintain our usual discipline with a view on our longer-term priorities and growth objectives. National Bank has a long-standing track record of delivering superior value to its shareholders over the long term. This remains both our philosophy and our priority. Before I turn it over to Marie Chantal, I would like to congratulate Étienne Dubuc and welcome him to our senior leadership team as Co-Head of Financial Markets effective November 1, a responsibility he will share with Denis Girouard. Étienne has been in leadership position with the bank for nearly 25 years, including as Head of Equities for the last 3. Congratulations to Étienne. We are thrilled to have him on our team. Marie Chantal, over to you.
Thank you, Laurent, and good afternoon, everyone. Turning to our results on Slide 7. Revenues increased by 8% year-over-year. All business segments performed very well, supported by solid asset growth, good client activity and a favorable interest rate environment. Pretax pre-provision earnings grew 9% year-over-year. Our strong performance reflects the resiliency and diversified earnings stream of each business segment. We generated positive operating leverage of 0.6% this quarter, bringing us to 1.5% year-to-date.
We are well on track with our target to achieve positive operating leverage for the full fiscal year.
Turning now to expense management. First, higher operating costs year-over-year are mainly related to investments made in our people over the past year to support the business and remain competitive in a tight labor market. Our amortization expense also increased in line with the deployment of technology projects. We are also seeing a return to travel and business development activities, which are contributing to the year-over-year increase.
Second, the other important component is our investment spend to support business growth and protect the bank. This includes technology projects to enhance client experience and acquisitions and to expand activities in areas of expertise. It also includes investments in our systems, processes and cybersecurity. The bank's balanced approach continues to contribute to high pretax pre-provision earnings growth with our expense line tied to our business performance.
All business segments generated double-digit PTPP earnings growth in the quarter. This was partly offset by our other segment. As a reminder, the Other segment includes our treasury function and corporate investments. In Q3, a number of factors impacted our top line performance in this segment. This included lower investment gains in the context of more favorable markets last year. Unfavorable mark-to-market due to hedging accounting inefficiency, and the impact of hedging activity against a potential decline in interest rates, reflecting our defensive positioning.
The bank's approach has always been to target stable and predictable NII growth through the cycle. We manage interest rate risk dynamically to balance the upside and protect against the downside. This is consistent with the overall prudent positioning of the bank. As demonstrated by our Q3 results, the bank is benefiting from higher interest rates. On a total bank basis, NII was up 16% year-over-year, and our net interest margin, excluding trading, was up 9 basis points year-over-year.
In the current market conditions, we expect lower PTPP earnings for the Other segment in Q4 compared to Q3. This will be in part driven by lower investment gains. In addition, we technically recognized higher expenses in the fourth quarter for this segment. At the same time, all business segments are well positioned, and we are seeing good momentum as we are entering Q4.
Looking now at expenses by segment on Slide 8. Each business segment remained disciplined in managing expenses, ensuring that the right investments in people and technology are made to support business growth.
Our teams are also constantly looking at generating efficiencies, which is key in an inflationary context. This has translated into best-in-class efficiency ratios in some of our segments again this quarter.
Now turning to capital on Slide 9. We maintained a high CET1 ratio, ending Q3 at 12.8%, while generating strong organic growth. Third quarter earnings net of dividends added 45 basis points to our ratio. RWA growth represented 47 basis points of capital. This was largely driven by asset growth in Commercial and Corporate Banking and by an increase in market risk RWA reflecting market volatility in the quarter. There was no NCIB activity in Q3.
At this time, we do not expect any buyback activity in Q4 as we continue to see organic growth opportunities in our businesses. In the context of heightened macroeconomic uncertainty, we believe it is prudent to maintain robust capital levels. Once again this quarter, the bank achieved strong revenue and PTPP growth as well as superior ROE. In an uncertain economic environment, the bank's strong fundamentals and prudent approach to capital, cost and risk management position us favorably to continue generating business growth and long-term value for our shareholders.
With that, I will now turn the call over to Bill.
Merci, Marie Chantal, and good afternoon, all. I'll begin on Slide 11. Although fixed income and equity markets experienced significant volatility during the third quarter, underlying employment and economic conditions remain supportive of a strong performance across our credit portfolio. Our provisions on impaired loans remained very low at just $17 million or 3 basis points. Retail impaired provisions remain well below pre-pandemic levels. Provisions were stable quarter-over-quarter in the International segment. And in the nonretail portfolios, we benefited from net recoveries, which can be lumpy from quarter-to-quarter.
Even excluding the benefit of these recoveries, our impaired PCLs would have still been low, however, more representative of the normalization we expect to continue well into 2023. Our provisions on performing loans totaled $33 million or 7 basis points. The primary drivers of the allowance build this quarter were the update to our forward-looking scenarios reflecting a deterioration in the outlook, an increased weight of the pessimistic scenario and portfolio growth, which were partially offset in the management overlay.
Looking ahead, we've maintained our fiscal year 2022 guidance on impaired PCLs at below 15 basis points. Current underlying conditions, particularly the strong level of employment and consumer savings, support a slower rate of normalization of impaired PCLs than we had expected at the beginning of this year. Our visibility on the outlook for performing PCLs remains more cloudy due to the significant uncertainties in the economy's path forward.
The same factors we discussed last quarter, inflationary pressures, supply chain challenges, geopolitical risks and the direction and speed of interest rate changes are still present and all contributes to a less certain outlook. In these uncertain times, we remain very confident with our defensive geographic and business mix as well as our prudent level of allowances.
Turning to Slide 12. Total allowances for credit losses increased to almost $1.1 billion, remaining more than 40% above the pre-pandemic level. Performing allowances increased by 4% to $854 million, taking our coverage of last 12 months impaired PCLs to 9.7x and coverage of pre-pandemic 2019 impaired PCLs to 2.7x. Our impaired allowance was stable in the quarter and provides a strong 51% coverage of gross impaired loans. We continue to believe it prudent to hold these significant levels of credit allowances in the current macro environment.
Now on Slide 13. Gross impaired loans were stable quarter-over-quarter at $615 million or 30 basis points. Net formations declined to $34 million, benefiting from net repayments in commercial and corporate loan portfolios. As I mentioned last quarter, we had expected the expiry of moratoriums at ABA to generate an increase in impaired formations and that these should peak before the end of this year.
So far, the actual performance is matching our expectations. These ABA loans are well collateralized and prudently provisioned.
Slide 14 provides details on our RESL portfolio. Geographic and product mix has remained stable, with Quebec accounting for 55% and insured mortgages accounting for 30% of the total portfolio. LTV on our uninsured mortgage portfolio improved to 50%. And on the HELOC portfolio, LTV was 46% based on authorized limits or 28% based on outstandings. Approximately 31% of mortgages have variable rates and investors account for about 11% of our RESL borrowers. While higher rates have already impacted the housing market through lower volumes and easing prices, the resilience in our RESL portfolio remains strong. Borrowers incomes are rising, delinquencies rates improve and clients have built up very healthy levels of equity as demonstrated by the low LTVs.
In summary, we are pleased with the credit performance again this quarter and remain comfortable with our defensive positioning, our resilient mix and our prudent level of allowances.
And with that, I'll turn it back to the operator for the Q&A.
[Operator Instructions]
Our first question is from Gabriel Dechaine from National Bank Financial.
Just want to ask about Credigy. We did see the assets grow 10% year-over-year. I'm wondering if some of the disruption in credit markets is getting you guys more optimistic about the growth at Credigy in coming quarters because it seems like that might be the case. And if it is, maybe where you're seeing those opportunities?
Yes. Thank you, Gabriel. This is Ghislain. As we discussed last quarter, we remain confident that the current environment will create multiple areas of opportunities for Credigy. I think it's more a question of timing now. So as you mentioned, in the third quarter, we saw a reversal of the trend observed in the first half of the year. So total assets grew compared to last year and last quarter, so -- which is very positive. But we may have more visibility in Q4. But in the current environment, the business remains highly selective and prudent, Gabriel.
Okay. The Wealth business, we saw a big increase in NII in that segment, highlighting the rate sensitivity there. I'm just wondering if -- since we had the 100 basis point rate hike at the midway point of the quarter, is there going to be a similar bump in Q3? And maybe if you can talk about further down on the outlook, what the deposit beta dynamics are in that business, if any?
Thank you, Gabriel. Look, we have a very large platform of AUA with $621 billion, and that brings all kinds of opportunities for deposits. There's 3 main categories of deposits. Broker deposits is by far the most important to our net interest income. And -- but they each have dynamics, the high interest cash performers at different dynamics, and we also raised GICs for the bank through the brokerage channel. So there's a lot of counter effects.
But in general, you're right, in Q3, we had rates increase through -- in the middle of the quarter, and we're going to benefit from this in Q4, for sure. I don't want to go any further in that. But I'll just tell you this that we've been working on net interest income optimization for years where there's a lot of optionality built in our model. And this quarter is a good example of this optionality.
All right. Well, one last one more broadly or for the bank. Just wondering about when we saw good NIM expansion at the consolidated level, ex trading, I'm wondering how you see that evolving over the next several quarters when you start to factor in maybe some funding costs pressure across the industry here, the substitution effect, people moving from 0 cost deposits to term deposits and eventually having to pass through some of the rate hikes to your depositors as well. Maybe you can just share your thoughts on how you see the all-bank NIM evolving over the next few quarters?
Gabriel, it's Marie Chantal. So I'll answer the first part of your question, and then maybe Lucie can jump in. So on an all-bank NIM outlook, we're actually very pleased with the level of the NIM at the moment. Good expansion year-to-date, 14 basis points, and we do expect it to continue to trade up if rates continue to increase. Of course, it's also dependent of the business mix, but we see a trend going up. Lucie, did you want to...
Yes. And if I can add to that, Gabriel, we don't really see a migration from core deposits to our term deposits. So we don't really factor in any effect of that. As a matter of fact, we continue to grow our core deposit base close to high single digits. So that's quite positive on the margin.
The following question is from Meny Grauman from Scotiabank.
Going back to Credigy, you referenced mark-to-market fair value asset adjustments. I'm just wondering if you could give us a little bit more color on what exactly is going on there? And also, if you could scale it in terms of the delta with the prior quarter?
Yes. So this is Ghislain. So first, I want to highlight that the underlying portfolio performance remains strong. So we continue to be very pleased with the positioning of the portfolio. As you know, now 85% of the assets are secured. So in terms of revenue drivers this quarter, we've had a negative impact from assets at fair value due to the rising interest rate environment essentially. So portfolio mix was also a factor this quarter. So of course, 85% of the assets are secured. The type of assets generally offering a lower return than unsecured. So those 2 elements explain essentially what happened this quarter.
So there's nothing in terms of credit in that mark-to-market you're saying.
No. No. And as you know, mark-to-market, it's essentially an accounting thing. So the fact that we hold our portfolios to maturity, we know that it's temporary. We will get the value back eventually. And as I mentioned, the underlying portfolio is still very strong.
Got it. And then Marie Chantal, you talked about the other segment a little bit. You highlighted 3 factors. I'm wondering if you could scale them a little for us in terms of -- was there one that was particularly impactful this quarter as you look at the difference between Q3 and Q2?
Thank you for the question. I don't think there is any one of them that were more important than the other. As I said in my remarks, investment gains, mostly because of the higher market conditions in 2021, then mark-to-market because of the hedging position and the interest rate positioning. Those are basically the 3 elements that explain our lower revenues on the Other segment.
And then I caught a little bit of it, but I wanted to clarify in terms of the guidance you provided, like, are you suggesting that loss could be bigger in Q4? I didn't quite catch what you were saying there.
Yes. Yes, you've catched it right. We are expecting lower PTPP earnings in Q4 compared to Q3, mostly related to higher investment gains. So we're seeing -- we're foreseeing a little, but given market conditions, it's going to be lower.
And then if we look out to 2023, is there anything we should keep in mind? This is obviously always a hard line to forecast. But is there anything that's likely to change in 2023 in terms of those dynamics?
I think it's -- there's so much going on. It's too early to say. A lot of moving parts. So we'll be able to give more an outlook next quarter on that one.
The following question is from Paul Holden from CIBC.
It seems like you get this question every quarter, but I'm going to take my turn this quarter and maybe get you to elaborate on the strength in financial markets relative to peers. What do you think were the main drivers that result in a better revenue and earnings than what the other banks have reported so far?
Thank you, Paul, it's Denis. Yes, good quarter. But what it stand out this quarter, it's not only one line of business like we saw in the first semester. Out of our 18 line of business that we're looking at, 12 shows positive results compared to Q3 last year. 2 were flat and 4 were down, then it's kind of a widespread results that we have. Nothing spectacular, but just kind of consistency about the revenue growth through many businesses. You're talking fixed income, commodities, FX, equity, it's all from all the centers and back and forth. And it's quite good, very, very pleased with the results.
Paul, it's Laurent. Just maybe adding to what is to the disciplined approach that Denis just talked about, one of the big difference that you should be aware of is we are focused on Canada. We have a Canadian platform, and most of our peers have businesses in the U.S., and I think that could be a big delta in the results that you're seeing so far.
That's helpful. Next question is with respect to the interest rate hedging that was mentioned earlier in the conversation. So hoping you can elaborate on that in terms of how you position the interest rate hedge? And then when I look at the disclosed interest rate sensitivity and compared to last quarter, doesn't appear to have impacted that disclosure. So maybe you can help us understand why.
It's Marie Chantal again. So let me try to answer your question. And if -- let me know if it's not sufficient enough. So in terms of hedging activity, it's really related to the normal course of hedging activities within treasury. So we generally aim to limit mark-to-market fluctuations over normal conditions through hedge accounting, but sometimes hedge accounting is not possible. Therefore, mark-to-market impact goes through the P&L. And we did saw some of the accounting inefficiencies in the next -- in the current quarter. So this is basically what happened. Does this give you a little bit more detail?
I don't -- I think the answer is a different question. I was under the impression that there is -- out of those 3 components in the Other segment, you mentioned there is the third one was the defensive interest rate positioning. Is that?
Yes. It is.
That you're referring to. Okay, okay. That's good then. And then last question for me, if I may. Laurent, you had mentioned a positive outlook for Commercial going forward. And I guess one of the things that scratched my head a lot about is when are higher borrowing costs going to impact the commercial market? It seems like everyone is putting up strong commercial growth, including National, but I have to think eventually higher rates do their job, not just in resi mortgages, but also in the Commercial segment also?
I think my comment is the trends are good. Obviously, with rising rates and overall slowdown, we do expect the growth of that momentum to slow down. But maybe I'll let Stephane maybe give you a bit more color.
Yes. Paul, we're not overly concerned with that. We're seeing a couple of things. For one, our clients are already using great risk management tools much more than they were during the pandemic or prior to that. Many of them have not seen rising rate environments. And so we're guiding our advising counsel to them to edge themselves, and that's working well. The second element is there's still residual liquidity in Canadian businesses that is higher than the pre-pandemic level.
So we've got quite a bit of time before. I think the cost of financings actually affect businesses. Yes, profits in 2022 among Canadian businesses will be lower than 2021, but 2021 was really a peculiar year.
Our following question is from Mario Mendonca from TD Securities.
Can we go back to Paul's question, Paul asked why the interest rate sensitivity didn't change from Q3 -- from Q2 to Q3? Is the answer as simple as the company's actions to limit interest rate risk were not new in Q3 that maybe that had already been -- those positions have already been put on in prior quarters. Is that the right answer?
Mario, that's certainly part of it, it is Bill. I'll just refer you to what Lucie mentioned in some of her comments that we are still seeing good growth in core deposits. And the volume of core deposits certainly has an impact on the sensitivity number that's disclosed. So that's another important component.
So were there actions taken in the quarter then that would have reduced the rate sensitivity ignoring the increase in core deposits?
No, no. The -- your assumption is right. We did not change any hypothesis in Q3.
I see. And when you -- when the bank says you take steps to protect the margin, is it also as simple as saying you're extending the duration of the liquid assets either in the cash market or in derivatives? Is that also an appropriate way to describe it?
Partially, that would be aligned.
Say that again?
Yes. I think that's part of it, for sure.
Okay. And then maybe just one who has already answered this question. When you were talking about Credigy, and you were talking about how there were some mark-to-market charges in the quarter or maybe it was less favorable this quarter than prior quarters. Did that go through the net interest income line? Because I know you don't disclose a margin in that business.
But when we sort of try to calculate our own margin, it looks like it was down fairly substantially from one quarter to the next. Are those mark-to-market through the net interest income line and that's why the margin looks weak?
Yes. Thank you, Mario. I will let Jean to answer that question.
Yes. In fact, it goes into the other income, the mark-to-market of the fair value to P&L portfolio. What will impact the net interest income will be more the mix of the type of loans that we will have on the book.
So the margin was down fairly meaningfully then. So it sounds like it is a number I can rely on it, but mark-to-markets are going through other income. The mix, are you referring to mix in Credigy or mix in ABA or both?
Mix in Credigy.
So that was a fairly meaningful drop from one quarter to the next. Is that all explained by mix?
Mostly mix and class of funds, that's altogether.
Okay. So we shouldn't necessarily expect that to rebound abruptly next quarter. Is that fair?
But we have new portfolio. So it will depend on the return on new portfolio. We have also extended a loan that is quite profitable that could improve the net interest income also.
The following question is from Doug Young from Desjardins Capital Markets.
Just going to Canadian P&C Banking, the expense ratio of 51.6%, that's the lowest -- or you can correct me if I'm wrong, but the lowest I can remember. Was there anything unusual in the quarter? Is this essentially a new run rate? Just hoping to dig a little bit into what drove that.
Yes, it's Lucie. So I would -- the nature in expense increases exactly related to what Marie Chantal referred to in her script. 60% of that is related to wages, FTE. And the rest is related to investments in the business, basically in our transformation. So we're very happy to deliver positive operating leverage in that context, and this is what we really focus on.
But I was more thinking not that the expense growth was big that you actually did a really good job in managing expenses and keeping expenses low relative to revenue growth. I guess that's where I was coming at that from. So is this -- trying to get a sense of is there -- it doesn't sound like there's anything unusual. Is this kind of a -- you've got this business running at 51%, 52% mix ratio, and that's what we should be essentially anticipating going forward. Is that what I read from that?
This is Laurent, Doug. I think we need to remain a little cautious about outlooks at this point in time. There's still a lot of uncertainty in the market and uncertainty in also the path of the current macroeconomic environment. So I can tell you what the objective is. The objective is always to continuously improve our performance. So from time to time, you will see some quarters where it could be a little bit more difficult.
But whether you want to -- the idea is we have -- we do have targets to always improve our mix ratio, but I think it's a little premature to -- at this point in time to say that this level is our run rate for the time being.
Okay. I was just wondering if there's anything allocated there to corporate, but it didn't seem like that, that was the case. And then, Bill, you talked $33 million performing loan bill. You're talking -- you gave a few different reasons for that. Can you kind of segment how much related to loan growth versus the FLI and the scenario weight changes? And then I think you also said that was offset by an overlay, meaning that you released an overlay, so that would have been higher, net of the -- I'm just trying to get a sense of some of the moving pieces there.
Yes. Sure, Doug. The vast majority of the driver of the bill was the updated scenarios, the forward-looking indicators. So that -- our baseline became more severe, our pessimistic scenario became more severe and the weight in the pessimistic increase. So that was far and above the biggest -- the driver of that. Loan growth certainly is always a driver. I don't have the specific mix, but to assume that the vast majority was from the outlook update.
What I meant by the offset is if you -- last quarter, when we described it, I mentioned that we had increased the overlay to take into account some of the uncertainties that weren't reflected in our models and scenarios. So as we updated the scenarios to more pessimistic, more severe, they now include more of what had been covered in the overlay. So there was -- there was a reduction in the overlay to offset that.
Okay. So it's a bit of an kind of -- okay, I get that. And I think new gross impaired loan formations, I think were [ 1 74 ], I think it was [ 1 34 ] last quarter. Is that mostly due to what you described at ABA? Or is there other items within the formation side?
So on the formations, you'll see on Slide 13, it was primarily ABA. And as I discussed last quarter and mentioned again in my prepared remarks, the moratoriums at ABA will all be expired by the end of the year. Last quarter, it was around 7%. Now it's around 2% are left. And as they expire, there will be some that will move into the 90-day past due and that generates their formations.
I had given color last quarter that we expected it to peak in the second half, and that's still the case. So we're close to the peak in the formation level. And then -- and it's following our expectations very closely. And then what we would expect to see in 2023 as -- through 2023 will be a decline in the gross impaired in ABA. The rest of the business, as you can see, formations are very, very low.
Current conditions with unemployment and the current GDP is -- everything is very strong in the current conditions. That is what's generating really exceptional performance in credit, not just at our bank, but across, I think, the sector in impaired loans. So delinquencies remain low, savings rates remain high. The -- it's a strange situation where current conditions are so benign and yet, there's so much uncertainty in the forward views. So that's why you'll see very low impaired and yet pretty significant build in performing provisions. Does that answer your question?
Yes.
Our following question is from Nigel D'Souza from Veritas Investment Research.
I wanted to follow up on allowances on performing loans. I know that you mentioned that you released about 43% of the allowances built during the pandemic and 42% above the pre-pandemic level. I just want to clarify that, that's more so on a notional basis. I look at your allowance rates relative to loan balances on Slide 26. Your ACL coverage relative to loans is just marginally above where it was before the pandemic. Is it fair to say that when you look at allowance as well as the loans, you actually aren't paring substantial excess allowances?
Nigel, thanks. So if you look at that table in 26 and why we provided it so clearly is that it helps you see the impact of mix. So while the -- if you look at the total retail -- while the total retail number, the total allowance over loans is less than pre-pandemic, that's primarily because of the mix of credit cards and mortgages. So we know that through the pandemic, excess savings built up, customers were prepaying, they're evolving and lower use on the revolving and the credit cards.
And so at the same time, there was higher growth in mortgages, which is a less -- a lower risk portfolio. So even though our mortgage line, you'll see that ACL coverage that you talked about is significantly higher still in Q3 2022 than it was in pre-pandemic. Taking into account the mix, you get the lower total retail. The metric which I'd point you to is -- and I think I maybe -- I've had it in the earlier slide on allowances, which is the total performing allowance over pre-pandemic impaired PCLs, I think that's a better or it's a useful metric to look at because it does contain insights around the mix of the portfolios.
And the way I think about that, Nigel, is pre-pandemic, we were end of cycle. We had been building up performing allowances, and we had a ratio of about 1.7x, 1.8x our run rate impaired losses, pre-pandemic losses, normal course losses -- impaired losses. Currently, we are at 2.7x our pre-pandemic run rate impaired losses. So that gives you an idea of, if we're going into a slowdown, we are even more prepared in terms of allowances for our nonperforming loans compared to our normalized run rate of impaired PCLs. And that's why I look to the pre-pandemic number. Does that help?
Yes, that's helpful color. And if I could just follow up on forward-looking indicators that you're using for performing PCLs on Slide 31. I just want to make sure I understand the assumptions for housing prices. When I see that number there, 6.8% for '22 and then 7% for 2023. That's Q4 relative to Q4. So is that assuming that essentially housing price index gets back to where it was in Q4 '21? Is that the correct interpretation that's your base case scenario?
Thanks to the -- I don't know whether this will answer your question directly. But when looking at the disclosures on the forward-looking indicators, there's a few ways looking at them. And sometimes the slicing and dicing can give -- cannot allow you to see the severity of some of the changes. So one thing I'll say is that when you look at it, and you can't see it in that disclosure or what's in our MD&A, but the baseline is peak-to-trough change in the National Bank Teranet HBI of 10%.
And it's important to understand, as I'm sure you do, the nature of some of the indices on prices. So the Teranet HBI is one that really compares actual -- changes in actual prices for the similar housing. Some of the numbers that you'll see in the press, the CREA number, which is very impacted by the value of the homes that actually transacted. So you may see more severe numbers in the CREA index, and that could be simply because there are less high-value homes transacting longer sales periods and such.
I think the more accurate in terms of our risk content for the forward-looking indicators is what we use, and I think it's consistent across the banks is more of the National Bank Teranet index. So that's a long answer, but does that help with your question?
That does help. Just a minor clarification in terms of your outlook. Does that incorporate an expectation for interest rates to decline in 2023? And the reason I ask that is because affordability is taking a hit with higher mortgage rates. So is that part of the scenario? And if not, then maybe some color on your rationale of expecting just a 10% decline in HPI.
Yes, it does include the scenario was kind of complete, including rising interest rates. And I think there's some qualitative language you can see in the MD&A, which gives you a sense. But since you've asked that question, I'll just give you a little color. I think consistent with what you've heard today and yesterday from some peers, the Canadian consumer -- the indicators of the Canadian consumer financial health and the capacity to address increasing interest rates and increasing cost of living from inflation is pretty good.
The savings rates -- excess savings which we had expected to decline throughout 2022 have continued to increase in 2022 across income cohorts. In our portfolio, our client base, there was a slight decrease only in the top earners. So the highest earning cohort had a slight decrease in excess savings, and that was because of more comfort in more consumption, so travel and spending. Across all of the others, it continued to increase quarter-over-quarter.
And the additional color, which I think I can share because of our overweight in Quebec is the capacity of the Quebec consumer to absorb higher interest rates and cost of living is even stronger for a few reasons. One, we've talked about a lot in the last 10 or 15 quarters of the Quebec households have got higher dual-income households because of the very high participation rate of women in the workforce in Quebec.
You know, of course, that the consumer debt to disposable income in Quebec is much lower than the average. That's because of affordability, lower house prices and such. But as well in this environment where inflationary -- inflation is driving higher costs, an important factor to consider too is actually the cost of energy for households in Quebec is not impacted in the -- as much in the same way as the rest of Canada and not in Quebec. The households, I think, it's 70% of the energy costs of households in Quebec is coming from electricity and the pricing of that has been quite stable as opposed to 35%, I think, in the rest of Canada.
So the -- some of the drivers of increasing expenses for the Quebec consumer are more tempered, and it gives us even more confidence on the resilience of the Quebec consumer, in particular. Does that help ?
Yes, that's really helpful insight. That's it for me.
My following question is from Scott Chan from Canaccord Genuity.
I wanted to go back to capital markets and you referenced like 18 buckets and 14 buckets were up year-over-year. And you called out like the 4 trading buckets, but was there anything else in Investment Banking in terms of those buckets that help us out with?
Yes. Thanks, Scott. It's Denis. Yes. In investment banking side, in fact, that bucket, as you all know, M&A was good for us. I think we have a -- we see increases of 25% of revenue in M&A. The CCM corporate book -- loan book increased by 14% year-over-year at good volume. And the other sectors who did not that well for the whole street, that's everything related to underwriting or its debt capital market, either government or corporates, they're quite down compared to last year and also the equity market then. Despite the fact that the underwriting was quite low, I think it was well then compensated by the CCM book revenue and also the stream book revenue. Does that give you a bit of color?
That's very helpful. And last question, Marie Chantal. I just want to clarify your comments on other income for fiscal Q4. And when I think relates to PTPP, did you state that the net income loss would be bigger in fiscal Q4, and that would affect the overall PTPP at National?
That's correct. for Q4 compared to Q3. That's correct.
The following question is from Joo Ho Kim from Credit Suisse.
Just wanted to ask on Wealth Management, and we saw a good improvement in the efficiency ratio not just this quarter but over the past several years. And now it's reaching below 60% on a year-to-date basis on my math. And I'm wondering if we could continue to see this kind of improvement in the medium term and if there's a target sort of that you had in mind? And whether we would need sort of a favorable market condition to continue to see the improvements in Q4?
Well, thank you for your question. It's Martin. Yes, we worked hard over the last 6 years on our efficiency ratio. We took it down by about 10%. And maybe early on, there were some low-hanging fruits. But I would say that we don't have a specific target in mind. We want to manage the operating leverage, so it's quarter after quarter that we managed this very carefully. This time, we benefited from net interest income, which comes with very little variable costs. So all of this to say that the business mix will impact our efficiency ratio. And if current trend continues, there could be some further gains to come.
And just last one for me. Just on the residential mortgage growth, growth is still relatively robust this quarter. We're seeing some moderation in the year-over-year trend. I'm just wondering if you can expand on what you're seeing in terms of client activity? And how should we think about the overall sort of housing market that's happening right now translating into the growth as you go forward?
Yes, it's Lucie. So definitely, the fast rate price had an impact on the demand. We had 2 years of unsustainable level in terms of transactions. So I think we're getting back to normal. And with the further rate hikes that we expect this fall, we believe that originations will continue to grow at a slower pace in Q4. And that being said, I think like Bill mentioned, we're well positioned because 50% of our originations are in Quebec, and we see the market as being more resilient in Quebec.
So the outlook for Q4 is that we should -- we anticipate to deliver slightly lower growth rate in Q4, but still strong in the context. And beyond that, I don't know if it's premature beyond Q4. But the trends that we see definitely is a market normalization, it's not the market collapse. So we think rising rates will continue to reduce the number of transactions, which should lead to more balanced markets across the country.
House prices, like Bill mentioned, should normalize and come down from their peaks in most major markets. So beyond that, I think the factors are there to be supportive of mortgage growth that should normalize to pre-pandemic level over the course of 2023. When will that happen? This is the unknown.
Following question is from Mehmed Rizvanovic from KBW Research.
A question for, I guess, for Bill or for Laurent. I wanted to go back to Laurent's comments about soft landing is a base case scenario. And if you can maybe just clarify, are you referring to just your own footprint? Is that mostly a Quebec dynamic? Or is that something that you're expecting for Canada? And then just maybe for Bill, that does seem to be quite a bit of a contrast with your conservative approach on reserving, which you basically held since the onset of the pandemic. I'm just wondering why you need to hold excess reserves at this level when you're looking for a soft type landing?
Thank you for your question. It's Laurent. It is -- our base case scenario is for the Canadian economy as a whole. We -- I mean, there is an increase probability of a recession, we know that, but it is currently not our base case. Look, I think the fact that we have seen increased savings during 2022. The tight labor market will act as a buffer in a slowdown. So these are, I think, the 2 major forces right now that are playing out in our scenario and why we think that the most likely scenario for the Canadian economy is a slowdown soft lending.
We think that the Central Bank will start to look at the impact on unemployment as rates go up and will potentially adjust accordingly. So those are -- the scenarios are Canadian economy is strong, there's excess savings, the unemployment level is very low, commodity prices that are up are a very good windfall for the Canadian economy. So it's not a Quebec thing. It's a Canadian story.
And then Mike, if I could just add on your question on the allowances and the reserving. So Laurent described the base case. We do also have a pessimistic case, and the pessimistic case is different. And it sees a possibility or that scenario with significant increase in unemployment, significant 300 bps increase in unemployment. GDP down 5.5%, pretty severe numbers. And we did increase our weight on that scenario, decreasing our optimistic case. So by the nature of the math, that generates additional performing allowances. And we're quite comfortable remaining prudent and holding significant allowances because while Laurent mentioned the base case, this is a situation that the uncertainty is high over where the -- where the path will go and the different potential paths are quite different. So -- does that answer your question, Mike?
Yes, for sure. And so is it fair to say that the -- whatever component of that is management overlay that conservatism that you've sort of had since the onset of the dynamic, that's here to stay, basically. That's not going to change anytime soon.
No, it does adjust. And I think I mentioned it changed. It was increased last quarter because there were -- we felt there were some aspects of the context that weren't perfectly reflected in the models and scenarios. And it reduced a little bit this quarter because some of those potentials were incorporated into our scenarios and models. So it can move.
Okay. Got it. And then just a quick one for Lucie. I just want to go back to residential mortgage growth and National's growth. You've been trailing peers for quite some time, the last several quarters. And it looks like it's exacerbated this quarter with respect to the banks that have reported so far. And my question is, just given the dynamics of the Quebec market, the lower issues on affordability and leverage perhaps, should we not expect National to benefit from a better Quebec housing market in terms of volume? And should we expect that growth rate to maybe pick up and maybe even surpass peer levels in the next few quarters in the higher rate environment?
That's a good question. I would say that we need to look a little deeper into the numbers. So about 50% of our originations comes from Quebec. And when we look at that, definitely, our growth rate in Quebec is higher than what we see on San Quebec. And when we blend that in, this is where you see kind of a modest growth relative to peers. That being said, we are very comfortable with our growth trend this quarter and also in the past quarter and across the cycle as we remain disciplined, as you know. And our discipline in terms of pricing is also guiding us, then we have to realize that the spreads on the mortgage business in the last year has been difficult. And we've made some decisions in the context of tighter margin.
Maybe I could add just one comment to Lucie's. Mike, it's Bill. Just you've heard Lucie talk for many, many quarters about the balanced approach on volume and pricing and risk. And the numbers that you're seeing in Q3 are for mortgage. Mortgage volume is dispersed in Q3, however, were originated well before Q3. So with the balanced approach that we take on the mortgage growth, you should expect to see when the market is more frenzy, then the growth rate will be below peers.
And hopefully, on the opposite side, when the market is less frenzied, our growth rate could be higher than peers. So I think some of that, if you mentioned, growth rate versus peers over the last 3, 4 quarters, that's during times that Lucie mentioned where prices were peaking, spreads were lower and potentially some more risk that was seen. So choices were made.
And just to complement that also, when we look at our Quebec growth, we are kind of ahead in terms of growth in the province.
The following question is from Darko Mihelic from RBC Capital Markets.
And I'm sorry, I'm going to be that guy that beats a bit of a dead horse here because I want to -- I think we bounced around a little bit. I really want to understand something. So apologies for these questions in advance. I've got a series of questions that will really help me understand the interest rate issue.
So maybe I can just draw your attention to Slide 21. And the third negative on this slide is the impact of hedging activity reflecting your defensive interest rate positioning. So my first question is the following. I read that to say you're starting to hedge against rates going down, you lost a little bit of money on that, and it showed up in the revenues here. I think I also heard you later on, say, however, that when rates go up in the fourth quarter, you will still benefit from a rising margin.
So here's my first question is just from a geography point of view, let's suppose the Bank of Canada raises rates by 50 basis points in the fourth quarter. I understand that there'll be a wider margin bank-wide. But here in this particular business segment, would I expect there to be a bigger negative to the revenues?
This is Laurent. Let me maybe at a high level answer your question. So overall, we have obviously a positive impact from rising rates in all of our core businesses, as you saw. And when we look at the current macroeconomic environment and the uncertainty around it, we have -- we took the decision to be a little bit more defensive in our positioning in our treasury. So yes, you are correct. We're slightly long bonds and that impacted revenues in Q3. But these activities are very dynamic, Darko.
So it could change from quarter-to-quarter. We could decide to reduce our position depending on how we perceive the uncertainty and the risks in the market. So it's not linear.
Yes. No, that's helpful. So I think I've got the geography right. I don't think you're going to help me with the quantum. So maybe instead of attacking the quantum, I do want to understand a couple of other things. First is, I mean, when I look at my coverage universe, your bank would never have screened for me as being the bank being the most sensitive to rates. In fact, it's the opposite. So the question is, Laurent, if rates do go up, would your bias be to continue and maybe hedge more for the downside or no?
Again, it will all depend on outlook and our read of the economic situation. So if we do believe that there is increasing risk, increasing uncertainty, we might decide to hedge more. If we don't see that and we do have greater exposure to rising rates, we might also decide not to hedge that. So it's not based on our overall exposure. It's a mix of different things. And what we believe the interest rate outcomes will be in to the forward rates -- will the forward rates realize themselves. So it's not a clear answer that I can give you on this one here.
Yes. So maybe give me the clear answer then on why you made a decision to increase the hedging for this quarter, that might help.
I don't think we increased hedging this quarter.
Okay. So the impact of previous that was done sometime mid-2021, that is continuing to impact, but it's not this quarter.
So it's just showing up this quarter for summary and didn't show up in prior quarters. I mean I just -- I'm trying...
Rising interest rates had that impact.
Yes. It's showing up more importantly this quarter.
Because what shows up is that, as you noticed on the slide, we put 3 main reasons. And so in previous quarters, some of the other elements were offsetting the impact. So this quarter, the reason is that the 3 main elements are all together in the same quarter. That's why it's a bit more impacting. But in many cases, one will offset the other.
So is it because we've passed a certain threshold of rates that it's showing up more now? And then even without more hedging that it could still end up showing up more as rates go higher?
I mean, definitely, the rates environment was very volatile over the past quarter. So yes, it did show up a little bit more, obviously. But it's not the only thing that showed up in the other segments, right? So there's hedging activity, mark-to-market impact also on some of our derivatives and obviously, lower gains in investment versus 2021. I think markets are such that it's not -- you're not seeing the same opportunities in terms of gains on investment.
And maybe, Darko, we could just conclude on the fact that total bank NII, like I said, is still up quite importantly as well as total NIM all-bank.
[Operator Instructions] Following question is from Lemar Persaud from Cormark Securities.
I'll be quick here, maybe for Marie Chantal. How should we think about the appropriate CET1 ratio for National in light of the current macroeconomic uncertainty?
So as I said in my remarks, we're very pleased with our current capital level that does provide us with flexibility to support organic growth. So in terms of the level of capital that you can expect, the level that we are at this point of time is the one that we're very comfortable with.
I guess really where I'm going, it's 1.8%. That seems to me like quite a strong CET1 ratio. And one in which I think the bank should be able to kind of pursue buybacks notwithstanding the challenging macro backdrop and organic RWA growth. So quick question, what could go wrong to cause a significant drawdown in that 12.8% CET1 ratio?
Look, it's Laurent. Buybacks we just said that we did take a bit of a pause in Q3 and we're going to extend that pause, but buybacks are not off the table forever, right? They are always a complement. And you are right, we are at a good level in terms of CET1. But in terms of a lower threshold, in our mind, right, we think that 12% is at a minimum where we want to be. So at this point in time, given the higher level of uncertainty in the market and market volatility, the economic path, we took that decision in Q3 and extended that through Q4.
We have no further questions registered at this time. I would now like to turn the meeting back over to Laurent Ferreira.
Well, thank you very much, everyone, for joining us, and we will speak to you at Q4 in December. Thank you.
Thank you. The conference has now ended. Please disconnect your lines at this time, and we thank you for your participation.