Good morning, everyone, and thank you for joining us. Now we've got Étienne Dubuc. He's the head of National Bank's Financial Market segment. Étienne, thank you for being here. I wanna get us started with a very broad question. I have a number of conversations with investors about National Bank's Financial Market segment. They go something like this: "Man, have these guys had a great run, um, but something's inevitably gonna go wrong." For many years now, that has not been the case. National Bank has delivered one solid, consistent quarter after another. There aren't the massive home runs, but nor are there a bunch of strikeouts either. So how is National Bank, the financial markets, how is that segment steering itself away from some of the ditches that we've seen in the past? How do you do it?
Well, thanks for the question, Mario, and really glad to be here. Thanks for having me. I think it's right that we've had a really steady performance that has surprised the observers. I think it boils down to a few things. First of all, our domestic focus. So we are first and foremost a platform about Canada, a specialist of Canada. Our trading businesses, our CIB business has some really deep expertise in our niches, and we haven't tried to go out internationally and be everything for everybody. When we go out, it's really on a position of strength, having built something really differentiated, we feel domestically, and then we go out one product at a time.
The other factor, I think, is the way that we've organized some businesses to be more countercyclical. So I think we have a very interesting mix of countercyclical and cyclical businesses that has allowed us to weather some of the storms of the last few years. I'm thinking of 2020, the COVID year, and 2022, which was a bear market, both on the rates and the equity side. We have a business mix where a lot of trading businesses tend to do well in volatile environments, and we've organized these businesses to do well.
I'm thinking of our focus on liquidity, providing on technology, on being the best at that, and I'm thinking about our focus on securities finance, so being very nimble with the way that we deploy capital. And also our focus on structured products, where we have a really interesting franchise, both on the retail and institutional side, that we've been able to gear towards being long volatility and being really anti-fragile because it is long volatility. It keeps a lot of volatility, and that means when the markets get rocky, it's in a better position to react well and then deploy opportunistically as maybe some of our peers are hurting a bit more. So having that business mix allows us...
And that's really something that we wanna do, is to have a, like, a risk management over the cycle. I've been trading for about 20 years before I was a full-time manager, and I've lived through the dot-com, the Great Financial Crisis as a trader. And so we really want in all asset classes to do well when markets get volatile.
That, I wanna flip over to the rate story. So yesterday we had our first rate cut in Canada. I don't imagine one rate cut is that meaningful, but it does signal there's more to come. Can you speak to how this impacts your business? Presumably, it's positive, but give us some perspective on this rate cut and further rate cuts, what that could mean to financial markets for National Bank.
Yeah, overall, it is a positive, Mario. You're right. I think that the Bank of Canada starting its easing cycle and even starting it a bit sooner than the Fed will have a really positive impact, especially on corporate activity. I think it will continue to allow the reopening of capital markets. If you look at our first two quarters this year, one of the stars of the show has been debt capital markets, both on the government and the corporate side. But I think these rate cuts, and you're right, I think it is the first of several rate cuts. I think it will allow debt capital markets to continue its progression.
I think it will allow for the reopening of equity capital markets, where we've seen spurts of activity lately, but mostly in some sectors, like mining. I think this will become a lot more broad-based. I think M&A has been a bit slow this year compared to last year. I think this also helps a lot as capital markets reopen, as more opportunity to deploy money at better rates become available. And so overall, I see it as very good.
Also, having an equity market that is very strong, that really helps us in a number of our trading businesses, both on the ETF side, where it's a very big factor in what we do, and on structured products, where, as equity markets, I think, will continue to be pushed by this very positive climate with rate cuts. I think you will see us being very active on the issuance side, calling a lot of products, reissuing a lot of products, having great conversations with investors because of that. So overall, it is very much a positive that the easing cycle has started.
... You know, when I look at capital markets, Canada and the U.S., the U.S. capital market story, these U.S. banks that reported Q1 2024, the results were very, very strong, and we're seeing U.S. capital markets very strong. Does that benefit National? Your opening comments seem to suggest National's very Canadian-centric, and I get that.
Mm-hmm.
Is there an opportunity for National in the U.S., considering how much stronger U.S. capital, the U.S. capital markets environment appears?
There is an opportunity, and we've been absolutely investing south of the borders in what we're good at. So, we are doing a lot more U.S. dollar deals on the debt side. So, we've been very active on that side, building out those activities. We've just opened an office in Paris, where we will cover continental SSA clients. So, there, absolutely, you see the traditional strengths of U.S. banks. There are some things we wanna build. We wanna build them from a position of strength. Another example is our... So we are very active as a structured products issuer in the U.S., but that's with institutions. So we don't have the end client relationship.
We're more of a, it's more of a wholesale approach, where we face off against the large wealth networks over there. That's gonna get even more active. And, and finally, the market making, there are some products where we compete against the best in Canada. We can do those in the U.S. I'm thinking of what we're good at, commodity-based products, synthetic products, where we were the first to structure those, in Canada about 15 years ago. So I think we can take these relative strengths and port them in the U.S., and be a relevant player over there.
So let's marry together two concepts we already discussed. One was National Bank has exhibited very good resilience and consistency in capital markets, and in response to that question, you highlighted the focus of the bank in Canada. A moment ago, we talked about a move into U.S. Do you see any increased risk associated with that great reputation the bank has for stability in capital markets associated with the move into the U.S.? Can you move into the U.S. without changing the risk profile of the bank?
Well, that's the goal, Mario, because what we wanna do is move into niches where we'll be relevant and keep the kind of pricing power we have in Canada. I'm not interested in moving in spaces where we'll be 2% of the market, and that's good because it's such a big market that that's actually appealing. These things do not appeal to us. We wanna move into situations where we have pricing power, we control our risk, and we're a relevant player. So, you... Yeah, you will not see us move into things where we are number 15, for example. These are not, I think, like, these are situations that are good in a bull market, but-
Yeah
... but once things get rockier, these businesses become marginal a lot quicker, and that's not appealing for us.
Let's talk about structured products. It's an area that myself, I'm sure others, thought could be, could lead to some volatility, maybe lower revenues when that change in the taxation of Canadian dividends came into play. So help us understand why that never had a meaningful effect on National. We would've expected something in 2024, either revenue hurt or, or maybe the tax rate change in a meaningful way. Did the business - Was the business... Did we misunderstand the business? Is it not really tied to that taxation of dividends?
So we're doing the business because it's a great client business. That said, there was that tax aspect, which was incidental to it, but we guided to a hit of about CAD 60 million shortfall per quarter, and that has materialized. So if you look at our equities results, without that rule change, they would be CAD 60 million higher. So the hit has materialized. I think what you see is that our diversified business mix has been really impactful there. And where we so far more than made up for the tax impact is in securities finance. It is extremely active right now in securities finance. Short-term funding levels are at a level that is, I don't wanna say unprecedented, but it's very, very high, especially on the equity side.
A lot of clients are very bullish, looking to deploy leverage, and it looks like a lot of prime brokers are full up all over the world. So what we have built that is very interesting is an operation that operates with these prime brokers to provide liquidity in a flexible and very punctual manner. A lot of those operations are based around how we do equity swaps, or we do securities lending. We do those businesses in Europe and in North America, and that has picked up a lot of the slack. So it's been a really, really great environment for financing trades lately. These are trades we love. They are super liquid. They are short-term. We can adjust really quickly whenever there are changes in the market.
I think that's what, that's what you're seeing because, yeah, the structured products trading has been okay. Volatility has been low, but what has picked up the slack is really on the securities finance. Now, that said, because of the strength of overall markets, as I said, we are very active in on the issuance side. So we are calling a lot of products, had market make new highs. We are reissuing a lot of products because we have clients who are making money, who are very happy, so these are very positive conversations. And so the issuance side of the business has been close to record levels this year.
Maybe speak to the dynamics that created this resurgence in securities finance, and dovetail into what could go wrong. What would cause that activity to slow materially?
I think what would cause the activity to slow materially is a downturn in the market.
Equity
... where, mostly equities, also fixed income to some extent, but mostly equities. That's where, that's where the action is right now. So there are a lot of animal spirits on the equity side. You look at the situation, especially on the U.S. equity side. It's been so strong, especially with the technology sector. But even Europe is... We are seeing a resurgence there. So I think that as long as this keeps up, you will see a lot of clients looking to deploy to match or outperform their benchmark. Now, if you were to get equities, equity markets turning around and starting to go down, well, that's where I think our defensive, defensive positioning kicks in.
So we have a number of businesses that tend to do well when volatility goes up and markets have a down move. I'm thinking market making and options in ETFs, where we tend to do real well. And I'm thinking of our structured products business, where we keep a lot of downside protection in the books instead of hedging it, like some of our peers do. And so we feel that we'd be in a good position if the markets were to turn around. So we're really playing with these levers to try to deliver a consistent performance.
That's where I was gonna go next. If that business falters, presumably that's where the countercyclicality comes in. There are businesses that recover, and I think you referred to a couple there. Let's flip over to-
And more, Mario-
Go on
... what we're trying to do is build building the same thing on the rates side, as we are taking our technology from the equity side to the rates side and also improving the speed there. We were not a big player 10 years ago on listed futures contracts, for example, listed futures rates contracts. We are now very high and sometimes dominant in a lot of these products. So I'm trying to build that optionality also in the rates complex, and that's a lot through technology, but that's also with our liquidity-providing philosophy, first and foremost.
Let's flip over now to a part of the business I guess you didn't grow up in. You didn't grow up in the corporate lending side. You would've grown up on the trading side, as you said.
That's right.
But the corporate lending side is an awfully important part of capital markets as well, or financial markets. Let's talk about where trends are on in lending first, what your outlook would be for capital markets lending.
Yeah, the outlook is very good. I look at the book, it is mostly investment grade. The performance has been very solid. Now, we've grown that book over the last couple of years as we felt that there were some opportunities to deepen the conversation with a lot of our clients, our core clients. That said, I'm now seeing, especially, for the last three, four months, a bit of a slowdown in the growth of that book. And why is that? Well, I think it's mostly the reopening of capital markets, so-
Mm-hmm
... you'll get a lot more debt deals, you'll get a lot more equity deals instead of going to bank debt. That's a better option in a lot of cases. So, you will see that. But overall, historically, the utilization rates of our facility is still high compared to what the historical mean would be, but I'm looking for that to normalize over the next six to nine months. That said, we have grown that book. We really like how it is diversified geographically. For sure, we want to continue to be a dominant presence in Quebec. That's one of the mandate. I'm expecting us to lead every file in Quebec, and that's really our objective there.
But more and more, we have a very well-diversified book, both geographically and per sector. We've made a lot of investment on the project finance side over the last few years, where we feel that we are now a North American player, not just a Canadian player. And it is a very interesting place to be. It's a nice source of green assets for the bank. And it's... And now we wanna maximize the ancillary around that activity. But so that's been the main vector of growth in that book. But overall, really happy with the performance of the book, and looking to grow it, but maybe at a 5% clip per year, not a 10%-15% clip.
I was surprised that you mentioned the U.S. in that. I've always thought of National's not being a player in U.S. lending. Maybe I've misinterpreted that. Has that changed recently? How relevant is the U.S.?
So the U.S. is relevant for our project finance business, where we will finance a lot of renewable build-outs. I mean, with the Inflation Reduction Act in the U.S. coming online a few years ago, there's been a lot of opportunity to fund great projects with super solid sponsors, with minimal vendor or merchant risk. And so that's a space that we've increasingly occupied. So we're in the top 10 in North America in terms of funding renewable projects in North America. And increasingly, a proportion of that has gone to the U.S.
So I think the book is now even a bit heavier in the U.S. than Canada, and that's a function that, well, it takes a bit longer to build things in Canada, so there's been a lesser quantity of projects to look at, whereas the U.S., there, there's maybe a higher quantity and a bit more variety, so we can hedge our risk by funding a variety of types of projects. So that's a space that interests us a lot. Now we wanna make those loans work harder for us by driving more ancillary business. But for sure, that's been an interesting part of our strategy.
Where are you on that journey, though? That's a ... It's a theme I've heard many times in my career, that the banks use their balance sheet to drive cash management and other products. Where are you in that? Have you had some initial proof points that the strategy's working, that you're actually selling stuff more than just your balance sheet?
Absolutely. And that's, I think we're in a good position there, and maybe that's a function of our size. That's also a function of the seniority of the teams. We've had probably less turnover than some of our peers. So people know each other, and they trust each other, and they trust each other to involve everybody at the right time in the right conversation. So we are having a lot of success on the risk management side of the business. So corporate derivatives has been a really... I think it's a key strength of our approach. But overall, we...
You look at where our franchise was on the advisory side a few years ago to where it is now. I think it's probably doubled, and looking to invest even more there. Because you're right, everybody wants to do it, but we need to do it. And with the Basel floors coming in and changing the profitability of some of these loans, well, we need to be really sharp in making those RWAs work harder for us. So that's one of my key priorities. That's something that I follow really closely, and that's what we discuss a lot at my management meetings.
You know, I've always found that objectives like that deriving more from how you put your balance sheet to work, there are some preconditions that need to be in place for this to work. Number one, the very top has to insist on it. You, the leader of the bank, you guys have to insist on it-
Yeah
... or it doesn't happen. And then the second, equally important, is how do you incentivize? How do you incent the folks underneath you to, to make this work? Have you changed your compensation structure?
Well, so I'm glad you asked this, Mario, because I think that's one of our key differentiation, is that there's only one pool in Financial Markets. And so I'm able to incentivize because it's all about behavior. It's all about teamwork. And by the way, this is how I'm able to ask a lot of the trading businesses to keep a defensive posture, even during a bull market.
I see
... because they're able to grow the overall pie. When a group has maintained a defensive posture during 2021, which was the bull market year, where you had all sorts of IPO, SPACs, well, they're getting paid because by maintaining that defensive posture, it allowed us to take more risks elsewhere in other trading books and to be more aggressive going after business. Same thing about ancillary and how to achieve these ancillary. It's all about, did you grow the overall pie of financial markets? There is one pool. It's all about behavior. I'll give you an example. Some of our groups from 2021, super active on the corporate side. 2022, almost nothing's going on. Well, some of these groups get paid the same because-
Oh
... they did everything they had to. They continued to pitch clients. They continued to show the best face of National Bank, and so they're getting rewarded because overall, we made a lot of money. It was a very volatile market. The trading businesses did great. Everybody benefits because everybody is there to grow the franchise.
That's interesting. It's hard to imagine a single pool, bonus pool. I've never seen it in my career, but-
Well, it's-
... obviously, you've got work done.
Yeah, and it's been like that for almost 10 years now. And yeah, at first there were some growing pains, and you know what? Some individuals could not make it work. I mean, it was not... They liked more of a eat-what-you-kill type of approach, and so they chose to go work elsewhere, and we're fine with that. But now when we hire people, we have very, very frank conversations. That's how we work, and-
Got it
... take it or leave it. And so we're able to attract some really, really interesting talent who actually want to be able to grow the overall pie and not lobby for their own P&L or their own bonus for the last three months of the year. So that's been, I think that that's been one of the best moves we ever did.
... For sure. Let's flip over to a different topic now. Let's go to credit. Credit for National Bank as a whole has been stellar. But in your segment in particular, I mean, there are no credit losses. It, it's virtually-
Yeah
... almost zero. Help me understand how that's possible?
Well, so it's been a great track record. We had one large loss two years ago. It was a very idiosyncratic file based in Quebec. But other than that, you're right, the way that our corporate bankers have deployed, I'm over the moon with that. They've done a great job, and again, it's because they are thinking about risk reward. Everybody's got skin in the game. Now, touch wood, I mean, sometimes these things can be lumpy. We're not immune to that. Sometimes the market can turn around. Looks like now with the Bank of Canada starting to ease, the odds of recession are probably dropping even further.
I was more in the recession camp until a few months ago, but now it looks like we may be in a really good position for the next couple of years. But there's no magic formula. It's just about super diligent underwriting. It's about asking the right questions during our processes. Our risk people have done a fabulous job, too, and yeah, we're really happy where we are. And I think overall, National Bank has been a really good performer in terms of how they look at credit and how they manage credit.
No doubt. The 15-25 basis points guidance on a bank as a whole is very low, and I suspect that reflects business mix in some respects, but also reflects some sound underwriting practices. Let's flip over for a moment, and would it be right to suggest then that absent a hard landing, losses, credit losses in your segment will... It'll be more episodic or idiosyncratic. You don't expect anything meaningful then?
That-
Absent hard landing.
Absent a hard landing, I think we're in a really good position, like I said. Well, the Quebec economy is doing well, and that's also a factor. We are overweight Quebec, and the Quebec economy has been doing better than some other provinces. So that's been a positive factor. But other than that, I look at the sectors, and yes, I don't see a hard landing, so very, very optimistic for the next couple of years.
Okay. Let's talk about the regulatory environment then. Anything on the regulatory front? We had the Fundamental Review of the Trading Book. There are floors. Are there any issues that are pressing right now that you would alert us to, specifically to the Financial Markets segment?
Not anything on the regulatory side. You're right to talk about FRTB. For us, that was a big one. Because of the way that we manage the books, we suddenly lose a lot of diversification that exists. It is there. It is effective diversification, but we don't get recognized for it, and so cost of business has gone up a little bit because of that, and that's unfortunate. But so that was a big one that we had to think a lot about, but we're not changing our businesses because they're great businesses, and they put us in a great position across all of the market cycles. So outside of FRTB, and the floors coming, I don't foresee anything that's gonna change the landscape.
See, that was another thing that surprised me, and I think others, that something like the Fundamental Review of the Trading Book would be undertaken. It would have an effect on your CET1 ratio, I think of 40 basis points. I forget the numbers-
Perfect.
But it was meaningful.
Yeah. It was-
It 40 matters to me.
Yep.
But it didn't result in a change in the strategy. How could a Fundamental Review of the Trading Book have that kind of effect on capital without having to, you rethink the allocation of capital? Or did you rethink it, it was just blind to me?
Well, we looked at it, we thought long and hard about it, but these businesses return way above hurdle. And like I said, they. When you have market events like 2020, 2022, having these positions put us in a great position to then be super helpful with our clients, to be opportunistic in deploying liquidity, because we had that diversification. So that's how we approached it, and we ended up determining that there was no need to change anything because we had the right strategy.
That's impressive. I guess if you, sort of, falls under the caption, if you make your bed, right, you not only not a lot of things need to change. Étienne, I appreciate you taking the time to do this and going through. I think one of the big things that I struggle with, others struggle with, is how National pulls it all together in environments that you'd expect some volatility. So it's gone well, and I appreciate you taking the time today.
Well, I always appreciate the opportunity to talk about the business, so thanks for having me, Mario.
Thanks, everyone.
Thank you.
Thanks for watching.
Bye-bye.