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Good morning. My name is Chris, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the Home Capital Group Q3 Results Conference Call. [Operator Instructions] Thank you, Jill MacRae, Head of Investor Relations. You may begin.
Thank you, Chris, and good morning, everybody. We'll begin this call with some brief remarks from Yousry Bissada, President and Chief Executive Officer; and Brad Kotush, Chief Financial Officer, followed by an opportunity for questions.
Before we begin, I'd like to point out that this call may contain forward-looking statements and that actual results could differ materially from forecasts, projections or conclusions in these statements. Please refer to our advisory and forward-looking statements on Slide 2 of the presentation. I would also like to remind listeners that the company assesses its performance on a reported and adjusted basis and considers both to be useful in assessing underlying business performance. Yousry and Brad will be referring to both adjusted and reported results in their remarks.
It's now my pleasure to turn the call over to you, Yousry Bissada.
Good morning, and thank you, Jill. Before turning to our Q3 results, let me start with a quote from Statistics Canada report that was released in September of this year. “Everyone needs a place to call home, but home is just a roof over your head. One's home can also be a source of security, dignity and identity.” This quote tells you how we understand and look at the housing market. A house is not like a financial asset that an investment manager will sell when the price drops. People are invested in their homes in every sense of the word. Let me share some thoughts with you on the market environment.
With 6 decisive interest rate increases by the Bank of Canada, we are seeing a new cycle for the economy and the housing market, a rate environment that does not been seen in a generation. Inflationary pressures that are the highest since the 1980s. The Bank of Canada is determined to fight inflation through rate increases and quantitative tightening. These efforts by the central bank are essential to restore price stability in the economy, but they have made it more expensive to borrow. All of this has created near-term pressure on the housing market in the interest of long-term sustainability.
Turning to Home Capital now. Let me tell you about: one, the impact of market conditions on our results here at Home; two, how we're responding; and three, why we believe people -- why we believe we are well prepared to handle any conditions we may encounter going forward. Following a strong start in the first half of the year, single-family originations have slowed in the third quarter compared with last year.
Let's put this in context. In the first half of this year, we reported 2 of our strongest quarters in single-family originations. A slowdown from that pace is still meaningful activity level. Our single-family originations this quarter were comparable to Q3 2020, and we considered that a strong quarter. Looking ahead, we believe that housing activity will continue to soften as the market adjusts to rising rate environment.
Turning to our commercial volumes. Rising rates can create near-term pressure on commercial activity as well. However, the long-term outlook for commercial volumes is more constructive. This is underpinned by a multiyear requirement to add to the housing stock in Canada, particularly in multi-unit dwellings. We have a good pipeline of quality opportunities with creditworthy origination partners. Let me tell you about how we're responding to this environment here at Home. We're not standing still during the slowdown phase of the market. We continue to focus on delivering excellent service and support our broker partners. We're driving value through building out our deposit side. We have been happy with the growth in both our broker deposits and Oaken channel.
We are prudently managing our expenses while taking advantage of opportunities to improve and expand our service quality. Our investments in our Ignite project have allowed us to manage expenses. Last quarter, we went live on our new SAP banking service system. We did this while handling significant deposit inflows during the summer months. The new system will provide us with the benefits such as improved stability, enhanced reporting capabilities and the ability to bring new products or features to market quickly as needed to grow the business. In the past 4 years, we have upgraded over 90% of all our systems. This is a major infrastructure upgrade that will deliver all these benefits well into the future. Let me give you an idea of what we expect looking forward.
We are confident about our business model and going into this rate cycle. There are some strong drivers underpinning the long-term health of the housing market. We believe the demand for housing has been deferred and not eliminated as buyers adjust to changing borrowing costs and changing prices. Planned immigration levels for the next few years will provide a healthy supply of new homebuyers. Federal Minister of Immigration recently announced plans to welcome 500,000 new permanent residents in 2025 and over 400,000 in each of 2023 and 2024. A large cohort of millennials reaching home buying age is providing further demand for their first or even their second home. Rapidly rising rents are evidence that potential buyers are turning to the rental market while they remain on the sidelines. All of this, plus a strong employment picture bodes well for household income and credit performance. And our credit quality remains strong. Nonperforming loans and write-offs are very level.
We believe homeowners are making the necessary adjustments in their spending to keep their mortgage payments current. If there is a prolonged downturn, we have the liquidity and capital resources to sustain us. Looking more closely at capital, we completed our SIB and bought back over $44 million of shares during the quarter. We are pleased to make this progress towards our target capital range. The bid was not fully subscribed, from which we can conclude that investors see additional upside potential in our share price for their investment time horizon. We'll continue to seek opportunities to add value through our capital program while enjoying the flexibility made possible by holding capital during periods of uncertainty.
I'll now turn it over to Brad for a discussion on the financial results.
Thanks, Yousry, and good morning, everyone. I'll provide some insight into the drivers of our results this quarter. I'll be discussing our performance on a reported and adjusted basis. The adjustment is due to a write-down of some capitalized software development work as part of our Ignite project. Following a review, we recognized an impairment charge of $9.4 million on one of the Ignite software development components in our other operating expenses. The after-tax impact to our earnings was approximately 7 million after tax or 0.18 per share. We assess cost and time to complete and chose an alternative solution that we can implement more swiftly and at a lower cost. This charge is related to that component has no impact on the future operations of the company, other than reducing future amortization expense.
Starting with an overview of the quarter. We recognize that the interest rate environment can provide both tailwinds and headwinds to the business of mortgage lending. Our mandate is to take advantage of the opportunities afforded by the tailwinds to invest and strengthen our business to succeed through the softer part of the cycle. We believe we have done this over the past 2 years, and we will use this time ahead to lay the groundwork for the company to thrive when we inevitably emerge from this period. We look at growth in our assets and in our loans under administration as important measures of the health and success of our organization and are pleased to see year-over-year double-digit growth in both metrics this quarter. We reported net income of Q3 of 31 million or 0.70 per share fully diluted. On an adjusted basis, net income was 38 million or 0.95 per share. Return on equity was 8%, and adjusted return on equity was 9.8%. Our book value per share grew by 11% year-over-year to end the quarter at 40.32.
Slide 7 shows the factors that contributed to the change in our EPS compared with last year's earnings per share of $1.10. The most significant contributor was a change in net interest income, which accounted for 0.24 of the variance. The difference in provisions accounted for a further 0.12. Partially offsetting those 2 was a 21% reduction in average shares outstanding, which benefited earnings by 0.16. The margin pressure from rapid rate increases persisted into the third quarter. Q3 margins were slightly below Q2 at 1.92%, but the pace of decline has slowed. Our net interest income for the quarter was in line with Q2. The effect of a 5-basis point reduction in net interest margin was offset by an increase in average assets. We expect our margins to start to improve for the balance of the year and into 2023 as the impact of rate increases on our loans becomes evident over time.
Looking ahead, higher rates within our loan book will have a longer-term impact on our results through retention and refinance volumes. We continue to benefit from our investments in technology and operating efficiency. Noninterest expenses of 72.1 million this quarter included the impact of the onetime impairment charge. Without this charge, our expenses would have been 62.6 million, which is lower than Q3 of last year despite a 15% year-over-year increase in assets under administration.
Slide 10 shows our loan originations for the quarter with a 28% decrease in single-family originations compared with Q3 of 2021, which was an exceptional year. We had another strong quarter in our commercial loans with over 400 million in originations. For the year-to-date, we have originated over 6 billion in single-family residential loans and 1.6 billion in commercial loans, which is higher than our originations for all of 2020. As of the end of Q3, we are reporting 19% growth in single-family residential loans on balance sheet and 5% growth in commercial loans. Savings through our Oaken channel continue to grow by double digits year-over-year. We finished the quarter with 4.8 billion in customer deposits.
Over 3/4 of those deposits are in the form of term deposits as customers are enjoying the benefits of safe investments with attractive guaranteed returns. Turning to a discussion of our credit provisions. We booked 4.4 million in credit provisions this quarter compared with a reversal of 3.8 million in the year ago quarter. This represents an annualized provision rate of 8 basis points of gross loans. Net write-offs of 1.4 million in the quarter represented an annualized rate of one basis point of gross loans. Slide 14 shows the breakdown of our credit provisions in the quarter. More than 75% of provisions during the quarter were attributable to loans in Stage 1 and 2 classified as performing under IFRS. Growth in loans on balance sheet was the main source of the increase in provisions on our performing loans. As of the end of the quarter, we had 44.1 million total allowance for future loan losses with 4.6 million attributable to loans classified as impaired or Stage 3. This represents coverage of 12% of our impaired loan portfolio, consistent with our prior quarter. As we have good security for our loans in the form of high-quality assets, we consider this level of coverage to be appropriate. Our provisions incorporate forward-looking economic assumptions under a variety of cases. The use of multiple scenarios adds 11 million to the loans calculated using just the base case. Slide 16 shows the composition of our gross nonperforming loans. Total gross nonperforming loans of 37.6 million represent only 16 basis points of our gross loans, consistent with the prior quarter and well below our long-term average. Our CET1 capital ratio was 15.41% at the end of the quarter, following our substantial issuer bid that user referred to earlier. This is a reduction of more than 700 basis points since this time last year as we took definitive measures towards our stated target range of 14% to 15%. We now expect to end the year above our target range as growth in risk-weighted assets was lower than our estimates earlier in the year, but we experienced higher levels of loan growth. We're evaluating both the economic environment and the most effective way of returning capital in this period of uncertainty.
Year-to-date, we have returned $171.3 million to shareholders through share repurchases and dividends. In the last 12 months, we have bought back more than 8.4 million shares through substantial issuer bids. We have also repurchased substantially all of the authorized number of shares under our normal course issuer bid that expires in February of 2023. Between the SIB and the NCIB in the 9 months to date, we repurchased over 5 million shares at an average price of $29.11 per share. These purchases have been accretive to earnings per share, book value and return on equity while delivering on our commitment to achieve our target capital range. Finally, the Board declared a common share dividend of 0.15 per share.
Now I will invite Yousry to make some concluding remarks.
Thank you, Brad. The housing market, like the economy, has always had periods of growth followed by periods of downturn. We have weathered them in the past and come out stronger, and that is what we expect to do again. We will continue to execute on our objectives of prudent underwriting, investment in our service capability and strategic risk management, while building an organization that we are all proud to call home. Our role as a leading near-prime lender is strategically important to the financial services ecosystem. We make Home ownership accessible to a broader group of creditors borrowers and provide the benefits that I mentioned at the start of this call; security, dignity and identity. This is how we deliver value to our shareholders.
I will now ask Chris, the operator, to poll for questions.
[Operator Instructions] Our first question is from Etienne Ricard, BMO.
Last quarter you should expectations for net interest margins to eventually bottom in Q3. Now considering another step-up in GIC rates in the recent weeks, when do you expect that interest margins to bottom to the extent funding costs remain unchanged from here?
We're anticipating or forecasting that we're at the bottom of that range now, and that over the course of future quarters, we'll be able to see increases in net interest margin. Our [indiscernible] industry, we also increased mortgage rates in the same time period. In the last 1.5 weeks, we've increased them again.
Understood. So, for crystal clarity, you expect Q4 net interest margin to improve relative to Q3?
We expect that it will not decline.
Okay. On credit, all the borrowers that would have taken on a mortgage during the housing market run up in 2021, must be nearing the end of the one-year churn by now. So, I'm curious to hear what credit performance are you seeing from the 2021 vintage relative to prior years?
The 2021 -- most mortgages, I think you know Etienne, that are near prime are one year. So many have come up already for renewal -- and we're renewing them at our current market rates, which, depending on when during this year, the gate could be anywhere between 6% and 8% range. We have seen our renewals to be strong, and we have not seen any lack of performance in credit. The arrears are normal, so we continue to feel that, a, the stress test is important. People were underwritten at 2% more than what they were written a year ago. And as I mentioned in my script comments, people are very resilient at figuring out paying their mortgage above all else.
Great. Last question for me. On capital allocation, with the government planning a 2% tax on buybacks, how do you think about dividend growth relative to buybacks starting in 2024?
Well, I think first, we'll assess what eventually is enacted. We've heard what the plans are. And we will determine at that point what the most effective way of returning capital to shareholders is. And if it is the case of increasing dividends, that's something that we'll have our Board evaluate at that time.
The next question is from Stephen Boland with Raymond James.
Maybe just start with the impairment. I just want to understand the time line here. So, Ignite, you installed or paid for a module. And then within a year or 2, you've kind of decided that it wasn't the right solution and you're kind of writing that off and putting in an alternative solution. Is that the right way to look at this?
So, I will say no. The SAP components have all been implemented at our running and exited what the post-implementation phase. This was one of the digital projects we have. There are roughly 8 components of Ignite of which SAP was migration was one of the most important. The component that was impaired was related to digital, not SAP. And as we continue to work on that development, we identified an alternative that we could implement more quickly and at lower cost. So, we cease development and effectively switch course.
And just on Ignite general. It seems like it's -- I think you mentioned how the time line is pushed into 2023. I think it was expected to be done by last quarter, we thought or thought. Is this going to be mid-2023 or is it substantially done now?
It is substantially complete. Over 90% of it is complete. There's just one piece that is going to probably take to mid-2023, but it's not a significant component in terms of the overall program in terms of cost.
And Steve, just for greater clarity, as Brad mentioned, it's not 90% of one big project. It is a number of projects, 9 of them, 8 are done and have touched 90%. So many, many upgrades are complete. This is the remaining part.
Okay. And my second question is basically on the single-family origination. So, I just want to make sure that everybody knows that the market conditions are slow. I just want to -- the sequential decline and obviously, there's seasonality here that this is -- would you say this is market conditions or that your -- you've become a little bit stricter on underwriting or you've adjusted, so you're not getting the same volume of business? Like are applications at the same level or overall, it's just the market conditions are a lot slower?
The market is definitely slower, Steve. The 40% to 50% range. We slowed less than that. So, we feel we're getting our fair share of what's out there. Our underwriting guidelines are to sound like people have stopped buying and selling homes. That's not true at all. There's still lots of activity, and we're getting our fair share. So, we think that will still continue at a...
Okay. So, when you say the same, that means like you haven't tightened further lowered LTVs exited certain geographies, things like that.
No, we're more cautious and look deeper in many situations to get comfortable.
The next question is from Graham Ryding.
The material move higher here in mortgage rates, particularly for people that have renewed within your business, are you expecting arrears to build higher in 2023 from where...
What we needed in that part of our business. So far, we haven't seen it, but we're prepared in the event higher earlier ago. Again, because what they did. Now the renewals are even above that 7.5% to 8%. So that's the marginal increase relative to what we saw a year ago, but people continue to be very prudent in their payments, and we are preparing for the worst, but haven't seen that yet.
Okay, understood. Do you look -- when you have clients that come up for renewal, do you look at their debt service ratios or is that you only do not going into new origination?
If the client has been current and made their payments, we don't look at it. We will offer an automatic renewal. But if the client wants more money or has had problems making payments, then we'll look at it.
Okay, understood. So would you have a feel for these borrowers like I'm trying -- what I'm trying to get at is sort of like the retention levels, I would expect are going to be higher here because there's going to be a certain cohort of borrowers that are not able to move their market somewhere off because they may not qualify somewhere else. Do you have visibility on how many of your borrowers renewing that would not qualify if you had to underwrite them under a B20 stress test at these higher rates?
We don't have visibility, but we have had increase in renewals, and we believe for the exact reason you say plus it's a pain to go get a new mortgage, all the documents again and so on. So, if home is offering 7.50 and let's say the market is somewhere between 7 and 7.50, you now have to qualify it close to 9% or 9.5%. So that is painful to do. You've got to go through the whole process, plus some people maybe it's just easier to renew. So, we have observed some renewals, but increase. And as we have already discussed in the last question and they continue to perform very well.
Okay. And then Brad, just to sort of on the theme of capital, are you still targeting to eventually move to 14% to 15% CET1 ratio? Or given the market uncertainty, are you comfortable sitting above that 15% level for sort of the near term?
We're comfortable sitting about that rate for the near term. That is our longer-term target. And -- we're just thinking that in times of uncertainty as we look forward, we'll have a clearer view when we result -- when we announce our Q4 results in February.
The next question is from Nigel D'Souza with Veritas Investment Research.
I wanted to follow up on the renewals line of questioning. Looking at where mortgage rates are today and where they were last year, monthly mortgage payments are likely going up by around $1,000, potentially more. I was wondering if you could give us a sense of, is there a level of increase in the monthly mortgage payment where you think Home Capital clients would have difficulty keeping up with those payments? Or is there a mortgage rate at which point do you think that the likelihood of delinquency increases?
Yes. Nigel, it's hard to give a general comment because each situation is different. Each mortgage or has a different situation. It's hard to give a blanket comment. But we will, at the beginning of the mortgage to know that they can handle 2% more. We will know the TDS, the GDS, we will know a lot of things about the client and their ability. What we also don't know is as a result of strong employment, have they now gotten a raise a second job more higher-paying job, circumstances change in a year. So, we think the book will perform well. But if the client has trouble, we know that our LTV is under 60% in the mid-50s overall in our book.
And even the people that got mortgages last year are still well we've got a lot of room. So, if they we feel that they get in trouble, they can get out because there is still a very big supply shortage. And as I mentioned earlier in the call, there's still activity out there. It's not like house Homes have stopped selling. There's still activity, there's still multiple offers. There's still these kind of things going on, just not as frequent as it was earlier in the year. So, we feel if they do get in trouble, they can get out, they performed well with us, circumstances change and mortgages in particular, business for sales are incredibly resilient at making sure that they make their payments.
And just to clarify a point there. So, on renewal, if I understand correctly, you're not looking at updated GDS, TDS employment status. Is that correct? When we look at those if a borrower has already missed a payment or is in arrears?
Yes. We don't -- we -- just to recap, Nigel, if they've been good payers, we don't -- look, we'll offer a renewal and hope to get it. If there is payment bumps or they want more money, we will re-underwrite them from scratch. We will do an appraisal; we'll look at their income. We'll look at everything again.
Sorry, by payment bumps, you mean an increase in the monthly mortgage payment or something else?
No, sorry, like if they want to borrow more. If they want to borrow more money than what they have.
Got it. And if I could switch to provisions for credit losses. When I look at Stage 1 provisions for single-family residential mortgages, I noticed that there's actually a reversal there for Stage 1. And it seems to be driven by change in risk parameters and models for the most part. Just trying to get a sense of why that occurred given that the outlook for unemployment and the home price index didn't improve this quarter.
Give us one second. Brad is pulling at you're looking at, and he'll answer the question.
You're referring to the 6.9 million.
Correct, yes.
[indiscernible] the overall was 4.8%. So, there was a change in risk parameters. We had a PD overlay that we had adjusted to take into account to more effective or better predictions through our models.
So, you probably default assumption is actually declining at the moment despite rising interest rates.
Not offset by increase in models. So, there is an overlay reduction and a model increase.
Okay. And then last question, just kind of minor point here. If you could just remind me, when I look at net realized gains or losses for securities along [indiscernible], could you just remind me again what the drivers are of that? Is [indiscernible], again, the loss or I assume that's related to the rate environment. Is that correct?
That is correct.
Any color you could provide on what we're seeing there in terms of trends?
Well, I think those are mark-to-markets on our economic hedges. So those vary from the rate environment. And so, there's not typically a trend that goes along with those.
The next question is from Ruben Gomez-Garcia with RBC Capital Markets.
Geoff Kwan. I had a question. First one is just on expense growth. Just trying to understand how you're thinking about this in the current market environment because obviously, we've got long housing market, more challenging economic environment, which would kind of suggest you might want to be more careful in expense growth. But on the other hand, then you've obviously been trying to make some investments to improve the business. Just wondering how you think about the net on that.
Yes, so in the second quarter, when there were signals that there was potentially a slowdown we immediately adjusted. I think like every lender, the volumes in the first and second quarter were so high and people were hiring up, we stopped. We anticipated some of that. So, we hired for lower volumes in the third and fourth quarter, which has turned out to be correct. So, we -- to answer your question, as early as May, we were anticipating where the market was going and relooked at our hiring. We didn't do any layoffs, but we didn't hire some people that we had intended because at the beginning of the year, we thought the year was going to continue in this regard. So, we are now running quite lean for the volumes that we're at. And as I mentioned in the script comments, we are still investing in the business very heavily. So, there's a lot of people who are building technology, AI solutions, CRM solution, database solutions to make the -- to make our clients' experience with home even better, including brokers who deal with our ultimate customers. So that we continue to invest the rest we have slowed down.
So, for looking out over the next year, are you expecting the efficiency ratio to improve versus where it is today or stay flat or potentially increase?
Well, we're certainly planning on having it to improve over time, Geoff.
Okay. Just the other question that I had was in terms of loan rejections, has that rate differed in the last -- today or recent months versus, say, a year ago? And does that differ on your accelerator book versus your classic book?
Sorry, Geoff I didn't quite understand. Can you try to explain again?
I'm just trying to understand is are you doing more loan rejections today than you would have been a year ago? And does that rate differ between your classic versus your accelerator book?
Yes. Not really anything measurable. We're definitely getting less applications, but we're accepting about the same amount. Maybe we're getting a little more canceling before funding because of higher rates, they're shopping the market a little bit more. So, our approved to funding may have gone down, not something huge, but something that we noticed. But the key is just less applications. It's a still the people who are getting mortgages are still high quality and can afford in these ways.
[Operator Instructions] The next question is from Jaeme Gloyn with NBF.
First question is on the -- on fee income or I guess, fees and other income. I noticed a nice step-up there from a quarter-to-quarter and sort of like a run rate over the last several quarters. Can you give us a little more color as to what's driving fees and other income higher this quarter?
Well, it's certainly a concerted effort on our part to increase our fee income. We altered our fee schedule. And we are continually looking at improving how we can increase that fee-based revenue.
So altered fee schedule would suggest that this level is sustainable. This is a run rate. There's nothing onetime-ish in that number, correct?
That's fair to say.
Okay. Great. I wanted to just ask about the credit card portfolio, and I know it's a small portfolio, but noticed a decline in the payment rate this quarter relative to what we've seen in previous quarters. Is there anything you're seeing in that portfolio from a credit performance -- payment performance as maybe a leading indicator for the rest of your book?
Mike Henry is here, who runs the credit card business. I will just ask him to comment.
Yes. Thanks for that question. The simple answer is no. We're quite pleased with the performance of the portfolio. Credit indicators are strong. That will be something we watch very closely as the world evolves around us because that will be one of the first things that will signal us if there is trouble coming for customers, but we're well positioned to help them with that.
Okay. So that lower payment rate, more in line with your expectations that nothing to be too concerned at this stage, I guess. If I shift over to the origination performance. You talked about the market slowing in the 40% to 50% range. Looking at like housing data, if you look at like dollar volume, it's down maybe 25% to 30% year-over-year. So, I'm wondering when you say 40% to 50%, you're specifically focused on the Alt-A market. And how are you arriving at that number?
I bet that was a GTA number. I should have been more clear. And it's you got to watch all these numbers, Jaeme, as you know well because the ones that we are more interested is number of transactions as opposed to dollars and averages because averages if $10 million homes aren't selling anymore and only $1 million homes, it looks like the average has gone down. But -- so we look at the number of units more than anything, and that's -- that number came from some GTA that somewhere. Specifically [indiscernible], just if you're looking for the source.
Yes. Got it. A couple more questions, actually. Just one around the capital allocation strategy. First, going back to the SIB, could you walk us through your conversations, your decision-making process as to maybe not increase the SIB price after the shares traded above it at that point? And then a follow-up on dividends.
Well, Jaeme, we did take a look at the shares we're trading. Our view was that we would not have thought a materially higher take up on the SIB by increasing the price. So, we chose not to. Yes, go ahead.
Yes. And then on dividends, I'm just thinking about how you're thinking about that policy. We have the dividend place from earlier this year? How are you thinking about payout ratios in the next year, timing of dividend increases in terms of like is there an annual cadence you're looking to hit? Maybe just walk us through how you're thinking about that as you're into next year.
Well, the overall expectation is that we would grow our dividend over time that's reviewed by the board on a quarterly basis in -- with our year-end results. So that's when we would typically make an announcement on payout ratios and what we would do for the dividend looking forward. As mentioned earlier, we'll have at least a few more months of experience in trying to determine the overall direction of the economy in the mortgage market, in particular. And we'll take a view then. We'll also probably know a little bit more about what's happening with the government policy in terms of the approach on the taxation of share repurchases, and that we'll have the ability to come back with a comprehensive program of return on capital.
We have no further questions at this time. I'll turn it over to Yousry Bissada for any closing comments.
Thank you, Chris, and thank you all for your interest in Home Capital. Please contact Investor Relations if you have any further questions. I wish you all a great day.
Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.