Earnings Call: Q3 2018

Nov 9, 2018

Good morning, ladies and gentlemen. I'd like to welcome shareholders and analysts to Equitable's third quarter 2018 conference call and webcast. Later, we will conduct a question and answer session with participating analysts on the call. Before we begin, and on behalf of our speakers today, I will refer webcast viewers to slide 2 of the presentation and our callers to the following information, which contains the company's caution regarding forward-looking statements. We remind you that certain forward-looking statements will be made today, including statements regarding possible future business and growth prospects of the company. You are cautioned that forward-looking statements involve risks and uncertainties detailed in the company's periodic filings with Canadian regulatory authorities. Certain material factors or assumptions were applied in making these forward-looking statements, and many factors could cause actual results or performance to differ materially from those conclusions, forecasts, or projections expressed by such forward-looking statements. Equitable does not undertake to update any forward-looking statements made by itself or on its behalf, except in accordance with applicable securities laws. Additional information on items of note, the company's reported results and factors and assumptions related to forward-looking statements are available in Equitable's Q3 2018 MD&A and earnings news release. This call is being recorded for replay purposes on November 9, 2018. It's now my pleasure to turn the call over to Andrew Moor, President and CEO of Equitable Bank. Please proceed, Mr. Moor. Thank you, Joanna. Good morning, everyone, and welcome. I'm joined by Tim Wilson, Senior Vice President and Chief Financial Officer of the bank. For all of our business lines, Q3 was one of the most productive periods in our history and for the bank's earnings, our best quarter ever. On the strength of better-than-expected market conditions and great execution, mortgages under management are CAD 1.4 billion higher than we thought they would be when the year started, which creates a substantial tailwind for future earnings. Meantime, EQ Bank surpassed CAD 2 billion in savings deposits, further solidifying its position as the consumer's choice for all digital banking. Based on these results and on our updated market and economic assessments, our outlook for growth has improved. Today, we'll be talking about the underlying reasons, update you on progress against our priorities, and provide insights into our position as Canada's challenger bank. Looking briefly to the quarter's key financial metrics. Diluted EPS was 27% higher than a year ago and 9% above the previous all-time record set in Q4 2016, which notably did not include any costs associated with managing through last year's liquidity events. As you know, liquidity event-related costs are now lower than a year ago due to declining insurance premium amortization and the downsizing of our backstop last quarter. These lower costs, along with strong underlying earnings performance, support an ROE of 15.9% in Q3. Either way, our returns were high and demonstrate the advantage of Equitable's value creation approach. On the shoulders of this performance, we increased our dividend again yesterday to CAD 0.28 per quarter or CAD 1.12 annualized. Turning now to report on our five key strategic priorities. The first is to grow our existing businesses through superior service. In the third quarter, mortgages under management increased 14% year-over-year or CAD 3.2 billion. In alternative single family, our book was up by 13%, based on strong originations and excellent mortgage retention. Although the updated B20 guideline that became effective in January was widely viewed as a headwind to originations, several countervailing factors worked in our favor, including a concerted effort by our single-family team to give great service to brokers and borrowers, market share gains, and higher retention rates on our existing book of business. As you know, for more than a decade, Equitable has centered its origination strategies on superior customer service to our mortgage broker customers. It was heartening to learn that in a recent national survey conducted by Canadian Mortgage Professional Magazine, Equitable finished first amongst alternative lenders in five categories: underwriter support, broker support, turnaround times, satisfaction with credit policy, and transparency of commission structure. These are coveted wins, and I thank our single-family team for the hard work and single-minded focus on customer service. Our outlook for growth has improved again. We now expect our alternative single-family portfolio growth to be in a range of 11%-13% for 2018, compared to our original forecast for the year of 2%-4% expansion. That difference means that we will end the year with approximately CAD 840 million more in assets than we had expected, setting the stage for a profitable 2019. As we reported last quarter, growth in single family also continues to be accompanied by higher average Beacon scores within our uninsured residential portfolio. This uptick is a function of benign credit conditions in the economy and may also be a byproduct of B20 changes. Considering current market conditions, the outlook for the broader economy, and renewal dynamics, we expect continued growth next year. We'll provide more color on our 2019 outlook next quarter after we've worked through our normal budget cycle. Needless to say, we're optimistic about the growth runway for our lending businesses. In commercial, the bank set new high watermarks for mortgage principal and quarterly originations, up 27% and 48% respectively. This best ever performance reflects our strategy of allocating more capital to commercial and the team's outstanding success in building the breadth and depth in our partner relationships through high-quality service. Improved renewal rates so far in 2018 have supported overall portfolio growth. Growth in our commercial assets has been spread across a wide variety of asset classes, including industrial, office, multis and construction facilities. We funded our first CMHC-insured commercial construction loan in the quarter. This represents a new lending niche for the bank and another solution for our commercial customers. More generally, it reflects our ongoing desire to diversify and be recognized as Canada's challenger bank in all business lines. We've also elevated our outlook for commercial. We now expect asset growth to range between 20% and 25% this year, compared to our previous range of between 18% and 20%. We continue to allocate a healthy amount of capital to commercial, and outlook is for ongoing growth in 2019. Securitization financing mortgage under management grew 11% versus last year, reflecting originations, renewals, and multi-unit residential mortgages and growth in our prime single-family book. Prime mortgages that we originated through our internal team grew 24% year over year as a result of a steady increase in broker relationships built on service. Those originations were supplemented by CAD 400 million originations sourced through third-party partners. These prime mortgages are not particularly profitable at the moment, given price competition in the market. We expect them to be much more profitable on renewal. Our second priority is to cement EQ Bank's position as Canada's leading digital banking platform. We gauge progress against this priority by tracking a number of indicators, including customer feedback, savings deposit growth, and new digital account openings. On each count, EQ Bank continues to make great progress. Last quarter, I said EQ had reached 60,000 customers. That total now exceeds 66,000. I also said that EQ was closing in on CAD 2 billion in savings deposits. That number is now approaching CAD 2.1 billion, 31% higher than a year ago. Pervasive EQ Bank marketing early this year by our advertising, social media, and partnerships has clearly lifted brand awareness and led to more account openings, while market-leading digital capabilities and the recent launch of EQ GIC products are encouraging existing customers to save more with us for longer periods. To pave the way for even more per customer savings, we recently increased the deposit ceiling for the Savings Plus high interest account to CAD 200,000 and allowed EQ customers to open up to 20 GICs each, which enables more effective laddering. We are very excited about the roadmap we are on. Just this week saw us launch a new EQ mobile bank app that includes the latest in biometric authentication capabilities, i.e. face recognition to open the app. We are also deep into planning for 2019 developments, including an enhanced customer contact center, a move to cloud infrastructure, and several new product launches. We are also delighted to receive approval from Bill Morneau, the Minister of Finance, to set up a new trust company, Equitable Trust, a subsidiary of the bank. Amongst other uses of the unique powers of a trust company, we expect to be able to offer more deposits insured by CDIC into the EQ Bank platform. Priority three is to leverage our capabilities and balance sheet to diversify into attractive adjacent markets that can support asset growth over the long run. So far this year, the headline story is the launch of our reverse mortgage business, which from birth earlier this year is now finding its feet and getting great feedback from our mortgage broker partners. We recently made changes that will enhance competitiveness. I am more convinced than ever that reverse mortgages will become an important business for the bank over time. More broadly, we are thinking about how Equitable can bring value to people at the decumulation of assets stage of their lives, also known as retirement, and how the bank can bring valuable solutions to these people. Within commercial, we also grew our specialized financing pipeline in the quarter, lending to other lenders who operate in attractive market segments such as equipment financing. This business allows us to combine our balance sheet and strength as a secured lender with the distribution and credit management experience of other companies and thereby diversify into new asset categories. We expect to continue to see this business grow in upcoming years. Priority four is to maintain a disciplined approach to capital management and a low risk profile. Compared to last year, higher asset growth meant that our CET1 ratio edged lower in Q3, which means we have successfully and profitably deployed a significant portion of our excess capital that will benefit shareholders through stronger earnings in future quarters. Although we are still carrying some excess common equity, it is not as pronounced as last quarter. As for maintaining a low risk profile, the evidence can be found in our credit metrics. Net impaired mortgage assets were just 16 basis points of total mortgage assets. While up from last year, due partly to the adoption of IFRS 9, 16 basis points is still an extraordinarily low rate even by our standards. Considering economic forecasts, our view is that risk in the Canadian residential real estate has decreased over the last couple of years due to the more balanced supply and demand dynamics. The credit quality of the mortgage has strengthened. As a result, we expect our arrears rates and credit loss provisions to be low for the remainder of 2018. That said, we are always prepared to act quickly to address any areas of elevated risk, and as a matter of policy, the bank remains well reserved with allowances for credit losses equal to 11 basis points of our assets, well above our long-term loss rates of four basis points. Our fifth priority is to strengthen our key capabilities. We continue to do this by hiring great people, investing in our technology infrastructure, and advancing our AI/BI initiative. As you probably saw in a press release put out last week, we have committed to invest in the Portag3 equity fund. This brings Equitable more centrally a globally leading fintech ecosystem. We already have a deep relationship with the team at Portage. We have been co-investors with Portage and Borrowell for a number of years, which is really paying off for us, and we are providing deposits into the Wealthsimple platform, a Portage investee company and the leading robo-advisor in Canada. I am optimistic that we will find additional opportunities for the bank to do business with other parts of the Portage ecosystem. In other important news, our board also strengthened its capabilities with the appointment of Sue Ericksen. Sue has worked as a chief information or technology officer at several Fortune 500 companies such as Coca-Cola, New York Life, Fiserv, Merrill Lynch, and Citi. Her experience in technology leadership positions will be invaluable to us as we advance the IT infrastructure that has made us Canada's digital bank innovator. Now I will turn the call over to Tim for his report. Thanks, Andrew, and good morning, everyone. In Q3, our key profitability measures, namely net interest income, efficiency, and EPS, were well above last year and the expectations that we had communicated last quarter. We attribute our record performance to strong asset growth, the diminished costs of the now smaller backstop facility, low losses, and improved margins. We were truly firing on all cylinders in Q3. Our results were also buoyed by CAD 2.8 million of derivative gains related to our participation in the CMB program. Even normalizing for these gains, our performance would have been above expectations. EPS would have still been an all-time record of CAD 2.68, and ROE would have been 15.2%. Net interest income was up by 29% over last year due to 13% growth in average assets and improved margins. Total NIM expanded by 22 basis points compared to last year to stand at 1.69% in Q3, the best showing in seven quarters. NIM in core lending was 22 basis points above last year due to lower liquidity event costs, higher margins in our commercial book, and various shifts in asset mix, all of which are itemized in our MD&A. NIM was higher despite reduced levels of prepayment income in single family. As expected, quarterly interest expenses associated with what is now an CAD 850 million backstop facility declined to CAD 2.3 million in Q3 compared to CAD 5.4 million a year ago and last quarter. In addition, last year we recorded CAD 4 million of amortization expense associated with mortgage insurance that we obtained during the liquidity event. This year, that number was essentially zero. In other words, quarterly liquidity event costs are down to CAD 2.4 million after hitting a high of CAD 9.4 million last year in Q3, and they should stabilize at that level at least until next June when our facility matures. Our NIM performance far exceeded what we had expected, particularly in core lending. We had expected core NIMs to be between 2.3% and 2.35%, but we exceeded the top end of that range by 12 basis points for four main reasons. First, the level of price competition in the single-family market abated slightly compared to our last outlook. Between May and October, we were able to put through a few rounds of price increases to some of the products on which we were seeing the tightest spreads, and those increases seem to have stuck. Second, GIC rates dipped by approximately 20 basis points for a period in both July and late August, which also helped third quarter margins. Thirdly, spreads on new commercial deals continued to move up in the quarter, partly due to ongoing increases in the prime rate. Finally, our low-margin liquidity portfolio decreased in relative size, which caused a positive mix shift in our assets. This decrease was a function of normal seasonality in our business. We need less cash on hand as we head towards Q4 and Q1, which are typically periods of lower mortgage funding. The spreads on our liquid assets were also helped by the prime rate changes. Looking ahead, we believe that Q4 NII will increase at year-over-year rates in the high teens. This is higher than we expected last quarter due to both asset growth and margin stability. While GIC rates have moved up over the past month, recent prime rate and mortgage rate increases should offset the majority of that rise in our cost of funds. I also want to highlight that while we expect NIM to be relatively consistent from Q3 to Q4 within each business unit, you will likely see a decline in our overall weighted average NIM, and this is partly due to asset mix. We expect our lower-yielding securitization financing portfolio to grow more quickly than core lending, which will cause the weighted average NIM to decline. Despite investing more in strategic initiatives, our efficiency ratio improved to 36.3% in the quarter, 1.1 percentage points lower than last year and 6.6 percentage points lower than last quarter. Expenses themselves grew at 19% year-over-year, just above the growth rates of our assets, as we had expected. Drivers of the year-over-year expense growth. Some of it in advance of the benefits realized included 12% higher FTE and a 23% increase in spending on technology and systems, consistent with our objective of building our IT capabilities to support our growth. Marketing and corporate expenses were up 39%, but down sequentially as we completed a very successful marketing campaign for EQ Bank in Q2. For the remainder of 2018, we will continue investing in our strategic priorities. Consequently, we anticipate that Q4 non-interest expenses will increase at year-over-year rates slightly higher than the growth rate of the bank's assets, and that our efficiency ratio will be in the high 30% range. In dollar terms, we expect expenses to increase by up to CAD 2 million from Q3 as a result of continued hiring and investments in some important technology initiatives, such as the move to cloud infrastructure that Andrew mentioned earlier. With that, back to Andrew. Thanks, Tim. Equitable is really hitting its stride as Canada's challenger bank. A challenger is partly a position of strategy and partly an attitude to taking an innovative and authentic position of change in the market. To reflect our challenger spirit, we have chosen to reimagine our bank's brand identification, including our logo, which you will now see on all public and investor-facing communications. We believe our new branding is bright, clear, powerful, and indicative of a commitment to rethinking all elements of banking as a service-focused innovator. All of the great work involved in this redesign was done internally by our marketing team at Equitable, and I sincerely thank them for their creativity and passion. I must admit, I'm pretty damn impressed by the intellectual insight that underpins what you see in this branding change. In closing, the record earnings we've reported and the strong growth we've delivered across all our business lines is very encouraging. Our plans for 2019 are taking shape. Our outlook for earnings growth is positive. Our opportunities to build new businesses are many, and we look forward to Canada's challenger bank delivering more value to its customers and shareholders in the years ahead. That concludes our prepared remarks, and now we'd like to invite your questions. Joanna, can you please open the lines to our analysts that have questions? Thank you. Ladies and gentlemen, we will now begin the question and answer session. Should you have a question, please press the star followed by the one on your touch-tone phone. Should you wish to decline from the polling process, please press star followed by two. If you are using a speakerphone, please lift the handset before pressing any keys. Your first question is from Marco Giurleo from CIBC. Marco, please go ahead. Morning, guys. Morning, Marco. My first question today is on the prime single-family growth. You saw very strong growth of 11% sequentially this quarter. I am just wondering if you could give us some color on, one, what is driving the growth? Two, Andrew, I think you mentioned these loans are less profitable, but I think you were referring to mainly the lower NIM. Can you talk about maybe the ROE on these loans and how you expect the growth of this business to impact your overall ROE? Sure. Thanks, Marco. It is something that we have been thinking about a fair bit actually recently as it turns out. In terms of growth, it has really been a matter of the prime team, and I may sound like a broken record on this, but we come in every day trying to outservice our customers, and our team has just done a fabulous job in this area over the last little while. It is almost as simple as that. Combined, though, with a really state-of-the-art switch program. So we are seeing more opportunity for when mortgages reach the end of the term, being able to switch them into the bank. So one could imagine a mortgage with another lender. And historically, it has been quite difficult for brokers to bring that mortgage on renewal to another bank. We have, I would regard, a state-of-the-art switch program, and that is helping to drive earnings. In terms of ROE, there is very little capital in this business. It is almost zero capital. These are insured either by Genworth or CMHC. If they are insured by a private insurer or for that matter, Canada Guaranty. If they are insured by a private insurer, there is a small amount of capital associated with the loans. To the extent you only make any margin, the ROE is effectively infinite, although it does use some of your leverage ratio. We actually end up with a slightly different accounting result when we buy loans from third parties. We will pay a single upfront fee and amortize it over the life of the loan. And those do have a positive impact on our ROE right from the day we buy them. When we originate them internally, the internal costs are actually expensed right up front. The accounting impact is actually to be probably to even make a loss in the first year, which is recovered in later years. So this does not really have much of an impact on earnings in the year of origination, any impact over the first three to four years. Once you get to renew this mortgage, though, the costs associated with re-underwriting are much lower and any fees to brokers are typically more modest, so there is a higher margin at that point. But I would say spreads are very tight right now. All right. What proportion of the growth would you say is acquisition versus EQB originated? There were roughly CAD 300 million of acquired mortgages added to that portfolio in the quarter, Marco. Okay. That is a number that we expect roughly to repeat in Q4. Beyond that, we are still in negotiations in terms of these sourcing partnerships, so do not have visibility into the origination potential beyond Q4 at the moment. Can we report what we originate on our own account as well separately in the MD&A? Not separately, no. No? Okay. The term on these mortgages, is that similar to your traditional business or your non-prime business or- These would be mostly five-year loans. Almost all of them. Five-year loans. Okay. Then on renewal you get better terms. That's right. All right. My last question is just on the tighter rules around HELOCs introduced by some of the big six banks this week. Just wondering if we could get your take on the tightening of the rules and if you think it will be a tailwind for your mortgage business. I think it's sort of too early to say. I've been asked recently about what we think the next regulatory change might be, if there are any. It does seem that HELOCs haven't really been fully embraced into the B20 world. One of the obvious gaps is that if you qualify for a HELOC, it appears that the qualification level is never revisited. You could be in your mid-50s earning at a peak earnings power, and you'd still have that drawable amount as the approved credit 20 years later without it being revisited for most banks. Which clearly doesn't make much sense when you think about the five Cs of credit and the capacity to repay. Generally speaking, we would think this is something of a tailwind for our reverse mortgage business if HELOC rules start to become perhaps a little more rational around how we think about these things. I'm not saying, by the way, there's any need for change, but there's clearly a much more rigorous approach to new regular mortgage advances than there is to HELOCs. It's an area that wouldn't surprise me to see regulatory pressure. All right. Thanks a lot, guys. I will re-queue. Thank you. Your next question is from Jaeme Gloyn of National Bank Financial. Jamie, please go ahead. Thanks. Good morning. Morning, Jamie. My first question is related to some commentary in your outlook. It is regarding some specialty lending programs and financing some of these specialty lending programs, three of them in particular. You highlight equipment leasing as part of one of the strategic initiatives. Can you give us some color around what kind of specialty lending programs these are, what is the underlying asset size, expected revenues, things of that nature? Yeah. Sort of modest revenue. I think the facilities are, roughly speaking, three facilities, CAD 25 million apiece, secured by hard assets typically. So think of things like trailers or construction equipment, where we are in the senior lender position, so the owner of the specialty lender has subordinated position behind us. Effectively, we are cross-collateralized across all the asset pool. So feel pretty good about the structures we are putting in place there. This is clearly part of a broader push to understand equipment financing markets in general, with a view that over time, that might be something that the bank as a whole is more encouraged in participating in more directly. It seems like a pretty interesting area of lending to us. It turns out that we have got a couple of senior people in our risk area that really understand this market, having come from one of the leaders in this business a few years ago. So it is a bit of a kind of evolution and development. The programs are set up to finance the lenders' activities. Are any of these lenders publicly traded, or is it I am just trying to get a sense as to who you are financing, who is doing the adjudication of some of these loans as well? None of them are publicly traded. These are smaller specialty finance shops, typically backed by private equity backers. Okay, thanks. One of the comments on page 15 of the MD&A around your non-interest income is lower gains on sale of foreclosed homes as a driver of a year-over-year decline in non-interest income, as well as amortization and categorization of certain fees. Can you talk about why that lower gains on sale of foreclosed homes didn't show up in the sequential decline as well? Also about what kind of changes happened here in non-interest income to adjust amortization periods and categorizations? Yeah, I can take that one, Jaeme. On the first point about the foreclosed homes, the gains or losses we realize are really individual property dependent. I'd have to go back and reference the exact properties we were able to liquidate. I think it wasn't a home actually. I think it was one commercial property. Okay. A mall that we had foreclosed on a few years ago that we sold for a gain last summer. A small mall. I do not think this is actually homes. The other point about the fee income, that one is easier to explain. There are certain fees we charge on renewals of mortgages, and we actually changed the categorization of the reporting of those fees during the quarter, and we moved them from other income into NII, which is more consistent with the way we treat every other fee. While the change was significant, that it created a bit of blip in other income, it is not significant enough that you would actually notice the difference in NII. Going forward, we will be reporting it as part of net interest income. Okay, so safe to say the Q3 number is a fairly clean number at this point. It is a clean number, and I would use that as your run rate. Right. Next question is related to some changes in the stage 2 mortgage commitment risk and stage 2 mortgages receivable both in the standard risk columns or rows, I guess. Seeing an uptick there from Q2 and Q1, can you just explain, or maybe just give us a little more color as to what's driving the increase in those stage 2 mortgage commitments and mortgage receivables? I wouldn't say there's anything in particular I'd note there. The stage 2 can be affected by the performance of individual loans, but also by macroeconomic factors. So to the extent that the macroeconomic forecast that we obtain from a third-party agency deteriorate a little bit in the quarter, that can move more loans into stage 2, which is exactly the dynamic we saw. There wasn't a significant change in the credit performance of our mortgages. Okay. Would there be any particular geographic focus in that change or underlying asset type that drove the increase? No, not that I'm aware of. Okay. I think it was a very small change, but across the board. Okay. So more broad as opposed to, let's say, B.C. given their troubles. But I'll take that away and loop back with you if that wasn't right. Okay. Thank you. Last one for me is around Basel III and potential OSFI changes on commercial mortgages. How are you guys thinking through the potential increase in risk weights on those products and any potential impacts there or thoughts? Well, I think since OSFI itself hasn't come out with any guidance, in general, the change of standardized, we think will actually provide risk weight relief, when you think as an aggregate. So, we'll wait and see what OSFI has to say on that. We have had dialogue with the regulators about how this might evolve, but it's clear they're thinking about it constructively and sensibly, and no decisions have been made yet. Really, the only sort of word on standardized so far is about floors as it relates to the DSIBs, and the fact that the standardized approach used for the DSIB floor calculation will be different than the made in Canada solution for the standardized banks. That so far includes Equitable, who would have some different calculation methodology to reflect the regulators view of risk as various to asset classes. Okay. Thank you. Thank you. Ladies and gentlemen, as a reminder, should you have any questions, please press *1. Your next question is from Stephen Boland from Infor. Stephen, please go ahead. Thanks. Just following up on Jamie's question on the equipment leasing. I guess I just want to clarify, these are not like securitization facilities. There is recourse to you. It's not like a credit enhancement type facility. You're actually, like you said, the senior lender on this equipment. That's right. We wouldn't think of it as a securitization, but it uses securitization technology, if you like. If arrears rates rise to certain higher levels, then we would get sort of turbo collection of all the cash flows out of these portfolios and so on. But it is a corporate loan. Okay. Just in your commentary in the beginning, you talked about the backstop facility. It almost seems that you're in a position where you feel that you don't need that backstop facility when maturity comes around next year since your funding mix has changed so much over the past couple years. That's where I'm at, Steve, personally. But this is still a conversation we're having with our board, with other stakeholders. This is obviously an important decision to make and to get it right, so we're thinking it through. My own belief is that our liquidity position, our avenues and taps to liquidity, the structural funding position of our balance sheet is such that we shouldn't need this. But this is a decision the board makes, and other members of the senior executive team have views, and people in the community broadly. So we're certainly welcome to listen to views from shareholders, creditors, and so on about how they think about this. But my sense is come next June, that we'll be in a position to eliminate the backstop. Okay. Just last question on getting another trust license. I remember when you converted from a trust to a bank, part of it was the lack of recognition about a trust, and certainly that you were paying more on deposits or you had to give out more on GICs. Is this really just to allow people to diversify if they want to sort of get the insurance, as opposed to going out to the market with a trust GIC that might be 10 or 20 basis points more than that you're offering with the bank? Certainly, we want to be able to offer higher limits to our customers from CDIC coverage perspective. You can imagine that as we build the tech stack within EQ Bank, the first CAD 100,000 will be sitting as an EQ Bank insured CDIC loan deposit. The second CAD 200,000 would actually be moved automatically down to the trust company, where it will also have the benefit of CDIC coverage because it is a separate legal entity with separate CDIC coverage. More than that, as I mentioned earlier, we are thinking about, as part of our challenger bank agenda, the decumulation of assets and the stage in the people's lives when that is relevant to them. Having trust powers may allow us to develop other businesses using this trust license. Yes, it is about CDIC, but it is about delivering other value to the Canadian consumer. Okay. Thanks, guys. Thanks, Steve. Thank you. Your next question comes from Jeff Quan from RBC. Jeff, please go ahead. Hi, good morning. You mentioned, I think it is page 7 of the MD&A, referencing market conditions causing non-prime origination shift to higher credit quality. Your comments on the call seem to suggest that you do not see market conditions turning the wrong way. Is it then just a matter of seeing maybe a higher proportion of borrowers with weaker credits, or is there something else that is behind those comments? I am not sure if I understood that quite right, Jeff. Could you give me a bit more? Well, it is just in page 7 of your MD&A, there is a reference talking about, oh, the market conditions, the way that they are is causing the non-prime originations to shift to higher credit quality borrowers. Yeah. I am just trying to get a sense as to what is driving that. Well, I think it is primarily because with the B20 stress test, you have to add 2% and so on to make the GDS, TDS work on debt service coverage. Some of the lower Beacon borrowers are getting knocked out by that. A disproportionate number of the lower Beacon borrowers are getting knocked out as lending opportunities. So it is causing a migration upwards in credit quality. Okay, so it is just purely, it is a B20 as to what it is, and there is nothing else that you have been seeing in terms of the applicants or the market conditions? No, I think that is right. It is B20. Okay. Just the other question I had was the gross impaired in the quarter on the single-family side went from CAD 23 million to CAD 29 million quarter-over-quarter. But the specific provisions was unchanged. Just wanted any color on that. Was it just the LTVs on the new gross impaired was really low, or is there some other factors there? Yeah, I think that is exactly right. It was a collection, I think the number is 14 single-family loans that became newly impaired during the quarter. Broad-based, no particular region of the country, and we do not expect really any losses or material losses on any of those loans. Okay, thank you. Thank you. Your next question comes from Graham Ryding from TD. Graham, please go ahead. Hi, good morning. Morning, Graham. Could I start with capital? There was just the drop in your CET1 ratio. Maybe I missed it on your comments. Was that a reflection of the strong growth of your commercial book this quarter? That's certainly one of the bigger drivers in risk weights. Of course, as earnings go up, we also put more risk weight against operational risk. It's a curious thing. The better you do, the more capital you have to put away. Those would be two of the drivers for sure. Given your outlook, I guess, for both commercial and residential growth going into next year, how are you thinking about managing your capital? Do you see commercial growth slowing, or if not, do you need to raise capital to keep that common equity tier-one ratio at this level? The best view we have today is that we don't need to raise capital, and that our kind of organic growth as we continue to face the markets in a constructive fashion will just about match the retained growth from earnings. So it feels like a pretty good level flight where CET1 should be relatively stable around these levels over the next little while. We do see seasonality. I think CET1 might grow a little bit in the slower winter months, but we need to kind of restore it a little bit to hit a more seasonal peaks again next summer. I think implied in that, Graham, is that the growth rate of our commercial portfolio will come down. I think the roughly mid-20 rates we've seen this year aren't sustainable over the longer term. We wouldn't want to be growing that portfolio at those rates indefinitely. So it will drop as we start to move into 2019. What is more sustainable growth rate for that commercial book? I think generally you should think about growth rates of our risk-weighted assets and those growing just below the rate of our return on equity. So our organic growth in capital. How commercial grows relative to single family is going to be partly a function of opportunities at a particular point in time. So to the extent one market offers more attractive returns than the other, we'll deploy our capital to that market. So can't comment conclusively other than at the portfolio level. Yeah. I think, though, we would expect we would continue to, the first choice is to put capital into the single-family market. But if that's growing at, say, similar cadence to this year, then the net result is you end up with a commercial book growing by 15%-20% next year. Okay. Then just sticking with capital, is there any discussion at the board level? I guess we're looking at a rising rate environment, fairly soft residential market. Is there any discussion around holding a bit more capital going forward relative to perhaps your last five-year average? Or how are you thinking about capital, given your outlook? I think there's certainly discussion at the board always about capital levels and capital we should be holding. I think when we think about our sort of sweet spot, though, sort of 13.5% CET1 is kind of 13.5% plus or minus a half is really how we think about our optimal capital position. And we don't think there's anything so evident in front of us that there's a need to change that. But it's a very active conversation every quarter as part of our ICAAP process to consider what the appropriate capital level is. So yes, it is reviewed very regularly, and that might change. But all the conversations we've had to date have left us sitting in that same position. Okay. Got it. Then when you talk about your commercial growth, you made a comment about increased depth and breadth of your partner relationships. I'm not sure if that was this quarter or last quarter, but are you referring to syndications with other lenders, or are these the relationships with the actual commercial investors that are becoming deeper and broader? I think, as you know, we have a long history with First National, Timbercreek, pretty much all of the commercial specialist mortgage banks. In many cases, we're putting A loans ahead where they're putting significant chunks of mezzanine or equity behind us. It's really those partners that I'm speaking of. So high quality commercial originators that have got a lot of skin in the game behind us. Okay. Just my last question, if I could. Equipment leasing, how much are you originating right now, and what is the size of this portfolio? As I said, I think there's three facilities of CAD 25 million apiece in place, and I think we've got drawn less than CAD 20 million, I believe. Yeah. That sort of scale. Got it. Okay, that is it for me. Thank you. Thank you. Next question comes from Nik Priebe from BMO. Nik, please go ahead. Hi. Good morning. Good morning. Just wanted to start by asking a few questions on some of the factors that might have impacted reported net interest margins in the quarter. I thought I'd start with liquidity. It looks like liquidity levels were a bit lower sequentially. I was just wondering if you could talk about whether there was a bit of a seasonal influence on liquidity there, and how we should expect that to evolve over the next few quarters. Yeah. Hey, Nik. It's Tim. There's definitely a seasonal influence in the liquidity numbers you see. In fact, it's almost entirely driven by seasonal factors. The way we think about liquidity is we look ahead at our cash flow needs, which would involve mortgage fundings and GIC maturities over the coming months. Then we hold liquidity partially based on those factors. As we enter a period of lower mortgage fundings, which would be Q4 and Q1, our need for a larger liquidity portfolio drops. So it's a normal pattern you'd see, and then we expect liquidity to move up again as we move into late Q1, Q2 of next year. Got it. Okay. Then maybe just one clarifying question as well, kind of staying along the same vein on the seasonal factor, but on prepayment income in the single-family portfolio. I understand that they're both kind of secular and cyclical forces affecting the level of prepayment income that you guys realize in any given quarter, but just wondering if you can talk about seasonality there as well. Should we expect kind of higher levels of prepayment as well in the more seasonally active quarters, kind of associated with above-average discharges, and then again, lower in Q4 and Q1, similar to liquidity? I just want to make sure I'm thinking about that correctly. You're thinking about it absolutely right. Prepayment income does peak in Q2 and typically drops off on either side of that. So Q2 being highest, Q3 second, Q4 and Q1 are both typically quite low. Got it. Okay, perfect. Maybe one last one here. Andrew, you alluded to this in your prepared remarks, but I was just wondering if you could expand a little bit on the advantages that you're kind of expecting to obtain from the investment in the Portag3 Fund. I recognize the connection with one of your new partners, but are there any other sort of opportunities that you see arising there? Yes, lots. In fact, I spent three days in Montreal a couple of weeks ago talking to many of the CEOs of their startup or their investee companies, and there's so many learnings they're bringing from all around the world. You may not think that an insurance broker in Germany with a very interesting model has much to sort of do with how a challenger bank in Canada may be operating, but there are lots of things to learn from all of these different approaches. I think we highlight two relationships within the Portage ecosystem, but I'm extremely confident there are going to be many over the ways ahead. Some of them may just be a sort of point solution and part of our value chain, so some clever widget, whatever, to help us with a mortgage application. Portage has an investment in one of the leading AI firms in the financial services space. Very interesting financial health firm out of California. It just opens your eyes to the possibility of what a challenger bank can be. So to be in the middle of that ecosystem is incredibly exciting for us. I think we're very realistic about it. We know what we're trying to do and build our own brand. But to see and think about what others are doing and how they're building markets and customer bases, is really interesting. I sort of sat next to, at the dinner, one of the leading guys from Chinese ventures in financial services. This is kind of learning that EQB never had before. I think our opportunity to really expand on our vision as Canada's challenger bank through this relationship is really enhanced. Okay. Thank you very much. Your next question comes from Jaeme Gloyn of National Bank Financial. Jaeme, please go ahead. Yeah. Hi, thanks. Just a follow-up here on the gross impaired loan question. It increased CAD 7 million in the quarter, and I think you said it was related to 14 loans, so let's say CAD 500 million a loan. That seems a little bit larger than your average loan that we discussed maybe a couple of years ago at the investor day. I think it was closer to in the three hundreds. Can you talk about maybe what those loans, are they within the last 12 months, or are they a different loan than your typical loan that you would be lending into? Maybe just a little bit more color around that. Yeah. Obviously, happy to answer that, Jaeme. I'm not sure I'd have all the details at my fingertips on this call. If I don't answer your question enough, we can regroup later. Obviously, since a couple of years ago, our average loan size would have increased given general inflation and the trends in the housing market. I wouldn't say any of these loans were typically outsized. Again, they're broadly geographically diversified. There were 14 single-family loans. There are also other movements within that portfolio, right? Various commercial properties and so forth. I wouldn't say there was anything, again, particularly outstanding about these loans. They were roughly in line with the average of the portfolio. Okay. Thanks. Thank you. There are no further questions. I will now turn the call back over to Andrew Moor. Thanks, Joanna. To conclude, we look forward to delivering our next quarterly report, which will be in 2019. Everybody have a great holiday season, and we will talk to you then. Thank you for listening. Ladies and gentlemen, this concludes today's conference call. We thank you for participating, and we ask that you please disconnect your lines.