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Laurentian Bank of Canada
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Good day, [Foreign Language], and welcome to the Laurentian Bank Financial Group First Quarter 2018 Results Conference Call. Today's conference is being recorded. And at this time, I would like to turn the conference over to Susan Cohen, Director, Investor Relations. Please go ahead, ma'am.
Good afternoon and thank you for joining us. Today's review of first quarter of 2018 results will be presented by François Desjardins, President and CEO; and François Laurin, Executive Vice President and CFO. All documents pertaining to the quarter, including Laurentian Bank Financial Group's news release, investor presentation and financial supplements can be found on our website in the Investors Center. Following our formal comments, the senior management team will be available to answer questions. Before we begin, let me remind you that during this conference call, forward-looking statements may be made and it's possible that actual results may differ materially from those projected in such statements. For the complete cautionary note regarding forward-looking statements, please refer to our press release or to Slide 2 of the presentation. It is now my pleasure to turn this call over to François Desjardins.
Thank you, Susan, and good morning, everyone. Our organization posted good results in the first quarter. On an adjusted basis, net income was up 20% from a year ago and ROE stood at 11.5%. We improved our efficiency ratio by 260 basis points compared to a year ago. With respect to our capital, as you know, we had 2 years of significant asset growth. Given that our CET1 ratio, our target range is 7.9% to 8.3% and that we had been tracking towards the lower end of this target, we elected to replace the preferred share issue that we redeemed with a common share issue and run the business at the higher end of this range. This provides flexibility to execute the transformation plan and to pursue profitable growth.We achieved double-digit year-over-year growth as loans to businesses were up 22%, with the acquisition of Northpoint accounting for about half of that growth. Residential mortgage loans through independent brokers and advisors were up 19%. We are also pleased with our deposit growth, which is up 10% from a year earlier.Before speaking about the progress that we are making on our transformation plan, I would like to give an update on the mortgage securitization issue that was discussed during our fourth quarter call and is presented on Slides 6 and 7. As a reminder, we are referring to the 2 residential mortgage securitization programs that B2B Bank and Retail Services branch network use and the 2 types of situations that were identified for these programs, specifically ineligible loans with documentation issues and loans that were inadvertently insured and sold. First, let me say that our mortgage book is performing very well from a credit perspective and we are confident that the credit decisions that we make are the right ones. Our organization has a long history of being a conservative lender, as evidenced by its low loan loss ratio. So where are we now? Since November 1, we have been implementing improved processes for the adjudication of new mortgage loans. We continue to monitor and adjust these processes in order to achieve the level of quality that we have set for ourselves. Moreover, the implementation of the new B20 guidelines is also leading to further changes in our procedures. We are making good progress towards the resolution of the situation with the third-party purchaser, or TPP. In regards to B2B Bank underwritten mortgages sold to the TPP, as we previously disclosed, we repurchased $90 million of mortgages of which $89 million had documentation issues and $1 million were inadvertently sold. Furthermore, the TPP completed a confirmatory audit and no further repurchases are required. As well, $17 million out of the $40 million cash reserve that was deposited with the TPP will be returned to the bank. The remainder will be kept by the TPP as additional credit enhancement and will be remitted to the bank over time, as the mortgages amortize. Consequently, I am pleased to say that this situation is resolved. In regards to the Retail Services branch underwritten mortgages sold to the TPP, as previously disclosed, we repurchased $90 million of inadvertently sold mortgages in the first quarter. Again, I am pleased to say that that situation is resolved. Also in Retail Services, we are in the process of conducting an internal review of about 1,900 mortgages. This review is expected to be completed by the end of the second quarter, at which time the TPP will perform a confirmatory audit. As we previously mentioned, we conducted a limited sample review and through extrapolation of the entire portfolio, we estimated about $124 million of ineligible loans with documentation issues that may need to be repurchased. A definitive amount will be determined upon completion of this review. As we previously indicated, we provided a $61 million cash reserve deposit, the release of which is subject to the repurchase of ineligible loans and a confirmatory audit. I would like to reiterate that our 2018 funding plan does not rely on the securitization program, but nevertheless we look forward to the confirmatory audit and having this program available to us. With respect to the CMHC securitization program that was referred to as the other third-party purchaser, we had previously disclosed that we had identified $88 million of inadvertently insured and sold mortgages. These were repurchased in the second quarter. As well, after discussions with CMHC, we are not required to perform a full review of the mortgages sold to CMHC nor make material repurchases. We continue to work with this party on reviewing and ensuring solid controls are in place, in addition to our continued engagement in the normal course audits by CMHC from time to time. I'm pleased to report that this securitization program remains available and we continue to securitize mortgage loans.As you can see on the summary table on Slide 7, we have made progress towards the resolution of this issue and have settled and repurchased $268 million of the $392 million of estimated total ineligible loans. It is understandable that this issue has been our focus over the past few months and will remain a priority until we are satisfied with our processes and elevated governance. The situation also reaffirms the need for our transformation into a simpler and more automated bank. Building a strong foundation is integral to our transformation plan and essential to future growth plans. The very positive past 2 years have also seen more than their share of economic challenges, market disruption and new regulatory requirements. For us, this means that to continue progressing, 2018 will be a pivotal year of investment in our businesses, people, processes and technologies that aim at ensuring disciplined growth by strengthening the foundation and simplifying the organization. Last quarter we had reset our midterm growth targets as we continued to focus on sustainable and profitable growth. Moving forward, we will continue to concentrate on target niches and as the bank transforms, we will continue to review our activities and determine areas and portfolios that we will grow or maintain as well as areas we need to fix or exit. This means that we could make decisions on non-strategic portfolios so that we may focus on niches where we can win. As a result, our net loan growth is expected to be in the low single digits in 2018 with growth skewed to '19 and '20. Our move from traditional to digital banking, the crux of our transformation plan, is highly dependent on simplifying procedures, going paperless, improving our IT capabilities, digitalizing processes and so on. The first phase of our initiative to replace our core banking system is on track. In the first quarter we installed the backbone of the new Temenos T-24 core banking system and started migrating B2B Bank products to this new platform. In the coming months, we will continue to migrate B2B Bank and business services products. As I have previously mentioned, the core banking system migration continues through the end of 2019. So until we can retire old systems, we must operate 2 separate core banking systems and technology teams to support them. As a result of our investments in this new platform, B2B Bank will be launching a fully digital suite of banking products. The plan calls for progressive rollouts focusing on transactional and deposit products in 2018, followed by lending products in early 2019. In preparation for this rollout, we have concluded an arrangement to be part of the EXCHANGE network. Prior to this arrangement, B2B Bank and Laurentian Bank clients had access to about 300 full-service ATMs in Quebec. Now they will have access to 3,600 full-service ATMs across Canada. As well, we are investing in and wish to adopt the AIRB approach in 2020, pending regulatory approval for which we also need to simplify product suites, streamline processes and elevate our governance. To this end on an organizational basis, we continue to invest in enhanced regulatory and compliance frameworks to better manage our risks. Lastly, an important pillar of our transformation plan is improving the profitability of Retail Services. This should be achieved through a combination of efficiency gains and revenue growth. We have already made great progress on efficiency, notably with the merger of 46 branches, most of which were done last year. Our plan is to continue optimizing our branch network and invest in our advisory force and customer experience. Nevertheless, on the labor relations front, we are currently in the process of negotiating a collective agreement to replace the one that expired on December 31, 2017. This agreement covers approximately 1,400 employees who work mostly in Retail Services. Given the uncertainty on this front, we are reviewing the pace of the Retail Services transformation. All these factors will impact the efficiency ratio over the next few quarters and we are making the prudent decision to maintain higher liquidity levels. As we had previously mentioned, the improvements in efficiency was not expected to be linear and there could be bumps in the road. But ultimately, it does not change our strategic directions nor our 2020 nor 2022 targets. In fact, our investments in strategy contribute towards building a solid foundation that supports our mission and our objectives. We are committed to becoming a renewed financial institution that is there to help customers improve their financial health by combining the value of human advice, the ease of doing business and the convenience of digital transactions. In closing, I would like to announce that starting May 1, François Laurin will become Executive Vice President, Finance, Treasury, Capital Markets and CFO. This change comes as Michel Trudeau has decided to take his well-earned retirement at the end of April. Michel has had a very accomplished career of which the past 15 years has been at the helm of our Capital Markets segment and President and CEO of Laurentian Bank Securities. I would not only like to thank him for his significant contribution to the organization, but for his friendship along the way. Michel will not be leaving the organization, as he will be staying on as Vice Chair of the Board of Directors of Laurentian Bank Securities. I would like to express my sincere gratitude and appreciation to Michel Trudeau and congratulate François Laurin and wish him well on his expanded role. And now François Laurin will provide details on our first quarter results. François?
Thank you, François. Good morning, everyone. I would like to begin by turning to Slide 12 which highlights the bank's good core financial performance. Adjusted net income in the first quarter of 2018 grew 20% compared to a year earlier. Adjusted EPS was $1.49, up 4% over the same period. First quarter EPS was impacted by the common share issuances which increased the average number of outstanding shares by 16% compared to a year ago. Adjusted ROE was 11.5% and while lower than the previous quarter, reflects a strong capital base which positions us very well in an evolving environment.As outlined on Slide 13, reported earnings for the first quarter were affected by adjusted items totaling $3.5 million after tax, or $0.09 per share and are largely related to business combinations. The drivers of our performance are presented on Slide 14. Total revenue in the first quarter of 2018 amounted $267 million, an increase of 10% compared to a year earlier. Net interest income rose by 16%, mainly due to the strong volume growth in the commercial loan portfolio, both organic and from acquisitions, and the higher margins earned particularly on the acquired loans. Other income was relatively unchanged from a year earlier.Net interest margin, shown on Slide 15, was 1.77%. The main factors contributing to the 11 basis points year-over-year increase was growth in commercial loans, including the acquisition of Northpoint with corresponding higher margins, and to a lesser extent rising interest rates. Sequentially, the margin was up 2 basis points, reflecting the positive impact of a higher level of commercials loans as well as higher interest rates, and was partially offset by higher liquidity. While average earning assets rose 9% year-over-year, reflecting 19% organic growth in residential mortgage loans through independent brokers and advisors and 22% growth in loans to business customers, it remained relatively unchanged from the prior quarter. Other income, as presented on Slide 16, totaled $88.4 million, relatively stable from a year ago. Favorable market performance positively impacted income from mutual funds. As well, fees and commissions on loans and deposits increased, mainly driven by higher lending fees due to the acquisition of Northpoint. These increases were partly offset by a decrease in income from brokerage operations mostly related to lower fixed-income activities. Compared to last quarter, the category of other income fell by 4% when the fourth quarter of 2017 included a contribution of $5.9 million from the gain on the sale of the bank's participation in Verico Financial Group.Slide 17 highlights that adjusted non-interest expenses rose by 6% year-over-year. This increase was mainly the result of the acquisition of Northpoint, regular salary increases and higher professional fees to support our transformation. Our adjusted efficiency ratio of 64.8% improved by 260 basis points compared to a year ago. While the efficiency ratio has been ahead of our 2020 target for the past 2 quarters, the investments required as the bank transforms, including running parallel IT systems for the next several quarters, is expected to exert some pressure on expenses. However, an efficiency ratio of below 65% on a sustainable basis by 2020 remains our objective. Slide 18 highlights our well-diversified sources of funds. In the first quarter of 2018, the bank continued to optimize its funding mix. Deposits stood at $29.4 billion, but 10% compared to a year earlier. Total deposits sourced through independent brokers and advisors grew by 11% and institutional deposit growth was also very strong. While we have reduced our footprint by to close to a third, our branch source deposits have experienced minimal attrition. I would like add that our liquidity positions continue to be strong and well above our internal and regulatory requirements through highly rated government securities.Slide 19 presents the CET1 ratio under the standardized approach of 8.6% at January 31, 2018, taking into consideration the recent share issuance. Our capital ratios are very strong and support the bank's transformation plan. Our diversified loan portfolio is highlighted on Slide 21. Loans to business customers have increased to 34% of the portfolio from 30% a year ago, and residential mortgages remain relatively unchanged at around 50%. Within the residential mortgage portfolio, Alt-A mortgages total $1.5 billion and represent 8% of the total mortgage book and 4% of the total loan portfolio. As well, mortgages in the GTA represent about 22% of the portfolio and the GVA accounts for 4%. LTVs remain low and credit scores remain high.Turning to Slide 24, credit quality remained good. The provision for credit losses at $12 million was $3 million higher than a year ago, reflecting the evolution of the business mix and growth in the loan portfolio. The loss ratio was 13 basis points in the first quarter of 2018, compared to 11 basis points a year earlier. 97% of our loan book is collateralized and the underlying credit quality of the portfolio continues to be good. Impaired loans are shown on Slide 25. Growth in impaired loans rose by 15% compared to last year and include the impact of the evolution of overall growth in the loan portfolio. The net impaired loan ratio stood at 31 basis points and we remain well-provisioned. We continue to expect that over the medium term the loss ratio will gradually move higher to reflect our changing business mix. Nonetheless, with our current portfolio mix and conservative provisioning, we expect that the loss ratio will remain below other Canadian banks. Turning to Slide 27, we continue to gradually progress towards our 2020 midterm growth targets and financial objectives. To conclude, we're pleased with the core earnings performance in the first quarter of 2018. We're also confident that our transformation plan and the strategic initiatives that we are implementing will lead to sustainable profitability and create long-term value for our shareholders. Thank you for your attention. And I will now turn the call back to Susan.
At this point, I would like to turn the call over to the conference call operator for the question-and-answer period. Angel?
[Operator Instructions] We'll go ahead with our first question from Mr. Nick Stogdill from Credit Suisse.
My question is on the fundings. Can you clarify? I think I heard you say that you're expecting the securitization program to open up to you after the review is complete. Is that right?
I'll ask Susan Kudzman to answer that, please.
Yes, you are right. As was disclosed, we've already dealt with the CMHC conduits as well as the B2B mortgages in what we call the third-party purchaser conduit. So we expect a successful confirmatory audit of our new processes and procedures as well as an audit of the internal review of the branch network mortgages in this conduit should be complete towards the end of Q2 2018 and that the conduit will reopen. I would also like to remind you that the credit remains good throughout this whole period and we continue to expect so.
Okay, and then related to that, when we look at your deposit profile in the MD&A, it shows your demand and notice are down. And we're seeing double-digit increases in your 1-to-3 and 3-to-5-year term deposits. So clearly by going to the term market that comes with additional costs, maybe you could walk us through your outlook for deposit growth. Should we continue to expect more growth in the longer-term deposits versus the notice and demand?
I will ask François Laurin to speak to that.
Clearly we expect growth in the term deposits. It's a very good source for us of funding. Basically half the market in that term deposits are in the 1-year basis and 50% in the 2-to-5. So we're basically aiming at keeping a healthy market share in all of those segments. But you can expect that we will be along the curve where the market is.
Have you adjusted pricing at all in the 2-to-5-year to spur that growth?
Basically we follow the market. And with the increase in rates, the deposits, the term deposits rates have increased slightly, but haven't kept up with the increase in rates overall that we had in the markets over the last 9 months. But they did actually increase a bit.
Okay, thank you, and just one more. You called out the lower mortgage originations in Q1 '18. Could you potentially give us a bit more color on how much you think is coming from B20 versus how much is intentional slowdown? And have you made any pricing changes to your mortgage products over the last few months?
François Desjardins here. We had reset our midterm growth targets in Q4 last year and we expect to grow mortgages through independent brokers and advisors by about $1.4 billion. That means from $8.6 billion to $10 billion by 2020. So of course this growth target is at a slower pace than what we had in previous years. Yes, new regulations have had an impact, not only B20 but other implementations and regulations, but B20 did have increased sales before the holidays as people were trying to beat the deadline. And since the holidays, we've seen a slowdown, I think, industry-wide. It's still too early to tell how this will settle and how the market will evolve. B20 is one thing, but there is rates and also market sentiment around pricing in certain areas of the country. So we'll have to see how customer behavior adapts to this regulation. For Retail Services, as a reminder, we had halted referrals to the branches from mortgage brokers late last year so that our Retail Services advisors may concentrate on advice, meaning investments, deposits and more regular business versus one-off mortgage products. And lastly, one of the priorities for the bank is to change the mix slowly towards business services. So growth in that area, specifically in niches where we can win, will grow at a faster pace than our mortgage business. On that note, can I ask Stéphane Therrien to just give in an update on Northpoint and CIT?
Yes. We're really happy about these two acquisitions. They are performing as planned. These two acquisitions are bringing to the bank higher margin loans and we expect these two businesses to continue to grow at double digits. The guidance that we gave in business services is $14 billion by 2020. This will include, as I just mentioned, growing these two latest high-margin businesses at double digits. We will maintain single-digit growth at other businesses. And strategically we will look at existing certain areas where we feel we cannot win going forward profitable volume. So doing these 3 things will optimize our capital and will permit us to reach our goal of $14 billion by 2020.
Nick, François Laurin here. I would just like to complement the answer I provided you earlier. Marginally the cost of funding increased from the GICs slightly. But our NIM was not negatively impacted. Because overall our NIM was not impacted. So I thought I'd complement my answer with that.
We will now take our next question from Gabriel Dechaine of National Bank Financial.
Just a clarification on Nick's question there, you're saying that when the audit is complete with the third-party purchaser, you expect that that funding channel will reopen?
Susan Kudzman again?
Yes, we do. That is our understanding. We have not planned for it in our funding plan. But we do expect after the confirmatory audit by the third-party purchaser of our review of the branch network mortgages in the conduit and as well as our new processes and procedures, we do expect that to be complete by the end of Q2.
Okay, and then on the branch deposits, they've been steadily going down. And your commentary on that is that the decline in core branch deposits is in line with your expectations. What does that mean? When do you expect it to bottom out and do you expect the branch deposits to grow at some point? I believe last year you were expecting it to kind of stop declining, but it hasn't.
I'll ask Stéphane Therrien to give an update on our retail transformation, including the deposits.
Just we base it on the strategic decision in terms of our footprint. Remind you that our footprint decreased by roughly 33% in the last 2 years and our deposits, we expected that our deposits would go down but not obviously as severely than our footprint. And this is exactly what happened. Our deposit level compared to a year ago, is way lower than the percentage of decrease in terms of our footprint. Going forward, yes, we expect with our new advice that we're giving to our customer and the way that we're now treating our customer in terms of advice only branches that our deposit level will go up.
If I may add, Gabriel on that, I also mentioned in my prepared remarks that we're investing and that B2B Bank will be launching its digital offering in the second half of 2018 and focusing on transactional products and deposit products, thus adding to the ability to increase the breadth of funding of the bank.
Okay, like a high-interest savings account of some sort I guess?
High yield savings, GICs, transactional accounts; but the important part here is the automated nature of the product. So we're really going fully digital on this.
Okay, and then some clarification. I guess these are expense items here. And I didn't quite catch it in your comments, the retail transformation, something about that being on hold. And then I apologize, I was distracted. But there was some pressure on the [mix] ratio that you're expecting over the little while, and is this the elevated initiative spending that's tied to B2B initiative?
I think a little bit all-encompassing. In my remarks, 2018 as we discussed late last year, is an investment year for the bank, where we're going to be investing in our people and processes and technologies. There's some improvements that are being made across the banks. But the big tickets items, of course, are the core banking system for which the implementation is 2018 and '19 and is going well. And core banking lays the foundation for the digital offering, which is being launched first through B2B. From a retail perspective, retail is an important pillar of our transformation plan. And I've said in previous calls that we needed to really work on efficiency in regards to retail. Though we are currently negotiating a renewed collective agreement and consequently we do have to review a little bit the pace of the transformation in the sector. Overall, this combined with AIRB investments, for which we're still looking forward to in 2020 and getting the benefits in the years after that, is still on track. But we're making those investments as well. So overall, from an efficiency perspective, we will see some pressure on the efficiency ratio and we are making the prudent decision to hold some higher liquidity to give us this flexibility. As we have previously mentioned as well, efficiency is not supposed to be linear. We're aiming for below 65% in 2020. That was the guidance that we said last time. And there will be some bumps in the road. But nevertheless, we're really excited about the progress that we've been making on the transformation plan. All of these things are required for us to create sustainable improvements in efficiency and overall performance. To date, building a new strong equipment finance platform with the acquisitions of CIT, for example and Northpoint, we're seeing revenue growth both in B2B Bank and business services are all things that work towards us. So we're thinking that the investments that we're making in '18 are well worth it to get to our targets and objectives of 2020.
I appreciate that. I guess my underlying question, and the communication of the strategy that makes sense. I just wonder how you view the challenges in your mortgage book is affecting it. Is it a curveball that's coming at you that it does affect your funding plan? Because all of a sudden you've got a third-party purchaser that's not there temporarily. The expense, you've got some initiative spending that you want to advance to get your transformation plan, keep that on track. But then at the same time you've got to step up investment in control, underwriting systems and whatever else IT system related to make sure that these problems don't reoccur or recur. I'm wondering, do you view them as a bump in the road or is this something that will be more noticeable this year-- that fallout from that issue I mean?
I think from a growth perspective, this issue, there's no material impact at all on our growth. We had already reset our targets to a lower pace. And of course we're having fallout from our regulation and B20 as we just recently discussed. Obviously we're taking this opportunity as a learning opportunity for the bank. You've heard me in multiple calls talk about simplifying the bank, automating the bank, working on processes, working on governance. Obviously this issue with the securitization conduit, we're seeing this as an issue to resolve and to put behind us to get back to the plan and move forward. Obviously for the moment it remains our highest priority. Because having any unknown in the market is never good. But as we've discussed in my comments and Susan's comments, we've made really good progress in the last quarter and we're looking forward to resolving this in the next quarter. And of course we're putting in place processes that are enhanced so that these issues don't reoccur ever again.
And our next question comes from the line of Meny Grauman of Cormark Securities.
François, as you go through this mortgage issue, I'm curious what, the lessons you draw from it are for the organization and maybe even for yourself. Thank you.
Well, that's a great question. I must admit that for the organization is that, well first of all, the securitization conduit that we're talking about here is about $2 billion. So it is relatively a small portion of the funding of the entire bank. But for the organization as a whole, respecting the criteria of securitization conduits to the letter is something that obviously we missed on. And that means that simplifying our bank and having a more simple and automated bank is still the way to go. It's reaffirms the need for our bank to transform more than anything else. It reaffirms the need for us to move forward more than anything else. For myself, of course, no CEO ever wants to go through these issues and I must say that the executive team here and the different teams in credit and processes that have been working on this issue have been doing a great job and taking this very seriously. In hindsight, could we have seen this coming? Obviously now we're getting into hindsight is 20/20. But overall, the plan remains the plan. And that's the best comment I could give.
Thank you, that's really helpful. And just as a follow-up, I was wondering what you would say to people and I definitely come across this. Some people say, why not do a broader review of your mortgage underwriting and just look at everything or look at a much larger swath of mortgages, understanding that you're identifying a specific problem in that channel. But why not just go through a bigger piece of the mortgage pie, maybe all the mortgages, and have full comfort that the underwriting was done properly, that everything is up to the perfect standards that you expect?
Well first, and I'll ask Susan Kudzman to chime in here. But first, we are running with excellent credit quality overall. And we have been from a historical fashion. This is a securitization eligibility issue and not all securitization conduits have the same criteria. And of course this is a miss for this conduit. And that is resolved by buying back the loans that are not eligible. The third part is regardless of loans being destined to be in securitization conduits or not, we are increasing governance across the board so that all new business is subject to enhanced quality control. So we will be paying more attention to the business overall as loans renew and new business comes in. Susan, do you want to add on that?
François has covered it well. Just to remind you that we take this very seriously and in the current environment we understand the consequences. However, this is not a credit issue. Our credit remains well below the industry. We are comfortable with the risk appetite of these loans. And it was an issue related to eligibility for conduits. We've been working with both of the conduits and have made tremendous progress. At one of the conduits, the situation has been dealt with and we're getting to the end. So to your question, we're comfortable with the credit of these loans of the entire book as well as the loans to address the situation, we've been repurchasing them. So we have them back on our books and are comfortable with the credit and these loans.
Your next question comes from the line of Sumit Malhotra of Scotia Capital.
First question is just going to be on your comments on liquidity. I thought you were tying that in with some of the discussion regarding the negotiation with the union. And you were stating that -- I think it was as a result of that you're planning on holding extra liquidity. Can you just clarify that for me? And if that is the reason, how are those two factors related in your mind?
Not specifically, Sumit, in regards to the labor situation, but as an overall. So in my prepared remarks, I talked about core banking, digital bank investments, IRB. There's a lot of change going on in the organization and now of course on top of that, after some disclosure that you've seen about the certification movements and now recently a vote taking place; we're now in the negotiation process with our union. And this is of course going to have some impacts on what we can do or can't do in the Retail Services area during the negotiation process. So it brings some uncertainty there. And we're just acting prudently. It's not more than that. I think it's a prudent thing to do to have increased liquidity when we're going through a significant amount of change.
And just thinking about what this means from a numbers perspective, you've had the net interest margin move higher the last couple quarters, chiefly due to the acquisition. You mentioned the rate hikes as well. So looking forward from here, does the increase in liquidity, is it going to be sufficient or significant enough to stem the NIM expansion? Do you feel NIM stabilizes for you here? Or does it actually step back because of the higher level of liquidity?
I'll ask François Laurin to give some color on that.
Sumit, we still believe there's going to be expansion in the NIM because we haven't had the full year of Northpoint in our numbers. So as we move forward, we'll have compared to last year, we see an expansion. But part of that expansion will be contracted by whatever level of liquidity we might hold higher than we had before, by a few basis points.
Yes, and I meant more from where you are now. Obviously this is, I think the first full quarter?
Yes, we still expect from the 1.77%, we expect expansion still, slight expansion. We expect a slight expansion, given what I mentioned about Northpoint and benefiting from the increased interest rates that have been implemented in the last few months.
Thanks for that. Second question is going to be on revenue and specifically some of your fee income lines. Now these are lines, I feel like at least from my perspective, I don't ask you too much about-- there was a conversation earlier. And we've heard it for a few calls now, about the softer trend in what I'm going to call your core deposits. And can I link the deposit decline over the last year to some of the trends we're seeing in things like deposit service charges, lending fees? These are usually more stable items and they have been trending downwards [indiscernible]. And I'll direct it to you, François, do you think this relates to what's happening with your core deposit base and some of the branch closings that you enacted over the past year, year and a half?
I'm guessing you're meaning François D here, right?
That's right. That's right.
No. Or I would say partially. And I'll ask Stéphane to again give some color on the results of our branch mergers. But there was an expectation closing or merging one third of the branches, of course we're going to have some reduction on deposits and that has been going as planned. But some of these lines are just up and downs of fees that we charge on new loans or self-directed fees or other line items that may vary from time to time. Stéphane?
There's an ensemble of things that happened at the same time. As François just mentioned, the reduction of the footprint by 33% obviously had an impact on deposits also partially, as François mentioned, on fee revenue. And the other thing is that there is a movement through what we're doing right now that our clients are using more and more electronic services versus cashier, for example. So there's a lot of factors going on at the same time. That being said, what's good is that we've been able and we're making progress to improve the efficiency ratio and rebuild overall.
Last one is going to be for François Desjardins again. And it just goes to the conversation around capital adequacy. I know we've had a lot of discussions over the years on what the right level of capital is for Laurentian. For a period of time it did seem like you were comfortable operating as long as you were above it. I think we had discussed 7.75. Obviously as you discussed at the outset of the call, you made the decision to replace the prefs that you redeemed with common, which at least was a little bit surprising to me, give that previous discussion. What changed in your mind as far management of the CET1 ratio and adequacy? And was this a shift that was aided in part by regulatory discussions or did you have a new line of thinking as to where common equity needs to be for Laurentian?
Well, two parts, and thanks for the question. Yes, the right level of capital for the bank is always calculated with the risk appetite which we review over time. And of course, even from my first days as CEO where the capital ratio was just a ratio, it was around 7.4; we calculated the risk appetite to be insufficient and raised capital to the 7.8 mark. Further evaluations of that gave us a range, an operating range that now stands at 7.9 to 8.3. And why we have a range is because of different aspects, whether it be just monthly fluctuations of paying out dividends or investments in core banking for which we need to deduct the capital as soon as it's spent or the other way around; we needed to have an operating margin so that we don't hit the bottom of the range. So in the first 2 years of our transformation plan, we experienced really strong growth in assets as you know and we were ahead of plan. So as we ended up looking at what we needed, strategically looking at the business mix which we know as we're pushing more loans into business services, common sense will tell us that this range will slowly go up as business services takes a higher proportion of the overall business of the bank. But what we did after the holidays is really take a look at the opportunity we had in the market to rebuild. We were at the bottom of the range. So sure, we can take our time and rebuild this, but it takes several quarters to do this and we were uncomfortable with that. So we took the opportunity to go and replace the preferred share issue of $100 million with a new common share issue, strengthening both tier 1 and CET1 ratios. Obviously with the greenshoe being fully exercised, it take us slightly above our operating range. But quite frankly I don't mind this buffer. I think it gives us extra operational flexibility. And as I've said in my previous comments, this is a big year for us. Just for transformation alone, we're implementing many changes. So having that extra buffer, I don't see this as a negative at all.
And just for clarity where I wrap it up, 8.2 to 8.5 on CET1 is the new range that investors should think about Laurentian managing the ratio going forward?
The risk appetite calculated is 7.9 to 8.3. And our guidance for the next few quarters is that we'll be operating at the higher end of this range, even slightly higher for the next several quarters.
Your next question will come from the line of Doug Young of Desjardins Capital Markets.
Just you've been crystal clear, I think that expenses are going to bounce around. I just wanted to put a finer point on that topic. François, maybe can you elaborate in terms of how much additional costs will flow through the P&L from running two platforms?
We haven't disclosed that for the reason of not disclosing yearly targets. We gave our midterm targets in Q4. And of course the question back then was you're aiming at below 65% efficiency ratio. You're already there. So what do you do for the next 3 years? So obviously the answer is it's not going to be a straight line. And the answer to the question is, is it going to be massive amounts of pressure? No. But we want to be clear that 2018 is an investment year and there will be some pressure on expenses. And that pressure on expenses is going to translate on a slight pressure on performance. But we're absorbing this investment cost within our operational capacity, which I think is something that will eventually disappear, running 2 core banking systems at the same time with two teams. Obviously that's more expensive than running 1. So as soon as we can retire those systems, it does give almost an immediate benefit.
So the new core banking system came live Q1. Is that correct?
Correct, a portion. So the foundation became live and we started migrating certain products of B2B Bank. Other products of B2B Bank will be flowed onto the new banking system in the next few quarters. [Technical Difficulty]Doug, do you still hear us?
I still hear you.
Good, you're there? In the next few quarters, and so will products from business services. The end of the program? [Technical Difficulty]
I don't know where that's from.
The end of the program is mid-to-late 2019, where Retail Services products all go into the core banking platform and that's where we expect some really nice efficiency gains there and cost reductions.
And have you disclosed or would you disclose how much you've capitalized for the new core banking system?
François?
It will be part of our capitalization cost once we do them, and we disclose them. But basically we said that the majority of our capital expenditures in the plan were coming from 2 major projects, the core banking and the AIRB. But that's [indiscernible].
You haven't disclosed them now but you've capitalized. Okay. And then I can't imagine the AIRB costs. You're just saying there is cost there. Is it incrementally increasing significantly? I wouldn't imagine it would change drastically, and the same on the retail. Is this just you may not get further cost savings from the retail side, but incrementally we shouldn't see an increase, should we?
From the AIRB program, of course, systems that are not implemented yet don't hit the operational lines. So that will just hit progressively as systems come on. But the cost of teams that are working on the implementation of different portions, procedures, models; putting that together is hitting the lines of costs as we speak. And of course we're not getting the benefit of that until AIRB is live. But as a reminder, while we're doing this is that better managing our capital requires better processes, documentation data. And the benefit of that as calculated and disclosed previously, is around 200 basis points of improvement in ROE, as we move from standard methodology to advanced methodology. So it's well worth the investments that we're making both in technology and in process.
Okay, and just lastly, on Page 12 of the SIP, it just shows individual provision, $7 million. I mean that's down significantly. I think that's your specifics. I just wanted a little bit more details as to was there recoveries in there. Was there something else? Just hoping for a little bit more color.
Doug, you're in the MD&A?
No, in the financial supplement package on page 12 under the provisions for credit losses, the $7 million versus 6.969 last quarter and 2.8?
Hold on a second. We're just going to flip to your line here, sir.
Sorry. It was $7,000 not $7 million and we can take it offline if it's easier.
Maybe we should and get back to you on the line.
Can we take it offline, Doug, and come back to you on this?
Yes, that's fine. Thank you.
And your next question comes from Marco Giurleo of CIBC.
My first question is on acquisitions. Over the past 2 years you've made a couple of material acquisitions. So first on the progress of those acquired entities, do you still envision 4% EPS accretion for each of them?
I'll ask François Laurin to answer.
Yes, we do. CIT we said in this year, and Northpoint next year. And we're still holding to that.
All right, so we should see the 4% EPS accretion plus whatever organic growth you generate?
From those two acquisitions, yes.
All right, great. And could you also touch on your acquisition appetite going forward?
I certainly will. We obviously we always look at acquisitions on a regular basis. But we do have criterias and targets and it really does have to be a good cultural fit, enhancing a current product line or as we did with CIT and Northpoint, leveraging things that we want to be in or where we can win. The challenge for 2018 and '19, of course, is that you can't really do big acquisitions at the same time as you're doing core banking implementations. And those 2 things really don't go hand-in-hand. You want to be successful on your core banking implementations and that's really where we're focusing on. So our appetite short term is curtailed because of that. And we're also being cognizant that a lot of the modeling and a lot of the work that has to be done for AIRB has to be reviewed over time. We need to have the historical data of these portfolios. So we have to be careful what we would put into the portfolios. I would say that from an appetite perspective, we'll get hungrier once some of these big ticket initiatives are behind us.
Your next question comes from the line of Scott Chan of Canaccord Genuity.
François, maybe big picture, your ROE has been trending down and I expect it to probably go down a bit more before it goes higher. Kind of regarding your target on attaining an ROE within 300 bps, with the Big 6 banks by 2022, is that still a reasonable target or medium-term target considering the challenges posed short term?
Yes. Our current evaluation of the implementation of the plans and the efficiency gains that have to happen with the investments that we're making in '18 and '19 take us there. We're willing to make these investments because that's the payoff.
Okay, and earlier you commented on mortgages. But I think that was more directed towards conventional. Maybe you can just update us on the Alt-A book and kind of expectations over the next few years there and kind of impact on B20.
Sorry. I just wanted to make sure I said the right thing. Our midterm targets are 2020, right? So we're making investments in '18 and '19 to get to there. Your question on the Alt-A book?
Yes.
Is the percentage?
Just in terms of like what to expect in terms of that book going forward. I think earlier your commentary was directed more towards the conventional mortgages. I just wanted to see if that kind of growth rate would kind of be more higher than your traditional book.
Overall, the mortgage growth rates I've already expressed that during this call. So low single-digit growth rates on mortgages from brokers and advisors. But please take into account that the bank [starts] the referral program to the branch network. So overall residential mortgages is going to be impacted by that. As far as the split between the different types of mortgages, one of the big trends that we're seeing is regulation impacting insured mortgages. So we're seeing less of that. And we're seeing more of the non-insured traditional mortgages. The percentage of Alt business coming in has remained relatively stable, so not a big change there.
And then just lastly, just a clarification question. On your supplemental on Page 13, just on your HELOC portfolios, it seems like the percentages in Quebec and Ontario flipped sequentially. Like Ontario is now 68% of the portfolio versus 17% last quarter. And Quebec is vice versa. Is that kind of a misstatement? Or is that related to something else?
Can we get back offline, Scott, with those particular details and we'll [indiscernible]?
And your next question will come from the line of Sohrab Movahedi of BMO Capital Markets.
I know it's been a full hour, so I'll try and be very quick here. François, what would have been organic expense growth absent Northpoint?
I'll ask François Laurin.
I'll have to get back to you with specifics, Sohrab.
Okay. And when you think about the expense or the investment program through '18 and '19, I guess is that somewhat revenue dependent? Or once you press the switch those expenses are coming at you regardless of the revenue environment?
A lot of the expenses that we're seeing happen to us before revenue is generated from them. So we see some of the work that has to be done in IRB and core banking, digital can be amortized from a systems work perspective. But a lot of it can't. So those have to go into the expense lines without any revenues being generated from them. Of course, we're not doing this for nothing. So we'll be eager to see the success on the digital bank launch later this year and grow that business. Of course we've made some investment already with CIT and Northpoint. So we're expecting to see some good business that way too. And as Stéphane mentioned earlier, some of the things that we're looking at as well is continuing to look at our portfolios to see are there things that we want to get out of too, which might have some short-term impact on the top line. But I'd rather spend my liquidity and capital on higher margin products and industries and product lines where I can win and be successful and relevant; than to leave them just hanging. I think that's the best summary I can give you at this point.
So maybe let me just come at it slightly differently. I mean you have had a very noticeable improvement in your expense-to-revenue ratio, let's say, over the last 8 or 10 quarters from, let's say, somewhere in the 70s all the way down to where you're at this quarter. I guess you've made it crystal clear that these things are not going to be-- this is not going to continue to go down. It will actually kind of fluctuate up and down. Can you put a bit of a range around it? Is it going to be a 65 this quarter plus 100 to 200 basis points, or could it go back up to 70%?
It's really an excellent question, Sohrab. But I wouldn't want to send you down the path of giving you disclosure that is more than this. We're aiming for below 65 in 2020. We're at 65 now. So we're going to have some pressure. It's not going to be massive pressure, both on efficiency ratio and of course on performance. But there will be some pressure.
Okay, and one last question, and I apologize. I think you answered this question, but I don't know if I got the full gist of it. I think you said you've adjusted your risk appetite ultimately and will be running with a higher capital ratio over the next few quarters anyway. Was the commensurate offset to a more conservative risk appetite willing to live with a lower ROE?
No. I'll just repeat the answer. We review the risk appetite on a regular basis. And that's independent of the performance. It's really just driven by mathematical calculation of total risk. The risk appetite when I first came in as CEO, we had a CET1 capital ratio of 7.4. We recalculated our risk appetite and it gave us a number of 7.8. And because of transformation, you can't run at 7.801. You have to give yourself an operational margin here. So the risk appetite that we're running at since last year is 7.9 to 8.3. The decision to run at the higher end of this ratio came as a reaction to 2 really big years of asset growth. And as we were running at the lower end of this ratio, we saw the opportunity. We had a pref share issue that was coming up. So we decided to replace that with a common share issue. And that both affects our tier 1 and the CET1 ratio. So now we're running at the upper end of the range, actually a little bit above our range. Because as we issued common shares, our greenshoe was fully exercised and now we're standing at around 8.6. And the last comment that I made for the question is well, are you going to be at that range? And the answer is yes. I think that having a higher capital buffer gives us added operational flexibility. There's a lot of stuff going on, core banking, et cetera that eats up capital as soon as you spend it. So we're being prudent on that. And if short term it has some impacts on ROE, obviously it might have a small impact. But we believe that is the prudent thing to do and is required to get us through this transformation. Susan, you want to add something on this?
Yes, maybe just to add a point that of course our risk appetite as we've mentioned before, is something that we review regularly. And we do expect the performance out of the level of risk that we take. So as François has said, we're just reiterating that our risk appetite determines an operating range and the performance that comes out of that is 7.9 to 8.3. And that we'll be running with an extra buffer for the reasons he explained, for a little while. It doesn't change our midterm targets.
The last thing that I might add on that is that although it doesn't have an immediate impact on the risk appetite, moving the mix of the business from retail products towards business services does slightly impact the risk appetite by a bp or 2 over time. But of course as you're moving that business, the revenue is generated proportionately. So there should be an expectation that the risk range itself in the next years might move by a bp once in a while.
Yes, that's very helpful. Thank you. I'm just trying to figure out at what rate you're going to be accreting book value here. That's all. I appreciate that, thank you.
Sohrab, François Laurin here. I've got the answer for you. So Sohrab, are you still there?
Yes, I'm still here. I'm still here.
Okay, so I guess your question was out of the increase in the non-interest expenses, how much comes from the acquisition?
Yes, I think you said that adjusted non-interest expenses are up 6% year-over-year and I just wanted to know what would it have been ex-Northpoint, yes.
Short of 2%.
Less than 2%?
Yes.
And your next question comes from the line of Richard Roth of TD Securities.
I'll go prompt. With respect to the commentary about there being a bump in the efficiency ratio over time, between the employment measures you're dealing with and the parallel system and the core banking system implementation; which of those two do you see as being a higher risk or a greater chance of causing one of those bumps?
It's a great question that of course we have to ask ourselves. But honestly, management cannot look at any given item in isolation. When we're talking about different costs, these might happen at different schedules or times. And I think that what we're trying to make sure that the market understands is that of course we are in negotiation with the union. This we don't control fully the process. It takes 2 to tango. So at what speed this will get to resolution brings some uncertainty. And of course then what we can do in Retail Services and at what time, well, it's hard for us to make decisions when we don't know the rules of the game. So bottom line, there are some costs and we had already said in previous calls that 2018 would be an investment year for us. But this is a new wrinkle, I guess, to add to the mix.
Thanks, I realize this is a sensitive issue. But would you be able to give some sort of bookend in terms of what the potential impacts of the employment matter could be? And I mean not just from a dollar value perspective. Because maybe you can't do that. But maybe from a timing perspective, like what sort of delay on the sort of transformational plan, worst case, if this thing carries on?
Unfortunately, no. I wish I could. But just from reasons that have to do with negotiations themselves, we can't disclose much on this. Because we can't negotiate in public. And so talking about any issue in regards to time, or money or et cetera, we have to do this at the negotiating table and we'll have to get back to you when that resolves.
Sure, totally understand that. And then final thing, with respect to the core banking system implementation; do you expect additional costs if they arise to be sort of consistent and linear in fashion or is there going to be a step function where one quarter there's a large expense that's just booked because that happens to be the quarter when costs were incurred?
Well the impact on capital occurs as soon as the amounts are spent. So every month that there's a hit on the capital side. But from hitting the expense side, it really happens when the systems are turned on. So we already have a partial hit in our run rate right now. Because we turned on the foundation and part of the B2B services. We'll have probably later in the year when we turn on business services in B2B, another bump there. And when we turn on Retail Services, another bump there, which is in 2019. But as much as I want to be transparent with you, this is all things being equal. So delays can happen. Movements of time can happen. This is a large-scale project. So what we've said is going to be over time within these 2 years. Trying to give you a little bit more color, but take it with a huge grain of salt.
And this now concludes our Q&A session. I would like to hand it back over to Susan Cohen for closing remarks.
Thank you for joining us today. Should you have any further questions, our contact information is included at the end of the presentation. Our second quarter of 2018 conference call will be held on May 30, and we look forward to speaking with you then. Have a good day.
This concludes today's call. Thank you for your participation. You may now disconnect your lines and have a wonderful day.