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Laurentian Bank of Canada
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Good day. [Foreign Language] and welcome to the Laurentian Bank Financial Group Third Quarter Results 2019 and Laurentian Bank Financial Group Conference Call. Today's conference is being recorded. And at this time, I would like to turn the conference over to Ms. Susan Cohen, Director, Investor Relations. Please go ahead, ma'am.
Good morning, and thank you for joining us. Today's review of the third quarter of 2019 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 supplements, can be found on our website in the Investor 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.
Thank you, Susan, and good morning, everyone. Today, the Laurentian Bank Financial Group reported improving financial results. Adjusted net income, EPS and return on equity increased this quarter compared to the prior quarter. We reduced the level of liquidity, which led to higher net interest income as well as higher margins. This was partially offset by lower other income, reflecting challenging capital market conditions. And finally, we prudently managed expenses. As a result, the adjusted efficiency ratio improved and operating leverage was positive. Real estate financing, along with equipment and inventory financing, are niches where we have built expertise and strong relationships, translating into profitable growth. Moving towards higher-margin commercial loans is one of our key strategic objectives. On that front, we increased loans to business customers and their proportion within the loan mix. We have yet to see a return to net growth of mortgages and personal loans. The underlying credit quality of our portfolio remains good and our capital position remains strong, providing a solid financial foundation to grow our balance sheet.The main focus of the last quarterly call was the new labor relations environment, which now have a redefined bargaining unit limited to specific existing positions and the signature of the collective agreement. From a strategic standpoint, there should be no doubt that this is a long-awaited, hard-thought, significant gain for this organization as it fundamentally resets how talent is managed going forward and eliminates costly and unproductive processes. The percentage of employees represented by a union is now less than 25% compared to more than 50% at the end of 2015. But more than anything, this great strategic achievement is allowing retail branch operations to turn their complete attention to customers' financial needs, translating into more revenue-generating activities, and the entire organization to resume efforts on transformation-related strategic objectives. Today, my remarks will highlight the progress we are making on 3 initiatives that aim at fixing and building our retail distribution networks. First, I am pleased to say that we have completed the Québec branch network transition from a traditional offer to 100% advice. Yes, 100% advice. From this point on, when customers visit our retail locations, they will benefit from a different experience where the conversation will be all about improving their financial health. Whether a financial health assessment or a full financial plan, an RSP contribution, a personal loan, a mortgage or mutual funds, customers have access whenever and wherever it suits them to the 450 advisers who now have the flexibility to meet their customers at home or in their office. What it also means for customers is no longer having to pay for in-branch services they do not use such as basic transactions that they can easily complete on their own by using our electronic services, including ATMs. No more walking around velvet ropes and waiting in line, no more different opening hours for services and no more passbooks. This is no longer an old sleepy bank anymore. We are the first Canadian bank to successfully transition our retail branch network from a traditional offer to 100% advice, a business model that we believe better fits the lifestyle and needs of modern customers. To reflect this change going forward, our branches will be called financial clinics. The team is really excited about this transition. For them, 100% advice means that they can now maximize value-added customer adviser relationships, see more customers, get more referrals and help more people. Second, we have begun to roll out our digital offering. B2B Bank is going to market with high-demand products starting with digital bank accounts and deposit products. Indeed, from now on, B2B Bank's current and new customers will benefit from using the new platform for these products and will have access through mobile devices. Clients of independent advisers and brokers across Canada are the first to benefit from our brand-new digital additional offering. Initial feedback from advisers is that the sign-up process is easy and intuitive, and they love the fact that this organization continues to support independent advisers and brokers and helps them build their businesses.Third, we are also planning to launch a digital offering under Laurentian Bank brand to all Canadians before the end of the fall. Even though Laurentian Bank has not been present outside Québec in retail distribution since 2003, our brand recognition across the country is high and we expect to attract new customers, the young and the young at heart, and develop new markets where clients are seeking hassle-free deposit products. Going forward, we are planning to use this mobile platform to strategically launch more digital products and gradually gain new customers and deepen relationships. Fixing our retail distribution is important to the success of our strategic plan. With these initiatives and more to come, we are doing just that. We are refocusing our team's efforts on revenue-generating activities, which also means prioritizing growth and efficiency. It should be no surprise that from a growth perspective, all our retail teams at LBC financial clinics, at B2B Bank advisers and brokers and at LBC digital are now focused on growing mortgages, personal loans, credit cards, deposits and mutual funds. On the efficiency front, we are eliminating noncore administrative activities and duplicate operations as well as automating and outsourcing back-office activities. We are looking forward to a more efficient cost structure, a simplified, less expensive operation. We're also reducing obsolete branch, back-office and administrative work. Indeed, moving to 100% advice reduces the cost of managing traditional banking activities, specifically expenses associated with handling cash and other obsolete processes.So far, this has allowed us to regroup or outsource all our retail credit adjudication, collections and administrative responsibilities. We believe the savings from lower headcount and associated costs will be between $15 million and $20 million annually, which we expect to gradually impact results through the first half of 2020. Since the beginning of our plan, I have been keeping you informed of our progress on key elements. I understand the eagerness to see strategic wins and investments translate to financial results because I myself am eager to report improved performance. I have said before that to achieve our goal, this transformation needed to be and would be profound. What we have accomplished in the last 3.5 years is tremendous work that had to be done to allow for real change in the way we do business. We have improved many aspects of our organization that are not yet visible to the naked eye: systems, processes, governance, leadership and culture. We are at a pivotal moment in our evolution. These are indeed exciting times. Therefore, I want to thank our teams for their continued support and passion and our shareholders for their confidence, it will be rewarded. Lastly, I want to welcome our new Board members, Ms. Andrea Bolger and Mr. David Mowat. The Board of Directors, my executive team and I are looking forward to working with them at this turning point in the history of our organization. I will now ask François Laurin to provide a more in-depth review of our third quarter financial results. François?
Thank you, François. Good morning, everyone. I would like to begin by turning to Slide 13, which highlights the bank's financial performance. Adjusted net income of $51.9 million, EPS of $1.15 and ROE of 8.5% in the third quarter of 2019 improved sequentially and were lower year-over-year. Reported earnings for the third quarter, as outlined on Slide 14, were affected by adjusting items totaling $4.1 million after taxes or $0.10 per share and are related to restructuring charges and business combinations. The drivers of our performance begin on Slide 15. Total revenue in the third quarter of 2019 stood at $244.7 million, up 2% from the previous quarter and down 6% from a year earlier. Net interest income in the third quarter compared to last year was marginally lower as the impact of lower loan volumes was partly offset by an improving product mix. Compared to last quarter, net interest income improved by 7% due to the positive impact of 3 additional days, seasonally higher penalties on mortgage prepayments and a lower level of liquidity.Net interest margin, shown on Slide 16, was 1.85%. The main factors contributing to the 8 basis point year-over-year increase was a lower level of liquidity, the change in the portfolio -- loan portfolio mix and the favorable Prime/BA spread. As we mentioned last quarter, the new labor relations environment allowed us to reduce liquidity. The 8 basis points quarter-over-quarter increase was due to lower liquidity and seasonally higher prepayment penalties and the favorable Prime/BA spread. In the fourth quarter of 2019, we expect that margins will -- may be relatively stable, excluding the impact of the seasonality of prepayment penalties. Over the medium term, margins should modestly expand as volumes increase and the business mix continues to improve. Commercial loans now account for 38% of the portfolio compared to 35% a year ago, and residential mortgages and personal loans account for 48% and 14%, respectively.Other income, as presented on Slide 17, totaled $68.6 million. Capital-market-sensitive revenues explain most of the year-over-year and quarter-over-quarter decline. Gains on inventory held for brokerage activities, gains on other trading activities and fees and commissions from brokerage activities were all lower than in previous periods, mostly stemming from higher volatility and lower liquidity in the capital markets.Slide 18 highlights the adjusted noninterest expenses, declined by 5% from last year and by 2% from last quarter as we prudently manage expenses. Compared to last year, lower salary expense from lower headcount, lower pension costs as well as lower professional fees and labor relations costs explain most of the improvement. Compared to the last quarter, lower premises and equipment expense as well as lower other expenses accounted for the decline. The annual reduction of -- in expenses of $15 million to $20 million related to streamlining operations, outsourcing and eliminating duplicate operations is expected to gradually impact results through the first half of 2020 once we have completed the transition. The adjusted efficiency ratio of 70.6% was 290 basis points lower than in the previous quarter. As discussed on previous conference call, as we continue to invest in the bank's transformation over the next few quarters, the ratio may fluctuate. However, we are making clear progress on our strategic initiatives, which is expected to lead to sustainable improvement. Slide 19 highlights our well-diversified sources of funds. In the third quarter of 2019, deposits stood at $26.6 billion and fell by 2% sequentially. This is a result of a planned reduction in liquidity given the new labor relations environment and is in line with loan portfolio. We continue to make use of efficient securitization conduits, and in the third quarter, securitized $582 million of residential mortgages through the CMHC and a third-party purchaser and $200 million of investment loans. These were partially offset by maturities and normal repayment.With the launch of our digital offering, we expect to further diversify our deposit-gathering channels. Our liquidity position continues to be strong, and our liquidity portfolio consists mainly of highly rated government securities. Slide 20 presents the CET1 ratio under the standardized approach of 9% at July 31, 2019. Our capital ratios are strong and support the bank's strategic investments and growth. Our diversified loan portfolio is highlighted on Slide 22. Total loans stood at $33.9 billion at quarter end. Commercial loans increased by 8% compared to a year ago and stood at $12.9 billion net of the sale of $433 million of noncore assets. Sequential growth of 1% was driven by an increase in real estate financing activity offset by seasonality of the inventory financing portfolio as well as foreign exchange. There was a slight decline in the investment loan portfolio as consumers continue to deleverage as well as in the residential mortgage portfolio with lower mortgage originations as we focus on higher-yielding loans. In 2020, we continue to expect double-digit growth in loans to business customers and a gradual resumption of growth in residential mortgages.Slide 23 provides a deep dive into our residential mortgage portfolio. We're maintaining our strategy to seek profitable niches, such as the high-end of Alt-A business. At July 31, 2019, our Alt-A portfolio represents 7% of the total mortgage book and 3% of the total loan portfolio. This portfolio remains well diversified with mortgages, loans and a GTE -- GTA representing about 21% of the portfolio and the GVA about 4% and is high quality, as evidenced by low loss ratios. Slide 24 highlights our commercial loan portfolio, which is pan-Canadian with a U.S. presence. It is well diversified, has a track record of strong credit quality and is positioned for sustainable profitable growth. Turning to Slide 25. Credit quality remained good. The provision for credit losses was $12.1 million. This compared with $4.9 million a year ago and $9.2 million last quarter. A year ago, the provision had benefited from favorable improvements to underlying assets. The provisions in the third quarter of 2019 were impacted in part by higher collective allowances resulting from changes to the probability of an economic downturn. Looking at the individual portfolios, credit losses on personal loans decreased by $670,000 sequentially, mainly as a result of lower loan volumes. Credit losses on residential mortgages increased by $1.6 million sequentially mainly as a result of higher collective allowances on impaired loans. Credit losses on commercial loans increased by $2 million sequentially. The loss ratio of 14 basis points reflects the underlying good credit quality of our portfolios.Turning to Slide 26. The net impaired loan ratio of 45 basis points and the gross impaired loan ratio of 59 basis points are within historical fluctuations. We remain adequately provisioned. We continue to expect that over medium term, the loss ratio could increase towards the high teens to reflect our changing business mix and macroeconomic conditions. However, with our current portfolio mix, conservative provisioning and a portfolio that is 97% collateralized, we expect that the loan ratio will remain below other Canadian banks. To conclude, we are confident that the good progress we're making on our strategic initiatives will lead to sustainable growth and profitability. Thank you for your attention, and I will now turn the call back to Susan.
Thank you. At this point, I'd like to turn the call over to the conference call operator for the question-and-answer session. Angel?
[Operator Instructions] Our first question will come from Mr. Scott Chan of Canaccord Genuity.
I just had a question on the tax rate. It looks like it was a bit low similar to last quarter. And I think you did guide a lower tax rate, but it did come in much lower again. Perhaps you can maybe kind of talk about that and perhaps an outlook into fiscal 2020?
I'll ask François Laurin to comment.
Sure, Scott. The Q3 tax rate, about an effective tax rate of 12.1% versus 19% basically last year mainly resulted from the proportionally lower domestic income. And it also includes a $1.5 million favorable adjustment related to the insurance business, which is about 290 basis points of the rate. So if you put that back, it's mostly like 15%. Know that this benefit would be in the next quarter but will not recur in 2020. So as for run rate going into 2020, would be high teens, closer to 20% at that point.
Your next question will come from Mr. Meny Grauman of Cormark Securities.
Question about the retail transformation, and just as you track the success of your decision to move to advice-only branch model, I'm wondering what indicators are you tracking to basically gauge the success of this initiative? And over what time frame do you need to wait before you can reasonably say mission accomplished here?
I'll ask Stéphane Therrien to comment.
Thank you for your questions. As you mentioned, during the first half of our transformation plan, a lot of our time was dedicated in simplifying our offering, preparing our customer to our new model and also in dealing with preparation activities in light of a potential work conflict. All of this is now behind us. And yes, we successfully transitioned our branches to 100% advice. We are now in a growth mode. We are getting back to basics. Our new financial clinics are now full of customer meeting their dedicated adviser to improve their financial health. We recently launched a financial health assessment tool, helping us to develop a full financial plan with our customer. Over 10,000 clients already use this tool with our advisers. We are confident that we can now win more going forward with our new model. Similar to Business Services, we had a dedicated sales force effectiveness team helping our sales force improve its performance by providing the right tools, improving the process and providing sales and technical training. Finally, as mentioned previously by François, the new labor relation environment from a strategic standpoint resets. Our talent can now be managed going forward, helping us create a culture of performance. So in terms of timing, as soon as possible. The good news is that we're now back in a growth mode.
And in terms of specific indicators, are there specific numbers that you're tracking? For instance, if we look towards the end of next year, is deposit growth going to be an important indicator telling you whether your customers are really accepting this change? I'm just wondering if there's key measurable metrics that you can highlight.
For sure. As we're now focusing on advice, deposit growth, mutual funds growth, mortgage growth, Visa growth are the key indicators that we would be looking going forward.
And I mean it sounds you're very confident in this, but there's always the chance that it doesn't stick with customers and this change doesn't work. The question is, what's plan B? Is it relatively simple to go back and to adjust the model? Or is this change much harder to fix? Curious about your thoughts.
Yes. This has not been done overnight. We've been obviously discussing with our customer, preparing them for the change. But frankly, the customer behavior has already changed a few years ago, so this model is in line with the new needs of our customers. So we felt very good about the new model and feel even better right now.
Your next question comes from the line of Marco Giurleo of CIBC.
My first question is with respect to the loss ratio. We've seen basically $7 million of reserve releases in stage 1 and 2 year-to-date and impaireds have been trending higher. So I'm just wondering if you could speak to the reserve releases. Is that a function of the personal loan book shrinking? And then on the impaired side, could you give some color on where you're seeing credit migration?
I'll ask Liam Mason to comment.
Thank you. Appreciate your questions. So first off, with regard to the stage migration, we are seeing a degree of that. There are puts and takes within that. We have an uptick -- some releases you've highlighted in stage 1 and 2, and that's as a result of some shrinkage in the personal portfolio. But in stage 3, small variation. Slight uptick in personal; an uptick in mortgages that's due to slightly higher impaireds; and commercial generally from a stage 3, pretty flat. So we are seeing some shifts in migration, but I would say it's normal variation. And then in terms of your question on overall PCLs, PCLs remain very stable for us and consistent with our previous direction.
All right. And if the contraction in the personal book continues as is, would it to be fair to continue to expect releases throughout the coming quarters?
Well, that's just a -- that's a functional result. I mean as you reduce your size of your book, your PCLs would go down proportionately. But our overall view is with the overall business strategies that are being laid out, we expect personal book to grow.
Okay. Great. And my second question is with respect to the margins. Just curious, how much of the increase this quarter was related to prepayment penalties?
François?
The biggest portion was the liquidity. Over half of the -- basically half of it. And the other half between -- the other reason where the prepayment is part of it and the Prime/BA as well, so a few bps.
Okay. And going forward, we've also seen a material fall off in brokered GIC rates year-to-date. Just curious if you anticipate this, providing a tailwind for the margin?
In terms of margin, Q4, we expect that it'd be relatively in the same range considering the benefit of this seasonally higher -- and we need to consider the seasonality of the higher mortgage prepayment in Q3, offset by the continued improvement in the loan mix. So we see this as just -- to remain in the same neighborhood of the margin for Q4. As for Q4 next year, we believe that we should be relatively stable. The only caveat would be whether lower rates -- the lower rates coming in, that might be a slight headwind.
[Operator Instructions] And we'll now take our next question from Gabriel Dechaine, National Bank Financial.
Just a follow-up on the -- those credit questions. The -- if I just look at the stage 3 provisions, commercial had an uptick versus what we saw in Q1 and Q2. Can you tell me where geographically those provisions occurred, or those impairments?
Liam?
Yes. I couldn't comment, Gabriel, at this point on the geographic, we don't tend to, but I think this is well within normal variation. I don't -- but there is a slight uptick, yes.
You can't tell me if it's Canada or the U.S.?
It's Canada. It's absolutely Canada.
Okay. How about the sector, industrial sector?
It's -- I'll have to come back to you on the breakdown of that. I don't think there's any clear delineation across the key sectors.
Okay. And just so I understand the messaging there, you've stated that you've added to collective provisions, i.e., stage 1, stage 2. You've taken a more conservative economic outlook and you still believe...
That is correct. We -- as part of our regular ECL and loan bridging process, we look at our macroeconomic scenarios every quarter. And consistent, I think, with a number of other industry players, we've put an uptick on the downturn scenario this quarter. And that had a marginal impact of about $2 million.
Okay. So that's -- if not for that, the releases from stage 1 and then stage 2 would've been $2 million higher. Is that then...
If not for that, we would've had a run rate more around $10 million, yes.
Got you. Then the branch -- let's talk about the strategy here. And I just want to make sure I understood that correctly. Part of the new structure of the bank and the manner in which you expect to gain efficiencies involves outsourcing. Did I hear you correctly that you've outsourced some of your credit adjudication and collections function?
What you heard is that either outsourced or combined or eliminated duplicate operations for collections, credit adjudication and administration. Of course, this has just occurred. So obviously, on day 1, you're not getting the benefits from headcount reductions or cost. But as these things are being combined over the next few quarters, what we're expecting is to see a gradual efficiency pull as we folded all of our retail operations' activities, back office activities together.
Right. I'm looking at it more from a strategic -- efficiency is obviously important, but when you're moving in this direction, credit adjudication, underwriting and collections, those are core parts of -- core functions of what a bank does, and I just make sure we're not -- I'm not hearing that you're outsourcing those functions entirely, are you?
No. What you're hearing is that some functions were outsourced, which are nonstrategic. But for credit adjudication per se, it's still within the Laurentian Bank Financial Group family.
Okay. All right. Cool. Then lastly on the mortgage book and the, I guess, bank service revenues. Mortgage book, you've indicated that you expect the growth to turn positive in the latter parts of 2020, if I understand that correctly. Any indication of when we could see this poised-for-growth mantra start turning into positive revenue growth in the services line in the other income?
Quite frankly, it can't happen soon enough, Gabriel. After a really hard-thought 1.5 years of preparing and hoping for the best and preparing for the worst on the labor front, we had to make some really strategic moves there for the long-term betterment of the organization as a whole. And I think that that's really what the executives of this company have delivered. Yes, short term, we had to pull back from some of the growth activities. But we've proven in the past that we can successfully grow businesses. We did that in the first 2 years of my tenure, at least, and that's what we're redoing now. So what I'm happy about is that it's all hands on deck. We are seeing some initial upticks, but it's not fast enough for me. But it's not going to be done overnight either, right? It's going to take the efforts required to shake hands and go out and get brokers, clients in the door and happy to do business with us, as we have in the past.
And we'll now take our next question from Richard Roth of TD Securities.
Just looking at other income for a second. Is the decline in, I guess, your brokerage other income lines sort of a similar explanation to what you gave us in Q1, namely sort of just weak market conditions, the venture is down, small-cap stocks are down?
Exactly, Richard. The volatility that we suffered -- we all suffered as participants in the month of May hampered the results for Q3.
And we've seen some volatility in -- subsequent to the quarter end, so in August. How is that looking for you guys from a Q4 perspective?
August is still -- August, as you point -- rightly pointed out, August is still a challenging month from a volatility perspective and liquidity on the market. So we have a strong pipeline of -- in DCM/ECM market, but we need the capital market to stabilize and be more positive to see positive outcomes on that front.
And what sectors are you guys generally focused on? Is it sort of mining and like commodity guys? Or sort of -- yes.
We have a few verticals in terms of equity, but our biggest sector is debt capital market. Within equity, we have mining and a few industrial sectors, like a bit of transportation and specialized services, among others. But we cover a few verticals.
Finally, I guess as you move into -- sort of you're fully advice now only in terms of branches. Should we expect to see lines like your commissions on mutual fund sales and other lines like that to start to move up? Or are those still just going to be really tied to your small-cap focus?
Now you're referring to the retail side of it?
Yes.
Clearly, on the retail side of it, so the -- from the broker side, clearly, that's part of the revenues, that stream that is generated. But most of it at this point is within the -- potentially in the retail sector, the financial clinics part of it from a mutual fund perspective.
Your next question will come from Darko Mihelic of RBC Capital Markets.
Just a question on the mortgage impaired loss. It seems like a lot. It's up 3x what you had as a provision for credit loss in stage 3 of last quarter and last year, and just curious as to what's causing that.And secondarily, as we think about sort of the build of allowances and release sort of competing factors, the release this quarter was bigger than the build. As I go forward in the kind of economic environment that we're in and as we think about you growing balances, maybe you can give us an idea of where we would go from here. I'm envisioning a situation where you're building allowances for both portfolio growth and possibly for weaker economic statistics because it's pretty hard to see the economy can get better from here. So just your thoughts on both those elements would be great.
Liam?
Yes. Darko, thanks for your question. We do see an uptick in the mortgage impaired losses. So as I said earlier, some of that is affected due to the shrinking in the portfolio, and I'd see some offset on that as we regrow. We have -- just if you're looking, though, at our doubtful accounts overall on mortgages as one of the indicators you've looked at in that vein, I would note, though, that in terms of total bank doubtfuls in the mortgage space that we did have a methodology change over the past year that drove up the doubtful numbers in the mortgage space. So that -- some of that explains that uptick in doubtfuls. In terms of the build and release, naturally, as we grow the book, I would expect absolutely a growth in PCLs commensurate with that. But our belief is that this will be fully offset by higher NII as we build the business. And then back to the weaker economic, it's really a function of good credit management, adjusting your reserves commensurate with market conditions, and it would go up or down commensurate with those conditions. So that's just normal course.
Okay. And just the -- so you're saying that there was a change in your methodology that resulted in the large stage 3 loss this quarter in mortgages?
No. I'm saying in terms of -- I just want to make sure I tie the picture together. I'm talking in terms of doubtfuls. In terms of doubtfuls and the absolute dollar amount of doubtfuls, we had a change in methodology where we shifted insureds greater than 90 days into the doubtfuls. So if you bring the whole credit picture together, you have to look at doubtfuls and you have to look at the shift in terms of the stages. So that explains the doubtfuls. And as I said earlier, the shift that increased this quarter in stage 3 is due to slightly higher impaireds.
Higher impaireds. But that's a big number to go $2.2 million versus $700,000 last quarter. Was there maybe some fraud in the residential mortgage portfolio or something?
No. But on the year decrement, its flat. So yes, there's some ebbs and flows within the book.
And our next question will come from Sumit Malhotra with Scotiabank.
Maybe, Liam, just to stay with you for a minute. So you've rolled to IFRS 9 provisioning to start this year, and I think that's come up a few times now that in every quarter, we've seen your performing portfolio has had releases in provisions. And at least to some degree, there's assumptions, parameters for your view on the economic outlook, especially when it relates to your, let's call it, your business lending portfolio. Can you give us some indication as to what perimeter updates you've enacted that have resulted in -- I know this quarter again, we see a small but still a release there. That's the part of the book you're growing the fastest, and certainly, that's what's been indicated to us. What are you changing in your model that's resulting in releases for commercial and the performing portfolio?
Thank you, Sumit, for your question overall on IFRS 9. So we implemented IFRS 9 and we put in place a model framework. We've had basically a shakeout on that model framework over the past couple of months and some marginal enhancements on the methodology. And some of this -- that enhancement comes as you do your annual renewals on the various business book. But overall, from an outlook right now, we have adjusted the scenario to a higher expectation of downturn. So that drives an uptick. But overall, we have marginal adjustments based on the annual credit renewal and in terms of enhancing our methodology on the margin. It's not big changes due to methodology.
And if I stay with what I'll just call your commercial loan book for a minute, obviously, there's been a significant shift in the interest rate backdrop in the last few months. I'm just curious as far as this portfolio is concerned. The bank has talked about margin improving as a result of mix shift, which I think essentially means commercial is going to be a larger portion going forward. How much of this book resets with market rates? Like what percentage is based off BA rates, LIBOR, that would see a more immediate repricing with the shift that we've seen? Can you give us any numbers around that?
I'll ask Stéphane Therrien to answer that question.
I think we should come back to you on this one in terms of the percentage that would be affected by the Prime/BAs.
Yes. A proportion of the book is Prime-based and is affected -- driven by the Prime/BA as an impact on our margin from a Prime/BA spread. That is at the wides. We would expect some degree of shift in that, but a good part of the book is floating.
And just lastly on the margin now. You folks had indicated last quarter that with the union negotiations complete, we would see liquidity put back to work, and that certainly seems to have benefited NIM this quarter. Is it fair to say -- is that liquidity now where you want it to be? Is that no longer a catalyst for NIM, one direction or another, as a result of the changes you've enacted post the negotiations completing?
Yes. In the third quarter, we've reduced the excess liquidity, which contributed to the improvement in net interest income and the NIM. The full impact of that is now behind us and realized in Q3. We also realized the cost related to labor relations, which contributed to lower noninterest expenses. That is also in our Q3 results. Through the first half of 2020, from now till then, we expect to see the rest, meaning the positive impact from outsourcing and eliminating duplicate operations that had no impact on Q3 and is still in the future.
So that -- and I'll stop there. Obviously, expenses were one of the bright spots...
Sumit?
Yes?
I just want to come back to your interest rate question. There are 2 components, just to try and answer it. We have a structural interest rate risk position that deals with the interest rate risk of the bank overall. We're close to our benchmark. We're not taking undue risk relative to our benchmark on that. And that drives the aggregate structural interest rate component of your NIM. The other component really is driven by basis just like Prime/BA. And we come back to you on that, but you need to always come back in terms of the aggregate banks to how we manage our structural rate position.
Your next question comes from the line of Sohrab Movahedi of BMO Capital Markets.
I was a little bit late getting on, so I apologize if some of these were covered off in your commentary or in earlier questions. But just with respect to the balance sheet growth that you are expecting now to come, if I kind of look at the slides, Pages 23 and 24, you've got the geography kind of listed out. And if you start with commercial, 17% from the U.S., the rest in Canada. As you think ahead, I don't know 12, 18 months, how is that -- how are those percentages going to shift?
Thank you for the questions. I'll give a comment on growth overall maybe just to set the stage here. I think the first part of your question really has to do with the percentage of loans to business customers in the total mix. We expected to have continued good growth in this portfolio. This portfolio has been growing in the last several years, and we expect that, that will continue to have double-digit growth as we continue, and that will continue to increase the loan mix. We haven't disclosed a target for the total percentage of loans to business customers within the whole portfolio, but needless to say that we have not reached the potential of this business, and also, we're still for away from where we want to be. On a volume growth overall, though, and for the rest of the businesses, now that the new labor relations environment is -- has stabilized, we're back in growth mode. So of course, that has had impacts in the first -- in the last quarter to reduce liquidity in that you see that in the deposit growth retracting. But what we're looking for really is growth in mortgages, personal loans, Visa cards, mutual funds as well. Last quarter, we said that we would stabilize and then grow the residential mortgage portfolio. You saw this quarter the decline was limited to 1%. We recently launched a new advertising campaign targeting mortgage brokers across Canada. We're introducing Alt-A mortgages back into the mix, business for self-products. So we expect to generate volume growth from those products. So we're still continuing to expect a mid-single-digit growth for 2020, we're not just there yet, right? It's taking us time to go and get that pipeline of business in the door. Personal loans are also part of the growth plan, specifically RSP lending, investment lending, which we want to put back on track and have initiatives to stabilize that portfolio as we exit 2020.
But is the mix going to stay kind of as it is right now geographically? Or in other words, do you -- or do you think the U.S. is going to represent a bigger proportion overall, let's say, in the commercial loan portfolio?
I'll ask Stéphane to answer.
The good news is that the Northpoint is performing according, if not better, than planned. So we're really happy about that business. And since day 1, when we acquired that business, we said that there could be synergies with equipment finance as well in the States. So that percentage could grow -- could slightly grow in the next few years.
And so Liam, when you talk about the credit considerations and the PCLs, you're taking into consideration that you may have higher growth in the U.S.?
We take into account -- obviously, you don't provision for future growth. But yes, in terms of our plans and our risk tolerance, we do take that into account.
So just one last question on that, Liam. How much room do you have in your current reserve levels to accommodate further growth in your, call it, performing stuff without having to add to the reserves?
Well, I talked about a couple of things, Sohrab. I talked about capital capacity. We have -- as described, we have a very strong capital position that gives us, per your question last quarter, an ability to grow RWAs. And from a provision perspective, our views are that if provisions were to grow, they'd be more than offset by net interest income.
Okay. But my question was a little bit more specific as to within your stage 1 and 2, how much more growth can you accommodate without having to add more to it?
Well, I think the normal process are as you add, you -- they will factor into stage 1 or 2 and come into there. I think it's a question really of capital capacity and what income are you seeing that offsets that increase.
And we'll take our final question from Doug Young of Desjardins Securities.
I think maybe just going back to what I think there's been a number of questions on is just the stage 1 and stage 2 PCLs. And I guess what we're struggling with is that there's a higher probability of an economic downturn built into your assumptions, but we're seeing releases in stage 1 and 2 and I'm still a little confused as to why that would necessarily be. So I don't know if there's more you can kind of flesh out on that, but I think that's where a lot of confusion lies right now.
So let's talk about -- obviously, an uptick, as we said, on the macro factors, but I mean the book has not been growing and we're turning that around. So as your book shrinks, depending on what stage the underlying assets are in, you're going to see a reduction in it. So it's that dynamic.
So it's just simple -- I mean you're growing the commercial, though, and the impaired is up materially in commercial, yet you've got releases on that side. So that's kind of -- I guess maybe there's a little confusion around that as well.
Well, I think you also see migration across the stages as we see normal ebbs and flows with individual credits. And what we'll try going forward is to provide a little bit -- and I think we provide in our disclosure how things are moving, but I'll try to ensure we provide additional commentary on this going forward.
It's very different than what we've seen from the other banks. And I know IFRS 9 is relatively new and we're all getting adjusted to this and whatnot, it's just that 2 opposing things that is confusing and tough to make sense of. So that's -- yes. So...
Yes. I would note that for us, IFRS 9 is as recent as last October. So it's a little bit -- some of the other banks have had a shakeout, and we're -- we've got some tweaks to some of the earlier questions.
And then just maybe I'll just finish off with just the mix ratio. And I think, François, you mentioned, yes, you would expect in Q4 that to fluctuate. And I understand what your target is for fiscal '21. By fluctuate, I would assume you mean you would expect higher expenses and so a higher mix ratio in Q4. And as you look out, as you move towards your fiscal '21 target, are we -- should we expect a gradual decline in that ratio through fiscal '20?
Doug, obviously, the target is to improve over time. We had said 2019 was years of investment. And we have -- we expect to see some benefit of outsourcing and elimination of duplicate operations, as François mentioned earlier, by the end of Q2 2020. But at this point, we're working to bringing those savings, and obviously, they should bring operational leverage -- positive leverage going forward. But it's hard to commit any number at this point for 2020.
And ladies and gentlemen, that's all the time we have for questions today. I'd like to turn the conference back over to Mr. François Desjardins for any additional or closing remarks.
Thank you, everyone, for joining us today. AT LBCFG, we're building a different and better financial institution. We talked about today transitioning our branch network to a traditional offer to 100% advice. This is a business model that we believe better fits the lifestyle of modern customers. We're rolling out digital offering, receiving positive feedback from advisers and brokers that are eager to open accounts, and we're eager to roll that out to all Canadians. We're addressing the efficiency ratio by reorganizing, outsourcing, simplifying teams, processes and product lines. This is something that we're working towards a better efficiency ratio in the coming years. We are moving towards higher-margin commercial loans and have increased their proportion within the loan mix. And finally, we're working towards improving the financial health of our current and future plans. Our teams have accomplished tremendous work and are now all hands on deck working on revenue-focused activities, efficiencies and transformation-related strategic objectives. These are indeed exciting times. I will now turn it back to Susan.
Thank you, François. Should you have any further questions, our contact information is included at the end of the presentation. And our fourth quarter of 2019 conference call will be held on December 4, and we look forward to speaking with you then. Have a great day.
And this concludes today's call. We thank you for your participation. You may now disconnect your lines, and have a wonderful day, everyone.