Earnings Call Transcript - BMO Q2 2020

Operator, Operator

Please be advised that this conference call is being recorded. Good morning, and welcome to the BMO Financial Group Q2 2020 Earnings Release and Conference Call for May 27, 2020. Your host for today is Ms. Jill Homenuk, Head of Investor Relations. Ms. Homenuk, please go ahead.

Jill Homenuk, Head of Investor Relations

Thank you. Good morning, and thanks for joining us today. Our agenda for today's investor presentation includes remarks from Darryl White, BMO's CEO, followed by presentations from Tom Flynn, the bank's Chief Financial Officer, and Pat Cronin, our Chief Risk Officer. We also have Ernie Johannson from Canadian P&C and Dave Casper from U.S. P&C. Dan Barclay is here for BMO Capital Markets, and Joanna Rotenberg represents BMO Wealth Management. After their presentations, we will conduct a question-and-answer session with prequalified analysts. Please note that forward-looking statements may be made during this call, and actual results could differ significantly from the forecasts or conclusions in these statements. Additionally, the bank utilizes non-GAAP financial measures to determine adjusted results for performance assessment by business and the overall bank. Management evaluates performance on both a reported and adjusted basis. Darryl and Tom will reference adjusted results unless indicated otherwise. More information on adjustment items, reported results, and factors related to forward-looking information is available in our 2019 annual report and our second quarter 2020 report to shareholders. Now, I will turn it over to Darryl.

Darryl White, CEO

Thank you, Jill, and thank you for joining us this morning. We always value the opportunity to connect with you, particularly during this extraordinary time. The global COVID-19 pandemic is having a profound and deeply personal impact on all of us. We want all of our stakeholders to know that, as one of the largest banks in North America, we feel a clear responsibility to do our part to support the health of the economy. We're working together with policymakers, customers, and other stakeholders to develop solutions to the complex challenges presented by the pandemic. The measures taken by governments and central banks to support the overall economy, individuals, and businesses have been significant and unprecedented. For BMO, the strength and the clear momentum that we had going into the crisis means that we can provide the needed support to employees, customers, and communities to ensure operational and financial stability for the long-term benefit of our shareholders. Our top priority has been and continues to be the health and safety of all of our employees and customers while maintaining critical banking services. We mobilized quickly to transition 90% of our non-branch employees to work remotely. We implemented strict safety procedures to protect those who need access to physical locations. We're acutely aware of the uncertainty and financial concerns our customers are facing, and we're committed to helping them navigate these challenges. We've provided personalized advice and access to a variety of flexible relief options, including payment deferrals for over 200,000 customers in Canada and the United States. As of last week, we facilitated over $2 billion in funding under the Canada Emergency Benefit Assistance Program and over USD 5 billion in loans in the U.S. SBA Paycheck Protection Program, helping 75,000 businesses to keep operating and pay their employees. We're maintaining access to branches, ATMs, and call centers, and we're also connecting with customers and each other in new and innovative ways. We very successfully expanded our virtual and digital tools to meet customers' needs, including broad use of e-signatures, phone and video meetings, and digitized processes. Our ability to implement these changes quickly has directly benefited from the investments we've made over many years in our technology and digital infrastructure. Turning to community. Guided by our purpose to boldly grow the good in business and life, we've announced several initiatives aimed at helping the communities where we live and work, including donations through the United Way to help get support to those in greatest need. For our frontline healthcare workers, who go above and beyond each day to help keep us all safe, we've converted our institute for learning building to provide a safe place for them to rest and recover. Together with MLSE, we've repurposed the kitchens at BMO Field to prepare and deliver meals to hospitals and shelters across Toronto communities. We also know the impact that the pandemic is having on mental health as people of all ages struggle with the challenges of social isolation and an uncertain future. That's why we remain fully committed to our ongoing sponsorship and as a founding partner with Kids Help Phone, reimagining our annual walk so kids can talk to a virtual Never Dance Alone-a-Thon. I invite you to join us on May 31 and help raise funds and awareness for mental health in Canada. And just yesterday, we announced that we've joined others to support a promising pan-Canadian COVID-19 clinical trial being coordinated by Sunnybrook Hospital research team, donating $300,000 to this potentially groundbreaking research. Turning now to our financial results. While COVID-19 had a meaningful impact on the bank's earnings this quarter, the bank's operational performance and capital position remain solid. We benefited from positive momentum across all our businesses going into the crisis with a focused strategy and a very disciplined approach to expense management. This quarter, we delivered $2 billion in pre-provision pretax earnings, demonstrating the resilience and earnings power of our diverse businesses. We fully absorbed a significant increase in loan loss provisions, including a $705 million provision for credit losses on performing loans. Our personal and commercial businesses in Canada and the U.S. continue to drive core profitability and revenue growth as both businesses worked very closely with customers. Strong loan and deposit growth was in part driven by customer reaction to the pandemic, which increased loan utilization and a movement to deposit safety. We're now seeing these trends stabilize. Our Capital Markets and Wealth Management businesses were impacted by the market volatility and dislocations during the quarter. Capital Markets results reflect the increase in provisions for loan losses, primarily for performing loans. Client-driven trading revenues were mixed with strong performance in certain asset classes, offset by negative impacts from the market environment. Underlying performance in Wealth Management held up very well with good net new asset growth in our advisory businesses and very strong online brokerage revenue as our teams supported a doubling of transaction volumes and account openings compared to a year ago. These good wealth results were negatively impacted by market movements on our insurance business and a legal provision. Capital Markets and Wealth Management continued to demonstrate their competitive strengths in supporting the efficient and effective functioning of global markets. BMO Capital Markets was the lead book runner for the $8 billion global benchmark sustainable development bond issuance with the World Bank aimed at strengthening health systems in developing countries. BMO GAM was proud to be selected as the asset manager for the Bank of Canada's provincial bond purchase program, which aims to support the liquidity and efficiency of provincial government funding markets. While the scope and the scale of the economic and social impact of the pandemic remains uncertain, our strong liquidity and capital provide the strength and stability to withstand a period of prolonged economic recovery. Our CET1 ratio at 11% is well above regulatory requirements and supports our commitment to maintaining our dividend payment record. We prudently provision for future losses, have a demonstrated track record of strong risk management, and are singularly focused on working with our customers across industries and geographies to help them withstand and recover as we always have through every part of the business cycle. Our commitment to improving the bank's efficiency is as strong as ever. On a year-to-date constant currency basis, we've held expenses flat to last year and maintained positive operating leverage. And we'll harness the speed and agility with which we've been executing change during this period to further improve efficiency in each of our businesses over the long term. We're not alone in finding efficiency improvements that will sustain future growth. The economic recovery is likely to be uneven with some sectors able to rebound quickly and even outperform as they take advantage of accelerating trends that were already emerging. Economies have proven to be resilient, and we salute our personal and our business clients who are incredibly resourceful as we work together with them to overcome challenges and close innovation gaps. We all have a shared accountability to make things better when we get through the other side of this crisis. At BMO, through the pandemic, we've developed a new way of working that has been core to our strategy for a long time but has now accelerated as we build a stronger, more competitive BMO for the future. We will continue to show discipline and accountability on how we allocate resources to areas with clear competitive advantages, strengthening value for our customers and delivering a more sophisticated, integrated approach on digital first, combining the power of our modern technology platform and proactive analytics. Before I close, I'll leave you with my summary reflections on how I feel about our quarter in such unprecedented and remarkable environments. First, I'm extremely proud of how our employees responded, supporting each other, our customers, and our communities in moments of extreme anxiety and need. I'm proud of our brand and our ability to live our purpose when it truly matters most. Here, I could not have asked for more. We earned $2 billion of PPPT, comfortably absorbing significant and prudent increases in provisions for credit losses. And we earned this despite meaningfully lower revenues in some of our market-sensitive businesses. We have a strong capital and liquidity position, a disciplined operating plan, and very good momentum. The strength and resilience of our overall diversified business model have been tested, and we are performing well through these challenges. As a result, I'm confident that our bank has never been positioned better to face the environment ahead. I'll now turn it over to Tom to talk about the second quarter financial results.

Thomas Flynn, CFO

Thank you, Darryl, and good morning, everyone. My comments will begin with the highlights of our financial results for the quarter. Despite the challenging environment, our pre-provision pretax earnings and operational performance are strong. From a balance sheet perspective, we are in a solid position with robust capital and liquidity. Our reported EPS for Q2 was $1, with a net income of $689 million. The adjusted EPS was $1.04, and the adjusted net income was $715 million, both lower than last year primarily due to increased provisions for credit losses, which accounted for 85% of the decline. Pre-provision pretax earnings were about $2 billion, a decrease of 5%, yet still comfortably absorbing the higher credit loss provisions. The adjusting items are consistent with previous quarters. Turning to revenue, our net revenue for the second quarter was $5.5 billion, down 3% compared to last year. Increased revenue from our P&C businesses due to strong loan and deposit growth was countered by decreased revenue in our market-sensitive areas. Our net interest income was $3.5 billion, a 12% increase or 10% in constant currency, driven by higher deposit and loan balances. However, net noninterest revenue fell to $1.9 billion from $2.5 billion last year, mainly due to lower trading, insurance, and market-related fee revenues. Expenses decreased by 2% from last year, reflecting effective expense management. The provision for credit losses was $1.1 billion. Now moving to our capital position, we are strong and well above regulatory requirements. The common equity Tier 1 ratio was 11%, down from 11.4% in Q1, largely due to higher risk-weighted assets from the Clearpool acquisition, partially offset by expected credit loss provisioning adjustments and other smaller positive factors. The growth in risk-weighted assets was driven by strong loan growth supporting our customers and changes in asset quality. During the quarter, we implemented a 2% discount on our dividend reinvestment plan, considering the uncertain environment and the loan growth we experienced. Our liquidity position remains strong, bolstered by excellent customer deposit growth that exceeded loan growth. Liquidity metrics, including the LCR at 147%, improved during the quarter. Looking at our operating groups, Canadian P&C maintained solid core profitability with pre-provision pretax earnings of $985 million, up 1% from last year, and net income of $362 million, reflecting higher credit provisions. Revenue rose by 2%, though the positive effects of higher balances were partially offset by decreased noninterest revenue and lower margins. Average loans increased by 7%, with commercial loans up 14%. Deposit growth was significant, with personal deposits up 12% and commercial deposits up 20%, indicating higher liquidity retained by customers due to COVID-19. The net interest margin was down 10 basis points from last quarter due to lower loan spreads resulting from a narrowing Prime to BA relationship. Although projections are challenging, the net interest margin is likely to decrease somewhat over the remainder of the year due to lower interest rates. Expenses increased by 3%, largely because of higher technology and pension costs. In U.S. P&C, net income was $253 million, lower than the previous year due to higher credit provisions, while pre-provision pretax earnings grew by 11%. Revenue increased by 6%, driven by deposit and loan growth along with higher fee income, somewhat offset by declining deposit margins. Commercial loans went up by 13% and personal loans by 9%, with average deposit growth at 18%. The net interest margin increased by 2 basis points from last quarter, as the adverse impact of lower rates was more than offset by elevated LIBOR and strong deposit growth compared to loan growth. Expect some decline in net interest margin over the next two quarters due to a more normalized LIBOR and potential rate cuts. Expenses increased by 2% from last year. Moving on to BMO Capital Markets, which faced a net loss of $68 million due to higher credit losses in the current market conditions. Pre-provision pretax earnings were $300 million, and revenue fell by 15%. Global Markets revenue dropped, although performance was encouraging in rates, foreign exchange, commodities, and cash equities. Trading noninterest revenue was negative, influenced by extraordinary market conditions impacting our equity-linked note-related businesses and credit and funding derivative valuation adjustments. Revenue in Investment and Corporate Banking decreased, as increased corporate banking-related revenue was overshadowed by markdowns on held-for-sale loans and reduced underwriting and advisory fees. Expenses fell by 15% from last year, mainly due to the effect of severance in the previous year, while the provision for credit losses was $408 million, including a provision on performing loans of $335 million. In Wealth Management, net income was $153 million, with traditional wealth net income at $169 million down from $236 million last year, primarily due to a $49 million after-tax legal provision and decreased fee-based revenue, offset by strong online brokerage revenue. Loan and deposit growth remained robust. The insurance segment reported a net loss of $16 million, compared to average income of about $60 million per quarter over recent years, mainly due to unfavorable market movements. The overall impact of market fluctuations and the legal provision reduced earnings per share by approximately $0.15 this quarter. Expenses were carefully managed with just a 1% increase. In Corporate Services, the net loss was $81 million, similar to the previous year, as lower expenses and higher revenue were largely counterbalanced by a less favorable tax rate this quarter. In summary, our pre-provision pretax earnings and underlying operational performance highlight the strength of our franchise. During this exceptional quarter, we navigated higher credit losses, supported our customers and employees, and maintained a solid balance sheet. I'll now hand it over to Pat.

Patrick Cronin, Chief Risk Officer

Thank you, Tom, and good morning, everyone. The current COVID-19 pandemic has had a meaningful impact on all of our risk types. With that said, we went into this crisis in a very strong risk position with a long track record of successfully managing risk through challenging times. As such, we expect to navigate the risks of the current crisis successfully and continue to serve our customers across all businesses. The most evident COVID-19 impact in the quarter is on our provisions for credit losses. As shown on Slide 17, our total provisions for credit losses were $1.1 billion or a provision rate of 94 basis points, significantly higher than what has been seen in recent quarters. The total provision was made up of a provision for impaired loans of $413 million or a provision rate of 35 basis points and a provision for performing loans of $705 million. Based on our estimates, we see approximately one-third of the impaired provisions being related to COVID-19 impacts in the quarter. As per Slide 17, this increase in provisions on impaired loans was due to increased provisions in Canadian P&C and in Capital Markets. In the Canadian P&C segment, the $212 million of losses were driven by elevated consumer losses, with the increase versus Q1, largely related to the impact of COVID-19, and elevated commercial losses, in part related to COVID-19 as well as one larger credit loss that occurred before the pandemic and that involved fraud. In Capital Markets, the PCL of $73 million, an increase of $20 million versus Q1, was driven by continued stress in the oil and gas markets, exacerbated this quarter by COVID-19-related demand declines for oil. In addition, Capital Markets had a larger PCL in the apparel retail sector, largely related, again, to the impact of COVID-19 on store operations. U.S. P&C impaired loan provisions were $124 million, a decline of $8 million from the prior quarter. Transportation finance provisions accounted for approximately $41 million or 37% of our U.S. commercial provisions this quarter. The remainder of our U.S. commercial businesses saw impaired provisions decline by 17% quarter-over-quarter. Turning to Slide 18, the $705 million provision for credit losses on performing loans was primarily due to the weaker economic outlook with other factors like changes in scenario weights, balanced growth, credit migration, and model changes largely netting out. While cognizant of the unique nature of this economic disruption as well as the substantial support provided by governments, we followed our normal process and portfolio overlay-type adjustments were not a large determinant of the overall provision. Our closing allowances by line of business are shown on Slide 18. We feel our closing allowances are appropriate when compared to our actual historical impaired loan experience as well as our own expectations for impaired losses in the future. In particular, this quarter, we saw a significant increase in the Capital Markets allowance, reflecting expected continued stress in the oil and gas sector. On Slide 19, impaired formations were $1.396 billion and gross impaired loans were $3.645 billion or 74 basis points. The elevated level of both formations and gross impaired loans are largely a reflection of continued stress in some industry sectors like oil and gas, U.S. agriculture and transportation as well as more recent stress on other sectors more impacted by COVID-19, like retail trade and services. Loan growth, shown on Slide 20, was largely due to borrowings by our existing accounts, in many cases, driven by draws against previously committed facilities. This utilization of revolving lines of credit peaked at the end of March and has been declining steadily and notably ever since. Consumer loan growth was modest, with utilization levels actually declining in Q2 relative to Q1 in several products. This was particularly noteworthy in credit cards, where balances declined 12% quarter-over-quarter, explaining about two-thirds of the increase in overall credit card delinquency rates in the quarter. Turning to Slide 21. We've included a view of our loan portfolio with additional balance information for some sectors that are generally viewed as more impacted by COVID-19. For the purposes of this disclosure, we have taken a very broad view of what sectors to include. And while we are not immune to the stress these sectors may experience, on Slide 22, we note numerous important considerations that give us some comfort when evaluating the potential for that stress to ultimately translate into loan losses. On Slide 23, we provide further detail on our oil and gas loan portfolio. Although the impaired loan rate of over 4% is clearly elevated, we expect to continue to benefit from the reserve-based nature of virtually all of our sub-investment-grade exposures in the extraction segment. In addition, we have a prudent oil and gas performing provision of $357 million as of the end of Q2, representing roughly 2.4% of the balance of the entire energy portfolio and 3.2% of the entire portfolio, excluding pipelines. You'll note additional disclosure on payment deferral programs in our MD&A this quarter. As of the end of Q2, we had 11% of our consumer balances and 9% of our commercial balances under deferral arrangements. With respect to consumer deferrals, 89% of the deferred balances are real estate secured lending, with 94% of those deferred RESL balances in Canada. Of the deferred Canadian RESL balances, the large majority are mortgages, of which 33% are insured. The credit quality of consumer deferrals varies by product, but the average bureau score weighted by deferred balances is approximately 750 in Canada, and 730 in the U.S. and the average LTV of deferred RESL balances is approximately 60% in Canada and 55% in the U.S. Commercial loan payment deferrals are adjudicated case-by-case based on a strict set of criteria, including, but not limited to, a requirement for all loans to have been current prior to COVID-19, minimum credit ratings, and an assessment that the business is likely to recover. Turning to Slide 24. Our trading-related net revenue shows several days in the quarter where we experienced notable losses. These days coincided with periods of extreme volatility, historic price declines in equity markets, and unprecedented discontinuity between previously well-correlated assets. Although many parts of our trading businesses performed exceptionally well this quarter, a small number of specific segments saw elevated losses. These segments have been closely evaluated and, where appropriate, material risk reduction actions have already been taken. Although the majority of the company is now working remotely, our operational risk remains within acceptable ranges, and our control activities across all three lines of defense are largely operating business as usual. In terms of outlook, given the historic level of economic stress due to COVID-19, we would not expect to see a reduction in impaired loan losses over the next few quarters. And depending on the length of the crisis and the impact on specific industry sectors, we could see further increases in impaired loan loss rates. We will review our allowance coverage as appropriate, given our current forecast for future loan losses, and as such, would expect the performing provision in the next few quarters to be largely a function of the normal factors that influence this provision in any given quarter. With that, I'll turn the call over to the operator for the question-and-answer portion of today's call.

Operator, Operator

We have a question from Ebrahim Poonawala from Bank of America.

Ebrahim Poonawala, Analyst

I guess first question on just on credit, Pat. If you can talk to us around the reserve coverage? So when you look at Slide 18, one, like a comment you made about future performing PCLs, like why is 49 basis points reflective of this macro backdrop? And why is that enough? Because we've already seen some sort of concern from investors whether this stack ranks lower against your peers and whether this might be enough, given some of the COVID sector and exposures that you outlined? So I would appreciate some thought process around why 49 basis points is enough? And why we shouldn't expect a meaningful increase in that number going forward?

Patrick Cronin, Chief Risk Officer

Sure. I believe I understood your question. To begin with, I wouldn't agree that there's a significant increase expected in the provision. We anticipate that the performing provision will decrease from its current level starting next quarter. Thus, we do not expect an increase in the quarterly provision. Regarding the adequacy of the coverage, we put considerable thought into that. You can assess it from an overall coverage perspective. With approximately $2.4 billion in total allowance, a good benchmark is to compare it against the trailing four quarters of specifics, which provides us about 2x coverage. This figure includes two quarters with notably elevated impaired PCL. Alternatively, if you analyze it based on the annualized current quarter, even under a stressed scenario, we maintain about 1.5x coverage. In comparison to our peers, we find that we align closely with the group. We also examine it by line of business. For instance, in U.S. commercial, we currently have 49 basis points of coverage, whereas the historical impaired rate for the past six years has fluctuated between six and 27 basis points. Therefore, we believe we have ample coverage in that area. In fact, this quarter in U.S. commercial, we noted a decrease in non-TF specifics, despite some impacts from sectors affected by COVID. In summary, we are not observing significant stress in the U.S. commercial book, which we consider very robust and capable of handling stress. At 49 basis points compared to the historical loss rate of that segment, we feel that coverage is sufficient. When evaluating all business segments against their historic loss rates or even under stress scenarios like we are currently experiencing, it's clear that we have sufficient coverage across all areas.

Ebrahim Poonawala, Analyst

Got it. And just on...

Jill Homenuk, Head of Investor Relations

Ebrahim, sorry, it's Jill. I'm just going to have to jump in with apologies, but I think we better keep it to one question just because we all know we have a hard stop at 8:15. Okay. Thank you.

Operator, Operator

The next question is from Scott Chan from Canaccord.

Scott Chan, Analyst

Pat, you mentioned trading losses on several days in certain segments. Can you elaborate on those sectors? Are they primarily commodity driven, or was there something else unusual during the volatility?

Patrick Cronin, Chief Risk Officer

Yes. Thanks for the question, Scott. I think what I'll do is maybe I'm going to ask Dan to make some preliminary comments on this. And if I have anything to add, I'll jump in after that.

Daniel Barclay, BMO Capital Markets

Sure. Thanks for the question, Scott. I think as you'll appreciate, the quarter was a fascinating quarter where the early part of the quarter we had some adjustments as COVID came in. The two weeks in March were extraordinarily volatile. And then subsequent to that, in April and now going on into May, we've actually had, I would call it, exceptional results. In that period of high volatility, we had a couple of places where we had such extreme market dislocation around historical patterns that we had some exposure. The first is what we call our equity-linked note business. And then the second is how we're covering off the hedging of our exposure around our derivative book, which you will have known as ICA. So those are the two places that we work through some of that dislocation to the marketplace.

Operator, Operator

The next question is from Gabriel Dechaine from National Bank.

Gabriel Dechaine, Analyst

I was surprised that the provisions amount to $54 million. Additionally, I appreciate the extra information you provided on the provisions for performing. Given the challenges in that sector, can you explain why that figure makes sense? I'm just playing the devil's advocate here.

Darryl White, CEO

Yes, that's a great question. We consider that rate of coverage in relation to several factors. First, it's significantly higher than the current loss rate we've observed over the past few quarters. The sector is under considerable stress, and the specific provision for credit losses has remained stable in our portfolio for the last three quarters. Additionally, if we look back at the stress levels we faced in 2015 and 2016, with 2016 being the most challenging year in the recent downturn, we experienced an average loss rate of about 150 basis points that year. We did recover some of those losses later on, but that serves as a reference point. Lastly, we conduct extensive stress tests on our portfolio. For a stress test assuming a flat $35 environment over three years, our estimation would indicate a loss rate of approximately 2% per year in that portfolio. Therefore, having a coverage of 2.5 times, or 250 basis points, which rises above 3 if we exclude pipelines, appears reasonable for the sector, especially considering it accounts for higher stress levels than those observed in previous downturns and aligns well with our stress test results.

Operator, Operator

The next question is from Steve Theriault from Eight Capital.

Steve Theriault, Analyst

Could we revisit Capital Markets for a moment? Regarding the equity-linked note marks, it seemed these products didn't really influence the equity line last time. While it wasn't as negative, if I reflect on 2008 and our significant sell-off, could you discuss the differences? Do you anticipate that they will return in tandem with the market's recovery, or have they begun to rebound since quarter-end? Additionally, I believe Tom mentioned earlier that some risk has been reduced in certain areas. Does that mean they will return alongside the market?

Darryl White, CEO

Yes. Thanks for the question, Steve. I think the piece I would give you is there was extreme volatility as we moved through that two weeks in March. And so as you think about some of that normalization, you're right, we will get some of that back over time with that normalization. But also as we went through there, we were doing dynamic hedging. And some of that dynamic hedging will then be permanent in terms of a realized loss. As we think about going forward, we've done a lot to take risk off the book, both in terms of market downside protection making sure that we have matched our term volatility profiles and then our exposure between different marketplaces, so I think Canada versus the U.S. and have worked very, very hard to take that book out and look at it today as being relatively balanced, strong, and immunized. And again, I do think there'll be some recapture as we go forward. It's a strong business for us and has been and will continue to be so.

Steve Theriault, Analyst

Is that a dynamic hedging program for that book new or just enhanced?

Darryl White, CEO

It's enhanced from where we were. And if you think we've taken a more conservative view of our risks. And so we're managing the business that way.

Steve Theriault, Analyst

And if I look at the trading days in the appendix, the day that had the $180 million, I think I'm reading that right, loss date, is that primarily this book? Or is that a combination of things?

Darryl White, CEO

In every one of those lost days is a combination of many things. If you think about the breadth of our positions. That day, in particular, was a combination really of the equity-linked notes as well as ex-VA. If you remember, that was the day of extreme market dislocation just before the Fed came in and put in place its positions with dramatic asset sale prices moving and dislocating. And so you saw some of the volatility there to the negative. You see the volatile positive after that as markets started to normalize. But I think of it, in my mind, is about two-thirds for the equity-linked notes and about one-third for the ex-VA.

Operator, Operator

The next question is from Meny Grauman from Cormark Securities.

Meny Grauman, Analyst

As I'm thinking about sort of where PCL ratios peak and also going back to the discussion of the adequacy of coverage on the allowance, I'm wondering how appropriate it is to look back. You referenced sort of the past few quarters and years, but if you go back further to past deeper recessions in Canada, the early '80s, early '90s, how appropriate is it to look back to those historical examples to gauge the magnitudes? And I guess government support is probably one factor; are there other factors that would make that comparison not the best in your view?

Darryl White, CEO

Yes. Thanks for the question, Meny. I think you answered your question a little bit right there. I certainly wouldn't discount the possibility that loss rates could end up being higher than what we factored into the performing provision. I mean when I think about impaired going forward, we're running this quarter at 35 basis points. That's clearly a rate lower than what you would have seen in the financial crisis or what you would have seen in prior recessions. But as you noted, there are some things that are quite a bit different this time around. Not the least of which, as you mentioned, there's some very, very substantial and quite targeted and direct stimulus provided by the government. The second thing I would suggest is loss rates tend to be very much a function of duration of the economic stress. And in prior recessions, you could think of those as running two to three years before we started to see recovery. In this one, just given the unique nature, most economic consensus forecasts would see a recovery much, much faster than that. And think about stress on corporates or consumers, a lot of them, particularly when you get to higher-quality credit folks like ours can withstand short periods of stress, but things start to get nonlinear in terms of PCL as that duration goes longer. So I would say the risk to our forecast is if a sharper correction or a correction that is anticipated by the consensus turns out to be much longer than we expect, then you're going to see some upward pressure and likely to push up into some of those more stressed loss rates that you're talking about from prior recessions. The other thing I'd highlight, too, is the mix has changed over the course of time as well. Our CRE portfolio is a great example. We had fairly elevated CRE losses during the last recession. That book looks dramatically different today than it did back then. And so when we run a stress test today on that portfolio, we see very different loss rates than what we would have seen in '08. So I would say those three things: mix, duration, and government stimulus would likely see loss rates lower. I'll caveat all that with we're in dramatically uncertain times. And so that forecast could be different. But I think about loss rates as from 35 basis points where we are today, they're likely to drift up higher, I think, likely into the 40s. The other end of that bookend would probably be at the 70 basis point range, which would be closer to what you saw during the GFC. So hopefully, that answers your question, Meny.

Operator, Operator

The next question is from Doug Young from Desjardins Securities.

Doug Young, Analyst

Questions for Pat. In your prepared remarks, you discussed the build-out of performing loans. I think you mentioned it but I didn’t catch all the details, so I’m hoping you can elaborate. The weaker outlook seemed to account for most of the build and change in scenario weightings and models. Could you clarify this a bit more and explain the process? Additionally, could you provide some insights on how much was influenced by the scenario changes versus the forward-looking indicators?

Patrick Cronin, Chief Risk Officer

Certainly. The primary factor influencing the provision was the change in macroeconomic variables, which accounted for a significant portion of the $705 million provision, likely even a bit more. Additionally, there was some balanced growth contributing approximately $40 million due to credit migration, along with a similar amount associated with credit migrations on the downside. Foreign exchange factors also played a role, adding about $50 million. These elements collectively increased the provision. Normal model adjustments, which typically occur each quarter, reduced the amount by roughly $60 million. We also modified our scenario weights this quarter, as our base case now closely resembles our previous adverse case, with a clear indication that we are entering a downturn. We assessed the probability of a benign scenario to be about equal to the adverse scenario, given our current economic state. This scenario reevaluation further lowered the provision by around $50 million. Ultimately, these factors balanced out and highlighted the significant impact of the macro changes.

Operator, Operator

The next question is from Mario Mendonca from TD Securities.

Mario Mendonca, Analyst

Can I get a quick clarification, Pat? When you mention that performing loan losses are declining but impaired loans are increasing, can you provide an outlook on the total PCLs ratio looking ahead? Is there a possibility that the increase in impaired loans could bring the total PCLs ratio to a level comparable to Q2 in the upcoming quarters, specifically Q3?

Patrick Cronin, Chief Risk Officer

Yes. I would say that our current expectation for totals is that it will not be at the same level as what we experienced this quarter. Beyond that, it becomes quite difficult to predict. As you can imagine, there are many variables involved that can change from quarter to quarter. Therefore, it's harder to forecast. However, based on my current perspective, I don't anticipate a significant upward pressure on the impaired provision. This gives me some confidence that the combination of these factors will result in a lower total provision number. That said, due to the considerable uncertainty in the market, I'm hesitant to specify a particular number regarding the loss rate at this time.

Mario Mendonca, Analyst

Okay. The actual question I wanted to get to then was, Pat, you mentioned the duration being very important to the trajectory of credit losses. When you consider setting your performing loan loss reserves, can you discuss when in your models things are normal? By that, I mean when unemployment returns to a pre-COVID level and GDP activity is essentially back to a pre-COVID level. Can you provide some commentary on that?

Patrick Cronin, Chief Risk Officer

Yes. First of all, I want to emphasize that while those factors are important, there are many other variables that influence the model, such as BBB spreads and VIX levels. All of these elements can fluctuate, either enhancing or offsetting some of the movement towards normal that you mentioned. Additionally, I would refer you to the MD&A, where we provide good insights on our observations. For example, in Canada, GDP declined by approximately 6% this year, and in 2021, it rebounded by 6%. Due to the way the math works, this won't bring you back to flat by the end of 2021, but it gives you an idea of our predictions for recovery. You'll also see similar patterns in the unemployment rate.

Operator, Operator

The next question is from Nigel D'Souza from Veritas. And it is the last question.

Nigel D'Souza, Analyst

I wanted to follow up on the macroeconomic factors related to your performing loan loss modeling. Referring to Page 32 of your shareholders' report, where you detail your updated forward-looking indicators, it seems that the outlook has become somewhat more optimistic. You anticipate a higher home price depreciation in your base case scenario, and in your adverse scenario, you do not predict a decline in home prices. Could you elaborate on your reasoning behind this, and also discuss how sensitive your performing loan allowances might be if you were to forecast a significant decline in the home price index in the future?

Darryl White, CEO

Yes. Unfortunately, I didn't catch all of your question due to a technical issue, but I'll do my best to respond based on what I heard. We do present the adverse scenario on Page 32, which should provide some context. In this scenario, if we assume a 100% weight, there's an estimated $600 million increase in the allowance compared to our current allowance. This offers some perspective, although we don't detail all the variables linked to our adverse case on Page 32. I hope this helps address the question that I missed.

Nigel D'Souza, Analyst

So if we have time, just for clarification, just the assumption on your home price outlook, it looks to be more positive now. So I was hoping you could just provide more color on forecasting a decline in real estate prices even in the adverse scenario?

Darryl White, CEO

Sure. Maybe I'll ask Ernie; she's very close to this market segment, and so she's probably got some very good color.

Erminia Johannson, Canadian P&C

Yes. Thank you for that question. What we're thinking on forecasting related to housing prices is basically what we're seeing now is some stabilization in certain sectors in certain geographies. And so I would say, right now, our position would be that we're going to be remaining quite flat on the housing prices. Obviously, in oil-affected regions, et cetera, we're going to see some nuances there. But for now, that's what our indicators are suggesting.

Operator, Operator

I would now like to turn back the meeting over to Mr. Darryl White.

Darryl White, CEO

Thank you, operator, and thank you to everybody on the call. I'll just wrap up with a couple of summary thoughts. In terms of bringing us back to our core messages, I would remind you that we are extremely proud. I'm extremely proud of the strong response our teams have had through the crisis. We're very comfortable with our capital and liquidity position, which drives the stability of the bank, the PPPT at $2 billion despite the softness in our market-sensitive businesses is very substantial relative to the prudent provisioning that we've got in our PCLs, and we're very confident in the outlook. So with that, operator, I will leave the call there, and I wish everyone continued health and safety. Thank you very much.

Operator, Operator

Thank you. The conference has now ended. Please disconnect your lines at this time. And we thank you for your participation.