National Bank of Canada (NA.TO) Earnings Call Transcript & Summary

Good morning. Welcome to the Barclays Global Financial Services Conference. I'm Brian Morton and I cover Canadian and Latin American banks here at Barclays. For this morning's presentation, we're going to start with -- we have Trey Greene, who is the Chief Operating Officer at Credigy. Credigy is a specialty finance subsidiary of the National Bank of Canada, it's headquartered in Georgia and has over $8 billion in assets under management. With that, welcome, Trey.

Thank you.

For the investors who aren't as familiar with the Credigy story, can you briefly describe your strategy and market position? And also, could you describe how you fit into the overall strategy for National Bank?

Sure. So first and foremost, we've been a part of National Bank since 2006. We've been a fully consolidated subsidiary for going on 20 years, which I think is important for people to understand that we are fully integrated part of the bank. In terms of our business, we like to think of ourselves as providing capital to either acquire or finance financial assets, primarily in the U.S. across a wide variety of asset classes, including mortgage, consumer, consumer-related products.

Great. Credigy has a very unique and diverse asset portfolio. I mean maybe starting with the largest segment, structured mortgage credit investments. Maybe talk about how your competitive advantages in this segment as well as the outlook for the mortgage investments and the stable to potentially lower interest rate environment, though elevated housing prices.

Sure. So competitive advantage for us, I think always, first and foremost, is our people. We've got a great team, about 185 people down in Atlanta, extremely tenured team. Our executive team has been together almost 19 years on average at the company. And I think we like to think of ourselves as competing on execution, not on price. We don't line up and try to compete with some of the big banks and other more recent entrants into the private credit space but really try to provide reliable execution and flexibility for our partners, which I think, hopefully, sets us apart from the crowd there. In terms of trajectory for our mortgage investments, I mean we think we've seen a significant increase in momentum in Q2 and Q3, and we think that will continue for us going forward. Typically speaking, we're targeting very high credit quality consumers and relatively low LTV mortgages that even in a complicated macroeconomic environment, we think will perform pretty well. And your last question on interest rates. Generally speaking, we think that a declining rate environment would be a tailwind for Credigy, but we've really tried to build our business over the last 20 years to be resilient and be able to deploy capital in a wide variety of environments, but certainly, lower funding costs and an increase in the velocity of cash coming back to us in the mortgage business would certainly be a tailwind.

Okay. Great. Also, can you talk about the insurance-related segment? Are you seeing opportunities to deploy capital in this segment? Are you seeing insurance companies looking to divest some of these assets?

Yes. So just to level set within our insurance-related segments, it typically does not mean that we're buying assets from an insurance company. Typically, the types of products that we're focused on in that segment are consumer-facing products that have an underlying credit exposure back to a high-quality insurance company. And certainly, we continue to see good opportunities there. We like the credit performance, and we also like that it's largely uncorrelated with the other drivers of the consumer kind of credit performance that we see within the rest of our portfolio. So less reactive to changes in interest rates or in underlying sort of consumer trends, so it provides a nice diversification for us as well.

Maybe a question just as I was thinking about, can you maybe talk about how more -- how you interact with customers? Are you just -- are you purchasing these assets through intermediaries? Or do you have direct relationships with the individual customers?

Yes, important question. So we're a purely B2B business. So we're not originating any assets or loans directly to consumers. Everything that we do is either directly with another company or through one of those intermediaries. So we have a large investment team that's focused on building relationships with asset originators, funds, banks, sellers, brokers of all shapes and sizes to help us generate the investments that we do. So -- but everything is on a B2B basis and nothing direct to consumer.

Okay. Great. I mean do you see other adjacent asset classes to expand into? And would you consider an acquisition to add scale or capability?

Unlikely that we would consider an acquisition. I mean for us, we want to grow our business by partnering with great companies that allows us to stay lean and flexible and really at the heart of our approach to the market is we want to be able to maintain our risk discipline at all times and having somewhat bulky origination operations could be limiting in that regard. So unlikely that we would acquire something via an acquisition, rather we think we can grow organically with the partners that we have.

Do you see other adjacencies outside to kind of the five verticals that you're working in?

Yes. So look, Credigy is always looking to kind of grow and evolve the opportunity set that we're focused on. I mean for us, the goal is to have the widest possible funnel to the market and filter through as many opportunities to find the good ones as we can. That being said, we have a pretty high bar for entering a new asset class. Some of the things that we're looking for there are availability and reliability of performance data, how predictable is this asset class? What does the servicing environment look like? Can we get to a place from an operational risk perspective that we feel comfortable with? So it's a very high bar, and I don't know that I necessarily see any massive changes there in the near term. But again, it's an important part of our culture to continue to innovate. If you look at our balance sheet going back 5 years, you'd see a dramatically different distribution of assets than what we see today. And if you were to go back 10 years, you'd see other dramatically different distribution of assets. To us, that's important. That's a good thing. We want to see that balance sheet evolving because that means we're being responsive to where we think we can find the best value in the markets.

One trend we're seeing is the rise in private credit as well as a growing number of fintechs and other financial -- nonbank financial intermediaries. How do you see the competitive environment right now from the nonbank community from potentially better funded competitors?

Yes. No doubt, it's competitive. We have seen a lot of new capital come into this business, in particular, you see these asset managers and insurance company tie-ups that could be very competitive with us. That being said, we're still able to find opportunities with our partners to find assets that we like. Again, our strategy is not necessarily to line up and compete against those larger sources of capital in the market. But to find places where our liquidity matters more, whether it's more complicated products or smaller opportunities or things that are maybe less attractive for those big guys or in certain categories where maybe they have less focus for one reason or another. But it's also important to know that they're not exclusively competitive. Those can often provide client opportunities for us as well. Asset managers and funds need leverage. That's something that we can provide, even if we don't like the prices at which they're acquiring assets, perhaps on a senior lending basis, we might be comfortable with the attachment points, and that creates opportunity for us. A lot of these funds have target durations that may not be matched to the underlying assets they're acquiring, especially in the mortgage market, and that may create periodic liquidity needs for them. So it's -- that increase in competition is not exclusively competitive for us. It's created a lot of opportunities as well. And I think the same is true of the fintech world generally. So we have a lot of long-standing partnerships with fintech originators and folks in that ecosystem that have the same needs for capital than anybody else would and are often innovating in some way that maybe makes it easier for a smaller, more agile organization like ours to partner with them as opposed to some of these larger names that have entered the space recently.

Okay. Great. Now there's one thing I was looking at. So it looks like the credit loss content in the portfolio looks relatively small, kind of given the structure and secured nature of the assets, but still, do you have any concerns from a credit perspective?

No credit concerns with our portfolio. I mean we have largely stayed focused on very high credit quality consumers and relatively low LTVs in the mortgage space where we're focused. I mean I think it's no surprise to anyone here that you've got really a bifurcated economy when it comes to the consumer and our focus for the last few years has been on the upper end of that spectrum. So no credit concerns from our perspective within the portfolio.

Also, maybe could you talk about the liquidity for these assets? I mean do you need to mark them to market? And if needed, do you think you can -- the assets could be liquidated quickly?

Yes. So first and foremost, I think it's important to say we think of ourselves as a long-term value investor. We're not buying these assets with the intent to do anything other than hold them to maturity and we're certainly not buying to any kind of near-term exit for these assets. But that being said, we do think there's liquidity there if we needed it. There have been a handful of times over the past few years where we've decided to sell assets or securitize assets on an opportunistic basis. And that's really how we have thought about asset sales is not a core part of our strategy. The goal is to continue to grow our balance sheet at 5% to 10% per year for the long term. But the liquidity is there. Again, we're buying high-quality assets. I'm sure we'd have a lot of takers if we wanted to make that a part of the strategy, but our goal is to just continue to build the asset base.

Great. Can you discuss your funding strategy? Are you raising deposits in the United States? And what kind of support do you have from the parent for funding Also, do you match the duration of the assets with funding?

Yes. So we are not taking deposits first and foremost. So all of our capital is coming from National Bank. And that funding partnership, again, has been developed over the last 20 years and is a really integral part of our business. So we can give our clients confidence that we can fund them quickly and easily because we have the ability to fund quickly and easily ourselves through National Bank. In terms of interest rate risk, you're absolutely right. We're going out and trying to match the duration of all of our investments to the funding that we received from the bank. And it's important to note that for a long time now, we've been an integrated part of the bank's risk management framework that includes credit. That includes interest rate risk management, all of that, we roll up through the bank and have for some time.

While the business model is very efficient with an operating efficiency ratio below 30%, are you feeling pressures to increase technology investments in the business, particularly as it pertains to the implementation of AI?

Sure. So efficiency ratio in our business, while certainly related to the scale of the business and the technology investments that we've made, I think is also notably just a byproduct of our asset mix. So if we're buying, for example, unsecured consumer loan portfolios, they're going to have significantly higher servicing expenses associated with them that's going to impact the efficiency ratio for those assets compared with something like mortgages, which is going to have dramatically lower servicing expense. So like a lot of things in our business. It's going to be dependent on asset mix. The same can be said of our PCL content, the same can be said of our ROAs. It's really a byproduct in large part of our mix. What was the last part of the question?

As it pertains to AI?

Right. Yes. Look, we are, like everybody else, trying to figure out the most efficient ways to implement those technologies. I mean for us, we've been able to grow our balance sheet fivefold over the last 10 years or so. And we've done that with a reasonably similar head count. I mean we've only got a few more bodies than we did 10 years ago. And the reason is that we've been pretty consistently investing in technology and automation, including those emerging technologies. I think what's important to us, though, is that we're doing so not in -- as a research project, but rather to find practical ways to enable our business to move faster. We win, as I said on execution meaning speed and decision-making and how supportive we can be to our clients, we're definitely leveraging and investing a lot in technology to make sure that we can do that. An example, in our world of how that works is like when we think about due diligence on financial assets that we're buying, whether it's mortgages or consumer loans or other products, we have invested heavily in technology that allows us to review all of the documents and all of the data associated with those loans. So that's going to tell us very quickly if the assets that we're looking at sort of pass muster from a quality and consistency standpoint, so that we can either decide this is not something that we want to do or we can say with much more conviction to our clients that it is something that we're interested in. That used to be the sort of thing that you could do on a sample basis because they required so much human intervention. But with the investment we've made in these technologies now, we can do full portfolio reviews in a much more efficient manner, which we think helps both kind of manage our expenses but also lower the risk content of our portfolios.

And maybe can you also talk about the amount of leverage used in financing these assets? And what is your kind of target level of returns? How much capital is required to run the business? And do you feel any capital constraints?

We don't feel any capital constraints. I mean, in terms of profitability, what we're targeting is something in the range of 2.5% ROAs. But as I said, they're going to be dependent heavily on the portfolio mix at any given point in time, right? If we're over allocated to, say, mortgages, and that tends to be on the lower end of the ROA spectrum. If we're doing more unsecured consumer, you would see that number be significantly higher. What's the last part?

About leverage.

Right. Yes, no other leverage. All of our capital comes from National Bank. It's -- we try to be a very simple business that way. We're looking to add quality assets to the portfolio, and that's really it.

And then do you target any type of level of like growth in the asset base? Or is it just kind of taking what the industry growth is?

So what we've said publicly is that we're looking for an average growth rate of 5% to 10% over the long term. But I think the important thing to understand is that we want to keep our risk framework consistent. And so that's a range because the market conditions are going to change around us, right? We don't want to be chasing what we think are unattractive risk-adjusted returns. If we find ourselves in an environment where we think the spreads are too thin relative to the risk that we're taking, we'll invest less. And the opposite is true if there was a liquidity event in the market or a major credit event in the market, I think you'd see us growing significantly beyond the 5% to 10% range. But if you look back, we reported relatively modest growth in the first half of this year. I think that really reflected the environment that we were in at the time prior to some of the volatility and liquidity issues that came up with the tariff announcements enable.

Can you talk about maybe some of your -- the regulatory framework for Credigy, your -- in the specialty finance area, a little bit smaller than some of the other financial firms out there, but you also have this Canadian parent bank. How does that at all this impact you on the regular framework?

Yes. So I think first and foremost, we are directly overseeing as part of the bank by OSFI, Credigy has been through a stand-alone review and our part and parcel with the bank from a risk management perspective. Within the U.S., again, not originating directly to consumers, we're not directly regulated by a lot of those entities. But of course, there's a regulatory compliance framework that we have to operate within, licensing that's required of us depending on what asset class we're investing in that's sort of on a state-by-state basis. But we think of our primary regulatory entity as OSFI through the bank.

Great. Thanks, Trey. That's pretty much from my question. Is there anything else we haven't covered? Or would you like to make any concluding remarks?

No, I think that's it. We think that we've had a strong third quarter, and we continue to see a lot of momentum building in our business and goal is to continue to be a part of the selective growth that the bank is targeting in the U.S., and it's been a great partnership and appreciate the time to talk about it.

Great. Thank you very much, Trey. Let's open it up to -- does anyone have any questions on the floor? And of course, I would like to kind of keep the conversation on Credigy, anything for National bank of Canada, we'll just take those questions later off-line. But we'll start here in the front.

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Yes, easy answer, zero in both cases. So we're pretty much exclusively focused on the resi market in the U.S. And again, that exposure for us is typically high FICO homeowners with a relatively low LTV. Again, it's not to say we wouldn't necessarily potentially invest in those asset classes, but it's not part of our portfolio.

What would you consider to be the binding constraint for growth for you guys? Is it just available opportunities? Is it competing versus the other biz segments for dedicated capital. How do you think about what your limiters are if there are any?

Yes. So look, I -- as part of the bank, I feel like we're obligated to sort of demonstrate that we can generate strong ROEs and strong risk-adjusted returns like any other units of the bank. But I feel good about that. That hasn't been a binding constraint for us. I mean what is potentially limiting growth at Credigy at any given point in time, it's just going to be how our risk framework overlays with what's available in the market. So certainly, there are competitive dynamics at play there in today's world, a high-quality loan portfolio of any type of scale is going to be extremely competitive with asset managers, insurance companies, funds of various shapes and sizes and so for us, the constant is our risk framework. And so in the event that there was some disruption there, some liquidity event, we think that opportunity set would increase dramatically. And we've seen that over many different sort of cycles at this point, whether it was early in the life of Credigy in the global financial crisis or events like COVID or even localized events like the tariff announcements in April, whenever there's sort of significant volatility in the market, that creates a massive inflow of opportunities for us.

Any more questions? Please join me in thanking Trey for his presentation.