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

Good morning, and welcome back, everyone. Our next presentation comes from National Bank of Canada. Joining us this morning from the company is Marie Chantal Gingras, the Chief Financial Officer. Welcome, Marie Chantal.

Good morning, Brian. Thank you. Good morning, everyone.

Thanks for coming. Let's start with the recently announced acquisition of the Canadian Western Bank. This proposed acquisition adds significant scale to National Bank as well as diversifying your footprint. Can you talk more about some of the benefits of the transaction, both in terms of expenses and revenues? And any concerns on the credit quality of the portfolio?

Yes, absolutely. Thank you, Brian. And we're very excited, obviously, about this transaction. And if you -- let me start by giving you a quick update on where we are, first, on the transaction. So very early in the summer, we submitted our regulatory applications and things are progressing quite nicely on that front. As you know, last week was an important milestone for us with the CWB shareholder meeting. So there was also a positive outcome out of that meeting. So we're very happy about that. And as you know, this transaction really allows us to offer more products and services to clients. So we see this as very positive for Canadians as it will bring more competition. So all the teams are working very hard in closing the transaction, and we are targeting early 2025. So in terms of benefits, I think the important thing to really understand about this transaction is that it fits perfectly within our organic growth strategy. It's not changing our priorities. Our priority remains the same, growing organically across Canada. But what it does really is it accelerates our growth. That's really the most important aspect of it. Now in terms of benefits and synergies, obviously, cost synergies, revenue synergies and as well as benefits on capital. So let me give you a couple of the levers behind each of them. So in terms of cost synergies, what the drivers behind those cost synergies and what we've announced in the market is $270 million of cost and funding synergies. Levers behind those are coming out of infrastructure, technology also automating some processes, and of course, centralizing some corporate functions, just to name a few. And on the funding front, obviously, a more diversified source of funding, which will also drive some benefits. Now what really is interesting is the potential that we're going to be driving out of revenue synergy. So obviously, CWB is a commercial bank focus. And this is where we're seeing the most revenue synergies, but we're also seeing some potential over on the retail banking front, over in wealth management as well as financial markets. So again, capturing the benefits of all of our segments across Canada. So in commercial banking, for example, offering more products and services to our clients, which will, obviously, bring more revenues. If you look at the proportion of noninterest revenues of CWB, it represents approximately 12%, while at National Bank, it's twice that proportion. So there's lots of potential there and lots of potential for growing deposits as well for commercial banking. So those are the main areas in terms of commercial where we see the benefit. In terms of the retail banking, we see benefits because we're increasing our footprint. We're going to go from 6 branches out west to 36 branches. So there is lots of opportunities for more retail products through commercial clients of CWB, which was not the biggest focus for them, and we also see some benefits even for our own clients by having a larger footprint, some of our wealth management clients, for example, who did not have the whole suite of retail products will now have access because of the larger footprint. In wealth management, the way we approach the client, the way we go to the market at National Bank is in synergies between wealth management, private banking and commercial banking. So we'll be replicating that approach to the commercial clients over at CWB. So that's also a very interesting upside. And lastly, financial market. It hasn't been a focus either for CWB. So we'll be able to offer risk management solutions, FX, interest rate swaps, advisory services, structured products. So then, again, lots of opportunities. So we're seeing really interesting benefits. And the last portion of it is capital. So in terms of capital benefits, we -- what we've announced, our assumption is that they won the CWB portfolio, which is on the standardized approach, we'll stay on the standardized approach. But very quickly, we're hoping to migrate to our advanced model gradually. So that we will definitely generate benefits from a capital perspective and also from an ROE perspective. So in conclusion, there is very interesting opportunities for us. The teams are committed to making this happen very quickly. We see also a very strong cultural alignment between the two organizations. So yes, of course, there is some differences between the two banks, but there is a strong cultural alignment. And as you know, this is a key success factor in integration. So we're very happy about that. So again, opportunities. We continue to focus on organic growth and CWB is really accelerating that growth. And as I said in the beginning, we're very excited about it.

Excellent. One of the questions we get from clients is you're paying a nice premium compared to the closing price just prior to the announcement of the deal. Maybe kind of tell us how you kind of gain some comfort around the price that's being paid for CWB?

Yes. And thanks, Brian. It's a fair question that you're asking. And let's maybe present it that way. So remember that the way we get comfort at CWB was trading at a discount to book. So when you look at it from a price-to-book perspective, we paid 1.4x book, which is quite a reasonable price when you compare relative to other transactions that happened in the financial -- Canadian financial industry. So that's one part of the comfort. And as I explained just before, if you look at it from a synergies perspective, well, you heard there's a ton of value for us. And what CWB really does is it builds upon our success of growing organically our domestic business. So really, this is what we're really working towards.

Okay. Great. Following the close of the CWB transaction, your business mix will be even more focused on Canada, how do you view growth and return opportunities in Canada compared to the U.S. or your ABA subsidiary in Cambodia? And how does this impact your thinking on additional capital deployment?

Well, first, growing across Canada is our top priority. So we're really comfortable with that orientation and that mix. And we see lots of opportunities for all of our business segments to continue to grow across Canada. Of course, each of them do it differently, but there is opportunity for each of them. So if I quickly go through our segments in Canada, we have P&C, Personal & Commercial, we have Wealth Management and Financial Markets. So over on the P&C side, we've been growing in Quebec and outside Quebec as well, very differently. So in Quebec, defending our market share in the mortgage business doing very well, and we see good upside from our internal channels. And from an outside-Quebec perspective, our commercial book has been growing quite significantly. If you look at the average growth rate for the past 3 years of our loan portfolio in commercial outside Quebec was 18% compared to the global portfolio, which was 13%. So lots of opportunities to grow across Canada in the P&C segment. When you look at the Wealth Management, focusing on distribution is our main priority. We have an open architecture that's really something that's very different when you compare to other banks, an independent network that's been growing outside Quebec, focusing on brokerages and fiduciary services. So again, wealth management is a sector that's already been growing across Canada for a while as well as financial markets who, as you know, has been performing very well over the past couple of quarters with an approach that's a mix of different things. So they are focusing in areas where they have a competitive advantage. So areas where they're really good at, very agile, innovation and most of all, client-centric. So all of those aspects contributed to good performance in Quebec as well as across Canada. And lastly, the one common thing even though they grow differently, their business across Canada. There is one common important factor for each of them which is our discipline in expense management and our mindset of positive operating leverage. So all of the businesses operate in that sense, and we've been seeing the benefits of that over the past couple of quarters with our efficiency ratio improving quite nicely.

Great. You mentioned Quebec a few times. And I know within Canadian Banking, your exposure is heavily weighted towards Quebec. We've heard from some of the other Canadian banks that have presented that the overall Canadian consumer has been probably a little bit more surprisingly resilient than what people would have thought at the beginning of the year kind of given the economic outlook. Maybe you can kind of talk to how the borrowers in Quebec are holding up compared to the rest of Canada from your perspective? And are there any real geographic areas of particular concern within Canada?

Yes. So good question. I think it's important to maybe position the Quebec economy within Canada. So first of all, the Quebec economy is very well diversified. It's actually one of the most diversified in North America. So that's a very good fundamental. Quebec clients are usually, generally less leveraged, mostly because of housing prices that are lower. So just to give you some example, the average price of a home in Montreal is about $600,000. It's $1 million in Toronto and $1.3 million in Vancouver. So that contributed definitely to clients being a little bit more resilient in the Quebec area. We've been fortunate enough to beneficiate from subsidized daycare for over 20 years now, which, in turn, led to a higher proportion of dual-income household. So that's also very positive in terms of the Quebec economy. So that being said, when you look at the payment shock of mortgage payments, it's been quite -- even though it's been a burden for our clients, it hasn't been such a high burden compared to the rest of Canada. The payment shock for Quebec, variable mortgages compared to early 2022 when we had low rates for variable mortgage payment, for example, was $600 per month of a payment shock compared to about $1,100 for the rest of Canada. So that's definitely something that's helping out in terms of the consumer. Now if you look at more precisely in certain portfolio, to go back to your question, if you look at the credit cards, for example, is often the product where we see delinquencies increase more quickly when there's interest rates hike or unemployment rate that is increasing. So that's been the case. Delinquency has been rising. But when you look a little bit more deeply in the portfolio, what we observe is that it's been higher for the rest of Canada versus Quebec. And it's been a little bit more difficult for non -- for clients that are non-homeowners, yes. When you look at the variable mortgages, a portion of the portfolio, the insured variable mortgages have increased the most. And again, when we deep-dive in the portfolio, what we are experiencing is that it's been higher for the rest of Canada. And when you look at the uninsured variable portfolio for the Quebec clients, the delinquency rates are still lower than pre-pandemic levels. So those are a little bit of the fundamentals and some of the highlights that I can share with you in terms of the Quebec economy and the impact on our different portfolios.

Great. And within your portfolio mix, you've talked about residential mortgage makes up a large portion. And commercial also makes a pretty sizable portion. How are you looking to expand maybe other parts of your existing consumer portfolio like credit cards or perhaps other lending products to add more diversity to your portfolio?

Well, we actually like our current business mix. If you look at our portfolio, for example, just to go back to your points and credit cards and automobiles, for example. Credit card represents only 1% of our portfolio. And in terms of auto loans, it's been growing quite nicely in the past couple of quarters and it represents approximately 2.5% of our portfolio. We're expecting that in terms of auto loans, the growth could reduce a little bit going down the road. But really, we like our actual mix in terms of portfolio. When you look at the commercial book, it's very well diversified into different industries, geographically as well. So we're going to be continuing to grow, as we said, outside Quebec and are different business segments contributing to that growth will continue to make us comfortable in the business mix that we have.

Okay. I just wanted to talk maybe a little bit of the impact from the recent rate cuts. And are you going to see customers benefiting from lower rates? Or is that more towards 2025? Are you seeing any other changes in customer behavior as rates come down?

Well, obviously -- so you're right. In Canada, we've had 3 rate cuts since the month of June. So our clients with variable rate products will beneficiate from those rate cuts because as you know, there are only 2 banks, us being one of them, in Canada, where the variable product is a truly variable product. So our payments go up and down according to interest rates, and it's not our amortization of the loan that gets cut. So yes, they will benefit from those rate cuts. So far, with 3 rate cuts compared to the increases that we have experienced over the past 2 years, it's not significant enough yet so that we can see some relief, but it will definitely gradually come as we continue to see rates decrease. What we're -- and it's the same for our commercial book, which also have some variable products. In terms of behavior, to go back to your question, we have not yet seen a lot of clients move to variable rate yet. Variable rate are still higher than our fixed-rate products. They're approximately 6% and the fixed are around 5% or a little bit lower than 5%. So right now, our most popular term is still 3 years. But we -- as rates will continue to decrease, we'll definitely some of that relief gradually impacting positively our clients.

Great. And then I just want to quickly move over to kind of the funding strategy, and maybe you can provide more color on your funding strategy. How do you feel about maintaining the wholesale funding at about 26%? And where are you seeing kind of your best sources for deposit growth? And do you feel any pressure to be like more aggressive on rates to attract deposits?

Yes. So on our funding strategy, I think the most important takeaway is that we rely on a diversified and resilient sources of funding. So if you look at our portfolio, we've got a great source of deposits, securitization as well, wholesale funding. So it's that diversified mix that we really appreciate. If you look at our deposit growth just last quarter, we had a 6% growth year-over-year in terms of deposits, sequentially a growth of 3% and our loan-to-deposit ratio was solid at 97%. So we're quite happy with the proportion of our deposits, our funding. Our deposit strategy has been paying off. And when you look at our approach, we do not focus on the specific deposit product. But really, it's the client approach, the diversified approach that we are really focusing on in terms of our funding strategy. So really diversified mix, a strong deposit approach. All of our business segments contribute to our funding. So in terms of retail and commercial, of course, lots of deposits coming from there. But our Wealth Management has been growing quite nicely in terms of deposits. They have over $3 billion worth of deposits coming from our distribution approach, as I mentioned earlier, the independent network also attracts lots of deposits. So we're quite happy with that and even our Financial Markets who contributes to our deposits through structured notes that we distribute to our retail channel. So we're very happy with our mix and our funding approach.

Just on Financial Markets, I did have a question. I mean, we're seeing pretty stable or pretty strong investment banking and trading revenues last couple of quarters, even though there has been some increased economic uncertainty. Do you expect this trend to continue in the near future? Maybe any comment on what's going on in the Financial Markets business.

Yes. Well, we're quite happy with the outperformance of our Financial Markets business. So far this year, we've had a really good, market was strong. Client activity was heavy as well. So that certainly contributed to our good performance. We usually see the second half of the year in the financial market being a little bit slower than the first half of the year. So this year was a little bit odd. Q3 was a very strong quarter, record quarter actually. We're not expecting Q3 to be a record quarter every year, but we were very happy with that performance. Financial Markets, really, their approach is they exercise their activities in areas where they have a competitive advantage. They go where they do very well. They are very agile. They're innovative, allowing them to be out there in the market when margins are interesting. So that approach, whether it's cyclical or noncyclical, will not change. So we're seeing -- Etienne was telling at the conference, we're expecting M&A to pick up a bit. We continue to see good client activity, and we are seeing more tailwinds than headwinds going forward.

Great. And then maybe you're also seeing some good momentum in the Wealth Management business. Maybe also talk about some of the key drivers of that performance and the outlook for that segment.

Yes. So Wealth Management, as I said very briefly, just a little bit earlier, is a business where it's one of the most important focus in terms of priority for our business plan, focusing on Wealth Management, and it's generating premium returns. Their approach is really based on distribution. It's not based on products. They have a really unique open architecture that's generating lots of business deposits and independent network that have an important market share in Canada, which also drives lots of deposits. They're offering brokerage services, fiduciary as well. So the approach for Wealth Management really is just like for the bank, all of our segments create our diversified model. Well, within Wealth Management, it's also a very well-diversified business. We -- Wealth Management in terms of private banking, work closely with commercial to generate more synergies between all of our different channels, commercial and Wealth Management. And so we have been very happy with the performance so far. The approach will not change, and we continue to see great opportunities. Wealth Management has always been driving performance historically through the cycle, and that's what we're going to be expecting going forward.

And one other segment that really maybe doesn't get as much attention is the ABA segment. It's less than about 5% of the loan portfolio. We actually see more than 36% of gross impaired loans. Are you seeing anything in that business that would give you concern there that these loans might turn into losses?

So first of all, just a few words on the economy in Cambodia. So it's picking up gradually, but it hasn't reached yet the full potential, and the tourism recovery has not yet fully recovered. But it's still an economy where we see great GDP growth, approximately around 6%, maybe a little bit more around 5% this year. This is what we're targeting. When you look at -- so in that context, formations in terms of loans have been increasing and Bill shared at the call that they will still be increasing for a couple of quarters. And when you look at gross impaired loans, they also represent a bigger portion because of the approach in Cambodia, the impaired loans, they stay for a longer period of time on the books because of the impact of COVID that created a backlog in treating those impaired loans. So in that sense, this is why we're comfortable. It's sort of something that's not as -- we're not seeing the same trends as in Canada. But when you look at the net charge-offs for ABA, they're very low. So for this year, year-to-date, 2/3 of the gross impaired loans that were recovered created 0 loss for us. So overall, that makes us very comfortable. And we take prudent Stage 3 impairments that are historically higher than what we are really seeing as a result. So overall, we're still comfortable with that portfolio.

Great. And then also looking at the gross impaired loans in the non-retail loan portfolio, transportation and real estate, construction real estate on some increases year-over-year. What do you think is driving these increases? And are you taking any proaction to kind of take to address this?

Yes. So yes, we saw 1 or 2 files in those sectors in the last quarter. So as you know, provision for credit losses can be lumpy from quarter-to-quarter. And we are not worried at all that this can be a trend. We're comfortable with the overall positioning in the credit portfolio. And we're still very comfortable with our guidance for impaired losses. We've -- year-to-date, we've been at 19 basis points, and we've guided between 15 and 25, and this is still our target for the end of the year.

Maybe we talked a lot about kind of on the revenue side of the income statement. But over the past year, National Bank has seen a nice improvement in the efficiency ratio towards 51%. Do you expect to continue generating positive operating leverage versus are you looking to make additional investments? Where do you think you stand compared to your competitors on technology investments?

Yes, well, we're quite happy with our performance year-to-date when you look at our PTPP growth of 13%, revenue growth, 10%, and we've been able to generate a nice improvement in our efficiency ratio that's below 15% year-to-date and even the past quarter. So I think what's really contributing to that performance is the fact that we have a very strong mindset of operating with a positive operating leverage approach and proactive cost management. And this is true for all of our segments. It's not just in one area. It's a mindset of the whole management team in terms of expense management. And what we are really making sure we do is always balancing growth and cost management. And what we've done more precisely in the past couple of quarters and we've accelerated that is simplifying our operations, optimizing, automating our operations in order to gain those efficiencies. And the way we do things is making sure that we -- that the initiatives that we do are permanent in our cost structure. So we've been working very hard on this, and it's generating very interesting results for us in terms of efficiency. When you look at, to your question, are we thinking of growing more and how do we compare? We've had a proportion of our investment envelope -- a higher proportion of investment envelope dedicated to initiatives that will simplify our operations and therefore, generate efficiencies, and it also helps us manage our head count. So same envelope in terms of growth of investments, but a bigger proportion dedicated to that simplification, which, in turn, helps us realize those efficiencies. So that mindset is really super important across all of our businesses from top management down to the employees who contributes to identifying those simplification initiatives.

Excellent. Maybe we can -- we have a little bit of time to open it up to questions if anyone in the audience wants? Up in the front, please.

When I look at your credit ratings from Moody's and S&P, they're in the sort of A-, BBB+ range, which is fine, but like, I look at your bank, and it's highly profitable, it's very well capitalized. You've got to kind of -- I would like to say that you operate effectively in your home market. So they could be higher. And one of the things they ding you for is they say that there's a relatively high contribution of capital markets relative to the size of the bank. So firstly, I'm wondering what's your pushback to that? And then secondly, can you help us understand what your capital markets franchise is?

Yes. Thanks. Thanks for noting that. So yes, we're quite happy with S&P increasing our long-term from A to A+. And really what's contributing to that increase and it's something that we've been demonstrating to regulatory, to agencies is our diversified business across Canada is really something that was -- our Quebec proportion, obviously, is higher than other banks in Canada. So growing across Canada is one of our priority, and it's something that the agencies were looking at. So obviously, our acquisition with CWB certainly contributed to a better diversification in the Canadian market. So we'll continue to work towards that. And the other aspect was, you're right, capital markets. So in the past couple of years, I don't feel that it's the same nowadays, but there was always some questioning on the volatility of the capital market business. But we've demonstrated over the past couple of quarters and couple of years that it is a sustainable growth sector where we see -- despite the environment, we continue to see great performance. So I think that's also something that was positive, and we've been able to demonstrate that. So as I said, Capital Markets is really focusing on areas where we are strong at. So a couple of them to give you examples, if you look at the global markets, structured products, ETFs is -- are areas where we're really good at, market makers as well. If you look at corporate and investment banking, we've been investing highly in talent in the past couple of years in that area, and we've been demonstrating good performance, been very -- we're very good at government debt as well. It's an area where we've been #1 for quite a while. So those are just some of the -- a couple of the areas where we feel that we have a competitive advantage. And if you take a step back, a little bit higher, as I said, a team that's very agile, innovation and technology is really part of their mindset. And they also have a very different cultural way of doing things where the clients for Financial Markets is really the clients of the whole business and not of the different trading books. And that's something that's appealing.

Thanks very much, Marie Chantal. Before we close, is there anything else we haven't covered? Or would you like to finish with any concluding remarks?

Yes. Yes, I'd love to. Maybe a couple of takeaways from us that you can leave with. We're very happy with our performance. Our diversified business model, our resilient business model and growing organically is our top priority. We are in a very strong capital position, allowing us to continue to grow in each of our segments across Canada. And obviously, we're very excited with the CWB transaction. All the teams are dedicated. As I said, it fits just perfectly into our strategy. And for the next couple of quarters, we're going to be focusing on discipline of execution so that we can make this happen with the success.

Great. Thank you very much. Please join me in thanking Marie Chantal for her time today.

Thank you, Brian. It was very nice to meet you.