Welcome to EQB's Earnings Call for the Second Quarter of 2023 on Wednesday, August 2nd, 2023. At this time, you are in a listen-only mode. Later, we'll conduct a Q&A session for analysts. Instructions will be provided at that time. It's now my pleasure to turn the call over to David Lee, Senior Manager of Investor Relations for EQB. Please go ahead.
Thanks, Colin. Your hosts today are Andrew Moor, President and Chief Executive Officer, and Chadwick Westlake, Chief Financial Officer. For those on the phone lines only, we encourage you to log on to our webcast as well to review our company quarterly investor presentation. Presentation includes on slide two, EQB's caution regarding forward-looking statements, as well as the use of non-IFRS measures on this call. All figures referenced today are adjusted where applicable or otherwise noted. It's now my pleasure to turn the call over to Andrew.
Thanks, David, and good morning, everyone. As this year and decade prove, EQB is consistently putting great numbers on the board. Through effective execution of long-term strategies, those numbers include Q2 earnings of CAD 115.5 million, an all-time quarterly record, and ROE of 18.3%, which adds to EQB's status as the Canadian banking industry's leader in shareholder value creation. We regularly assess the 10-year total shareholder return of all Canadian S&P 500 banks. This week, EQB is on top and it certainly is nice to see us outperforming all of the leaders on Wall Street and Canada's largest banks on this important outcome for shareholders. We do not take this performance for granted. This also comes while we firmly believe a wide discount remains in the value our bank for investors.
It reminds us that we must stay true to our capital allocation, branchless business model, and challenge a bank approach. On all fronts, we can be positioned to continue this return trend for the next 10 years and beyond, outperforming our industry in a very meaningful way. Another figure that delights me is 543,000. The number of Canadians now relying on Canada's Challenger Bank to deliver our mission of changing banking to enrich people's lives. We're making a concerted effort to grow and engage our customer base through innovative value-enhancing services. Those efforts are working. We're also an institution that responds to challenges. During this time of higher interest rates, our processes and monitoring activities are keeping our credit book in good shape. Chadwick will speak to results and the progress of our Concentra Bank integration plan.
For my part, I'll discuss conditions in our priority markets, updated increased 2023 earnings guidance, innovations to watch for and a comment on a regulatory development. First, market conditions. As expected, the 10 Bank of Canada policy interest rate increases, totaling 4.75% since March of 2022, and the resulting slowdown in the housing market reduced single family, family mortgage application volumes compared to prior periods. At the same time, loans are staying on our books for longer, and renewals are stronger as more customers opt to remain in their homes. The housing market has gone through a correction, and prices are now showing signs of improvement. At the very least, there seems to be a floor under house prices that gives us more confidence in our credit outlook for that part of the book.
With growth of 3% through June, we now expect the bank's conventional personal lending portfolio to grow 5%-8% for the 10 months ended October 31st. We will provide our 2024 outlook when we report our Q4 results in December. Now, I can share that we expect higher growth next year, a reasonable assumption given the housing market's fundamentals, fueled by population growth, some pent-up demand caused by current housing market conditions, and presumably by then, more stability in interest rates. In commercial, our priority market is multifamily, including affordable housing, where demand for CMHC insured products is strong. From a risk perspective, we like our positioning as over two-thirds of our commercial loans under management are CMHC insured. I encourage you to review past disclosures, which will help you get very comfortable with our commercial lending activities.
With growth of 5% through the first half of 2023, we now expect the conventional commercial portfolio to expand 8%-12% for the 10-month fiscal reporting period without degradation in our risk profiles. Growth will be faster in insured lending, where we are protected from credit loss by the Government of Canada. Turning to liquidity and funding market, it appears the fallout from US bank failures earlier in the year continues to be contained. Structurally, it's evident that Canada enjoys an advantage over the U.S. While U.S. money market funds have mechanisms to deposit funds directly with the Federal Reserve, taking liquidity out of the banking system, in Canada, money really only moves between banks. An important difference.
For our bank, total deposit growth was 37% year-over-year, with ample liquidity on the balance sheet, a well-positioned liability structure, and access to liquidity to fund the operations of the bank. Our foundation is strong. Moving to earnings guidance, we are realigning our financial results calendar to improve our reporting comparisons to Canadian bank peers. The 2023 fiscal year will end on October 31st, covering only 10 months on a one-time basis. To make it easier to track progress in the Q2 MD&A, we provide guidance for the 10-month reporting period, ending with a 4-month Q4, as well as 12 months guidance as a relative checkpoint if we had not been changing fiscal years. Not to be lost in the recut, we raised guidance for EPS, ROE, and book value per share growth.
As the slide in our deck and the table in our MD&A show, through June, we are performing well ahead of original guidance, including adjusted EPS growth of 20%, 7% year- to- date. Versus original calendar guidance, of 10%-15%. This momentum gives us confidence to increase expectations. Our next quarterly report is set for December 7th, and we'll publish our regular detailed annual guidance for next year at that time. I believe we are the Canadian bank with the most upside in the industry, and we're investing in ways that are adding value for our customers and momentum for Equitable.
The recent introduction of the EQ Bank Card, now in the hands of 75,000 Canadians who have used it in 140 countries, last month's addition of the mobile wallet to hold that card, and benefits from the launch of EQ Bank services in Quebec are all having their desired effect on customer expansion and engagement. At the end of the quarter, customer growth had increased 31% year-over-year. As of today, over 375,000 Canadians now have EQ Bank accounts. As a result of adding the value and functionality to make the EQ Bank platform capable of serving Canadians' everyday banking needs, we experienced a good increase in the essential customers who deposit payroll into, in EQ Bank, a sign of trust and belief that's evidenced our customer satisfaction measures.
Daily transactions also illustrate that customers increasingly see EQ Bank as a sound alternative to traditional bank checking accounts. In late July, we had another reason to make bank with Equitable by introducing the market's first all-digital first home savings account product to the EQ Bank platform. The EQ FHSA Savings Account is a tax-deductible way for customers to accumulate a down payment for a home purchase much faster than rival banks because of our high everyday deposit rates and zero fees. The EQ FHSA is completely free, and there's no need to visit a branch to start an account. In just two weeks since launch, customers have opened more than 2,400 EQ Bank FHSAs.
Full marks to the EQ team for working through CRA reporting requirements to get this product to market and to the Concentra team for introducing it to credit unions through our Concentra Bank partner portal. 80 credit unions have already signed up to participate. A great start. More generally, we're working hard to increase EQB's presence in the credit union system through outreach activities, including our attendance at the World Credit Union Conference in Vancouver. At the conference last week, I came away with a reinforced view that there is tremendous opportunity to work closely with credit unions to build value for all. We're actively pursuing a number of initiatives to make that happen. Progress in our reverse mortgage business also has been positive. This fall, you will see a more prominent advertising message to drive enhanced consumer awareness of our differentiated reverse mortgage solutions.
Around the world, we see the difficulties large banks have in serving small business effectively, with Canada being no exception to that general reality. We're on the cusp of changing that, too, as we put the final touches on our first EQ Bank small business account. To start, this will be a minimum viable product on desktop and then a mobile app. It promises to be a game changer for business owners due to the digital experience, elimination of bank fees, and good interest on deposits in the accounts. I'm really excited about this one. A final thought on a regulatory development. OSFI recently proposed changes to capital adequacy to address risks related to variable-rate mortgages. EQB has no exposure to these increased capital requirements because we stopped offering VRMs 12 years ago and moved to adjustable-rate mortgages or ARMs, which adjust payment to keep amortization at the original terms.
Financial institutions are always risks to address, and we are diligently ensuring that our bank is prudently managed to navigate the challenging economic environment. We're feeling confident, and I think justifiably so, in EQ's positioning as Canada's Challenger Bank. 23% year-over-year dividend increase we announced is delivering on the commitment we have made to shareholders and a reflection of the confidence, strength of the bank's place in the market. Over to you, Chadwick.
Thanks, Andrew. I'll be brief, as Q2 and year-to-date results demonstrate how well EQB is performing to guidance despite the economic backdrop. With year-to-date ROE now at 17.5%, our outlook for the rest of 2023, we're well positioned to achieve our goals with momentum into fiscal 2024. Q2 reflects the second consecutive quarter of full results from Concentra Bank. In this short time, what we believe to be true about the value we could create with this acquisition is translating well. We've set a target to achieve annualized cost savings of CAD 30 million within 18-24 months post-closing. This has been achieved ahead of schedule. This progress is reflected in our strong earnings momentum ahead of guidance year to date, our efficiency ratio closer to historical trending at 42.8%, a 2.6 percentage point improvement from Q1.
This is also particularly strong, given the prior efficiency ratio of Concentra was nearly 70%. We continue to invest in the Concentra technology migration, the adjustments in the quarter further narrowed, which you see between reported and adjusted figures. In general, I would call primary financial metrics, metrics for this integration complete. We are winning in service delivered to our new customers from Concentra and the credit union partners we serve, the technology work will continue in the year ahead. In Q2, the most notable adjustments to our reported results included CAD 3.4 million pre-tax related to integration costs, down from CAD 4.7 million last quarter. We also made a couple other adjustments, including removing the one-time CAD 28 million non-interest revenue benefit from a strategic investment that I'll speak more about in a moment.
Today, I'll complement Andrew's comments with a few key focus areas: margin of funding, non-interest revenue, credit performance and lastly, rounding out 2023 guidance. First, margin. This remains a distinct competitive advantage that was proven again in Q2. At 1.99%, NIM expanded seven basis points from Q1 and 18 basis points year-over-year. This trended even higher than target, with growth across our conventional loan portfolios and yields on those portfolios growing at a faster rate than our diverse funding costs, plus higher sequential prepayment income. You'll recall that prepayment income accelerated during the pandemic and dropped off when rates started climbing. Over the past couple of quarters, we're trending back towards a more normalized level. The strong net interest margin led to a 6% increase in net interest income over Q1 and a 50% expansion year-over-year, including the benefit of Concentra.
We're getting the expected lift from our long-term efforts to diversify and strengthen sources of low-cost funding. Retail and securitization funding markets continue to be liquid and efficient for our strategy. In terms of stability, 95% of our deposits continue to either be term or insured. Our match funding focus and approach to hedging are serving us well. Beyond direct deposits, our funding stack contains a variety of wholesale options, including CAD 1.7 billion of covered bonds, CAD 1.9 billion of deposit notes, CAD 2.2 billion of credit union deposits, and CAD 102 million of strategic corporate and institutional partnerships. Credit union deposits declined sequentially, aligned to seasonal expectations for the segment, consistent with past patterns at Concentra Bank.
I said last quarter that you should expect to see us in the market for a fourth covered bond issuance in Europe. We delivered that in Q2 with a successful EUR 300 million offering at 52 basis points over the Euro mid-swap rate, which translates to CDOR plus 68 basis points. We will remain a regular issuer of covered bonds in Europe as we see opportunity to add margin tailwind with this strategically important funding source. Our capacity for issuance expanded with Concentra Bank, another synergy. We've talked in the past about the low deposit beta, largely attributed to EQ Bank. This continues to translate on our margins while giving our customers a great deal, including competitive everyday savings rates and a host of no-fee banking services.
Sequential growth of 9% in EQ customer accounts, 35% growth in transactions, and its steady record-high 51% engagement score through the first six months of the year demonstrate our expanding franchise value. We are focused in particular on growing EQ Bank customers, this is trending extremely well on a daily basis. Deposits are below our prior targets, but that's the outcome of steering away from short-term competitor promotions and instead focusing on leveraging all of our various funding levers while fielding the long-term value of the bank with a customer lifetime value to acquisition cost ratio of at least seven to 10 times. We now expect EQ deposit growth of 5%-10% for the 10-month period ending in October, with an uplift from our new FHSA and more to come after small business launches in EQ Bank.
To complete the revenue picture, non-interest revenue increased 18% over Q1 and more than doubled year-over-year. Reflecting our strategy, non-interest revenue accounted for 12% of total revenue, compared to more mid to high single digit historical trending. The way to think about this deliberate non-interest revenue growth anchors back to our 2022 Investor Day, when we outlined our plan to increase this to at least 12%-15%, which is well on track. If anything, we'll be targeting a higher amount over time. This quarter, you can see strength in fee-based income that increased 7% compared to Q1 and 84% over last year due to the addition of Concentra, as well as strength in securitization income, which increased another 12% sequentially. We had a sharp increase year-over-year, with higher activity in our insured multi-unit residential business.
In terms of the one-time gain of CAD 28 million, we started separating out a line for strategic investments with non-interest revenue in our MD&A back in 2021 to isolate non-core gains. These are proprietary investments that from time to time, include fintech-related mark-to-market changes and also at times, special dividends from common share-based investments. To ensure a more consistent revenue line comparison, we remove this revenue from adjusted results. To credit risk trending. PCL was CAD 13 million, an increase of CAD 7 million from Q1, when we had a CAD 2.3 million recovery from 1 commercial loan. The increase reflected portfolio growth, modest changes in macro forecasts, and normal course loss recognition. Net ACL was 20 basis points, compared to 19 basis points at March 31st, 2023. This is in line with our expectations, given lending portfolio growth and economic conditions.
The way to think about the one basis point net ACL increase quarter-over-quarter is that about 2/3 is related to shifting macroeconomic variables and one-third is due to an increase in our gross impaired assets. Changes in macroeconomic forecasts really impacted our Stage 1 and Stage 2 allowances, where we deploy complex risk models to forecast future losses on our performing loans. These losses may or may not materialize, depending on whether customers behave as expected and economic forecasts unfold as anticipated. The CAD 2.3 million increase in Stage 3 allowances is where a credit event, such as a loan not making a payment in 90 days, has triggered a need for a specific allowance that's determined on a loan-by-loan basis.
Of the CAD 13 million PCL booked in the quarter, just over 50% is related to equipment financing, where the high loan yields reflect this risk. As a reminder on our lending portfolios, nearly 100% is secured, over 51% is insured. The average LTV for our single-family uninsured portfolio was 63% in Q2, compared to 65% in Q1. We don't offer single-family variable rate mortgages. Commercial office represents less than 1% of our total lending, and over 2/3 of all commercial lending is insured against credit losses. We are holding to our consistent risk management framework. As expected and communicated previously, impaired loans have continued to increase, but we continue to not expect to lose money on these impairments.
Due to growth of the portfolio and the fact that we are at a different point in the credit cycle, our gross impaired loans increased CAD 76.4 million, or 49% quarter-over-quarter, to CAD 233.3 million. About two-thirds of that amount relates to two commercial loans, and we are fully provisioned for any expected losses. Moving on, and as Andrew said, we are presenting guidance for the 10 months ending October 31st, and for what would have been 12 months if we were not changing to our fiscal 2024 reporting year as of November 1st this year. Our refined and higher guidance reflects excellent performance for the first two quarters. I'll repeat that we will not be reporting Q3 results with this change. Our next reporting will be for the four months ending October 31st.
As every month is different, we needed to recut guidance to account for November and December this year, moving into our 2024 fiscal reporting calendar. The change from a calendar to a fiscal year will make EQB more directly comparable to publicly traded Canadian bank peers. For the relative 12-month period, in the MD&A, we outlined that we would have expected diluted EPS growth to increase to 18%-21%, up from 12%-15%. Pre-provision, pre-tax growth of 30%-35%, up from 25%-35%, and book value per share growth of 14%-16%, up from 12%-15%. The corresponding 10-month period measures are also in the MD&A.
We expect CET1 for the 10 months to remain in line with our original guidance of 13%+ and no change in our 20%-25% dividend growth guidance. We expect stability in our net interest margin. Guidance for the 10 months also reflects our expectations for expense levels now that we're achieving cost synergies with Concentra and planned investments in people, process, and technology. While we plan to increase investment spending related to exciting new campaigns in the works, we expect efficiency within this range, but we're going to rank ROE as the North Star priority metric.
To sum up, our best quarter ever, more great and purpose-driven solutions introduced for Canadians with the best service of all banks and a lot of momentum ahead for our challenger story as we aim to continue to reduce the significant discount in our share price, while at the same time expand our track record of delivering the best long-term shareholder return of all peers. Now, we'd be pleased to take your questions. Colin, if you can please open the line for our analysts.
Thank you. Ladies and gentlemen, we'll now conduct a question-and-answer session. If you'd like to ask a question, please press star, then one on your telephone keypad. If you'd like to withdraw your question, please press star followed by two. If you're using a speakerphone, please lift the handset before pressing any keys. One moment for your first question. Okay, your first question comes from Meny Grauman from Scotiabank. Meny, please go ahead.
Hi, good morning. Thanks for taking my questions. First question, maybe on credit. Chadwick, you highlighted the equipment finance business, as a source of, some of the impaired loan provisions this quarter. I'm just hoping you could give us a little bit more color in terms of what's going on there. Is it a few specific loans? Anything you can give us in terms of what's driving the increase, that we're seeing this quarter in that portfolio specifically?
Yeah. Thanks, thanks, Meny, for the question. I think as we've always talked before, you know, where we would expect to see credit losses and we price the credit losses, is in our equipment finance business. I generally think about our real estate businesses as lending that we lend to not lose money effectively. The odd time we get an idiosyncratic loss, but that's why over the last 12 or 15 years, I think our average losses in our real estate businesses is our 1%, 1 basis point around per annum. Extraordinarily low.
We do end up with the odd. I always tell the story in front of investors, you know, a house slid down a cliff, so we changed our policies and stopped lending on houses that might fall down cliffs, and that's, you know, in an effort to reduce that 1 basis point. To go back to your question, though, on equipment finance, we do price for loss. We're lending on a faster depreciating asset, lending to startup businesses, which goes right to our purpose of helping people kind of build wealth. We're lending to people, say, starting up a trucking company or might have two or three trucks, where they're looking to buy another truck. Over the last couple of years, frankly, we've done much better than we would expect in this business.
This is a business we've only been in since 2018, and over the last couple of years, we've been running, roughly speaking, the earnings on this business is like two times our purchase price. Sorry, a PE of two is basically on a purchase price. We are seeing credit losses go back to more normalized levels. I'd say what, what you're observing in that area are falling secondhand equipment values, as supply chains get straightened out. You know, a year or two years ago the price of secondhand trucks and trailers, were high and in a shortage of and supply chains were constrained. Freight lines were able to charge higher rates, and to the extent we had defaults, we could get very good recovery values. Clearly, that situation has normalized.
The good news is we actually tightened our credit stance about 12 months ago, and the typical lease goes into default after about 20 months to 25 months. You know, it looks like we actually kind of got ahead of this issue, and it is diversified across a sort of large pool of mostly transportation equipment is, is really where we're seeing these defaults and losses. I do think that they're, you know, I don't know whether they peaked, but they, they certainly I don't expect to see in future quarters, you know, an increasing trend in a meaningful way of this kind of loss increasing.
If you sort of take a standalone view, even with these costs running through the P&L of the lease, the equipment leasing business, this is still a very attractive business for us.
Thanks for-
Sorry, long answer. A long answer to a short question there, Manny. I apologize, but I think it's important to have the background there.
That's helpful. I, I wanted to switch gears, Andrew. In your remarks, you gave us a little bit of insight into the outlook for growth, or loan growth next year. I think you referenced it, but I just wanted to clarify in terms of what kind of rate outlook is that based on? Is that assuming the Bank of Canada stays at 5%? What's the rate assumption as you look ahead into next year?
As we've always been consistent on we don't think we have any insight into forecasting rates, so we just use what's the implied market, the implied rates from the forward market curve. I think, you know, the jury's out as to whether the Bank of Canada goes one more 25 pip move. You know, I think we would probably. My comments are not particularly sensitive to that one more move, but that we wouldn't if we started to see more than one rate increase upwards, that might take my comments off the table a bit. I'm starting to see the Bank of Canada move into an easing cycle, perhaps in the sort of first, second quarter of next year. I think that would, that would be the context in which I'm making those remarks.
Got it. I wanted to ask about the revised guidance, specifically the ROE. Year-to-date, ROE is 17.5%, so it makes sense that you're taking the guidance up. I guess the question is, so you're taking it from 15%+ to 16%+. Given year-to-date performance, there's room, presumably, to take that guidance up even higher. I'm just trying to understand your thinking there. Is there any sort of message we can read into that in the context of 17.5% year-to-date, potentially, you know, signaling that you do expect a little bit of a moderation here in terms of the ROE going forward?
Yeah. No, we'd expect a consistent trend, Meny. It's just, it's sort of the nuances of where we're at year-over-year. You know, A, you got the Concentra portfolio. We had a different earnings picture, obviously last year as well in Q1 and Q2. For ROE, I think we're just being thoughtful about where the market goes really over the next four months. You know, I'd still expect us to see us at the higher end of the range. At a minimum, we want to move up the floor to provide some comfort. I would expect some consistency.
I think just to add on to that, I think our, our approach is generally to be sort of relatively conservative in our, our approach and stance. You know, whether it's in a 1% difference, you know, a few things can, can move to change the high. Either way, obviously, a 16% plus ROE is a very credible outcome by any standard.
That was kind of the a s you see that consistently too, right? That's part of why, I think you might have seen in our guidance as well. We've obviously given that 12-month and 10-month view to the guidance. But it's also just the nature, remember, for some of these pictures of, you know, 10 months versus 12 months. EPS on a relative basis may look a little lower, but that's just, again, we can't earn as much in 10 months. Again, you look at the year-over-year, what happened in Q2 last year. The earnings picture is very different now on a year-over-year basis, and Concentra kind of changes the delta. I think net-net, you should see, see the guidance is quite positive across the board.
Got it. That's it for me. Thank you very much.
Thanks, Meny.
Your next, your next question comes from Geoffrey Kwan, from RBC Capital Markets. Geoff, please go ahead.
Hi, good morning. I had a question on the Alt-A part of your business. It just, it appears that despite having the higher mortgage rates that we've seen, and also relative to, prime borrowers and also a perceived higher credit risk profile, how would you explain why your Alt-A borrowers so far haven't seemed to have issues renewing their mortgages at these, significantly higher mortgage rates?
Certainly, the very encouraging thing is when you look at the performance of those borrowers within our book that are self-employed. They seem to be a pretty resourceful bunch, I mean, that's certainly my I have a high degree of respect for that kind of, part of that, part of the economy. I think it's fair to say that they've probably still got, they've got more reserves and more capital available to support mortgage, their mortgage payments than, than probably is even clear to us in the underwriting.
Look at the typical self-employed person, if they're having, you know, increased mortgage payment shock in this kind of environment, they're able to take on an extra contract or whatever it is to get that extra income, you know, work an extra day in the week to get that extra income. I think that's what we're seeing, observing. The entrepreneurial community is pretty good at adapting to these changes in the economy. That's what I would mostly put it down to.
If I may add to that too, Geoff. Remember again, we don't label these as Alt-A . Again, these are single-family uninsured with and you can think about a residential mortgage underwriting policy is pretty consistent with the D-SIBs, but we are underwriting, right? We're investing more to underwrite and understand these customers in a different way, other borrowers, that's why we've also framed that very carefully. Then hence the quality of that borrower is higher, and you see that consistency in our Beacon scores, the LTVs, the markets where we're lending. Again, just the framing and how to think about these borrowers, they are high quality.
I think the other dimension is, is sort of the character element of the five Cs of credit that we really think about, which is, many of our customers have, first-generation Canadians around to new to Canada and the pride of home ownership and the effort that people go to maintain that home, to bring up their family and so on is very high. We see that as, you know, being aligned with their values is helping keep the mortgage current, and so we're much aligned with them in that world.
Okay, and just my second question was the adjusted efficiency ratio was just under 43% in Q2. Just wondering, bigger picture, as you pursue your growth, as we get through the Concentra integration, you know, where do you see that adjusted efficiency ratio going over the medium term?
Yeah , I'd say, again, I'll say it again, I don't want to be a broken record, but the, the main one we're going to focus on is ROE, Geoff, every day of the week. Efficiency, the way to think about it is it's probably within this, this ballpark, but it's going to be ± on the quarter as we particularly think of some of our investments in EQ Bank and this inflection point that we're at. In general, you know, if we were historically in that kind of 42 range, it's still on that, in that ballpark, ± but our priority will be the ROE, to be honest.
Yeah, and just to sort of follow on that, so what's only one area that I'm very interested in believe we've underinvested in the past is marketing. The running advertisements during the hockey playoffs really seemed to change the mindsets of consumers about the EQ Bank proposition, and we're working on something that I'm, I find really compelling in that area that could really sort of change the mindset with a different demographic. We may choose assuming that comes to fruition, lagging . We're not there yet.
We haven't got lined up what we want to do yet, but, you know, I'm hopeful that we would have a, have a good opportunity good NPV in terms of advertising and marketing in the upcoming quarter and then probably through the next quarter. That really could change our brand proposition, but that will create some short-term expenses that would have a negative impact on the efficiency ratio.
Yeah, kind of the other way to think about it, Geoff, we've said in the past, we'll continue to think about it at an annualized trend and around trying to keep that operating leverage flat to positive. To Andrew's point, right, it doesn't mean you won't see a quarter at say, 44, you won't see a quarter at 42± as we make some of these smart investments that will pay off in the top line too.
Great. Thank you.
Your next question comes from Lemar Persaud from Cormark Securities. Lemar, please go ahead.
Yeah, thanks. I want to turn to Concentra here. You achieved those synergies well ahead of target, so the velocity was faster than expected, but what about the magnitude of the cost savings? Can you maybe talk about any additional synergies you may have identified above and beyond? I think it was the CAD 30 million you referenced.
Why don't I just give you the big picture and then, and then Chad will, will give you the numbers. I think generally we're feeling good about having achieved cost savings faster, and they're likely to be better than we had hoped. I would say there's more complexity under the hood around sort of unwinding systems and that kind of thing. You know, fully resolving all of those issues will take a little longer than we might have expected going in. I think we did great diligence on that.
I feel really good about the big picture, but there is a lot of complexity in these technical stacks in banks, as you all know, and that'll probably take a little bit more, well, take more effort on the part of our team. Probably not so meaningfully to you as outside investors, but certainly a fair bit of energy required just to sort that all out.
Yeah, I'd say, if you think back to day, as we looked at this as a business case investment or as a how do we deploy capital, I'd say the top line is coming in stronger than expected, so we've retained more business and we're growing more business, as Andrew noted, with our credit union partners. That includes loan syndication opportunities, more credit union services, and there's some more referral business, including as you think about even equipment financing and how we're partnering with that distribution channel and offering our products. Those have been positive upsides, including the how we've retained those funding sources. You think of an additional synergy level, for example, even the credit rating increase that we received, that had positive tailwind as well for our interest expenses.
You think of the covered bond issuance we just did, that we were able to also pursue this year because of the additional capacity, because of Concentra, that's another plus side. When you look at the cost side in general, Lemar, if we were saying CAD 30 million, you know, I won't necessarily give a precise figure, but I would say we well over-delivered that on an annualized basis, and by over, I'd say, you know, comfortably stand by well over 10%, that we over-delivered that on an annualized basis. All that, with the way we're going, as these numbers become more integrated, all that's reflected in our updated guidance, and that's why our guidance has also increased in addition to the other core portfolio growth. Does that answer your question?
Am I answering it?
Yeah. Yeah, it does. I mean, the Concentra is clearly evolving better than I think any of us were, were expecting. I'm just to really kind of understand all the moving parts here. Some of them are easier to understand than, than others, to be honest with you. Just moving along then, just on non-interest revenues. Chadwick, I think you might have mentioned this in your opening remarks, but I probably missed it. Why are we excluding the gain on strategic investments in your adjusted results? Like, we don't usually see those kind of reversed out of adjusted. Wondering why that was the case this quarter, and then can we expect that moving forward?
It was the, the magnitude of it. You're right, you have seen those in the strategic investment line in the past, you know, CAD ±2 million here and there. When we, we think of consistency and transparency on the core business for our investors, we didn't think it was appropriate to show that through the adjusted results, especially when you look forward a year and look back, it would be, it could be a little bit confusing. It's certainly there and reported. Importantly for our investors, it's there in the book value either way, but for cleanliness and of reporting on a go-forward basis, we've made the prudent choice, I think, to exclude that from the adjusted side as a non-core gain.
It's kind of that simple, to be honest.
Is there kind of a hurdle rate? Like, let's say it's over $10 million, we're gonna see it adjusted, but if it's less, then, then it'll be included in the, in the, in the, in the adjusted results. Like, is there a hard line in the sand on that or no?
Well, there's no hard line. It, it may be something we need to think about to actually sort of set the expectations with you, 'cause otherwise it can get a bit noisy, but,
Okay. Okay.
I think that's actually a good, good suggestion that you have there, and we might, we might choose to adopt kind of...
Okay, then-
It's easier for us.
Yeah, that'd be helpful if you could just communicate that.
Yeah.
Then just sticking with non-interest income, that's 7% sequential loan growth in fees and other incomes. It seems that there's some reclass benefits in there from gains on loans and investments. Maybe could you, could you talk a little about what the, let's call it, the core underlying growth figure would have been? That 7% sequential in, in fees and, and other income seems a, a bit high, higher than I would expect. 'Cause I see, I typically think of that line as being more stable. Maybe you could help me understand that a little better.
That would be. The fees would be core. We've had. Remember, there's a lot of things built into fees, though, right? We have the credit union services, we have Concentra Trust, we have EQ Bank Payment Solutions. We have actually quite a few, few categories that come in there. A lot of that is core, where you could see, sometimes in some quarters, you could see some very light volatilities, depending on even on our trust business, when you see certain estate fall ins. Some of those businesses, the newer businesses for us, can be a little bit more lumpy. I'd say that is core fee-based growth, including even new things we offer, including on the payment side and EQ Bank and some of the, the prepaid solutions, and including what we do with Blackhawk. There are some great, great new solutions.
Let me try this. Would with that CAD 14.5 this quarter, is that an appropriate starting point to think about the fees and other income line, like going forward?
I think, I mean, don't forget there is securitization income in that number, right? That's, it's not...
It's all part of the 16.1. So it's, it's kind of ± . Yeah, t's a fair starting point, Lemar. And I know it's you're trying to get to a new clean baseline because this is only the second full quarter with Concentra, but kind of ± for the fee side.
Okay. That's, that's helpful. Thanks again for the time, guys.
Your next question comes from Étienne Ricard, from BMO Capital Markets. Please go ahead.
Thank you. Good morning. On EQ Bank, you're expecting deposit growth to be in the high single digits this year, which essentially implies that EQ Bank, as a percentage of your mix, should stay relatively flat. I, I understand it's a balancing act. On one hand, you're offering, you know, offering the, the attractive rate and growing deposits, but on the other hand, also leveraging that platform for NIM expansion. Looking forward, how do you think about balancing those two, given we're in a higher and arguably more competitive deposit market today relative to a year or maybe two years ago?
Yeah, I'm not convinced we're in a higher competitive scenario, frankly. You know, our proposition is very clear. You get a great rate with EQ Bank every day, every year, and we're consistent on that. You know, our competitors, the primary two competitors we think of in that space, tend to come out with these short-term rate specials that today, because of the inverted yield curve, various other factors, they're coming out with some pretty high rates. Now, you only get that high rate for 90 days or whatever the particular promotion is. We're not really interested in chasing and competing with it, with that. There's no real way for us to do that other than to break our brand promise to our existing customers. It is a subtle thing.
What we're trying to do, what we believe we're doing and where we're having, we believe, fantastic success is showing that the innovation we're bringing to Canadian banking really makes EQ Bank the place to deposit your money. You know, for example, if you take your EQ Bank Card on Europe with, to Europe with you to draw money at the ATM, you're likely to end up with 3% more cash in your jeans after drawing money out of an ATM than you would otherwise. It's these kinds of value-added, you know, compared to any other bank account, frankly. I stand correct if I challenge anybody, the EQ Bank Card is the magic card to take on vacation. You know, that's where we're trying to drive the value prop.
As we say, you know, if we sneak up rates, we will see faster deposit growth, a little bit at the expense of NIM, but also, you know, potentially kind of eroding our brand promise. Really, we're trying to present the full value of the platform. I think you will see over the next little while, you know, some enhancement in rate for those people that are super engaged with us, and of course, you know, from a risk management perspective, we want this to be, you know, we believe, first of all, there is huge value in the, in the account for this being somebody's everyday banking account, everyday bank account.
Clearly, from a risk perspective, to the extent that we're part of a household's kind of key financial metrics, it reduces the liquidity risk to us and the risk of runoff, which is an important part of our consideration set. Clearly, we could grow EQ Bank faster if we increase rates and so on, and it would be a huge source of liquidity if we did that. I see it as a huge safety valve. That, that option is always open to us as a management team. I think we're sort of going, picking our way through quite nicely right now, kind of growing at a good clip, but, but not choosing to participate in some activity in the market.
If I may say, too, just again, and I'll bring it back to what we said earlier. The one key metric we're tracking is customer growth, right? What we still believe to be true, we're making a difference, and we're growing the franchise value, and you see that in the 31% customer growth year-over-year and the amount of growth sequentially. We're literally still adding hundreds a day. As we think about the rate environment, the products and services coming on, we do believe we could increase the deposit levels with those customers that we're bringing on as the time is right and as we add more products and services. Then again, you see the momentum to points like the FHSA and as we add small business.
It's how you think about the overall economics of the business are, are evolving and maturing.
Just, we seem to be long-winded in our answers today, but the other thing to think about is the value of the term deposits inside EQ Bank. You do get great rates on term deposits. In general, you should deal with EQ Bank rather than deal with a deposit broker to get a term deposit. We're generally gonna always beat the term deposit market. It's an extremely attractive platform to come in from that perspective. Even then, because we're able to not pay as much in commissions for the deposit brokers, this represents a kind of funding cost saving compared to going through broker deposits that really only plays out over a multi-year period.
If somebody, somebody buys a five-year GIC through EQ Bank today, we might be saving 20 basis points a year over the next five years, and that will show up as, you know, increased NIM over that five-year horizon compared to raising a, a broker deposit.
Well, Andrew, that was my next question, actually. What, what do you see as the optimal balance between term and demand deposits at, at EQ Bank, and how, how should investors think about the resulting economics?
Certainly, you know, certainly the resulting economics are much higher to the extent we have demand deposits, but of course, there's an offsetting riskiness around demand deposits, which, you know, I understand and worry about. Just to reiterate, we only allow demand deposits up to CAD 200,000 in that platform. That's why we've been lobbying, lobbying for higher CDIC rates. In the overall scheme of things, we believe we're at a very stable demand deposits. I mean, this 50/50 split between demand and term is something I feel very comfortable with. Frankly, I don't think we've cracked the marketing nod of people coming to us just to buy GICs.
We think most people come into us, looking for the savings account, and then we're able to cross-sell on term deposit to them. I do believe that, you know, a message around this is the best place in Canada to buy a GIC is something we need to get out there more as a louder voice. If we were able to do that, then I'd be certainly very comfortable if the amount of term deposit, the relative share of term increased vis-à-vis demand.
Thank you very much.
Thanks.
Your next question comes from Graham Ryding from TD Securities. Graham, please go ahead.
Hi, good morning. Just wanted to start with, you know, your guidance and maybe what's implied for NIM with your revised guidance. Is it fair to say that if NIM stays at this level, that there's upside to your guidance, or are there some other offsets, perhaps, baked into your outlook?
Yeah, no, it's fair, Graham. Morning, we expect some consistency and then the margin to achieve that guidance. You know, that's, I'd say it's, we're not implying a lot of expansion in the NIM from there. Sure way to think about it.
Okay. NIM has, the expansion this year has been very strong. What, what would you be expecting as we sort of look into 2024 or even 2025, if we do see interest rates start to come back down, you know, in line with sort of, you know, consensus forecasts? What does that do to your NIM going forward?
It's hard to know, Graham, because the, you know, the market's sort of dynamic and how we have to compete and change mortgage rates, you know, is, is unknown to see how competitors behave. In general, I would say that what, what I've observed over the last 20 years in the industry is that, that if anything, in a falling rate environment, NIMs tend to expand a little bit with mortgage books, with mortgage lenders. You know, when, when rates are going up, people are somewhat reluctant to increase. These are managed rates, so here we will post our rates every, you know, we think about it every week or two. As rates go up, people are reluctant to increase rates for fear of losing market share.
Similarly, when rates are dropping, people don't feel the incentive to be the sort of market leader to, to drop rates, to, to maintain their market share. You do tend to see a slight sort of stickiness in that environment and then NIMs expanding. I would add the proviso, that all depends on sort of competitor response and exactly what's happening in the market and a whole bunch of things. In general, dropping rates are good for NIMs.
Yeah. Yeah, it's just, it's kinda you get to that consistency at the product level, right? The NIM changes at the, or as the product mix changes. Hopefully that, that helps.
We, but we have not, you know, we haven't been seeing that dynamic this year for your NIM. What is it? Is it the evolving portfolio mix? Is it higher prepayment income? What are the key factors that are driving your NIM expansion this year as rates are going up?
I think, it's two things. I mean, if you think on the mortgage books, you are seeing that prepayment income, normalizing. In an increasing rate environment, then, where, where you've got low coupon mortgages, as rates increase, you tend to see the prepayment on any individual loan will be reduced because it's a, done on an interest rate differential basis. That interest rate differential falls in a rising rate environment, and therefore, the prepayment probably is lower. As the mortgages reset to higher rates, essentially, the mortgage on a prepayment, becomes higher again, so that you'll see that normalize. I think the other big factor for us is the, deposit beta on EQ Bank, frankly.
It's not really related to mortgage pricing, it's really more related to EQ Bank and frankly, the skills in our treasury team and setting up the balance sheet to kinda go through this kind of environment.
Okay. My last question would just be some color around the increase in the arrears that you saw this quarter. In particular, I guess on the commercial side, I noticed that, you know, your Stage 3 provisioning had very little in there for commercial specifically. Maybe just some color on why you feel like your allowances, of I think around CAD 30 million commercial, are sufficient for the current level of arrears.
Yeah, I mean, it, it's really a matter of, of looking at them loan by loan basis. The nice thing about commercial is you can go, go very. Actually, for single family too, frankly, but for commercial, you can look at these larger loans a nd analyze where you are on a key basis, what's your resolution plan? Certainly, two of them I've looked at in detail, and they're pretty low LTVs. The resolution might be messy and so it takes some time. I think i n both cases, two larger loans were involved with your bank and some others with the same borrowers. I think they will resolve attractively, but, it, they are, the asset coverage is pretty good.
Okay. That's it for me. Thank you.
Thank you.
Your next question comes from Jaeme Gloyn from National Bank Financial. Jaeme, please go ahead.
Yeah, thanks. Good morning.
Good morning. Good morning, Jaeme. We do know how your name is pronounced.
Thank you. Appreciate that. Sticking with the NIM theme, just wanted to get a bit of an update, I guess, on the covered bond program, some success this quarter. What, what type of cadence would you be expecting in size? Like, I assume that demand remains strong from investors on that front, so just wanted to get a sense as to how you see that, that funding structure building over the next several quarters.
Yeah, sure. Thanks for the question, Jaeme. It's that certainly remains our lowest source cost of wholesale funding. We believe in the strategic value of the program, especially having gone into Europe for that program. We have, I'd say plenty of capacity left. At a minimum, we'd want to be in the market once a year. You could still even see at some point, a reopening trade, moving some say, one of our other issuances to a euro benchmark at EUR 500 million. Going forward, consistency at least once a year, and growing to probably more like a CAD 3 billion+ Canadian program as our assets grow.
At the last issuance, you'll note, we had seven new investors, great investor appetite, really healthy marketing, and the overall program continues to grow.
I guess, why not more than once a year?
It's how you manage your capacity, right? We are still capped at 5.5% of assets. We would hope that that changes at some point to reflect the balance sheet growth. You have to be thoughtful about how issuance could come up for renewal, so they're often three-year term. How they come up for renewal and how you manage your, your balance sheet and your issuance capability, because it is important to be in the market at least once a year.
I think the other thing, Jaeme, just again, is this whole risk management, overlay. The covered bond market seems to have been, been resilient for the last 400 years, so hopefully it'll be resilient for the time that's important to everybody on this call. To have some, some covered bond capacity, available in a, in a tight, you know, a tight liquidity market, is just something that I see as a very valuable thing to kind of have sitting on the shelf. We would never want to be kind of completely maxed. We would want to have a lever to pull there to be able to go into that market.
Okay. You know, as I think about the NIM going forward, I, you know, I hear the guidance is, you know, consistent or I guess, flat for the rest of this year into next year. I'm wondering why there wouldn't be more NIM upside to be expected in the, in the upcoming quarters, at least this extended Q4 quarter, as, mortgage prices or mortgage yields that are rolling off are repricing now still at, significantly higher rates, I would assume. You know, my view is that there would still be some NIM upside here in the next couple of quarters as that mortgage yield repricing is higher and faster than deposit costs or overall funding costs are.
I'm just, want to get a little bit more color from you guys as to why you wouldn't expect more NIM upside here near term?
Well, there, there, there could be. What we're saying, we, you know, we'd expect for some consistency, but you gotta even think of the nuances, right? When you think of margin, we said this last quarter, too. Things like normalization of prepayment income. As rates change, will that prepayment pattern continue or not? You know, every CAD 1 million there is about 1 basis point you can almost assume as well. There's, there's a lot of variables here. We're saying, yes, should expect consistency, but it, it could expand from here. Andrew, how do you think?
Yeah, well, the, the other thing, of course, is just mix. I don't think we, you know It's pretty hard to communicate the impact of NIM, of mix, of aggregate NIM. Our NIMs at the business line level are, are very consistent. As we see a mix change, because we have lower risk weights on residential mortgages, we have a lower NIM on them, and they still produce great ROEs. As, as we see the single-family mortgage, single-family market, you know, expand at a faster rate, which is, is our expectation, you know, that puts a little bit of pressure on, on NIM at the top of the house. At the business unit level, that's great.
I think we, we always try to have a little bit in reserve to kind of think about the, the impact of, of product mix. Clearly, we don't want to make the guidance so complicated, sort of assuming this product mix, and then we'll do this or that. You know, there, there is room, I think. I think, you know, the general sense that we have an optimism we'll be able to at least deliver on what we've promised and perhaps there's some upside. I think this is the right way to think about it.
Okay, yeah, I mean, conventional loans growing faster than residential loans or personal loans should support that, that NIM upside as well. At least that's what the guidance for the rest of this year looks, looks like.
Exactly, Jaeme. I mean, like, I'm not expecting much in the way of, not expecting to see insured single-family, for example, expand faster than, than other parts of the book.
Yeah.
That actually helps NIM. You're right on. That's exactly. You're thinking about it right, for sure.
Okay, good. Shifting to the credit side of the story. You know, someone touched on the commercial side, but I, I wanted to focus more on the personal loan side and delinquency rates, you know, jumping up. Still, still low levels, obviously, when we're talking about these delinquency rates, but, you know, the direction is obviously unfavorable. We're kind of at a level now on personal loan delinquency rates that are higher than 2019. I just wanted to get a little bit more color from you guys on, you know, what you're seeing with those delinquency rates. Is there any, any, you know, characteristics or themes in those personal loans that you're seeing that is driving higher delinquencies?
Yeah, not, not really. I'm still pretty relaxed about it, frankly. I, I do think you do end up sometimes with this kind of. I suspect that high mortgage shock is encouraging some people to sell their house and, you know, preserve the equity and move to different types of accommodation and so on. So there might be a little bit of a churn in the book as a result of that. Sometimes it, you know, I've observed in the past, and I don't know whether this is true, true this time, is that when people sort of actually sold the house, know they're gonna pay the mortgage off out of the house proceeds, they tend to maybe, maybe not make that last month or two of payments doing, it's gonna quickly resolve.
I think that could be one of the underlying pieces. Of course, of course, quarter end was exactly when people would most likely be active in the housing market, moving, you know, once the kids are out of school. There may be a little bit of that there. I mean, these, as you say, though, are still very much within kind of historical norms. Yes, there's definitely, you know, some challenges for some people, for sure, you know, interest rate shock and what the Bank of Canada has done and how people might even be listening to the chairman of the Fed a year, you know, a year or two years ago and, and not being concerned about interest rate rises.
Then we've, all of a sudden, the market to change, change the perspective is causing some, some, some interest rate shock for people. I would say the general big picture is it's amazing the other way, how, how well people have been able to take these interest rate shocks in their stride.
Okay, just sort of following on that, you know, interest rate shock, I guess, you know, if I look at the remeasurement of allowance for credit losses, pretty big driver of, you know, say, Stage 1 and Stage 2 increases. Normally, I would, you know, attribute that to deteriorating macro assumptions, but it seems your macro assumptions are actually improving. So that would indicate that this is being driven by changes in credit risk. So, you know, is it that interest rate shock that you're, you're baking in and overlaying some more risk attached to that? Or are there some other factors here that are playing into that increase in remeasurement in Stage 1 and Stage 2 allowances?
I mean, there's a bunch to unpack there. Maybe, probably Chad could give you more color offline, frankly, that, you know, the, the impact of the models are not just the sort of instantaneous changes in, in forecasts. There's some time effects about how those, how those changes flow through the models. That's creating a little bit of, even though the, the forecasts are changing in a positive way, still putting a bit. The models lead us to put, to put more away going forward. Chad can get into the nuances of that. It's pretty technically complicated. I think that's probably the big driver.
We do apply expert judgment to put some overlays in place here, and, and so that's kind of how we, how we. That's, the overlays are done with the technical driver, and again, Chad can give you more feeling, feelings on that.
Okay. Thank you.
Thanks, Jaeme, and follow up, not a miscall. Yeah.
Yeah.
Okay, there are no further questions at this time. I'll turn it back to Andrew Moor for closing remarks.
Thank you, Colin. That's, that's a great voice to conclude the call on. Before we leave you today, I want to thank my fellow Challengers for living our purpose of driving change in Canadian banking to enrich people's lives. More than ever, Canadians need a bank that works for them, and ours does. We look forward to our next analyst call in early December. In the meantime, please keep an eye out for new innovations coming your way from Canada's Challenger Bank. Be sure to avail yourself of the opportunity to have less take and more bacon. For any of those, any of you traveling to Europe in the next few weeks, I would encourage you to take the EQ Bank card with you. Enjoy your summer. Thank you for participating, and have a great day.
Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.