Laurentian Bank of Canada

TSX:LB

Earnings Call Transcript 2018-Q2

[Operator]

Good day. [Foreign Language] And welcome to the Laurentian Bank Financial Group Second Quarter 2018 Results Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Susan Cohen, Director, Investor Relations. Please go ahead, ma'am.

[Susan Cohen, Director of Investor Relations]

Good morning, and thank you for joining us. Today's review of the second 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 report to shareholders, investor presentation and financial supplement, can be found on our website in the Investors Center. Following our formal comments, the senior management team will be available to answer questions, after which François Desjardins will offer some closing remarks. Before we begin, let me remind you that during the 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 the call over to François Desjardins.

[François Desjardins, President, CEO & Director]

Thank you, Susan, and good morning, everyone. Earlier this week, we provided an update on the mortgage loan review. The summary can be found on Slide 4, with additional information in the appendix of today's investor presentation. All in all, I'm pleased with the progress we have made, and although not yet complete, management is confident that we have a clear path to resolution. As I have previously mentioned, managing this file has been a learning experience that will help us better manage our business, implementing enhanced quality control and originations processes throughout the group strengthens our compliance and risk management practices. In fact, it strengthens our foundation. It is also a reminder of why we are transforming. Simplifying product lines and channels, eliminating paper and more not only lowers costs but also improves the quality of our processes. With that said, we are more determined than ever as we continue to move towards a fully digital banking offer and serve the changing needs of our customers. With respect to our performance in the second quarter, our organization posted good results. On an adjusted basis, net income was up 25% from a year ago, and we improved our efficiency ratio by 210 basis points. Adjusted ROE was 11.6%. This was achieved while maintaining strong capital and liquidity positions, which provides flexibility to execute the transformation plan and pursue sustainable profitability. I'm also pleased to report that loans to business customers increased 19% year-over-year. Furthermore, if we exclude the impact of the sale of the agricultural loan portfolio at the end of the quarter, loans to business customers increased by 23%. The acquisition of Northpoint accounted for about 2/3 of that growth. An important component of our transformation plan is to increase the proportion of loans to business customers in our loan portfolio. Business loans now represent 34% of the portfolio, up from 30% last year. And like I discussed during our last call, the sale of the agricultural loan portfolio is consistent with our desire to exit nonstrategic portfolios so that we may focus on specialized niches where we can win. 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. We also achieved double-digit year-over-year growth as residential mortgage loans through independent brokers and advisers were up 11%. But as you know, however, the whole industry is feeling the effects of tighter mortgage rules and rising interest rates, with the result that mortgage growth is slowing, and we expect this trend to continue. With respect to deposits, we are also pleased that they grew by 7% from a year earlier. Our plan requires investment, and I have previously mentioned 2018 and '19 will be years of investment in talent, performance culture, processes and technologies. Undertaking the transformation from a traditional bank to offering a fully digital banking products requires us to build on strong foundations. The first phase of our initiative to replace our core banking system, the backbone of our digital offer, is progressing. With investment loans already on this platform, we are working to gradually migrate all products onto the Temenos T24 platform. Until we can retire the old systems, we must keep 2 separate core banking systems and the technology teams to support them. I'd like to add that during the second quarter, we successfully implemented our new financing and leasing system at LBC Capital, which will provide improved scalability and flexibility in meeting our customers' needs. As we continue to execute on our strategy of advice-only branches, along with a simplified product offering, we are ensuring that our customers will benefit from value-added approach and investing to prepare our customers. To this end, we have been actively encouraging our customers to use electronic channels. Last quarter, we joined the EXCHANGE network, giving our customers access to 3,600 ATMs across the country. We will continue to focus Retail Services on advice and live up to our mission statement of helping our customers improve their financial health. Our investment in digital banking is continuing. Transactional accounts and deposit products will be our first products offered, thereby supporting deposit growth and further diversification of our funding sources across Canada. Through B2B Bank, these fully digital products will be offered by independent financial advisers and mortgage brokers that we already do business with, enabling them to better serve their clients, enhancing their ability to grow their business and, in turn, making us a key and reliable product provider. Nurturing culture is important, and we believe that offering a dynamic environment for our various Montréal-based teams will contribute to improving the working environment and foster a culture of performance. Montréal-based corporate teams will be moving to our new premises in the fall, an investment in our people as well as in Montréal, where our institution took root. As you know, we are now in the third year of our plan. In the last 2 years or so, many have focused on growth and performance as core elements. These certainly garnered tangible outcomes, but it is important to remember that our first and most important strategic objective is to build a strong foundation. With a strong foundation in place, we will be able to rebuild our service offering and realize the benefits of our transformation. Since we first announced our plan in January '16, the environment has evolved considerably, and we are facing increased headwinds. Some of these challenges are industry-wide, while others are more specific to the organization. With respect to industry-wide challenges, I have earlier alluded to the softness in the mortgage market. Regulatory initiatives to cool the housing market and to slow consumer debt that have been put in place over the last 2 years are having an effect. The mortgage market is tightened. The growth in insured mortgages has slowed and competition for prime mortgages has become fierce, and the private unregulated mortgage market is expanding. Moreover, we have seen 3 interest rate increases in the last year, further impacting affordability for consumers. With respect to challenges that are more specific to our organization, we have yet to reach a new collective agreement with the union. As a result, the transformation of our Retail Services segment is progressing slower than initially expected. While we have been able to simplify our product offering, reduce cost and improve our efficiency as well as continue to focus the network on financial advice, other changes have not happened as planned. We have always been a conservative organization. In the current environment, having a strong capital and liquidity position, while it may come at a cost to earnings in the short term, is simply prudent and conservative. The investments we've already made and will continue making that will allow us to shore up our foundations will continue to put pressure on short-term performance. We strongly believe that this is a temporary cost worth bearing to ensure operational flexibility through the transformation as we build the bank of tomorrow. Although we must adjust our plans and take into account changing times, this does not deter us from our goals. The banking industry is ripe for disruption, and customer behaviors are changing fast. The future will not be kind to organizations that are not transforming, and I am proud to say that at Laurentian Bank Financial Group, we have the foresight and courage to meet these challenges head-on. The Board of Directors shares our confidence in our transformation and has approved an increase in the quarterly dividend of $0.01 to $0.64 per share. I will now call upon François to provide a more in-depth review of the financial results for the second quarter of 2018. And following the Q&A, I will return to offer a few closing remarks. François?

[François Laurin]

Thank you, François. Good morning, everyone. I'd like to begin by turning to Slide 12, which highlights the bank's good core financial performance. Adjusted net income in the second quarter of 2018 grew 25% compared to a year earlier. Adjusted EPS was $1.47, up 6% over the same period. Second quarter EPS was impacted by the common share issuances, which increased the average number of outstanding shares by 23% compared to a year ago. Included in adjusted EPS is the sale of the $380 million agricultural commercial loan portfolio, resulting in a gain of $0.11 per share. Adjusted ROE was 11.6%, and while 10 basis points lower than a year earlier, it reflects a strong capital base which positions us well in an evolving environment. As outlined on Slide 13, reported earnings for the second quarter was -- were affected by adjusted items totaling $5.3 million after tax or $0.13 per share and are largely related to business combinations. The drivers of our performance are presented on Slide 14. Total revenue in the second quarter of 2018 amounted to $259.9 million, an increase of 9% compared to a year earlier. Net interest income rose by 18% mainly due to 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 decreased by 6%, reflecting in part, less favorable capital market conditions. Net interest margin shown on Slide 15 was 1.82%. The main factors contributing to the 15 basis point year-over-year increase was the larger proportion of higher-yielding loans to business customers, including the acquisition of Northpoint with corresponding higher margins and recent increases in the prime rate that were partly offset by the higher level of liquid assets. Sequentially, the margin was up by 5 basis points, reflecting the positive impact of the higher level of commercial loans as well as higher interest rates. While average earning assets rose 8% year-over-year, reflecting 11% organic growth in residential mortgage loans through independent brokers and advisers and 19% growth in loans to business customers, it remained relatively unchanged from the prior quarter. Other income as presented on Slide 16, totaled $82.8 million, down 6% from a year ago. The declines were primarily driven by market-related conditions, with income from brokerage operations down $4 million, reflecting a lower level of activity. And income from treasury and financial markets operations, down $3.3 million due to lower net securities gains. As well, deposit service charges declined by $1.7 million, as clients continue to modify their banking behavior and as we simplify our product offering. This was partially offset by the $5.3 million gain from the sale of the agricultural loan portfolio. I'd like to add that simplifying our product suite is impacting other income. For example, as we no longer offer safety deposit boxes in our branches, while this reduces fee income, it also is offset by a reduction in expenses. Slide 17 highlights that adjusted noninterest expenses rose by 5% year-over-year. This increase was mainly the result of the acquisition of Northpoint, regular salary increases and higher technology costs related to ongoing activities to enhance IT service levels and security. Our adjusted efficiency ratio of 65.1% improved by 210 basis points compared to a year ago and is up 30 basis points sequentially. As we previously discussed, the investments required as the bank transforms will exert 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. Deposits stood at $29.5 billion, up 7% compared to a year earlier. Total deposits sourced through independent brokers and advisers grew by 11%, and institutional deposit growth was also very strong. While we have reduced our footprint to close to 1/3, our branch-sourced deposits have been stable when compared to the previous quarter and have experienced low attrition over the past year. Slide 19 highlights the numerous initiatives that we have undertaken to diversify and optimize our funding. We also have strategies in place for future initiatives, including a U.S. funding program. Slide 20 demonstrates the success of our strategies to increase our non-redeemable broker-sourced GICs over the past 2 years, a higher-quality term funding source, while reducing our exposure to more volatile broker-sourced, high-interest investment accounts. Impaired loans are shown on Slide 28. The gross impaired loan ratio stood at 43 basis points, 1 basis point higher than the previous quarter, reflecting the strong credit quality of the underlying portfolios. The net impaired loan ratio stood at 34 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 lending practices, we expect that the loss ratio will remain below other Canadian banks. Turning to Slide 30. We continue to gradually progress towards our 2020 medium growth targets and financial objectives. To conclude, we are pleased with the core earnings performance in the second quarter of 2018. We're 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.

[Susan Cohen, Director of Investor Relations]

At this point, I would like to turn the call over to the conference call operator for the question-and-answer session. Valerie?

[Operator]

[Operator Instructions] And we'll move to our first question from the line of Sohrab Movahedi of BMO Capital Markets.

[Sohrab Movahedi, Analyst]

Just a couple of clarifying questions. It looks like interest rate sensitivity has changed since year-end. You talked about the structural interest rate sensitivity now resulting in negative or a decrease in net interest income versus an increase before. Can you just talk through a little bit of that, François, as to what's causing that? And ultimately, are you positioned for rate increases or not?

[François Laurin]

Sure, Sohrab. Thank you. First, from the year-end, we reduced -- there are 2 items: the stress test for the next 12 months of the 100 basis points you've seen in the MD&A, and there's the market value. So I will address both. So first, we shortened our duration in the portfolio, so you see a reduction in the market value impact from year-end that we positioned ourself in the shorter end compared to our benchmark. And we basically adopted more of a steepening going forward to benefit higher rate -- future expected increase -- rate increases. And the picture you see is really on that day. Basically, we will benefit. We were in the moving -- end of April, we're moving our position to shorter and to benefit from longer-term interest rate increases, and since then, we have a positive impact going forward. But on that day, on April 30, when you do the stress test of 100 basis points over the whole curve for the next 12 months, it derives a negative $4 million. But since then, as we transition to the desired position, now we have the positive impact on that same stress test. Does that answer your question, Sohrab?

[Sohrab Movahedi, Analyst]

That's helpful. So you are positioned for a rising rate environment, so to speak?

[François Laurin]

Yes. So we were transitioning in the last quarter to move to a shorter end and then to benefit from that. But on that date, that's -- the calculation is as of April 30.

[Sohrab Movahedi, Analyst]

Okay. And then François, maybe just staying with you. You have some discussion in the MD&A around future taxes being higher. And I think you've talked about it in dollar terms, maybe $4 million annually. I wonder if you could kind of position that for us on an effective tax rate basis. Where do you think it will come in? And would this have to do with some sort of -- I wouldn't have thought you had foreign insurance operations, so maybe if you could just talk to me a little bit about what gives rise to that.

[François Laurin]

Okay. Two things. It's a captive reinsurance business for insurance business and insurance that we sell on our products and self-insurance, so that's the business. Second, it would be about 100 basis points in the tax rates if everything is equal, all other things equal, and the legislation is adopted as presented in the budget.

[Sohrab Movahedi, Analyst]

Okay, perfect. And just one last one for me, I guess. And I think about it, you have been collectively fairly transparent about the ongoing collective bargaining arrangements and the like. I mean, are you just exercising an abundance of caution here? Or are things kind of going a little bit less favorably as far as the discussions, given some of the discussion both in the MD&A and in François' opening remarks?

[François Desjardins, President, CEO & Director]

François Desjardins here. It's an abundance of caution. From a relationship perspective, we were at the table still bargaining. I think that from a strategy perspective, though, I think it's fair to say that some of the things that we wanted to do from a Retail Services side didn't happen as fast as we would have wanted them to. And that's really what we're saying. We're looking forward to ongoing talks. And since we're at the table, we can't really speak to the quality of those talks. But I would say abundance of caution is the right answer here.

[Sohrab Movahedi, Analyst]

Okay. Sorry, and I lied, I have one more question. I guess as you kind of sit back and you think about the narrative of we'll have to make some investments '18 and '19, you've talked to us about that a little bit, stay committed to the structural transformation-type targets that you have communicated, how quickly, if need be, are you able to swaddle back on those expenses if the operating environment, either unique to you or industry-wide, were to deteriorate?

[François Desjardins, President, CEO & Director]

I think that pretty quickly, 2018 is a big year in terms of investment, '19, a little less. And further years down the road, certainly less, especially in -- given that this year, we're doing core banking and next year as well. But your question is more in the likes of adjusting to expenses. We're still holding true to our 2020 targets of being at an efficiency ratio of 65%, with some lumpiness along the way. I think that Laurentian Bank has been pretty good at adjusting to situations in the environment, and I think that we'll continue to do that just as well in the future.

[Sohrab Movahedi, Analyst]

And none of this distraction with the mortgage documentation and the like has altered the timeline towards AIRB compliance and the like by the end of 2019?

[François Desjardins, President, CEO & Director]

No. I'm not going to pretend that the mortgage review has no impact. Of course, it does. We're working on it. It takes time, energy and focus. But in the end, it will have no material impact, and that's what we've said all along. In terms of just the general plan, as we said back in 2016, we have 7 years. Everybody was saying it's a long time, but this is transformation, right? Things will evolve, but some things taking a little longer. Some things taking less time, right? As a reminder, last year, we were able to do the branch mergers in advance of the plan. But some things are taking longer. We have AIRB right now at the end of 2020. And what we had said earlier is that the project, when we launched the plan 2 years ago, but that has been evolving, we said that we would get the benefits before the end of 2022, which is still the case.

[Operator]

[Operator Instructions] We'll move to our next question from the line of Richard Roth of TD Securities.

[Richard Roth, Associate]

I had a question on the fee income line, I guess both the brokerage and deposit fees. It seems like there's some permanence to this decline. You mentioned -- François, you mentioned the safety deposit boxes. Do we see now this current level as a steady run rate? Or are we going to still see some more further decline as you economize or streamline your branches and your service offerings?

[François Laurin]

Well, thank you, Richard. I may comment on that. In the other in -- as far as other income, our concern -- as we simplify our product suite, obviously, we will eliminate some fee-generating products. However, we see expenses also move our way, and overall, we see an efficiency contribution bottom line. But if the trend on service fee is going down, we expect that going forward, and that's part of our plan. But we also expect that our revenues will benefit positively from the implementation of our strategies in the retail to move to financial advice and the advent of the digital products as well to the retail level. So all in all, we will have revenues and positive contribution efficiency ratio-wise and bottom line-wise going forward. But if you look at just the one line of service fee, clearly, that will change over time.

[Richard Roth, Associate]

Got you. And I guess this is somewhat related to that. We saw this quarter, I guess, your FTE, your headcount was elevated and, I think, higher than it's been for a little while. How would you describe that in the same context of streamlining branches and all that?

[François Desjardins, President, CEO & Director]

I would -- François Desjardins here. I would just -- in the same vein that we're saying that we're making investments in the business, this is just a direct correlation to that.

[Richard Roth, Associate]

Okay. And is this a good run rate? Or are you guys going to continue adding more heads, I guess, for core banking system conversion and the other investments you're doing?

[François Desjardins, President, CEO & Director]

There's both. Some projects will require higher headcount. Efficiencies and elimination of certain services or automation will require lower headcount. So over time, there's going to be some lumpiness in the total FTE count. But in the end, what you should be looking for is lower headcount in terms of general administration-type positions and more towards advice, specifically in the Retail Services sector. And just generally, I would say the same level as today with a different composition.

[Operator]

We'll move to our next question from the line of Meny Grauman of Cormark Securities.

[Meny Grauman, MD & Head of Institutional Equity Research]

First question is just on the issue of the union negotiations. François, you mentioned that it's not allowing you to do certain things in the retail channel that you'd like to do. Can you just explain what those kinds of things are? What is it preventing you from doing that you'd like to be doing?

[François Desjardins, President, CEO & Director]

I'll ask Stéphane Therrien to answer that question, Meny.

[Stéphane Therrien]

Yes, thanks for your question. As you mentioned, we are negotiating to renew the collective agreement. So for example, in the last couple of -- I would say the last 2 years, we've merged a couple of branches, but we have not opened new branches. So that's one example of investment that is taking us a bit more time. And as François just mentioned, we, in our plan, we wanted to change the mix of employees from back office to front-end type of employees. And unfortunately, we're not moving as fast as we want on that front.

[Meny Grauman, MD & Head of Institutional Equity Research]

So the negotiation is preventing you from hiring new people, and that's preventing you from opening branches. Is that sort of the connection to the collective agreement?

[François Desjardins, President, CEO & Director]

I think that -- François Desjardins here. I think that just in general, the way that you should position it is that there are some things like that, that are a little bit more strategic and positive that we have to negotiate with the union. And the negotiation is taking longer than expected. So we're still hopeful that -- this is still the plan. It's just taking a little longer to get to an agreement.

[Meny Grauman, MD & Head of Institutional Equity Research]

Okay. And then just to try to understand on Slide 31, some of the targets. I mean, it was mentioned before, just the efficiency target, and I appreciate you're not changing that target. But I was wondering if you could help us kind of think through it in the context of the mortgage issues. I mean, you've talked about how you have some higher expenses related to that. So the fact that your target is not -- is still in place, do we think about those extra expenses related to the mortgage issue as just being temporary? Or you're just able to find offset somewhere else where you didn't expect, maybe you built in some contingency. Help with that, I think, would be useful.

[François Desjardins, President, CEO & Director]

Sure. We've said all along that managing the mortgage review sure takes time, energy, focus, but from a pure cost perspective, it's not really that material. It's not a significant cost, so it's not really material to the business. In terms of the efficiency ratio, what is more important is that 2018 and 2019, we are making investments in the business, and that's what we've been talking about. Investing in core banking, we have to hold 2 systems side by side. We have to hold 2 teams side by side. That's a significant expense that once core banking is completely done, then those costs go away. And that's why there's lumpiness in 2018, 2019, and we're saying like these are going to be investment years. These are the type of items that are driving those costs. Of course, different projects also have different costs. But as it relates to the mortgage review itself, we're not saying that, that's significant at all from a cost perspective.

[Meny Grauman, MD & Head of Institutional Equity Research]

Okay, understood. And then if I could just ask about the ROE target. I mean, on that same slide, you talked about the gap to peers and you have a target relative to peers. Given some of the expenses you're talking about, the challenges that you're talking about over the next 2 years, is it reasonable to assume that, that gap could actually -- that gap to peers on ROE could actually widen, at least temporarily?

[François Desjardins, President, CEO & Director]

I think the guidance that we've been saying for 2018 and '19 is that the ROE would be -- or possibly slightly below what we've seen in the last quarters. As a reminder, some of the reasons for that is we're holding higher capital than we used to, and also, we're holding higher liquidity just to help us -- and then be prudent and conservative and to give us operational flexibility around these 2 years of investment. But from a guidance perspective, we haven't changed our mind. Of course, this gap is also -- I know there's a -- it takes 2 to tango here. I can't predict with certainty what the industry average is going to be, but certainly, we're working towards narrowing the gap. And as I've said in previous calls and even since the beginning of the plan, these mid-term targets are one thing, but the real target is to narrow the gap completely. And that is something that we're holding ourselves true. The plan is not only to get to 2020 but to get to that narrowing of the gap completely, which is achieved not only by efficiencies, but also by better capital management which is the AIRB project. As you know, moving to advanced methodology, we've said and we've resaid it has an impact of about 200 basis points on our ROE. And with the implementation in 2020, that takes us to a really completely different level in terms of profitability as RWAs are calculated downwards. And of course, getting there requires us to make investments and better processes and such, but that's the real part of the plan on that front.

[Operator]

And we'll move to our next question from the line of Scott Chan of Canaccord Genuity.

[Scott Chan]

I just wanted to look at some of the volume growth trends. If I look at the commercial side and if I kind of x out the ag sale and acquisitions, is 8% year-over-year the right number over the past 12 months?

[François Laurin]

That's, yes. That's a good number.

[Scott Chan]

That's a good number. And is that 8%, is that a good number for the next 12 months on an organic basis?

[François Desjardins, President, CEO & Director]

What we said was low to mid-single-digit loan growth overall.

[François Laurin]

The target is to meet the $14 billion that we have by 2020.

[François Desjardins, President, CEO & Director]

You can refer to Page 30 of the PowerPoint presentation for the targets for 2020, which we feel are the targets we're working towards.

[Scott Chan]

Okay. And maybe just a modeling question on other income in terms of the gains on sale. On a quarterly basis, like are you comfortable providing a number that we can use on an annual basis just because it's so volatile?

[François Laurin]

We don't -- Scott, we don't provide that information. This is when we do -- we've had one last year. We have one this year. We can't predict. We review our portfolios regularly, but we don't disclose and we don't project this. We project our stuff on the mid-term. It's part of our midterm and guidelines into efficiency and profitability that we maintain.

[Scott Chan]

Okay. And maybe just lastly, just on the CHMC (sic) [ CMHC ] review. In terms of the 50-65% mortgage product that was specified, that you guys specified, what percentage of that is -- of that product of your total mortgages? And is it predominantly in that B2B channel?

[François Desjardins, President, CEO & Director]

I'll ask Christian De Broux, Senior VP of Credit, to answer that question.

[Christian De Broux]

It's about 10% of our mortgage book, and it is predominantly B2B. About 3/4 of the amount is B2B. And I think it's important to state that this is -- these are loans with great customers where we have 35% and upwards all to 50% of cash down. And because of this, we have simplified documentation to make it easy for these customers to do business with us. Under the new B20 guidelines, now it's the same full documentation that is required regardless of the cash down being given. But these are good mortgages.

[Operator]

We'll move to our next question from the line of Gabriel Dechaine of National Bank Financial.

[Gabriel Dechaine, Analyst]

Just wanted to follow up on the fee line there, and you did highlight one example, anyway, of safety deposits eliminating those. Between the various actions that are taking place there plus the change in consumer behavior for -- putting downward pressure on the deposit fees, like is there a way you can quantify the revenue and offsetting expense elements that will come out of this?

[François Desjardins, President, CEO & Director]

The change that you've seen in the year-over-year from the deposit line is pretty much from the change in the service offering. I would say that in terms of guidance, removing safety deposit boxes is behind us, so you should see some stability going forward on that line. But I think if we're looking much further into the future, customer behaviors are changing, right? So there are pressure on eliminating fees overall. Of course, like François said earlier, that has to be balanced with an equal or greater amount of cost reductions. If people aren't going to counters anymore to do transactions, they won't pay fees for them. But at the same time, we won't have employees there waiting to make those transactions happen. And therefore, the net should be positive for us but in a sense, also for the clients. People pay a lot in fees in Canada, and reducing those fees is a theme that has to do with financial health. We aim to improve our customer financial health, and in the Retail Services sector, that's exactly what we're doing.

[Gabriel Dechaine, Analyst]

So I thought these deposit boxes, you said that's built into the run rate. Are there other actions? I can't imagine it's just the one. I can't imagine you made that much money on safety deposit boxes. Like is there more to come that we'll see in this particular line?

[François Desjardins, President, CEO & Director]

I can ask Stéphane Therrien.

[Stéphane Therrien]

Just to remind you that we converted roughly 23 of our branches to advice-only, which means that there's no transaction over the counter anymore for these branches. As we continue on this route, this will generate, obviously, less fees but, as François just mentioned, obviously a lot less expenses for us as well.

[Gabriel Dechaine, Analyst]

Yes, okay. But it's a near-term hit to the fees, and then longer term, you've come out ahead basically. Is that the idea?

[François Laurin]

They're more aligned than you think.

[Gabriel Dechaine, Analyst]

Okay. My other question is on the, well, I guess, the NIX ratio. If I back out that gain on the ag portfolio sale, we saw the NIX ratio pop up over 66% this quarter. And you're talking about investments that you're making this year and next. I'm just wondering if this sort of 66% level is -- you're going to be bumping around that over the next 1.5 years, say?

[François Desjardins, President, CEO & Director]

I'll ask François Laurin to comment on that.

[François Laurin]

Well, basically, the NIX ratio and the efficiency -- it's very tied to the efficiency ratio, Gabriel. And we said that this year and next year would be a time where investments in people, processes and technology, as François mentioned, will be performed and done. And it's also a period where we're enhancing our technology and our compliance framework, regulatory and compliance framework. So last quarter, we mentioned that there would be a bump and it won't be a straight line direction towards the 65% on a sustainable basis of efficiency ratio. So this period reflects that. This quarter reflects a bit of that and the next ones as well. But our objective is still to get back to 65% on a sustainable basis by 2020.

[Gabriel Dechaine, Analyst]

No, no, I get them because you're very clear on that, but you made big strides in the last few years. This year and next are investments, and then we're back on track to lower that ratio. But beyond 2020 -- or 2020, I guess, is the timeline in the interim, where it's kind of more flattish efficiency performance. Is that the idea?

[François Laurin]

Well, as you see this quarter, slightly above last quarter, so we'll have -- we'll fluctuate a bit. We said last quarter that we were less than 65%. Now we're a bit above 65%. So it's going to fluctuate a bit by -- clearly above 65% for -- within a small range over the next 2 years.

[Gabriel Dechaine, Analyst]

And the liquidity discussion keeps coming up in your margin outlook, and I appreciate the slide that you -- I forget which slide it is now, but the one where you break down what's in your liquidity. I've asked this question before. I'm trying to track it on the balance sheet and maybe if there's a direction there that we should anticipate. Are you building more liquidity? I know there's an internal capital measure -- or sorry, liquidity measure you use, but for calculation of margins and such, we've got to use the balance sheet. So if I look at cash and some of the securities, that's around 8% of your earning assets. Is that -- and that's been pretty flat for the past few years. Is that number going to bump higher or not?

[François Laurin]

So you mean -- which number are you referring to now, Gabriel, if I may ask?

[Gabriel Dechaine, Analyst]

I just take cash plus AFS securities and held to maturity and divide that by earning assets, and it's 8%. That's how I look at it, and it's been pretty tight around that level for a couple of years. So I'm not actually -- from what I see, I don't really see the big bump up in liquidity that you're alluding to, so trying to figure that out.

[François Laurin]

Okay. First, we don't publish -- it's François Laurin. We don't publish LCR, but I can tell you that we're higher than the average of the banks who publish their LCR. So it doesn't give you a quantum, but it gives you, I think, a range, a point of reference. Obviously, both the LCR and our internal requirement methodology takes into account also our requirement of cash. It's not just the pure liquidity cash asset but what our commitments going forward. And one of the things that we've done is that we straddle our institutional funding on a longer-term basis, so that alleviate the requirements on a short-term basis, which in fact, helps our -- what we call the liquidity level that we need to maintain and that we maintain. So I think it's a combination of the numbers you've mentioned. And when you look at the balance sheet on the other side, especially on the funding side, as you see a longer funding duration, then obviously, it does impact the liquidity requirements, measures, both regulatory and internal. I mean, have I helped you?

[Gabriel Dechaine, Analyst]

Let me ask this way. Do you expect the cash and securities balances, that rate of growth, to outpace your loan growth, for example?

[François Laurin]

Typically, it would be in sync, give or take a small margin. But the portfolio build-up would be similar as we move the balance sheet at a higher level. That's a fair assumption.

[Gabriel Dechaine, Analyst]

Last one. The broker channel, is there a push toward -- like are you seeing some consumers going for more 2- to 3-year terms? And how is that affecting your funding cost?

[François Laurin]

Our funding cost? You mean from a broker deposit?

[Gabriel Dechaine, Analyst]

Yes. Sorry, broker deposits with rates moving higher. Consumers might be looking more to 2- to 3-year deposit terms as opposed to what they were doing when rates were super low and you can sell those. Is that a trend?

[François Laurin]

It hasn't moved that much. The needle hasn't moved that much. It's still the 1 to 2 years predominantly in the GIC world at the moment.

[François Desjardins, President, CEO & Director]

We have seen rates go up on both sides of the balance sheet, though, both on mortgages and on non-GICs in general.

[François Laurin]

But the point of reference for us, Gabriel, is what does our NIM do, and our NIM improves even when the cost of fund improves. It's all reflected in our pricing, and obviously, the NIM is the best reflection of how we manage them.

[Operator]

We'll move to our next question from the line of Marco Giurleo of CIBC.

[Marco Giurleo, Associate]

I'd like to touch on mortgage growth quickly. We saw a 2.8% decline in the book this quarter, and you cited B20 headwinds and the exit of the broker channel in Québec. I was just wondering, in addition to that, was that partially offset by any loans acquired originated by third parties this quarter?

[François Desjardins, President, CEO & Director]

I'll ask François Laurin to answer that.

[François Laurin]

Yes. Clearly, what we originate, that's the number you have and that you quoted. And obviously, we still have the program, the NHA MBS, while we acquired some in the market and put it out in conduits. That's the other part that ends up in the mortgages numbers in the end.

[Marco Giurleo, Associate]

Okay. So would the mortgage balances have been down more sequentially ex this and how much more?

[François Laurin]

No. No, I don't think...

[Marco Giurleo, Associate]

They came off the books?

[François Desjardins, President, CEO & Director]

The portion of the NHA is not really that significant in terms of the ones that we buy from third parties, so the number that you have is pretty much in line. I would say, though, as a general comment on growth, we reset our medium-term objectives last year after 2 important years of growth, as you know. And we reviewed our growth targets, I said earlier, to low mid-single digits, both on mortgages and on loans to business customers. We're really happy with the progress that we made on the Business Services side, especially in equipment finance and inventory finance. I think that, that is really helping us in our objective to move the mix of the bank towards Business Services. And as you may recall in my prepared remarks, that has been working. We're up 30% of the mix, up to 34% now. On the mortgage side, though, there's been many environmental impacts at play here. The market has been soft in general for the industry as a whole, rising interest rates, B20. And as you know, we had high growth in Q1, before the holidays, as people were trying to beat the implementation date of B20. But a big part of the loss here is we stopped accepting referrals from mortgage brokers to the branch network and concentrated Retail Services on financial advice. We just didn't think that it was the best use of our financial advisers. And now they're concentrating on our own clients, financial advice, investments and deposits. And deposit growth has been actually really good, including in the branch network in the last quarter. So that paints a good picture of growth in general, I think. Looking forward, though, still looking forward to growth, both in loans to business customers and mortgages, to be able to get to our 2020 targets.

[Marco Giurleo, Associate]

All right. Great. And I just had a quick follow-up on the tax rate. So the effective tax rate was over 200 basis points -- it was down over 200 basis points sequentially. You mentioned a benefit from the 100 basis point benefit from the reinsurance business. What else was impacting the tax rate this quarter? And is the current tax rate that we saw this quarter a good run rate?

[François Laurin]

For the rest of the year, yes. Basically, 20% to 22% is a good range for tax rate. What I mentioned earlier is 29%. The impact of the 100 basis points would be only beyond this year, '19 and following.

[Operator]

[Operator Instructions] And we'll take our next question from the line of Sumit Malhotra of Scotia Capital.

[Sumit Malhotra, Managing Director of Canadian Financial Services]

First questions are going to be around capital. So the ratio, CET1, was up very little bit quarter-over-quarter, so pretty flat. You would have had the benefit, I'm assuming, of the portfolio sale coming out of RWA. Just maybe for François Desjardins in thinking about that ratio going forward. If the mortgage portion is going to be a smaller part of the growth going forward, is it fair to say or is your forecast that we shouldn't see too much organic capital growth from here, given that it will be more higher RWA components that are driving your loan growth?

[François Desjardins, President, CEO & Director]

Yes. I think that you're right on this. I mean, what we had said is that we would be operating at the higher end of the operating range that we had set for ourselves, which we are. And over time, as the business mix changes towards Business Services, of course, the CET1 adjusts accordingly to the business that we have. These things are really progressive, I would say, over time. So you're right towards that. The level that we're at currently, I think, is what you should be expecting in the near future. We said so for the last little while here that for us, managing this transformation prudently is important, and having higher liquidity and capital ratios just, I think, ensures that we have the means to make the moves we need to move -- make the moves we need to make when we need to make them. So that's where we are.

[Sumit Malhotra, Managing Director of Canadian Financial Services]

And related to capital, on the AIRB transition, I don't want to put too specific a time line on a few quarters, but you and I have had conversations about this in the last few years. It does seem like have changed from now the end of '19, start of '20 to one year later. Is it -- you've made a few references to having to run the 2 systems. Is there anything in terms of the information that you're providing to OSFI that is responsible for this delay? Or is this just part of the process as you shift through? Because I think you'll agree, we had talked about starting '20 under AIRB previously.

[François Desjardins, President, CEO & Director]

I'll ask Susan Kudzman to comment on that, Sumit.

[Susan Kudzman]

Yes, Sumit, you're right. We are speaking a little bit more about later 2020 now. But there are no real issues, be the regulator or even the project itself. As you well know, it's a very big project involving a lot of work on models but also data government and processes within the bank. So as we're getting further along and it's progressing well, we've refined their time line and now we're looking at later 2020, which you mentioned, more just a process. Business case for AIRB remains as strong as ever. As we refine our time lines, we also refine our numbers, and that still is very solid and still expect the 200 basis points on our CET1 ratios as in the past.

[François Desjardins, President, CEO & Director]

And as you might remember, Sumit, when we started talking about this back in 2016, the actual physical date that you put the switch on is not the actual physical date that you get 100% of the benefits. That has never occurred in any bank. It happens over the next few months and years, and that's why we built the plan up until 2022 because when you turn that switch on, then the benefits happen in 12, 18 months that come after that. And therefore, that's why I said earlier that we're still expecting to have those benefits within the timeline of the plan.

[Sumit Malhotra, Managing Director of Canadian Financial Services]

Since Susan came in there, let me go back to her for a minute. Credit quality has been so good across the sector that maybe we don't have to look or talk too much on these calls about some of the underlying metrics. But just as we're going through the process here, I noticed with respect to your coverage ratio, so if I have it right here, it's about 65% this quarter. There's reference made earlier on that with the portfolio composition changing again more towards commercial, that you would expect the loan losses to reflect that and, obviously, be offset by margin. But at least -- I've covered this bank for a long time. I don't think I've seen the coverage ratio in the mid-60s. Like conceptually, as the portfolio changes, should we expect this number to move higher as far as the overall allowance build is concerned? I know your gross impaired loans have been lower, and that's a big part of it. But a 10, 11 basis point provision ratio at this point in the cycle, with the portfolio changing, from a risk perspective, Susan, where is your thought process on how the allowance build trends from here?

[Susan Kudzman]

Well, a couple of things, and you've touched on some of the correct facts in here. Our loss ratio has always compared favorably to the industry, and we've had a higher coverage ratio in the past. And more importantly that I repeated over quarter after quarter, that this loss ratio is quite low. And we had spoken about the business mix changing, and we're coming off a good cycle. However, one thing maybe to mention is that as we are moving to AIRB, we're reviewing our models. And we had a very conservative provisioning, and that's maybe appropriate when you're under standard methodology and using, if you will, a tool that's a lot more -- less refined than AIRB. So as we continue, and it's relevant to your earlier question, as we continue to get further -- move along that process, our models are becoming more and more refined, allowing us -- as you see, we've released provisions in the review of the models. And I would just say that's all that coverage -- that the decrease in coverage is really coming from -- obviously, more from less avenues. That will be even furthered as we go forward with IFRS 9 in the future.

[Sumit Malhotra, Managing Director of Canadian Financial Services]

Okay. So I hear you. That's one of the...

[Susan Kudzman]

Maybe Christian De Broux would like to add something on that.

[Christian De Broux]

As we grow the commercial, I think it's important as well to understand that we're not changing the conservative-ness that we've always shown in our credit approach. I think the level of provision that we have is reflective of the collateral that underpins all our deals, and we've proven ourselves on that.

[Sumit Malhotra, Managing Director of Canadian Financial Services]

All right. No, I think I understand you that some of the process and shifting to AIRB is giving you more kind of visibility in underlying credit trends. And perhaps, that's the reason that ratio is lower. And we heard something similar from other banks as well.

[Susan Kudzman]

Exactly, and that's a good thing. We're getting a better, more refined view of our risks.

[Sumit Malhotra, Managing Director of Canadian Financial Services]

All right. Last one for me, go back to Mr. FD, is just thinking about the targets and where we stand halfway through '18. I think we'll agree that the last 6 months have been more challenging on a few fronts. And when I look at EPS this quarter, maybe this is the way to look at it, maybe it isn't. If I take out the portfolio sale, the EPS in Q2 is down 2% year-over-year. There's been a lot of reference to the medium-term targets of 5% [ DRP ] in general, but if I look at the EPS one, it's 5% to 10% annually. If I go ahead 6 months from now, hopefully, the review with CMHC is behind you, and it's back to that not having -- you said there's some impact on management time from that, so that's behind you. When you think about 2019, it feels like for a few calls now, I've heard you make references to higher liquidity, investments required, some of the impact that we're seeing on the industry in mortgages. Do you think that 5% to 10% range is applicable to 2019? Because in hearing you the last few calls, it seems like your messaging is, hey, that's a medium-term target and maybe not something that we're able to do in the very near term as a result of some of these initiatives and headwinds we're encountering.

[François Desjardins, President, CEO & Director]

Well, I think that all of the midterm targets go together, right? So including the EPS growth, which is a CAGR, you can't say that there's going to be lumpiness on the efficiency ratio and the ROE without talking about lumpiness on the EPS as well. But all in all, our guidance to you is that these investments are required. They're going to create a little bit of lumpiness in the results. But in the end, we're going to get to a better bank and a sustainable efficiency ratio and also one that we can build upon to get the rest of the way. We're looking at -- we're not making investments for investments here. We're making investment so that we have a better foundation in which to build on. And of course, we've said this since the beginning of the plan, we're absorbing these costs within "operating budgets" here, right? We're not -- investments in core and et cetera, et cetera are done within our normal business activities. So specifically, for '19, we usually don't give guidance, as you know, for a specific year, and I think that we're pretty open with trying to make a -- give a good idea of what to expect in 2020 with some lumpiness from now till then.

[Sumit Malhotra, Managing Director of Canadian Financial Services]

No, I hear you. And look, as I said, it's been -- there's been a few bumps in the road the last 6 months. And it's just when I look at market expectations, it seems like there's a view that the growth is going to be right in line with your target range. And at least from my seat, listening to you, it seems like you're saying, hey, it's not a straight line path.

[François Desjardins, President, CEO & Director]

No. And I want to be clear on this, right, because I have to separate out the mortgage review from other headwinds that we're facing. Doing a transformation, in any case, is never easy. Forget the mortgage review for a second and just look at the other things that are going on in the industry and economics. We have to adjust to those things. But the real question is, how are we creating long-term value for investors? By investing in the business and transforming into something that's going to be better and sustainable. So sure, I mean, I would have rather talked about something else in the last 6 six months. And of course, I don't want to lessen the importance of this. The team is addressing the mortgage review with urgency and transparency as much as we possibly can with you. But the more measured response here is that once this is behind us, and it will be, the plan -- we have some big years of investments in front of us, a lot of work, and we're going to be proud of the outcome.

[Operator]

And we'll move to our next question from the line of Darko Mihelic of RBC Capital Markets.

[Darko Mihelic, Financials Analyst]

First question is, how much did you earn in the U.S. this quarter?

[François Laurin]

We don't disclose that, Darko.

[Darko Mihelic, Financials Analyst]

Okay. Second question, why did you decide to sell the agricultural loan portfolio?

[François Desjardins, President, CEO & Director]

I'll ask Stéphane Therrien to answer that, Darko, if you don't mind.

[Stéphane Therrien]

Yes, Darko, thanks for your question. As François mentioned, we -- as a smaller bank, we continually review our portfolio to determine which one we should grow, fix, exit or maintain. And as you know, for the last couple of years, we had a specialized approach, and we play where we can win in this across Canada. So for us, agricultural portfolio was only Québec-based and not strategic for us because of its small size.

[Darko Mihelic, Financials Analyst]

Are there any other portfolios that are at risk here or -- it's just peculiar because you have growth plans, right, in commercial, and so I wouldn't have thought you would be selling portfolios.

[François Desjardins, President, CEO & Director]

Well, I wouldn't use the words at risk, and of course, I'm not going to announce anything today. But I think that the comments that I've made earlier are there are some areas or portfolios that we want to grow and maintain and some that we might need to fix and some, exit. And I think that pretty much covers what we want to do. We do have growth plans in Business Services, and we're proving that every day. But it doesn't mean that if we're looking at growth plans -- some of our portfolios like equipment finance or inventory financing, real estate financing are all on growth mode. It's when we have smaller portfolios where we can't necessarily or we feel we can't necessarily win, we're not going to fight it out for nothing and concentrate on things that we can be relevant to our customers.

[Operator]

It appears that there are no further questions at this time. Mr. François Desjardins, I'd like to turn the conference back to you for any additional or closing remarks.

[François Desjardins, President, CEO & Director]

I'd like to thank everyone for their questions and comments today. And of course, there's a lot of comments about what we're doing in this quarter and in future quarters, but I'd like to give you a few thoughts as well in terms of how are we creating future value. In 2016, we announced that we were going to transform the bank. First time I said the words 7 years, people said it's a long time. It's going to be -- but that's what is required. So how are we basing our goals here of becoming profitable to the level of the industry, managing our efficiency? We're doing that through efficiency gains and changing our model and implementing AIRB. Yes, we said growth, of course, but as you remember, when we were speaking at the investor forum, growth just pays the bills. And investing in growth that's not profitable is not going to take us the way there. There's going to be lumpiness along the way. I've said that from day 1. But what have we done so far? 2 really big growth years, 2 acquisitions, transforming the branch model. We merged 50 branches, implementing the systems, worked on efficiency gains, which many thought weren't possible for Laurentian Bank. And now we are facing some headwinds and challenges that we're addressing head-on. But sometimes, I ask myself the question, what if we didn't do these things? What questions would you be asking? Well, what are we doing about fintech or about millennials? What about competition and staying relevant to our changing customer base? How about digital? And what are you doing to move the efficiency ratio to an industry standard? These are the things that we would be answering today if we weren't doing our transformation. So since we presented our plan just 2 years ago, our vision has taken shape, and I think we've made significant progress so far. There's been a lot of excitement about what we're doing both internally and externally about our plan, and I think more and more people are realizing that the transformation is real and that we're making it happen. We're more determined than ever, and we're seizing this opportunity to build a much better bank than what we were. I want to thank you and leave you with that and your interest and support. Thanks, everybody.

[Operator]

This concludes today's call. Thank you for your participation. You may now disconnect.