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

Welcome back, everyone, to the conference. Louis Vachon, the CEO of National Bank, will be joining me for this presentation. He's been the CEO of National Bank of Canada since June 2007. Before we begin, I've been asked to tell you that Louis Vachon's 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. So with that out of the way, Louis, welcome to the conference. Great to see you if, at least virtually, and welcome to the conference.

Well, thank you, and happy to be there for my 14th or 15th conference, I don't remember, but anyways, well, it's an issue.

Yes, it has. And so I think what we'll start with is credit quality in terms of our themes today and speaking with you. Your bank was one of the banks that provided some very decent forward-looking guidance, 25 basis points to 35 basis points of total PCLs was what you guys discussed in your conference call. Can you maybe elaborate a little bit on that range? And what might cause National to be in the high end of that range versus the low end of that range? And how much -- we think about Stage 2 allowances for credit losses as being something that can really sort of create a corridor around your provisions for credit losses effectively, if necessary. So maybe you can weave into your answer, your expectations on Stage 2 ACL reversals as well.

Okay. So yes, I think we were proactive and prudent in our provisioning in 2020. And having -- taking large -- very large provisions in for credit -- in performing credit provisioning in Q2. We continue to provision for Q3 and Q4. So I think we're very well provisioned and positioned for 2021. That's why we were comfortable providing the 25 to 35 basis points guidance in Q4. And that's why, even today, with a lockdown in curfew in Quebec, we remain comfortable with that range. So what could be -- what could lead us to be at the top end of the range is obviously vaccination taking longer, mutation of the virus, making the recovery more complex and longer. And on the opposite scenario, what could put us to the lower side of the range and maybe lowering the range would be better news on vaccination and better news on the economic recovery. So in a nutshell, that's how we see things evolve over time.

And is that going to be the major driver of your scenarios? In other words, the releases of reserves from Stage 2, will it really be tied to the vaccination? Or will there be a number of other -- I mean, is that the primary thing that you're thinking about today as we think about reserve releases?

Well, it is. It's not the only one. As you know, there are a number of other variables that go into the macro, but that is certainly one of the important ones. I think it is quite critical to going back to a more normal environment from both an economic and center standpoint. Now I think, in -- we've said that, I think if the modeling and the recovery is rapid, and we have to -- we find ourselves with excess performing provisions, then, I think, we'll have -- we may have releases. So I think we'll see at that point. I suspect it's not going to be early in 2021. It could be more in the second half of 2021. But let's hope for the best.

And your bank was one of the banks with a relatively quick runoff of the deferral book. Maybe can you give us some updated thoughts on any potential delinquencies or nonpayments from deferrals? And when should we think about sort of a peak in gross impaired loans at National Bank?

So right now, our best case scenario, and there's a lot of guessing around that. As you know, one of the things with this pandemic is we've seen economic correlations and relationships that we thought we would never see before. So we're being very prudent on this. But at this stage, at least for losses tied to our personal loan book, we feel that probably the second half of 2021 would be the peak. For commercial, it's really hard to say. Some of that may be delayed to '22, who knows. And under better scenarios, it could be quite a bit lower than we have provisioned for. So that's how we're approaching this.

And so maybe that's the segue into the recovery. I mean one of the things that we're very interested in is hearing your view of how the recovery could take place. And specifically, with respect to Quebec, especially now that you're in a lockdown in curfew, as you mentioned. So maybe give us an overall general theme or view on how you see the recovery playing out for your bank specifically?

So from the recovery standpoint, yes, we have a new lockdown and even a curfew. That being said, you saw, on Friday, Quebec is going to the lockdown with the lowest unemployment rate of all the Canadian provinces. So I think generally, I think we're well positioned going into the lockdown. And I think coming out of it also, I think, Quebec could continue to outperform for the many of the reasons we discussed in the past. So that's the thing. In terms of the path of the recovery, when we discuss the '21 and '22 in terms of our financial performance, Darko, I would look at -- I would discuss 2 things. One is the recovery, but the other 1 is the fact that the economy is adapting to the new reality. And that is in terms of digitization and transformation, and it's not waiting for the vaccine, and it's not waiting for the recovery in and of itself. So we were -- there's 2 main phenomenon. One is getting out of the sanitary situation and the pandemic in getting out of it. But also there is the real-time transformation of the economy and of financial markets that's occurring. The -- for the level of PCLs having -- putting the final estimate on PCLs, we do need more information on the path and the length of the recovery. For revenue generation, if you're running a healthy, diversified franchise that is connected to the digital economy, you should not have to wait for the recovery to be able to generate revenue growth. That's why I tell my colleagues, and I think, as a franchise, we think and we're hopeful that we're well positioned on this that even though we may not have a full recovery till the end of 2021, we should still be able to generate good revenue growth in 2021 if we are able to adapt and transform as rapidly as the economy is adapting and transforming.

Okay. And one of the things that we noticed with respect to some of the differences between your bank and other banks is, when we look through the data around economic scenarios and maybe this leads into your view of the recovery, one of the things that we noted was National's assumptions looked different from peers. And one of the ones that looked very different was your bank assumed that house prices would decline in Canada over the next 12 months. Now is this just a conservatism? Or did you actually harbor some real concerns regarding residential real estate prices? And how would that affect your view on the mortgage market? And how we should expect mortgage growth at National Bank?

It was clearly a prudent way of managing our scenarios and related provisions. It's not our view that the housing -- that house prices will go down in Canada in 2021. I think we remain quite constructive on the real estate market. We remain quite constructive on the mortgage market and its potential growth in 2021. So I think it was a prudent positioning for our modeling and provisioning purposes.

And so with the view of thinking about revenue growth, even though you may not necessarily have to tie that to the vaccine, where do you see the revenue growth specifically coming for your bank? NIMs are under pressure, loan growth may be a bit tougher with people being a little less mobile under restriction. So what specifically are you looking for in terms of revenue growth for National?

So going back to my point that the economy is adapting real time. Yes, they may be on lockdown, but they're still buying houses. And in the world of working remotely, working at home, we've seen a large pent-up demand, continued large pent-up demand for particularly single residential housing stock. So we have not seen, in fact, the strong momentum we had in the mortgage market and the residential mortgage market in -- at the back end of 2020. It is continuing now as we speak. So we're hopeful that we'll continue to see good growth in mortgages. In -- another area we see potential growth is in the wealth management space. The pandemic has created -- people have more time, more time at home, and they're spending a lot more time. They have more cash because they're spending less. But they're spending a lot more time looking at their personal finances and investing in the market. So it is -- continues to be a very positive environment for wealth management. On capital markets, a theme we've discussed for a number of quarters already. The M&A super cycle, the merger and acquisition super cycle is very much there, very much present. If you look at the headlines, just since we've been back in January, it continues to be very, very strong, and that's fueling revenues in the capital markets segment. And lastly, as you know, we've had very strong momentum going back a number of years in our global businesses, both Credigy and ABA, and these businesses continue to perform exceptionally well. So in short, where do we see revenue growth? Well, in all 4 of our business lines. That's where we expect to see revenue growth in 2021.

And is it possible that net interest margins put a crimp on it a little bit? Or do you think that revenue growth could rival 2020 and even 2019? Or is the crimp on net interest income from the low interest rates, is it a significant headwind?

Well, you saw that our NIM stabilized quite nicely in Q4. So there's a lot of things going on with NIMs, but the large increase in deposits are helping our NIMs, the large increase in low-cost deposits, namely current account and cash and brokerage accounts are helping our NIMs. The slightly steeper yield curve that we've seen in the last 3 or 4 weeks is helping our NIMs. So it's not just bad news on the NIM front, Darko. It's a more balanced picture than maybe is in the consensus of the market.

And do you see a significant difference in some of these -- let's just go back, step backwards for a moment and specifically target on mortgages. Do you see a difference in Quebec versus the rest of the country in terms of mortgage growth? Or do you see it pretty much across the entire country? And is there anything that we should think about with respect to your planned growth of the mortgage book in 2021 versus what we've seen in the past?

No, I think the growth in the housing market and in the mortgage market is a Canadian phenomenon. It's not a Quebec phenomenon. So it should be right across the country.

Okay. And your bank has a bit of a more of a focus on commercial, and so maybe you can give us a bit of a window into what your commercial borrowers are telling you, what the pipeline might look like for commercial loan growth? And maybe give us a sense of, we -- from the outside looking in, we are bombarded with information on the consumer. We can see the consumer balance sheet. We can see how healthy the consumer is. And this pandemic has actually forced savings on the consumer. How healthy is the commercial borrower? And what's the pipeline look like for commercial loan growth?

A lot of commercial clients are sitting on more cash, especially smaller commercial clients given all the different programs, which have been very effective at supporting the balance sheets of smaller clients. So what we see in terms of balance sheet is a lot of cash. I think before we see a significant acceleration in commercial loan growth, we'll have to get through that cash. Because I think the first thing that these accounts, commercial accounts will do is invest some of that excess cash. So that's probably going to be -- take us to the second half of 2021, with a few exceptions to that. I think where we see activity, anything related to merger and acquisition is very big and very positive for corporate and investment banking. A reminder, it is also quite positive for commercial banking. So it's not just corporate and investment banking that benefit from that trend. In the smaller accounts, there's also a lot of M&A going on. So the merger and acquisition super cycle will fuel and will help commercial loan growth in 2021. Other areas, which are tied directly to the transformation of the economy like new tech and so forth, also growing in terms of balance sheet. And lastly, we see pockets of opportunities in commercial real estate, not everywhere, some segments are still challenged. But we saw good growth in the back end of 2020, in early 2021, in some of the segments like fulfillment centers, construction of new warehouses, data centers, anything that's tied to the digital transformation and the e-commerce transformation of the economy, helping some segments of commercial real estate. At some point also, the shock to the commercial real estate market for office and retail has been so important that also, I think, there will be some consolidation. And again, selectively, that may lead to some opportunity in commercial real estate financing.

Okay. Thank you for that. And maybe just switching gears to the international. I mean we saw tremendous earnings growth from ABA. You own now Credigy, a lot more of it anyway. And so maybe you could talk a little bit about the outlook for growth in your international businesses in terms of both balance sheet and earnings.

So ABA, I think, was -- speaking of transformation, that's a perfect example. The pandemic did impact the economy in Cambodia, but ABA benefited from the digital transformation of the payment system in Cambodia away from cash to digital solutions. And ABA has among the best digital solutions in the banking space in Cambodia, so they benefited directly from that. And we saw large increase in the number of accounts and account opening from retail and small businesses and large increase -- related increases in deposits in the back end of 2020. So clearly, having the core relationship payment business in Cambodia positions -- we're extremely well positioned for the future. So we remain very optimistic on this. Simply for Credigy. Credigy has done very well. It's an agile, adaptable platform, very well connected to the fintech industry in the U.S., with good relationships with many of the major fintech players. So we are both well positioned to continue to benefit from capital repositioning of the legacy financial institutions and also benefit from the growth of the new generation of fintech companies in the U.S. So for that reason, I think we remain very optimistic on our capacity to grow our earnings in the international division going forward.

And are we talking double-digit kind of earnings growth? Are we...

If we're not generating double-digit earnings growth in these businesses, I think we'll be very disappointed.

Great. And one of the things I thought about with respect to this recovery. And something that I would specifically ask you and only you because you have a slightly different focus and a slightly more regional bent is, is there an opportunity here now to take advantage of the other side of the pandemic in the sense that the other banks have very large footprints, maybe they have to be slimming them down. But maybe, in your case, you can actually now start to grow your branch footprint outside of Quebec and think about expanding outside of Quebec in an organic manner with real estate that should be, in theory, much less expensive than before, retail outlets and so on. Any thoughts on what that might mean for National on the other side of this pandemic?

Well, we've looked at -- and unsurprisingly, that you raised a very good point and a very interesting one from a strategic standpoint. And we've spent a lot of time and effort looking into that in the last few years. Now I remind you that our expansion of 1859 in Western Canada was a branch-light -- was not a branch-less, but it was a branch-light expansion of a particular segment of our businesses. Same thing with the specialized commercial banking groups. So we have done that already in private banking, and we've done exactly what we just described in commercial banking. The question is, can we do it in retail banking? Maybe, but I need to be convinced that we have a truly differentiated offering. Build it and they will come, I don't believe in that. It's been tried by other incumbents, either in the U.S., and I remind you that our main competitor in Quebec tried the same thing with Zig or Zag or a combination of the 2, I don't know what it was called, and it did not went well. So you need to have a really -- I think it's not going to be branchless, I think it has to be branch-light. It has to be very, very differentiated. So we felt that we had that with 1859. We felt that we had that with the specialized commercial banking groups. And if we see -- we are looking into that. If we see an opportunity in retail banking, we'll go after it, but only if we see a real opportunity in retail banking.

And the digital side now that you've seen -- we had to live through this rapid transformation. Going to digital, you mentioned that the economy is not waiting, does anything change for you on that front? And does it change your strategy, the amount of money you're willing to spend on technology and what you're spending it on? Is there a pivot here at National Bank that might have -- that might not have otherwise occurred because of the pandemic?

No pivot, Darko, an acceleration of time line. And I'm referring particularly to rebalancing our digital offering versus our physical footprint. And we had a plan that was spread out over 3 years, and we basically accelerated over 2 years -- over. It was supposed to be '20, '21, '22, we're basically going to be done by the end of '21, in terms of slightly repositioning our physical footprint. So we did accelerate in the second half of 2020 given what we saw with the increased digitization and increased demand for digitization and the corresponding decline in some of our in-branch services. So we did that. So it was not a pivot, but it was an acceleration of what we were planning to do.

Fair. And so maybe switching gears now and talking about capital. Our view is the banks are clearly well capitalized. In the past, they often talked about how much they could generate a year or a quarter, not sure if you're willing to talk about that. But I am interested in knowing -- one of the things, again, with National Bank that may have been a little bit different is you had been under the -- a moratorium, let's say, of investments in the international business. Right now we have restrictions on buybacks and on dividends, so a lot of changes coming in 2021. Potentially, back end of the year, we think restrictions can be lifted. So when we think about your position, what would you tell investors today about where you'd be leaning with respect to what to do with capital? And do you favor EPS growth? Do you favor ROE? Do you think that some dilution of the ROE might be necessary to further the strategic endeavors? Would you consider going international and spending more? A lot of questions in there, Louis. So I know this is a topic that often we could talk about hours for, so I'll throw it over to you and see what you'd like to say on the capital front.

So capital, just a couple of things. One, we -- I think, over the last 6, 7 years, maybe going further than that with Credigy, we managed to build a nice international division without diluting our ROE. So I don't believe in the premise that you need to dilute your ROE to diversify, either from a sectorial standpoint or geographical standpoint. Two, we're not -- we've never been in the business of transformational acquisitions, large acquisitions. We feel that they're too risky. Usually they end with the result in single-digit ROE and in single-digit ROI. So we'd rather do smaller deals with strong potential for growth and do tuck-ins and grow from there. So in the immediate future, what you should expect is a focus on organic growth. We see -- I've given you, in the last few minutes, some areas where we see potential for deploying the balance sheet in terms of organic growth. I think we've shown that we can do that in a very effective manner for both ROE and quality of credit standpoint. And then when we get to excess capital, which we will continue to generate because we have, as you know, a very high ROE, I think a mix between buybacks and dividend has been our preferred way of doing this. And I think it will continue. We've always said, however, that buybacks were a complement to a growth strategy, not a substitute to a growth strategy, and we'll stick to that. I think the important is to have the franchise grow organically at a nice pace, and then you can top that up a little bit with buybacks.

Okay. Fair enough. I think you've been very consistent on that for many years. And so I wasn't expecting a different answer, but it's always great to hear the answer from your directly.

Tend to be boringly predictable.

But one thing is the dividend payout ratio is relatively high, and so I think the expectation should be that your dividend -- once the restrictions are lifted, that the dividends just basically follow EPS growth? Or would you ever consider pushing towards the higher end of your payout ratio?

Well, I remind you that of all the Canadian banks, we're the only one that stayed within our ratio. We didn't go out of the ratio. We stayed below 50% payout, despite the volatility of earnings. I think the market wants to be -- wants to see steady, predictable and defendable dividend increases that can withstand shocks and recessions. I think that's what you want to see. If you increase your dividend payout too much, I'm not sure that has a positive impact on your valuation because the perception would be that under any kind of economic shock or surprises that you'll be forced to cut your dividend, to cut back on your dividend. So they want to see dividend that are -- that can be sustained through a recession scenario. And that's why we've been very steady, very progressive and quite conservative in our payout ratio because we want people to know that we can absorb a major shock and continue to pay that dividend.

Yes. I guess I was just thinking the opposite side of the coin, which is, in the last 2 major crises, Canadian banks were allowed to continue paying dividends. So if you're at the upper end of that payout ratio and another cycle were to come around, well, you'd be -- you'd have the juiciest yield out there. So that's what my thought process was.

Yes. But you do not want to be -- Darko, you don't want to fly too close to the sun here. You don't want to be in a position where you have to cut your dividend because it is on the -- you end up with an unsustainable payout ratio and with negative impacts on your capital. That is a very risky proposition.

Very good. Thank you. So what I'm going to do now is switch over to the questions that we've got from online. And the first question that has been upvoted is how does the more severe lockdown or curfew in Quebec harm or not harm your outlook on Quebec? What is your short-term outlook on the Quebec economy? I guess short term will probably be in the next 2 to 4 months.

Yes. So clearly, we'll have an impact -- a lockdown and a curfew will have an impact on economic growth. That being said, we look carefully at what they did, or Quebec government did, and how different this lockdown is compared to the one in the spring. And so the -- from an economic standpoint, this current lockdown is much less negative in terms of impact than the one in the spring, particularly for manufacturing and for the real estate and construction space. So that's why we feel -- our economic team feels that the impact of this current lockdown will be significantly lower than the one we had in the spring. As I said earlier, Quebec went into the lockdown with the lowest unemployment rate in Canada, so we were quite well positioned ahead of time. Indebtedness, the level of debt for consumers, is lower than Canadian average. The savings rate has been higher than the Canadian average. So generally, there'll be a short-term impact much less severe than the one in the fall -- sorry, last spring. But I think after that, I think we're well positioned for recovery. So we remain quite optimistic, and that's why we did not change, we're not changing our guidance in terms of our PCLs for 2021.

And the next question is, you last mentioned that you were extending your moratorium on significant initial investments in emerging markets until the end of 2021. What will it take for you to remove that moratorium?

Frankly, I think the first thing we need to do is to dispose of the other assets that we have in the international portfolio. I remind you that we have positions in 2 other banks in -- on the African continent. And I think we want to dispose of those assets before we look to do anything else and create a third leg to our international division, which we haven't decided to do. But even before we have that conversation, we need to dispose of those assets and to repatriate that capital and decide what we do with it.

And as a corollary to that, Louis, are you still actually combing and looking for opportunities in emerging markets? Is that -- or is that sort of activity really slowed down to a crawl, and you simply may not be seeing opportunities in emerging markets?

That's on pause. No, we're not looking at opportunities. We have a very small international team, and they're completely focused on executing, doing good execution around the growth strategy of ABA and Credigy. So no, they're not chasing the planet, looking to do deals, especially not in this environment.

Well, maybe there will be opportunity -- maybe there'll be opportunities in this environment?

Maybe, but not for us.

Yes, it's tough. And so last question is, can you explain your thought process for acquiring the remaining stake in Credigy, will you be losing any talent as a result? And how committed is the current management team?

We've been working with that team for 14 years. Now a couple of things. We've -- the bench strength of that team has been expanding as the business has expanded. So we remain confident that the founders will stay involved with us. But over a long-term period, long-term horizon, there is significant bench strength underneath the 2 founders to continue to work with us. So it was not a big surprise. We're quite happy to purchase the last 20% of Credigy. We would not expect any changes in terms of either strategy or management of that business going forward.

And I guess as a corollary to that, was it always planned that you would purchase that last 20%? Or was there some sort of up-in-the-air around that 20% that you did not?

The only thing I think was planned, the timing was the question. So -- and I think, at that point, the -- I think the plan changes and on the treatment of capital gains tax in the U.S. may have had something to do with their decision and their timing.

Okay. Great. Okay. So we're now at the moment in time where I revert back to you, and I ask you for some final words and some key messages that you want shareholders to take away from today's discussion.

Well, the year is still young, obviously. But as I said, we're not waiting for the recovery and the return to normalcy to try to generate revenue growth. As I said, I think we've positioned our bank, both from a cultural standpoint and from a strategic standpoint, to be able to grow the business in different and even difficult environments, like the one we're going through right now. So hopefully, we'll be able to show, yet again, in 2021, the good work we've done with culture and with our strategic choices, and lastly, with our execution. So on that, more to come for -- at the end of February for the Q1 results.

Okay. Great. Thank you very much, Louis. Always a pleasure having you join us at the conference. Thank you for participating.

Thank you for the invitation, Darko, again. Thank you.

Thanks. And with that, we will end this session of the conference.