Earnings Call Transcript - CM Q2 2022

Operator, Operator

Good morning. 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 will begin this morning's presentation with opening remarks from Victor Dodig, our President and CEO; 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, US Commercial Banking and Wealth Management, Harry Culham, Capital Markets; Laura Dottori Attanasio, Canadian Personal and Business Banking and Jon Hountalas, from our Canadian Commercial Banking and Wealth Management. They're all available to take questions following the prepared remarks. During the Q&A, with a hard stop at 8:30, we ask that you limit your questions to one. 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 will now turn the meeting over to Victor.

Victor Dodig, President and CEO

Thank you, Geoff, and good morning, everyone. I'd like to open the call with a few comments on the macroeconomic environment, followed by a summary of our second quarter results. So there's no doubt we're all in a very fluid environment. First and foremost, our thoughts are with those who have been affected by the war in Ukraine. Beyond its human impact, the conflict is exacerbating COVID-related supply chain disruptions and contributing to inflationary pressures around the globe. Central banks around the globe are responding by raising interest rates to cool inflationary pressures, which is leading to concerns about an economic slowdown. Now during times like this, our unrelenting support for our clients, together with our diversified business model, strong balance sheet, and prudent risk management will drive consistent and sustainable performance for CIBC. You can see this resilience in our financial performance. Against this macroeconomic backdrop, we reported solid results this quarter, underpinned by our strategic focus on investing for profitable and enduring growth. Revenue was up 9% over last year, driven by broad-based loan and deposit growth, higher fee income, and strong client-driven trading activity. Adjusted earnings of $1.7 billion or $1.77 per share were down modestly from the prior year as we were starting to see a normalization in provisions for credit losses. We also reported an adjusted ROE of 15.2% and a CET1 ratio of 11.7%, well above the 10.5% minimum requirement. Having delivered solid financial performance on behalf of our shareholders in the first half of the year, today, we also announced a $0.025 increase to our common share dividend to $0.83 per share, while maintaining our target payout ratio target of between 40% and 50%. Note that the dividend also reflects the previously announced 2-for-1 stock split that took effect earlier this month. So turning to our business results. Our Canadian consumer businesses demonstrated continued strength during the quarter with growth on both sides of the balance sheet. Excluding contributions from our Costco Mastercard acquisition, card purchase volumes were up 22% from a year ago, most notably in discretionary spending, such as hotel, entertainment, and restaurant expenses, as well as for transportation services, as economic reopening took hold. During the second quarter, we also completed our acquisition of the Costco credit card portfolio in Canada, adding one-third to our total purchase volumes. We're very pleased to welcome more than 2 million new clients to CIBC. Early performance of the portfolio has been positive; new account acquisition, purchase volumes and balance growth are all tracking ahead of expectations. We have initiatives in place to deepen relationships with our newly onboarded clients and look forward to reporting on our progress to you in the quarters ahead. We also continue to build relationships with our existing CIBC clients by making investments for the future. Post quarter-end, we launched CIBC Smart Start, a no-fee banking and no-fee self-directed trading solution to help Canadians up to the age of 25 get a head start on their financial journey. Better said, if you're under 25, you bank for free and you trade for free at our bank. We're the first among the major Canadian banks to offer this, and we believe it will further our momentum in new client acquisition. This program simplifies our existing offerings for youth and students by providing a market-leading solution to this cohort. Over the last 12 months, we've seen a 32% growth in our student population and the new offering will further support this segment. In North American Commercial Banking and Wealth Management, loan demand increased on both sides of the border, fueled by our existing client base to support their increased working capital requirements and from new client relationships. In Wealth Management, volatile markets driven by geopolitical concerns dampened asset growth to single digits in Canada with a slight decline in the US, and this compares to double-digit growth in both regions last quarter. Now, in spite of this market volatility, we continue to deliver solid net flows across our wealth businesses in both regions. In Capital Markets, our focus on supporting clients through volatile markets generated strong trading revenue. As well, our direct financial services business continued to benefit from volume growth in both Simply Financial and our currency conversion business associated with our international student pay and international student banking offers. Overall, each of our businesses contributed to solid results. Now, we're proud to be recognized this quarter by Mediacorp Canada, who named CIBC as one of Canada's best diversity employers for the 12th consecutive year. And by Equileap, who ranked CIBC as the number one gender equality employer in Canada for the second consecutive year. At CIBC, culture matters. Providing an inclusive environment to attract and retain talent with differing ideas and insights is a cornerstone of our bank's culture. By having a team that reflects our clients and communities, we can better deliver on our purpose of making our clients' ambitions a reality. Now looking ahead, we're well positioned to continue to deliver for our shareholders. In an environment that's increasingly fluid, one thing remains unwavering: our focus on what we can control. As we did at the outset of COVID, we will continue to demonstrate our resilience as we adapt to the changing economic environment with an emphasis on agility and stewardship. Today, CIBC is a bank with a streamlined and increasingly digitized infrastructure. Our collaborative culture and client-first strategy will enable us to drive profitable growth over the short, medium, and long term. You're going to hear more about our strategy, our capabilities, and our vision for the future and have the opportunity to connect with our leadership team more directly at our upcoming Investor Day. And now with that, let me turn the call over to Hratch to review our second quarter results in more detail. Over to you, Hratch.

Hratch Panossian, Chief Financial Officer

Thank you, Victor, and good morning, everyone. Our CIBC team continued to deliver solid growth and profitability this quarter, fueled by the disciplined deployment of balance sheet resources and targeted investments against our client-focused strategy. Diluted earnings per share were $1.62, and excluding the items of note detailed in the appendix of this presentation, adjusted EPS was $1.77. Pre-tax pre-provision earnings growth momentum remained strong, while provisions for credit losses against performing loans trended higher due to a more pessimistic economic outlook and the initial IFRS 9 expected credit loss against the Costco credit card portfolio treated as an item of note. 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 eight. Net income of $1.7 billion was comparable to the prior year, and ROE remained above our 15% target. Pre-provision pretax earnings of $2.3 billion were up 7% from the prior year, and revenues of $5.4 billion were up 9%, supported by broad-based volume growth, stable margin, and robust trading and fee income. Expenses were up 1% sequentially or 11% from the prior year, largely due to continued investments, inflationary headwinds, and performance-based compensation across our business. Diving into revenue further. Slide nine highlights the key drivers of net interest income. Excluding trading, NII was up 13% from last year, due to robust growth in funds managed on both sides of the balance sheet. We anticipate NII growth to remain strong in the back half of the year, benefiting from continued volume growth and the interest rate outlook embedded in the forward curve. Total bank NIM was up 1 basis point sequentially. And underlying this, Canadian Personal and Commercial Banking NIM was up 2 basis points, benefiting from the impact of the Costco credit card portfolio and rising interest rates, partly offset by changes in mix and competitive pricing. PNC NIM is positioned to continue improving on the back of rising interest rates and growth in higher-margin unsecured lending. Consistent with our prior guidance, NIM in our US segment was down 6 basis points over the last quarter, primarily due to lower nonrecurring items, including prepayment income. Slide 10 provides an overview of our go-forward sensitivity to interest rates. We continue to be positioned to benefit significantly from rising rates. Turning to slide 11. Noninterest income of $2.3 billion was up 5% from the prior year. Market-related fees were up 6%, helped by strong growth in trading revenues, particularly in interest rates, foreign exchange, and equities. Conversely, lower underwriting and advisory fees were impacted by a more modest industry issuance and deal volumes. Transaction-related fees were up 9% from the prior year, benefiting from credit as well as deposit and payment fees. Turning to slide 12. Expenses were up 11% over the prior year, or 9% excluding higher performance-based compensation, driven by strategic initiatives, most notably the Costco credit card program and investments in our US platform, as well as the impact of inflation on baseline operating expenses. While inflationary pressures have been more elevated than originally anticipated, we continue to target neutral positive operating leverage for fiscal 2022. Over the last several quarters, we've successfully deployed excess balance sheet resources towards organic growth across our franchise, but our capital and liquidity position remains strong, as highlighted on slide 13. We ended the quarter with a CET1 ratio of 11.7%, down approximately 50 basis points from the prior quarter, driven largely by the closing of the Costco credit card portfolio and the impact of market volatility in the quarter on both the fair value of CI securities and market-related RWAs. We expect capital ratios to be more stable going forward, as internal capital generation funds organic growth and return of capital to shareholders. Starting on slide 14, we highlight our strategic business unit results. Net income in Canadian Personal and Business Banking for the quarter was $577 million, down 4% from a year ago, driven by higher provisions for credit losses. Pre-provision pretax earnings of $962 million were up 9% from the prior year, reflecting share gains as we continue to grow our consumer and business franchise. Revenues of $2.1 billion were up 10% from the same quarter last year due to broad-based volume growth, including the Costco card portfolio and higher fee income, partially offset by margin pressure, particularly in mortgages. We have added some incremental disclosure on this page, highlighting the diversified nature of our revenue growth, which is supported broadly by contributions across our Canadian franchise. Expenses of $1.2 billion were up 3% sequentially and 11% from the same quarter last year, which included a one-time recovery as highlighted in my remarks at the time. The remaining growth was largely driven by higher strategic investments and employee-related expenses. Moving on to Slide 15. Net income in Canadian Commercial and Wealth Management was $480 million, up 20% from a year ago. Pre-provision pretax earnings of $648 million were up 23% from a year ago, benefiting from strong volume growth in constructive markets. Commercial Banking revenue was up 24% and supported by robust double-digit loan and deposit growth, which is expected to moderate going forward. Wealth Management revenue was up 9%, primarily driven by higher fee-based assets which benefited from net sales and market appreciation over the last year, and increased expenses were largely due to higher revenue performance and investments in strategic initiatives. Net income in US Commercial and Wealth was $152 million, down 17% from the prior year, driven by higher credit provisions. Pre-provision pretax earnings of $228 million were up 2% over the same period. We continue to execute on our plans to scale our US business organically by simultaneously investing in our client base to drive revenue growth, as well as our operational and risk management infrastructure in order to keep pace with the scale of the business and support our long-term growth ambitions. Revenues were up 10% over the prior year, supported by strong growth in average loans and deposits and fee income. Expenses were up 1% sequentially and 18% from the prior year, largely due to our ongoing investments in client-facing capabilities and infrastructure across our US operations. We expect expense growth to moderate in fiscal 2023 as we complete the ongoing foundational investments towards the next phase of our organic growth. Slide 17 speaks to our diversified capital markets business. Net income of $540 million was up 9% from the prior year, while pre-provision pretax earnings of $724 million were up 10%. Revenues of $1.3 billion were up 10%, driven by strong performance from Global Markets, corporate banking and direct financial services, partially offset by lower investment banking revenue as both originations and advisory activity was more muted year-over-year. Expenses were up 10% as well, driven by employee-related compensation and continued investment in support of our strategic growth. Slide 18 reflects the results of our Corporate and Other segment. Net loss of $137 million in the quarter compared to a net loss of $60 million in the same quarter last year. The decline in profitability in this segment was largely related to treasury driven by increased funding issuance, as well as significant market volatility and rapid increases in credit spreads experienced in the quarter. We anticipate losses in this segment to remain elevated in the short term if the current market conditions persist. To close, our second quarter results demonstrate continued momentum across all of our businesses, notwithstanding a more uncertain operating environment. Our balance sheet continues to provide us with significant flexibility to deploy capital in support of our clients to fuel organic growth and enhance shareholder returns. Thanks to our client-focused strategy, diverse business mix, and disciplined approach to capital allocation across our client franchise, we are well-positioned to respond to a changing operating environment in order to continue delivering growth and solid profitability. With that, I'll turn the call over to Shawn.

Shawn Beber, Chief Risk Officer

Thank you, Hratch, and good morning. Our credit performance was strong this quarter and our portfolios are performing well. We have 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. As Victor mentioned, in the second quarter of 2022, we also closed our acquisition of the Costco credit card portfolio, which is reflected in our Q2 results. It's a very high-quality portfolio and credit quality and performance have been in line or slightly better than our expectations. Slide 21 details our provision for credit losses on both a reported and an adjusted basis. Our reported PCL was $303 million in Q2 compared with a provision of $75 million last quarter. Excluding the performing allowance related to the Costco credit card acquisition, which is treated as an item of note, our adjusted PCL was $209 million in Q2. Provision on impaired loans was $196 million in Q2. Impaired provisions were up in Canadian Personal and Business Banking due to the impact of rising interest rates on our modeled Stage 3 allowance and higher write-offs as clients have begun reverting to pre-pandemic spending patterns. This is aligned with our expectation, and net credit losses continue to perform better than pre-pandemic. Provisions in business and government loans were up this quarter due to slightly higher impairments and fewer reversals. The adjusted provision for our performing portfolio was $13 million this quarter, reflecting some deterioration in our forward-looking indicators from last quarter. We're pleased with the continued strong performance of our portfolios. Turning to slide 22, our allowance coverage ratio was down a net three basis points quarter-over-quarter, mainly attributable to our portfolio growth and impaired allowance release, partially offset by the build in allowances associated with the Costco portfolio acquisition. Our allowance dollars were flat quarter-over-quarter. 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. Against the backdrop of an evolving mortgage market with respect to our mortgage portfolio, I'd make a few observations. The average loan-to-value for our uninsured mortgage portfolio has been trending down over the past several quarters and is currently 46%. The majority of originations over the last two years, including this past quarter, have been with our higher credit quality clients who have deep and balanced banking relationships with us. The loan-to-values of new originations have trended down over time from 70% in Q2 of 2020 to 65% in Q2 of 2022. Client credit scores have been favorable, deposit balances have increased, as have client incomes, and debt service metrics have remained stable over the past year. We're pleased with our origination activity and the strength of our portfolio. Turning to our business and government portfolio, the average risk rating has been stable, remains equivalent to a BBB, and continues to perform well. Slide 24 details our gross impaired loans. Overall gross impaired balances were down in Q2. Retail impaired balances were down slightly, while the business and government portfolio experienced a larger decrease due to higher write-offs. New formations remained stable and low from a historical perspective, and both the gross impaired loan ratio and new formations remain lower than our pre-pandemic run rate. Slide 25 illustrates the net write-off and 90-plus day delinquency rates of our Canadian consumer portfolios. Net write-off dollars trended higher in Q2 as expected, as clients have begun reverting to pre-pandemic spending patterns. The new Costco card portfolio also contributed a small amount to the write-off dollar increase this quarter, in line with our expectations. Overall, retail 90-plus days delinquency rate remained relatively flat in Q2 with a decrease in residential mortgages, partly offset by a slight increase in personal lending and the impact of the Costco card acquisition. In closing, we continue to see strong overall performance. We expect to return to more normalized credit losses over time, though performance year-to-date has been favorable. We are, of course, monitoring closely for potential impacts from the pandemic, the inflation and rate environment, and broader geopolitical developments that could affect our outlook. I'll now turn the call back to the Operator.

Operator, Operator

Thank you. We’ll now take questions from the phone lines. And the first question is from Ebrahim Poonawala from Bank of America. Please go ahead.

Ebrahim Poonawala, Analyst

Good morning. I guess, maybe just sticking with expenses, Hratch. If we could talk through the breakdown that you provide on slide 12 in terms of the makeup of the expense growth this quarter, as we look into the back half, remind us how we should think about either operating leverage or year-over-year expense growth? And also talk to us about its flexibility to pull back on expense spending, particularly as we look out into next year, on the one hand, inflationary pressures are going to probably push expenses higher. Just give us a sense of how we think about expenses in the back half of the year? And as we think about 2023, I realize you are not going to give any guidance, but just your thought process around investment spending versus areas to pull back if you need to?

Hratch Panossian, Chief Financial Officer

Thank you, Ebrahim, for the question. I'm happy to provide some color, and we'll certainly get a lot more into our 2023 plans in Investor Day in a couple of weeks here. But as context, I'll remind everyone how we think about our investments and increases in our expenses and our targets from a financial performance perspective, which have not changed. We continue to target over time, pre-provision earnings growth and positive operating leverage. And we continue to believe that we have the ability through our strategy and capital allocation approaches to make adjustments in order to respond to the environment and deliver that. And so as I look at this year, we had promised 5% to 10% pre-provision earnings growth and positive operating leverage. We talked last quarter about the fact that there are some puts and takes, but we felt overall pretty good about being able to deliver that. In fact, on the pre-provision side, to some extent, we feel we will deliver more than what we had expected. And so we're staying the course in terms of our approach. But we are aware of a lot of the things that you're talking about. We look at the environment. And on this chart here, I'll highlight we’ve got the inflation impact and the normalization of the environment impact in that half of that 5% operating cost increase. There have been probably about 1% more pressure there than we had expected. But against that, we have had successes in our efficiencies, which have been outperforming our expectations. We have looked at our strategic investments and paced them to some extent. And so we've already been reacting, and we have the ability to react through the rest of the year. Now I will point out in our strategic investments, you'll see two big buckets we've highlighted: Costco, and that's been ramping up over several quarters now as we're preparing to bring that program on, and we had a partial impact of those expenses this quarter. We'll have the full impact next quarter. After that, that will start plateauing. Our investments in the US franchise, which, again, has been ramping up, but we see that plateauing towards the end of this year. And so overall, we will continue investing at a high level, but that accelerated investment and the step-up in the increase in expenses that was causing us, there will be some room for that to moderate. So I would expect going into the back half of the year into next year, some of that moderation. We have levers to pull again to move that around by a couple of percent if we need to, obviously, for this year. Every day that passes, there is less and less of that lever. But net-net, I think we'll be able to offset some of the headwinds, and we'll be able to deliver a better pre-provision earnings result than what we expected in that range. And we are still striving for that positive operating leverage for this year.

Victor Dodig, President and CEO

And Ebrahim, just to build on Hratch's remarks, this is all consistent with what we've telegraphed to our investors. We are investing to grow, to grow client franchise with enduring value. You see that in terms of our market-leading revenue growth, our market-leading pre-provision growth, and our strategic and focused way of growing market share profitably by deepening client relationships and improving client experience scores. So all of these investments, and I look at them as investments, are delivering growth above market and above our peer group. And I think that's the most important thing to note here: the linkage between what we've telegraphed, what we've done, what we've delivered, and what we will continue to deliver going forward.

Ebrahim Poonawala, Analyst

Noted. Thank you.

Operator, Operator

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

Scott Chan, Analyst

Thank you. Good morning. Maybe Hratch, a technical question on OSFI. I think it's slide 8. There's another large gain on the financial instruments; it was like 286 similar to last quarter. Just maybe some context around that, and maybe some guidance on whether that is going to persist going forward, or should that moderate towards historical standards?

Hratch Panossian, Chief Financial Officer

Sorry, it was a bit muffled in the beginning, so we didn't hear the beginning part of your question.

Scott Chan, Analyst

Just in the supplemental, I think it's slide 8, there was a large gain of 286 million on the financial instruments. I'm just wondering, what that was. Did you get a large gain last quarter as well, and is it certainly a lot higher than historical standards?

Hratch Panossian, Chief Financial Officer

Yeah, nothing that I would highlight with that respect; that would be something on an ongoing basis.

Scott Chan, Analyst

Okay. And maybe just on mortgages. You talked about margin pressure. Is that due to competition mostly?

Hratch Panossian, Chief Financial Officer

Yeah. And we are seeing – and Laura can jump in here from a business perspective. But we did – I referenced some of the pressure on margins, and there was some of that pressure on the mortgages as we said on the PBB side.

Laura Dottori Attanasio, Canadian Personal and Business Banking

Yeah, hi, Scott. Yes, we did see a lot of, I'm going to say, inflow margin compression, and the whole industry has seen that. I'd say the market's been incredibly competitive. Our economic environment did see our funding costs, I'd say, rise faster than client rates. So our expectation when it comes to mortgage inflow spreads is that we expect them to slowly improve when we enter the back half of the year, and that's as we see sort of the increased pricing work its way through the system. I think you've seen – we've taken a market leadership position in raising prices over the last few months when it comes to mortgage pricing. So we're working hard to restore, I'd say, more sustainable margins. So as we get through the back half of this year, we should see some of that margin compression start to come off in the mortgage book.

Hratch Panossian, Chief Financial Officer

If I may address your question, it seems there was a misunderstanding regarding the slide reference. You are likely talking about slide 6, which pertains to the fair value profit and loss related to trading revenue. The strong trading revenues are typically reflected in that section as part of other income. You saw robust trading revenues last quarter, and we are seeing the same this quarter.

Ebrahim Poonawala, Analyst

Okay. Thanks a lot. Thanks Hratch.

Operator, Operator

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

Meny Grauman, Analyst

Hi, good morning. Just a question on cards. First, just in terms of numbers, the card fee line down sequentially. Is that just seasonality, or is there something else there driving that?

Laura Dottori Attanasio, Canadian Personal and Business Banking

Good morning, Meny. I'll take that. So on cards, we're actually seeing, I'd say, continued improvements in purchase volume. So when I exclude Costco, we're actually up almost 30% year-over-year. I think we're up about 30% from 2019 levels. So we have seen, I'm going to say, full recovery, if you will, in the categories that are travel, hotel, and entertainment. So everything is good. If you're looking at quarter-over-quarter where you see, if you will, things coming down a bit, that's really just seasonality. But when we go back over the years and look at quarter-over-quarter seasonal decreases, this has actually been one of our better quarters. So we're feeling pretty good about our card performance. What I would say, though, is that our interest-bearing balances, those did remain flat on a year-over-year basis. And again, they were also down a bit quarter-over-quarter. That's all seasonality. And I do think, as I've mentioned in previous calls, it's going to take some time before those increased purchase volumes translate into revolving balance growth. But it is coming, and when it does, I would say that we are very well-positioned for growth, just given, again, the strong value propositions of the cards that we have out there. We've been leading the market on new account sales in cards, excluding Costco. And as of March, we now have the Costco card portfolio, and the new account growth on that, it's still early days, has been well above expectations. So I think things are looking good for us on a go-forward basis.

Meny Grauman, Analyst

Thanks for that. Your comment is a good transition. The second part of my question was about comparing card spending to borrowing and what that indicates about consumer health. While there are concerns about recession risks, I’m curious whether you've observed any signs of stress. From my perspective, it seems to suggest a more positive situation. I'd like to get your views on the health of the consumer as reflected in your card portfolio.

Laura Dottori Attanasio, Canadian Personal and Business Banking

We feel confident about the health of the consumer. We have observed consistent prudent behavior from clients, a trend that started during the pandemic and continues today. When we analyze our card and unsecured line data, we see that utilization rates are significantly better than they were before the pandemic. Utilization rates have decreased by about 20% compared to our unsecured lines and HELOC. If we compare today to pre-pandemic 2019, we notice that people are borrowing less. In our card segment, the revolving rates have decreased by approximately 7% to 10% since 2019. This indicates responsible management of debt and payments on credit cards, and we are very pleased with our clients' performance.

Victor Dodig, President and CEO

And very well positioned strategically for growth going forward. What we've built and what's happened here with our card portfolio is a market-leading portfolio, Meny. You look at the travel card portfolio, the non-travel card portfolio, and CIBC has the best card portfolio in the marketplace. The 2 million plus newly onboarded clients from Costco, most of them don't bank with us, and a large majority are affluent, and a significant minority are small business owners. Both of those will contribute to increased growth going forward. And that's why the message about investing for the future is an important narrative for us that differentiates us from the rest of the marketplace. We're one of the few banks in North America that are investing and growing at the top end of the market. And a lot of that is due to these investments in the card portfolio, our US business, Innovation Banking, the list goes on. And that's why we're confident going forward that we're going to be able to continue to deliver market-leading growth.

Meny Grauman, Analyst

Okay. Thank you very much.

Operator, Operator

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

Gabriel Dechaine, Analyst

Hi. Good morning. My question is for Shawn. I mean the change in provisions there caused by the additions to performing, excluding the Costco stuff. I mean, it looks driven mainly by adjustments to your economic indicator, forward-looking indicators. I'm seeing more conservative versus last quarter, Canadian GDP, US GDP forecast and the Canadian housing price index. Is there one of these factors that's much more influential than the others, just to kind of get a sense of GDP in Canada and the US more important than the housing price forecast?

Shawn Beber, Chief Risk Officer

Great question. Gabriel, thanks for the question. The - you're right, the FLI would have driven the performing build, excluding the Costco acquisition this quarter. We're very pleased with the performance from an impaired loss perspective on the portfolio. Given the deterioration in the FLI quarter-on-quarter, it sort of resulted in a flat or small build. But the more significant in the context of this quarter, the more significant item is the debt service ratio change, which is reflective of the higher interest rate environment and some of those knock-on impacts. And so, that's really one of the more influential ones this quarter. The GDP deterioration in the growth forecast impacted some of the business units as well, but I'd say DSR was one of the more sensitive ones this quarter.

Gabriel Dechaine, Analyst

Where it’s not is that just one you don't list in these.

Shawn Beber, Chief Risk Officer

Yes. It's in Note 6.

Gabriel Dechaine, Analyst

Okay.

Shawn Beber, Chief Risk Officer

Okay.

Operator, Operator

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

Mario Mendonca, Analyst

Good morning. Shawn, can you help me understand. And I think you described it, but I think I could do with a better understanding of the increase in impaired PCLs in the Canadian personal and business. I didn't see any deterioration in delinquencies or formations. Is that increase predominantly Costco, or is there something else going on there?

Shawn Beber, Chief Risk Officer

No, it's remember that the impaired losses also have a modeled component to them, and so when the FLI and, again, the debt service coverage for both personal and for mortgages, when that change occurred in the forecast, that has a knock-on impact both from a performing perspective, but also from an impaired loss perspective for those portfolios. So that's what you're seeing; more than half of the build in the PBB results was a reflection of the modeled FLIs.

Mario Mendonca, Analyst

And Costco would be a modest portion then?

Shawn Beber, Chief Risk Officer

Yeah.

Mario Mendonca, Analyst

No, I don't expect you to comment on other banks, but DMC is the only one where I saw this play out. In no case did I see this play out for any other bank? Is it just all the banks have their own sort of models and sensitivities, and we shouldn't expect it to match quarter-to-quarter?

Shawn Beber, Chief Risk Officer

Yeah. I can't really comment on the other banks. We've built our models. We obviously follow IFRS 9 based on our interpretation and understanding of it when we've imputed our FLI, we have generated the results that you've seen. So you could see variability quarter-on-quarter. We've also had significant growth in the portfolio, so that also impacts the performing provision. We've had some release; you'll have seen in capital markets, there was a release that related specifically to oil and gas, given the improved outlook for – well, the improved results and outlook. But from quarter-to-quarter, as we've talked about, as the macroeconomic environment deteriorates, we may see a build. If it improves, then we could see releases but quarter-on-quarter, we had a modest deterioration, and so that came through our results.

Mario Mendonca, Analyst

Okay. Then a broad question then, probably for Victor or Hratch. All our banks have used their capital to grow in different ways. Some are doing a few acquisitions. It's clear that CIBC's approach has been to grow RWA organically. But it would appear to me that with the capital ratio checking back a little now, and your guidance that it should maybe remain stable going forward. Would I be correct in suggesting that the bank will manage the RWA a little bit more or manage that growth a little more closely? By that I mean, we may not see RWA growth at the same pace we've seen in the past.

Victor Dodig, President and CEO

Mario, good morning, that's a good question. I'd highlight a couple of things. One, you're absolutely right that our focus is on organic growth. And that's why you'll see that reflected in every single business unit that we run. You see growth, and it's client-focused growth. If you lift the hood on that growth, there are deep, meaningful client relationships from personal banking right through to capital markets. At 11.7%, we feel very good about where we're at. We have the cushion to deal with any market volatility that may come to all the banks in the banking sector. And it allows us the room to continue to grow. You may have seen the peak in terms of high growth rates, but we will continue to pace to be at the top end of the market, win client relationships, win profitable market share going forward. You'll see some Basel-related changes next year that will add to capital, and that will give us continued excess capital to keep growing and deploying that capital through the various avenues that we've articulated in the past. So we feel good about our strategy of organic growth; we feel good about our level of capital, and we feel good about our level to continue to grow at the top end of the market, to do it profitably and to do it sensibly. And Hratch, I don't know if you'd like to add anything to that.

Hratch Panossian, Chief Financial Officer

As Victor covered, this was a deliberate strategy, Mario. So maybe the only thing I'll add, right, as a reminder, as we were coming out of the pandemic with peak levels of capital and liquidity, we made a conscious decision to deploy that capital for growth organically. We've also communicated the reason we did that, and we will talk a lot more about that in Investor Days. Look, we've done good M&A in the past, and we believe we can continue to do good M&A, but organic growth returns are always superior, particularly in the short term. And as long as we have good opportunities to grow organically, we feel that is a better use of capital than any other avenue we have, including returning capital to shareholders. We are focused on generating tangible value and growing tangible value for our shareholders. And that is the best lever we have. And so, we've leaned on it. And so we've deliberately been bringing down our excess capital position through organic deployment to your point, that continued this quarter, right? Take out some of the market volatility, which will be back and forward, take out Costco, which is a one-time; you'll see that we drew down on capital even on an organic basis, and that was deliberate and planned. At the levels we are now, as Victor said, we feel comfortable there's still a buffer. But from this point on, I would expect a more balanced approach, where, as I said in my remarks, generation will be offset by the deployment and the return of capital. So, we'll be generally around these levels, plus or minus, is what we expect on capital, but that still allows us with that level of capital deployment, given the investments we've made so far and some of the investments we made now will allow us to grow more capital-light growth on the back of those. Costco is a good example. We have RWAs against that portfolio. But now there's a lot of franchising opportunities that will be more capital light. And so that's what allows us to now continue to grow, have the revenue and pre-provision earnings momentum, but keep capital more flat from here.

Mario Mendonca, Analyst

That’s clear. Thank you.

Operator, Operator

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

Lemar Persaud, Analyst

Thanks. My question is for Shawn. Maybe just coming back to the response to Gabriel's question on the debt service ratios impacting the performing build this quarter. Should we expect additional builds if interest rates continue to move higher? Just because, as you're aware, consensus estimates for Banking Canada interest rates, they still contemplate a number of further rate hikes throughout the course of 2022 and 2023. So, I'll leave it there.

Shawn Beber, Chief Risk Officer

Good morning, Lemar. So, the FLI contemplates a rising rate environment. So they're forward-looking. So, we've built into the forecast is that rising rate environment. I'd say we've captured our current view of it, maybe an extra 25 basis point move in the outer quarters. But we've reflected our view of what that rising rate environment is going to be. So unless that outlook changes materially, then we wouldn't expect to see additional builds just as a function of that.

Lemar Persaud, Analyst

Okay. That’s it. Thanks, guys.

Operator, Operator

The next question is from Sohrab Movahedi from BMO Capital Markets. Please go ahead.

Sohrab Movahedi, Analyst

Shawn, you are – I guess you're on the spot today, I'm just going to come back to you. I just want to – I hear you on the IFRS and the forward-leading indicators and the models and all of those tools that I guess management teams use. But as the Chief Risk Officer, when you stand back and you think about qualitatively the outlook, the quality of the portfolio and the growth that the bank has been delivering, do you feel adequately reserved?

Shawn Beber, Chief Risk Officer

Good morning, Sohrab. It's a great question. I'd say yes, the portfolio continues to perform well. When we look across the various businesses, when we look across the growth that we've achieved across our retail and our business and government portfolios, we're very comfortable with the underwriting that we've had in place. I think it positions us well. As you know, the way the models work, if there's a deterioration, we had the results from last quarter. We reflect the change in the economic outlook and then reflect that in our performing provisions. And so this quarter, as I said, you wound up with a flattish performing provision but feel very good about our portfolio and the road ahead. We don't see near-term stresses. We've seen some – we've talked about this in prior quarters. We expect to see some normalization of those loss rates over time as things get to some level of sort of pre-pandemic activity, expect that sort of over the coming several quarters. But frankly, there's the uncertainty out there and I think is reflected in the performing provision. We feel good about our allowance coverage, which remains strong.

Sohrab Movahedi, Analyst

And just as a kind of addendum to that to you, I think you mentioned the GDP growth forecast as one of the forward-leading indicators, the higher rates. And I think the debt service ratio, is it fair to say that there was a countervailing balance here because of unemployment rate and that – is that yet another area that I guess could become a negative here, or how should I think about how you have factored unemployment rate outlook, I suppose, into your thinking like that?

Shawn Beber, Chief Risk Officer

Yes. In Note 6, we share our forecast for the unemployment rate. There have been minor adjustments, but we will keep that in mind for our analysis moving forward, as it is certainly one of the forward-leading indicators. The debt service coverage had a particularly significant impact this quarter on the performance.

Operator, Operator

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

Nigel D'Souza, Analyst

Thank you. Good morning, guys. I had a follow-up again on your allowances for performing loans. And I wanted to tackle it a different way. When I look at your disclosure on Stage 2 loans, based on my math for personal and credit card loans, you have about 20% of both portfolios sitting in Stage 2, and that's relative to Stage 2 loans running at about 10% prior to the pandemic. So I'm trying to get a sense of what's the ratio now for about 20% of that portfolio being in Stage 2? And what's preventing the migration of those loans back into Stage 1?

Shawn Beber, Chief Risk Officer

As you may remember, we had some builds throughout 2020. We started with coverage on our performing balances at 35 basis points, and we have increased that to 45 basis points after releasing provisions over time. If the environment continues to improve, we anticipate some migration in that area. However, given the way forward-looking indicators are moving, we are monitoring that migration carefully. It still reflects our overall performing build.

Nigel D'Souza, Analyst

So I'm trying to get an understanding here because Stage 2 loans represent a significant increase in credit risk. So should we interpret that as your expert credit judgment that 20% of your personal credit card portfolio is exhibiting a significant increase in credit risk, what's vulnerable to a significant increase in credit risk?

Shawn Beber, Chief Risk Officer

Well, it did. We did recognize that over the course of 2020. And to the extent that we continue to look at those portfolios, in some areas continue to exercise that same judgment. We're watching for those indications of continued positive migration. And you could see that coming through in subsequent quarters. And so it's really a reflection of the build over the course of 2020.

Nigel D'Souza, Analyst

And I assume that's the same rationale for your mortgage book with 6% in Stage 2 versus closer to 3% pre-pandemic?

Shawn Beber, Chief Risk Officer

Correct.

Operator, Operator

Okay, great. That’s it from me. Thank you. Thank you. The next question is from Doug Young from Desjardin Capital Markets.

Doug Young, Analyst

Hi. Can you hear me?

Victor Dodig, President and CEO

Yeah. We can hear you, Doug.

Doug Young, Analyst

On commercial loan growth, there has been significant strength in both Canada and the US, which I know you and your team have been focusing on. I'm curious about the feedback you're getting from businesses, as it seems to contrast with the current sentiment. Many people are wondering what your impressions are based on daily news, and I would also like to know what level of growth we should anticipate moving forward. Do you believe this growth rate is sustainable over the next year?

Jon Hountalas, Canadian Commercial Banking and Wealth Management

Good morning and thank you for the question. It's Jon Hountalas. I'll start and then pass it over to my colleague, Mike. So last quarter, when we – I was asked the question about confidence in the environment, I classified business confidence as very strong. And today, three months later, it's still strong. It's a nudge down for sure, but people are still feeling good. Demand for product is there; price increases continue to get passed on. Labor remains a challenge. Supply chain is hit and miss. Some people tell me it's getting better, some people worse. But overall, people remain confident. So, in terms of Canada and growth, I mean this quarter was particularly strong. I think we were 6% quarter-over-quarter in loan growth. I don't think you'll see that. I think you'll see us go back to our normal healthy historical rates, low double digits. And I think we'll outperform the market. Mike, I'll pass it to you.

Mike Capatides, US Commercial Banking and Wealth Management

Thank you, Jon. So, it's more of the same in our commercial book and with our clients in the US, as Jon just described. Our clients remain confident. They're a bit more cautious as they're dealing with, as you mentioned, supply chain issues, employee shortages, and inflation, but they're focused on growth; they're borrowing to rebuild our inventories, and that's reflected in our revolver utilization getting back up to more historical levels. And on the real estate side, they're building to meet housing demands in the US. So for our commercial clients, we can describe the sentiment as good, as confident. What they're telling us, mostly, if you had to sum it up, is that demand and revenue is not an issue for them. They're experiencing margin compression. That's a bit of concern, but they're still looking at growth. Like Jon, in the US, we see this very healthy growth that we had in the US, which on a spot basis got to 18% year-over-year. We see that moderating. But we still expect to see growth in the double-digit range moving forward.

Doug Young, Analyst

And just a quick follow-up and maybe for Canada and the US. Is there a particular sector where you're doing particularly well or sectors that you're taking more market share?

Jon Hountalas, Canadian Commercial Banking and Wealth Management

It's Jon. In Canada, about 40% of our growth has come from real estate; 15% has come from innovation Banking. We'll talk a little bit about that on Investor Day. That's been a focus for us, and I think we're doing very well there. The rest is very broad-based by industry and by geography. Mike?

Mike Capatides, US Commercial Banking and Wealth Management

A little bit different in the US and a bit of a reversal from prior quarters. Our C&I portfolio and businesses and customers led the way on growth the past couple of quarters in this past quarter in particular. We were also seeing a fair number of payoffs in the real estate area. But it's reflective of our growth and our strategy in the US, where our network of offices around the country, where we've brought in new teams, new bankers, new products, they're all coming online. A lot of that's on the C&I side, and we expect that to continue going forward. It’s part of the investment in organic growth that both Victor and Hratch mentioned earlier. Put simply, it's working.

Doug Young, Analyst

Thank you.

Operator, Operator

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

Sohrab Movahedi, Analyst

We know you'll get rewarded sort of complying with the rules here. Harry, Capital Markets, I mean, I think loan growth there we keep on looking at it elsewhere. But Europe, I think 30% plus in loans in the Capital Markets segment, trading revenue at a record level. What are you doing differently there? And how sustainable is this?

Harry Culham, Capital Markets

Thanks very much for the question. Good morning. So, it's more of the same. We have a well-diversified franchise. In terms of the loan growth, it is very well diversified across our corporate franchise, across our institutional client franchise, which would include insurance companies, asset managers, pension plans, and private capital on both sides of the border. As I think I mentioned last quarter, we expect to see lending growth taper off throughout the year. In fact, quarter-over-quarter growth on average balances was 8%, down from 10% last quarter. But more importantly, we're seeing growth across the platform. We're seeing very, very good results with our trading businesses, quite often in the less capital-intensive businesses such as foreign exchange. We saw a 26% increase year-over-year in our trading revenues. The team is working extremely well to deliver capital markets products across our franchise, including our commercial wealth and retail clients, so we've seen revenue growth in the US of around 30% year-over-year and double-digit growth servicing nontraditional clients I just mentioned. So, really, it's all coming together, delivering for our franchise across our bank. The Capital Markets product suite. So, we're quite optimistic on the outlook. The pipeline is quite strong. The environment is the environment, but we're standing with our clients. It is a cycle-tested business. So, I'm optimistic that, given the strength of the pipeline, we can continue to deliver on that $600 million plus earnings growth.

Victor Dodig, President and CEO

And Sohrab, just to build on Harry's comments, our capital markets business is another point of distinction from our bank relative to our peer group. Not only is our strength in Canada notable. Our growth in the US is notable, but one in every $4 in revenue in the capital markets business comes connected to our overall bank in retail, wealth management, commercial banking, and other retail banking partnerships that we have outside our country through our direct financial services business. Again, something that we'll highlight more deeply at Investor Day.

Sohrab Movahedi, Analyst

Thank you.

Operator, Operator

Thank you. There are no further questions on the phone lines at this time. I'll turn the call back over to Victor.

Victor Dodig, President and CEO

Thank you very much, operator, and thank you for your great questions. I wanted to just close off by taking this opportunity to thank our 45,000 CIBC team members who play a critical role in bringing purpose to life for ourselves and for our clients each and every day. And to our shareholders and to all our sell-side analysts, thank you for your continued support and for your good questions. We will speak with you in a couple of weeks at our Investor Day, where you'll learn more about our bank, and you'll get to spend more face time with our leadership team. Look forward to seeing you then. Have a good day.

Operator, Operator

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