EQB Inc. (OTCPK:EQGPF) Q2 2022 Earnings Conference Call August 10, 2022 8:30 AM ET
Company Representatives
Andrew Moor – President, Chief Executive Officer
Chadwick Westlake – Chief Financial Officer
Ron Tratch – Chief Risk Officer
Richard Gill – Vice President, Corporate Development and Investor Relations
Conference Call Participants
Meny Grauman – Scotiabank
Étienne Ricard – BMO Capital Markets
Geoff Kwan – RBC Capital Markets
Lemar Persaud – Cormark
Graham Ryding – TD Securities
Jaeme Gloyn – National Bank Financial
Operator
Welcome to EQB’s Second Quarter Analyst Call and Webcast on August 10, 2022.
It is now my pleasure to turn the call over to Richard Gill, Vice President, Corporate Development and Investor Relations at EQB. Please go ahead, Mr. Gill.
Richard Gill
Thanks Pam and good morning. Your hosts today are Andrew Moor, President and Chief Executive Officer; Chadwick Westlake, Chief Financial Officer; and Ron Tratch, Chief Risk Officer.
For those on the phone lines only, we encourage you to log on to our webcast as well to see our accompanying slide deck, including slide two containing EQB’s caution regarding forward-looking statements, and slide three concerning non-IFRS measures. All figures today are adjusted where applicable or otherwise noted.
It’s now my pleasure to turn the call over to Andrew.
Andrew Moor
Thanks Richard and good morning everyone. This is our first earning call under our EQB umbrella, reflecting our shareholder approved name change from Equitable Group. EQB is a name that we think dovetails perfectly with our challenger bank image and we look forward to socializing it with our shareholders.
For our core operations, Q2 performance was one for the record books. Conventional loan growth increased 36% year-over-year. Net interest income was up 18% compared to last year. Thanks to effective margin management by our treasury team, NIM was strong and consistent with our own guide. We performed in line with our own industry leading track record on credit and we added thousands of new EQ Bank customers. In short, all the things you’ve come to expect from Canada’s Challenger Bank.
And yet this is a tough quarter report. Despite taking a by-the-book approach to achieving and ultimately deliver strong core earnings growth, our efforts within Q2 were offset by mark-to-market declines, primarily in our strategic investment portfolios due to a down draft in North American equity markets.
What we’ve learnt by participating alongside really smart fintech invest entrepreneurs since our first strategic investments over five years ago is incredibly valuable to the advancement of our Challenger Bank approach and our all-digital platform.
As far as capital allocation, we invest in fintech’s knowledge and access not for investment gains. One of the focus, we have had the benefit of positive mark-to-market P&L gains with some of these investments over the past few years and continue to drive and generated a very strong ROE on our portfolio.
Strategic investments in Q2 – Q1, 2022, we booked a gain of $15.9 million, but in the second quarter we had a partial reversal of some of those gains, lowering revenue overall to Q2. Chad will have more to say about these fair value and mark-to-market adjustments. He’ll talk from some of the six months year-to-date highlights, including North Star ROE performance of 15.6% and the benefits of funding diversification, including our now nearly $900 million European covered bond program.
For my part, I’m going to share thoughts on what you can expect from a performance ability that’s effective for the balance of the year; lots of positives in my estimation. And talk about the tactical adjustments made to respond to heighten economic and market risks.
For our Q&A, Ron will contribute his subject matter expertise as he did at our Investor Day, a recording of which is available on the website and worth referencing for more information on the sheer and proven risk management strategies.
Turning to our outlook. I will say that performance including conventional asset growth of 36% year-over-year across our Core Personal and Commercial lines puts us on track to achieve our earnings guidance for 2022. This guidance envisions NIM, consistent NIM, 8% to 10% adjusted EPS growth over 2021 and adjusted ROE of 15% plus.
Asset growth in one quarter creates natural learnings momentum in the ensuing quarters. We’re confident in confirming our guidance, because when we published it we assumed the market activity would moderate during our forecasting horizon, because our conventional asset growth was well ahead of guidance over the first half of 2022 in virtually all parts of the bank.
To get deeper into our outlook, we do expect the four increases in the Bank of Canada’s overnight rate since March, with more to follow as early as September. It will reduce activity in property markets in the second half of 2022.
Like you, we’ve seen a variety of market forecasts; all point to sale volume declines of varying proportions. Well those forecasts and our own risk appetite suggests that origination in our personal and commercial bank segments will most likely reduce from last year, I think context is important. We expect a reduction compared to the very strong originations posted in the first – in the past few quarters in both segments, but even with that we expect to achieve on-guidance conventional portfolio growth by the time our books closed on December 31.
As a reminder, that guidance has a 10% to 15% growth in conventional commercial loans and 12% to 15% growth in commercial and personal loans compared to December 2021. In my view, this is all doable in the context of the outlook for the housing market, supported by our team’s performance in the first half of the year.
Looking at recent performance, our alternative single family business certainly set a high bar. We vested annual guidance so far with portfolio growth of 35% year-over-year. These results included a 6% increase in Q2 alone. It was driven by higher originations and deploying in loan attrition.
With respect to our market share position in the broker channel, supported by our fundamental focus on good service, augmented by our new Equitable Connect broker portal, also played to our advantage in securing the high quality origination opportunities that we covered in the tighter market.
Given the period of greater housing market stability will challenge today’s homeowners with a mortgage. But a case conservatively made of strong employment opportunities for Gen Y and Z, call it cohorts, rising immigration, and shortage of housing stock and our reason to focus will provide support the market needs to be healthy in future years.
As Ron told you at Investor Day, our risk appetite is designed for the long term and we are prudent bankers in risk-on and risk-off environments alike. The risks we see today include Bank of Canada’s response to elevated inflation, and our expectations of changing collateral values.
According to the assets we put on the books in recent quarters adjudicated, such the average LTV on the banks uninsured residential mortgage portfolio was 57% at the end of June. While house price declines would naturally cause that ratio to increase, we still have plenty of protection.
That said and to be prudent, we ratcheted back on the LTVs in search of areas, suburban areas in Ontario. Adjusted debt service coverage ratios on certain mortgage products, and we are taking a more cautious view to refinancing. To be clear, these are tactical moves consistent with our past practice, not a whole set of changes in our already sound approach.
The fundamental factor that works in our favor at down market is we land in large urban areas, which it backs us by forces such as population growth and diversified sources of employment.
On the front the accumulation business is very positive, as we continue to gain profile, market share and assets. Year-over-year our reverse mortgage portfolio grew nearly 2.5x the $421 million and 38% in the second quarter alone, with June being our best month for originations yet. While this business is not as closely correlated to housing market trends of single family, we also made tactical moves to tighten up our reverse mortgage lending approaches.
Portfolio growth and insurance lending amounted to 95% year-over-year and a very solid 24% in Q2 itself. While trending a little below our 100% 2022 growth guidance, we believe we can end 2022 on a robust target as we gain strength from partnerships with nine leading life insurers.
On the commercial banks side total asset growth year-over-year was 25% and 11% in the quarter, which puts us well ahead of annual guidance. Every part of our commercial business expanded year-over-year and sequentially. I’m particularly pleased with recent growth in our commercial finance group, specialized finance and equipment leasing portfolios.
Looking ahead, we do expect the pace of conventional commercial originations to slow in the second half, but we also anticipate lower loan attrition than we’ve seen in recent quarters. We expect to meet annual guidance for asset growth.
When we think of the many positives on running a diversified commercial bank, a top consideration is our strong position of apartment lending. Apartments are an attractive source of housing for many Canadians, and will continue to be in the event of a recession. This asset class has also experienced rapid rent depreciation and low vacancies.
Another positive is our multi-unit insured mortgage business. Year-to-date you would have seen that we’ve grown the portfolio by 15%, outpacing guidance for the full year of 0% to 5%. We expect out performance to continue in the final half of 2022, some technical dynamics in the market place will add to the strong tailwinds.
From a risk management perspective, the commercial team and frankly our own customers dialed back on construction lending and demand for such products earlier this year, in order to be prudent while there is a greater uncertainty around the cost of finished products and in the online collateral values.
In equipment leasing, we continue to shift the portfolio in favor of higher credit quality business. Two-thirds of new assets of our Bennington book are comprised of prime leases and we are focused on more economically resilient business sector with overall excellent margins and ROE well above our 15% target.
Canada’s Challenger Bank has committed to long term growth and pro-actively making moves to adjust its risk appetite. These changes are fundamental to our reputation as an institution, with much lower loan losses in our peers. A reputation that was reinforced over the fast half of 2022, with realized loan losses of just $2.4 million on a portfolio of $40 billion plus. The levels [inaudible] are the lowest in my entire 15 years as CEO of Equitable.
An important reminder also is that under IFRS 9 rules, when a bank originates new business we book new provisions. With our high growth in originations of $4.5 billion in Q2, these provisions were also naturally higher in Q2, even though losses may not ultimately be realized.
The majority of the small losses that we actually did incur were within our leasing portfolio, which is where we expect to see them where the offset of returns are much higher with this pool of lending. As you heard in Investor Day, we never sacrifice loan quality or compromise risk management or growth. Each and every transaction must meet our stringent lending criteria.
While preparing for new market realities has been an obvious priority, we have not lost a single day or step in moving forward on all the exciting initiatives you heard about in Investor Day. I’ll mention just a couple as they relate to EQ Bank.
We are choosing our payments card that’s full, a move that will invite our customers to use our old digital platform as their primary bank as well as a great place to save. The difference between these two realities is a whole lot more functionality for EQ customers, who will be able to pay wherever MasterCard is accepted.
We are also looking forward to the full launch of EQ Bank in Quebec, a move that will leverage our proven technology to bring a differentiated value proposition to a large, digitally savvy population. Equitable Bank has a really good customer following compared to our broker deposit and broker mortgage businesses. Our presence there for over a decade should give our early marketing efforts a boost.
These two advancements will allow us to build our EQ Bank’s recent momentum, which featured year-over-year growth in our customer base 26%, including over 13,000 new customers in the second quarter. Another 5,000 Canadians joined us in July, during July alone.
Of equal importance, the now more than 285,000 Canadians at the end of July then trust their banking needs to EQ are using the platform more than ever. Digital transactions increased 7% in the second quarter and we saw continued growth in products held by each customer. We are growing great value to EQ customers, EQB is benefited from improved economics as customer lifetime value grows while customer acquisition costs remain stable.
Thinking about the deposit market generally, rising interest rates should act as a catalyst to continued growth and demand for saving solutions, particularly of those offered by Canada’s Challenger Bank through EQ Bank. But also within the rest of our now $15.9 billion deposit business.
Rising interest rates have caused investors to take a much more active interest in GICs, the issuances through the major broker platform, up more than 2.5x in June 2022 compared to the same month last year. The significant increase in liquidity in GIC market is certainly encouraging for our approach to business.
Our outlook would of course not be complete without mentioning how much we look forward to completing the acquisition of Concentra Bank. As you saw in the quarter, we received unconditional clearance from the Competition Bureau of Canada, so a good check mark there in terms of ongoing regulatory review. As that process proceeds, our Transformation Management Office continues its important work with the help of Concentra’s team to insure that we hit the ground running quickly in bringing two organizations together.
The scale impacts and opportunity benefits are significant and we are excited by what we can do together to lower value for customers, including credit unions and all EQB stake holders. While it’s important for you to know that our performance prospects remain strong, we are managing for hyper risks in the housing market. You should also know that always remain on task with respect to producing interest, industry leading returns on equity.
As a result of our risk management approach, we will continue the level of confidence in this rising interest rate environment and achieve our traditional 15% plus ROE when the books closed on the year, adjusted for Concentra cost closing and integration costs. It’s too early to put a pin on the wall on 2023 guidance, but as with last year, we will offer initial guidance together with our Q3 results in November.
I’m also pleased to note that EQB shareholders can now look forward to the third dividend increase in 2022. This latest increase of 7% sequentially or 68% year-over-year is in keeping with our longer term commitment to growth our dividend, while reinvesting at an attractive ROE.
As CEO I see one of my major accountabilities being to ensure that we reach our longer term goals by allocating capital in a disciplined manner, such that EPS and book value per share grow at a compound rate of over 15% annually. But not every year will always be consistent towards our five year average targets.
We shared our economic value, a model at our recent Investor Day, but to reinforce what I said, 15% annual compounding takes us towards an EPS of 18.20 in 2027, a book value of 127.98 and a dividend of around $4 using 2022 consensus estimate as the baseline. The recent quarterly results give me more confidence than ever that this is achievable, although we’re going to have to hustle hard and work hard to get there.
To summarize, I’m confident in our ability to build value for our shareholders in the quarters ahead, as we are able to reinvest in our many businesses to create consistent compound and capital.
Now, over to Chadwick.
Chadwick Westlake
Thank you, Andrew. Our bank entered and exited the first of 2022 with strong capital and liquidity, resilient margins and strategic momentum. As Andrew said, we are again confirming our earnings guidance for the year, which takes into account core personal and commercial banking business performance year-to-date, including net interest income and fee based income growth. Our expectations for continued risk manager expansion and our conventional lending portfolio, as well as the current and a quickly evolving market sentiment on Canadian Housing, inflation and rising rates.
There are two distinct areas that cover this quarter with core and non-core considerations. Core performance remains strong and stable, positioning us well for the rest of 2022 and into 2023. While not quarter earnings, part of a broader strategy does include priorities that have an impact on our quarterly non-interest income, including realized and unrealized changes in the value of strategic investments, as well as fair value in certain securities through the P&L to offset fair value changes in derivatives.
Given these mark-to-market and fair value adjustments, were a sufficiently large [inaudible] for us in Q2. I’ll first start with additional clarity here, before moving to comments on our earnings engine that is progressing well to annual guidance.
For the $2.5 million net loss we booked in non-interest income in Q2, you can see the reconciliation on the slide in the Q2 investor presentation and in our MD&A. There are three main drivers to consider for reconciling non-interest income in Q2. First, fee based growth which we view as core revenue. At $7.9 million in Q2, this is up a solid 41% year-over-year. It’s a priority that continued to grow this revenue over coming years as we comment on regularly through new products and services.
Then there are two sides to the coin for how you can look at the negative offsets in the quarter. It’s important before of these types of offsets. When I say regularly, we don’t manage for the quarter, but we do set targets and expectations for the average across quarters in the short term and most importantly for the medium term.
First side of the coin is the strategic investments. You can think of this as around two-thirds of the negative net impact for Q2. This line item was marked down to the P&L by about $8.7 million in Q2 with unrealized losses. With corresponding gains booked of a positive $15.9 million in Q1, we remain at a net gain year-to-date of $7.2 million.
To add even greater transparency, we started reporting this strategic investment line more clearly as of the Q2, 2021 MD&A. Even after including the negative impact in Q2 we booked cumulative gains of nearly $20 million on these investments over the past four quarters. I indicated at our Investor Day that I expected strategic investments to come down for at least a quarter or two from Q1, 2022 levels and that’s exactly how it played out, consistent with the significant declines in North American equity markets, and also private market corresponding write downs. This includes investments such as Kortaj [ph] Funds, Framework Venture Funds and was simple.
We continue to be enthusiastic about these investments and to repeat what Andrew said again, we don’t actually make these investments for the gains, but we do generate well above target ROE not withstanding on it. There is potential for further moves up and down on a mark-to-market basis in coming quarters. This is the volatility that comes with accounting treatment of recognizing changes through the P&L regularly, even when they aren’t realized.
Then the other side of the coin is primarily the impact of fair value gains and losses on derivative financial instruments. This comes back to accounting treatment and includes the treatment of cost-to-funds hedging and CMB slots. Unlike items such as changes in the value of strategic investments, gains and losses on derivatives used for hedging often reflect timing mismatches, where income or expense recorded in any period will be reversed over the life of the derivative.
There are a couple of lines in that of the MD&A, but as you see in the slide and in our Investor Presentation, you could view these generally as a net fair value negative adjustment of $3.9 million in Q2. Our hedging has been effective by reducing interest rate risk and reinvestment risk, but again can be impacted in a particular quarter when there were very significant shifts in interest rates.
From an outlook perspective, we do not forecast the impact of mark-to-market or fair value adjustments in our guidance given the variable and non-core in nature. I’ll also make a note of gains on sale from securitization activities which are booked under non-interest income. These are expected to normalize and improve from Q2, but I’ll caution is always, that these gains fluctuate from period-to-period based on volumes that you recognized, which are driven by consumer preferences.
Diversifying and increasing non-interest income by growing fee based in other income with new products and services is part of our core business strategy, and we’ll provide long term benefits and stability to this revenue line. This growth will be very positively accelerated on closing our agreement to acquire Concentra Bank.
Now, turning back to the core business of EQB, performance was strong in both the quarter and for the first six months of 2022. This reflects disciplined, risk managed capital allocation in a fluid, but generally constructive economic environment. As usual and as Richard noted up front, all the numbers I quote are the adjusted numbers we publish, which exclude Concentra Bank related acquisition and integration costs.
At $167.6 million, quarterly net interest income was ahead of Q2 last year by 18% and up sequentially from Q1 by 3% on strong, stable margin performance. While core revenue was of the usual high quality and personal and commercial business lines grew sequentially compared to Q1, that marcs and accounting treatment of fair value adjustments are referenced under non-interest income, resulted in total revenue still up 4% year-over-year in Q2, but down 12% sequentially, resulting in diluted EPS of $1.75 for Q2 with ROE at 12.1%.
Even with that, diluted EPS for the first half of 2022 was still record setting at $4.40 per share, 10% above last year, at the top end of our 8% to 10% growth guidance and ROE landed at 15.6% year-to-date. That’s aligned with our historical early average and on target for the years guidance of 15% plus. Book value per share increased 16% to a record $59.25 per share, well ahead of full year guidance of 12% growth.
Now Andrew already profiled the strong growth in our lending portfolio, so I’ll move right to providing comments on our sources of funding, where the story equally positive.
During the quarter we completed our second European covered bond issuance, this time in the amount of 300 million Euro, at a spread of 20 basis points over euro mid-swaps, meaning from a comparison to GIC pricing, relative pricing in our second issuance was even better than our first. Based on the timing, the benefits of this second issuance won’t be fully flowing through the quarterly results yet. Our capacity for covered bonds will further increase with Concentra Bank and we may proceed with another issue for the end of 2022.
Our broker deposit business expanded again to $12.8 billion with double digit year-over-year increases in both churn and demand deposits. Volumes in this channel are exceptionally high based on customer preferences for GIC’s, also corresponding to the sell-off in equity markets. While this will continue to become a lower relative proportion of our funding staff over time, the opportunity for broker deposits has been excellent in 2022. And as Andrew profiled, EQ Bank showed growth in customers and all measures of engagement. We expect it will perform the guidance by the end of 2022.
Moving towards NIM or Net Interest Margin, our 2022 guidance was for a consistent to moderate expansion in NIM from the 1.81% at the end of 2021. Trending the date is right on point and Q2 NIM was 1.81% and year-to-date stood at 1.84%. We see the positive effects of the asset mix shift toward higher yielding conventional loans on a year-over-year basis, although this was offset by a couple of factors, including an expected decline in prepayment income.
We profiled in depth how we manage margin in the ROE on every $1 we land and invest at our June Investor Day, with great details shared by our world class treasurer, Tim Charron. I encourage you to listen to my finance update section in the playback on our investor relations website if you haven’t had a chance yet for this content.
In a rising rate environment, our margin strength and potential is also being enabled by the scale of our EQ Bank deposits with our everyday savings account. This is proving to be the best digital bank in Canada, plus a great source of lower cost, diverse funding with margin expansion contribution.
Moving to expenses or again what we view as our investments in the bank. In Q2 we continue to invest in people, process and platform innovations. With core revenue growing at double digit pace, non-interest expenses were up 16% year-over-year. Normally, this would allow us to achieve a trending of positive operating leverage. However, the marks against our non-interest income within Q2 reduced revenue, thereby inflating efficiency for the quarter to 45.8%. The impact was not so dramatic on a year-to-date basis when efficiency was 41.1%. If non-interest income was more normalized to recent trending, efficiency would have remained tight to our 40% average range.
Expense growth in Q2 year-over-year was mainly due to a 24% increase in compensation and benefits as we expanded our FTE by 29% to over 1,300 challengers. Expense growth generally reflects our focus on acquiring the best talent, including in both banking and technology and compensating our top talent accordingly. This momentum in growth will slow in the second half of 2022.
For the process including our corporate and marketing categories, expenses were up 10% year-over-year on a combination of factors, including campaigns promoting our new and growing offerings in reverse mortgage and insurance lending and building the EQ Bank brand in the Canadian marketplace. And platform, product cost and technology were up 13% year-over-year and 1% quarter-over-quarter. Baked in here was the amortization of investments for projects completed over the past 12 months and a continued increase in innovation investments as we prepare for more product and service enhancements.
Looking ahead, we expect relative expense growth to be lower compared to the growth in the first half of 2022. We will actively manage our investments in the bank accordingly towards our general target of approximately flat operating leverage on an annual basis. Again, that excludes costs associated with our agreement to acquire Concentra Bank.
All integration related spending remains on target. As a reminder, the integration expense budget we communicated at the onset was 45% to 50%, which relates back to our previously communicated goal of generating mid-single digit EPS accretion within the first year of closing the acquisition.
In the quarter, these costs were $3.6 million or $0.8 per share after tax. $2.7 million of that was specifically for acquisition and integration related expenses, and the rest was a dividend equivalent amount paid to subscription receipt holders in accordance with the terms of the offer, which shows up as an interest expense until those roll into common equity. Corresponding updates on our expectations on transaction synergies will be provided following the closing, including updated guidance for EQB.
On the next slide you can see the trend lines for credit metrics, another great chapter in EQBs long history of prudence and risk management responsiveness. Andrew mentioned the low level of realized loan losses in the quarter, which is an outcome of our approach in the health of the economy.
Following five consecutive quarters of net PCL benefit booked due to improving macroeconomic verticals, in Q2 we resumed a more normal pattern and booked a PCL expense of $5.2 million. The majority of this PCL expense in Q2 reflects the growth in our business, with higher Stage 1 and a shift in macroeconomic variables in our models that contributed to higher Stage 2. However, the Stage 2 is not a result of higher delinquency.
Net impaired loans contributed a small amount, but over a third of that NPL related to one loan where we don’t expect to take a loss. Net impaired loans declined 18 basis points of total assets compared to 22 basis points at March 31 and 41 basis points a year ago. The improvement over last year reflects a reduction of $36.7 million in conventional commercial loans, $17.5 million in single family mortgages and a $2.7 million reduction in equipment leases. The 4 basis points sequential improvement reflected the full discharge one delinquent commercial loan.
EQB remains well researched with allowances as a percentage of total loan assets at 14 basis points at quarter end. This is lower than 19 basis points a year ago, but in line with pre pandemic rates. In coming quarters PCLs are expected to be consistent with Q2 levels, assuming current economic forecast proved to be accurate and borrower behavior is consistent with what our credit loss model anticipate. Excluding PCL as a consideration, our 2022 guidance for pre-provision, pre-tax earnings growth was 12%. Year-to-date we are precisely on target at 12%.
Moving to capital, our current CETI level of 13.5% means we continue to operate at the top end of all bank peers in the S&P TSX conference and index and we remain ahead of our 2022 guidance of 13% plus. This stability reflects a combination of organic regulatory capital growth, and a capital investment in Equitable Bank funded through EQBs funding facility established in Q1, offset by conventional loan growth and corresponding risk weighted assets.
Risk weighted asset growth does remain above our target level of around 15% on average across years. In Q2 it was up 29% year-over-year to about $14.7 billion. This higher RWA growth is all within our risk appetite framework. With actions we’ve taken and our expectations for the portfolio over coming quarters, we do see a general return to our target range over time. Upon closing the Concentra acquisition, we expect to continue a CET1 ratio of 13% plus.
To summarize, core business performance was strong in Q2 and the momentum created in all lending positions us to deliver our 2022 guidance. We are attuned in changing risk dynamics and have adjusted our underwriting to protect shareholder capital such that we have confidence in lending in this environment.
Our messages at our June Investor Day are the anchor point. We are continuing to build a bank that we expect will generate 15% to 17% ROE on average over the next five years and beyond, same as the past 10 years. We’re building innovative products and services for Canadians; we are bringing needed and significant change to Canadian banking during rich people’s lives. We’re building technology capabilities distinct from all peer banks in Canada, and our business model is built and proven to perform across all economic cycles.
We don’t manage to the results in the quarter, but we are very thoughtful about our guidance across an average of quarters. I again encourage you to check out the June Investor Day replays posted on our Investor Relations website if you haven’t had the chance.
Pam, can you now please open the line for Q&A.
Question-and-Answer Session
Operator
Thank you [Operator Instructions]. Your first question comes from Meny Grauman with Scotiabank. Please go ahead.
Meny Grauman
Hi! Good morning. A question on the originations, they beat expectations. Is there any color in terms of the timing? As the quarter went on, did you see a more pronounced slowing towards the end of the quarter and then if you could talk to what you’re seeing early in Q3, if there’s anything notable there in terms of the pace of originations?
Andrew Moor
Yeah, Meny I think you know applications is obviously pre-date closing. So we continue to see strong closings in loans right through quarter end and we’ve definitely seen a bit of slow down continuing in terms of new applications through July here. But it is still a bit slotty. I think yesterday was similar to the prior year, so it’s definitely not entirely consistent. There’s definitely activity in the real-estate market contrary to some of the commentary where we are getting, but we are seeing a bit of a slowdown to stop the quarter.
Meny Grauman
And are there any portfolios in particular, and any specific loan categories or sort of any way to focus on areas that are weakening more than others. If you could highlight sort of anything more specific in terms of where you are seeing more weakness compared to the broader book.
Andrew Moor
Yeah, I mean, let’s start with strengths as well. So we are continuing to see the priorities in the west generally seem to be you know bucking the trend of it, which perhaps you would expect with the improved quality markets there, and this is a bit of a negative going back five years ago for equitable, so showing the strength of expanding into those markets. You know as is widely reported in the press, you know the slowdown is probably mostly around the Ontario markets, which is obviously you know a critical market for the whole country and for us.
Meny Grauman
In terms of, Andrew you talked about tactical moves in the mortgage book, including adjusting LTVs in some areas. Can you just give us a little bit more color in terms of where you’re making those changes and maybe clarify what’s driving you to make those changes? Are you seeing certain dynamics that you don’t like or is it more about being proactive?
A – Andrew Moor
Yeah, I think we’re always trying to be proactive Meny and sort of think through how consumer preferences might be changing. So you got a few things going on. Obviously you got interest rates rising, but you also got the pandemic kind of moving more into the rear view mirror, so the view is that – and we saw asset prices or house prices moving upwards most over the last couple of years in areas further from the city centers as people were looking for more space to work from home, places for the kids to play, that type of thing.
We are expecting that pref, and we are seeing that preference start to swing back to more high density of living. So the result of that is that we’re more concerned about those areas where large commutes would be required to get back into the major urban centers and that’s where we focused our efforts in terms of sort of…
Just thinking a little more, we’re still constructive but being a little more concerned about those areas. We also think that people that are already stressed and therefore looking for refinance might be – you know might be an area that we just need to show that additional caution in this environment, so that’s another area we are quite focused on. But I’m saying, this is very much kind of trimming rather than wholesale changes I mentioned, and consistent with our past practice that’s been proven through cycles up and down.
Meny Grauman
Got it. I’ll be in queue. Thanks.
A – Andrew Moor
Thanks Meny.
Operator
Your next question comes from Étienne Ricard with BMO Capital Markets. Please go ahead.
Étienne Ricard
Thank you, and good morning.
Andrew Moor
Good morning Etienne.
Étienne Ricard
On the funding side, what level of competition do you expect on deposit markets over the next few quarters, given that you know on one hand loan growth appears to be slowing, while on the other hand inflation pressures could be draining household savings. So how do you see those two dynamics interplay on the cost of deposits?
Andrew Moor
Certainly I’ll stick to EQ Bank and maybe Chadwick will talk more to the wholesale geo – the wholesale with the broker GIC markets if that makes sense.
On EQ Bank, you know I think we are just differentiating ourselves from the competition. We have the best digital experience of any bank in Canada, and as I mentioned in my remarks, you know we’re adding more features and capability with our payments card coming soon and launching in Quebec.
You know I saw some recent – even as recent as yesterday I saw our NPS scores, you know how customers are thinking about it. Those are improving quarter-over-quarter, so I think we’re moving into all different environments and creating a different category almost. So super confident about that and then what that means for our shareholders and funding costs.
And as I mentioned, there’s you know huge liquidity in the brokered deposit market, just extraordinary. I don’t know if I called that in the script, but the volumes in the CanEx market are up 2.5x year-over-year. Chadwick, if you could maybe share some comments for what that means for cost and deposits, that would be helpful.
Chadwick Westlake
Yeah, we’re certainly seeing a change as you’ve probably seen directly with the – the pricing has certainly moved up on the broker deposit boards, but our market share has maintained pretty well consistent in this and we’ve certainly taken on some more deposits. But the important benefit to remember as you know is the diversification on our funding, so we’re not entirely relying on that channel and from a – I wouldn’t necessarily view it as a competition perspective.
A lot of people want the funding there. We may be more, for example in the corporate bond market, right, that’s where we did the data issuance and we may do another one where the, in the wholesale side, the unsecured wholesale, those margins have widened, but they are still pretty tight when it comes to securable sale in the corporate bond market, that’s part of why we are such an excellent choice for it.
So we can dial up and change our leavers accordingly. So competitive, yes, but we have great options and I think the balance will result in some continued relative tailwind in our funding, and again a reminder as you know to once the Concentra Bank closes, that’s going to expand our options and diversification even further.
A – Andrew Moor
Étienne, if you’re looking to buy a GIC, I recommend you to look at the EQ Bank platform. You’ll find the rate is pretty attractive there.
Étienne Ricard
Noted.
Andrew Moor
Hey Chad, it’s like the 1.2. So even to that point the beauty of our diversification or strategy, we don’t have the wholesale or top of market price, right. Because of our diversification we can focus on margin management and it’s a very important delaying factor too.
Étienne Ricard
Chadwick, on one of your last points on the covered bonds and deposit notes, given where spreads are today, how do you plan to scale issuances over to next year.
Chadwick Westlake
Yeah, it’s probably what I would say without being conclusive as you’d see, maybe a higher, potentially likelihood for another cover bond versus another deposit note in the near term, but I think with the normal expectation of the cadence we’ve set, I wanted two deposit notes per year, at least one cover bond issuance per year should continue. So you could see another cover for bond as I mentioned. It’s always possibly as early as this fall, because that market is exceptional stuff.
Étienne Ricard
Okay, and lastly just on your accumulation segment, how was demand for reverse mortgages holding up in a higher rate environment relative to a traditional mortgage. I mean in other words, given the lack of scheduled repayments, how do you think about the reverse mortgage affordability when rates rise?
A – Andrew Moor
I mean affordability doesn’t really change from the consumer’s perspective, because as you say there’s no payment to be made. You know we do adjust our actuary models and thinking about the LTV’s in that and I shared the dimension in my remarks, but we’ve also tinkered with that a little bit and going to cut back LTV’s a little bit in the face of relatively higher interest rates, vis-a-vis the expectations for the housing market.
So we’re feeling pretty good that we got the risk appetite dialed correctly and we continue to see as you saw, you know a very strong demand for reverse mortgages, perhaps tempered a little bit over the last two or three months as people have seen the higher, you know has a bigger shock effectively on the underlying interest rate that will accrue on the mortgage.
But again, we’ve got some strong tailwinds here, you know preference of moving away from communal living as a result of the pandemic, the broader acceptance of the product and don’t forget the one of two landed in the space and we really was meant to raise a strong franchise in this business.
Étienne Ricard
Thank you.
Operator
Your next question comes from Geoff Kwan with RBC Capital Markets. Please go ahead.
Geoff Kwan
Hi! Good morning. My first question was just on the originations in the quarter. It was a good number. You’re key competitors also I think had a pretty good number there. Just trying to get a sense from your side as to you know what was driving it? Was it just a matter of strong sales activity in the spring with the deals closing by quarter end or was there some market share gains from other direct competitors, maybe some people at the banks that were falling into your lap or alternatively some people on the mix side that are higher quality that you might have been able to get at better rates, because there might have been less appetite.
A – Andrew Moor
Yeah, I think we continue to dial in on the broker experience and mentioned we’ve opened up a new portal in the quarter, but you know I think it was already in part at the beginning of the year, but really got a broader group of brokers during the quarter, so I’m feeling good about market share.
As you know, it can be a bit hazy and that we’re feeling fairly good about that. I don’t think we’re really yet seeing any spillover from the big banks, but that may well be one of the outcomes as we move forward here with GDS ratios and TDS ratios getting tougher, but I don’t think we’ve already seen that flow through yet.
Geoff Kwan
Okay, and just my second question is, looking ahead into 2023, if we see greater EPS growth pressure, let’s say we’re into more or a much softer housing market environment, loan losses are rising. Do you still stick with the dividend growth strategy given the payout ratio is still really low or is there a scenario where you might slow or even kind of halt the dividend growth. I’m just trying to understand here if there’s a reasonable scenario where you might deviate from what you’ve articulated on your dividend kind of growth strategy over the next couple of years.
A – Andrew Moor
You know I think Geoff, we can always create scenarios, but as you know we’re pretty committed to this program and I would – by the way, I wouldn’t necessarily expect rising losses in our single family book. I just don’t think we expect losses, maybe stresses, but not losses. So I think they are slowing, a slowing growth in the book actually leads to more, you know more regulatory capital accumulation. So I would expect that we’re pretty committed to living with this dividend, not going to be prudent if there’s need to preserve capital, but I think it’s extremely unlikely we are going to get to those kinds of scenarios.
I think our investors should be confident that we are going to live with our 20% to 25% dividend – compound dividend growth over the next few years. As you point out, our dividend payout ratio is very low compared to the other banks, and it’s all part of our value creation model, but there’s lots of room for us there.
Geoff Kwan
Okay, great thank you.
Operator
Your next question comes from Lemar Persaud with Cormark. Please go ahead.
Lemar Persaud
Yeah, thanks. Just maybe on these mark-to-market losses on the strategic investors, I just want to circle back to that. Would it be fair to say that if the quarter was to end today, you wouldn’t see much more in terms of the mark-to-market impacts on the strategic investments, derivatives, loans and investments, so I think the $8.7 million and $3.9 million losses in Q2 from traffic side.
Andrew Moor
If we were to end today, if we were to end Q3 today, how would that be playing out, is that the question?
Lemar Persaud
That’s right.
Andrew Moor
Yeah, I think it would be hard to say. I haven’t even seen July’s results yet, so I know that some of the ones that are more absorbable in the market are actually up since quarter end, but I don’t think we can make a generic comment about where we expect to be in Q3.
Chadwick Westlake
Yeah, so like I know where you’re going Lemar. It’s obviously the activity is pretty negative in the quarter, but that’s why, you know it could be up, it could be down. But we are a taking a bit of an initial stance and that’s why obviously we don’t forecast those lines. But if we could say there’s certainly some pretty extreme activity in the past quarter, and obviously the marketed headlines on this topic. But we took some prudent actions and obviously as we refer to these as unrealized loss to that point too, right, we haven’t existed these positions. So you’re right, that they could be marked up or down further, but I think there will be some volatility for a little while longer in these markets.
Lemar Persaud
Okay, and then maybe just moving on I guess then to kind of operating leverage, I know that you guys are still confident in kind of the neutral operating leverage for the year, and on an adjusted basis. That would imply quite a bit of an improvement from the first of the year. I think its negative 4.4%. So talk to me about what gives you the confidence in that, what kind of levers you have to adjust maybe expenses up or down and you know the assumptions baked in from a revenue growth perspective.
Andrew Moor
Yeah, I mean I think one of the interesting developing leverages, there’s two elements to that right. The cost sits on the [inaudible] and then you’re running to see it’s a dominator. So what you saw here was frankly more of a denominator issue than a numerator issue, in the sense that with those mark-to-market changes, you just talked about, it drove down the value of the denominator.
But then, you know we’re also pretty diligent about looking after our cost base. You know we travel in the regular part of the plane and we don’t have private jets and any of that kind of stuff. So we keep a really tight focus on costs, as with an expectation of lower originations through the next quarter to two. We certainly haven’t been adding to our underwriting teams in the way that we used to. So there is a bit of room to constrain costs there, and I can assure you, with the check we keep [inaudible] team and I think we are on top of it to – you know we wouldn’t be expressing this level of confidence if we hadn’t done a pretty detailed dive to be able to give you that confidence.
Chadwick Westlake
Yeah, and reminds me too Lemar, so part of the delta that you are seeing with other banks where we are targeting approximately flat, because we have the best efficiency ratio going on, right. So the goal was in general a maintainer, a competitive advantage through efficiency and a bit on digital. So operating leverage was just indicated, one stand out range versus saying we are going to be precisely X% in efficiency, but to the normalized point or your day point we are still within that radius around the 41% that is meant to be more of a guide point. So our first one is always going to be the ROE is our lead anchor either way.
Lemar Persaud
Okay, that’s great. And then you know just last one for me, that just a high level question, but you know given the increase in macroeconomic uncertainty, are you seeing any hesitation from commercial borrowers, maybe discussions about pushing out planned CapEx that sort of thing or are all signs still flashing green.
Andrew Moor
Sorry, I think because I mentioned in my remarks, talking about say our commercial borrowers. We have engaged in a business-to-business relationship, mature relationships in many of these players. That’s certainly about – a lot conversation about inflation and construction costs. So not choosing to go in the ground with new projects is a result of inflating prices. They are concerned about where ultimately they are going to be able to sell the product at, that kind of conversation.
So I think the Bank of Canada is having its impact on the market in terms of slowing down new construction starts, which is presumably one of the things we’re trying to just take some demand out of the economy. So that those conversations are going on, and I said that you know we got a great – it does seem like there’s a lot of optimism about a longer term story for building housing and other kinds of real estate and kind of those major cities if you are taking a five to 10 year, and how we continue to keep our customers close to us, so as those opportunities, the inflation gets more – you know gets under control, we’ll be well positioned with our clients.
Lemar Persaud
Great! Thanks for the time guys.
Andrew Moor
Thanks Lemar.
Chadwick Westlake
Thank you.
Operator
Your next question comes from Graham Ryding with TD Securities. Please go ahead.
Graham Ryding
Hi! Good morning. Maybe I’ll stay on the same theme. Just are you using the record quarter for commercial originations. What – I guess the commercial sectors in particular drove that volume and it seems like a fairly fluid market and maybe just some commentary on your comfort level around sort of pretty active originations in the quarter.
Andrew Moor
I mean, a lot of apartment lending was a big driver for me, much of that ending up, which we’ll provide the pipeline as reminder for some of our CMHC activities, so sometimes originating these, we would call them a CMHC bridge ones. So these are going to buildings that perhaps the purchaser is planning to increase the rents. Once they increase the rents, they’ll get a CMHC insurance and then we’ll securitize it in the CMHC pooling, so that was the only big one in the quarter and a continuing funding into pre-committed construction programs, I think would be another that was good.
We also saw a specialized finance group continue to really step up and that’s – I really love that business. It’s seems like it’s got some operational complexity, but they’ve really got a good grip of the specialized lenders that we spend funds doing that. So I think right across the broad our commercial teams did a fantastic job and I know that they are very confident. They did also a fantastic job of doing a deeper diver into the risk and the portfolio and I’m feeling really good about it and we have a great team on top of that brief.
Graham Ryding
Okay, perfect! On the specialty finance, can you just elaborate on that? I think there’s a fair amount of lending, sort of a private mix is part of that business. Can you sort of talking about your comfort level there or is that now perceived to be higher risk area in the market right now?
Andrew Moor
Yeah, I mean many perceive that as high risk and generally speaking we are lending somewhere around 75% margin against first lean mortgages with a wonderful type structure, sort of private securitization structure. A lot of operational risk controls in behind the scenes there and to knowledgeable people in the space. So it feels like a pretty low risk sector to us, actually that’s been our experience. We’ve never had a loss in that portfolio.
Graham Ryding
Okay great. And then my last question. Maybe just Chadwick, some color on sort of the key inputs in your credit loss model that your obviously in the higher, call it PCL expenses this quarter. I wasn’t surprised to see that. I think the outlook for employment over the next 12 months in your model seemed to improve quarter-over-quarter. So likely it wasn’t employment that was driving the higher PCL expenses this quarter.
Chadwick Westlake
You want Ron to… [Cross Talk]
A – Andrew Moor
Yes right, that would be more of a Ron issue.
Ron Tratch
Sure Graham, this is Ron here. The key inputs in our models is consistent with most of the industry is unemployment like you just noted, as well as GDP. And from Q1 to Q2 I’ve described the changes in our forecast as very moderate changes, but what we saw in the quarter was in the near term reflecting what we’re currently seeing in the actual markets with respect of unemployment being stronger than were anticipated a quarter or two ago.
And then as you get out to, about the 15th month into the portfolio seeing some moderate reduction in the strength and unemployment numbers. And so what that does in our book is for the stage 2 losses, which I’ll remind you are lifetime losses, of course the stage 1 which is just a 12 month look. When you get out there, that part of the forecast, those lower unemployment numbers do result in a modeled increase in our stage 2. But it is a modeled increase and as Chadwick noted it, our Stage 2 did not grow as a result of current delinquency.
Graham Ryding
Okay, understood. Thanks. That’s it for me.
Operator
[Operator Instructions]. Your next question comes from Jaeme Gloyn with National Bank Financial. Please go ahead.
Jaeme Gloyn
Yeah, thanks. Good morning guys. First question, just on the NIM and the driver’s quarter-over-quarter within compression you guys are talking about it in the MD&A. Higher funding cost, lower prepayment, higher use on that cash. So my first observation here is the net impact of these drivers seems likely to remain negative in the next quarter, so we should expect NIM to push down quarter-over-quarter is that fair?
Andrew Moor
I actually don’t think so, no quiet clearly. So what you are offering is – there’s a couple of things behind that. You’re not seeing some margin expansion. You may see from the lower funding costs from EQ Bank coming through to the fall. EQ Bank is a diamond in the Equitable Bank crown and it’s going to really show for you in Q3 and Q4 in terms of that funding cost.
The other thing is that Chadwick is not boasting proudly enough about the covered bond program. We got another covered bond program done in Q2 and you haven’t really seen the lower funding cost associated. That stopped the flow through statements, we haven’t – that next issue we’ll see that lower funding cost you know flow through in its entirety for Q3.
So no, I think I’m optimistic that NIM will – you know the numbers you see even in the quarter were pretty marginal changes and that can be, that can always happen. But I think in generally we are feeling confident about the outlook for NIM with expansion possible.
Chadwick Westlake
Hey Jamie! You can look at the number right. Like Jamie if you look at for example with EQ Bank, that’s an interest point is really an important one to crystalize. We already have a great everyday rate on that and with Bank of Canada 225 basis points so far this year, EQ Bank is up 40 basis points. You already have that level of expansion to, within it what we are doing extremely well for Canadian, so it’s a great opportunity for us. So it’s a bit of a timing as well, that’s why you see the flow through come in a little bit later.
Jaeme Gloyn
Got it, got it. And just still on the NIM, I noticed that business mix, it had been a positive NIM driver for the past several quarter-over-quarter and year-to-day comparison, but it’s not a driver whatsoever in this quarter, and I was wondering if there’s – is there anything more to that given that conventional loans are still going more, far more rapidly than insured loans.
Andrew Moor
I think there is much behind that. Generally you know my broader comments, if you look at NIM by business lines, if you out over the next couple of quarters you should see pretty much stability. So as I mentioned, you might see some slightly faster growth in the multi-family. It depends on both, but we do have a skinner margin associated with the NIM and net-net is still expecting NIM to be…
Chadwick Westlake
You did see the yields go up. When you look through the MD&A you do see the yields go up when you have the product-by-product rate. They did increase quarter-over-quarter and some of that pricing will continue to increase. You will see on the yield side.
Jaeme Gloyn
Okay. Shifting to the PCL guidance, my understanding is that it should be in line with or consistent with Q2 levels. Does that guidance, does that apply to each of the asset classes or just on the aggregate?
Chadwick Westlake
Sure Jamie, we are just having a hard time hearing you. I think what you are asking is just back to the point I made on will PCL be consistent.
So I guess there a couple of things right. So we made a point that part of why PCLs increased, because the business increased. So if we have slightly lower originations, could there be slightly lower Stage 1, yes, that could be true. Part of why we said there could be come consistencies, it depends as well on consumer credit behavior and the macroeconomic variable assumptions that we have, so those two will be connected here, but for the general time we set some level of normalized consistency.
Jaeme Gloyn
It was more on asset class perspective. Is that a comment on the aggregate business or just – or does it also apply to each asset class?
Andrew Moor
Yeah, we wouldn’t expect to see any sort of additional piece in differential PCLs by asset class and I think Chadwick’s comment about loan portfolio growth slowing a bit shouldn’t mean there isn’t too much pressure on PCL this current quarter unless something surprised us between now and quarter end.
Jaeme Gloyn
Okay, great. And with the Concentra acquisition, I presume you have a little bit more insight as to the performance of that business and maybe we can see in public filings. Are there any of Concentra’s key performance metrics, are they vastly different than at the time of the acquisition? For example, you know has growth been stronger, weaker, same thing for NIM, PCL can go on those lines?
Andrew Moor
It’s certainly earnings are stronger than we anticipated when we complete the deal. At this point, I wouldn’t like to comment much more than that, but I’m sure you can see it in the Q3filings, so probably better than you might expect it, but there’s a number of moving parts behind that, and we sort of need to be a part as we want to tell our story in a more integrated way with Concentra. I think that’s single – there’s some of the single variables out, without the broad story about how much synergy has been getting and so on.
I think the way that Chadwick continued to frame it as an accretive with EPS is still the right way to think about it and nothing that we’ve seen out at the more recent performance data that would change our broader perspective to the stream.
Jaeme Gloyn
Okay, great. Thanks guys.
A – Andrew Moor
Thanks Jaeme.
Operator
Mr. Moor, there are no further questions at this time. Please proceed.
Andrew Moor
Well, thanks Pan, and thanks everybody for their interest day. As there are no further questions, we look forward to reporting our third quarter results in November. Thank you for listening today and good bye for now.
Operator
Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines. Have a great day!
Be the first to comment