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Good afternoon, ladies and gentlemen. Welcome to the TD Bank Group's Q2 2019 Conference Call. Please note that this call is being recorded. [Operator Instructions] I would now like to turn the meeting over to Ms. Gillian Manning, Head of Investor Relations. Please go ahead, Ms. Manning.
Thank you, operator. Good afternoon, and welcome to TD Bank Group's Second Quarter 2019 Investor Presentation. My name is Gillian Manning, and I am the Head of Investor Relations at the bank. We will begin today's presentation with remarks from Bharat Masrani, the bank's CEO; after which, Riaz Ahmed, the bank's CFO, will present our second quarter operating results; Ajai Bambawale, Chief Risk Officer, will then offer comments on credit quality, after which we will invite questions from prequalified analysts and investors on the phone. Also present today to answer your questions are Teri Currie, Group Head Canadian Personal Banking; Greg Braca, President and CEO TD Bank, America's Most Convenient Bank; and Bob Dorrance, Group Head Wholesale Banking. Please turn to Slide 2. At this time, I would like to caution our listeners that this presentation contains forward-looking statements, that there are risks that actual results could differ materially from what is discussed and that certain material factors or assumptions were applied in making these forward-looking statements. Any forward-looking statements contained in this presentation represent the views of management and are presented for the purpose of assisting the bank's shareholders and analysts in understanding the bank's financial position, objectives and priorities and anticipated financial performance. Forward-looking statements may not be appropriate for other purposes. I would also like to remind listeners that the bank uses non-GAAP financial measures to arrive at adjusted results to assess each of its businesses and to measure overall bank performance. The bank believes that adjusted results provide readers with a better understanding of how management views the bank's performance. Bharat will be referring to adjusted results in his remarks. Additional information on items of note, the bank's reported results and factors and assumptions related to forward-looking information are all available in our Q2 2019 report to shareholders. With that, let me turn the presentation over to Bharat.
Thank you, Gillian, and thank you, everyone, for joining us today. Q2 was a great quarter for TD. Earnings increased 7% to $3.3 billion, and EPS rose 8% to $1.75, driven by record results in our retail businesses and a rebound in wholesale. We had good revenue growth in the quarter. Credit quality remains sound, and we continued to invest in building the bank of the future. Our CET1 ratio held steady at 12%, including 5.5 million common shares bought back during the quarter. Given our robust capital base and consistent ability to generate organic capital, we announced our intention today to initiate a new NCIB for the repurchase of up to 20 million common shares for cancellation, subject to regulatory approval.Overall, I am pleased with our results this quarter. They reflect the benefits of our diversified business mix and North American scale as well as our risk discipline. Our proven business model is a powerful enabler, allowing us to deliver on our purpose today as we reinvest in our competitive advantages to transform the bank for the digital age. This quarter, we took a decisive step forward with our enterprise cloud strategy as part of a broader effort to modernize our operations and put in place a state-of-the-art technology architecture, one that increases our agility and creates productivity savings we can reinvest in delivering better customer experiences. We participated in the launch of Verified.Me, a blockchain-enabled digital ID service, designed to allow customers to verify their identity quickly and securely, using personal information they consent to share from their bank with service providers of their choice. Verified.Me is an exciting new application of an emerging technology, developed through a collaborative market-led approach that is putting Canada at the forefront of the global move toward digital ID. We also continue to support the development of Canada's AI ecosystem. On the heels of our acquisition of Layer 6 last year, we are seeding the next round of innovation with our foundational investment in Radical Ventures, an AI-focused venture capital fund. Canada has become a magnet with top AI talent globally, and we are seeing the same phenomenon at TD where the Layer 6 team has doubled in size over the past year, accelerating our ability to drive better business decisions and enhance the customer experience. These investments are at the heart of our forward-focused strategy, and they are just a few examples of how we are continuously adapting and reinventing ourselves to deliver innovative experiences for our customers. We were delighted to be recognized for our efforts on that front this quarter with not 1, not 2 but 3 J.D. Power awards for customer service excellence. In Canada, TDCT won the award for highest customer satisfaction levels among the big 5 banks, ranking highest in overall satisfaction, convenience and channel activities. And TD Auto Finance Canada ranked highest in dealer satisfaction among non-captive retail lenders for the second year in a row. And in the U.S., TD Bank, America's Most Convenient Bank, received highest customer satisfaction with retail banking in the Southeast. As I've often said, we don't design our strategy to win awards, we win awards because of how we execute on that strategy. It's a testament to the value of our omni-channel approach and the power of the One TD model. And none of it would be possible without our people and their relentless focus on doing more for our customers every day across the enterprise and in each of our businesses. Let me turn to our business segments now. Canadian Retail delivered again in Q2 with $1.9 billion, up 2%. Our strong revenue growth was matched by continued high level of investment. In the personal and commercial banks, our J.D. Power wins are just one outcome of putting the customer at the center of everything we do. Another is the volume growth we continue to generate as customers respond to the investments we've made in our products, platforms and advice capabilities by entrusting us with more of their business. We also saw strong net asset growth in our wealth business as we leverage our scale to create new sources of value for our customers from digital resources like TD Direct Investing's new goal assist tool, which enables WebBroker clients to build personalized investment plans, to the new mortgage and private debt funds we launched for our private wealth clients, offering access to TD Greystone's expertise in alternative assets. We're delighted with the progress of the Greystone integration, which is bringing together 2 first-class investment teams with complementary capabilities and highly compatible cultures. Turning to the U.S. Our U.S. Retail bank delivered impressive results this quarter as well with earnings up 12% to USD 753 million. The strong performance was driven by good revenue growth, reflecting higher deposit margins and volume growth and positive operating leverage. And with the contribution from TD Ameritrade up 27%, segment earnings rose to USD 948 million, up 15% or 20% in Canadian dollars. We've laid a strong foundation for future growth in our U.S. business. Over the past 10 years, we've been rebuilding our core infrastructure and platforms this quarter, successfully converting our small business customers to our new digital next-generation platform. A J.D. Power win is a strong endorsement of these continued investments and of our commitment to create experiences that respond to our customers' evolving needs. Rounding out our businesses, Wholesale Banking bounced back from a tough first quarter. Earnings were $221 million, reflecting higher levels of M&A and underwriting activity, alongside continued investment in the global expansion of our U.S. dollar strategy. TD Securities also won several signature mandates. We advised Goldcorp on their USD 12.5 billion merger with Newmont to create the world's leading gold company. We advised Brookfield Business Partners and CDPQ on their acquisition of Power Solutions from Johnson Controls and co-led Brookfield's dual currency term loan B and high-yield bond financings. In our global markets business, we were awarded our first euro benchmark mandate by KfW, the biggest SSA issuer in the euro market. The EUR 5 billion deal is TD Securities' largest SSA bond underwriting to date and marks a major milestone in the growth of our euro franchise. And we led TD Bank's highly successful EUR 1.5 billion 5-year senior debt issue, the first benchmark senior offering in the euro market from a Canadian bank of bail-inable securities. As I reflect on the first half of the year, I am pleased with our performance. It reflects continued momentum in our franchise businesses, good credit quality and better conditions this quarter for market-based revenues. Looking ahead, the macro environment remains fluid, trade and geopolitical tensions are heating up and economic conditions remain mixed with several output indicators still soft while employment growth remains strong. As we move through the second half of the year, we will remain focused on our long-term strategy, which has delivered consistent earnings growth over time and provided us with the capacity to invest in our purpose to enrich the lives of our customers, colleagues and communities. This month, we issued 2 reports demonstrating our commitment to this purpose. Our environmental, social and governance report, which presents TD's ESG scorecard for 2018, and our report on The Ready Commitment, which outlines the impact of our corporate citizenship strategy in our 4 priority areas of environmental stewardship, financial security, connected communities and better health. I encourage you to read these reports, which provide a wealth of information on the purposeful investments our strategy is enabling. I also want to take a moment to focus on the spring flooding in Eastern Canada. These events have impacted thousands of people in multiple communities. We've taken steps to provide support including financial contributions to the Red Cross and through our branch network as well as through direct customer outreach to help those we serve cope with the challenges. We're also closely monitoring the fires in Western Canada and are in touch with the Red Cross to determine how best to support those affected. In these moments, we want to be there for our customers, colleagues and communities. To wrap up, we are delivering strong results today while laying a strong foundation for the future. That includes the new workspace we are creating at 160 Front Street West, a brand-new office tower in the heart of Downtown Toronto. Our vision for the future of our workplaces is built around the goal of bringing our people and teams together in ways that promote collaboration and improved workflow, supported by investments in the right tools and resources. 160 Front Street is a key part of this initiative. It will be a powerful complement to our flagship TD Center and a best-in-class workplace for our people, our most important asset. I'll close by thanking them, our more than 85,000 colleagues around the world who're living our shared commitments each day and devoting themselves to being ready for our customers. With that, I'll turn things over to Riaz.
Thank you, Bharat. Good afternoon, everyone, and please turn to Slide 7. This quarter, the bank reported earnings of $3.2 billion and EPS of $1.70. Adjusted earnings were $3.3 billion and adjusted EPS was $1.75. Revenue increased 8%, reflecting volume growth and higher margins in our retail businesses, as well as higher fee-based revenues. Provisions for credit losses decreased 26% quarter-over-quarter, primarily reflecting seasonal trends in the U.S. credit card and auto portfolios. Expenses increased 8%, reflecting continued investments in employees supporting business growth and strategic initiatives. Please turn to Slide 8. Canadian Retail net income was $1.8 billion, up 1% year-over-year, reflecting higher revenue, partially offset by charges related to the Greystone acquisition as well as higher expenses, insurance claims and credit losses. Adjusted net income increased 2%. Revenue increased 8%, reflecting volume growth, margin expansion, higher insurance and fee revenue and the acquisition of Greystone. Average loans increased 6% year-over-year and average deposits increased 3%, reflecting growth in both personal and business volumes. Margin was 2.99%, up 5 basis points sequentially, reflecting a refinement in revenue recognition assumptions in the Auto Finance portfolio and an increase in the prime-BA spread. Total PCL decreased 10% quarter-over-quarter with reductions in both impaired and performing PCLs. Total PCL, as an annualized percentage of credit volume, was 27 basis points, down 2 basis points quarter-over-quarter. Expenses increased 11%, reflecting higher spend supporting business growth, including additional FTE and volume-related costs, charges related to Greystone, an increased investment in strategic initiatives, including marketing and capability builds in data and digital technology. Please turn to Slide 9. U.S. Retail segment net income was USD 948 million, up 23% year-over-year on a reported basis and 15% on an adjusted basis. U.S. Retail bank reported earnings rose 14% on strong revenue growth of 6%. Average loan volumes increased 5% year-over-year, reflecting growth in the personal and business customer segments. Deposit volumes, excluding the TD Ameritrade sweep deposits, were up 4%, including 5% growth in core consumer checking accounts. Net interest margin was 3.38%, down 4 basis points sequentially, primarily due to seasonal increases in deposits. Net interest margin was up 15 basis points year-over-year, largely reflecting higher deposit margins. Total PCL, including only the bank's contractual portion of credit losses in the strategic cards portfolio, was $170 million, down 26% sequentially, reflecting lower provisions for the commercial portfolio and seasonal trends in the credit card and auto portfolios. The U.S. Retail net PCL ratio was 45 basis points, down 14 basis points from last quarter. Expenses decreased 2% year-over-year, reflecting the elimination of the FDIC surcharge, recovery of a legal provision this quarter and charges associated with the Scottrade acquisition in the same quarter last year. The contribution from TD's investment in TD Ameritrade increased to USD 195 million and segment ROE increased to 13.2%. Please turn to Slide 10. Net income for wholesale rebounded sequentially to $221 million, reflecting higher trading-related revenue and advisory and underwriting fees as market conditions improved. Net income was down $46 million from the same quarter last year. Revenue was comparable with Q2 of last year but reflecting higher advisory and underwriting fees, offset by lower trading-related revenue. Noninterest expenses increased 16%, reflecting continued investments in the global expansion of our U.S. dollar strategy and the impact of FX translation. Please turn to Slide 11. The corporate segment reported a net loss of $161 million in the quarter, compared to a net loss of $163 million in the same quarter last year. Net corporate expenses were lower year-over-year, largely reflecting lower net pension expenses in the current quarter. Please turn to Slide 12. Our common equity Tier 1 ratio was 12% at the end of the second quarter, consistent with the first quarter. We had strong organic capital generation this quarter, which added 40 basis points to our capital position, and this was mostly offset by growth in RWA, reflecting volume growth as well as the transition of our Canadian credit card portfolio to AIRB, as well as the repurchase of common shares in the quarter. Our leverage ratio was 4.2% and our liquidity coverage ratio was 135%. We announced our intention to initiate a new NCIB for up to 20 million common shares, subject to regulatory approval. I will now turn the call over to Ajai.
Thank you, Riaz, and good afternoon, everyone. Please turn to Slide 13. Credit quality remained strong in the second quarter across all business segments as evidenced by reductions in gross impaired loan formations, gross impaired loans and credit losses. Gross impaired loan formations were $1.34 billion or 20 basis points, down 6 basis points quarter-over-quarter and up 2 basis points year-over-year. The quarter-over-quarter decrease in gross impaired loan formations reflects higher prior quarter formations in the U.S. commercial portfolio, primarily attributable to the power and utilities sector and seasonal trends in the U.S. credit card and auto portfolios. Consistent with recent quarters, there were no new formations in the Wholesale segment. Please turn to Slide 14. Gross impaired loans ended the quarter at $3.3 billion or 48 basis points, down 5 basis points quarter-over-quarter and stable year-over-year. The U.S. Retail segment was the primary contributor to the bank's $238 million quarter-over-quarter decrease in gross impaired loans, reflecting a reclassification to performing for certain U.S. HELOC clients current with their payments and seasonal trends in the U.S. credit card portfolio. The Wholesale segment maintained a 0 impaired loan balance quarter-over-quarter. Please turn to Slide 15. Recall that our presentation reports PCL ratios, both gross and net of the partners' share of the U.S. strategic card credit losses. We remind you that credit losses recorded in the corporate segment are fully absorbed by our partners and do not impact the bank's net income. The bank's PCLs for the quarter was $636 million or 39 basis points, down 11 basis points quarter-over-quarter and up 3 basis points year-over-year. The $219 million quarter-over-quarter PCL decrease was driven by typical seasonal trends in the U.S. credit card and auto portfolios and the Canadian consumer lending portfolios. Please turn to Slide 16. Both impaired and performing PCL decreased quarter-over-quarter, reflecting U.S. seasonal trends, as already mentioned, generally lower performing PCL across Canadian Retail and higher prior quarter impaired PCL in the U.S. commercial portfolio, primarily attributable to the power and utilities sector. In summary, credit quality was strong across the bank's portfolios, and we remain well positioned for continued growth. With that, operator, we are now ready to begin the Q&A session.
[Operator Instructions] The first question is from Sumit Malhotra from Scotia Capital.
First question is for Riaz on capital. Riaz, one of your counterparts this morning talked to us about IFRS 16 and the impact that would have in the start 2020. Just thinking about that for TD and especially with your larger branch footprint, are you able to give us an idea of what you're expecting from a capital impact for that implementation?
We're working our way through the standards, Sumit, and as you can appreciate, there are some interpretational items that we need to work our way through and some choices that need to be made. So we're not prepared to quantify what the impact would be. However, as you well know, when the right of use asset gets capitalized at the beginning of the next fiscal year, it will be risk-weighted, and I assume -- I'm expecting the impact to be very manageable.
All right. So that's something, as you said, there are some choices to be made, we can revisit that later in the year?
Yes.
And then I'll wrap up with a question on the Wholesale side. So I think you communicated just last quarter, revenue would stabilize, we've seen that here. I just want to focus on the expense side of the equation and specifically the buildout that has been referenced a few times. When we look at the headcount in this segment, it's about -- it's up about 10% year-over-year and you've had a pretty steady climb over that period of time. Just maybe 2 questions here, if you can give us an idea how this expansion is going to trend. Is there a number you have in mind as to the amount of full-time complement that has to be added to get to the scale in wholesale outside of Canada that you're looking for? And then secondly, I hope I'm not putting you in the spot but I didn't see this in the annual report. Approximately how much of your revenue in this segment is being generated outside of Canada, if we use full year numbers for 2018?
Okay. Thanks. Yes, we have, as we've mentioned on the way through invested in building out both the global markets businesses as well as the corporate investment banking business, particularly to grow U.S. dollar revenue, both in the U.S. region as well as in other parts of the world in which we operate. We've had a fairly aggressive build in people on the front office side. In the last 2.5 years, we've added approximately 200 front office people, roughly half-and-half split between global markets and corporate investment banking. And then, of course, you need to also invest in infrastructure and people and support and control, et cetera. So it's been a relatively large investment for TD Securities. We feel we're at a point now though where that will slow down fairly meaningfully. We're still looking to add a person here and there in some of the areas, but now we're more focused on achieving the revenue that we're making the investment for. And that -- there is a J curve in that. Some businesses are further along in the cycle. We've been working at them. Our SSA U.S. dollar business has been up and running now for a number of years, and we're at a market share there where we're in the top 5 banks in the U.S. dollar SSA space. In that business now we're starting to add euro and sterling but it's a fully invested business. Contrast that, primary services or Prime Services, I should say, in the U.S., it's a couple of years old. The first part of that was investing in systems and policies and metrics and people. But that is now running and the focus there is adding the clients that we now need to make it a more profitable business. And we have probably more of the latter type than we do in the SSA business. So bottom line, Sumit, is we've -- the growth in FTE will be relatively small on the front office side.
On the matter of...
Part two was on the revenue mix or geographic mix.
Yes. I think -- Sumit, it's Riaz, on the matter of geographic mix of the revenue, as you know, we make very careful choices about how we define segments. And I think you should look at TD Securities as an integrated global segment. Yes, we do make disclosures in the annual report about where the sources of revenue are and that is more a legal entity reflection of the accumulation and aggregation of earnings. But when you have global centers, for example, from a trading perspective that are in London, Singapore, New York, Toronto, you have funding sources that come from variety -- the trading book really should be thought of more as an integrated business unit. So I don't think it makes sense to break it out, the wholesale results, in that way.
Yes, I'll leave it here. I mean obviously some of the Canadian peers anyway who have expanded more into the U.S. in the wholesale business have provided that information, and I think really what I'm getting at here is, as Bob has detailed, you've certainly added full-time complement in the U.S. and it would be interesting to see how the revenue progression for that expense that you've made is trending and I think that would be helpful to gauge that. So I hear you but hopefully that's another one we can revisit going forward.
The next question is from Meny Grauman from Cormark Securities.
If I look year-to-date adjusted EPS growth about 4%. So I'm wondering how confident you are that you can still get to the bottom end of your 7% to 10% range for 2019?
Meny, this is Bharat. Last quarter, when we talked about this, we said, there's a lot of headwinds, and there's tailwinds. That has not changed. In my remarks upfront, I talked about some of the risks that we see out there. But overall, the way we've set up, the way we are -- our medium-term target of hitting 7% to 10% earnings growth continues to be applicable from TD. And we'll try very hard, as I said, last quarter, to try and get towards the bottom end of that range going forward.
Okay. So it's still realistic. And then just in terms of expenses, what's the outlook? In the past, you've talked about sort of a slowdown in the second half of the year in terms of expense growth and a ramping-up in operating leverage. Can you update us on how you're thinking about expenses in the second half of the year and operating leverage?
Yes, absolutely, Meny. It's Riaz. As we said coming out of 2016 that we were making room to make investments. And then if you look at our expense growth coming into '17 and '18, you can see that steady ramp-up of expenses and, particularly, in 2018, over the 4 quarters, we had an increase in expense profile, which is now beginning to plateau out, and we're seeing a more level set of expenses from a quarter-to-quarter basis. So what that means is that we have brought our expenses to a level where we feel that we're making the investments that we need to make and still driving out the right productivity. But it just turned out that the result of that is, in the first half, you see a larger expense growth number, which will moderate quite a lot in Q3 and Q4, but at comparable expense -- absolute expense spending levels.
The next question is from Ebrahim Poonawala from Bank of America.
I guess just wanted to clarify something to your previous statement on expenses. From what I recall, like we saw pretty meaningful ramp-up in the back half of last year. So was the point there that we should see pretty healthy operating leverage in the back half of the year when we look at third and fourth quarter?
Yes, I think that's exactly right, Ebrahim, that as our expense spending growth rate and investment growth rate will normalize or moderate in the second half, it should create better operating leverage. And as you know, we always strive to create operating leverage year after year after year. And so I do expect that you'll see much better metrics on that front.
Got it. And I just wanted to focus on the U.S. Retail margin. One in terms of, Riaz, if you can just talk about what you're seeing in terms of deposit pricing pressure with the Fed on hold and your outlook for the margin. And secondly, if you can talk about any actions you're taking to protect the margin if the Fed ends up cutting interest rates at some point over the next 12 months, given sensitivity to your margin as well as sensitivity at Ameritrade to declining interest rates.
Ebrahim, thank you for the questions. It's Greg Braca. I would just -- first on the margin question, if we think about the quarter-over-quarter, you saw we were down 4 basis points, but I would like to point out that year-over-year, we're still up a healthy 15 basis points. And generally, the way we would look at the sequential quarter-over-quarter, a little bit of a dip is, Riaz upfront mentioned some seasonal deposits or we could talk about it in terms of mix of loan and deposit volumes in quarter-over-quarter and that contributed to the decline. But the way I would think about it and I've talked about this for a couple of quarters now is the quality of the deposit growth in what we're seeing in the U.S. as a very competitive and dynamic environment with both large and small organizations really looking to put on deposits and show some ability to grow. Some are going about it with core franchise growth and some are paying up for it. We clearly are not in that latter half camp and we -- our betas remained very well in check, and we've done a very good job growing core DDA and core checking account growth. And we've talked about that in the past as well. Core consumer checking account growth up year-over-year of up 5% is really -- is healthy household acquisition and goes to our whole model around primacy and convenience and all the things that we talk extensively about. To your second question, when you think about protecting that margin, if interest rates would go the other way or whatever the case may be, I do think it goes back to the way I answered this first question is that our goal here, regardless of the environment, is to drive core household growth, not pay up for hot deposits, drive core checking account growth. And we're seeing that across all of our lines of business, including small business and consumer. So that's how I'd answer that.
And just a quick follow-up on that. So the margin went down seasonally impacted because of deposit mix shift, is the outlook that it should hold relative to 2Q levels or do you expect incrementally more compression as the year progresses?
Yes. So the way we look at any quarter-over-quarter or the next few quarters out, these things are going to tend to bump around a bit. And very difficult because in addition to just volumes there's a whole host of things that we always talk about that goes into it, long-term rates, investments, loan yields. So there's a whole suite of things that would go into that margin story. But what I would generally say is with a stable outlook from the Fed and barring anything further dramatic on the long end, you'd generally tend to see a general statement over several quarters, fairly stable margins.
The next question is from Robert Sedran from CIBC Capital Markets.
Riaz, I just wanted a quick clarification actually on the comment you made about the Canadian margin, which was the impact of, I guess, a change in revenue recognition around the Auto Finance book. Can you -- a little more color on whether that is a onetime item on the revenue line that will fall away or if that was a recurring thing that will keep the margin at the level it got to?
Yes. No, Rob, what that's about is that we are seeing faster prepayments in the auto book, which would therefore result in faster revenue recognition. So it wasn't a methodology, it's actually the underlying assumptions. And so I think that as we continue to see those prepayments, we'll see more faster revenue recognition along in that portfolio.
So as long as consumer behavior remains what consumer behavior has been, the margin is going to evolve from here as opposed to getting back 2 or 3 basis points that it was up this quarter.
Yes. I don't think that it should have a big impact on margins going forward. It may just come off every -- as things level off a little bit in our new assumptions. So similar to what Greg said about the U.S., I think Canadian margins probably bump around a bit from here, but that would be an adjustment to assumptions that doesn't occur all the time.
And so the rest of the margin trajectory from here is consistent with the prior guidance. A bit of a leak upwards, I guess.
I think a slight bias upwards, but I would say, as Greg indicated, it's true in Canada as well that lots of changes in terms of product competition and consumer behaviors. So I think it's better to say that it will bump up and down a little bit here and there.
The next question is from Steve Theriault from Eight Capital.
If we could go back to capital markets for a moment and focusing on expenses. So the last couple of quarters, the expense line has been about $600 million plus or minus a few million. I'm wondering how, like if that -- should we think of that as the new run rate and I look at year-on-year, the revenue line was identical, expenses were about $80 million higher. How much of that $80 million or so year-on-year increase is from the higher U.S. expenses as you build that out?
Yes. I think there is some -- I think we're of the view that the $600 million a quarter is something that we should probably be modeling in ourselves and the reason I was hesitating is that there is also a regulatory build and technology build and Brexit build and some of that may be recurring and some may not be recurring. So I think we certainly have been spending money on, if you want to call, the EU 27 regulatory, we've been spending a lot of money on that type of activity. So that may slow down. I think what the real key though is that we need to grow revenue to make the return on the investment, and if that is not occurring at the pace we need then we need to reduce expenses as well. So we are focused on both.
Do you have a base case on when you'd like to see that return on equity get back to sort of a -- the high teen level in terms of sort of trying to gauge your level of patience with all that?
This quarter would be good. No, I mean we still have an objective of making an ROE more in the 15% range. I think we've referred to in the last number of years, I think the high teens are a little bit of an error in the past given what's going on in the business. So that's the focus and we'd like to try to achieve that as quickly as we can.
Okay. Maybe one more for you then. After the volatility from last quarter, I'm curious if there was any actions taken this quarter sort of in reaction to last quarter that may have mitigated any revenue upside for Q2 in what's proving to be a pretty strong capital markets quarter across the whole group here?
I don't think there was anything that we were doing last quarter that we've changed than we're doing this quarter that caused anything in the results. But what we continue to do though is the U.S. markets were strong, especially in the latter 2 months of this quarter and our investments there really are what's going to cause the change in the mix and, perhaps, more stability in our revenues overall. So it's that investment that was -- that certainly helped the quarter and markets helped that. Whereas in the previous quarter, the lack of market activity in both Canada and U.S. combined with the expense run rate, as you spoke of, certainly was a negative factor.
The next question is from Doug Young from Desjardins Capital.
Just two quick ones. Riaz, just in U.S. Retail, I think there was a recovery of a legal provision. I just want to see if you can quantify that? And just so I have this correct, that was netted out of net non-interest expense. Is that correct?
It's Greg, Doug. So the way we would talk about that is we're not going to put a number on that. And the way we think about expenses in general is, if that item had not occurred, our expenses would have been up year-over-year, and expenses in general would have been reflecting our continued investment in the business. But we wouldn't put an absolute number on that release.
Would that -- I mean I don't know if you can just give us a ballpark here but like the -- would mix have been up like low single digits, is that or...
Well, as we've said all along, we still would have had positive operating leverage. And if I were to think about this for the first half of the year, we had expenses up 6% and for the first half -- you're going to have these numbers from time to time in any given quarter. So for the first half of the year, our expense rate, even with this item, is running roughly 3%. And certainly, we've had positive operating leverage for the first half of the year.
Doug, just look at the trend of non-interest expenses over the last 6 quarters, I think you can assume that's a good trend.
Okay. That's fair. And then just lastly, CET1 capital generation, I guess, I'm trying to get a sense of, I think historically, if we went back, I think 15 to 20 basis points per quarter is typically what people have talked about. I think maybe we've talked about in relation to TD. We're going to a different environment, there has been regulatory goal changes. Is that still a reasonable level to expect for TD? Or is there something that's changed that would cause that to be lower going forward?
I think, Doug, if you look at Slide 12, you can see that the net income less dividends contributed 40 basis points, and then off the RWA increases of 27 basis points, just a little bit less than half of that was devoted to the migration of the card portfolio from standardized to AIRB. So I think you can see in that, that the capital accretion continues to still be very strong even in a very fluid environment.
And that, I guess, move of that card portfolio to AIRB, I mean that in and of itself is done and so that's onetime. Is there anything else that's on the horizon that would be similar in such that if you move to AIRB would have a negative impact?
Well, really, in our business mix, cards are one portfolio, which when they migrate to AIRB, the risk weights on them are higher than standardized. Typically it's the other way around and, of course, you're well aware that our U.S. non-retail portfolio still is in the process of migration to AIRB. But that should be a benefit.
The next question is from Gabriel Dechaine from National Bank Financials.
I want to talk first about the commercial book in Canada. And it looks like you guys didn't have any credit noise there, no real losses out of the ordinary like we've seen from a few other banks this quarter and last, mind you. I guess I'm kind of -- outside of your in-quarter performance, we have seen some issues then the Bank of Canada is raising their own concerns about corporate indebtedness and then we've also got this massive growth in commercial and wholesale loans in Canada. I'm just wondering, what do you think about that growth and what are you seeing differently than what the Bank of Canada is maybe concerned about? Why are you not concerned about credit quality in commercial lending in Canada in general? Sorry, that's a bit of a wordy question but...
It's Ajai. I'll start with PCL and then Teri will talk about growth. We're definitely seeing very low PCL and loss rates across the commercial book and I would describe the quality as good. But that doesn't mean there's no migration. There is some migration occurring, and I would put it in the category of gradual normalization. So it's not like it's not occurring at all. I can't speak to the peers and what their book is like but certainly in our book, like I feel it's strong, it's performing well but there is some normalization occurring. And if you actually go to some of the ECL tables and you look at stage 2 ECLs, you'll see a bit of an uptick and especially you look at business in government, so you'll see some migration there.
And what's driving that?
I think we're late in the cycle. So it's not abnormal to see some migration so late in the cycle. I can't pinpoint a single thing that's pointing that and it's not a single sector, but I would say it's broad but it's still low dollars.
And then it's Teri. From a commercial growth perspective, I'd say we're very comfortable with the business that we're putting on the books. We're continuing to put bankers on the streets in markets where they're building great relationships, business succession continues to be an opportunity for us. And I feel comfortable that I think Riaz has quoted earlier this morning, we're prudent lenders through the cycle and so we're very comfortable with the business growth that we're seeing and open for business going forward.
Teri, while I have you at the mic, thought I'd ask you something with a bit more of a positive spin, we've seen the housing market go from source of intense concern last year and in the wake of B20 and starts data was dipping lower and lower. In the last few weeks or months, we started to see some good starts data, some positive sales data coming out of the GTA and Montreal as well. And the industry seems to be, I guess, bottoming out in terms of mortgage growth, RESL, I would say. I'm just wondering if you're generally as optimistic as you were about this business a little while ago or maybe if there's some additional optimism today in your growth outlook for RESL growth and the ancillary businesses.
So I continue to feel very comfortable with we've been talking for quite a while now about the mid-single-digit medium-term outlook for proprietary total real estate secured lending growth and I feel very comfortable with that for this year and going forward. We've been investing, as you know, in this business more mobile mortgage specialists, more training for our branch advisers, a leading capability that is fully digital to apply for a mortgage online. We've got a position, as we've talked about in the past, where we are forced in hybrid HELOC loan market share and we're continuing to be able to advance there with customers, primarily who are already customers of TD. And so -- and retention is very strong as well. So continue to feel good about that guidance going forward.
Outside of what you're doing, though, is there anything in the macro that's maybe more...
Certainly, we're seeing -- as you mentioned, certainly, we're seeing particularly in the GTA, the kind of start of the spring lending season and some good trends. It really is a tale of the 2 sort of halves of the country, if you will, a little bit tougher in the West. Although I would say under $1 million in Vancouver and condos is still a hotly contested market for purchasers, and then GTA, in particular, a little bit stronger. So it's early days in the spring season but we're seeing some green shoots.
The next question is from Nigel D'Souza from Veritas Investment Research.
So I had one on just the loan volume size. And I wanted to focus on your auto books. So if I look at the Canadian Retail segment, auto loans are relatively flat and in the U.S. they're down slightly quarter-over-quarter. You mentioned prepayment rates or higher prepayment rates this quarter and -- so wondering if -- what we're seeing in Q2 here, is that a just a one-off, non-recurring kind of trend? Or what is your outlook given that autos tend to -- we are late cycle and autos tend to be kind of leading -- lead the cycle. Where do you see Auto Finance volumes playing out for the rest of the year?
I think on the matter of the prepayment -- Nigel, it's Riaz, I'll just say that the way we look at these from an accounting perspective is we sort of look at the trend over a period of time. So I don't think you should interpret this as a 1 quarter trend. When we look at our revenue recognition policies and this applies across a wide number of products, whether it be mortgages, auto or even corporate, like you always look at kind of prepayment trends over longer periods of time to see if you've got an appropriate assumption that is going into it. So I don't think you should look at it as 1 quarter. As far as longer-term trends go, I'll let maybe Greg comment on the U.S. auto piece.
Sure. So you are right and it would have been similar to last quarter. Nigel, if we looked at Q1-over-Q1, we were really coming down to relatively flat year-over-year numbers for the last couple of quarters. We have a view too that we are later in the cycle. We also want an appropriate return. We also want to manage relationships and volume versus just a couple of years ago, where you would've seen us growing 8%, 9%, 10% year-over-year in auto. We think we have the right mix of the business that we've been positioning this as you -- in the U.S. And I wouldn't be surprised if over the next few quarters you saw it bump around at this level maybe up a couple points. But this is generally where we see ourselves for the foreseeable future.
That's really good color. And I just have one last question on if I could turn to just credit losses and PCLs, in general. There is a step-down in provisions for your Canadian Retail segment and although seasonality has benefited that quarter-over-quarter, there was a larger step-down in prior years, so it's still fairly elevated up, as you noted, nearly 30% year-over-year. So just wondering if you could provide more color there. Is there anything at play here in terms of do you expect that to trend lower over the coming quarters and have another step-down or what are you seeing just on either the performing or impaired side on the Canadian Retail?
So I'll talk about the year-over-year, it's Ajai. So we're kind of moving up very low numbers. Like if you look to Q2 '18, our number was 23 bps and the lowest we've had is 22 bps. So we're really moving up those very low numbers into what I would consider a little more normalized numbers. And I think 27 bps still remains in a very acceptable range of 25 to 30 bps. But what I am seeing is, and I mentioned this earlier, a gradual normalization of credit losses across the various books in Canada. So my expectation is that normalization will continue to occur at a gradual pace, unless the economy turns -- I should clarify, unless the economy turns.
The next question is from Darko Mihelic from RBC Capital Markets.
I have two questions. One for Bob Dorrance and then an obscure question and anybody can answer, I hope. So first for Bob, you mentioned that you didn't really change anything in the quarter. And that's cool but I guess the question that I have is one of the things that has been changing for you is the way you account for your trading deposits, and we've seen a bit more shift in the fair value through profit or loss. And of course, this quarter, we see trading rebounds to $411 million from $251 million last quarter. So the question is sort of twofold. First, did -- were there any marks from that, that suppressed or helped the trading revenue? But more importantly, from my perspective, is as we continue down this path of shifting, the accounting regimen, will there be any sort of headwinds or tailwinds to trading revenue for the next couple of quarters?
There was nothing meaningful quarter-to-quarter, Darko, in that particular part of the business. I think as you look at -- I think Q3 last year was where we had called out for the first time that there was a meaningful reduction in revenue that occurred as a function of marketing to trading deposits and the way that we were marketing them. We have probably migrated roughly 50% of the book to fair value through OCI. So I don't think we'll -- it will be a positive year-over-year but it won't be on a full amount.
Okay. So in other words, just modest headwinds -- or tailwinds I suppose to trading revenue?
I would say that. Yes.
Okay. And then my obscure question. So I appreciate the commentary that quarter-over-quarter, and it looks as though when I look at the presentation and the way you sort of designed it around credit quality, is that quarter-over-quarter, we saw a bit of an improvement and there's less stage 1 and stage 2, less nonperforming, I suppose. But when I open up the supplementary capital, it's a different story. In Q1, asset quality helped your RWA, and this quarter, asset quality went the other way and you actually had to increase risk-weighted assets because of asset quality movements. And the reason why I ask this is typically, what we're concerned about in some pieces is that as provisions rise and as things get worse, not only will your provisions for credit losses rise but so will your RWAs. Yet in 2 quarters, we have the opposite sort of phenomenon happening at TD. So I'm wondering if you can maybe connect the dots for me, if at all.
Are you, Darko, looking at the flow statements for risk-weighted assets?
Yes.
Yes. So I think, as Ajai indicated earlier that you can see a little bit of migration in the books and so that you end up having -- you can end up having an instance where both the PCLs and risk-weighted assets are experiencing the similar migration in that way because with the way Basel III and IFRS 9 works, you can get a little bit of doubling up of your procyclicality. But as we indicated earlier, that number you can see in the flow statements is not that significant and so a gradual normalization is how we like to describe it.
So when I look at it though, I mean for year-to-date, I mean you have a 3.5% increase in your risk-weighted assets. And most of that would be just from portfolio, from adding to the loan book. But a portion of it is also because of credit quality. And I'm not singling out TD, there's much bigger at one of your peers. But again, it's just quarter-to-quarter I suppose, I guess what I'm getting from you is -- the answer is, they can go opposite ways but over a period of time, I'm just trying to confirm that the general view would be that provisions for credit losses and RWA inflation, for lack of a better word, should be -- should go hand-in-hand?
They could. But there are sometimes differences in how the 2 are looked at. For example, the calculation of expected shortfall in capital is different from how it's done for IFRS 9 purposes. So there can be methodology differences. And if you look at that asset quality line over the last 5 quarters, you can see it was up in Q2 of 2018 but it was down in Q3, down again in Q4, down again in Q1. So I think your thesis that there is a general trend indicator here would not be evident in the numbers.
Let me just build on that. I mean, there's definitely some credit migration occurring and that credit migration is going to be reflected in the RWA numbers but if you really look at ACL and if you look at ACL year-over-year and go on and look at it by stage, okay, so total ACL is up $333 million and these are all in the disclosures, year-over-year, a big part of that is FX. But excluding that, the increase in stage 3 is actually very little. It's $50 million. And then most of the increase is actually stage 1, which I would describe as largely volume but there's some mix and seasoning there. But there is a number for stage 2 as well and some of that is commercial migration, which naturally show up in the RWA numbers and there is mix and seasoning also occurring across some of the portfolios.
The last question is from Scott Chan from Canaccord Genuity.
I wanted to -- lots of questions on the Canadian housing, but I wanted to switch to U.S. housing and perhaps get your take on kind of what's unfolding there. And when I kind of look at your book share, your residential mortgage is very solid and your HELOC book is trending downwards. And maybe some thoughts regarding those portfolios for the balance of the year.
Sure, Scott. So first, I would say, I'm glad you pointed it out. The mortgage book has been up for several quarters now, year-over-year, and we were up 8% this quarter. As you might know, if I just contrast this to just a few quarters ago or back before last year and the cycle of rate hikes really intensified, it would have been more of a balanced mix between refinanced and purchased, and we're seeing this certainly swing to a purchased market, with far less on the refi as rates have been moving up for the last 1.5 years. So the volume that we're seeing is decidedly being driven by jumbo mortgages and certainly not only into the consumer book but also into the private bank and in the wealth business in the U.S. You correctly pointed out that the home equity business is down and we're down 6% year-over-year, but I would also contrast that to many of our peers and they're seeing double digits for quite some time now. And that's just evident of when rates started going up, there's been a large refinance out of home equity into more permanent or fixed-rate mortgages. And even we're seeing a little bit of an uptick with that with rates beginning to stabilize over the last 3 or 4 months and actually come in, in the long end, folks have had another bite at that apple on the refi side for home equity balances. So relative to peers, while we're down in home equities and it's certainly less than half of its sizable book than we are in the mortgage side, it is -- we are still seeing outperformance relative to peers, even though we're down year-over-year.
And our next question is from Sohrab Movahedi from BMO Capital Markets.
Just 2 quickies. Teri, do you -- does your business do any lending to the private mortgage market?
My business does not.
And so Ajai, is there a policy around any lending to mortgage investment corporations or otherwise at the bank?
I'm pretty confident there are policies and we limit any of that kind of lending.
Can you quantify it?
No, I don't have that information available.
Okay. And then just to go back to Darko's question, if you have negative migration and you are reflecting that negative migration through higher provisions, whether it's stage 1, 2 or 3, will that then relieve some of the pressure that we would've otherwise expected to see from RWA appreciation?
Well, as I said, Sohrab, it might to some extent but the 2 systems don't really work hand-in-hand. The risk-weighting system is different from the IFRS 9 accounting system. So as I said earlier, you can get overlaps and that just increases the procyclicality of the regime, but given the quality of the credit book and our underwriting, we wouldn't anticipate that it would give us big swings.
So just to play that back to, Riaz, maybe take another kick at it, if capital ultimately is intended to defend against unexpected losses and you, therefore, have expected deterioration in the credit quality and reflected through higher RWAs then presumably -- or through higher provisions then presumably, you will need to also account for it through higher capital retention. Is that fair?
I think in principle, that is the correct framework, Sohrab. And if you go back and look at all the comments that were made to the various authorities around the accounting provisions and the introduction of the various Basel rules, those provisions were pointed out, and I think those papers give you a pretty good understanding of what that -- how those 2 interact.
There are no further questions registered at this time. I would now like to turn the meeting back over to Mr. Masrani.
Thank you, operator. And nothing obscure about our results, I might add. TD delivered a great quarter and I want to take this opportunity to thank our 85,000 TD bankers around the world for continuing to deliver for our shareholders. Thanks for joining us this afternoon, and see you in 90 days.
Thank you. The conference has now ended. Please disconnect your lines at this time, and we thank you for your participation.