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Edited Transcript of HCG.TO earnings conference call or presentation 9-Feb-17 1:00pm GMT

Thomson Reuters StreetEvents

Q4 2016 Home Capital Group Inc Earnings Call

TORONTO Feb 9, 2017 (Thomson StreetEvents) -- Edited Transcript of Home Capital Group Inc earnings conference call or presentation Thursday, February 9, 2017 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Laura Lepore

Home Capital Group Inc. - AVP, IR

* Martin Reid

Home Capital Group Inc. - President & CEO

* Robert Morton

Home Capital Group Inc. - EVP & CFO

* Pino Decina

Home Capital Group Inc. - EVP, Residential Mortgage Lending

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Conference Call Participants

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* Geoff Kwan

RBC Capital Markets - Analyst

* Jaeme Gloyn

National Bank Financial - Analyst

* Dylan Steuart

Industrial Alliance - Analyst

* Graham Ryding

TD Securities - Analyst

* Mark Kearns

GMP Securities - Analyst

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Presentation

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Operator [1]

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Good morning. My name is Melissa and I will be your conference operator today. At this time, I would like to welcome everyone to the Home Capital Group Q4 and year-end 2016 earning results conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions). Thank you. Ms. Laura Lepore, AVP, Investor Relations; you may begin your conference.

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Laura Lepore, Home Capital Group Inc. - AVP, IR [2]

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Thank you, operator, and good morning, everyone. Thank you for joining us to hear about our financial results for the fourth quarter and year ended 2016. With me on the call today are Martin Reid, President and Chief Executive Officer; Robert Morton, Chief Financial Officer; Chris Whyte, Chief Operating Officer; and Pino Decina, our Executive Vice President of Residential Mortgages. Before we begin, I would like to caution listeners that this conference call provides management with the opportunity to discuss the financial performance and condition of Home Capital and as such, comments may contain forward-looking information about strategies and expected financial results. Various factors, many difficult to project and control, could cause actual results to differ materially from results projected in forward-looking statements. Accordingly, the audience is cautioned against undue reliance on these remarks.

With that, I'll now turn the call over to Martin Reid, President and Chief Executive Officer.

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Martin Reid, Home Capital Group Inc. - President & CEO [3]

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Thank you, Laura. And good morning, everyone, and thank you for joining us to discuss our fourth quarter and year-end results. This morning I will review with you our 2016 annual and fourth quarter results and spend some time talking about Home Capital's priorities looking ahead. You will also hear from Rob Morton, our CFO, who will provide details on the financials and our new long-term goals and then we will end with questions-and-answers. Let's begin with the highlights of 2016. 2016 has been a transitionary year for the Company as we continued to strengthen our core residential mortgage business. This occurred alongside strong results in our commercial mortgage, consumer lending businesses, and Oaken Financial. We grew total loans under administration to CAD26.4 billion at the end of 2016, a 5.5% increase over the end of 2015.

Our strong balance sheet allowed us to return more than CAD264 million to shareholders during 2016 and still maintain strong capital levels. We increased the dividend for the ninth time over the last five years, twice during 2016. Our adjusted return on shareholder equity was 16.3% and book value increased 8.4% to CAD25.12 at the end of 2016. Unadjusted net income per share was CAD3.71 per share compared to CAD4.09 in 2015. Adjusted earnings per share on a diluted basis were CAD3.95 per share compared with CAD4.11 at the end of 2015. Adjusted net income were impacted by several items of note. In the fourth quarter there was a goodwill impairment for our PSiGate business of CAD9 million and we had a writedown for intangible assets of CAD5.1 million related to software development.

Turning to originations. We generated CAD2.43 billion in the fourth quarter originations, a year-over-year increase of 14.5% taking total originations to CAD9.2 billion for the year. This performance represents the good progress our residential teams have made on improving service levels for the mortgage brokers driving increased volumes. We saw our response times for commitments improve, improved turnaround times on documentation process, and better service levels on approval and funding while keeping standards within our risk management framework. Our core traditional single-family residential line saw its volumes increase 3.5% to roughly CAD5 billion in 2016 versus 2015. Our high quality uninsured Ace Plus product continued to meet a growing demand for products catering to those that just barely don't miss the insured mortgages with originations growing to CAD407 million in 2016 from CAD253 million in 2015 when Ace Plus was first introduced.

Accelerator, our insured product, saw originations increase 16.5% to CAD1.6 billion compared to 2015. As expected, we started to see Accelerator volume softening late in 2016 due to the mortgage rule changes announced in October. As we commented in our earlier press release, we expect Accelerator to be negatively impacted in 2017 as a result of these changes, however we anticipate a relatively limited impact on net income. Non-residential commercial mortgages were up 39.8% year-over-year while residential commercial originations combined were up 38.4%. Originations in our credit card business was up 7.2% to CAD168 million while our retail credit originations were down slightly at 1.4% to CAD184 million. While there were many positive things happening across various business lines, our overall performance was negatively impacted by lower than anticipated retention and renewal levels.

This combined with elevated expenses resulted in lower net earnings. Efforts towards improving retention during 2016 were slower to take effect than anticipated. We anticipate these efforts to demonstrate results in the early part of 2017. At the end of Q3 2016, we identified these issues and highlighted the need to take action. Over the last quarter, we completed a review of our strategies and we have refined our strategic plan to better manage costs, streamline our products, and drive revenue growth. The outcome is that we have refined our strategic priorities to guide the business this year and beyond 2017. These priorities will leverage the Company's key strengths, our talented team, and our commitment to service leveraging technology, and our agility and strong risk management.

Before Rob speaks in detail to the 2016 financial results and our outlook, let me tell you about those priorities moving forward and why I'm confident in our ability to deliver on our plans in 2017 and beyond. Our first priority is to prudently strengthen our core traditional residential mortgage business. Building our traditional residential business and improving the profitable way means we must continue to grow our assets under administration through our originations, but in particular through a stronger focus on retention while ensuring the transactions are well within our risk appetite. Changes to our retention process have taken place and the benefits from these initiatives take time to be realized. We anticipate the results of these efforts to show in the early part of 2017. We are working across a few key work streams to boost retention.

We're looking at actively managing the full lifecycle of our customers while they have a mortgage with us and identifying all touchpoints that offer an opportunity to promote retention. This includes looking at onboarding mortgage servicing in our contact centers to drive an enhanced overall customer experience. We work to improve our call centers handling of calls that signal the customer was likely to shift their business to another institution. Now we are working on productivity improvements through more streamlined process controls and digitization to be able to respond appropriately to customer requests in a timely fashion. Our second priority is to continue to provide innovative products and solutions to service all of our customers. As the regulatory landscape continues to evolve, we will remain innovative with new products to attract and retain customers.

A product such as Ace Plus is a great example of Home delivering real solutions for our customers. With recent regulatory changes and potential future changes, we are investigating new products and opportunities to offer competitive products and services to take advantage of any opportunities that may arise. Our third strategic priority is to generate positive operating leverage. This will be achieved through both revenue growth and diligence on expenses. We are working towards improving future revenues through current actions on retention as well as longer-term strategies in line with our long-term goals. However, in the near term, we are addressing our expenses to right size them for the organization. We are instilling a rigorous expense management process in all aspects of our business.

We have launched a project called EXPO, an initiative that will target CAD15 million of cost reductions based on an annualized run rate of our Q4 2016 expenses excluding items of note savings over the course of 2017. We expect this work to be complete by the end of 2017. However, we won't realize benefits during the course of the year. As we announced in our press release yesterday, this will result in a restructuring provision to be taken in 2017 and more detail on that will follow in our Q1 results. We will report on project EXPO to you on a quarterly basis and this initiative will encompass most expense categories including employees, premises, and other operating expenses. There will be difficult decisions in the coming months, however, we are taking the necessary steps companywide to strategically effect meaningful change.

This effort in realigning our expenses will be done in a deliberate and strategic way so as not to negatively impact the work that is being done on our revenue related initiatives. In January we began executing our plans and a portion of this work is related to a reorganization to create a more agile and effective organizational structure to meet our strategic priorities. We realigned some positions to optimize our structure, which also resulted in a few of our senior team members leaving the Company. Moving forward, we will ensure that future costs will rise in a more measured way in a manner to move us toward positive operating leverage with the necessary investments that will enable the Company to meet its strategic goals. Finally, we will continue to focus on our final priority for 2017, which is to remain disciplined around balance sheet efficiency and the use of our capital.

As we did in 2016, we will continue to maintain strong levels of regulatory capital well above and in excess of regulatory and internal targets. In 2016 we were also active in our share repurchase program given the valuation of our Company throughout the year. Those decisions were made to maximize shareholder value and we will continue to evaluate opportunities for the highest and best use of capital deployment. We will be strategic on how we can effectively deploy our capital whether it be through our dividend, executing on buybacks through M&A or organic growth opportunities that may come available. As we look ahead to this year, we expect that early 2017 will continue to be a period of transition. We will work through retention and revenue generation and initiatives as well as Project EXPO. I am confident in our team's ability to execute on our plan and everything that we control.

There are however several external variables in our operating environment that are largely outside of our control. We continue to watch and expect the impact of the recently implemented measures to tighten mortgage rules will become clearer as we move further into 2017. Further policy changes, particularly pertaining to risk sharing, are also expected to be more defined as we move into the latter half of the year. The housing environment although stable on a national basis has elevated risks looking ahead and significant regional differences. It is a priority of ours to maintain (inaudible) to react to our competitive and economic environments to achieve our goals. We are mindful of these factors and have made an effort to capture some of this external volatility in our longer-term goals.

We have entered the year with good momentum and we remain confident in our ability to execute on our longer-term plan. We are well prepared to meet our strategic priorities and continue to create shareholder value. On that note, I highlight that we have laid out new long-term goals that reflect how we think about the potential of the business and how we think about managing the business. We run Home Capital for the long term and I think it's very important that the goals align with that. Now, I'll turn it over to Rob Morton, who will go into the financials in more detail. Rob?

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Robert Morton, Home Capital Group Inc. - EVP & CFO [4]

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Thank you, Martin, and good morning everyone. In 2016 Home Capital reported full-year earnings of CAD247.4 million and EPS of CAD3.71 with earnings down 13.8% year-over-year. Adjusted earnings were CAD263.4 million, down 8.8% from 2015 and adjusted EPS was CAD3.95. Adjusted earnings include the impact of several items of note including a fourth quarter goodwill impairment charge related to the Company's PSiGate business that totaled CAD9 million after tax or CAD0.13 diluted earnings per share and an intangible asset impairment related to internally developed software costs which totaled CAD5.1 million before tax and after tax of CAD3.8 million and CAD0.06 of diluted earnings per share. Additionally, adjusted results include the impact of severance and other related costs accounted for CAD5.1 million pre-tax and CAD3.7 million or CAD0.06 per share after tax, which was booked in the first quarter of 2016.

Net interest income was CAD485.2 million during 2016, an increase of 0.8% compared to CAD481.1 million in 2015. Lower average balances in our traditional single-family residential mortgages and their lower average rates were offset by higher Ace Plus and commercial loan balances and lower average interest expense rates from our interest bearing liabilities. Non-interest expenses were CAD238.9 million in 2016, up 25.3% from CAD190.7 million in 2015. This increase was mainly due to higher salaries and benefits resulting from an increase in the number of employees combined with higher operating expenses reflecting continued investment in technology, ongoing investment in the Company's IT security platform, and costs associated with the strengthening of risk management and compliance infrastructure.

Adjusting for the CAD9 million of goodwill impairment, the CAD5.1 million intangible asset impairment, and the CAD5.1 million in severance and other related costs; non-interest expense was CAD219.7 million in 2016. Our provisions for credit losses decreased 11.6% year-over-year and net non-performing loans as a percentage of gross loans ended the year at 0.30% compared to 0.28% at the end of 2015. For the fourth quarter, the Company reported earnings of CAD50.7 million or CAD0.79 diluted earnings per share, down from CAD70.2 million in the fourth quarter of 2015 or CAD1 of diluted earnings per share. Excluding the one-time items previously discussed, adjusted net income was CAD63.5 million and CAD0.98 of adjusted diluted EPS. Fourth quarter adjusted net income was 11.6% lower than the CAD71.8 million in the fourth quarter of 2015 and 4.1% lower compared to CAD66.2 million, which we reported for Q3 of 2016.

Expenses in the fourth quarter were CAD71 million, up from CAD54.7 million in Q4 of 2015 and up from CAD55 million in Q3 of 2016. Excluding the impact of goodwill and intangible asset impairments previously discussed, adjusted expenses rose to CAD56.9 million in the fourth quarter reflecting among other items investing in our business as we discussed. I will add that while achieving our expense reduction target, as Martin just previously discussed, we will continue to be investing in the business in 2017 primarily in initiatives that will drive revenue. Provisions for credit losses in the fourth quarter were CAD2.4 million compared to CAD1.4 million in the fourth quarter of 2015 and CAD1.3 million in the third quarter of 2016. The annualized credit provision as a percentage of gross uninsured loans for the quarter was 0.07% compared to 0.04% in both the fourth quarter of 2015 and the third quarter of 2016.

At the end of 2016, total loans under administration were CAD26.4 billion, up 5.5% from CAD25.1 billion at the end of 2015 and an increase of 1.6% compared to CAD26.0 billion at the end of the third quarter of 2016. In 2016 total deposits reached CAD15.89 billion increasing 1.4% year-over-year and 1.2% from the end of Q3 of 2016. Total deposits raised through the Company's efforts to diversify its sources of Oaken Financial by interest savings account and institutional deposits totaled CAD4.59 billion, an increase of CAD943.6 million or 25.9% over the end of Q4 2015 and CAD26.8 million or 0.6% over the end of last quarter. We continue to have strong capital ratios including a total capital ratio of 16.97% and has CET 1 ratio of 16.55%. Now let's turn to our outlook. While we did have challenges in 2016, we have delivered on several of our mid-term targets.

We were within our dividend payout ratio, we exceeded our return on equity targets, and maintained our strong capital ratios. As we look out to 2017 and the longer term, we are introducing new performance goals and these include on an adjusted basis; revenue growth of 5% or greater, diluted earnings per share growth of 7% or greater, and return on shareholders' equity ROE of 15% or greater. We have repositioned the dividend payout ratio under one of our four strategic priorities. We will continue to report on our dividend payout ratio as a part of our ongoing disclosure. These goals are consistent with our strategic plans and long-term objectives. Our goal is to achieve these annually over the long term while 2017 will be a transition period where cost reductions and revenue generation initiatives continue to unfold. With that, I'll now turn it back to Martin for some final words.

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Martin Reid, Home Capital Group Inc. - President & CEO [5]

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Thanks, Rob. We look forward to reporting to you with our Q1 results, on our progress on all of our revenue initiatives, as well as an update on Project EXPO as we move toward positive operating leverage. And now we'll turn it over to Melissa for questions-and-answers.

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Questions and Answers

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Operator [1]

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Thank you. (Operator Instructions) Geoff Kwan, RBC Capital Markets.

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Geoff Kwan, RBC Capital Markets - Analyst [2]

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My first question was when I take a look at the originations, you had a pretty good quarter there. But when I take a look at the mortgages both the on and off balance sheet outstanding and take a look on a year-over-year basis, I think it was up 6% year-over-year and when you take a look at Q3, it was up 11% so it's slowed quite meaningfully. I know you've talked about from a retention perspective you're seeing some signs of that getting to where you need it to be, but it seems like it's still a challenge. So, I guess I'm just trying to get a little a bit more color as to about what time frame do you think you can get in terms of where you want to be on having customer retention in a range that you are expecting? And also can you remind me in terms of where some of these customers are, ones where the banks have the initial referral and they have the right to bring them back, if they want to take them afterwards or are they going to other lenders?

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Martin Reid, Home Capital Group Inc. - President & CEO [3]

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Addressing your second question, Geoff, it's not the bank referral clients. If you look at our customer base over the last five years, the credit quality of that customer is a lot better than what it used to be so they do have a lot more choices. In terms of the initiatives, on the retention side you're dealing with customers where the mortgages are maturing several months out so the benefit of that does take a bit of time. I would say in the first half of 2017, we'll see some meaningful results on that. Pino, I don't know if you wanted to add any color to that.

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Pino Decina, Home Capital Group Inc. - EVP, Residential Mortgage Lending [4]

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Really the strategies that we've put in place, you may remember in Q2 last year we talked about a small specialized strategic theme that we implemented in our renewals group. And really that was contacting customers, at the time I think I mentioned customers looking for information statements on their mortgages or discharge statements, and it was really talking to these customers and better understanding where they're going, why they're leaving, what offerings do they have. And in line with what Martin just mentioned, it's all about this new look customer that we've seen post [D20]. They have come on board with a higher credit quality, which also means that they have more choice and earlier on than clients that we've had in the past. So, it's about developing new opportunities for our retention folks to better put their grips into these customers and make sure that they stay on longer term.

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Geoff Kwan, RBC Capital Markets - Analyst [5]

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Okay. Just around how you talking about a little bit about origination guidance for 2017. So I think what we were classifying as the insured securitized mortgage lending, which is the multi-unit as well as Accelerator, I think you guys were indicating that would you had in H2 2016 that annualizing that as to what you think 2017 kind of looks like; but I'm also guessing if that is the case given the Government of Canada changes last fall that in terms of contribution wise, Accelerator would be less of that because that would have been more impacted relative to obviously the multi-unit side?

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Martin Reid, Home Capital Group Inc. - President & CEO [6]

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The insured multi-unit is a low margin business to begin with. Accelerator is relatively low as well although more than the multi and it is the Accelerator that is going to be impacted by the rule changes. It is still early days, but we are seeing that impact and I think the real test will come with the spring market as to how much of a negative impact on Accelerator and what if any positive impact on our insured will come out of that.

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Geoff Kwan, RBC Capital Markets - Analyst [7]

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What I was getting at is if you're annualizing the second half of 2016 and given multi isn't a big part of that number, it does seem to suggest that maybe the Accelerator side won't actually be very much impacted in terms of on a year-over-year basis. Am I understanding that right or it actually is going to have a little bit more of an impact given the changes?

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Martin Reid, Home Capital Group Inc. - President & CEO [8]

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I would refer to the press release we did earlier in terms of the impact, I think that's conservative. But I think that given the way things are now as far as the impact of the insured business, pretty good indicator.

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Geoff Kwan, RBC Capital Markets - Analyst [9]

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Okay. And then just if I can sneak in one last one again on the origination side on the commercial. That on a percentage basis on the originations grew 40% in 2016. I think your commentary mentions the rate of growth in 2017 similar to last year. So, are you suggesting that the CAD1 billion in originations is going to CAD1.4 billion or were you talking maybe perhaps more about the level kind of staying flat at what was previously a good year?

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Martin Reid, Home Capital Group Inc. - President & CEO [10]

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It wouldn't be a consistent trend, you may see a little bit of a slowdown in the percentage growth.

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Geoff Kwan, RBC Capital Markets - Analyst [11]

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Okay. But you're expecting it to be up from the CAD1 billion that you did last year though?

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Martin Reid, Home Capital Group Inc. - President & CEO [12]

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Correct, yes.

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Operator [13]

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Jaeme Gloyn, National Bank Financial.

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Jaeme Gloyn, National Bank Financial - Analyst [14]

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My first question is maybe a couple of big picture questions. Can you just sort of walk us through the decision to switch from mid-term targets to longer-term targets and what that says maybe potentially about the near-term outlook over this transition year and maybe into 2018?

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Martin Reid, Home Capital Group Inc. - President & CEO [15]

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In the short term, as mentioned, we see the early part of 2017 as being a transition year as we get these expense initiatives and revenue initiatives underway. The targets are long term and I'll turn it over to Rob, our CFO, to talk a little bit more about that.

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Robert Morton, Home Capital Group Inc. - EVP & CFO [16]

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We thought that we had introduced a little bit of confusion when we talk about mid-term three to five years previously a few years ago. So, we looked at the long term ones as this was the value that we're going to deliver to shareholders over the long term. But as I said, our goal is to achieve these annually but over the long term. So I think if you look at the literature, long term is considered three to five years but where we see the value of our business being and if something changes, we'll change them. But like I said, we expect that these will be achieved annually over the long term and, as Martin said, 2017 might just be a little bit of a transition year.

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Jaeme Gloyn, National Bank Financial - Analyst [17]

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Okay. And with respect to capital, obviously you guys have done away with guidance around CET1 ratios and also the dividend payout ratio. Can you give a little bit of color about how you're thinking about where CET1 and return of capital to shareholders will be trending?

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Martin Reid, Home Capital Group Inc. - President & CEO [18]

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It's really about the efficient use of capital and so that is a combination of whether it be buybacks or increasing the dividend. So, it is being opportunistic about that. So it's not that there's just as much emphasis on those things today as there ever has been, but it's really acknowledging the flexibility in terms of how we deploy capital.

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Robert Morton, Home Capital Group Inc. - EVP & CFO [19]

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This is Rob again. I think the other thing was we didn't actually give exact guidance on CET1, we just said that we would maintain strong capital ratios. That's one of our core strategic priorities. So, we just actually thought it was a little bit (inaudible) and so it is our strategic priority to do that. And then with respect to your thoughts on the dividend payout ratio or buybacks or anything on that, we're going to report on those things quarterly as well as part of our strategic priorities and I think our thinking hasn't changed on any of that. We'll take the opportunity to raise the dividend were it makes sense and just [put] in buybacks and other forms of capital utilization and we'll report on those initiatives quarterly.

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Jaeme Gloyn, National Bank Financial - Analyst [20]

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Okay. So, just two follow-ups on that then. First with respect to the buybacks, they've been a little bit slow in the Q4 2016, only a couple hundred thousand shares bought back. Should we interpret that as suggesting that maybe the share price during that period is not reflective of good use of your capital?

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Martin Reid, Home Capital Group Inc. - President & CEO [21]

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We are looking at it opportunistically so the more that share price is driven down, the more active we will be. The intent is not to be active in the market all the time and on a regular basis. It is to be opportunistic with the use of capital.

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Jaeme Gloyn, National Bank Financial - Analyst [22]

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Okay. And then the second follow-up is in terms of defining what is strong capital ratios, is the bogey at 16.5% or would you consider that 16.5% to be excess? Can you just trend somewhere lower perhaps and align with other peers that operate in your target market? How would you think about what is strong?

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Martin Reid, Home Capital Group Inc. - President & CEO [23]

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So, we would say where we're positioned today is very strong and if you look at the Company historically, we've always maintained very strong capital levels and capital levels in excess of our peers. We do a lot of things internally in terms of measuring that and determining what those levels are going to be and I wouldn't look for an appreciable drop if that's what you're trying to imply.

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Operator [24]

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Dylan Steuart, Industrial Alliance

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Dylan Steuart, Industrial Alliance - Analyst [25]

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Just a quick question, follow-up on the retention. Just the confidence that you have that things will improve in 2017, is that more of a factor that the customers that you're targeting, they're coming up in the next couple of months here so you expect those to bear fruits in the first half of 2017?

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Pino Decina, Home Capital Group Inc. - EVP, Residential Mortgage Lending [26]

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Dylan, it's Pino here. No, actually the reason we're confident is I explained the work we did last year and it was really to better identify what we term as a high flight risk customer and so yes, we've done a lot of work at the renewal stage, but really we're at a point now of getting ahead of the game. So, it's really identifying these customers mid-term to work with them in advance of their renewal and push them out further. So when you can get ahead of the game like that and we started to see that in Q4 rolling into January as well, it's almost like building a pipeline on the origination side. And so because of that, we're confident that with those two approaches we should have better retention certainly in 2017 and the years beyond as well.

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Dylan Steuart, Industrial Alliance - Analyst [27]

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Okay. And maybe if you can just touch on any other initiatives on the revenue side of things to boost it whether you have any designs on additional products or continued focus on the commercial side of things, maybe just if you can talk to that a bit?

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Martin Reid, Home Capital Group Inc. - President & CEO [28]

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I'll let Pino add some color. But the introduction for the complete rollout of Loft through to all of our brokers will help to improve that service levels of the brokers which should in turn result in better originations. We are looking at products in light of recent regulatory changes how we can take advantage of opportunities that may exist in the market given the number of people that are impacted by that. There's a number of other initiatives that we are looking at at early stages, but the ones that are going to have a material impact short term are going to be the service levels to the broker, those initiatives around that and around retention.

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Dylan Steuart, Industrial Alliance - Analyst [29]

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Okay. And just one more if I can just on the intangible writedown really to the core banking system, maybe just a bit more color on the writedown of the capitalization there?

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Martin Reid, Home Capital Group Inc. - President & CEO [30]

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There's a number of different modules and software pieces that we develop or modify in terms of for different aspects of the business. And on this one here, we're part way through it and sort of revisiting the cost benefit and the decision was made that the benefit moving forward really wasn't there and so we chose to write that down. It's not to say that we couldn't revisit that at a later date, but at this point in time the decision was made to write that down.

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Dylan Steuart, Industrial Alliance - Analyst [31]

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So, that wasn't tied into the rollout of Loft or other improvements?

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Martin Reid, Home Capital Group Inc. - President & CEO [32]

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No, not at all.

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Operator [33]

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(Operator Instructions) Graham Ryding, TD Securities.

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Graham Ryding, TD Securities - Analyst [34]

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Maybe I could just follow up on that. So where are you at with the broker portal rollout and also the broker loyalty program? Are they fully ramped up or maybe you can give some color there?

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Pino Decina, Home Capital Group Inc. - EVP, Residential Mortgage Lending [35]

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Graham, this is Pino again. The broker loyalty program is in full flight. We're in year two of it and we're very happy with what that's producing. As far as the portal goes, I'll give you some color on that and maybe I'll go back a bit too. We're in a position now to continue the rollout of our Loft broker portal prior to the spring market and really we've applied sort of that 80-20 rule to it. So by the time the spring market hits, 20% of our most impactful mortgage brokers will be on Loft. And the reason we're in a position to do that is really as a result of the work that happened in the back half of last year. So, you may remember again that we talked about in the fall of 2016 implementing some enhanced process improvements to our delivery of mortgage originations. We tested that in our traditional mortgage originations group.

We continued the rollout to all the teams in our traditional group throughout the balance of 2016 and I'm happy to report that all the teams in Toronto are currently on that. And we're in a position now to deliver confidently what we call our 688 service level agreement. And effectively what that stands for is six-business hour turn time on commitments on all approved applications, eight-business hour decisioning on supporting documentation, and eight-business hours to instruct our solicitor partners. So, those are the three key areas when speaking on mortgage originations and I'm happy to say that in the month of December although we did see a steady improvement leading up to the month of December, we saw all three meeting those service level agreements.

It was perfect timing. No surprise too that we had a very good mortgage originations month in the month of December. That continued into January. We're not going to stop. We're going to continue looking at ways to improve that 688 and drive that even further down and that bodes very well for the continued rollout of Loft where one of the key drivers needs to be service on our end as obviously our partners will have full visibility into our service level. So, we think we're well positioned for that continued rollout and that will happen before the spring market.

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Graham Ryding, TD Securities - Analyst [36]

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Okay. And did you say you're targeting 20% your brokers on Loft in the spring market and then I assume the remaining 80% throughout the rest of 2017, how would you think about it?

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Pino Decina, Home Capital Group Inc. - EVP, Residential Mortgage Lending [37]

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That's correct. So, we have a calendar that's really identified who those top producers are. Effectively they generate 80% of the volume, but we'll have those 20% of our brokered partners on there before that spring market and to your point, roll out the rest over the course of the balance of the year.

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Graham Ryding, TD Securities - Analyst [38]

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Okay. Jumping back into the retention issue, just appreciate the color you gave around the client is a higher credit quality client than five years ago so there is more potential that there is flight risk there and you're getting on top of them early. How does that flow through into your outlook for net interest margin? To some extent, are you having to compete earlier for these clients on price to make sure that they extend their mortgages with you and also just a higher credit quality client, does that filter through into a lower mortgage rate on average?

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Pino Decina, Home Capital Group Inc. - EVP, Residential Mortgage Lending [39]

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Yes. That's safe to say that if you're going to attack them earlier and the client is in a position where they've graduated from a credit quality standpoint, then certainly you're going have to be more aggressive on your pricing in order to extend out their terms.

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Martin Reid, Home Capital Group Inc. - President & CEO [40]

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And just to add to that, these are clients that were already priced aggressively coming in the door so you had that margin compression as they were coming in the door. You may have to be aggressive in price in the renewal, but you also don't have the same kind of origination cost that you would on new customers. So, you are saving a little bit on the brokerage commission.

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Graham Ryding, TD Securities - Analyst [41]

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Are you not paying any brokerage commissions, is that what you mean?

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Martin Reid, Home Capital Group Inc. - President & CEO [42]

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We do pay some when the broker is involved, but there's a lot that there isn't. So, I would say on an overall basis you're probably a bit of a wash between the aggressive rates and what you're saving.

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Graham Ryding, TD Securities - Analyst [43]

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Okay. And then on the cost side, just timing. Should we be sort of thinking about this CAD15 million in targeted savings to be fairly balanced throughout the year or is this expected to be realized earlier in the year?

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Martin Reid, Home Capital Group Inc. - President & CEO [44]

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We are trying to realize things as soon as possible, but the way we look at is the Q4 2017 run rate annualized should be a minimum of CAD15 million lower than where we were in the Q4 annualized run rate of 2016. So, some things are going to happen quick, some things are going take a little bit longer. In terms of any impact on the people side of things, we are trying to be very strategic about that and we don't want to make it a death by a thousand paper cuts. We really want to address that quickly so people know what the new org structure looks like and how we look going forward and then we can take it from there.

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Graham Ryding, TD Securities - Analyst [45]

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Okay. And is there an efficiency ratio that you're targeting once you hit this figure of savings?

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Martin Reid, Home Capital Group Inc. - President & CEO [46]

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We're not because there's a number of things. Revenue can drive the efficiency ratio by itself. So, we are looking at an absolute dollar drop on the revenue side. There's a number of initiatives there. We should see improvement in the efficiency ratio, but we're not targeting a specific efficiency ratio at this point. What we are looking is to get back to positive operating leverage and then drive that. Longer term as we get in a better position with that, we may revisit the efficiency ratio or have a little bit better guidance on the efficiency ratio.

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Graham Ryding, TD Securities - Analyst [47]

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Okay. And then just the increased spending last year on technology and IT security risk management. Should we expect the growth there to slowdown? Have you got yourself to a run rate at the --?

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Martin Reid, Home Capital Group Inc. - President & CEO [48]

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Yes, I would say that's a fair assumption.

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Operator [49]

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Mark Kearns, GMP Securities.

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Mark Kearns, GMP Securities - Analyst [50]

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I had a question on LTVs and general sort of risk appetite you guys have in the GTA market. Seem like LTVs over the last few quarters on new uninsured originations they've eased lower. Just wondering how you guys are feeling about the market and where you'd like those LTVs to go?

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Pino Decina, Home Capital Group Inc. - EVP, Residential Mortgage Lending [51]

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Mark, it's Pino. I think that's pretty accurate. We're just watching very closely in particular in the GTA on some of the big ticket items, not being aggressive on loan to value where we don't need to be. And when I say big ticket, we sort of look beyond that CAD1.5 million markdown as sort of that step where you want to start to scale back that loan to value. And I think that's prudent and probably an approach that we're going to continue certainly throughout the year.

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Mark Kearns, GMP Securities - Analyst [52]

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Okay. And then my second question would be on credit, it seemed like generally held pretty steady for the quarter but I did notice that loans past due but not impaired did tick up a bit QoverQ. Some of that appeared to be securitized, some just in the single-family space. Anything specific that contributed to that?

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Martin Reid, Home Capital Group Inc. - President & CEO [53]

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No unusual trends or anything that we're seeing there. We talked before about Alberta sort of creeping up a little bit, but I think that's largely happened. But nothing in particular in terms of a trend that we're seeing.

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Operator [54]

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Jaeme Gloyn, National Bank Financial.

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Jaeme Gloyn, National Bank Financial - Analyst [55]

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Asked and answered. Thank you.

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Operator [56]

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There are no further questions at this time, I'll turn the call back over to management.

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Martin Reid, Home Capital Group Inc. - President & CEO [57]

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Thank you very much. And as mentioned earlier, we look forward to reporting on Q1 results where we hope to clearly demonstrate the progress on Project EXPO, addressing the expense side of the equation, as well as progress on revenue initiatives and retention initiatives. Thank you very much.

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Operator [58]

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This concludes today's conference call. You may now disconnect.