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

[Audio Gap] Rejoining us. I've got Louis Vachon, the CEO of National Bank, joining me here on stage for the next session. But before we begin, I've been asked to tell you that Louis' comments today may include forward-looking statements. Actual results could differ materially from forecasts, projections or conclusions in these statements. Listeners can find additional details in the public filings of the National Bank of Canada.

In other words, I don't know what I'm talking about. Is that right?

No. No. You know what you're talking about, just could be wrong.

Oh, yes. That, too.

So I think for an opening question, just to start off the session, Louis, is you sort of reiterated your medium-term objectives of 5% to 10% EPS growth, 15% to 20% ROE and a common equity ratio that's greater than 10.75% for 2020. So in the context of the macro environment that we're in today, we talked a little bit this morning with a lot of CEOs about headwinds and issues, particularly the interest rate environment, what can you tell us about your ability to achieve these objectives in 2020? And what might be helpful in achieving your results? And what might be a bit of a difficulty or a difficult -- or a bit of a headwind for you achieving your medium-term results -- or targets, sorry?

Well, we're -- I think in providing these -- this guidance, I think, basically, what we assume, and I think it was quite specific on the call, I think we see the Québec and Canadian economy growing 1.61%, 1.7%. Real, very limited decline in administered rates in Canada. So maybe one drop, but not much more than by the Bank of Canada. So that's essentially the background. So anything that's a little stronger than 1.6%, 1.7% for growth in Canada I think would be helpful. No decline in interest rates by the Bank of Canada I think would be helpful. A continued, very strong pipeline in M&A and financing would be helpful. Those will all be scenarios where I think we will be in the -- probably at the upper range of our guidance as opposed to the lower range of our guidance in terms of EPS growth for 2020.

One of the things you said in the past, with respect to your bank in particular is, you operate in Québec, which right now is strong -- very strong economically. I remember hearing from you, hey, Québec is a no boom, no bust kind of economy. Well, now you're booming, right? So as we're seeing this boom, it's being helpful to your results, we're seeing it in the numbers, what are you doing to prepare for an eventual slowdown in Québec? And are you expanding now or using this as an opportunity or springboard to sort of grow out of Québec.

Yes. Québec grew probably close to 3% real, and in 2019 that's a very good number. Now before I say, boom, I think I'd like to see a couple of years growing at 3% before we call it a boom. I think that would be a nice problem to have, frankly, if we got to that point. But suffice it to say, I think whether we -- that continues or not, I think we're very comfortable with our positioning. Even though Québec's economy is growing very quickly, the level of debt in -- by the average consumer in Québec is still very low for the simple reasons that despite recent increases in Montreal real estate prices, housing affordability is still very good in Québec. So people simply have less debt because it's cheaper to buy a house. And you would need an exponential increase in real estate valuation in Québec to see that change over the next 5 to 10 years, which I don't think is going to occur anyways. So I think the fundamentals are still good. As you know, we are overweight secured debt, i.e., real estate secured debt, underweight on a relative basis, credit cards, which could be an area which would -- could suffer if there was a slowdown in Quebec economy. So generally, I think we -- it's not a -- I think we continue to be -- the interesting thing about the Quebec economy, and Stéfane Marion, our Chief Economist, is working on that right now, is trying to figure out -- now we're re-questioning whether we've been targeting a normal growth rate for Québec, which should be about 1.4%, 1.5%, given demographics growth. What we're realizing is demographic growth is actually much higher than we thought. Because what's happening is the Québec government has given targets for permanent immigration about 45,000 a year. But they've also given this year 45,000 permits from nonpermanent immigration; student visas and nonpermanent workers. So Quebec's population actually grew by 90,000 last year. That's a 1% growth. To put it in perspective, Ontario, which is the champion in North America, grows at about 1.2% per year its population. The U.S. is 0.8%. So now Québec, if we look at extended trends, is actually fast and growing on a relative basis faster than the U.S. So that's what we're trying to figure out how that -- if that continues to be the case, and we target about that number of new immigrants every year, perhaps the 1.4% number, is too low as a target. The real number should be higher than that, closer to 1.7% to 2%. In which case, a 3% boom, it's a good year, it's a good number, but not completely out of whack because maybe the potential for growth long term is a bit better than people think.

And with this growth that Québec is experiencing right now, there are some banks that are underrepresented in Québec, but are suggesting that, hey, you know what, we should use this an opportunity to grow and compete and get into Québec. What can you tell us about the competitive environment in Québec, especially in a low-rate environment? So somebody coming into your turf, they're going to compete on price, presumably. What can you say about the...

Well, clearly, a good performance will attract attention. Now if you don't have branch network, it's pretty hard to improvise one overnight. So I think that we've seen competition, it's the same competition, but from people who've been there, frankly, some of them were used to be based in Montréal. So they still have their branch network there. So that's -- I would say, the competition has been ourselves, Desjardins, and some of the banks that used to have a greater presence in Montréal, but still kept a significant one. So that's -- I think that's the same. We haven't seen a much different change in patterns in competition.

And judging from what you've seen, is pricing any different in Québec than it is in any of the other provinces where you might be seeing stuff like mortgages or -- particularly, we hear mortgages is hotly contested. Is that the case in Québec or...

I think competition in mortgages, frankly, is pretty fierce across the country. Is it better or worse in Québec than the rest of the country? I don't get the sense. I think it's very much the same. It's a very competitive market right across the board.

Okay. And so given the strength that we've got in the Quebec economy, and you posted some very strong results, especially in the Canada P&C business in 2019, but your expense growth was fairly muted, at about 2%. And for 2020, you guided to more normalized, like 3%, and that's while investing in growth. And we had another bank up here suggests that their expense growth rate would be a little bit higher than that. We had one come in here a little bit lower than that. So a fairly wide range of expense expectations. But coming in 3% higher than last year, what are you investing in, in 2020 that -- and what about the revenue side? What kind of revenue growth are you looking for Canada P&C in 2020?

Well, I think what we've given as a guidance is relatively flat NIMs. Again, assuming maybe one drop at Bank of Canada, not more than that. So NIM is relatively flat. We're targeting a 4% growth in terms of the mortgage market this year, in terms of retail lending. That looks like a very realistic number right now, maybe even a bit conservative. We'll see how the market evolves over time. But I think it looks like a very solid number. So with good discipline on cost, I think decent NIMs, I think we should have another very good year in P&C.

What about the commercial side in terms of [ commercial ]? You decelerated a bit in 2019.

It is because we did a bit of a cleanup -- we had some loans on trade finance, international trade finance, to jurisdictions that we decided to reduce. So that made the comparison a little bit tougher. But net-net, I think we're targeting high single digits for commercial lending, very comfortable with that number. We feel that's a number where we can achieve decent margins, good risk management. And we want to grow the commercial real estate segment at about the same speed. So we don't want commercial real estate to be a disproportionate amount of the growth of our commercial book. So same things we've been communicating to The Street now for a couple of years already.

And geographically on the commercial real estate growth, is there any changes there or...

No. It's about the same. A little bit overweight in Québec, but we're still very active in Ontario and Western Canada.

And I've been getting a little bit of noise in the marketplace with some participants that we're starting to see some late cycle behavior, some maybe higher-hold levels, maybe competition on price always, but on the commercial side specifically, we're seeing the commercial borrower, perhaps, levering up a little more than usual and in terms that are just a little looser. Are you seeing any of that? And is it a cause for concern or...

A little bit. I would say the one -- generally, I think it's quite good in Canada. The one segment we're watching is the leveraged loan segment. So we've been extremely careful in the U.S. leverage loan market, not very much at present. It needs to be a big, big, big exception with a very, very good client for us to be involved in that particular market. Otherwise, it's no or no in whatever language you want. The -- what we've seen is, some of the structures, looser covenants, a little bit more leverage on debt-to-EBITDA, there are standards in U.S. starting to creep up to Canada. And we've been trying to fight back a little bit, but private equity are under pressure to maintain IRR, they have to pay more for acquisition and the way they're trying to equalize that dilemma is by trying to put a little bit more pressure on the leverage ratio. So we've seen a little bit of that. It's not epidemic. It's not a huge source of concern, but it is certainly something we're watching quite carefully.

But if we're thinking about high single-digit growth rate in commercial loans, does that mean that you're still investing in the segment or you're hiring bankers? Or is this just mostly coming from existing clients? Like, how should we think about that growth rate? Because it's still -- it's about 4, 5 years in a row with really high-growth rates in commercial.

Yes. But I think there's a couple of things driving this. So short answer, the one area that we've added more bankers is the Greater Toronto Area, particularly for large private companies. That is a segment where we've added staff. That was done in 2019. So now they're in the market right now, as we speak. But that is an area we've added bankers. But generally, as you know, the growth has come from where we have -- the M&A business, the old concept that you and I have discussed for many years now of this old generational change in ownership of Canadian businesses, we're right in the middle of that. In fact, if anything, that's accelerating. We see an acceleration in 2020 of that as the biological clock is ticking. And then commercial real estate, obviously, being very active and Montreal, Toronto and Vancouver is driving a fair amount of volume, too.

Okay. And so wanted to touch also on the innovative branch concept that you launched late in 2019. Advisory services technology, you want to sort of grow this across Québec. Can you touch a little bit on this branch concept? Would you ever roll it out outside of Québec? And I know it's early, early days, but any feedback on this, it would be interesting, I think, for this.

Actually, we've been doing a pilot of this for the last 3 years. We've talked about it in '19, but in fact we've been running this, at least for close to -- yes, 2.5 years, now close to 3 years. So basically, if you walk into our branch now that has this new concept, every employee of the bank is sitting in front of the counter. Not -- no one is behind the counter waiting for you. So we're very proactive. So we're proactive. We approach our client as they come into the branch. Everybody has a tablet, so all the applications on a mobile basis, including the transactional one. And we're trying to resolve ask for the need and resolve the issue as much as possible. The only reason someone would go behind the counter is if you need cash, physical cash and/or you don't want to use the ATM. Otherwise, everything should be resolved in front of their counter in an open area. Now what it allows us is to do a couple of things: one, we're more even more proactive. Secondly, with the tablet, where we're aiming for, in terms of functionality and culture, is a culture of multi-tasking within the branch. Yes. The branch will continue to exist. But you want people who can do many things within the branch, both transactional, problem resolution and advisory. So for us, it's not just a nice little marketing thing and being more proactive, it's actually moving toward having employees in the branches who are multitasking and can do different things. So we deploy in about 35 branches now and 100 more are planned this year, including some in Toronto between now and April. So if you walk into probably the one here downtown, you'll be able to -- by April, should be able to visualize this. So that's where we're at on this. The feedback is been very good. The branches where it has been deployed, the Net Promoter Score has been significantly higher. And as I said, I think it is a good -- it's good for customers, but also for employees. We're really getting employees prepared for the future of in-branch employees, which is multi-tasking and being able to do many different things.

And the cost of this branch is presumably lower than...

Lower. Because less -- you need less footage. We estimate we need about 30% less square footage.

Okay. So it will be a gradual roll out of this.

Yes. As we -- our branches, the leases in our branch mature over the next 10 years. So we did some last year, but I think we feel that over the next 10 years, we'll reposition physically the whole branch network.

So one of the things that National did was sort of a retreat from mortgage brokers, but then kind of buying mortgages and this innovative branch. What can you talk about with respect to mortgage growth expectations for National Bank? And in particular, I'm also interested in your view on what would happen if we eased up the mortgage stress test? Would that be a benefit to National? Are you for it? Are you against it? Can give us any color on that?

On the stress test, I think, generally, I've been in favor of it for the simple reason that when you look at what occurred in markets where you ended up with disequilibrium in the housing market and excessive household debt, the one differentiating factor, the one key factor in all these markets has been the underwriting standards applied to the mortgages. That's been the differentiating factor, more than any other markets. And when you look at the lessons of what the Americans should have done in 2006, if they had a time machine, what they would do differently, most of the U.S. regulators would say, we would have tightened up underwriting standards in 2005, 2006, to avoid what occurred later on. So I've always been in favor of proactive macro prudential policies adjustment to avoid a repeat of or avoidance of what occurred in some of the markets in Canada. So I think it was the right thing to do. I think both the government and the regulators and also the banks and the industry, I think, have been responsible on that. Before we change anything, I think we should -- and I've been saying that for a while now, I think we need another 3 to 6 months, just to figure out exactly what the impact has been, as some consumers have been disproportionately impacted, trying to figure out exactly, but I think we need a bit more time and a bit more data before changing anything.

And of course, rates could go lower, and we could see...

They will go higher or whatever. But frankly, yes, there was a bit of adjustment, and it was also the foreign tax that was imposed in Toronto and Vancouver, but the market now seems to be growing again. Do we have a problem with real estate growth in this country, I don't think so.

But all this to say, as a purchaser of mortgages, this is something that you favor. And as when you say, we're looking for 4%, maybe that's on the conservative side for 2020.

Yes. It is. But I think, at the same time, as I said, 4% with good underwriting standards and good margins, we're perfectly happy with that. I'd rather have that than 6% with loose underwriting standards and margins dropping. So that's where that -- now on the mortgage brokers, yes, we flip flop. I mean that's okay, we're French. What can I tell you? The -- but I think what we realize with benefit of hindsight is in the Quebec market, where our chances -- where we do a much better -- where the franchise is, frankly, stronger, our chances of on-boarding the client and cross-selling is much higher. So we should have been a little bit more conservative in dealing with the mortgage brokers in Ontario. I think we should have stayed somewhat active in the market. And our latest announcement in the last 12 to 18 months was to bring that balance a little bit more to, I think, where we should have done in the first place.

So let's switch gears to the International business, if we can. So one of the things you talked about in fourth quarter was Credigy. Low growth in 2019. But you're guiding to double-digit earnings growth in 2020. So let's get a little more color around the pipeline that you're seeing, Credigy, completed deals. What can you share with us on the Credigy side in terms of expectations and what you're putting on the balance sheet?

Yes. So it's -- portfolio remains very diversified. So we have strong growth in secured. We're doing some stuff on the unsecured space also. So -- and the reason that we were quite confident and remain quite confident in our guidance is most of the trades are closed and have either funded or will fund over the next few months. So we have strong -- very good visibility on good growth in Credigy in 2020. Now the team, I think some of you have met Brett Samsky when we had our Investor Day in 2016. Brett and the team remain very conservative. So I think they're very good at selecting portfolios or providing credit enhancement that provide good downside protection on the structuring of these different structures. And so I think not only we're satisfied that we'll have good growth in 2020, but also that we're not -- I think we'll -- that perform -- that portfolio could do well also, if there was a bit of a slowdown or a major slowdown in the U.S.

And can you talk about geographic footprint? And [indiscernible]

Right now, the business is 100% U.S. They see so much opportunities in U.S. that they don't have to bandwidth of the team to go outside of the country. They're very much focused. They see opportunities because people want to reposition their capital. And frankly, also, as you know, we've been a beneficiary of the growth of fintech in the U.S. A lot of companies originate a lot of assets, but they're having difficult time funding these assets. So that create opportunities also for Credigy and its platform.

So what kind of growth are we talking about? Because on the loan growth and risk-weighted asset side, because one would presume that with this kind of growth in these kinds of assets coming on, I would have assumed at stage one reserves would be higher. And yet your guidance on PCLs is very much similar to previous guidance. So you said most of it is already funded or about to fund. So is that it? I mean we should see like -- by my last math, it was -- I'm going to stretch here to think about it, but I think it was less than 10% growth in the Credigy book. So is that the kind of growth that we're looking at or...

It could be a little bit more than that. The -- I'd say, in terms of ACLs and all that, it depends on the mix between secured and unsecured. On the unsecured, it has a bit more of an impact, by definition. The secured portion of the book tends to have very low impact in terms of -- because the history in credit losses has been almost zilch. And because of the nature of the portfolio, they tend to have a lower impact on regulatory capital. So it really depends on the mix of unsecured versus secured net of portfolio.

And where do you -- do you see a big opportunity in unsecured? Because it -- we have heard some...

We see some, but some of the deals we've done have been provided with credit enhancement. So I won't give the whole secret recipe here. But clearly, there's -- we've positioned ourselves a bit differently than what we did in the past on the unsecured book. It's better protection on the downside than we did in the past.

Okay. So ABA Bank then, switching gears in the International business, very good growth, you acquired the last 10% interest. Can you give us an update? What are your expectations for ABA in 2020?

Still another very good year. And...

I mean it was very explosive growth last year, right?

Yes.

So we shouldn't be thinking about those kinds of growth rates going forward or should we?

Listen, I think you're still -- if we don't generate good double-digit growth, it's going to be disappointing comparable. We'll see -- next year we'll compare the numbers, but it's still -- they generally good double-digit numbers. Where we are? We're still in a good phase. We're still going to open 10 new branches this year. And that tends to fuel interestingly enough in a country that's very young and very digital. Yes. Physical branches still matter. And we see a direct correlation between client acquisition and physical infrastructure, even though our ABA's app is the #1 financial app in the country. So it's both physical and digital acquisition, but it's still linked between the two, and the business continues to -- And last year, as you saw, we're generating faster growth in deposits than we did in loans. And those deposits are transactional banking deposits, of which we essentially pay 0. So we're basically paying down interest-bearing deposits and replacing them with free deposits. So that tends to be very positive on NIMs. So we have the conditions for another very good year in 2020.

And -- so for the audience and for myself in particular, let's talk about the economy in Cambodia. I mean what do we worry about? I mean this kind of growth is very good. And the provision for credit losses there is pretty much just following growth. So what are -- is there anything that we should be thinking about on the horizon?

I think we've said it all along, any kind of the test, we're very happy with the results of ABA. But the ultimate test of a franchise -- of a banking franchise is when you see it throughout a complete business cycle. So the ultimate test for ABA will be when there's a global recession, Cambodia is an open economy with a strong tourist, agricultural and manufacturing import and export business. When there's a global recession, that's going to be the real test in how that franchise performs and appear. Now we think the book is well-secured with that real estate guarantee on the small business loan. But that's going to be the ultimate test. So before we have the Stanley Cup Parade on St. Catherine Street for ABA Bank, I think we want to see a complete -- looks as though we're not going to have it for the Canadians this year again. So we want to see a complete business cycle go through.

And so turning our attention into credit from that discussion, a little bit of one-offs last year, anything to take from that? And not necessarily for you guys, actually, you guys avoided a lot of the one-offs, but when we think about credit, is there anything that you're avoiding in 2020? Any segments or anything -- you talked a little bit about late cycle behavior, I know you talked about levered lending. But apart from that, is there anything else that we should take into -- because your guidance for next year more or less is the same as last year, which is -- typically, we're getting higher guidance from other banks. So can you talk to...

One-offs are always a possibility. The minute I'll tell, there are not going to be one-off, I'll have one tomorrow. So we have to be -- these things can occur. And we've had them before and it could occur. Fundamentally, though, I think our guidance reflect the fact that it's the same positioning from a risk perspective as the last 3, 4 years. Namely, we're not very much in the U.S. We're not in the leverage loan market in the U.S. We're overweight Quebec in the Canadian lending. We're overweight secured lending versus unsecured lending, and we feel that positioning from what we see today is still a very good positioning. So -- and the goal -- the strategic goal in all this is obviously to try to do -- to outperform our peers in the down cycle, not just for the sake of that but to then, on an organic basis, go on the offensive, a lot more here in Canada and try to gain even more market share. That's exactly what we did in 2009, 2010 and 2011, and that was immensely accretive to the shareholder. So that's the thing we're trying to replicate here again.

One of the things that National has done differently over a period of time here is, you created a transformation officer, you went aggressively at costs. And -- can you give us a sense now, is -- given that you've gone through quite a bit of a transformation, going forward, where is the next area of efficiency improvement going to come from? And what kind of efficiency improvement should we be expecting from National on a go-forward basis?

Well, we're still guiding to positive operating leverage for 2020. Areas where I think we still -- I mentioned one, which is the square footage of the branch network. That is one. In terms of back office, we still have work to do for at least 2 years and probably even more on automation in terms of back office and administrative functions. So we still have some room there. The general -- in terms of other efficiencies, both in cost/loan losses and revenues, data, we're just at the beginning we feel of using data effectively. We're very happy with the results of the last 2 or 3 years, but I think we're just getting started on that front. So those are rooms where areas where we feel technology and transformation should continue to have an improvement on the cost of operating.

Is anything like this require restructuring charges? Or does it...

No. Not for right now. No.

So it's more or less continuation...

Yes.

And we had an interesting presentation yesterday with Laurent talking about the ETF technology side. My sense was from reading some annual reports that technology spending was cresting. Is that the case at National? And is it a potential that you can pull back on tech spending or...

I think what I've tried to communicate is, our ramp on numbers in new projects -- total number has been about $800 million, quite consistently in the last 3, 4 years, and new project is $350 million. I -- the last thing you want to do in technologies go from feast to famine and back and forth. Try to get a steady number and manage that number in terms of managing projects and managing -- looking forward I think is better than feast or famine type of structures. So I try to stick to a number that short of a massive global recession we can stick to. That's been, I think, our approach in terms of technology spend.

So before we open it to questions, I want to just touch on capital markets because on a relative basis, your capital markets results last year were very good. And frequently get a lot of questions on what makes National different versus peers. So I thought maybe I'll just give you a very open-ended question today, and maybe you can just touch on for shareholders the key -- what are 2 differences of your capital markets business and -- versus others? And I think there is an expectation that, look, last year was so bad that 2020 should be a bit better. In the context of your capital markets business being better, what should we think about from your -- sorry, different, what should we think about for your capital markets business in 2020?

Well, I think the comparative for comparison for Q1, Q2 for the industry should be pretty good this year. So yes, I think the industry should look better generally for Q1, Q2 because of weak quarters last year. And we still expect a good year this year in capital markets. Differentiating factor? We are more focused on Canada than our peers. We have very limited expansion project in the U.S. for investment banking. So that's the biggest difference. And that's where I think some of our peers have imported volatility on their results from their U.S. expansion, frankly. So that's I would think the biggest differentiating factors.

Okay. So we'll switch gears and hit some of the questions that are being asked in the audience. Number one voted question is, can you talk about the rising unemployment trends in Québec?

If you're referring to -- I have absolutely no concern. Is it -- was it a statistical blip in December in the Stats Canada numbers? Yes. I think it is. I was in Quebec City during the holidays. I went to a resort and -- their skiing resort and the person checking the tickets was 12 years old. So it doesn't suggest to me that there's a problem. Yes. If there is a problem in employment in Québec is lack of manpower. So there's absolutely nothing in our numbers that suggest. I think the biggest issue right now, as I said, is -- we -- but I think, as I mentioned, that's why the number of temporary work permits are increasing too because in Montréal it's -- there's -- that's where most of the immigration comes into, it's manageable. Outside of Montreal, there's a chronic lack of manpower. So the issue in employment is not rising unemployment, is where we're going to get more workers to finance economic expansion. That is the key issue for Québec in 2020.

And next question is, did the 2019 election indicate there is rising support for separatism in Québec? And maybe what I would add to that is, does it change the way? Would it change the way you manage the bank?

No. No. And no I don't think that's what it was. I think it's -- when you look at the votes, it's votes that go from the NDP to the Bloc Québécois. So no, I don't think that was really the signal of that election.

Okay. And then maybe one more. What are the key risks to growing Credigy at this point in the cycle? And how are you managing them?

Well, I think the key risk is overloading on assets that would not perform well in the down cycle. That's why we're very careful on our mix of secured versus unsecured. And that's we're very secured, careful of building cushions and buffers to protect the unsecured part of the portfolio in an economic downside scenario. But as I said, the team at Credigy is extremely conservative. So we think that we'll be well prepared in that scenario, should that occur. And frankly, strategically, should there be a significant slowdown in the U.S., we feel that would be actually a strategic opportunity for Credigy to expand the business even faster.

Okay. So with the last remaining time, I think what I'll do with you is, as we do with every CEO, I'll throw it back over to you and ask you for some key messages for shareholders that you'd like them to leave here today with.

Well, I think, first of all, thank you, everyone, particularly the shareholders, for their trust over the last few years. We -- I think the bank has performed well. I just want to reassure that despite our success, it's not getting to our head. We have a saying at the bank, we don't panic when things are tough and we don't get too cocky when things are good. So I want to reiterate that. I think we, despite our recent successes, we stay very grounded. I think we have a good game plan to -- for the bank to perform, regardless of what kind of economic scenarios we're dealing with in the forward -- in the future. And we're very happy with that. And don't expect big surprises from us in 2020. We're not in the business of delivering bad surprises, the very least. If there are ones, hopefully, it'll be good ones.

Okay, all right. With that, thank you very much, Louis.

Thank you.