We're good to go? Okay, great. Thank you. Good morning, everybody, and welcome back. I'm very happy to have Hratch Panossian up here from CIBC, the Chief Financial Officer. As I was mentioning yesterday, the Canadian banks have just gone through a reporting period. There's going to be what I would say is a lot of sort of follow-up on what we heard from the first quarter conference call with CIBC. Hratch, thank you very much for joining us this morning.
Thank you, Darko. Always great to be here and, thank you all for joining us this morning as well.
I think I'm gonna kick off talking about capital because prior to the quarter there was some concern that CIBC's capital ratio may have been on the light side. We have a recent increase in the capital ratio at the regulator. Voila, you came out with a CET1 ratio of 11.6%. Clearly allaying those fears. You talked about a path towards 12% by the end of the year and yet we're thinking about like a Basel III impact that's neutral- In Q2. Maybe you can talk a little bit about the waterfall or the path towards 12% and why are you not receiving much capital benefit from some Basel III reforms because many other banks are receiving in fact, and in some cases a fairly happy benefit from the reform?
Yeah. Thanks, Darko. Good question. Clearly capital is something that's on everybody's mind and certainly ours. The strength of our balance sheet, the ability to have the resources to continue investing in our strategy is a critical part of our approach to things. Something we're always on top of. Look, I know there was a lot of questions in Q4. We were always very confident and consistent with our stance. We've been saying for a while now that we thought operating at the 11.5%-ish range was a good place to operate, right? We moved that up.
If you go back to our Investor Day, we had talked about 11%-11.5%, and as the environment changed and got more risky, we started communicating this 11.5%-12% range. I'll get into why and a number of the factors that drive our decisioning on that. There's really three things we look at. We look at obviously the minimum regulatory requirements, and those are a factor. We like operating at a buffer to that. We look at our own view of the forecast, our needs to deploy capital strategically against our clients and our strategy, as I said earlier. Any headwinds that we expect coming in the environment and therefore look at the overall forecast and say how much capital should we have at hand at this point in time.
Lastly, we look at the peers, and I think it's important to stay within the pack. We're not that concerned are we top or bottom in terms of capital, but we think that operating in a similar range as the industry is a good thing at any point in time for many reasons, right? Strategically, you're not an outlier, an ability to take opportunities on if they come. Defensively, you're not an outlier if things turn negative and so forth. Those are the ways we look at it. Putting all three of those together, we always thought 11.5%-12% right now is a reasonable place. Our CEO, Victor, when he had the chat with you in January, he covered that, right?
He did say, "We believe strongly we have a path to be 11.5%+ this quarter and then work up from that." We're very pleased. We're pleased in Q1 to deliver 11.63% despite over 51 basis points of one time headwinds, including the phase outs of the OSFI ECL add back. That was partly our capital generation, that was partly our issuances through the DRIP program, and that was partly some things in market related factors, particularly counterparty credit risk, going our way. Now we're realistic about the outcome forward. Let me do that waterfall that you spoke about. As I said on the Q1 call, you have to normalize for a few of the things that have happened. Basically our starting point right now is more like an 11.7%
We had press release that we ended up settling the legal matter for less than what we had reserved, there'll be a release against that coming in Q2. That'll put us right around 11.7%. You have the Basel III reforms that are gonna be implemented this quarter. On that point, you know, to address your question, we do have some benefit. We have some benefit from the credit risk side of things. So we'll get a benefit, a substantial benefit from the credit risk side. The op risk side, as we move to the new methodology that looks at loss history as well over time, the op risk side is actually gonna go up. You're gonna see a bit of an offset in the two RWAs.
There are still a few things that are in the works and not finalized. Maybe slightly net positive, but we're guiding and assuming at this point for conservatism net neutral on the Basel III fronts for this quarter. By the way, just while we're on it, we don't anticipate any material negative impact going forward from the market risk reform implementations next year from floors kicking up over time to their eventual state and so forth. I think materially after this quarter we're not anticipating any big negatives or positives from the remaining Basel III impacts. From that point on, what we said in Q1 is we've got strong capital generation. We have the ability to generate 30- 40 basis points net of deploying against our strategy and clients capital per year.
I'd say it's in a five to 10 a quarter or 30-40 per year. That's what allows you to get to about 12% by the end of the year. We are expecting some headwinds. We think there will be some negative migration in the portfolios. We think some of the things like counterparty credit that went our way will revert back to normal as commodity prices adjust, as interest rates stabilize, et cetera. We've taken all of that into account, but that's generally in the zone of call it up to 10 basis points a quarter, and that's where our issuance comes in. We're issuing about 10 basis points a quarter because of the DRIP. I said this in Q1. That'll offset those headwinds and allow us to get to 12%. Continue to grow from there, right?
Longer term, our U.S. business is still under AIRB, under advanced, we would have the opportunity to take that to AIRB, to advanced, from standardized. That would give us some benefit on top of that. There are other model changes and so forth that could help. Being 12% at the end of the year, we think relative to what the peer group has said, relative to what we see in the forecast, relative to the current regulatory requirement of 11%, puts us in a pretty good place. Look, I won't speak to the regulator and what they may or may not do, right. The DSB buffer is now the maximum then is 4%.
We're comfortable that if we are where we are at the end of the year, even if they were to go to that maximum buffer at some point, and I don't expect that that would be a surprise. It's to nobody's benefit to surprise the industry on those things. Even if they were to go there, it would be in a time frame that from where we are at 12% or a bit above 12%, we could easily manage to a buffer to that new requirement. That's the way we think about it.
That's a great answer. Thank you. We've touched on some of the things that I wanted to talk on. That's great. Maybe just circling back on some of the headwinds. One of the things that we're hearing, preparing ourselves for is RWA inflation, the potential for that. Is that one of the things that you're considering? Where would the RWA inflation, if it comes, where is it most likely to come?
Yeah, absolutely. It is one of the things we're considering, like I mentioned, and given I took eight minutes for the first question, I'll be brief on this one.
Okay.
look, we have seen some net positive impact from credit quality since the pandemic. What you had is this odd effect where on the retail portfolios, you actually saw RWAs coming down, largely because utilizations dropped and so forth. On the wholesale portfolios, you had some negative migration, but now that has actually started to revert. On a net basis altogether, you still have a net help of in that sort of 20- 30 basis points benefit range. What we expect to see is that to basically go away by the end of the year. When I said, you know, we've got about 30 basis points of issuance that will offset some of the headwinds, some of that 30 basis points of headwinds is that migration that we expect.
By the end of the year, we'll be right back to pre-pandemic type quality levels in terms of migration. A lot of it is coming from the retail side. We did have this quarter significant amount of negative migration from the mortgage portfolio driven by the LTV changes, and we're anticipating a similar amount going forward every quarter from here.
Touching on mortgages, I wanted to blend this into the conversation on the mortgage book and what we're seeing in the behavior in the mortgage book and whether or not it could further migrate RWAs. One of the things that's been topical recently is the idea of negative amortization. You know, you have some disclosures out there that suggest that there's a portion of your book that's now negatively amortizing. I wanted to give you an opportunity to talk to that and maybe describe for this group what that means and how you're viewing that and if there's any incremental risk as a result of that.
Yeah. Thanks, Darko. It's a good question, right? There's a lot of attention on mortgages. The punchline is we feel very comfortable with our book. We feel comfortable with what we see on the horizon. We feel comfortable with how our clients are reacting. For the foreseeable future, you know, I think we're in a good place, right? Let me cover a few of those things, and then we can talk about longer term and what may happen. Our portfolio is strong. We start with an LTV as of Q1. Our LTVs are 52%. We've got a portfolio that we've been very cautious in underwriting and originating. Our quality and standards were never compromised in historically. We feel good about the book.
A lot of the book was actually qualified at rates in the 515-550 basis points range because of the government's stress test requirements. That's pretty close to where things are renewing now, right? You've got about 550 on 6% variable. You've got to keep that in mind. These folks, unless their circumstances have changed and employment continues to be strong and so forth, they qualified with rates that are similar to what's out there now. What are we looking at? Well, there's been a lot of talk around variable versus fixed. At the end of the day, given the way our product works, and you referenced it, right?
If you do end up getting to a place where interest isn't covered by the monthly payment, the client can choose to increase their payments, but is not obligated to until they get to a certain point later where they've capitalized too much interest. That point will not come for many years. We've looked at the portfolio, we've stressed it even with rates going up a little bit more from here. That's not a concern over the next two years. Folks won't hit that. You've got about CAD 30 billion renewing in the next 12 months. We've got about almost CAD 80 billion renewing in the next two years.
If I look at that population, let's go in the one year and two year. Stats are about the same. Roughly around 1% of that is what we would call high risk. What's high risk? LTV sorry, FICO score is less than 650. Relationship shallow, therefore, we don't have a lot of data and knowledge about the client, including income and so forth. That's 1% already. You're talking about, on the book, call it CAD 300 odd million for one year, and you're talking about CAD 800 million or so for two years. Now, if I take those numbers, it's less than 1/10 of that high-risk group that's actually got an LTV of more than 70%.
You get to numbers that in terms of losses, based on where we stand today, given those LTVs, even if there are default events, we are not talking about very significant numbers on that portfolio, right? That's what we're watching. We're working with clients closely. We know what increase they will likely have. If you look at the fixed portfolio today, those folks that are gonna renew in the next two years, their average increase is just over CAD 300 a month. If you look at the variable portfolio, it's a bit higher. It's around CAD 500 a month. If you look at the deposits of these clients, largely you've got, actually, the overall mortgage portfolio is over CAD 20,000 average balances for those clients. The variable population has slightly higher balances. They're north of CAD 25,000.
You're almost in a position where even if these folks renew over the next couple of years, as long as employment is strong and they're still employed, they're able to afford the payment increase. If their deposits are still there, their deposits today alone would be enough to almost get them through the next term. Even if they renew at a higher rate for one more term of three years, five years, whatever they pick, then at the end of that, they could have just used their deposits to cover the difference. As long as employment stays strong, we feel good about it. Where could things get more challenged in the market? It's that scenario, and it's sort of hard to picture it could happen, right? It's a scenario where rates stay high and mortgage rates stay high.
The economy is very challenged. Unemployment has gone up. You start seeing the combination of employment income going away, payments on mortgages going up, maybe inflation still being slightly higher and drawing on people's income. In that scenario, you can start seeing things get a bit more challenged. In that scenario, again, we'll go back to what we've always been saying. I'm not worried about mortgages. I think unsecured portfolios are ones that that would be more challenged in that scenario, given the coverage on LGDs.
Okay, that's a very good, thorough discussion on mortgages. I do wanna wrap up on it quick, but again, when we think about the next two years, these are mortgages that are largely underwritten, call it four or five years ago. There are a couple of vintages that we're a little more concerned about, the 2021, 2022, where rates were excessively low, and since then, house prices have gone down. That's a further out problem, if I'm correct in thinking that really we're thinking about something that's four to five years away, and that's something that's clearly it also must be on your mind.
Absolutely. For us, Darko, and I think this is the case for the industry, right, you sort of had this 80/20 where 70% and 80% client preference was fixed versus variable, and that had shifted over the last one year. Those cohorts you're talking about, a lot of it is also where the variable product growth happened. The good news on that is because those cohorts, the variable product, and those cohorts were later, the renewals are also later. Those stats that I gave you, right? The 3/4 of the next one year of renewal is the fixed-term product. 1/4 of it is variable. As I said, the fixed-term product average increase in payment is lower than the variable. You look at the variable population, only about a third of our variable book will roll over the next, not two years, three years.
Right.
You're talking about 2/3 of the book, which is that later cohort, is three years plus. You've got to think about where the world will be three years later. That's where I go back to my comment, right? If employment is strong, there's time. The element of time is important here, right? People have three plus years to adjust their own spending, their own budgets, their own household requirements, or for interest rates to adjust during that time, right? I go back to it. It's hard to see a scenario, I'm not saying it's impossible, but it's hard to see a scenario where Bank of Canada keeps rates at current levels while you have significant challenges in the economy and unemployment, et cetera, et cetera, three years out from now, when inflation so far doesn't look like it's going to persist that long.
Of course, we're worried about the house prices as well during this entire timeframe as well.
Correct. We've assumed some normalization of house prices. Again, when you're starting from a portfolio LTV of 52%, our GVA GTA markets, that's Vancouver and Toronto, lower than that, I think there's some cushion there.
Okay, great. Now that's been a good discussion on mortgages. I think we beat that one down. Let's move on to a couple of other things. Again, going back to the quarter, I wanted to touch on net interest margins. It's been pretty topical around here, actually, yesterday. You know, we'd heard a lot about deposit betas moving a little bit, and we're worried a little bit more about margin expansion. Your margin sort of went down in Q4, up in Q1, a little bit erratic. Maybe we can talk a little bit about the movement we saw on the margin and where your confidence comes from for margin expansion for the rest of the year.
Absolutely. Yeah, Darko, it's, you know, it's a little bit of the story we covered in Q4, right? Our long-term trajectory is stable, it's consistent, it continues to follow our expectations and our guidance. Orderly, there can certainly be noise. I mean, when you're in a rate hike cycle like we've never seen before in terms of extent and pace, lots of things can happen that create noise in any given quarter, right? Including when does the Bank of Canada or the Fed move, and does that happen late in a quarter? When do the assets and liabilities reprice with a little bit of lag to that? Those kinds of things create a lot of noise. There can be noise on hedges and so forth. Let me go back to the numbers for a second.
If you look at it on a year-over-year basis, by the way, you have to exclude trading. Trading creates a lot of noise. Net trading is up significantly, as you saw in our business, but a lot of interest income going to non-interest income as interest rates go up, and there's the pay lag of certain hedges that goes up with rates. If you take that out, we've basically been, other than Q3 last year, there was a bit of a bump. We've basically been stable. We were around 163 basis points total bank margin. We had 168 in Q3, and then we came back down to the 161, and we're now back up to 166. When we were 161 in Q4, we said there's a few basis points of negative here, right?
Part of that was CDOR/CORRA spread, which is the one-month, overnight spread in Canada. Because of the large expectations of rate increases by Bank of Canada, that spread went to levels we've never seen before. What that does is things like your HQLA portfolios, where you're usually earning a yield that's referenced off overnight versus your funding that's usually referenced to one month plus. It creates all sorts of noise on things like that, and it's temporary. As those things normalize, it normalizes. We said in Q4 there was a few basis points negative, and some of it would come back in Q1. In Q1, we said some of that was the few basis points that came back. Interestingly, you know, nobody seems to have picked up on that too much, so let me re-highlight that.
I said the 166 you should view as a 163, 164. If you average those two quarters out, it was basically like 163, 164 average across the two quarters, which is essentially flatish year-over-year. I go back to what I said at the beginning, right? Our overall through the quarters, if you look through the medium term, we're seeing what we said, more stable with a slight momentum upwards. As we get into this year, it'll start accelerating upwards. Why? What are the factors that are driving it? You've got three big ones. You've got interest rates, you've got deposit behaviors and mix changes, and you have mortgages and mortgage margins particularly. Other asset margins have been pretty stable. Mortgage margins in Canada have been a big story.
What you've seen over this year is we've continued to get the benefit of structural positioning on deposits a few basis points a quarter, as we talked about. Some of that was offset by the decline in mortgage margins that we were seeing, and a little bit of that trend of deposits moving from non-interest bearing to interest bearing, and that sort of stabilizing things. What do we expect going forward? We still expect some headwind from deposit mixing. We expect the forward curve because we don't think we're smarter than the market. We just assume the forward curve continues to realize. We expect mortgage margins based on what we're seeing to get a little bit better.
If you put all of that together, that gives us the trajectory that we said we're confident on some margin expansion towards the tail end of the year. While we had said 10- 15 basis points Q4- to- Q4 over 2023, now we're saying probably closer to 10. The rate environment's playing out about what we expected, the mortgage margin's playing out about how we expected. That deposit mixing seems to be putting a little bit more pressure across the industry, not us. There's been some changes there, a few percent a quarter going into term products and interest-bearing products from the non-interest bearing side. That we expect will continue, and it'll put a little bit more pressure.
Okay, good answer there. Lots of things to talk on and revisit. A couple of, just a couple of follow-ups there. When we think of the 10, it's the 10 is on that 163-ish range, right, from here to the end of the year.
Yeah, I think in that neighborhood. Right. Again, if deposits continue to mix a bit higher than what we expect and so forth, there could be a little bit of pressure on there. Yeah, I think in that range is probably reasonable.
I'd always thought to myself, you know, maybe it was the tax season. You know, in Canada it's RRSP season, TFSAs, and maybe people walked in and spoke to and worked with the bank a little bit more about maybe moving deposits over. Shouldn't we see it relax a little bit going forward now that we're past that season? Secondarily, just as a follow-up to that, you didn't mention competition- on the deposit side. Why is that? Is it not simply not a factor at this moment?
Look, I think deposits are always competitive. You know, there was a time, I think in certain markets, certainly in the U.S., right, we were in a period where deposits had less value in a lower rate environment and maybe the competition wasn't as much. I think in Canada there was always competition, and I think there always is competition. The balance sheet structure in Canada is such that all loans are on balance sheet and therefore funding, and all banks use the wholesale markets to fund it. So long as you can do business with your clients, serve their needs, and create a margin to funding in the wholesale markets, which you generally do, deposits are a good thing to do. That's our approach to it. That's what we've always done.
Look, we've done very well on deposits, and you'll notice this if you look at over the last year, client deposits versus wholesale funding across the industry. We're very pleased, and we've actually been, we've been able to be successful with client deposits. Some of that has been going out ahead of our expectation of the client needs as interest rates started going up and with attractive rates on GICs, with attractive rates for corporate commercial clients and so forth. But we've been very successful, and we've been doing those at positive margins. Again, as we replace wholesale funding, that's positive to our NIMs across the bank and positive to NII. Is competition a little bit more now? I think it's been competitive all along.
We are definitely seeing competition out there, maybe a little bit more intense, but our approach doesn't change. We're there to serve our clients, but we're there to do business profitably, and we've been able to do that so far and grow our deposit base.
Okay, great. Thank you. I'm gonna move on to the expenses, which has also been relatively topical, or at least was. I thought you cleared the air in Q1 with an expense number that actually came in, like, the dollar value was less than Q4, and I thought, you know, you'd kind of suggested that it should be more or less similar to Q4 levels. Is that how we should think about it going forward now? Is that sort of the run rate of expenses, and from here it can more or less remain flat for the rest of the year? How should I think about it, just to be very clear on it so we can once again put the expense concern aside?
Absolutely. Yeah. Thanks for the question, Darko, I'm always happy to talk about expenses, right? We, maybe I'll reframe it as investments because for the most part, what we're very focused on is containing expenses. Managing and growing investments and on a net basis, having good operating leverage results over the medium term. Let's step back for a second. Last year we were very clear. We talked about this at Investor Day, even before we got there, we were very clear about the fact that we were increasing investments. We've right around doubled the level of strategic investment we've put in the bank. We talked at Investor Day a lot about our disciplined capital allocation framework around accountability on those things and delivering value and delivering CAD 2 billion of pre-tax pre-provision earnings over a few years out of those strategic investments.
What have we done? We've invested in those areas. Where have we invested? We get that question a lot, right? It's along the three key areas in our strategy we highlighted at Investor Day, our high growth, high touch segments. We've invested in that. Part of it is the co-brand portfolio we bought. Part of it is the planning tools that we've built, like CIBC GoalPlanner. Part of it has been our private banking front office, both in Canada and the U.S. Private wealth advisors, both in Canada and the U.S. We've added infrastructure for those clients. Better tools for our advisors, better tools for clients in that space of advisory and wealth. We've also created future differentiators. We've invested in our energy transition, and we have a leading energy transition franchise now in our capital markets business.
We've invested in our Direct Financial Services business. We've invested in our Innovation Banking business that we've spoken a lot about. Lastly, we've invested to simplify the bank, improve client experience, improve employee experience and generate better efficiencies. Our CRM implementation of Salesforce, our transition to cloud, there's a number of those areas where we're investing and you're seeing the results, right? Through last year we had top or top two in terms of revenue growth, pre-tax pre-provision earnings growth, again growing above median, met our strategic goals, had ROE for the year right around 15%. That's still with a lot of our investments in the J-curve state. Where do we go from here? That's why we said we can stabilize the level of investment at this level. We can continue to look for efficiencies, which we do.
We're always looking to get a couple of percentage out every year out of those core operating expenses to cover normal course increases, inflation or what, whatnot. What we're left with is a mid-single digit expense growth, which we're targeting. That largely is driven by deliberate investments that will drive value going forward. If I put all of that together, what you will see, now punchline to your question, yes, we've been clear in Q4, we take guidance seriously. We will be going right around sideways in terms of quarterly expenses for the rest of 2023. The only caveat I'll make is if we have very good performance and revenue that drives variable expenses, that's fair game. Outside of that, we've got very good visibility and we'll be going sideways.
That means full year will be mid-single digits, 2023 over fiscal 2022. That means operating leverage will improve over time. Interesting how things change, right? We had operating leverage and expense growth top of the pack this quarter. We think on a relative to industry basis, we can do well on operating leverage going forward.
Okay, that's great. Thank you very much for that. That makes my modeling a lot easier. I'm gonna quickly look out here to the audience if there's any questions. Sorry, we do have a question here.
Hi. Thank you for your time.
Thank you.
I think this commentary around deposit remixing and customer behavior is actually quite consistent among yourself and your peers, I don't know if you can give us a little more narrative around that. Is it certain rate thresholds or maybe inflation impacting people's desire to seek yield or, I'm trying to kind of sound this in the context of history. How far can that rotation continue? Thank you.
Thank you. Very good question. I'm not surprised, right? It is, it is absolutely happening industry-wide. We see it and it's happening in not just in Canada and other markets like this one as well, right? I think a few things driving it. It does depend by which client segments you look at. Generally, there's deposits and going into markets or going into higher yielding deposit products like GIC. Some of that is the yield opportunity. The second big category would be spend, right? We spoke about the fact that you've got inflation, you've got higher interest expense for certain folks and businesses, and we are seeing that require some of those deposits. I think it continues to normalize on the non-interest bearing balances going forward. We sort of hit the peak.
If you go back to middle of last year, that's when we hit the peak on non-interest bearing balances for us. Since that sort of May timeframe, they have been coming down, but we still haven't gotten through that hump of deposit, excess deposit that built up during the pandemic. I think we've got some ways to go still. By the end of this year, you likely will see between those two things, right? Those that were parking businesses or individuals that were parking just because there's risk and uncertainty out there, the cash, but they don't need to use it, will invest in higher yield opportunities or the markets. Those that need to use it, I think you're gonna see some of that starting to come off the books.
Okay, great. I see this screen is telling me that we have run out of time. Hratch, thanks again for a great conversation this morning.
Well, thank you. Thanks, Darko.
Cheers.
Thank you.