Canadian Imperial Bank of Commerce (CM) Earnings Call Transcript & Summary

We're good to go? Okay. Great. Thank you. Okay. Great. Good morning, everybody, and welcome back. I'm very happy to have Hratch Panossian up here from CIBC, the Chief Financial Officer. And as I was mentioning yesterday, the Canadian banks have just gone through a reporting period. So there's going to be -- what I would say is a lot of sort of follow-up on what we heard from the first quarter conference call with CIBC. So Hratch, thank you very much for joining us this morning.

Thank you, Darko. Always great to be here, and thank you all for joining us this morning.

So I think I'm going to kick off talking about capital because prior to the quarter, there was some concern that CIBC's capital ratio may have been on the light side. We have a recent increase in the capital ratio at the regulator. And voila, you came out with a set common equity Tier 1 ratio of 11.6%. So clearly leading those [ fears ]. And then you talked about a path towards 12% by the end of the year. And yet, we're thinking about like a Basel III impact that's neutral in Q2. So maybe you can talk a little bit about the waterfall or the path towards 12%? And why are you not receiving much capital benefit from some Basel III reforms because many other banks are receiving in fact, and in some cases, a fairly happy benefit from the reform?

Yes. Thanks, Darko. Good question. And clearly, capital is something that's on everybody's mind and certainly ours. We do -- the strength of our balance sheet, the ability to have the resources to continue investing in our strategy is a critical part of our approach to things, which is something we're always on top of. And look, I know there was a lot of questions in Q4. We were always very confident and consistent with our stance. So we've been saying for a while now that we thought operating at the 11.5-ish range was a good place to operate, right? And we moved that up. If you go back to our Investor Day, we had talked about 11% to 11.5%. And as the environment changed and got more risky, we started communicating this 11.5% working up to 12% range. And I'll get into why kind of a number of the factors that drive our decisioning on that. So there's really 3 things we look at. We look at, obviously, the minimum regulatory requirements. And those are a factor. We like operating at a buffer to that. We look at our own view of the forecast, our needs to deploy capital strategically against our clients and our strategies, as I said earlier, any headwinds that we expect coming in the environment. And therefore, look at the overall forecast and say how much capital should we have at hand at this point in time. And then lastly, we look at the peers. And I think it's important to stay within the path. We're not that concerned. Are we top or bottom in terms of capital, but we think that operating in a similar range as the industry is a good thing at any point in time for many reasons, right? Strategically, you're not an outlier and ability to take opportunities on if they come, defensively, you're not an outlier if things turn negative and so forth. And so those are the ways we look at it. And putting all 3 of those together, we always thought 11.5% to 12% right now is a reasonable place. And our CEO, Victor, when he had the chat with you in January, he covered that, right? We could say we believe strongly we have a path to be 11.5-plus this quarter and then work up from that. And so we're very pleased. We're pleased in Q1 to deliver 11.63% despite over 51 basis points of onetime headwinds, including the phaseout of the [indiscernible] ECL add-back. And that was partly our capital generation. That was partly our issuances through the DRIP program. And that was partly some things in market-related factors, particularly counterparty credit risk going our way. Now we're realistic about the outcome forward. So let me do that waterfall that you spoke about. So as I said on the Q1 call, you have to normalize for a few of the things that have happened. And basically, our starting point right now is more like an 11.7%.We had a press release that we ended up settling the legal matter for less than what we had reserved. And so there'll be a release against that coming in Q2. So that will put us right around 11.7%. So then you have the Basel III reforms that are going to be implemented this quarter. And on that point, to address your question, we do have some benefit. We have some benefit from the credit risk side of things. So we'll get a benefit, a substantial benefit from the credit risk side. And the off-risk side, as we move to the new methodology that looks at loss history as well over time, the off-risk side is actually going to go up. So you're going to see a bit of an offset in the 2 RWAs. There are still a few things that are in the works and not finalized, maybe slightly net positive, but we're guiding and assuming at this point for conservatism net neutral on the Basel III fronts for this quarter. And by the way, just while we're on it, we don't anticipate any material negative impact going forward from the market risk reform implementation next year from floors kicking up over time to their eventual state and so forth. So I think materially after this quarter, we're not anticipating any big negatives or positives from the remaining Basel III impact. And so from that point on, what we said in Q1 is we've got strong capital generation. We have the ability to generate 30 to 40 basis points net of deploying against our strategy and clients capital per year. It's in [indiscernible] quarter or 30 or 40 per year. And that's what allows you to get to about 12% by the end of the year. And we are expecting some headwinds. We think there will be some negative migration in the portfolios. We think some of the things like counterparty credit that went our way will revert back to normal as commodity prices adjust as interest rates stabilize, et cetera. And we've taken all of that into account. But that's generally in the zone of, call it, up to 10 basis points a quarter, and that's where our issuance comes in. We're issuing about 10 basis points a quarter because of the DRIP. I said this in Q1, that will offset those headwinds and allow us to get to 12% and continue to grow from there, right? And longer term, our U.S. business is still under AIRB, under advanced. And so we would have the opportunity to take that to AIRB to advance from standardized. And so that would give us some benefit on top of that. There are other model changes and so forth, that could help. So being 12% at the end of the year, we think relative to what the peer group has said, relative to what we see in the forecast, relative to the current regulatory requirement of 11 puts us in a pretty good place. And look, I won't speak to the regulator on what they may or may not do, right? But the [indiscernible] buffer is now the maximum end is 4%. So we're comfortable that if we are where we are at the end of the year, even if they were to go to that maximum buffer at some point. And I don't expect that, that would be a surprise to -- nobody benefit to surprise the industry on those things. But even if they were to go there, it would be in a time frame that from where we are at 12% or a bit above 12%, we could easily manage to a buffer to that new environment. That's the way we think of them.

That's a great answer. Thank you. We have touched on some of the things that I wanted to talk on. That's great. Maybe just circling back on the -- some of the headwinds. One of the things that we're preparing ourselves for is RWA inflation, the potential for that. Is that one of the things that you're considering and where would the RWA inflation, if it comes, where is it most likely to come?

Yes, absolutely. It is one of the things we're considering, like I mentioned and given I took 8 minutes for the first question, I'll be brief on this one. Look, we have seen some net positive impact from credit quality since the pandemic. And what you had is this odd effect where on the retail portfolio as you actually saw, RWA is coming down, largely because utilizations dropped and so forth. And on the wholesale portfolios, you had some negative migration, but now that has actually started to revert. So on a net basis altogether, you still have a net help of in that sort of 20 to 30 basis points benefit range. And what we expect to see is that to basically go away by the end of the year. And so when I said we've got about 30 basis points of issuance that will offset some of the headwinds, some of that 30 basis points of headwinds is that migration that we expect. So basically, by the end of the year, we'll be right back to pre-pandemic type quality levels in terms of migration. A lot of it is coming from the retail side. So we did have this quarter a significant amount of migration -- negative migration from the mortgage portfolio, driven by the LTV changes, and we're anticipating a similar amount going forward every quarter from here.

Okay. So touching on mortgages then, I wanted to blend this into the conversation on the mortgage book and what we're seeing in the behavior in the mortgage book and whether or not it could further migrate RWAs. And one of the things that's been topical recently is the idea of negative amortization. And you have some disclosures out there that suggest that there's a portion of your book that's now negatively amortizing. I wanted to give you an opportunity to talk to that and maybe describe for this group, what that means and how you're viewing that and if there's any incremental risk as a result of that?

Yes. Thanks, Darko. And it's a good question, right? And there's a lot of attention on mortgages. The punchline is, we feel very comfortable with our book. We feel comfortable with what we see on the horizon. We feel comfortable with how our clients are reacting. And for the foreseeable future, I think we're in a good place, right? So let me cover a few of those things and then we can talk about longer term of what may happen. Our portfolio is strong. We start with an LTV as of Q1, our LTVs are 52%. We've got a portfolio that we've been very cautious in underwriting and originating our quality and standards. We're never compromised historically. And so we feel good about the book. A lot of the book was actually qualified at rates in the 5.15% to 5.50% basis points range because of the government stress test requirements. And that's pretty close to where things are renewing now, right? So you've got about 5.50% on 6%, 6% variable. So you've got to keep that in mind. These folks, unless their circumstances have changed and employment continues to be strong and so forth. They were -- they qualified with rates that are similar to what's out there now. And so what are we looking at? There's been a lot of talk around variable versus fixed. At the end of the day, given the way our product works, and you referenced it, right? If you do end up getting to a place where interest isn't covered by the monthly payment, the client can choose to increase their payments, but is not obligated to until they get to a certain point later where they've capitalized too much interest. That point will not come for many years. We've looked at the portfolio. We've stressed it even with rates going up a little bit more from here, that's not a concern over the next few years, folks won't hit that. So you're really talking about payments changing when people renew, and we're looking at those renewals, and we've had a number of disclosures around that, right? So you've got about $30 billion renewing in the next 12 months. We've got about almost $80 billion renewing in the next 2 years. If I look at that population, let's go in the 1 year and 2 years. stats are about the same. Roughly around 1% of that is what we would call high risk. So what's high risk? LTV -- sorry, FICO scores less than 6.50 relationship shallow, Therefore, we don't have a lot of data and knowledge about the client, including income and so forth. So that's 1% already. So you're talking about on the book, call it, $300-odd million for 1 year, and you're talking about $800 million or so for 2 years. Now if I take those numbers, it's less than 1/10 of that high-risk group that's actually got an LTV of more than 70%. So you get to numbers that in terms of losses based on where we stand today, given those LTVs, even if there are default events, we are not talking about very significant numbers on that portfolio, right? So that's what we're watching. We're working with clients closely. We know what increase they will likely have. So if you look at the fixed portfolio today, those folks that are going to renew in the next 2 years, their average increase is just over $300 a month. If you look at the variable portfolio, it's a bit higher. It's around $500 per month. If you look at the deposits of these clients, largely, you've got between -- actually the fixed -- the overall mortgage portfolio is over $20,000 average balances for those clients. The variable population has slightly higher balances. They're north of $25,000. So you're almost in a position where even if these folks renew over the next couple of years, as long as employment is strong, and they still -- they're still employed, they're able to afford the payment increase. And if their deposits are still there, their deposits today alone would be enough to almost get them through the next term. So even if they renew at a higher rate for 1 more term of 3 years, 5 years, whatever they pick, then at the end of that, they could have just use their deposits to cover the difference. So as long as employment stays strong, we feel good about it. So where could things get more challenged in the market? It's that scenario, and it's sort of hard to picture it could happen, right? But it's a scenario where rates stay high, if mortgage rates stay high, the economy is very challenged. Unemployment has gone up, and you start seeing the combination of employment income going away, payments on mortgages going up, maybe inflation still being slightly higher and drawing on people's income. In that scenario, you can start seeing things get a bit more challenged. But in that scenario, again, we'll go back to what we've always been saying, I'm not worried about mortgages. I think unsecured portfolios are ones that would be more challenged in that scenario, given the coverage on LGDs.

Okay. That's a very good thorough discussion on mortgages. I do want to wrap up on it quick. But again, when we think about the next 2 years, these are mortgages that are largely underwritten, call it, 4 or 5 years ago. There are a couple of vintages that we're a little more concerned about the 2021, 2022 where rates were excessively low. And since then, house prices have gone down. Now that's a further problem. If I'm correct in thinking that, really, we're thinking about something that's 4 to 5 years away. And that's something that clearly is also must be on your mind.

Absolutely. And for us, Darko, and I think this is the case for the industry, right? You sort of have this 80-20 where 70% to 80% client preference was fixed versus variable. And that has shifted over the last year. So those cohorts you're talking about, a lot of it is also where the variable product growth happened. Now the good news on that is because of those cohorts, the variable product and those cohorts were later, the renewals are also later. So those stats that I gave you, right, the 3 quarters of the next 1 year of renewal is the fixed-term product, 1 quarter of it is variable. And as I said, the fixed term product average increase in payments lower than the variable. If you look at the variable population, only about 1/3 of our variable book will roll over the next, not 2 years, 3 years. So you're talking about 2/3 of the book, which is that later cohort is 3 years plus. So you've got to think about where the world will be 3 years later. And that's where I go back to my comments, right? If employment is strong. there's time. The element of time is important here, right? People have 3-plus years to adjust their own spending, their own budgets, their own household requirements, or for interest rates to adjust during that time, right? I go back to -- it's hard to see a scenario, nothing is impossible, but it's hard to see a scenario where Bank of Canada keeps raised at current levels while you have significant challenges in the economy and unemployment, et cetera, et cetera, 3 years out from now when inflation so far doesn't look like it's going to persists that long.

And of course, we're worried about the house prices as well during this entire time frame as we're concerned...

Correct. And we've assumed some normalization of house prices. But again, when you're starting from a portfolio LTV of 52% our GVA, GTA markets, that's Vancouver and Toronto, lower than that. I think there's some cushion there.

Okay. Great. Now that's been a good discussion on mortgages. I think we beat that one down. So let's move on to a couple of other things. Again, going back to the quarter, I wanted to touch on net interest margins. It's been pretty topical around here actually yesterday, and we've heard a lot about deposit betas moving a little bit, and we're worried a little bit more about margin expansion. Your margins sort of went down in Q4, up in Q1, a little bit erratic. So maybe we can talk a little bit about the movement we saw in the margin and where your confidence comes from for margin expansion for the rest of the year?

Absolutely. Yes, Darko, it's a little bit of the story we covered in Q4, right? Our long-term trajectory is stable, it's consistent. It continues to follow our expectations and our guidance. Quarterly, there can certainly be noise. I mean when you're in a rate hike cycle like we've never seen before in terms of extent and pace, lots of things can happen that create noise in any given quarter, right? And including when does the Bank of Canada or the Fed move? And does that happen late in the quarter? And when do the assets and liabilities reprice with a little bit of lag to that? Those kinds of things create a lot of noise. There can be noise on hedges and so forth. So let me go back to the numbers for a second. If you look at it on a year-over-year basis -- and by the way, you have to exclude trading. Trading creates a lot of noise. Net trading is up significantly, as you saw in our business. but a lot of interest income go into noninterest income as interest rates go up and there's the pay lag of certain hedges that goes up with rates. But if you take that out, we've basically been -- other than Q3 last year, there was a bit of a bump, we basically have been stable. So we were around 163 basis points total bank margin, then we had 168 in Q3, and then we came back down to the 161, and we're now back up to 166. When we were 161 in Q4, we said there's a few basis points of negative here, right? Part of that was [indiscernible] cholera spread, which is the 1-month overnight spread in Canada. Because of the large expectations of rate increases by Bank of Canada, that spread went to levels we've never seen before. What that does is things like your HQLA portfolios where you're usually earning a yield that's referenced off overnight versus your funding that's usually referenced 1 month plus. It creates all sorts of noise on things like that, and it's temporary. And as those things normalize, it normalizes. So we said in Q4, there was a few basis points negative and some of it would come back in Q1. In Q1, we said some of that was the few basis points that came back. Interestingly, nobody seems to have picked up on that too much. So let me re-highlight that. I said the 166, you should view as a 163, 164. So if you average those 2 quarters out, it was basically like 163, 164 average across the 2 quarters, which is essentially flattish year-over-year. So I go back to what I said at the beginning, right, overall, through the quarters, if you look through the medium term, we're seeing what we said, more stable with a slight momentum upwards. And as we get into this year, it will start accelerating upwards. So why? What are the factors that are driving it? You've got 3 big ones. You've got interest rates, you've got deposit behaviors and mix changes and you have mortgages and mortgage margins, particularly, other asset margins have been pretty stable, mortgage margins in Canada have been a big story. And so what you've seen over this year is we've continued to get the benefit of structural positioning on deposits a few basis points a quarter as we talked about. But some of that was offset by the decline in mortgage margins that we were seeing. And a little bit of that trend of deposits moving from noninterest-bearing to interest-bearing and that sort of stabilizing things. So what do we expect going forward? We still expect some headwind from deposit mixing. We expect the forward curve because we don't think we're smarter than the market. We just assume the forward curve continues to realize. And we expect mortgage margins based on what we're seeing to get a little bit better. And if you put all of that together, that gives us a trajectory that we said we're confident on some margin expansion towards the tail end of the year, And while we had said 10 to 15 basis points Q4 to Q4 over 2023, now we're saying probably closer to 10. The rate environment is playing out about what we expected. The mortgage margin is playing out about how we expected that deposit mixing seems to be putting a little bit more pressure across the industry, not us. But there's been some changes there. A few percent a quarter going into term products and interest-bearing products from the noninterest-bearing side. And so that, we expect, will continue and will put a little bit more pressure. So...

A good answer there, lots of things to talk on and revisit a couple of -- just a couple of follow-ups there. So when we think of the 10, if the 10 is on that 163-ish range, right, from here to the end of the year? Is that...

Yes, I think in that neighborhood. Right again, if there's -- if deposits continue to make a bit higher than what we expect and so forth, there could be a little bit of pressure on there. But yes, I think in that range is probably reasonable.

And I always thought to myself, maybe it was the tax season. In Canada, it's RSPCs and TFSAs and maybe people walked in and spoke to -- and worked with the bank a little bit more about maybe moving deposits over. So shouldn't we see it relax a little bit going forward now that we're past that season? And then secondarily, just as a follow-up to that, you didn't mention competition on the deposit side. Why is that? Is it not -- simply not a factor at this moment?

Look, I think deposits are always competitive. There was a time, I think, in certain markets, certainly, in the U.S., right, we were in a period where deposits had less value in a lower rate environment and maybe competition was it as much. I think in Canada, there was always competition, and I think there always is competition. The balance sheet structure in Canada is such that all loans are on balance sheet. And therefore, funding and all banks use the wholesale markets to fund it. So long as you can do business with your clients, serve their needs and create a margin to funding in the wholesale markets, which we generally do, deposits are a good thing to do. And that's our approach to it. That's what we've always done. Look, we've done very well on deposits. And you'll notice that if you look at over the last year, client deposits versus wholesale funding across the industry, we're very pleased, and we've actually been -- we've been able to be successful with client deposits. Some of that has been going out ahead of our expectation of the client needs as interest rates start going up and with attractive rates on GICs, with attractive ways for corporate commercial clients and so forth. But we've been very successful. And we've been doing those at positive margins. So again, as we replace wholesale funding, that's positive to our NIMs across the bank and positive to NII. And so is competition a little bit more now? I think it's been competitive all along. We are definitely seeing competition out there, maybe a little bit more intense, but our approach doesn't change. We're there to serve our clients, but we're there to do business profitably, and we've been able to do that so far and grow our deposits.

Okay. Great. And then move on to the expenses, which has also been relatively topical. Or at least was, I thought you cleared -- slightly cleared there in Q1 with an expense number that actually came in like the dollar value was less than Q4, and I thought you kind of suggested that it should be more or less similar to Q4 levels. So is that how we should think about it going forward now? Is that sort of the run rate of expenses? And from here, it can more or less remain flat for the rest of the year? How should I think about it? Just to be very clear on it, so we can once again put the expense concern aside.

Absolutely. Yes, thanks for the question, Darko. And I'm always happy to talk about expenses, right? We -- maybe I always frame it as investments because for the most part, what we're very focused on is containing expenses and managing and growing investments and on a net basis, having good operating leverage results over the medium term. So let's step back for a second. Last year, we were very clear. We talked about this at Investor Day, even before we got there, we were very clear about the fact that we were increasing investments. And we've right around double the level of strategic investment we've put in the bank. We talked at Investor Day a lot about our disciplined capital allocation framework, around accountability on those things and delivering value and delivering a couple of billion dollars of pretax preprovision earnings over a few years out of those strategic investments. So what have we done? We've invested in those areas. And where have we invested, we get that question a lot, right? It's along with 3 key areas in our strategy we highlighted at the Investor Day, our high-growth high-touch segments. So we've invested in that part of it as a co-brand portfolio. We bought part of it is the planning tools that we've built like CIBC GoalPlanner. Part of it has been our private banking front office, both in Canada and the U.S. Private wealth advisers, both in Canada and the U.S. We've added infrastructure for those clients, better tools for our advisers, better tools for our clients in that space of advisory and wealth. We've also created future differentiators. We've invested in our energy transition, and we have a leading energy transition franchise now in our Capital Markets business. We've invested in our Direct Financial Services business. We've invested in our Innovation Banking business that we've spoken a lot about. And lastly, we've invested to simplify the bank, improved client experience, improved [indiscernible] experience and generate better efficiencies. So our CRM implementation of Salesforce, our transition to cloud. There's a number of those areas where we're investing. And you're seeing the results, right? Through last year, we had top 2 in terms of revenue growth. Pretax pre-provision earnings growth, again, growing above medium, met our strategic goals. Had ROE for the year right around 15%. And that's still with a lot of our investments in the J-curve state. So where do we go from here? We -- that's why we said we can stabilize the level of investment at this level. We can continue to look for efficiencies, which we do. We're always looking to get a couple of percent out every year out of those core operating expenses to cover normal course increases, inflation and whatnot. And so what we're left with is a mid-single-digit expense growth, which we're targeting. That largely is driven by deliberate investments that would drive value going forward. So if I put all of that together, what you will see, punchline to your question, yes. We've been clear in Q4, we take guidance seriously. We will be going right around sideways in terms of quarterly expenses for the rest of 2023. The only caveat I'll make is, if we have very good performance in revenue that drives variable expenses, that's fair game. Outside of that was got very good visibility, and we'll be adding going sideways. That means full year will be mid-single digits 2023 over fiscal 2022. That means operating leverage will improve over time and interesting how things change, right? We have the operating leverage and expense growth, top of the path this quarter. So we think on a relative to industry basis, we can do well in operating leverage going forward.

Okay. That's great. Thank you very much for that. It makes my modeling a lot easier. I'm going to quickly look out here to the audience if there's any questions. If there isn't -- sorry, we do have a question here.

I think this commentary around deposit remixing and customer behaviors actually quite consistent among yourself and your peers. And I don't know if you can give us a little more narrative around that? Is it certain rate thresholds or maybe inflation impacting people's desire to seek yield? Or -- I'm trying to kind of found this in the context of history, how far can that rotation continue?

Very good question. I'm not surprised, right? It is absolutely happening industry-wide. We see it, and it's happening and not just in Canada and other markets like this one as well, right? So I think a few things driving it, and it does depend by which client segments you look at. Generally, there's deposits going into markets or going into higher-yielding deposit product like GICs. So some of that is the yield opportunity. And then the second big category would be spend, right? And we spoke about the fact that you've got inflation, you've got higher interest expense for certain folks and businesses, and we are seeing that require some of those deposits. So I think it continues to normalize on the noninterest-bearing balances going forward. We sort of hit the peak. If you go back to middle of last year, that's when we hit the peak on noninterest-bearing balances for us. And then since that sort of May time frame, they have been coming down. But we still haven't gotten through that hump of deposit, excess deposits that built up during the pandemic. And so I think we've got some ways to go still. And by the end of this year, you likely will see between those 2 things, right? Those that were parking businesses or individuals that we're parking just because there's risk and uncertainty out there, the cash, but they don't need to use it, we'll invest in higher yield opportunities over the markets. Those that need to use it, then I think you're going to see some of that starting to come off the books.

Okay. Great. I see the screen is telling me that we have run out of time, Hratch. Thanks again for a great conversation this morning.

Well, thank you. Thanks, Darko.

Thanks.