Earnings Call Transcript - CM Q3 2022

Operator, Operator

Good morning, and welcome to the CIBC Quarterly Financial Results Call. Please be advised that this call is being recorded. I would like to turn the meeting over to Geoff Weiss, Senior Vice President, Investor Relations. Please go ahead, Geoff.

Geoff Weiss, Senior Vice President, Investor Relations

Thank you, and good morning. We'll begin this morning's presentation with opening remarks from Victor Dodig, our President and Chief Executive Officer; followed by Hratch Panossian, our Chief Financial Officer; and Shawn Beber, our Chief Risk Officer. Also on the call today are a number of our group heads, including Mike Capatides, U.S. Commercial Banking and Wealth Management; Harry Culham, Capital Markets and Direct Financial Services; Laura Dottori-Attanasio, Canadian Personal and Business Banking; and Jon Hountalas, Canadian Commercial Banking and Wealth Management. They're all available to take questions following the prepared remarks. As usual, during the Q&A to ensure we have enough time for everyone to participate, please limit your questions to one and then re-queue if need be. As noted on Slide 2 of our investor presentation, our comments may contain forward-looking statements, which involve assumptions and have inherent risks and uncertainties. Actual results may differ materially. With that, I'd like to turn the meeting over to Victor.

Victor Dodig, President and CEO

Thank you, Geoff. Good morning, everyone, and thank you for joining us today. My remarks this morning will include comments about our third quarter results and the operating environment as well as a summary of our key strategic priorities, which we outlined to you on Investor Day. Hratch will then provide a more detailed review of the quarter, followed by Shawn, who'll cover our credit performance, after which all of us will be happy to take any questions you may have. Against an increasingly challenging macro environment, our CIBC team delivered solid third quarter results with earnings of CAD1.7 billion. Revenue growth of 10% was underpinned by strong net interest income and fee growth as well as a 19% year-over-year increase in our connectivity revenue. Our asset quality remains very strong with a net write-off ratio that is well below our pre-pandemic levels. Our earnings generated a return on equity of 15.1%, and our capital position remains strong with a CET1 ratio of 11.8%. The results were driven by organic growth in all of our businesses. We delivered solid volume growth in both consumer and commercial loans and deposits and higher fee income. We also had strong contributions from Direct Financial Services, a key differentiator for CIBC, which I'll speak to later. Let me turn now to our business segment highlights, starting with Personal and Business Banking. Our Consumer segment continues to see good momentum as we remain focused on executing against our strategy. Our priorities are to gain market share in the high-growth, high-touch affluent segment while delivering exceptional client experiences to all of our clients through leading-edge technology. As a proof point, our strategic investments in providing personalized advice are contributing to solid client acquisition growth. On a rolling 12 months basis, and excluding our Costco acquisition, we've added over 300,000 clients, 25% of which are in the affluent segment, comparing to our baseline of 11% in our current book of business. The continuous improvements we're making to our online banking platform have also been recognized with three awards this quarter: the number one ranking from J.D. Power for online banking customer satisfaction; and two leadership awards in the Digital Bankers 2022 Global Digital Client Experience banking awards. Our commitment to making our clients' lifetime ambitions a reality led to our recently announced partnership with Willful, an online platform for will creation. With this collaboration, we can offer our clients peace of mind through a convenient and affordable online estate planning tool. Going forward, we will continue to seek new and innovative enhancements to our digital banking platforms as we advance our digitization strategy and build our business with the affluent segment. Turning to our North American Commercial Banking and Wealth Management platform, we see continued solid loan and deposit growth on both sides of the border in Commercial Banking. Despite economic uncertainties, entrepreneurs remain cautiously optimistic about near-term growth opportunities. As a result, we expect to see continued growth with our clients across our Commercial Banking Business. Our Wealth Management segment also performed well. The market declines in AUM were offset by positive net sales. We remain focused on growing our Private Wealth business to generate stable fee-based revenue as well as increasing connectivity with the rest of our bank to drive referrals and deepen client relationships. Our capital markets business performed well in a volatile market, with top line growth in all business segments, benefiting from increased advisory services, higher foreign exchange trading revenue and growth in our direct financial services business. The latter was helped by rising interest rates, robust volume growth and new client relationships in both Simply Financial and in our alternate solutions group. We also increased currency transactions, which arise from a recovery in travel and continued growth in our international student banking offer. As we enter the second half of this year, the geopolitical tensions and macroeconomic challenges from the first half are expected to continue, leading to a more tempered outlook for second half GDP performance in both our operating regions. Despite the economic uncertainties, our CIBC team remains confident in our ability to navigate the market, serve our clients and create long-term value for our shareholders while maintaining a disciplined approach to risk. We have a client-centric growth strategy, a disciplined leadership team, and an ability to manage the pace of our investments as the economic environment evolves. As presented at our Investor Day in June, our client-focused strategy consists of three priorities: first, to focus on growing our share of the high-growth, high-touch segment, where we're well-positioned. We have close to 4,000 CIBC professionals dedicated to building our business with affluent and high net worth client segments. Secondly, we need to continue to elevate the CIBC banking experience for our clients through investments in digitization, cloud-based technology, and further increasing connectivity across our businesses. We're focused on continuously adapting to the evolving financial services landscape. Our third priority is to continue to invest in our future differentiators that will make a difference to the growth profile of our bank. These differentiators include our direct financial services business comprised of Simply Financial, Investors Edge, and our Alternate Solutions Group, all of which are well-positioned to reach higher-growth, digital-savvy, and value-conscious clients. Another differentiator is our innovation banking franchise, which supports early-stage companies in technology, life sciences, health care, and clean tech sectors. We're also focused on modernizing our payments platform to better serve our clients as the attitudes, behaviors, and preferences of consumers and retailers evolve, and our leading renewable and energy transition platform supports our clients on their journey to a low-carbon economy. In closing, we're mindful of the challenges in the current operating environment, and we're confident that we have a strategy and a foundation in place to deliver sustainable value consistently to all of our stakeholders. Our CIBC team has demonstrated our resilience in challenging environments in the past, and we'll continue to demonstrate that resilience going forward. With that, I'll turn the call over to Hratch.

Hratch Panossian, Chief Financial Officer

Thank you, Victor, and good morning to all of you. Our team delivered yet another successful quarter in Q3, resulting in reported net income of $1.7 billion or diluted earnings per share of $1.78. Excluding items of note, adjusted EPS was $1.85. While provisions for credit losses against performing loans trended higher, driven by the negative shift in the economic outlook, credit performance remains strong as evidenced by an impaired loan loss ratio of 12 basis points. Shawn will cover credit provisions in further detail later in our presentation. The balance of my presentation will refer to adjusted results, which exclude items of note starting with Slide 8. Executing against the strategic priorities we outlined at our recent Investor Day, we maintained strong growth momentum across our bank. Pre-provision pretax earnings of $2.5 billion and revenue of $5.6 billion were both up 10% from the prior year, supported by broad-based balance sheet growth, improving margins, as well as higher trading and investment gains. The strength of our Canadian P&C franchise underpinned this quarter's results, delivering revenue and pre-provision pretax earnings growth of 16% and 19%, respectively, over the prior year. Total bank expenses were up 2% sequentially or 10% from the prior year as the impact of inflation and increased strategic investments begins to stabilize. As highlighted on Slide 9, net interest income growth continues to be strong, up 14%, excluding trading compared to the prior year. NII was helped by diversified loan and deposit growth across our franchise, up 16% and 12%, respectively, over the prior year. Total bank NIM was stable sequentially and up 4 basis points, excluding trading. Canadian Personal and Commercial Banking NIM was up 13 basis points, mainly due to product margins, which benefited from higher interest rates, partly offset by lower margins on new mortgage originations. Growth in higher-margin assets and elevated mortgage prepayment activity also supported margin expansion. NIM in our U.S. segment was down 3 basis points over the quarter, primarily due to lower prepayment and investment gains, partly offset by higher product margins. We anticipate NII growth momentum to remain strong in the medium term, supported by volume growth and higher rates but expect some offsetting pressure from mortgage origination spreads in the short term. As shown on Slide 10, we continue to be positioned to benefit from rising interest rates. We've included additional disclosure this quarter to provide more color on our interest rate sensitivity. Over 80% of the benefit from a 100 basis point rate increase relates to the structural repricing of capital and deposit balances across our various segments as depicted on the slide. The Canadian P&C businesses account for approximately 65% of this NII increase, primarily due to the expansion of deposit margins. Turning to Slide 11. Non-interest income of $2.3 billion was up 8% from the prior year. Trading income as well as investment management and custodial fees were up from the prior year despite market-driven sequential declines. Market-related fees excluding these items faced headwinds from market conditions this quarter, which negatively impacted assets under management and commissions on securities. Transaction-related fees were up 6% from the prior year, benefiting from credit as well as deposit and payment fees. Client card activity continued to improve, and purchase volumes now exceed pre-pandemic levels. Turning to Slide 12. Expenses were up 10% over the prior year or 11% excluding performance-based compensation, resulting in relatively neutral operating leverage. Ongoing strategic investments contributed 5% to year-over-year expense growth, with investments in our U.S. platform and in our Canadian affluent strategy through the acquisition of the co-brand portfolio accounting for over half of the increase. Excluding strategic investments, in addition to business-as-usual growth, expenses were impacted by higher inflation and normalizing travel and business development costs. We expect inflationary factors to start stabilizing over the next few quarters, and we're proactively managing the pace of our strategic investments to deliver against our operating leverage targets in the context of a moderating market environment. Our capital and liquidity position remained strong this quarter as we continue to deploy balance sheet resources towards organic growth across our client franchise. We ended the quarter with a CET1 ratio of 11.8%, up 4 basis points from the prior quarter as a result of internal capital generation, partly offset by organic growth in risk-weighted assets. We continue to expect internal capital generation and organic deployment to be largely balanced going forward, and our current capital level positions us well to withstand any emerging risks. Starting on Slide 14, we highlight our strategic business unit results. Net income and Canadian Personal and Business Banking for the quarter was $637 million. Reflecting our continued progress in strengthening our consumer and business franchise, pre-provision pretax earnings of $1.1 billion were up 14% from the prior year and 11% from the prior quarter. Revenues of $2.3 billion were up 13% year-over-year, supported by a 17% growth in net interest income and stable non-interest income. Expenses of $1.3 billion were up 6% sequentially and 12% from the same quarter last year, driven by higher strategic investments, including costs related to the co-brand portfolio and employee-related expenses. Moving on to Slide 15. Net income in Canadian Commercial and Wealth Management was $484 million. Pre-provision pretax earnings of $668 million were up 13% from a year ago, benefiting from strong results in Commercial Banking, partially offset by the impact of unfavorable markets on the Wealth Management business. Commercial Banking revenues were up 27%, driven by double-digit loan and deposit growth, increased client transaction activity and favorable margins. We expect lending and deposit growth to continue but to moderate from current levels over the next few quarters. Wealth Management revenue was comparable to the prior year, as higher fee-based revenues and net interest income in our brokerage and private banking businesses were offset by the impact of 5% lower AUM, driven by market depreciation as well as lower commissions due to decreased transactional activity. Increased expenses were in large part due to the higher performance and continued investments. Net income in U.S. Commercial and Wealth was US$162 million, down 28% from the prior year due to normalizing credit provisions compared to a reversal of provisions last year. Pre-provision pretax earnings of $225 million were marginally lower than the prior year. Revenues were up 8% over the same period, supported by strong growth in loans and deposits and stable margins, excluding the impact of lower prepayment activity. Expenses were up 4% sequentially and 18% from the prior year, partly due to our ongoing investments in infrastructure and client-facing capabilities across our U.S. operations. We expect expenses to stabilize starting next quarter as we complete the ongoing investments. Slide 17 speaks to our diversified capital markets business. Net income of $447 million was down 9% from the prior year, while pre-provision pretax earnings of $606 million were comparable. Revenues of $1.2 billion were up 5% from last year as stronger trading, direct financial services, and corporate banking revenues were partially offset by lower underwriting and investment banking. Expenses were up 12%, driven by employee-related expenses as well as continued investments. Slide 18 reflects the results of the Corporate and Other segment. A net loss of $50 million in the quarter compared to a net loss of $74 million in the same quarter last year. Revenue was comparable year-over-year, while expenses were lower due to timing of strategic initiatives and lower enterprise costs retained in the center. Consistent with our prior guidance, we anticipate quarterly losses in this segment to remain in the $75 million to $125 million range. To close, we're proud of the results our team delivered this quarter. We maintained strong revenue momentum across the business in a less constructive environment. While our disciplined resource allocation framework allowed us to proactively manage execution of our strategic initiatives and drive improving operating leverage despite continued investments. As we look forward, we remain confident in our strategic plan and are well positioned to continue delivering value for our stakeholders in a broad range of economic outcomes. And with that, I'll turn the call over to Shawn.

Shawn Beber, Chief Risk Officer

Thank you, Hratch, and good morning. Our overall credit performance remained strong this quarter, reflecting the resilience of our portfolio, notwithstanding various headwinds impacting the overall economy. We've continued to support our clients while proactively managing our underwriting activity in response to the evolving environment, and we remain comfortable with our risk levels and coverages. Slide 21 details our provision for credit losses. Our PCL was $243 million in Q3 compared with a provision of $303 million last quarter on a reported basis or $209 million on an adjusted basis. Provision on impaired loans was $156 million in Q3. Impaired provisions were down quarter-over-quarter across our businesses. Other than in Canadian Commercial Banking and Wealth Management, we've had a small provision this quarter versus a recovery last quarter. The relatively low level of impaired provisions this quarter is partly driven by a few provision reversals in our business and government loan portfolio. Impaired provisions in retail remained stable quarter-over-quarter and continue to perform better than pre-pandemic. Provision on performing loans was $87 million this quarter, driven by deterioration in our forward-looking indicators from last quarter and other portfolio movements. Turning to Slide 22. Our allowance coverage ratio remained flat at 58 basis points in Q3. Allowance dollars were up quarter-over-quarter, mainly due to an increase in performing allowance as mentioned earlier, partially offset by a decrease in the impaired allowance. We continue to be comfortable with our coverage ratios, which remain above pre-pandemic levels. Slide 23 details our lending portfolio mix. Consistent with previous quarters, our portfolio reflects good diversification and strong overall credit quality. Our total loan balances were $517 billion, of which 56% is real estate secured lending. Our variable rate mortgage portfolio accounts for a little over 1/3 of our mortgage portfolio and shows strong credit quality and performance. The average loan-to-value for our uninsured mortgage portfolio has decreased further this quarter and is now at 45%. Recently published data indicates a small drop in the housing price index. Should that continue, we would expect average loan-to-value to increase somewhat over future quarters, but still provide strong coverage. I'll provide more comments on our mortgage portfolio in a few slides. The business and government portion of the portfolio has an average risk rating equivalent to a BBB and continues to perform well. Slide 24 details our gross impaired loans. Overall gross impaired balances were down in Q3. Retail impaired balances were up slightly, while the business and government portfolio experienced a decrease principally due to write-offs of two loans. Despite the slight increase quarter-over-quarter, new formations remained stable and low from a historical perspective. Both the impaired gross loan ratio and new formations remain lower than our pre-pandemic run rate. Slide 25 details the net write-off and 90-plus day delinquency rates of our Canadian consumer portfolios. Net write-off dollars trended higher in Q3 as expected, as client activity continues to revert toward pre-pandemic spending patterns. Overall, retail 90-plus day delinquency rates remained flat in Q3, with a delinquency dollar increase in credit cards and personal lending. As I've noted in prior quarters, we continue to expect an increase in retail delinquencies and write-offs from the lows experienced in fiscal 2020 as clients' liquidity and spending patterns normalize over the coming quarters. Slide 26 provides an overview of our Canadian real estate secured personal lending portfolio. Our business strategy has been to focus our origination efforts with clients where we have deep and balanced relationships, and we've seen that in our results. Almost three quarters of our mortgage originations over the last two years have been with clients where we have those relationships. 88% of mortgages are owner-occupied, with the balance being principally investor mortgages. Investor mortgages are subject to heightened credit qualification, which shows strong performance that compares favorably to owner-occupied mortgages. Our late-stage delinquency rates across these portfolios continue to remain low and stable, with the Vancouver and Toronto portfolios outperforming our Canadian average. We'll continue to take a prudent approach and closely monitor as interest rates rise and markets evolve. On Slide 27, we've included additional disclosure on the portion of our mortgage portfolio that we'll be renewing in the next 12 months. Over that period, $19 billion of fixed rate and $7 billion of variable rate mortgages contractually come up for renewal. Almost all of our variable rate mortgages have fixed payments during the term and are, therefore, impacted by rising rates through an extension of amortization rather than an immediate change to the monthly payment renewal. Mortgages are reverted to the original amortization schedule, which may require additional payments. At this time, we see only a small portion, less than $20 million of mortgage balances with clients that we see as being at higher risk from a credit perspective, and those LTVs are in excess of 70%. We actively monitor our portfolios and proactively reach out to clients who are at higher risk of financial stress, and we don't expect to see material losses from our portfolios. Slide 28 shows our FICO score and LTV distribution in our Canadian uninsured residential mortgage portfolio. Only 4% of our uninsured mortgages have a current FICO score of 650 or less, and 3% of the portfolio have LTVs over 75%. Less than 1% of our uninsured mortgage portfolio has both a score of 650 or less and an LTV over 75%. In closing, we continue to see good overall performance this quarter. Our portfolios exhibit strong credit quality, driven by our disciplined underwriting through the cycle, and we're pleased with credit performance to date. We continue to expect a return to more normalized credit losses over time and maintain prudent allowance coverages. As economic conditions evolve, we work proactively with our clients who are more at risk to provide solutions that ultimately drive positive outcomes. I'll now turn the call back to the operator.

Operator, Operator

And the first question is from John Aiken from Barclays. Please go ahead.

John Aiken, Analyst

I was hoping that you could give us a bit of an update in terms of the Costco portfolio, how the performance has been working through the system and whether or not you can speak to any early wins in terms of cross-selling into that customer base?

Laura Dottori-Attanasio, Canadian Personal and Business Banking

John, it's Laura. Happy to take that question. Maybe I'll just start from a financial perspective to say that we do continue to track within our expectation of delivering positive net income within two years. So that's good. I'd tell you, we're really pleased with our strategic investment. As we've talked about, it really is a key part of our strategy to grow in the mass affluent segment. So when we look at the early client results, we're really encouraged. I'd tell you that the portfolio has performed well above our expectations, and that's in terms of client migration, engagement, purchase volumes, and new client acquisition. We're actually about 2x greater than we had expected when it comes to new client acquisition. So feeling really good about that. And when it comes to the strategic, if you will, value of this acquisition, it was all about franchising these affluent clients. What I'd tell you is, while the bulk of our activities really start to kick off this fall, we've already made some pretty encouraging progress. So we've franchised about 20,000 clients so far. So early days, we're only five months in, but we're really pleased with our momentum trying to grow how early on we are. So thanks for the question, John.

John Aiken, Analyst

If I can just do a quick follow-on. With the plans that you have later on in the year, should we expect to see continued expenses to pursue that strategy?

Laura Dottori-Attanasio, Canadian Personal and Business Banking

I would tell you, yes, over the next few quarters. So we did show, I think, in our disclosures. So Costco contributed about 3.5% increase to our expenses. And so you can expect to see that in the next few quarters.

Victor Dodig, President and CEO

I think the most important thing, John, just to reaffirm what Laura was saying, is we strengthened our hand in the credit card segment, and we're a strong number three, and we're chasing number two and number one. We've got an opportunity here with a very, very attractive client base. Things have gone really well. The growth prospects over the medium term are what we're particularly encouraged by, especially with the franchising opportunities. This falls into the heart of our affluent segment growth strategy that we laid out at our Investor Day.

Operator, Operator

Thank you. The next question is from Ebrahim Poonawala from Bank of America. Please go ahead.

Ebrahim Poonawala, Analyst

I guess maybe Hratch can just spend some time in terms of the margin outlook. A twofold question. One, when we think about the margin at the top of the house, give us a sense of the outlook for the trading NII. Is that inherently liability sensitive? So as rates keep going higher, that $141 million should continue to go down? And then just give us some color around the trajectory for the margin and the puts and takes both in Canadian and U.S. P&C and the deposit pricing pressure that you're seeing in the U.S. in particular?

Hratch Panossian, Chief Financial Officer

Thank you, Ebrahim, for your question. Overall, we feel optimistic about the trajectory of net interest income (NII) and net interest margins (NIM) over time. To provide some clarity, the mix across our business can influence these metrics. This quarter, the mix positively impacted total bank margins, particularly due to increases in property and casualty (P&C) in our Canadian operations. However, trading had a negative effect, which is why we prefer to analyze it from a non-trading perspective. Trading results can fluctuate based on market conditions, client flows, and how our desks are positioned. This quarter saw trading results increase by over $60 million year-over-year, suggesting strong performance, and we anticipate good trading volumes moving forward. Now, focusing on the non-trading aspect, the two major components we emphasize are the Canadian and U.S. margins. Both are expected to have a long-term positive trajectory, benefiting from strong product margins and rising interest rates. In Canada, we are seeing a modest positive movement from interest rates, with a few basis points of underlying momentum. Some elements helped this quarter, including mortgage prepayments, but we may see those effects moderate. I expect the medium-term trajectory to remain positive, although we expect some stability in the short term due to a decrease in prepayment activity and tighter mortgage origination margins. Our strategy for the U.S. margin is similar to Canada, where we have hedged against U.S. interest rate exposure with a structural hedging program. This approach aims to protect margins and stabilize NII. When comparing our margins now to pre-pandemic levels and against U.S. mid-market banks, we have maintained significant stability. Although our current margins are favorable, we might experience slower benefits from rising interest rates, leading to stable margins in the short term.

Ebrahim Poonawala, Analyst

Just as a follow-up, if you can talk to what you see in terms of deposit spreads and pricing both in U.S. and Canada.

Hratch Panossian, Chief Financial Officer

Yes, I'll start with that, and the businesses can chime in as well, Ebrahim. We are experiencing strong momentum in the margins on deposits, with most of the benefits from rising rates occurring on the deposit side. As mentioned in our overall disclosure, 25% of our deposits are non-interest-bearing, which benefits from these rising rates. For the interest-bearing portion of our portfolio, it splits evenly; half is mid-beta, meaning sensitive to changes, while the other half is indexed and shows less sensitivity. In areas where we see beta sensitivity, we've performed very well, at least meeting the assumptions in our interest rate sensitivity disclosures. We don't anticipate any short-term changes to this trend. In the U.S., the mix is even better, with 35% of our deposits being non-interest-bearing, and that has remained stable. Balances continue to grow, and the percentage has been consistent. Again, our betas appear to be stable, giving us confidence in deposit margins moving forward.

Operator, Operator

Thank you. The next question is from Gabriel Dechaine, National Bank Financial. Please go ahead.

Gabriel Dechaine, Analyst

I've got three great questions, but I'll stick to one. It's not that great. I just want to delve into the expense commentary a little bit. If I look at the first half, excluding variable comp, it was a 10% growth this quarter. And I'm including the initiative spending all that of Costco, that we're at 11%. And it sounds like we could be running at that rate for the next little while. Just if you can kind of give me the glide path over the next four quarters because I figure some of that should fade if only because we've got easy comps.

Hratch Panossian, Chief Financial Officer

Gabe, it's Hratch. Happy to take that. Let me backtrack for one second. Our approach to investing in our bank, investing in our strategy, and the financial targets we're striving for remain consistent. It's done that for the last couple of years. We have a well-thought-out strategic plan we outlined in our Investor Day. We're executing against that plan, and we're getting the results as you see. So financially, we've guided that, that will translate to accelerated revenue growth, share gains, 7% to 10% pre-provision earnings growth, and positive operating leverage over the medium term. We've been delivering on all of that. You mentioned some of the results on the expense side. But I would look at all of it, right? I'll have over the 12-month period, if you look at the last four quarters trailing, we've delivered revenues, and that's been 10%. We've been delivering expenses 11% on a 12-month basis, and 10% this quarter, right? In terms of this quarter, happy to give you a little bit of color. Our increased expenses are a large part, as we highlighted in the presentation, still impacted by the investments as well as the inflation piece. In the quarter, 5% of it was the investments. About half of that, as we've highlighted, was Costco and the U.S. So the number Laura gave, 3.5%, Costco, call it, 3.5% of the PBB expenses on a total bank basis, it's about 1% and change, combined U.S. and Costcos at 2.5% we show. Both of those are plateauing. So I would look at those. We have a full quarter of expenses related to Costco this quarter. There's some variability going forward, but largely stable. Our U.S. investments are plateauing. We anticipate that starting in the fourth quarter, expenses in the U.S. will stabilize. This will aid in achieving overall stability. We are actively managing the remaining areas of our portfolio to meet our operating targets. The inflation factors we expect in the upcoming quarters are likely to account for about one-third to one-half of the remaining expenses we've mentioned, and we anticipate these will decrease over time. Our focus remains on fulfilling our commitments. We have projected high single-digit pretax pre-provision this year and neutral operating leverage. We are confident in achieving the pretax pre-provision target and continue to improve our operating leverage. In this quarter, we achieved nearly neutral operating leverage, despite unforeseen revenue pressures from the markets. We aim to maintain this positive operating leverage in the next quarter and beyond, working towards the mid-single-digit expense growth we've referred to at Investor Day as we approach next year.

Gabriel Dechaine, Analyst

Into next year?

Victor Dodig, President and CEO

It's well outlined. As a leadership team, we have a clear vision for achieving profitable growth and recognize the need to invest to drive that growth across all our businesses. Our goal is to excel in everything we do. Everything we presented at Investor Day emphasizes our commitment to being number one in affluent client growth, providing the best client experience, and investing in future differentiators. These investments are contributing to the results we're seeing in our bank, including market share gains, top line growth, and margin expansion. We will continue on this path, although you may occasionally observe that operating leverage lags in the U.S. business. Overall, we have an optimistic outlook on growth in the U.S., with a primary focus on organic growth. We're preparing for increased organic growth in the commercial bank and Wealth Management segment, which is why we're making these investments. Cap, could you share some insights on the U.S. and our financials and strategic growth priorities as we head into the new year?

Mike Capatides, U.S. Commercial Banking and Wealth Management

So thank you, Victor. Again, as we outlined on Investor Day, we're simply making investments in our people, our technology, our product offers, and our infrastructure teams in the U.S. And we're doing all that to fuel organic growth and that we've achieved and planned for, for the coming quarters and years. As Hratch mentioned, starting next quarter, we expect those expense levels to plateau. Combined with our robust revenue growth in all of our U.S. businesses, we hope to achieve in the U.S. Commercial and Wealth segment positive operating leverage by mid-next year.

Operator, Operator

Thank you. The next question is from Scott Chan from Canaccord Genuity. Please go ahead.

Scott Chan, Analyst

Maybe for Harry on Capital Markets, generally resilient on a segment basis, but one of your peers yesterday took a write-down on the leverage loan book. I was wondering if you can comment on your kind of book in the U.S. and if you see any issues near term?

Harry Culham, Capital Markets

Well, thank you for the question. As I mentioned in the past at Investor Day and other calls, we really do have a differentiated platform that is highly connected with the rest of our bank. We're building a true client-centric North America business that delivers relatively lower volatility pre-provision earnings. With that backdrop, we're highly selective and disciplined with respect to the area you're referring to. It's a very small area, not essentially a material part of our business, and we're really focused on our client needs. We experienced no losses due to this exposure in quarter three, and we really feel comfortable with our platform as we move forward in that respect.

Operator, Operator

Thank you. The next question is from Meny Grauman from Scotiabank. Please go ahead.

Meny Grauman, Analyst

Just a question on your estimate of the impact of the Canada recovery dividend based on the drop that was just made public, I believe, on August 9. I'm just wondering how much certainty do you have in that number given that it's a draft. Is the fact that you gave the number, I guess, a good indication that you don't see this changing too much by the time it gets finalized?

Hratch Panossian, Chief Financial Officer

Thanks for the question, Meny. I wouldn't read that into it. In terms of how much certainty we have in the number, calculating the number is pretty easy given the draft legislation. So we have lots of certainty in the number given the draft legislation, as we said in our disclosures. But it's draft legislation. It's still up for public comment. If the legislation changes, then the number will change. But we felt it was important since we can calculate the number to disclose that to our shareholders at this point in time. I will say our capital position, we're very comfortable can absorb that, right? If that were to come in all at once and impact capital, it’s 18 to 20 basis points of capital, and it still allows us to stay around the capital levels that we discussed at Investor Day, continuing to invest in our business. So, it's not going to be that significant to us. We disclosed the number; we thought it was the right thing to do.

Meny Grauman, Analyst

All right. That makes sense. So just to clarify, it's reasonable to assume that it could still change though, right? Is that a fair assumption?

Hratch Panossian, Chief Financial Officer

I know as much as you do on that; it’s draft legislation, and it will, at some point, presumably get finalized.

Operator, Operator

Thank you. Next question is from Sohrab Movahedi from BMO Capital Markets. Please go ahead.

Sohrab Movahedi, Analyst

Just a quick one for you. I think you had some interesting stats here, one of which was the average credit quality of the business and government book is investment grade at BBB. Do you have a sense of what it would have been 5 or 10 years ago? And is there any reason to believe that in the next cycle, then because of the improving credit quality there? Also in retail, I suppose, being more secured that your through-the-cycle kind of PCL shouldn't be lower than would have been over the last 5 to 10 years?

Shawn Beber, Chief Risk Officer

Thank you for the question, Sohrab. We are very confident in our business and government portfolio overall. In recent years, we acquired the Private Bank, now known as CIBC Bank U.S.A., which has a robust profile. We are pleased with the portfolio we took on, as it has met our expectations. We have consistently maintained our underwriting discipline through various cycles, including our recent originations, and we feel positive about those across our commercial and corporate banking platforms. Our retail portfolios also show strength, with steady and consistent underwriting discipline. Our clients are in good shape as we enter this new phase after the pandemic, exhibiting positive behavior. We have seen increases in deposit balances, investment balances, and bureau scores. Looking at the bigger picture, we provided some guidance during the Investor Day regarding our expected impaired losses for the coming years, and we are not altering that outlook today.

Operator, Operator

Thank you. The next question is from Nigel D'Souza from Veritas Investment Research. Please go ahead.

Nigel D'Souza, Analyst

I had a couple of questions for you on your forward-looking variables if you could bear with me that you outlined on Slide 37. The first was on your household debt service ratio outlook. It looks like that was revised lower this quarter relative to the last quarter. I'm wondering what led to that downward revision in the outlook. Has there been a change in the outlook for interest rates? Just trying to get a sense of why you expect the DSR to be lower?

Shawn Beber, Chief Risk Officer

So yes, there was a small change in the interest rate outlook in the outer years. That really impacted principally the mortgage DSR calculations in the model. So that's really what's driven that change quarter-on-quarter.

Nigel D'Souza, Analyst

Okay. I assume that you're assuming or your revision, which is a lower pace of interest rate hikes on interest rate costs, is that correct?

Shawn Beber, Chief Risk Officer

Yes.

Nigel D'Souza, Analyst

Okay. Then sticking with the theme here. Looking at your downside scenario, or the HBI, you have a decline in the first 12 months, which makes sense. That's typical. But you also have a sustained decline in the remaining forecaster. So I'm wondering what your rationale was there for the HBI to continue to decline, not just in the near term but over the medium term in your downside scenario?

Shawn Beber, Chief Risk Officer

Again, it's a downside scenario. So it anticipates a longer period of low growth. In fact, this quarter more of a recessionary sort of profile than it was in prior quarters. So, over that the period that the FLI cover, we saw some reduction there. That's the outlook from our macroeconomic department. We build that into our models and incorporate that as part of our overall assessment of the quarter. But that's really what's driving the change quarter-on-quarter.

Nigel D'Souza, Analyst

Okay. Lastly, comparing Canadian versus U.S. GDP. Across all the scenarios, you have Canada GDP growth outperforming in the U.S. trying to get a sense of, again, what's the rationale there? I mean, what we're actually seeing right now is perhaps more interest rate sensitivity in the Canadian economy. So, why do you expect Canada to outperform even your downside scenario you have U.S. in a mild recession, but Canada not entering a recession, at least from a GDP standpoint?

Shawn Beber, Chief Risk Officer

I think there are a few things that the economists have been looking at, including sort of the starting point for the recovery that happened between Canada and the U.S. Canada was slower to recover. So we've got a bit of that relative tailwind if you would between the geographies. We also have certain elements within the Canadian economy from a commodities perspective and strong employment that continues to provide some level of cushion to the Canadian economy relative to some of the other headwinds. It's a bit of a relative call based on those factors that result in a different perspective on where GDP goes from here.

Operator, Operator

Thank you. The next question is from Mario Mendonca from TD Securities. Please go ahead.

Mario Mendonca, Analyst

Could you help me reconcile two things that you've offered on this call so far? It's hard for me to see how they come together. One, you said that you don't expect a lot of margin improvement in Canada and the U.S. in those personal and business banking segments in the near term and fairly modest going forward. But your sensitivity suggests this is in your presentation, but there is meaningful upside in NII from changes in rates. Is the reconciliation of those two concepts really that the margin and the NII benefits will accrue to the center of the house in treasury and not the segment? Is that the right way to reconcile those two statements?

Hratch Panossian, Chief Financial Officer

I wouldn't say so, Mario. If you look at the sensitivity and run the numbers on the $354 million plus $100 million, remember, that's over four quarters in the first year. If you run the math on basis points to the total bank, that's 4 basis points. If you look at that on a segment basis and look at it on a quarterly basis, you get to something that's in that modest quarter-over-quarter impact perspective as that ramps up. When you look at even to date, if I look at what's happened from an interest rate perspective, if I look at quarter-over-quarter trajectory purely isolating the impact of interest rates as those have started coming up, that's what we've seen: a few basis points positive contribution to the margins in P&C to the margins overall to the bank. That's what we expect from interest rates. That's part of the gradual re-pricing of the balance sheet as we manage that interest rate sensitivity to our targets.

Mario Mendonca, Analyst

And then the year two sensitivity, would you offer a similar, that it might just be slightly better in year two, but it's entirely consistent with your guidance then on what margins can do?

Hratch Panossian, Chief Financial Officer

Yes, that's right. And actually, those slower in the year two part. It's because the first year amount we disclosed is due to short-term rates. That's basically the short resets that happen within a quarter even. The rest is the longer-term repricing that takes several years to price through. Once you get to the second year in that interest rate sensitivity, it’s just assumed that you get this 100 basis point increase and then rates stay there. There’s no more short-term impact. So it's just that ongoing repricing of the long exposure that becomes more gradual when you get into the second year.

Victor Dodig, President and CEO

I just add one other point is that our ability to grow market share is not factored into that. If you look at the money in at CIBC, we're number two in the market today, and our goal is to be number one. We’re focused on continuing to grow deposits from our client base, continuing to grow investment management business from our client base. As we go forward and see the balance shifting perhaps away from loan growth and more continued deposit growth, we are going to be driving those numbers going forward, Mario, and just watch out for that across all of our businesses.

Mario Mendonca, Analyst

And Victor, do you believe that CIBC's 11.8% capital rates can support that type of momentum?

Victor Dodig, President and CEO

I think deposit growth actually contributes to capital origination as does investment management. We're very focused on that.

Operator, Operator

Thank you. The next question is from Lemar Persaud from Cormark. Please go ahead.

Lemar Persaud, Analyst

I'm just going to come back to some more detailed questions on the soft pack, so page 6, non-interest income that other. Can you talk a bit about what drove that increase of $114 million this quarter? Typically, it's below $70 million.

Hratch Panossian, Chief Financial Officer

Yes. Thank you for the question, Lamar. Happy to take that one. There’s a little accounting noise here; it's a technicality between the different line items. The large fluctuation in that line this quarter, if you dig underneath it, is specifically the subline that's gains and losses on non-trading derivatives. We had a $76 million quarter-over-quarter increase, and $53 million year-over-year increase. That's basically the movement. There are two things that impact that. One is a lot of our treasury activities related to again non-trading derivatives used for hedging and that's hedging of interest rate positions, and hedging or funding that we issue both on the interest rate and the currency side. Also, financing activities in capital markets. Sometimes derivatives are used in those structures where we're financing securities positions providing leverage to clients. Through that line item, about $30 million to $35 million of that number, whether you look at it year-over-year or quarter-over-quarter, is actually noise that's offset in other line items. This is similar to what I was saying about the trading side. Sometimes you've got an underlying position, and that comes through NII, and then there's a hedge on it with a derivative that comes through this line item. So there's about $30 million to $35 million of this that I would consider noise. The remainder of it is real. If you look at it quarter-over-quarter, about $40 million of that is related to our treasury hedging activities, which had a positive impact. So that’s the only real net revenue benefit I would highlight; the rest of it is noise.

Lemar Persaud, Analyst

Okay. That's understood. Sticking with that same schedule and non-interest income, the card fees. I know this has come up in the past, but the lowest level in two years, you've added on the Costco portfolio, purchase volumes are increasing. Can you talk to me a little bit about why is that card fees line not increasing? The number I'm referring to is the $98 million?

Hratch Panossian, Chief Financial Officer

Yes, thank you, Lamar. That's a good question. With the addition of the Costco portfolio, there has been some pressure on the card fees in PBB. We've discussed this previously. The revenue from that program includes income from fees, but there are also expenses that offset that income related to points and other card benefits. The Costco program has placed about $30 million of pressure on the fee line item. However, moving forward, I don’t anticipate it to have any impact on that line item; it will be neutral. As we continue to grow the program, there won't be any contribution or further pressure on fees. Although it has affected the current fees compared to previous quarters, that won't be the case going forward. On the net interest income side, it compensates for that, which reflects how the revenues from that program are structured. I hope this clarification is helpful.

Operator, Operator

Thank you. The next question is from Mike Rizvanovic from KBW. Please go ahead.

Mike Rizvanovic, Analyst

First question, just a couple of numbers questions, maybe for John. Just looking at the Canadian wealth. So I'm just taking your adjusted numbers. And correct me if I have the numbers wrong here. But when I calculate Canadian Wealth on its own, it looks like you had a pretty sizable decline quarter-over-quarter in the adjusted earnings number. It looks like it's all revenue-driven. Can you comment on Canada Wealth specifically this quarter?

Jon Hountalas, Canadian Commercial Banking and Wealth Management

Yes. The flow piece of the Canadian Wealth business was very good. On a retail mutual fund basis, we're in line with the industry. The industry is soft. In Gundy, we had our record flow. We've had record flows in the third quarter, record flows year-over-year. What you see there is just market fluctuations. It's a Canadian business. Markets were choppy in Q3, and that’s nothing else but the market, and reasonable flows within that market.

Mike Rizvanovic, Analyst

Okay. I guess I'm just surprised by the magnitude. Based on my numbers, it's $94 million this quarter, down from $139 million. It just seems like a sizable decline just even given the market conditions. Anything else in that? Is there anything related to mix or what the flows have been?

Jon Hountalas, Canadian Commercial Banking and Wealth Management

The industry and retail mutual funds are showing the best margin flows, but the overall industry experienced negative flows in Q3. We ranked second in the industry with fewer redemptions than most. Our Gundy flows are at record levels. While full-service brokerage flows typically yield lower margins, that does not account for the decline we've seen. The decline can be attributed to market conditions.

Mike Rizvanovic, Analyst

Okay. Appreciate that. And then a quick one for Laura. I just wanted to ask about the Canadian residential mortgage book. If you look at Page 34 of your report to shareholders, it shows that 22% of your book is greater than 35 years on amortization. I think that was 12% last quarter. It was zero at the end of last year. I don't know off the top of my head; I'm guessing that's probably higher than peers. But is there any reason to look at this and think that CIBC's borrower base on the mortgage side in Canada is just more highly leveraged than what we see with the peers? Any color on that would be appreciated.

Laura Dottori-Attanasio, Canadian Personal and Business Banking

Yes, Mike, I'm happy to answer that, and Shawn can add on if he likes. Yes, I don't see any issue with that. As you know, and Shawn talked about it with the rise in rates and the variable rate mortgages with how our book functions, you see increased capitalization as rates rise because our clients' payments that are under variable rate mortgage don't change until they hit a threshold. That's why you see higher amortization. Shawn talked about what we're seeing is our clients proactively start to make payments. That’s why you see increased amortization, but nothing to worry about, as Shawn pointed out. A lot of that will get reset at renewal time from our clients, so not concerned. I don't know, Shawn, if you wanted to add.

Mike Rizvanovic, Analyst

Sorry, go ahead, Shawn.

Shawn Beber, Chief Risk Officer

Look, I'd just say that this is a function of, as we talked about, it's a fixed payment. As interest rates rise, more of the fixed monthly payment goes towards interest rather than principal, which mathematically extends the amortization. If that continues to a level, clients can start to capitalize that interest, which we're not seeing at current rates; but if rates continue to rise, you could see some of that happen. As we've talked about in prior discussions, if that capitalization continues to a level it hits what we call the designated amount, which is 105% of the original principal amount, then they would need to make an immediate payment to deal with that. At this point, the 22% of the portfolio that has the amortization beyond is simply the mathematical outcome of more monthly payment going towards interest rather than principal and automatically extends the amortization based on that payment.

Mike Rizvanovic, Analyst

Okay. Got it. And then just to your knowledge, Shawn or Laura, would you think that CIBC would have a higher number than peers? Because the structure on that variable product is pretty similar for most of the banks, I'm just wondering if it's something that's maybe a bit more elegant at CIBC and why that would be? It would suggest potentially maybe borrowers taking on a bit more leverage with respect to the most recent originations. Any thoughts on that?

Shawn Beber, Chief Risk Officer

Yes. I haven't seen the other results. I'd just say that this is the way the product would work. Given that we've got the fixed monthly payment, it doesn't adjust with interest rates. As Laura said, we are seeing some clients just proactively making payments to keep that amortization flat. We don't have concerns based on what we're seeing to date in terms of credit quality or issues building.

Operator, Operator

Thank you. The next question is from Doug Young from Desjardins Capital Markets. Please go ahead.

Doug Young, Analyst

Hopefully, this will be relatively quick. Victor, at the very beginning, you talked about the addition of 300,000 clients. I think that was in Canadian Banking, and you gave some stats around that. What I'm particularly interested in is where those clients are going? Are you having success attracting them into core deposit accounts where paychecks are going into? Is this more mortgage origination? Is it across all of it? And how much and how many of these clients would be multiple product clients? How is the cross-selling on that side? Just trying to get a sense; could you talk about growth, as that’s obviously an important part of that. So just color would be much appreciated.

Victor Dodig, President and CEO

Thanks, Doug. If you go back to first principles and our key strategic priorities to grow within the affluent segment and to over-index there. As we took you through the data on Investor Day, in Laura's presentation, she outlined our current portfolio of clients, 11% of our households are in the affluent segment. Our strategy is to over-index on that and to grow our market share in that affluent segment. When you see us bring in 300,000 clients, 25% of which are in the affluent segment, that strategy is on track. Overall, clients in the affluent segment tend to have deeper relationships with us. They go through the CIBC GoalPlanner platform. They tend to have business on both sides of the balance sheet. That is exactly the kind of business we're focused on. That is highly aligned with the strategy that Laura outlined at Investor Day, and we continue to deliver on that. Laura, I don't want to add anything to it. We're highly encouraged that one of our key priorities is well on track, and we plan on delivering on that after quarter after quarter.

Laura Dottori-Attanasio, Canadian Personal and Business Banking

Well said, Victor. I would state that to your question, where we're seeing it, it's across all of our products, but really leading the way, and this is great, is in the deposit side. So with everyday banking products, that is how we engage with our clients. We're really happy with how we're leading in that regard. So thanks for the question, Doug.

Operator, Operator

Thank you. Ladies and gentlemen, this is all the time we have for your questions. I will now turn the call over to Victor.

Victor Dodig, President and CEO

Thank you, operator, and thank you all for your very insightful questions, and we hope we answered them to your satisfaction. I want to close by saying a couple of things. The solid results we reported this quarter demonstrate our strength and agility in a challenging economic environment. As we've laid out to you at Investor Day, we have a strategic plan that's built for sustainable growth and our continued capital strength enables us to focus on targeted, high-return investments to deliver value to our shareholders over the long term. Our senior leadership team at CIBC is highly focused on delivering against these objectives. We're going to continue to take a disciplined approach to our risk and expense management. We'll proactively calibrate our growth investments to changes in economic conditions. If things get better, we'll continue on the path. If things soften up, we'll adjust accordingly, but we're always focused on strategic growth for the long run, and we're going continue to leverage technology to improve efficiency and the banking experience we offer to our clients. In closing, I'd like to thank our entire CIBC team for being on purpose as we deliver for all of our stakeholders. I want to thank you for your continued interest in our bank and your investment in our bank. We look forward to speaking with you at the next quarter call and certainly in between them. Take care, enjoy the rest of summer.

Operator, Operator

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