National Bank of Canada Earnings Call Insights: Commercial Lending Portfolio, Expected Gains

On Thursday, National Bank of Canada (TO:NA.TO) reported its second quarter earnings and discussed the following topics in its earnings conference call. Take a look.

Commercial Lending Portfolio

Sumit Malhotra – Macquarie Capital Markets: My first question is in regards to your commercial lending portfolio. It’s, obviously been a very good source of growth for the bank over the last couple years. So, it did seem like there was a slow down this quarter, don’t want to put too much emphasis on three months of data, so maybe you could give us an update on what you’re seeing in regards to this business and what are the pause this quarter? Is just that one quarter’s pause or are you starting to see some signs of deceleration in the growth of that portfolio?

Louis Vachon – President and CEO: Sumit, it’s Louis. So, far I would from what we’ve seen. I think it’s more a one quarter phenomena. I think the pipeline is somewhat, when we talk to the business line, is still good. The other thing too is when you see a phenomenon where you see corporate loans – the corporate portfolio being strong and commercial a little less strong. It may be an issue of categorization here. I think what constitutes a corporate loan at National Bank sometimes is a – can be qualified as a large commercial loan at some of our competitors. So that’s what I would attribute this for this quarter and let’s see what the numbers are. I think the trend that we discussed in the past Sumit, the invest and divest phenomena in Quebec is still very much on. So we’re hopeful that the volumes will pick up over the next few quarters.

Sumit Malhotra – Macquarie Capital Markets: Then staying in the P&C segment, the margin compression this quarter, which specifically in your presentation you seem to attribute to the loan yields was larger than I was expecting anyway. I think larger if I recall correctly than you had suggested we may see going forward, I will leave that to you if that’s correct. My question here is more on channel mix. We certainly talked a lot in the last couple quarters about the growth you’ve enjoyed in the consumer side and how the broker channel is working for you. Can you talk about the potential impact that channel mix is having on margin specifically when you look at the residential real estate loan book?

Louis Vachon – President and CEO: I think from Jean’s numbers. I think we’ve – it’s certainly having an impact. I’ll start with the first part of the answer and then I’ll pass it over to Jean, but basically I think we should, the way we’re looking at it is Quebec and outside of Quebec. In Quebec right now there’s as I mentioned, most of the volume growth is coming from our branch network and from our mobile sales force and generally I think we are very happy with our volumes, our market share gain and generally we seen better spreads. In Ontario we have seen good volume growth. A lot of that is coming, 40%, 45% is coming from brokers. Clearly over the next few quarters we are going to look at net margins in that business. I’d mentioned that in my opening statements and we are going to look to hopefully increase the branch and the mobile sales force contribution in Ontario and decline the – but we are not pulling out of the mortgage brokers market. But on a relative basis we would like to reduce it a little bit. Secondly, clearly in Quebec, the on-boarding and cross-selling numbers whether they come from any channels are very, very strong. We want to make sure in Ontario that we monitor these numbers and that we get the same amount of cross-selling numbers and on-boarding as we do in Quebec. Diane anything to add on this.

Diane Giard – EVP, Personal and Commercial Banking: Just say that in the last – the broker business is very price sensitive, so what we have done recently is we’ve increased slightly our pricing on the broker business and thus we have seen a year-over-year and quarter-over-quarter basis a change in our – in the weight of our distribution in the CWA in the rest of Canada. So I think we are heading in the right direction and I’m positive about the future. Let’s not forget that it’s also a – broker business is a customer acquisition business and we are watching cross-selling very closely.

Louis Vachon – President and CEO: On your comment that it was a little bit more than we anticipated the net margin compression you are absolutely correct. This is – there was a little bit more than we had foreseen and we are taking action to correct that.

Sumit Malhotra – Macquarie Capital Markets: I will leave it here, in your report to shareholders the resi mortgage I think you called them the average monthly volumes year-over-year is about (C$3.5 million) would you be able to ballpark how much of that growth on a percentage basis has come from the branch and how much has come from the broker channel?

Louis Vachon – President and CEO: Yes, Giard would have that information.

Diane Giard – EVP, Personal and Commercial Banking: If you are looking at all Canada the current rating at the end of this quarter we have 49% of our growth coming from our branch, 30% coming from our mobile sales force and the rest coming from the mortgage brokers.

Sumit Malhotra – Macquarie Capital Markets: I’ll leave it here, the last one just a clarification Louis when you mentioned the buyback you said it would be over the next two quarters. The amount you are willing to allocate is linked to the amount of potential gains you may receive from your AVCP notes so am I looking at in the items of note for example this quarter you had a C$34 million gain, if that was to repeat that would be the amount you would allocate to buybacks.

Louis Vachon – President and CEO: That is correct.

Expected Gains

Andre-Philippe Hardy – RBC Capital Markets: I just like to follow-up on what Sumit ended with, what led to the C$34 million ABCP gain in the quarter. What makes you confident to make the statement that more gains are expected and then can you help us quantify what would lead to further gains or just how much you are thinking about here.

Louis Vachon – President and CEO: First of all in terms of certainty I think I said clearly in my opening remarks I mentioned if and when the gains occur, so there is still a fair amount of global volatility out there. That being said if we look at the history if you look at the portfolio over last three or four years. The fact is that over a very long period of time the amounts we recover from the MAV-notes is directly correlated to the number of defaults that there will be on the underlying CDS contracts. The portfolios are generally performing extremely well. There’ve been very limited number of defaults in the portfolio and so basically what we’re saying it’s the same trends we’ve seen over the last two, three years, continue over the next — the next couple of years then we think that the MAV-note as a whole will move gradually especially for the A1s and A2s should move gradually toward par. In terms of evaluation we’ve had a pretty wide band in terms of a range for evaluation and we are moving up against the upper part of the evaluation in the band, so the trend continues then I think we face a situation we would move out of our evaluation range and we would have to recognize non-recurring gains on that portfolio. So that’s what lead us to – in terms of amounts, it can be as low as zero clearly if the best case scenario does not pan out. If things continue to perform relatively well we are looking certainly at a range of on a pre-tax basis it could be anywhere from C$200 million to C$500 million over the next two, three years.

Andre-Philippe Hardy – RBC Capital Markets: Just one last question your evaluation is based on many different factors. How different are broker quotes relative to your evaluation which is in the low 60s relative to par?

Louis Vachon – President and CEO: I think we’re looking at a number of factors, credit rating being one of them. So, one thing that would continue to help in terms of evaluation, evaluation range is their credit rating assigned to the MAV notes. Secondly is some of the structures are starting to mature and some of the more aggressive structures are maturing over in the next few months and should those mature, I think the market I’d assume that some of them are going to be impaired. And if they are not impaired by maturity that will be positive and I think in terms of valuation, I think we are moving pretty close now to – there are some slight differences between individual notes. But I think between what we have in the market, I think we are getting pretty close.