Bank of Nova Scotia (BNS) 2016 Q4 法說會逐字稿

Good morning, everyone, and welcome to Scotiabank's 2016 fourth-quarter results presentation. My name is Jake Lawrence. I'm Scotiabank's Senior Vice President responsible for Investor Relations.

Presenting to you this morning is Brian Porter, Scotiabank's President and Chief Executive Officer, Sean McGuckin, our Chief Financial Officer, and Stephen Hart, the Bank's Chief Risk Officer. Following our comments, we'll be glad to take your questions. Also in the room with us to take questions are Scotiabank's business line group heads, James O'Sullivan from Canadian Banking, Nacho Deschamps from International Banking, and Dieter Jentsch from Global Banking and Markets.

Before we start the call and on behalf of those speaking today, I'd like to refer you to slide 2 of our presentation which contains Scotiabank's caution regarding forward-looking statements. Also, some of our comments related to 2016 results are adjusted for the restructuring charge of CAD278 million after tax that we announced earlier this year in Q2. With that, I'll now turn the call over to Brian Porter.

Thank you, Jake, and good morning, everyone. I'll start on slide 4. I am very pleased with the Bank's results in 2016. Scotiabank ended the year in a strong position and has good momentum that is driving continued success across our business lines. Our entire team worked hard to deliver these strong results for our shareholders and achieved them despite ongoing market volatility, global economic and political uncertainty, and historically low interest rates.

Compared to this time last year, the narrative around Canada's economic outlook is more positive. Despite some ongoing challenges in certain parts of the country, the Bank is forecasting improved growth in 2017. Beyond Canada, we remained focused on our key markets in the Pacific Alliance, namely Mexico, Peru, Chile and Colombia. These countries will benefit from relatively attractive growth rates and they have great potential. We expect the region will continue to generate strong results for our shareholders.

Heading into 2017, we are continuing to move quickly, but thoughtfully, to improve the Bank. For example, the Bank is focused on the thoughtful construction of our balance sheet to help improve risk-adjusted margins. We are growing targeted assets prudently and emphasizing deposit growth. I am pleased to report good progress is being made on both fronts.

Also, as you know, the Bank has embarked on a major transformation to become a digital leader. Through this effort, we are strengthening and deepening our customer relationships by removing friction points and we are driving efficiency improvements across the Bank. Our efforts on this front were recently recognized in digital and mobile banking, where Forrester Research awarded Scotiabank the highest overall score among our Canadian peers for mobile banking functionality. And earlier this month, Forrester ranked our online account opening process number one among our peer group.

A key driver of our success has been our ability to attract digital talent, and I am pleased to report that we have added many experienced digital leaders, including in our Pacific Alliance countries, to run our digital banking programs. I will now shift and comment on our financial performance for the year.

The Bank delivered a strong year of financial results, with adjusted net income of CAD7.6 billion, and is seeing good momentum across our businesses. Adjusted EPS of CAD6.00 per share, up 6% from 2015. The Bank's strong results were supported by earnings growth across all three of our business lines, each of which I'd like to touch on briefly.

Canadian Banking had a very strong year of operating performance and earnings growth across its retail, commercial and wealth businesses. The Management Team, led by James O'Sullivan, remains focused on optimizing the business mix, improving the customer experience, and enhancing productivity.

In International Banking, full-year earnings exceeded CAD2 billion for the first time and we see continued momentum. I am proud of the progress we've made to date and confident that under the leadership of Nacho Deschamps, we will see further momentum as we focus on our key Pacific Alliance countries. Overall our Canadian and International Banking businesses are generating 80% of Scotiabank's earnings, with solid high single-digit earnings growth. Global Banking and Markets also had a strong performance in the second half of the year and we look forward to Dieter Jentsch's first full year of leadership in 2017.

As you know, earlier this year, we announced a restructuring charge for a program that will generate annual run rate expense savings of CAD750 million for 2019. The structural cause transformation effort will improve our productivity ratio by 200 basis points to 250 basis points for 2019. We are on track and we will start to see more meaningful contributions from these efforts in 2017. Our expense management efforts have resulted in positive operating leverage of 1% this year.

In terms of risk management, we have maintained good credit quality throughout the year. As it relates to our energy exposures, which we have actively managed during a period of challenging commodity prices, our portfolio remains high quality. As we indicated previously, loan losses have continued to improve from peak levels in Q2. In regards to our previously disclosed cumulative energy loan loss ratio target range of 3% to 3.5% until the end of 2017, we now believe losses will be below the low end of the range.

For 2016, our adjusted return on equity was strong at 14.3%, ahead of our medium term objective. Looking at our capital position, the Bank remains well capitalized with a strong common equity Tier 1 ratio of 11%. Our strong capital position provides us the opportunity to invest in and grow our businesses organically or strategically through acquisitions. In 2016 we raised our quarterly dividend twice, reflecting a 6% increase compared to 2015.

To recap, we are proud of this year's accomplishments and the strong performances across all our business lines. More importantly, I am confident that we have the right strategy going forward and we have built strong momentum to sustainably grow our businesses and earnings for our shareholders. Later on, I will provide some additional comments on the outlook for 2017, but for now I'll pass the call over to Sean to review this quarter's performance.

Thanks, Brian. I will begin on slide 6, which shows our key financial performance metrics for the current quarter and comparative periods.

Q4 diluted earnings per share were CAD1.57, up 8% year over year. All three of our business lines delivered a strong quarter to end the year. Provision for credit losses remains well managed and the Bank's focus on improving efficiencies helped drive positive operating leverage for the year.

Revenue growth was strong, up 10% from Q4 last year, with solid asset growth across all of our business lines, including personal and commercial lending in International Banking, growth in targeted assets in Canadian Banking, as well as good corporate lending growth in Global Banking and Markets. Revenues were also positively impacted by higher banking fees, wealth management and trading revenues.

Gains on sale of real estate were more than offset by lower net gains on investment securities. Our core banking margin was 2.4%, up 5 basis points year over year. Higher margins across all of our business lines were partially offset by higher liquidity and funding costs in the Other segment.

Adjusting for the impact of acquisitions, foreign currency translation, a large pension credit and reorganization cost in Q4 of 2015, non-interest expenses were up 5% year over year. Higher performance and stock-based compensation, as well as technology investments in the business accounted for the growth. Partly offsetting were savings realized by our previously announced structural cost transformation initiatives, which amounted to approximately CAD30 million in the current quarter and CAD55 million for the year.

The Q4 productivity ratio was 54.1%, up 50 basis points year over year, while the Bank's full-year productivity ratio improved and declined 50 basis points to 53.7%. For the full year, we delivered positive operating leverage of 1% on an adjusted basis.

Moving to capital on slide 7. As mentioned, the Bank continues to maintain a strong capital position with a common equity Tier 1 ratio of 11%, up from 10.5% in the prior quarter and compared to 10.3% in Q4 of last year. The improvement in the CET1 ratio was driven primarily by strong net internal capital generation offset by only a modest increase in risk-weighted assets, which combined netted approximately 30 basis points to the growth, with the balance a combination of benefits mostly from some pension recovery and shares issued under stock option exercises. Risk-weighted assets adjusting for foreign currency translation were up only 0.5%, as increases in credit risk and operational risk RWA was partially offset by lower market risk RWA.

Turning now to the business line results, beginning on slide 8. Canadian Banking produced a strong quarter, with net income of CAD954 million up 14% year over year. Adjusting for some real estate gains, earnings were still up double digits year over year. Loan and acceptances increased 3% from last year. Residential mortgage growth was up 1%, or up 3% excluding the Tangerine mortgage run-off book. Our personal lending portfolio, which reflects targeted growth in select assets, grew 7%.

Our effort to deepen customer relationships includes growing core deposits. This quarter continued the trend of deposit growth, with retail savings and checking deposit balances up a strong 11% and 8%, respectively.

Our thoughtful and risk sensitive balance sheet construction reflects the execution of our strategy to continue improving Canadian Banking's business mix. As a result of business mix and acquisition impacts, the net interest margin rose 13 basis points from Q4 last year. Wealth Management delivered a strong quarter, with earnings growth of 16% year over year, driven in part by market appreciation and efficiency improvements. AUM was up 7%, while AUA was up 3%.

Total revenues were up 8% from last year, with net interest income up 9% and non-interest revenues up 8%. Non-interest revenue growth was primarily in card revenues, mutual fund fees, and gains on sale of real estate. Provision for credit losses were up CAD37 million year over year, or 21%, due mainly to higher provisions in the retail portfolio, driven by growth in higher margin products. The PCL ratio was up 4 basis points. Notwithstanding, the risk adjusted margin was up 9 basis points from last year.

Expenses increased 4% year over year, or 2% adjusting for acquisition impacts. The increase was driven by higher technology, project spending and strategic investments, partially offset by benefits realized from cost reduction initiatives. Canadian Banking delivered very strong positive operating leverage of 3.2% in 2016, or 2.2%, the gain from the sale of a business in Q2 is excluded.

Before turning to International Banking, I wanted to discuss our residential mortgage business, which has garnered some increased market focus given recent industry rule changes. First and foremost, we are very comfortable with our residential mortgage book, which we believe is high quality, low risk and well diversified. The Bank follows underwriting and origination metrics as required by regulatory standards and has more conservative policies or additional measures for select mortgages. We have a total residential mortgage lending book of approximately CAD193 billion, of which nearly 60% is insured. The uninsured portfolio has an average loan to value of 50%.

This year, we have seen a number of new regulatory measures announced that will impact the residential mortgage market. The most recent changes related to the borrower's qualifying rate, reduced access to portfolio insurance, limiting of foreign homeowner's ability to claim a principal residence to avoid capital gains tax on the sale of the residence, and proposed risk sharing. By and large, these changes will moderate residential mortgage loan growth; but over time, we are optimistic we will maintain and grow profitable market share.

With respect to the qualifying rate, all insured mortgages are now evaluated at the posted five-year rate and we expect some moderation in the available credit that will be extended to borrowers. The changes to portfolio insurance now limit coverage of properties valued at a maximum of CAD1 million and will impact various industry participants who rely on securitization for funding purposes. Given Scotiabank's diverse funding programs, mortgage securitization activities account for less than 10% of the Bank's wholesale funding.

On mortgage risk sharing, there is a white paper being circulated with a comment period until February, 2017. Overall, it is still too early to provide exact impacts to the market, as there are both potential positives and negatives, including potentially improved margins and volumes in certain mortgage types.

Turning to competition in the residential mortgage market, it remains intense. But from our standpoint, the environment has improved from earlier this year. Mortgage pricing decisions are made on a lender-by-lender basis and dependent on factors including market conditions, strategy, and funding.

Overall, we remain comfortable with our mortgage lending exposure and expect growth to be in the low single digits. We agree in some cases the level of housing price appreciation and growth is not sustainable and generally welcome regulatory changes that help moderate the market.

Turning to the next slide on International Banking. For the first time, the business line reported annual earnings greater than CAD2 billion. Earnings of CAD547 million this quarter were up 9% year over year. This earnings growth would have been 14% if the negative impact of foreign currency translation was excluded. These results reflect continued strong operating performance including loan, deposit, and fee income growth in Latin America, particularly in our key Pacific Alliance countries.

International Banking grew loans by 5%, or 8% adjusting for the impact of foreign currency compared to a year ago. On a constant currency basis, Latin America grew 9% compared to a year ago, led by strong retail growth of 13%. Compared to last quarter, Latin America was up only 1% on a constant currency basis. Strong retail volume growth of 4.5% was partly offset by some large pay downs in other Latin American countries outside of the Pacific Alliance. The pipeline for next quarter looks healthy; and given the year ended with spot volume growth higher than the average volumes for the quarter, we are well positioned for further volume growth in 2017.

The good asset growth in International Banking was supported by excellent deposit growth, up 14% versus the same quarter last year on a reported basis and up 17% when adjusting for the impact of foreign currency translation. The net interest margin increased to 4.77%, up 7 basis points year over year. Relative to last quarter, loan losses decreased CAD22 million to CAD294 million and credit trends remain well controlled, with the loan loss ratio improving 2 basis points compared to Q4 last year.

Expense growth was 3%, primarily due to inflationary increases and recent acquisition integration costs, which were partly offset by the positive impact of foreign currency translation and the benefits of expense management programs. For 2016, operating leverage was strong, at positive 2.9%.

Moving to slide 10, Global Banking and Markets. Net income of CAD461 million was up a very strong 42% compared to last year. This earnings growth was driven by higher contributions, mainly from fixed income and corporate banking. Trading revenues on a TEB basis increased more than 20% year over year, driven by higher revenues across all product categories, but fixed income, in particular. Loan growth was strong, with total corporate loan volumes up 8% versus Q4 of last year.

Revenues also benefited from an increase in the margin, primarily from higher levels of loan origination fees and higher lending volumes and deposits in Canada, the US and Europe. Provision for credit losses of CAD39 million were up CAD12 million versus Q4 of 2015 and the PCL loss ratio increased 5 basis points. Quarter over quarter, loan losses were essentially flat. Operating leverage was flat for 2016 versus the prior year, due to higher expenses driven by higher performance-related stock-based compensation, technology, compliance and regulatory costs.

I'll now turn to the Other segment on slide 11, which incorporates the results of Group Treasury, smaller operating units and certain corporate adjustments. The results include the net impact of asset and liability management activities.

The Other segment reported net loss of CAD23 million this quarter. Earnings in the segment were down from CAD117 million in Q4 last year and reflect lower contributions from asset liability management activities, higher expenses and higher taxes. After-tax gains on sale of real estate of approximately CAD30 million were more than offset by approximately CAD60 million after-tax lower net gains in investment securities. This completes my review of our financial results. I'll now turn it over to Stephen, who will discuss risk management.

Thanks, Sean. We remain comfortable with the underlying fundamentals of the Bank's risk portfolios, including our residential mortgage exposure, as Sean has discussed earlier. The Bank's credit performance is within expectations and on a reported basis, I'm pleased to note that our loan loss rate improved by 2 basis points quarter over quarter and year over year.

Looking at our corporate and commercial loan books, this quarter we had a small amount of energy-related provisions, but the overall portfolio continues to perform well. Our energy portfolio remains well managed with a cumulative loan loss rate since 2015 of 2.1%, well below our guidance of 3% to 3.5% until the end of 2017. And as Brian has noted earlier, assuming commodity prices stabilize at current levels, we now believe cumulative losses will be below 3%. As we are comfortable that we have moved past the key issues in this sector, our energy slide has also been moved into the appendix of the Investor Presentation deck.

Overall, our retail credit performance in both Canada and International is performing as expected. In Canada, we continue to see some regional weakness in Alberta, but that is being offset by strength in our other markets, such as Ontario and BC. Retail exposures are driving a higher loan loss ratio, while commercial improves. In International, overall credit quality remains good and is improving in both retail and commercial portfolios.

Now looking at our credit metrics, our gross impaired loans were up 1% quarter over quarter. The increase was driven overall by foreign exchange and is actually down slightly on a Bps basis. Our net impaired loans as a percentage of our portfolio also improved 2 basis points quarter over quarter. Net formations amounted to CAD645 million, down from the CAD788 million in the prior quarter. The improvement was driven primarily by lower formations in Global Banking and Markets, as well as international retail. Looking at our market risk, which remains low, our average one-day all-bank VAR was CAD10.4 million, down CAD0.6 million from the prior quarter.

Turning to slide 14 shows the trend in loss rates over the past five quarters for each of our businesses. For context, nearly 80% of our total PCLs relate to our retail business. Our loan loss ratio this quarter is 45 basis points, down 2 basis points from last quarter and year over year on a reported basis. Canadian Banking's PCL ratio of 28 basis points was generally stable, down 1 basis point compared to last quarter. On a year-over-year basis, higher retail loan losses drove the loss ratio up 4 basis points. The increase continues to reflect, in part, the Bank's evolution in asset mix to higher risk adjusted margin products.

International Banking had a strong quarter, with the loan loss ratio down 11 basis points quarter over quarter and down 2 basis points compared to a year ago. Global Banking and Markets was unchanged from last quarter, but up 5 basis points year over year.

Overall, we believe our credit portfolios remain in good condition, and as we have been proactive in managing our energy exposures and taking provisions when required, we expect PCLs to come in lower next year, due to reduced energy-related provisions. And with that, I'll now turn the call back to Brian.

Thank you, Stephen. Before we open the call for questions, I'd like to provide some thoughts on our outlook for the year. As mentioned earlier, we are very pleased with our operating performance in 2016 and what we have accomplished for Scotiabank shareholders. We are in a strong position as we exit the year and we've built strong momentum across all our major businesses.

Looking ahead, we expect growth prospects for 2017 to be similar to the past year. We expect global growth to be moderate, with strength in North America partially offset by lower growth in other markets, including Europe. We expect the Canadian economy to improve over the course of 2017, with growth approaching 2%. And in the US, we are forecasting growth greater than 2%. In the Pacific Alliance region, we expect growth to be in the 2.5% to 3% range, led by Peru at 4% and Colombia at 2.8%.

The US election results have driven some degree of market speculation and volatility. In terms of any impact on Mexico, it would appear the market is discounting a bigger impact to Mexico than we believe is realistic. To that point, we remain confident in our medium-term growth objectives for Mexico and we will continue to actively and prudently manage our businesses.

We remain committed to the Bank's overall medium-term objectives, including those for both International Banking and the Pacific Alliance that we provided at our Investor Day in Mexico City. With this context as a backdrop, I'll now turn to the outlook for our businesses for 2017.

Canadian Banking is focused on delivering a superior customer experience and profitably growing primary banking relationships. More specifically, James and his team are continuing to focus on business mix through the thoughtful construction of Canadian Banking's balance sheet to produce improved shareholder returns, as well as executing on our structural cost initiatives to both improve Canadian Banking's productivity ratio and create capacity to invest in our businesses and digital initiatives.

With an improving growth outlook for Canada, we expect continued loan growth in select assets. Combined with higher core deposits, this should help drive some margin expansion over the course of the year. PCLs should rise in line with asset growth and also reflect our evolving business mix. As mentioned, management is sharply focused on improving our productivity; as such, we expect to deliver positive operating leverage. Overall in 2017, we expect another strong financial performance from Canadian Banking, building on the 9%-plus growth experienced in both 2015 and 2016.

In International Banking, there is good momentum in our operating and financial performances. As mentioned, the business achieved annual earnings of CAD2 billion for the first time. For 2017, International Banking will make further progress against its strategic agenda. The major areas of emphasis include customer focus, digital transformation, business mix and structural costs.

The key priorities for Nacho and his team in 2017 include building digital banking operations within our Pacific Alliance countries, which will upgrade and expand our online and mobile banking platform to offer enhanced customer experience and functionality, as well as reducing expenses to fund strategic investments in growth and technology and improve overall productivity.

While the year has started with some increased rate and foreign exchange volatility, it is important to remember the countries of the Pacific Alliance have strong balance sheets, the governments are focused on structure reforms, and have promising demographics, with a young and growing middle class that supports the growth of their internal economies.

With a good growth outlook for the Pacific Alliance, we continue to expect strong loan growth in International Banking, with generally stable margins and credit performance. Consistent with Canadian Banking, expense management is a key priority, and in 2017, we again expect to deliver positive operating leverage. As mentioned, we expect International Banking over the medium term to grow constant currency earnings 8% to 10%, led by growth in the Pacific Alliance of 9% to 11%.

Turning to Global Banking and Markets, the business line saw an improvement in the second half of 2016. GBM will continue to execute on a more focused strategy under Dieter Jentsch's leadership. In 2017, GBM is focused on strengthening customer relationships, with stronger emphasis on our core markets here in Canada, the US and the Pacific Alliance, realizing on cost savings and allocation of capital and resources to optimize profitability.

We expect Global Banking and Markets will benefit from the improved business performance, credit quality and improved trading, reflecting better market conditions next year. We expect higher revenues from our focused clients across Canadian Banking and Investment Banking. Expense management efforts will improve productivity and loan losses should migrate back towards longer term averages. From a geographic standpoint, we believe earnings growth will be driven by the US and Canada, while Europe manages through a period of uncertainty.

In summary, the Bank remains comfortable with our medium-term guidance, EPS growth of 5% to 10% and return on equity of 14% plus, driven by our strong retail and commercial banking businesses. As well, the structural cost efforts that we outlined in Q2 of this year will see the Bank realize approximately CAD350 million in annual run rate savings in 2017, driven largely by the Canadian bank. These efforts will continue to build over the next couple of years and we expect the Bank's productivity ratio to improve by 200 to 250 basis points for 2019.

We are pleased that we've built our common equity Tier 1 capital ratio to a strong level of 11%. This provides us with good optionality for capital deployment, including investments in organic growth, acquisitions, as well as ongoing dividend increases. As we execute on our strategy, we are delivering improved financial results and our business momentum is growing, all of which positions us well moving forward.

On a final note, we are also pleased with the progress we've made on our journey to become a digital leader. We have hired some great new people with strong leadership in place and are doing many exciting things across the Bank. Our flagship digital factory is now up and running here in Toronto, where we look forward to hosting our Digital Banking Investor Day on February 2, 2017. With that, I'll turn the call back to Sean for Q&A.

Thanks, Brian. That concludes our prepared remarks. We'll now be pleased to take your questions. Please limit yourself to one question and then rejoin the queue to allow everyone the opportunity to participate in the call. Operator, can we have the first question on the phone, please?

We'll go to Sohrab Movahedi at BMO Capital Markets.

Okay. Thanks. Brian, just a quick one on capital ratios. Obviously, very robust 11%. I know there's a little bit of movement because of stuff outside of your control. But can I get some thoughts as to what is the right level you think you would like to run at, and is 11% above that? And then maybe also, what are some of the key risks management is focused on over the next 12 or so months? You've been pretty good in calling out the risks, I think, and so I'd like to hear your thoughts on that for the industry and for the Bank, as well.

Okay. Thank you for the question. I'd say on capital that as you've heard me say before, we like optionality. And 11% Common Equity Tier 1 gives us optionality to both grow our businesses organically or look selectively at acquisitions that are on strategy, and that's a position we like to be in.

In terms of what's an optimal capital position for any bank in today's climate, that's really an individual question per bank. We've got flexibility, as you've heard me say. If we saw the right acquisition, we'd be comfortable doing that if it was on strategy and we'd take our capital levels down and we'd grow it back, but I wouldn't want to go much below the 10% level.

In terms of risks out there, I think the risk that I think about every day would be macro. I'm concerned about developments in Europe. You've got 14 different elections there, the rise of populism. You're going to have governments change in Europe, so that's a risk. The state of the Italian banks is worrisome for the global banking community. So I think about that. And then in terms of one has to be and think about cyber security in this day and age. We're very comfortable where we are. We've got lots of great people and systems in place to protect the perimeter of the Bank, so we're comfortable from that perspective. But I think the biggest risk is on a macro basis for the year ahead, Sohrab.

Okay. Thank you.

We'll go to Gabriel Dechaine with Canaccord.

Hi. Good morning. I have a housekeeping one, then a real one, I guess. Could you, Sean, go through a bit more of an explanation on the higher liquidity and funding cost that drove down your NII in the Other segment?

And then somewhat related to that topic, the rate moves we've seen in the past few weeks have been pretty phenomenal. I'd like to hear both from Sean, and Sean, first of all, what does that do for your margin outlook in 2017? The five-year in particular is up 30 basis points or so since the end of September.

And then Stephen, that's the second part of it, how much is too much? When do we start worrying about the level of rate increase, the sharpness of it, and a potential negative impact on credit quality in Canada?

All right. So Sean, I'm not sure which one of those is a housekeeping one, but I'll take the first one. Yes, the higher funding and liquidity costs you saw in the Other segment is that as we continue to position ourselves for some liquidity coverage metrics, the net stable funding ratio, we've been terming out a bit more of our wholesale funding. So we've been bearing a bit more of that cost before these ratios come into place, so we're being well positioned for that. We expect the growth of that negative carry to moderate next year and come off a bit, so that's really what is increasing the funding cost in the Other segments.

In terms of the margin outlook, definitely a rising rate environment and a steeper curve definitely adds value to the Bank's earnings, both from our savings and checking accounts, as well as the value of capital. But you have to bear in mind, it takes time to work through the system. It just doesn't happen in one quarter. Because as those deposits are really and capital is financing some longer term assets, as they renew and reprice up, that's when you get the margin impact. So definitely we will have advantage from the rates rising, but it's just not going to come right away in the next one or two quarters.

Can you quantify any of it? What should I look at, five-year rate and that should help your margins by a couple basis points?

We haven't quantified that, but yes, we think a few basis points, at this point, but we haven't modeled through all the permutations, combinations, but definitely it's going to be an impact, a positive impact. Again, it's going to take time to work through the system. And in terms of the pace of the increase, Stephen?

Yes, as it relates to the credit portfolio, quite frankly, that is what, on the retail side, what the new measures are looking at for improving the stress test by adding a couple of Bps, and we do test our existing clientele for most at higher rates so they can perform. Quite frankly, at the end of the day, the yield curve today has basically returned to where it was a year ago. It's just that we've lived so long at the last nine months, but it really hasn't moved year over year.

Having said that, it's unemployment that I look at from a risk viewpoint, as opposed to interest rates. Most of our clients are locked in for a longer term, so a rising interest rate really doesn't affect them immediately, whereas obviously, unemployment does.

So if job growth is stable, we need to see rates move a lot more than we have already before we --

Oh, yes, exactly.

Okay. Thank you.

We'll go to Steve Theriault with Dundee Capital Markets.

Thanks very much. So a question for Brian on the long-term outlook for ROE as a bank. You cut the target last year and came in above on the ROE front this year, but just above the 14% target. So Brian, wanted to ask in the face of still some coming regulatory pressures, the potential to maybe do some modest to medium size deals, how confident are you that the ROE will head higher versus lower over the next one, two, three years, or is 14% in the range where you think the ROE will settle out at the end of the day?

Well, if you look at this quarter's results, we produced a 14.6% ROE with a Common Equity Tier 1 ratio of 11%, so we're very comfortable with our medium-term guidance. And as we've outlaid here and we've talked about our structural cost initiative, it's going to definitely help that, in terms of the impact on the productivity ratio of 200 to 250 basis points over the next few years.

So we like where we sit, Steve, in terms of the optionality we have to grow our business from a revenue perspective, as we've demonstrated in the Canadian bank, the optionality we have in our international bank, and what we're doing to manage our cost structure.

And so when you think of some of the minimum risk weights and some of the mortgage changes, do you feel like we're towards the final innings here where the rules of engagement are relatively known? Obviously, the higher capital requirements and a number of other items have pushed that ROE lower over time. Do you feel like we generally know the rules of the game, with the caveat that there's still some uncertainty into next year on some of the known unknowns?

Yes, I think we're close. I think that question's been asked of bank CEOs for the last five years and they were probably wrong in terms of their guidance. But no, look, I think that we're pretty close to the end here. And again, we're very comfortable with our capital levels and our strategy and our ability to execute.

Okay. If I could ask a quick clarification for Stephen. When you were talking about some of the credit ebbs and flows, you mentioned BC and Ontario, mind you, as an offset to the Alberta weakness. When I look, I see BC unemployment rising from about 5.5% to over 6% through the quarter. Maybe if could you walk me through why BC is looking stronger. Anecdotally, I would have thought BC might be joining Alberta in contributing to the weakness.

We're certainly not seeing that in our early debt delinquencies as yet, Steve. So at the moment, it's still reasonable growth. And quite frankly, BC is not our largest market, but it is a strong market. We're not as big in the unsecured area, and quite frankly, our mortgage book, as Brian said before, is pristine with regard to loan to value and insured, so we're in a pretty good spot in BC vis-a-vis some of the other competitors.

But BC was looking incrementally better in the quarter?

From our viewpoint, from a delinquency viewpoint, yes.

Thanks very much.

We'll go to Rob Sedran with CIBC.

Hi. Good morning. Sean, just following up on that capital question, you called out pension as one of the issues that gave you a bit of a benefit this quarter, but most of the rate move happened subsequent to the quarter. So if rates happen to hang around these kind of levels, should we expect another outsize move in Q1, all else equal?

And then on the related note, just for Brian, when you think about the optionality you have, given that you said maybe you're more optimistic on Mexico and Lat Am than the market appears to be today, is this a time where the bias should be to more aggressive deployment into that opportunity or do you think it's still thinking about a buyback potential?

I'll take the capital question. So the pension benefit was 5 or 6 basis points this quarter. You may recall, we're still down about 25 basis points over the last 18 months of the low-rate environment. So if the 20 to 30 basis point movement in the longer term rates hold into Q1, we will definitely see a pick up, and that could be 10 basis points plus next quarter.

Rob, just on the question on capital, buybacks are always in the tool kit, and that's an option we think about from time to time, although we generally only use them to offset option exercise.

In terms of capital deployment in the Pacific Alliance, there's lots of options again there for us to do that. And I would reiterate, our performance in country, if you look at our performance in Mexico, Peru, Chile or Colombia, Mexico I'd highlight here that if you look at any metric you want, revenue growth, EPS growth, operating leverage against our peer group, we're number one or number two across-the-board. And that's a function of better management. That's a function of our cost initiatives there, the amount of money we're investing in a new technology system. So these investments we're making in the individual countries are paying off and we're going to continue to do those.

Thank you.

We'll go to Meny Grauman with Cormark Securities.

Hi. Good morning. Hoping you could just refresh us on how you manage FX risk, particularly in Latin America. And then I'm wondering whether you made any changes to the way you manage that FX risk, either before or in the wake of the US Presidential election?

All right, I'll handle that. With our international footprint, as you'd expect, we have many currency hedging discussions at our asset liability committee sessions. I think it's also important to note that with the basket of currencies like we do have, sometimes you've got some appreciating and some depreciating, so there's somewhat of an overall play that offsets each other. And it's also important to remember that these currency exposures is also the local currency against Canada. So if the US is streaming higher or lower, that doesn't necessarily translate into lower currency values against the Canadian dollar.

But with respect to foreign earnings, I think as we've signaled before, we generally hedge about 25% to 35% of the rolling next four quarters' earnings of our international units. Currently on the nearer term quarters for Mexico, we're at the higher end of that range. But it is something that we talk a lot about around the risk table about what is the right positioning. We take the forward premium into consideration, as well, when we think about the hedging options. But we are very active and dynamic on it. In terms of has things changed over the last three or four months, I wouldn't say necessarily so. We still have the same conversations, it's just what level of hedges we want to put on, more or less.

Okay. Thanks for that.

We'll go next to Mario Mendonca with TD Securities.

Good morning. First, just a quick question on securities gains. We saw that they were down, it was offset by the real estate. Is there any reason why securities gains could be depressed going forward, lower than we've seen in the past?

We've had some high up elevated levels the last couple years. It's expected to moderate somewhat into next year.

And the reason I'm getting there is the real estate gains seemed a little bit unusual, but I understand that they were more than offset by the decline in securities gains. So where I'm going with this is if the securities gains are depressed going forward, can we reasonably expect the real estate gains to offset that?

Real estate gains are a little bit lumpy. They come and go. But it's all part of our strategy to look at the value of our assets. And we've seen cap rates at almost historical lows these days, so there is some opportunity to grab some good value there. Also, as part of our branch network realignments, there are opportunities to dispose of certain branches. So it's a combination of things. I can't say that real estate gains will be a regular quarterly event, but again, it's just [management]. In the overall scheme of things, Mario, it really isn't that material to the Bank's bottom line.

Going forward than we've seen in the past?

Yes.

Okay. And then Brian, you made the point that you felt like the Bank's earnings growth going forward, 2017 -- or rather, 2016 and 2017 -- or sorry, 2017 and 2018 would be similar to what we saw this year, 2016, which I think is a little bit over 6%. Given everything the Bank has said about restructuring initiatives and cost savings and the increase in rates, I was a little surprised you wouldn't talk about a slight acceleration in earnings growth. Is there something else that's on the horizon that I'm not thinking about?

No, we're certainly very confident about the year ahead and out into 2018, Mario, and we continue to deliver on what we've promised the Street. If you look on a macro basis, the International division, we're very proud of this. As I said in my comments, we've delivered CAD2 billion of earnings for the first time, five straight quarters of net income over CAD500 million. The Canadian business is running very well.

We've got lots of levers and optionality in that business. James and his team have grown our margin nicely there and keeping risk in check. So our mortgage book, in terms of quality, is very strong. We'll see better, more consistent earnings out of GBM. So we're very comfortable with our outlook for 2017.

Capital. The 11% capital ratio, two ways to look at that. One, that's great. The second way to look at it is, is the Bank building the capital ratio in anticipation of something that will consume capital in 2017? And I'm not talking about acquisitions or buybacks, but any changes that you expect to actually consume capital going forward, more aggressively than in the past?

No. Our view on capital is the same as it's been on prior calls. We like the optionality. We're not planning for any external event that we haven't talked about here or that's in the public domain. It's that acquisitions opportunities will come by for us once in while awhile. And if it's on strategy, whether it's like the JPMorgan credit card portfolio here in Canada, we'll execute, or like the Citibank assets in Peru or Costa Rica.

So there are opportunities, if you look at periodically, and we like the flexibility. And I think that I don't want the marketplace consumed with our capital levels. As I said in this quarter, for instance, we delivered 14.6% ROE on 11% Common Equity Tier 1. So we'll continue to deliver for our shareholders and manage capital appropriately.

All right. Thanks, Mario. Next question. And for the sake of time, can you just answer one question? We still have a few people that want to ask a question. Next question, please.

We'll move on to Darko Mihelic with RBC Capital Markets.

Hi. Thank you. Just a quick clarification. I think Stephen, during your commentary, you mentioned that the expectation would be for the PCLs to go down for next year. Do you mean, if I look at a CAD2.4 billion for the year, 50 basis points, you're just suggesting that it's below 50 basis points next year and the primary reason for that is the lack of oil and gas. Is that a good characterization of what you said?

That would be close, yes. We expect our Canadian retail to move up slightly as the asset mix continues to mature, and the commercial corporate will come down overall as it normalizes after the energy.

Okay. That's the extent of my question. Thank you.

Thank you, Darko. Next question, please.

We'll move on to John Aiken with Barclays.

Good morning. Outside of capital, I think technology was the word that was used most in both the prepared commentary and the questions. What should we look for in terms of the technology spend going forward? If we're looking backwards, we did see a step up in this quarter, and I know that this is probably going to be a little bit lumpy, but we did see a step up in the fourth quarter of last year that actually set a new run rate.

So can you give us some expectations as to what we should be looking for going forward, and how much of this increase in technology spend is being baked in in terms of the cost savings guidance as you've given us for 2017?

Sure, John. It's Sean. Yes, definitely technology investment and spend is our highest growing expense category, as you would expect, as we make important investments to improve the customer experience, build out our digital capabilities. But what's important, though, is that we're really trying to repurpose our cost base away from the old traditional cost being more efficient, being better organized, to really help pay for that higher technology spend.

And so in terms of rate of growth, the rate of growth next year should be similar to what we saw this year. But again, with the various efficiency initiatives we've got in play, that more than compensates for that growth.

Great. Thanks, Sean.

We'll go to Ebrahim Poonawala with Bank of America.

Good morning. I just had one remaining question in terms of outlook on energy PCLs. I just wanted to get your sense, Stephen, if we do actually see a sell-off in oil, say back below $40 post-OPEC, what is the sensitivity to PCLs going forward to a drop in oil price?

Thanks. We're still working off of our original assumptions of nine months ago. So we were using $30 to $35 oil in our stress test, so that would continue.

I'm not looking for oil to hit $60. I'm not even looking for it to maintain at around $45 to $50. So we feel most of the companies, the oil and gas companies, have gone through the restructurings. We only had one new formation this quarter. And we're continuing to see them find alternative capital sources. So if there's any small drop in oil prices, it has no effect on my forecast.

That's helpful. Thank you very much.

We'll go to Peter Routledge with National Bank Financial.

Hi, Steve. I noticed your PCL ratio in Canada dropped, which is great, but your bad loan formation ratio went up in Canada for retail. So can you talk about what was driving those two, that divergence?

Yes, we did see an increase in formations, mainly in our newer products on the unsecured side, credit cards and, to a lesser extent, autos. So at the same time we've been building up our reserves appropriately. It's going to take awhile for the credit card portfolio to mature. This is one that we moved to expand over the last two or three years. It usually takes three to five years for the portfolios to stabilize. We're starting to see that. We expect it to happen later in 2017. So we had a build up in our reserves appropriately.

And is that pressure coming from Alberta, credit cards and auto?

It's broad. But yes, it obviously, there's a regional weakness that we're seeing in Alberta and some of the related oil provinces. But we've actually seen a stabilization, I would say, in Alberta over the last quarter.

And just on that Peter, we've seen a higher loan loss Bp. But don't forget, our risk adjusted margin, which we focus on, is up 9 or 10 basis points year over year.

You're getting paid for the risk you're taking.

We're getting paid for the risk we're taking, yes. Apparently we have time for one more question, please.

And we'll go to Doug Young with Desjardins Capital Markets.

Hopefully this will be quick. I just noticed in Global Banking and Markets, your net interest income was up 26%, but loans was up 8%. And I know you talked a bit about fees and whatnot. Just hoping to get a little additional color on that. Thank you.

It's Dieter. We had good loan growth in North America, which is covered with good fee income, and also deferred fee income from past quarters and past years came into this quarter. So it was a combination of our fees and our interest and our loan growth which was quite substantial in North America.

All right. That concludes our call. Thank you all for participating. We look forward to talking to you in the New Year.

Thank you.