Canadian Western Bank (OTCPK:CBWBF) Q4 2022 Earnings Conference Call December 2, 2022 10:00 AM ET
Patrick Gallagher - Vice President, Strategy and Investor Relations
Chris Fowler - President and Chief Executive Officer
Matt Rudd - Chief Financial Officer
Conference Call Participants
Doug Young - Desjardins Capital Markets
Gabriel Dechaine - National Bank Financial
Meny Grauman - Scotiabank
Sohrab Movahedi - BMO Capital Markets
Darko Mihelic - RBC Capital Markets
Lemar Persaud - Cormark Securities
Mike Rizvanovic - KBW
Stephen Boland - Raymond James
Paul Holden - CIBC Capital Markets
Joo Ho Kim - Credit Suisse
Good morning. My name is Michelle, and I will be your conference operator today. At this time, I would like to welcome everyone to CWB’s Fourth Quarter and Fiscal 2022 Financial Results Conference Call and Webcast. [Operator Instructions]
Mr. Patrick Gallagher, you may begin your conference.
Thank you, Michelle. Good morning and welcome to our fourth quarter financial results conference call. My name is Patrick Gallagher and I am the Vice President, leading our Strategy and Investor Relations team.
I would like to remind listeners and webcast participants that statements about future events made on this call are forward-looking in nature and based on certain assumptions and analysis made by management. Actual results could differ materially from expectations due to various risks and uncertainties associated with CWB’s business. Please refer to our forward-looking statement advisory on Slide #2. The agenda for today’s call is on the third slide. Presenting to you today are Chris Fowler, our President and Chief Executive Officer; and Matt Rudd, our Chief Financial Officer. Following their presentations, we will open the lines for a question-and-answer session.
I will now turn the call over to Chris who will begin his discussion on Slide 4.
Thank you, Patrick, and good morning. We have a lot to discuss with you over the next week. Our remarks on this call focus on our strategic progress in the fourth quarter, our financial results and our 2023 outlook. At our Investor Day in Toronto on December 7th, we will provide further detail on how our strategic execution has positioned our talented teams to drive an unrivaled experience for more full-service clients, deliver strong core operating performance and increase value for our investors.
Our full executive leadership team will be present at our Investor Day. I'll be joined by Matt Rudd, Kelly Blackett, Stephen Murphy, and our new additions over the past year of Carolina Parra, Jeff Wright, John Steeves, and Azfar Karimuddin. The change to executive team marks the successful completion of our planned succession. I'm confident that we have the right management team to continue delivering a differentiated client experience and award winning workplace culture.
This year, we successfully launched our personal and small business digital platforms. We look forward to the opportunities our digital investments will provide across our established commercial business, and to open an entirely new and scalable growth channel for small business owners.
We successfully combined our wealth management brands with the launch of CWB Wealth. The launch further integrates our acquired wealth management operations under one brand and strategically positions us to provide a differentiated client experience in Canadian private wealth advisory services and strengthen full-service relationships with successful business families, business executives and employees of the businesses CWB serves.
We continue to increase our brand awareness, familiarity and physical presence in Ontario and are leveraging these improvements to drive market share gains. Very strong annual growth of 11% in the province was augmented by our existing full-service banking center in Mississauga and our new banking center in Markham that opened this summer. Our accelerated market share growth in Ontario will be further supported with the opening of a new banking center in Toronto's financial district next year. We're also well positioned to capitalize on opportunities available for full-service client growth in Western Canada and we will leverage our new modern flagship banking center on West Georgia Street in Vancouver to support market share growth in British Columbia.
General commercial loans represent a broad section of the Canadian economy that we believe is underserved by the other banks and is a core strategic target for growth. This category is our largest full-service client opportunity and we delivered 14% loan growth last year. We have also continued to diversify our sources of funding through the strategic growth of full-service relationships with branch-raised deposits up by 8% this year.
Rising commodity prices, supply chain pressures, labor shortages and strong global and domestic demand drove persistent levels of inflation. In response, the rapid and significant increase in market interest rates began to cool economic growth and fuel the potential for recessionary conditions to emerging Canada. The rapid movement upwards in interest rates increased deposit costs faster than asset yields this year, and put downward pressure on our net interest margin. Matt will speak to this in his section. We expect this pressure to reverse as interest rates stabilize and see net interest margin begin to expand next year. Our disciplined approach to growth remains within our prudent risk appetite. We continue to deliver very strong credit performance and are in a position of strength to face the potential economic volatility on the horizon. We expect to maintain credit losses within our normal historic range.
We are confident we will succeed in our transition to AIRB, but don't expect that to occur in the next two fiscal years. This quarter, we materially completed the redevelopment of our AIRB tools incorporating targeted enhancements and the final CAR 2023 guidelines. As expected, with material completion of the redevelopment, we recognized accelerated amortization of our previous models.
As a point of reference, following our unsuccessful AIRB submission, we commenced a parallel run of our AIRB tools to evaluate their operation through a period of economic volatility in 2021. Our goal was to determine if they would meet OSFI's use-test requirements prior to resubmission of our application. As the parallel run progressed this year, we gained significant insights into the performance of our AIRB tools and processes. We learned that our original approach to AIRB required a level of manual processing that did not support the operational efficiency needed to deliver a seamless and scalable operating model to our teams. We also identified areas within our AIRB models that required further refinement. We identified enhancements to improve the efficiency of the tools for our teams and our effectiveness as a model-enabled bank. We also made the decision to incorporate the new CAR 2023 AIRB Capital Adequacy Requirement guidelines that will be effective February 1, 2023. The implementation of these enhancements and regulatory update was supported by third-party advisors to ensure our approach reflected industry best practices. The redevelopment of our AIRB tools now better reflect our underlying credit risk with a more efficient link to our underlying data and business processes.
We learned a lot through this process and are confident we will begin to benefit from our comprehensive redevelopment of our AIRB tools. We will now implement the tools into our underlying business processes to create a sustainable and scalable operating platform that will support our long-term growth aspirations. Following implementation, we will operate the revised tools and processes for a sufficient period of time to support successful resubmission of our application.
Our strategic execution in fiscal 2022 enhanced our digital capabilities, increased our physical presence in key markets, and further improved our client offering to provide a foundation to accelerate full-service client growth. Our new financial scorecard lays out the key performance metrics we expect our teams to deliver over the next two years as a standardized bank to increase value for shareholders.
I will now turn the call over to Matt, who will provide greater detail on our fourth quarter performance and outlook.
Thanks, Chris. Good morning, everyone. If we start on Slide 7, our branch-raised deposits were up 8% from last year. That reflects 34% growth in fixed term deposits that's partially driven by a shift from existing demand and notice deposits which were roughly flat on a net basis this year. Branch-raised deposits represent 57% of our total funding that’s relatively consistent with last year.
On a sequential basis, our branch-raised deposits increased 2%. That was a 12% increase in fixed-term deposits, partially offset by a 2% decline in demand and notice deposits. The change in branch-raised demand and notice primarily reflected a shift to term deposits. We also saw a reduction in our existing deposit balances as clients put excess funds to use, and that more than offset the solid growth we saw from net new full-service client additions in the quarter. Sequentially, our capital market deposits increased 10%, reflected an opportunistic capital market deposit issuance in the quarter at favorable pricing and our broker deposit balance decreased by 3% in the quarter.
If we flip to Slide 8, our total loans were up 9% in the past year. On a sequential basis, total loans were up 2%. General commercial represented nearly 2/3 of the net loan growth in the quarter. We're also pleased to see equipment financing loan growth strengthen as the year progressed, and we delivered 2% growth in the fourth quarter.
Ontario loans grew 2% within the quarter and now represent 24% of our total loans. We delivered very strong 4% growth in Alberta this quarter, and BC loans remained relatively consistent.
Our performance compared to Q3 is on Slide 9. Common shareholders' net income decreased 16% sequentially and diluted EPS decreased $0.16. That was primarily due to the impact of accelerated amortization of our previously capitalized AIRB assets, as Chris mentioned in his opening.
Adjusted EPS decreased $0.02 and pretax pre-provision income remained relatively unchanged. The provision for credit losses increased EPS by $0.01. That was due to a lower impaired loan provision, partially offset by higher performing loan provision due to a further deterioration in the forward-looking macroeconomic outlook.
Noninterest income contributed $0.07, primarily driven by foreign exchange revenue. Higher adjusted noninterest expenses reduced EPS by $0.07, primarily due to the continued investments in our strategic priorities. That included the redevelopment of our AIRB tools and processes, the harmonization of our wealth management brands with the launch of CWB Wealth in the quarter and the customary seasonal increases we typically see in advertising, community investment, and training costs, along with higher people costs in the quarter. Additional costs related to the accelerated AIRB amortization reduced EPS by $0.13, which is reflected in adjusting items. The other items that reduced EPS in the quarter included a $0.01 impact from a higher effective tax rate, higher LRCN distributions that decreased EPS by about $0.01 and a $0.01 isolated impact of the incremental shares issued under our ATM program. Common equity raised under the ATM supported incremental loan growth in the quarter and with an income contribution that exceeded the dilutive impact of the incremental shares.
Our performance compared to the same quarter last year is on Slide 10. Our common shareholders' net income decreased 25%. Diluted EPS was down $0.29. That was primarily due to an increase in the provision for credit losses on performing loans and the impact of the accelerated amortization of our previously capitalized AIRB assets.
Adjusted EPS decreased $0.15, while pretax pre-provision income increased 8%. Increased net interest income contributed $0.09 and higher noninterest income increased EPS by $0.07 compared to last year. Higher noninterest expenses reduced EPS by $0.08, and reflected targeted investments in our strategic priorities. This includes our AIRB tools and processes, digital capabilities, investments in our client offering, and our new banking centers in Markham and Downtown Vancouver as we optimize our business, deliver an unrivaled experience to our clients and position ourselves for an acceleration of full-service client growth.
The accelerated AIRB amortization reduced EPS by $0.14. Provision for credit losses reduced EPS by $0.19 due to the increase in the performing loan provision that I previously referenced. Other items reduced EPS by $0.04, and primarily reflected the isolated impact of the incremental shares issued under our ATM.
As shown on Slide 11, the 3% sequential increase in total revenue reflects consistent net interest income and a 27% increase in noninterest income, and that was driven by higher foreign exchange revenue and higher credit-related fees, partially offset by lower wealth management fees. Net interest income was 4% higher than the same quarter last year, as 9% loan growth was partially offset by a 14 basis point decline in NIM. Noninterest income increased 29%, primarily due to higher FX revenue and higher credit-related fees, partially offset by lower wealth management fees, and that was due to the market value declines that reduced average assets under management.
Our 10 basis point decline in net interest margin is shown on Slide 12, and reflects that the growth in asset yields has not caught up yet to the growth in funding costs in the rising interest rate environment. Through Bank of Canada policy, rate increases totaling 125 basis points occurred during the quarter, and that contributed 9 basis points to our net interest margin, isolated to the impact of the increase on our floating rate loans, net of the impact on our floating rate branch-raised deposits. Higher asset yield contributed 20 basis points, and that includes the impact of higher interest rates turning through our fixed rate loan and securities portfolios that was partially offset by lower loan-related fees. Higher funding costs had a negative impact of 37 basis points. This primarily reflected increases in market GIC rates on new fixed-term deposits and pricing adjustments that were made to certain administered-grade deposit products to maintain competitiveness on pricing.
Our asset mix reduced NIM by 2 basis points, primarily driven by a reduced proportion of higher yielding equipment finance and real estate project loans from the prior quarter.
On Slide 13, we highlight our continued very strong credit performance. That's supported by the secured nature of our lending portfolio, our targeted borrower selection, disciplined underwriting practices and proactive loan management. Our fourth quarter provision for credit losses on total loans was 14 basis points compared to 16 basis points last quarter. Our performing loan provision for credit losses was 14 basis points compared to 4 basis points last quarter that reflected a softening in forward-looking macroeconomic assumptions, primarily due to the forecast impact of the rising interest rate environment, generating lower GDP growth, a decline in housing prices and higher unemployment rates, which also moved a larger proportion of performing loans into Stage 2 this quarter.
Gross impaired loans of $167 million compares to $187 million in the prior quarter, and now represent 46 basis points of gross loans. On a quarterly basis, write-offs as a percentage of average loans of 12 basis points remained well below our historical average, and we recognized a nil impaired loan provision for credit losses.
The sequential change in our CET1 ratio is shown on Slide 14. Calculated using the standardized approach, our CET1 ratio was 8.8% compared to 8.9% last quarter. While organic capital generation and common shares issued under our ATM program more than offset growth of risk-weighted assets, our capital ratios were negatively impacted by an unrealized loss on our debt securities portfolio held for liquidity management purposes, with that impact recognized and accumulated other comprehensive income and due to the rising rate environment.
To support strong loan growth as we navigate current and future economic volatility, while prudently managing our capital, we issued common shares for net proceeds of $29 million under our ATM program. Despite the recent downward pressure on our share price, the net earnings contributed by the incremental loan growth, supported by the ATM issuances this quarter more than offsets the dilutive impact of the incremental common shares issued, which drives an ongoing increase in EPS and ROE.
Yesterday, our Board declared a common share dividend of $0.32 per share, which is up $0.01 or 3% from the dividend declared last quarter and up $0.02 or 7% from one year ago.
Looking forward on Slide 15. Current economic forecasts anticipate lower GDP growth through 2023, including a moderate to sharp decline in housing prices and a steady increase in unemployment rates. In this environment, our growth will continue to be focused on portfolios that support further full-service client opportunities and remain within our strict underwriting and pricing criteria. We expect to deliver high single-digit annual percentage loan growth, with stronger loan growth in the strategically targeted general commercial portfolio and in Ontario.
Additionally, we expect to deliver double-digit annual percentage growth of branch-raised deposits, supported by our enhanced digital capabilities and continued focus of our teams to drive full-service client growth.
Based on the assumption that policy interest rate increases taper off in fiscal 2023, our net interest margin is expected to increase over the next year to reflect the combined benefit of normalized lending spreads and the impact of fixed term loans continuing to reprice at the current market interest rates.
We'll manage to an annual efficiency ratio below 50% and deliver positive operating leverage next year. We expect lower growth of noninterest expenses next year, and our approach to expense management will focus on execution of our most important strategic priorities with prudent management of our discretionary expenses. Supported by our disciplined approach and leveraging our enhanced credit risk management tools and processes, we expect that our provision for credit losses will remain within our strong historical range of 18 basis points to 23 basis points next year, likely on the higher end of that range given the potential economic volatility.
With all other assumptions constant, a provision for credit losses in the high end of our normal historical range drives annual adjusted EPS percentage growth in the low single digits and adjusted ROE of somewhere in the midpoint of a 10% to 11% range. On the same basis, our provision for credit losses in the low end of our historical range drives annual adjusted EPS growth in the mid-single digits and our adjusted ROE that approaches 11%.
On Slide 16, you will see we've introduced a multiyear financial scorecard. Our financial objectives are reflected by three key performance metrics that we expect to drive over the next two years: Pretax preprovision income growth greater than 10%; an efficiency ratio below 50%; and achieving adjusted ROE of 12% by 2024. These targets have been developed on the assumption of a relatively stable economic environment and under the standardized approach for capital management.
We look forward to spending time bringing you through the value of our strategy and what it will deliver against these financial performance scorecard metrics in detail at our Investor Day in Toronto on December the 7th.
And with that, Michelle, we're ready to open the lines for Q&A.
[Operator Instructions] Your first question comes from Doug Young of Desjardin Capital Markets.
Maybe I'll start with the AIRB conversion. Chris, did I hear you correctly that you're not looking to reapply to OSFI until fiscal '25? So two additional fiscal years down the road. Is that -- did I hear that right?
You did. Yes. We have done the redevelopment of the models. We are doing the implementation. We will run them in an internal use test, and then we'll move forward with the application.
Okay. So is the intention then for the next two years to continue to run an ATM equity issue. Is that to support the loan growth? Because it sounds like the loan growth you're anticipating you'll continue to need to have an ATM in place? Or are you considering other solutions?
Well, Doug, we'll get help from a couple of factors. So I'd say under the current standardized CAR guidelines we do have a bit of a speed limit in the high single digits in terms of our loan growth and just what it consumes under that approach. We adopt new standardized CAR guidelines on February 1, and that does introduce a bit more sensitivity and the ability for us to target our lending to lower RWA densities, particularly for commercial growth. So that's quite important for us.
There are pockets within there where, today, our commercial loan growth is at 100% RWA density. Under CAR guidelines next year, going forward, we'll be able to target growth in areas that will be below 100%, for instance, SME lending and general commercial. That attracts 85% instead of 100%, lower loan-to-value on commercial mortgages, which is the sandbox we play in. That attracts lower risk weights under the new CAR guidelines. So not quite the benefit of AIRB, which gives you credit for strong borrower selection. But at least there is some risk sensitivity introduced in those new guidelines, and you'll hear me give a little more detail on that at our Investor Day, maybe with a couple of examples.
The second piece that's been putting a bit of downward pressure on our CET1, it's our core liquidity portfolio. This isn't a trading book. These are not losses that we would realize. But this is a book we're required to measure at fair value each quarter. Those, in this case, unrealized losses are recognized in AOCI and reduce our CET1. That's something that as interest rates stabilize, we'll see reverse basically as that bond portfolio either approaches maturity or eventually matures because these bonds mature at face value, obviously. So we'll have some wind in our sales. And Doug, there's a path to turning off the ATM. That is not dependent on AIRB.
So when you see for next year, within your expectations, have you modeled it that you will have to continue to use the ATM through next year? Or is that something that you think you can turn off based upon your projections?
It's a case where we'll likely continue to use it in the first part of the year until we adopt the new car framework. Once we've adopted that, and we can be very targeted and see that new lending come on at the lower risk density, our intention would be to structure our growth and target our growth in such a way that would allow us to turn off the ATM. That would be our priority. Of course, there are other things that can consume capital, and we'll continue to prudently manage it, but that would be our focus.
And then just the third, and I promise I'll stop it. On the NIMs, obviously, it's a huge focus this quarter for all the banks, and given what we saw with Big 6, I guess, I'm not too surprised by what we saw with yourself. But can you -- I guess, my question is can you describe a scenario help where NIM start to expand? Like can you kind of give an example? And like you said, should we be looking at prime versus CDOR or prime versus BA to kind of gauge where NIMs are going to go?
And I guess, ultimately, what I'm asking is like on Slide 12 -- and I guess this is a follow-on, a second part of this. But if I look at Slide 12, you have an asset yield benefit this quarter of 20 basis points as the lag impact starts to come through. And I guess my question is like, if interest rates don't move from here, like how much more of a lag of that -- something similar to that 20 basis points is left to flow through the books? Again, assuming that no more rate increases. I don't know if you can give some perspective on that.
Yes. Well, there's a couple of ways you can tackle it. I mean, looking backwards, if you just look at our NIM performance this year, you'll see Q2 and Q4, where we had pretty significant increases in the yields -- bond yields. I think Q2 we would have been up more than 100 basis points within that one quarter on yields. And then if you look in Q4, we would have been very close to 100 up. And in both those two quarters, we saw a downward pressure on our NIM where just -- it's just a case where the deposits reprice a lot quicker than the assets, given the difference in duration of those books. We had one quarter this year in third quarter where we had only, and I just put air quotes around “only” 40 basis point increase in the yield curve through the quarter, and that's a quarter where you saw us expand our NIM a little bit.
So on the basis of stability in market interest rates, which is really what we need, it allows our assets to catch up and continue to reprice where deposits have been pretty quick to react already.
So just to give you a sense of a bit of the torque here, if we look at just the change in Bank of Canada rates through the year, our deposit costs, I mean, they reflect about, call it, half of the Bank of Canada rate increases. On our asset side, it's about 1/3. If we just saw no further shifts upwards or are no significant shifts upwards, that delta nearly closes over the next year in terms of assets catching up and passing through about the same amount of that Bank of Canada increase.
So that's why we're feeling pretty constructive on NIM next year and seeing just a mechanical path to NIM expansion just from our asset book catching up to our liability book, frankly.
The next question comes from Gabriel Dechaine of National Bank Financial.
Just, Chris, in your opening remarks, you said don't expect AIRB transition over the next two years, I want to make sure I understand those comments. I didn't expect anything fiscal 2023, but you're also saying you don't expect the transition to 2024.
Yes. So what we're doing is we redevelop the models and processes. So now in fiscal '23, we'll put them into implementation and then we will run a use test and then take it forward for approval. Gabe, this is a long-term win for the bank as we think about what the future has of us being able to manage capital much more proactively and really target our lending and really focus on portfolio management. It just provides all sorts of opportunity. So we're just going to make sure that all of the internal processes are such that we have a clear path and we're absolutely convinced we have no issues.
So that's the -- we just want to give that sort of time frame that just sets the stage for what we're doing. We're confident in the work we've done, and we're confident in the process we have going forward. And we just want to say that I don't expect to see it for two years.
And I appreciate it's a long-term process, but investors obviously want to know. Today, you talked about stuff like more manual input, and I think fixes or refinements to some of your existing models, are those some of the items that you learned over the course of this year or, I don't know, for prior year?
Yes. That was the outcome of our parallel run. We found that the ability to replicate did not -- was not as strong as it could be. So we are putting in more automated processes that allow us then to have a structure that just eliminates the challenge of replication so that we have a really strong process in place.
Okay. I'm going to ask Doug's question differently. Just if you can -- I was not fully paying attention there, but you can really dumb it down as far as -- in the last few quarters, you've talked about margin expansion and it's gone the other direction. You're seeing margin expansion in the coming year. What are the critical factors? Is it just that the rate hikes kind of flatten out at some point and that has less of an inflationary impact on your funding costs and then the assets just reprice gradually and catch up? Is that the gist of it?
Pretty much it, Gabe. Like we need a quarter where yields don't go up 100 basis points in a single quarter. I mean, that's highly unusual in a historical context, and it happened in two quarters this year.
The interesting thing, our deposit costs, they've actually behaved quite well, and we're pretty please. I mean, we've made a lot of investments over the years to start building a funding profile that's a bit more consistent with what you'd see at the larger banks.
When you look backwards at the last year, and I look at the change in our deposit costs relative to the large banks and including some that are being celebrated for their strength on that regard, our deposit cost increases kind of in the top quartile. I think maybe only one other bank that had a lower increase in their deposit costs over the last year. We're about the same as one other one. And then the four others actually had more of an increase in deposit costs. So I wanted to highlight that because some might find that surprising.
Really, the difference we've seen has been on the asset yield side. For us, this has been a mechanical repricing of our book at the higher interest rates. And I can't speak for others, but there are other ways to find yield in this environment. But for us, we have not adjusted our credit risk appetite, it has remained very consistent, and we don't take on market risk or trading risk outside the management of the interest rate risk in our banking book.
So for us, it's just a timing factor, and we expect that to resolve next year. And really, all we need is have a quarter where even if you see increases, they're just not at the pace and speed that we saw through the last fiscal year.
Okay. And just to -- your statement there, well, I guess not the statements, but on the update, those are prospective changes. So it only affects new originations but the way I'm reading it in your annual report, in the CAR guidelines, it sounds more prospective. It wouldn't affect your existing balance sheet?
Yes, it does. Yes, you're absolutely right, Gabe. You do a remeasurement on adoption of the existing book. Now the existing book is based on what we've originated over the last couple of years. And while there are areas within the new CAR guidelines that allow you to target lower risk weight densities, there are other areas that go the other way where you can end up holding a higher risk weight than what we would have had under the current standardized approach.
So on day 1, you're adopting the portfolio you have. But on a go-forward basis, you can absolutely be targeted and reduce the risk weight density if you are prudent and smart lenders, which that's how we categorize ourselves.
So historically, you weren't optimizing for rules that didn't exist yet in their proposed form, but in the future, you will basically.
Yes. And then last one, expenses. So I know I've been harping on this for a while now, but I don't want to gouge you for 7% expense growth. That's a great outcome compared to what we've seen in the last little while, and you're looking at a sub-50% mix ratio next year. Just want to -- on the quarter, the salaries and expenses were pretty flat year-over-year. Is that anything unusual in there? That's the biggest expense component. Was there anything unusual there? Or is that a sustainable? Kind of I guess that we're all living in the world of wage inflation and probably does not mean anyway, but others?
Yes. I mean, we've taken a pretty measured approach and dealing with wage inflation. I mean, we did make some targeted adjustments through the year where we felt we needed to. But it was just that. It was targeted. I think what we've seen in the last quarter is it's proven to be the right approach because that -- a lot of the heat has come out of the labor market, at least from our perspective and what we've seen kind of emerging here over the last quarter.
When we look to bring in new talent, our proposition hasn't come here for a financial windfall that people are coming here because they believe in the strategy. They like the upside, they like the culture, but they're not coming here to make a higher wage necessarily. We're competitive, but we don't need to be top of the table, and that's consistent with like loan pricing, deposit pricing, our proposition is service, value and culture, and not necessarily price. And it's similar on wages. So I think that's allowed us to weather the storm pretty effectively actually.
The next question comes from Meny Grauman of Scotiabank.
Just a question on the delay of AIRB. I'm wondering if there's any expense implications that we need to think about specifically for next year?
No, Meny, even though we have some implementation work to do, and we're building some automated portions of that implementation. It gives us a much better sustainable operating model for sure, maybe pushes out the time line a bit. But when we think about expenses for next year or would this cause me to think there's a higher run rate or puts our ability to lower our efficiency ratio in jeopardy? No.
We're executing the work that we need to execute, but it's not one that we think will cause any pressure on NIEs next year. It's a case where as we progress with AIRB, now that we're through this big chunk of development work, that was the big push in terms of effort from our teams and our third parties to get that up and running. It was a very expensive piece of that process. And from here, things start to get less expensive.
Understood. When we look at the credit picture for CWB specifically and broader, I mean, it definitely doesn't look like there's any big credit issue out there, just more of a normalization. But I'm wondering, more from your perspective, speaking to customers, are there certain areas or geographies where you are hearing about more stress? I'm thinking, in particular, maybe the franchise finance business in particular. Are there any areas that you would highlight that are dealing with more challenges across your customer base?
We've not seen any particular portfolio have kind of systemic increase in risk, which is great. The franchise finance, of course, came through the COVID structures with actually very good outcomes. We've got a very -- we've talked before about a very defined lending process within franchise finance with we're focused on suburban hotels that have lots of flexibility, with operating leverage that can cut their costs quite dramatically, which they did. And the borrower profile that we focus on there is to make sure that there are typically multiple hotel owners on flagged hotels, so they come in into it with a very strong loan to value.
And what we've seen is really great resilience in that whole portfolio through the entire global finance through the entire COVID period. So we're not seeing that as one that is providing extra risk. But again, we are following all of the segments of the portfolio as we monitor the future and see what will occur as the impact of higher interest rates come on the economy.
The next question comes from Sohrab Movahedi, BMO Capital Markets.
Sohrab Movahedi - BMO Capital Markets Equity Research - Banks Analyst
I just wanted to get a perspective. Do you anticipate any benefit your franchise from the HSBC Canada acquisition here?
Well, we are -- our largest portfolio is in British Columbia. That's our -- we have a big footprint of branches there. That's the largest portion of HSBC from what I understand. We have lots of clients that we share. We have lots of opportunity to be very focused on how we approach that market. We have grown up in BC and Alberta. So we've got a good familiarity there, good brand awareness, and we'll be very focused on making sure that we can look and speak to clients.
Just by pure coincidence, Sohrab, we just opened a flagship banking center and regional office like right down the street from them. That wasn't obviously intentional, and this was planned a while ago, but just kind of further highlights how well positioned we are relative to that opportunity.
And just, I guess, that's both in terms of client and talent acquisition on your part, maybe attrition on their part. Is that fair to say, Chris and Matt?
I think we're focused on the same markets. Our general commercial focus is definitely one that HSBC has always been very active in. And as I say, we do share clients. So we've got a very similar underwriting structure as they would. The opportunity, I think, both for clients. And as we look at supporting our growth with excellent staff, that would be an opportunity.
And just to stay with it for two more kind of quick follow-up questions. The type of outlook or guidance math that you provided, both in terms of loan growth and NIM, I guess, that did not factor in any -- did it factor in any kind of windfall gains, whether it's business or otherwise from this HSBC disruption? Or did it assume status quo as far as the competition kind of landscape is concerned?
Yes, Sohrab, I think it's fair to characterize it as it was more status quo. I mean, when we were developing our outlook and budget for next year, frankly, we did not have this necessarily top of mind. So this is something I would look at as putting a bit of wind in our sales relative to the hand we thought we might have been dealt next year. So obviously, other things can happen, but we look at this one, and it gives us a pretty high degree of confidence in the outlook, put it that way.
Okay. And then, Matt, just one final one then just on that same topic. I mean, obviously, HSBC is both active on the retail and the commercial side. I think you run more into them on the -- you respect them as competitors, I think is the way, ultimately, Chris characterized it as competitors on the commercial side. Would -- is there any -- from what you would have seen in deals that you would have been with them, is there any indication that the removal of them as a competitor will be net beneficial to margins, I don't know, either on asset yields or funding side? Or that may be more of an impact on the consumer books, less so on the commercial where you're at?
Yes. I'm not -- I'm racking my brain to think about when we've been up. We're up against the big banks, and we often see them pretty significant pricing pressure, and we find ourselves priced a little bit wider of the large banks. And then people take it because they're -- frankly, we're charging for a premium service and then delivering it. Again, to HSBC, though, at times there, we've seen them get aggressive, but overall, they're fairly well behaved, I think, Chris, unless you've seen something different?
I think on the commercial side, I think it's not a dissimilar approach to the client base, not a dissimilar pricing structure. I think they'd be much more aggressive on the personal side.
The next question comes from Darko Mihelic of RBC Capital Markets.
I just wanted to ask about the dividend increase, it was $0.01. Annual earnings per share down, adjusted down. And what's the thought process there? Why bother for just $0.01, and this is a bank that's using an ATM? So I just wonder if you can just talk to the decision to suggest that the Board to raise the dividend?
Yes. So we think about it, Darko, from a payout ratio first. And I think if you look back historically and you look back to the last time we had medium-term targets, we wanted to be in that 40% range. If we're going year-over-year comp, I think last year, a tougher comp from an earnings perspective because we had very benign PCL. We had performing loan releases, et cetera, and a fairly low payout ratio. Even with this increase, we'd be still in the mid-30s, which we'd still characterize as fairly low.
So when we think dividend, when we think payout ratio, it's about the ratio of earnings, very confident in the earnings outlook and the ability to grow and expand from here. So that was the logic behind the increase. I mean, it's something we look at is more structural, whereas use of an ATM, a bit more reactionary, a bit more in the moment based on immediate, more near-term capital needs relative to near-term capital demand from loan growth, whereas the dividend a bit more structural and not the tool I'd necessarily look to as a capital management tool.
Okay. And then just switching to the AIRB tools that are sort of in your toolkit. I just wanted to understand a little bit, like my understanding was you were already using parts of it to help you to gather insights into the lending book and the behaviors and so on of certain products. So what is it now that requires a full year and plus of using this tool that you would not have already garnered from using it up until now? Or am I just missing something? Am I missing the full extent of what you're capable of using? Or maybe you can just provide some sort of insight into how much of it you were using this past year versus what the full use would be next year?
So the difference, Darko, is that when we do a loan underwriting, we use a scorecard. And the scorecard that we're using today, which does utilize the AIRB categorization on risk for the different portfolios we're in, it's a pretty manual scorecard. And what we will be replacing that with -- and the model that drives that is the one that we've replaced. What will be replacing that is a more automated process for the manner under which we calculate the risk rating per client. Essentially that gives you that granular look on loan-by-loan, and that's where that implementation time is taking over the next year.
The next question comes from Lemar Persaud of Cormark.
Before I start the question, I'm just going to be really borne with this one. So I got to apologize in advance for that, but I really want to understand it. I think you guys, be it that the guidance has been a bit of a moving target throughout in 2022 and in Q4, again with a sharp decline in margins. So I'm wondering if you could really talk to us about what the real surprise was from the last quarter's conference call as you kind of move through the quarter? Not to put too fine of a point on it, but you guys offered like, let's say, the NIM guidance at the end of August.
So I guess what moves so sharply against your expectations in September and October to drive margins down a sharper than expected? Maybe you could comment relative to the waterfall you provided on Slide 12, which is very helpful. And I guess the reason I'm asking this is, I guess, how confident are you more broad in the guidance for the year ahead? Like is there a margin of safety built into your 2023 outlook? Or is that kind of a best case scenario where it could be walked down throughout the year?
Yes, no problem, Lemar. So the outlook we provided, and if we look at where just simply pull up the two-year yield curve as an example, our expectation when we got through the quarter and had our call was that, and this was not a CWB position, this is frankly what the curve reflected. At that point, the expectation was that yields have captured about all the upcoming Bank of Canada rate increases that they were going to capture, and we thought we would level off from there.
Rather than leveling off from there, we saw continued sharp increases in the yield curve. And that's something that you see right away reflected in GIC rates. And you look at the sort of funding we generated in the quarter, no different from the other banks, I would think if you ask them. A lot of the deposit growth in the quarter was GICs, which is just natural in the sort of rising rate environment and the sort of rates you can get on a GIC these days. So that was the biggest factor, Lemar, is interest rates we thought were done sharply increasing and they just kept going for the rest of the quarter. Felt that immediately in deposit costs, and it's something where asset yields will catch up.
So when we look through to next year, if we continue seeing each quarter 100-plus basis point movements in yield curve, that would be a very challenging environment for us to expand NIM and just because our deposit book is shorter dated than our lending book. So that would be a very challenging dynamic for us to work through. I don't think that's different from the other banks, but I wonder if other tools were used to help find yield in this sort of an environment.
Okay. That's helpful. And then can you talk about kind of a margin that state that you guys building in that 2023 outlook on your Slide 15? Or is that exactly what you guys are thinking in your internal models?
Yes. So for us, obviously, we would need stability in interest rates to think about robust expansion of net interest margin. If rates continue to tick up a bit next year, we'd be thinking about a less robust expansion of net interest margin. Beyond running through different scenarios, we're comfortable with the outlook of an increase to put a fine point on it.
The next question comes from Mike Rizvanovic of KBW.
Just sorry if I missed this in your prepared remarks, but can you talk about that FX benefit? And more importantly, is this something that -- well, first off, how is that manufactured? And is this something that you could potentially manufacture going forward? Could we see the noninterest income line elevated because of FX and maybe even these credit-related fees? But FX more specifically, it looks like that was a really big one. Can you manufacture that going forward? Or this sort of go back to that normal level, which is -- looks like something around $7 million or $8 million lower than it came in this quarter?
Yes. On the -- so we saw very unusual things in the interest rate curve and beyond what we expected. And I mean, somewhat related on the USD-CAD exchange rate, that was a pretty sharp and significant movement in the quarter and not something that we expected either. We have a small U.S. dollar balance sheet, a little bit of a net asset as the position it usually fluctuates in. So the sharp strengthening of the U.S. dollar in the quarter is what drove that gain, not something we necessarily manufactured or engineered. It's frankly just what happened.
Looking forward, I'd say, from the start of the quarter, the USD was weaker than usual and finished the quarter stronger than usual. If you got back to neutral -- if you call a CAD 0.75 neutral-ish, if you go back to there, we'd be giving back about half of the gain next year. So if you're thinking about the noninterest income line, that's one that I'd circle and say, likely going downwards. The one I'd circle as going and more than offsetting that decline would be in wealth. I mean, we've just done a harmonization, a rebrand and really the full integration of the acquisition, and that business is ready to rock and roll and really leverage cross-sell to and from the rest of the business. So we've circled that as something giving an offset there.
So will you see really large noninterest income growth next year? I don't think so given that FX potential headwind. But will we continue to grow and will it be pretty solid growth? Yes, and wealth will be the big help there.
Okay. And then just on that wealth, can you give us the ballpark? Is this a revenue line that could grow double-digit range?
We hope so. You need a bit of help from the market there, and that's we put a headwind on the growth rate this year. But from the new client generation and harvesting a lot of the cross sell, that would be the growth target of this business and in an environment where, call it, market wasn't helping or hurting.
Okay. So it sounds realistically only a partial offset. If I normalize that other noninterest income line, the $8.5 million, it looks like it's got -- like if you're suggesting that comes down by half, $4 million, I'm guessing you're not looking at wealth hitting that $18 million level anytime soon just based on your commentary. Is that fair?
Yes, that would be fair. Yes, and then I think through next year, you'll see the normal growth in credit-related and retail fees. Those typically just grow with the loan and deposit book.
The next question comes from Stephen Boland of Raymond James.
There were two pieces guidance given in Q3. You addressed the NIM and what the reason was for that decline. But the other piece of guidance was the 20 basis points of provisions that you expected to put up in Q4, it's nice to see 14, but you also mentioned that things maybe have deteriorated, the outlook has deteriorated, and sequentially, that premium is down quarter-over-quarter. So maybe what changed from the Q3 guidance that you provided for this quarter and what the decision was for that 14 basis points?
Yes. So I'll tee it up, and Chris will finish so we can brag about credit quality. But for us, if I gave you the guidance of zero basis points impaired loan PCL in the quarter, you guys might have thought I hadn't had my coffee that morning. It's highly unusual for us to put up no impaired loan provision. And I think Chris, here's your chance to talk about the way we manage credit here.
Yes. Well, Stephen, we've talked about many times, and we really are very focused on that core client, very strict underwriting, secured loan portfolio, strict follow-up monitoring, we got a strong management team should we have clients that move into our watch are impaired. So credit is in our DNA. We make sure that it's something that supports our ability to grow. And growth is our focus. But prudent growth is really the #1 outcome that we've been able to deliver, and that's our intention going forward.
That said, obviously, it's not sustainable for us to think we're going to deliver either zero or even single-digit impaired loan PCL. Just structurally, that's not a consistent or supportable assumption, we think. But at times, we can have quarters where it's just very, very benign. And this quarter was very, very benign. When you think about impaired loan PCL, you think about write-offs being much lower than usual. You think about our impaired loans going down $20 million-ish quarter-over-quarter, like these are all strong indicators, but also things I'd circle and say are fairly unusual, but in a good way, I suppose. Our teams have done a great job so far.
Okay. And maybe just my second question. Just for the guidance for loan growth, when we look at the different buckets of the segments that you lend in, should we expect similar growth in those segments? Is that what's building your guidance for next year, like general commercial real estate, things of those which were the highest year-over-year?
Yes. We're obviously most bullish about general commercial. That's a book we've had a lot of success and that's our target client, and that's one that we expect continued very strong growth in next year. Portfolios that we circle perhaps for lower growth, which is relatively consistent with the themes you've seen this year, but our real estate portfolios and commercial mortgages, we've obviously been very targeted there. We will continue to do so.
In real estate project lending, we've been very specific about the sort of project and borrower we're targeting in that book. And that's one, I'd say, would grow at less than the portfolio average next year, just maintaining that same discipline and prudency. And then equipment is one, it likely rebounds and grows pretty similar to the overall loan book, which would be a nice rebound year-over-year, frankly. And then the personal lending is probably one that grows out to about the same level as the overall book would be kind of our feel right now. And obviously, this can shift and change as the year goes. And so, Rob, in his question, highlighted another interesting opportunity. But based on how we see it right now, that's kind of a high-level estimate.
The next question comes from Paul Holden of CIBC.
So I want to challenge you a little bit on the deposit -- branch-based deposit growth outlook. And I guess that comes from two perspectives. First off, you put 8% growth up this year, which is still a good rate, but you're forecasting double-digit growth next year. And I think in what's going to become a more challenging environment, right, for economic conditions because of liquidity across the broader system, and then also competitive intensity for deposits is ramping up as well. So just wondering what is it in your plan that gives you confidence that you can grow at a faster rate in '23 than '22?
Well, it is our target, Paul. We've talked about this ability for us to take many of our single product to multiproduct. We continue to work on improving that product suite that attracts the clients to the bank. That continues to be a way that we are winning more clients, and that is an addition to our deposit opportunities as well, the launch in this past year of our personal and small business digital. Small business is a growth area for us. It hasn't been a historic market for us that we look to gain traction in with our ability to hit that with the product that we think is going to have some good market appeal.
So it is a key focus, right, as we think about the core client that we're on and having that both sides of the balance sheet for us and for the client as what we're really looking to drive for. And again, that 14% growth of general commercial last year is indicative of that targeted focus, and that's continuing. And that's how our teams are kind of looking at the market. And that's where we're looking to really help drive that branch-raised deposit growth as well.
Okay. And then sort of a follow-on question. How important is that branch-raised deposit growth in terms of your expectation for NIM expansion next year? I mean, I don't know if you can quantify it at all, but let's say, deposit growth was 2% different than expected, whether higher or lower? Like is that enough to actually impact your PTPP guidance? Or is it sort of a nonmaterial impact? Just trying to get a sense if you can help with that.
Yes. Paul, I wouldn't highlight it as a material impact, especially on the PTPP. I wouldn't look at that as a big headwind. A lot of the growth in branch-raised deposits has been in GICs, which are quite expensive. So for us, we're thinking that, just in the high rate environment, that continues to be a big proportion of our branch-raised deposit growth, and we'll continue to see a migration from the cheaper notice and demand into term as a continuing impact next year already.
Our opportunity would be to get more of the, call it, notice and demand, cash management, less expensive deposits. We've assumed we have a fairly solid batting average on that next year. If we did not deliver that same batting average and didn't see solid growth in notice and demand, yes, I mean, it puts a headwind on NIM, but not something I'd look at and say that would be the reason we wouldn't deliver NIM expansion. I don't think it would be a big enough factor. The biggest headwind against delivering NIM expansion next year would be similar to what we saw in the fourth quarter this year, second quarter this year, just the yield curve massively expanding like it just did.
Okay. That's very helpful. And last question for me is just going back to that NIM headwind. Matt, you've articulated it well in terms of what happened in Q2 and Q4 in terms of the move of the yield curve. What I want to understand just a little bit better is, does it matter what part of the yield curve? And obviously, I asked that question because we know Bank of Canada rates are going up in Q1 and perhaps the long end of the curve or medium end of the curve, if you will, might not move that much or might actually come down. Like what does that shift or twist in the curve mean for your funding costs?
Yes. On the funding side, our bellwether would be the kind of more near term in like that one, between kind of one and two years. And then on the lending portfolio, that's kind of like a two or three-year type tenor would be more important.
The next question comes from Joo Ho Kim from Credit Suisse.
Joo Ho Kim
Just wanted to go back to noninterest expenses, and I apologize if this was already asked. But it just seemed higher than usual for some of the line items like professional fees and others. So just wondering if there's anything sort of onetime in nature there. And specifically for that professional fees line, let's moved around quite a bit, so wondering where you see that going, just given some of the projects like AIRB that's going on at the bank?
Yes. So professional fees, kind of the big, big pieces that fell into that bucket this quarter. AIRB, obviously, some expenses fell into there. The other piece was in our wealth harmonization, the costs we incurred to complete that. Some of those costs ended up in that bucket. So those are the two items that would have pushed it up sequentially.
Thinking through the next year, I mean, that's a bucket if we just thought on an annual basis, it's one that I wouldn't see a potential for a large increase. That's one that I think finds a bit of stability and perhaps starts coming down a bit. And that's really our AIRB project kind of getting through this initial build phase and now moving into an implementation phase. And just our overall kind of volume of strategic projects were coming down.
That's one I'd circle and say there's opportunity for stability in that bucket rather than you would have seen a pretty big buildup of that bucket over the last couple of years. I think we've plateaued there, and you'll likely see that start working down.
Joo Ho Kim
And just wanted to go back to margins and that guidance for modest improvement for margins next year. How much of that will be tied to improvements in loan yields or loans repricing into higher rates? I'm just trying to get a sense of how quickly your book turns over and whether you see potential or any potential competitive pressure potentially limiting that ability to reprice?
Well, the competitive story, it's certainly reflective in the commercial mortgage book, which you saw lower growth in this past year as we really kind of picked our spots in growing that. We're going to be zeroed in on our core client, that general commercial, and we had very strong growth in 2023. We see that, and really maintenance of our yields, too, in that category. So we want to make sure that we're deploying capital in a very effective and efficient and accretive way. So we will be targeted and ensuring that we have -- we think it through.
Yes. And just to give you a sense of speed of the churn. I think you heard me say that, so far, our asset yields and really our loan yields, if I isolated them, would be behaving in the same way. I mean, they've reflected about 1/3 of the, call it, market rate increases. You fast forward a year, and nothing else happened in terms of the curve or shape of the curve, and you just allowed that book to reprice and you made same assumptions on today's spreads. You might move from 1/3 to somewhere between half Q 2/3 of the market rate increases being churned through. So hopefully, that gives you a better sense.
Thank you. There are no further questions at this time. I'll turn the call back to Chris Fowler for the closing remarks.
Thank you, Michelle. Our performance this year reflected solid growth and continued investment in our strategically targeted full-service growth initiatives in a volatile economic environment. With a focus to grow full-service relationships with business owners and their families, we delivered very strong general commercial loan growth, double-digit loan growth in Ontario and supported our strong diversified funding profile.
Our disciplined approach to driving growth within our prudent risk appetite delivered very strong credit performance, and we're in a position of strength to face the potential economic volatility on the horizon. Our strategic execution has delivered enhancements to our digital capabilities, increased our physical presence in key markets and further improved our client offering to provide a foundation to accelerate full-service client growth. We're focused to deliver strong core operating performance next year and achieve the financial performance targets we have set for 2024.
I look forward to talking to you next week at our Investor Day in Toronto. If you haven't preregistered, please see our website for further details. With that, we wish you all a good day. Thank you.
Ladies and gentlemen, this does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.