National Bank of Canada (NA) Earnings Call Transcript & Summary
September 9, 2020
Earnings Call Speaker Segments
Meny Grauman
analystWelcome back, everyone. My next guest is Mr. Louis Vachon, President and Chief Executive Officer of National Bank of Canada. Louis, good to see you.
Louis Vachon
executiveLikewise.
Meny Grauman
analystAnd I like the picture behind you of the new building.
Louis Vachon
executiveYes. Hopefully, we'll use it one day.
Meny Grauman
analystHopefully, hopefully, we'll all have a use for the real estate.
Meny Grauman
analystBut Louis, I wanted to start off with a big picture question. I think you win the award for best phrase of the pandemic, you call the current environment, Star Trek Finance. I think it was in -- maybe it was in the Q2 call. And I just want to know what exactly were you referring to when you made that comment? And is it still an accurate depiction of the environment we're in? Or are we closer to the end of the tunnel? Are we seeing the light at the end of the tunnel here?
Louis Vachon
executiveI think it's still appropriate. I think what I was trying to -- using my limited cultural references, what I was trying to communicate is that we're really dealing with a first year in terms of -- from macroeconomic and just from a general social standpoint. When we have financial crisis or economic crisis, we -- one of the things we tend to look at are precedents to see -- to give us a little bit of a path to how things could evolve. In this particular case, it was the first time in history, where you had a suspension of economic activity engineered by governments to protect the population against a pandemic. There were no precedents on that. They were precedents in pandemics, some of which quite horrible, like the great plague, but no situation of a government engineered suspension of economic activity engineered by governments in the context of a globalized and digitized economy. So when people were asking us how things will evolve, and we're trying to -- I was answering that question -- I was making that comment in the question trying to answer how will loan losses evolve. I was trying to highlight in a rather unusual way, how little information. So it's literally we're going where no one has gone before. We don't know because we don't have that kind of precedent. And are we still -- is the episode over? No, the episode is still not over. I think we -- so far, I think the less -- the more pessimistic scenarios are less likely. I think if we have to move between pessimistic and optimistic, I think right now, the things are moving more closer to our more optimistic scenarios that we came up with 3 or 4 months ago. But we -- by any means, we're still in the middle of the crisis. It's not over.
Meny Grauman
analystAnd so taking that idea, are there any conclusions that you can come to at this stage, given what we've seen and what we know? I mean we know that government support works, I think you would agree with that. We know that technology -- without technology, we wouldn't be able to speak the way we're speaking. So that's the big plus. Is there anything in terms of the outlook that you have more of a definitive view on, especially, as you look out to 2021?
Louis Vachon
executiveWell, a couple of things. One, I don't think it's a surprise, but 2 things is, the first one is, if you have a good strategy and you have a good strategic positioning, you'll do fine, you'll do okay during a crisis. And I think that's not -- we're not learning anything new but that highlights what we already know. The second one is crisis tend to accelerate existing trends. And we saw that with digitization, where the digitization of the economy probably accelerated by a year or 2 within a quarter or 2. The issue also of geopolitical tension that was an existing trend prior to the COVID situation was made worse by COVID, not better. So a crisis tends to accelerate or make worse or make faster existing trends. And I think that's one of the other conclusion we've seen.
Meny Grauman
analystThey say that you shouldn't get a crisis pass you by. And so the question for your bank, in particular, do you see a strategy coming through the pandemic to make National Bank a better bank, say, a stronger bank? But I don't mean to take light of the pandemic but maybe a better bank is the right way to phrase it?
Louis Vachon
executiveI think -- as I said, the -- I think the investments we made in technology and our strategic positioning, I think the crisis so far has confirmed that we made the right choices in terms of capital allocation, managing costs, managing risk and managing our business. Now the question is, from a risk perspective, are there new opportunities we can look at. The answer is, yes. But the big part is, I was around in 2008, 2009, 2010. This is not 2009, 2010 when at that time, we put on, as a bank, a pretty much a generalized risk on expansion strategy coming out of the crisis in 2008. This time, I think, because the crisis is a lot more complex, the consequences are less obvious to us and that generally, the economy is in a different place than where it was in 2009. We're not going to have a risk on everywhere strategy coming out. There are areas where we can take on more risk, and we will do so. But I think it's going to be a lot more selective than what it did -- what we did in 2009.
Meny Grauman
analystCan you go into more detail in terms of those areas? And what attributes those areas have that make them suited for this kind of environment?
Louis Vachon
executiveRight now, for instance, we're still comfortable on the retail mortgage market. But debt to disposable income in Canada is much higher today than it was in 2009. So I think in the real estate secured lending, you do need to be a little bit more careful. You need to be a little bit more specific. Same thing with subsegments in Corporate Banking. There are areas and especially in capital markets, the Fed has been intervening a lot more in this crisis than it did in 2008, 2009. We had a greater level of certainty in 2009, 2010, that the financial crisis has washed out some of the excesses out of the financial markets. The Fed intervened so quickly this year, that I'm not sure that all the excesses have been washed out, out in the markets and particularly in leverage finance and other areas like that. So just to give you a couple of examples where this time around, I think you need to be -- you lose a lot more discerning judgment in terms of where you apply risk than what we did in 2009, where we felt the opportunities were more general and more and broader than what it is today.
Meny Grauman
analystAnd you raised an interesting point. It seems like Central Bank intervention is covering up a lot of mistakes that have been made along the way. At what point will those mistakes not be able to be covered up anymore? Like, is there a sense, do you have a timeline in terms of how long can this go on for before a lot of those areas of risk that aren't so obvious jump out and to scare us.
Louis Vachon
executiveI don't have a specific answer to that. All I know is I'm pretty sure that excess liquidity will not make up for a bad business plan and for an outdated business model. So at some point, the invisible hand will do its work. Injecting liquidity may delay that a little bit, but it will not indefinitely postpone what should occur, unfortunately.
Meny Grauman
analystLouis, does this pandemic -- will this pandemic have a permanent impact on earnings power or ROEs for the sector as a whole and speak to your bank specifically. And I'm most curious about ROEs, actually, given the kind of capital levels we're seeing across the group right now?
Louis Vachon
executiveWell, our ROE target has been 15% plus for a long time, probably predates me as a CEO. Right now, as a management team, we're not looking to change that target. I think we can still generate 15% plus despite the complexities of the current environment and despite the headwind that the net interest margins represent for the industry. So we're still going to, very humbly as a management team, try to for the next few years, generate 15% plus. If we're proving wrong, then we'll make the adjustment. But based on what we've seen so far, I think we still have good probabilities of generating 15% plus.
Meny Grauman
analystRight. In terms of credit. Just wanted to get your perspective on credit. Specifically, what lesson did you learn from the 2016 mini credit cycle in the oil and gas sector that you have been able to apply to the way you approach credit this time. Is there any way to -- are there any lessons that have been learned that can be applicable to where -- what we're facing right now?
Louis Vachon
executiveI think we -- I've learned -- we've learned -- as a management team and myself, we've learned out of every episode, there's always lessons to be learned. We certainly learned lessons in 2007 and 2008 with the asset back commercial paper and other issue. And the lessons are as follows. As soon as you identify an issue, a risk issue, go at it proactively and with transparency. And that's what I think we did with the ABCP crisis in 2008, that's what we did with oil and gas in '16. And that's what we tried to do, I think, so far, okay, with the consequent -- the credit consequences of the COVID situation. So that's why we were quite proactive in Q2 and remain proactive at Q3 in taking provisions. Also, that's why I think our policy differed a little bit from our peers in terms of how we manage deferral. We were also granted 6 months deferral to most of our clients. But certainly, for the unsecured book, unsecured clients, we did reengage conversation after the 3 months period just to see how things were evolving. We do not want to wait and try to contact tens of thousands of clients at the end of the 6 months in a span of a few days or even a few weeks, I think that would have been bad for customer experience. And so generally, I think we felt we wanted to be a little bit more proactive. And I think so far also, I think, for both our customers and for ourselves, has been the right decision.
Meny Grauman
analystI wanted to talk about expenses in the context of scale. Your bank has managed expenses exceedingly well despite your relative size. And I want to get a better sense of how you understand that. I mean, again, we tend to think about expense management and which bank has a better ability to manage expenses in terms of scale, yet National delivers the results. So how do you understand that? Are we just kind of focused on the wrong thing when we think about expense management on a relative basis?
Louis Vachon
executiveA couple of things. One, scale matters, but it matters locally. If you have a large operation and it's very focused on a particular geography, that's where you get the most out of scale. Scale gets diluted across the geographic and across regulatory borders. So you have to look at scale, looking at the business model and adjust it for the number of geographies where you operate and so forth. That would be my first comment. The second one is, I think what we've tried to avoid at National Bank is a feast to famine cost management system and investment system. I think it's good to be disciplined at all times in cost management and do not let good or bad business cycles dictate your cost management structure. If you have a more steady approach, a cost management and investment management in your -- particularly in technology, we feel that it is more predictable and it will give better results over time than one that is too volatile or dictated by the business cycle. So that's why it's been our approach. And again, I think we're quite comfortable with that approach, and we don't expect to -- we do not expect to change it over the next few years.
Meny Grauman
analystSo the approach is resilient enough that even if you have a pandemic, then you can still maintain your expenses?
Louis Vachon
executiveYes. I think so far, and knock on wood, again, we're not out of this thing yet, but knock on wood, I think we've been disciplined in terms of costs, but we still managed to generate a positive operating leverage, but we -- without having to put both feet on the brake pedal for cost management or in new investments.
Meny Grauman
analystAnd in terms of investment priorities right now, what are some of the key investment priorities? And I think you basically mentioned it, but to confirm that the pandemic hasn't changed any of those menu items?
Louis Vachon
executiveNo. And I think what they did is, and I think we're reassured by that. I think they did confirm that we are investing in right areas, namely, continue to invest in technology to continue with the strong trend of digitization of the banking services. And the more effective use of data to improve customer experience and more automation over the next few years. And so far, I think that's been the right choices. And again, we have not made any significant changes in our investment priorities following the COVID crisis.
Meny Grauman
analystThe -- we touched on capital, but I want to go back to it. In terms of relative ranking of capital ratios, does that matter at all? You have the second lowest CET1 of the group now. Is that a factor at all? Or is it the absolute number that's important as you manage the bank?
Louis Vachon
executiveI think the absolute number is the most important. Now I've experienced being far away from the average in the industry in the past. And I'll be -- we need to be conscious of that. That being said, I think, as you know, as well witness, there's been a lot of volatility in quarterly numbers of CET1. So I think we need to wait a little bit to see where the real CET1 ratios will land and where the new targets are for the industry. That being said, right now at 11.4%, 11.5%, roughly where we are, I think, is a comfortable number for us given how we are provisioned in terms of credit and potential credit hits and also for the fact that we're not looking to make large acquisitions. That's not our -- not within our strategic priorities. So for us, that's why we're 11.4% right now, 11.42%. We said we would creep up over the next few quarters. Why creep up? Well, if we're comfortable with 11.5%, let's say, we do want to make some provisions for the fact that there's about 30 bps of regulatory relief from OSFI in these -- in that number. And I think we do want to provision for that over the next few quarters. So that brings us roughly to, let's say, 11.7%, 11.8%. And once the special measures are removed from OSFI, we're back down to 11.5%. That's the extent roughly where we expect to be, and we feel that's an absolutely appropriate number given our risk and strategic positioning.
Meny Grauman
analystLouis, do you think capital levels can come down in the wake of this crisis? Is there a case to be made? And would you agree with that case that we've seen the biggest crisis of our lifetimes and capital levels are solid?
Louis Vachon
executiveListen, I'll give you the opinion. One, the answer is no. Because I think this crisis is one. I think there'll be other crisis. I'm not trying to sound pessimistic. I'm relatively optimistic about how technology and how society will evolve. But when you have massive transformation within society and within technology, it always brings some episodes of volatility. There is no such thing as a completely smooth transformation or completely smooth change. Change management is hard and sometimes it brings volatility, including economic volatility. So my point of view, I think 11.5% is a good number. And even if we have strong recovery, which I certainly hope will have economic recovery in '21 and '22, I'll still keep a relatively high number in terms of capital. I think that's the prudent thing to do, given all the uncertainty we have. And lastly, if you want to be opportunistic when things are a little bit more difficult, you do need excess capital. Otherwise, you have great ideas, but no money to act upon them.
Meny Grauman
analystRight. I wanted to ask about ABA Bank. The performance there, certainly surprised to the upside in Q3 and your outlook definitely suggests that it's sustainable. So I just want to get a little bit more insight into -- it seems like performance there certainly evolved better than you would have expected through the pandemic and get a better understanding of that really as a first question.
Louis Vachon
executiveSo 2 things that -- 2 differences between Q2 and Q3. What did we learn between Q2 and Q3 that makes us a little bit more informed today? The first thing, we already knew that Cambodia, even though it is a developing economy, still has the advantage of diversification. And I think that -- we saw that at Q3. So tourism was still severely impacted. But manufacturing came back. For instance, Cambodia is now the second or third largest producer and exporter of bicycles in the world. The agriculture economy, which is the basis of the economy for a long time in Cambodia, picked up by 20% year-on-year at Q3. They export a lot of rare spices or nuts and food stuffs, and that continued to grow very well. And then the real estate market did not collapse. Construction continued because of inflow of foreign investment into the country. So that's the first thing. So the economy is diversified and was, therefore, a bit more resilient than all of us had predicted. The second thing is, which is more ABA specific because we do offer what we believe is one of the better, if not the best digital banking experience and digital payment experience, we've seen an increase in client activity and also an increase in client acquisition. We're now up to 1.1 million clients in Cambodia. Just in July, where we picked up 52,000 new clients on a net basis, and our retail deposits grew by $200 million just in 1 month. So that also, I think, highlights some of the choices we made prior to the pandemic of investing in the digital platform there, but it's also working out quite well. So I think over the medium term, that's why we remain quite optimistic about the potential for ABA to continue to grow.
Meny Grauman
analystThat's a good point that I want to extend, and that's -- so this business really has gone through a severe stress test and looks like it's passing with flying colors. So the question is, doesn't this embolden you in terms of your international strategy? Or even more positively, isn't it a big checkmark to say this is the right strategy? So let's keep going here. Let's do something else. Let's make it bigger. What's wrong with that sort of analysis based on what we know today?
Louis Vachon
executiveWell, I think it suggests that I think with both Credigy and ABA, I think we made the right strategic choices. But no, it does not embold us to go and make other acquisitions. For no other reason that we're generating very good organic growth out of those 2 assets. So the #1 priority for us is not to get distracted by a very active M&A calendar or agenda. I think it's better to really focus our international team and our risk management teams on making sure that the execution and the continued organic growth from ABA and Credigy remains as good as it is. Because we do see an organic growth potential for both assets for the foreseeable future. So I remind you that we still have minority interest in 2 assets in Africa. And I think we do want to make sure we have strategic finality with those 2 assets before we move on to something else. So I think we're quite busy, and we are enough busy with the current portfolio that we have. So we're not looking to add anything else in the foreseeable future.
Meny Grauman
analystMoving the question maybe closer to home. Obviously, the super-regional footprint in Canada has delivered and delivered in a big way. The question is, do you take the opportunity now to maybe think about expanding that and not rest on your laurels? Could it be that you bet right, but the economic engine of Canada has certainly shifted towards Québec but that might not last forever. So is there an opportunity here to think longer-term and to start making investments further away from your home market?
Louis Vachon
executiveWe have. But as you know, the Canadian market is a very competitive market. And any kind of strategy of expanding coast-to-coast is a multi-year. And I would even say, when you look at our wealth management and financial market strategy has been multi-decade. So I think when you look at where we were 15 years ago, already, the percentage of revenues coming from Québec has declined steadily over the time. That being said, Québec is our home, and we'll always stay very active and very present. It is one of our social missions that we need to accomplish. And it means sometimes -- it's great when Québec is popular, but it also means in many instances, when I was President that Québec was not popular, and we kept defending it and explaining why we were here. And then we still keep telling people why it was a great place to do business. So we still see a lot of potential in Québec for growth in any kind of scenarios going long term. And outside of Québec, we've been doing -- we've been at it now for decades, very successfully, clearly, in a number of segments. Wealth management is now 50% in Québec, 50% outside of Québec. Capital markets now is 70% outside of Québec, 30% in Québec. And in commercial lending, that's where we're -- the latest initiative has been in specialized sectors in commercial lending is where we see the most growth and the most potential. So specialized in health care, subsegments in real estate, agriculture, and technology. Those are the main segments, specialty at the commercial lending level, where we've been expanding our teams in Toronto and Vancouver mostly and continue to grow on that business. So right now, I think we're doing, I think, exactly what you're saying we should do, but it is a long term effort. You cannot gain -- people tend to be loyal in terms of customers here in Canada, both in retail and commercial level. You -- it has to be a long-haul effort for -- to gain credibility and market share in any markets in Canada. It has to be a multi-decade initiative, not just a 1 or 2-year effort.
Meny Grauman
analystRight. In terms of that commercial strategy, clearly, technology and health care are winners coming out of this pandemic, through the pandemic coming out of the pandemic, the real estate business looks a lot more challenging. From where you sit, how do you -- I mean it's a big picture question, but do we have enough information to see what the world will look like coming out of this from a -- in terms of the real estate business and your real estate lending book?
Louis Vachon
executiveNo. I think there's still some uncertainty, but a couple of things. One, as you know, and I think we were quite clear in communicating that to our shareholders and to analysts. I think we've been a bit more prudent over the last few years in terms of commercial real estate, and we were capping on a relative basis, how much growth was coming from commercial real estate. And as a percentage of our total commercial lending book, not because we saw anything that looks like what we see today, but just to be a little bit more prudent. Right now, I would say we're -- we've been a little bit more aggressive in the last few months in real estate, particularly in commercial residential. We see strong demand for multifamily units. We still see some segments in residential. Condo projects, the supply has dropped on new projects, but the ones we've seen have been a relatively good quality. So in terms of multifamily housing, I think we've been a little bit more active. Anything to do with retail. I think like everybody else, we're being a bit more prudent. But it does mean that in some segments in commercial real estate, there's still opportunities, and there will be in the future.
Meny Grauman
analystI wanted to end things off. We have 2 more minutes talking about capital markets, which is a big strength. I think as a streak, we've learned to appreciate capital markets revenues a lot more in terms of their counter cyclicality. In terms of your specific business, I think for the last little while, we've better understood how you're able to deliver -- what you've been able to deliver in terms of consistent results with lower volatility. The question is really, as you look out in this business you guys have delivered, is there an appetite to give them more capital to run with, either on the trading side or on the corporate lending side? Can you grow this business more aggressively?
Louis Vachon
executiveI think we want to grow, and I think we've been very clear on that again for the last quite a few years. We want to grow the capital markets franchise at the same speed as the rest of the franchise, namely, 5% to 10% EPS growth per year. We feel that it is a sustainable pace of growth that is: a, realistic; and secondly, would avoid temptations or pressures to take undue risks and then leave areas where -- and end up in areas where we could get into trouble. That's, I think, what we're trying to achieve. For 2021, 2022, we'll have to see what kind of trading environment, obviously, we'll be dealing with. It's -- we've had exceptional trading environment in all the aspect of the word in 2020, we don't know what it's going to look like. I am hopeful, however, and we see clear signs of that right now that if we have an economic recovery, and we're pulling out of the consequences of the COVID crisis that the merger and acquisition super cycle that was very strong prior to the crisis, will come back and will continue. We have a lot of strategics looking to consolidate their industry. We have companies that need advice in terms of transforming their balance sheets. And then we have private equity that's sitting on hundreds of billions of dollars of capital looking to be deployed. All that is a recipe for a strong M&A cycle. And hopefully, that strong M&A cycle will continue to propel capital markets earnings through '21 and '22.
Meny Grauman
analystLouis, I think you made a lot of bankers smile. So we'll keep them smiling. Thank you very much. We're out of time, but I appreciate you speaking with me. And speak to you soon.
Louis Vachon
executiveSure. And thank you for the invitation. Thank you for organizing this. Take care.
Meny Grauman
analystHave a good day, and thanks.
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