Earnings Call: Q2 2017

May 24, 2017

Good afternoon, and welcome to the BMO Financial Group's Q2 2017 earnings release and conference call for May 24, 2017. Your host for today is Ms. Jill Homenick, Head of Investor Relations. Ms. Homenick, please go ahead. Thank you. Good afternoon, everyone, and thanks for joining us today. Our agenda for today's investor presentation is as follows. We will begin the call with remarks from Bill Downe, BMO's CEO, followed by presentations from Tom Flynn, the bank's Chief Financial Officer, and Surjit Rajpal, our Chief Risk Officer. After their presentations, we will have a question and answer period where we will take questions from pre-qualified analysts. To give everyone an opportunity to participate, please keep it to one or two questions and then re-queue. We have with us today Darryl White, Chief Operating Officer, Cam Fowler from Canadian P&C, Dave Casper from U.S. P&C, Pat Cronin from BMO Capital Markets, and Joanna Rotenberg from Wealth Management. On behalf of those speaking today, I note that forward-looking statements may be made during this call. Actual results could differ materially from forecasts, projections, or conclusions in these statements. I would also remind listeners that the bank uses non-GAAP financial measures to arrive at adjusted results to assess and measure performance by business and the overall bank. Management assesses performance on a reported and adjusted basis and considers both to be useful in assessing underlying business performance. Bill and Tom will be referring to adjusted results in their remarks unless otherwise noted as reported. Additional information on adjusting items, the bank's reported results, and factors and assumptions related to forward-looking information can be found in our annual report and our second quarter report to shareholders. With that said, I will hand things over to Bill. Thank you, Jill, and welcome to everyone joining us on the call. Today we announced net income for the second quarter of CAD 1.3 billion and earnings per share of CAD 1.92. Earnings growth reflects the continued benefit of our diversified business model, which I'll expand upon in a moment, with good contribution from our wealth and capital markets business. On a year-to-date basis, earnings per share grew 21%, including the net impact of non-strategic assets in the current and prior quarters. Underlying earnings growth of 11% has been driven by overall good revenue and expense management, resulting in positive operating leverage of over 3%. We remain focused on achieving operating leverage for the year in line with our medium-term target of 2%. Provisions for credit losses were up this quarter. On a year-to-date basis, the ratio of provisions to loans is 23 basis points, relatively stable to last year and reflecting good continued credit quality. Surjit will provide detail in his remarks. Our capital position remains strong with a CET1 ratio of 11.3%. ROE was 13.1%. Today, we announced an increase to our dividend of 2 cents per common share, bringing our quarterly payout to $0.90, up 5% from last year. Moving to slide 5, I will review a few highlights from our operating groups. Canadian P&C continued to have diversified balance sheet growth in both the commercial and personal businesses, with loans up 5% and deposits up 8%. Net income grew 1% from a strong quarter a year ago. Consistent with our vision of delivering an exceptional customer experience across our channels, we continue to invest in expanded product capabilities and functionality. In business banking, we introduced MasterCard products that provide a range of reward options tailored to the specific requirements of commercial customers. These new integrated card products combine convenience, flexibility, and functionality in a comprehensive and simplified business payment solution. We continue to make our digital banking experience more attractive for customers that increasingly value the convenience of self-serve and the ability to manage their money anytime, anywhere. For example, e-transfers, which have quickly become a preferred method for sending funds, are now included free of charge with all personal banking plans. In U.S. P&C, net income was impacted by higher commercial loan loss provisions this quarter. While there has been a general moderation in loan and deposit growth in the U.S., reflective of slower than anticipated business activity in the quarter, we are well positioned to continue to build on the strength of our U.S. franchise. In this environment, expenses remain well controlled and the business continues to achieve positive operating leverage. We are committed to growing our retail and commercial business by continuing to enhance our existing platform and leveraging it to retain and attract customers. On the retail side, we introduced new checking products that are simple, differentiated, and tailored to diverse and evolving banking needs. At the same time, we continue to enhance the experience of customers in ways that are important to them. This quarter, we announced a partnership with Allpoint that expands our no-fee ATM network by over 43,000 locations and provides convenient access anywhere in the United States. While our commercial banking business is firmly anchored in the Midwest states, we continue to expand nationally into key markets where our team of experienced commercial bankers bring a combination of industry expertise, local market knowledge, and differentiated cross-border banking capabilities. We recently opened a new office in Columbus, Ohio, adding to offices in cities such as Atlanta, Dallas, and in Southern California. BMO Capital Markets delivered another strong quarter driven by momentum in our investment and corporate banking businesses on both sides of the border. Our client-focused U.S. business continues to deliver solid results as we expand lead relationships with established companies across North America. Net income was up 12% in the quarter and 28% on a year-to-date basis, driven by diverse sources of revenue, good expense management, and continued operating leverage. We are well-positioned to deliver solid results for the full year. In Wealth Management, we had strong performance in an improved environment with a disciplined focus on efficiency. Our traditional wealth business had good AUM/AUA growth of 13%. This quarter we added four global sector ETFs for a total of 90 listings. Since first launching ETFs in 2009, BMO Asset Management has captured the most inflows in the Canadian ETF industry for the past six years. Overall, the competitive advantage we have in the current environment is threefold. First, our mix of complementary businesses. It is well-diversified across products, key geographies, and customer segments. We have a highly profitable Canadian P&C business built on BMO's strength and long legacy as a commercial bank. In our personal business, our focus is on continuing to grow primary customers combined with a disciplined approach to lending. Today, our mortgage portfolio represents just 27% of our total loan book, well below the Canadian peer average. Our priority continues to be to strengthen customer relationships by providing a broad range of advice-based services. BMO's well-established brand and relationship-based approach is consistent across all areas of our business. U.S. P&C, Capital Markets, and Wealth Management each contribute approximately 20% of bank income, and growth in these businesses has been targeted and deliberate. Over time, this mix will continue to deliver resilient earnings and shareholder value. Second, we have invested significantly in technology over the last five years. We have been specific in our approach, starting with our underlying architecture that leverages the power of large scalable systems. This has enabled us to develop and launch new digital solutions in a fraction of the time and cost and apply them across the bank. We are using sophisticated data analytics to provide more personalized customer experiences seamlessly across channels, and we are digitizing processes both in the branch and back office. This digital transformation is supporting deeper customer relationships. More than 50% of Canadian customers now engage with us digitally, completing over 30 million mobile transactions so far this year. With 16% of product sales done via digital channels, we have created the capacity for more meaningful advice-based conversations in our branches. Finally, in all the dimensions of change we are managing across the bank, everything begins and ends with the customer. Consistent with our first strategic priority to deepen customer loyalty, we are creating a more personal bank for a digital world. As Darryl transitions into the CEO role, he will continue to focus on growing the bank's customer base, expanding BMO's responsiveness to market opportunities, and ensuring consistent operating discipline across the bank. Building on our track record of innovation and ability to anticipate and manage change, the bank will continue to deliver financial performance. Now I will turn it over to Tom to present the Q2 results in more detail. Okay. Thank you, Bill. As shown on slide 8, reported EPS for the quarter was $1.84 and net income was $1.25 billion. Adjusted EPS was $1.92, up 11%, and net income was $1.3 billion, up 12% from last year. As Bill mentioned, the results this quarter reflect the benefit and resilience of our diversified business mix. As a reminder, last year reported net income included a restructuring charge of $132 million after tax, and both reported and adjusted net income included the impact of an investment write-down of $79 million after tax. Adjusting items this quarter are similar to past quarters and are shown on slide 25. Adjusted net revenue of $5 billion was up 7% from last year. Net interest income was marginally lower year-over-year. Adjusted net non-interest revenue was up 15%, with growth across most product areas, including underwriting and advisory fees and investments in associates and joint ventures, partially offset by lower trading revenue. Adjusted expenses were up 5% from last year and up 4% in constant currency terms. On a net revenue basis, adjusted operating leverage was 2.3% and the efficiency ratio was 63.8%. On a reported basis, efficiency was 65.1%. The adjusted effective tax rate was 17.1%, down from 19.6% a year ago and was 27% on a TEB basis, up from approximately 26%. Moving to slide 9, the common equity Tier 1 ratio was 11.3%, up from 11.1% last quarter. As shown on the slide, the increase reflects capital growth largely from internal capital generation, partially offset by higher risk-weighted assets. Source currency risk-weighted assets were up from the prior quarter, mainly due to business growth. Moving to our operating groups and starting on slide 10, Canadian P&C adjusted net income was CAD 531 million, up 1%. Revenue growth of 3% was driven by higher balances across most products and increased non-interest revenue, partially offset by lower net interest margin. Total loans were up 5%, with personal up 4% and commercial up 8%. Total deposit growth was good with both personal and commercial deposits up 8%. NIM was down two basis points from last quarter due to product mix and the low rate environment. Expense growth was 5% with ongoing investments in the business, and operating leverage was negative 1.6%. Provisions for credit losses were stable compared to last year. Moving to US P&C on slide 11, adjusted net income was $260 million. The comments that follow speak to the US dollar performance. Adjusted net income of $194 million was down 10%, primarily due to higher credit provisions. Revenue was down 2% due to lower loan spreads and volumes, partially offset by higher deposit revenue. Average loan balances declined 2% as lower personal loans, including the sale of auto loans in Q1, were partially offset by growth in the commercial portfolio. Excluding auto loans were up 3% from last year. Net interest margin increased three basis points from Q1 due to the benefit of higher interest rates, net of loan spread compression. Expenses continue to be well managed and declined 2% year over year. On an adjusted basis, operating leverage was positive 0.8%. Credit provisions were up from last year as higher provisions in the commercial portfolio were partially offset by lower consumer provisions. Turning to slide 12, BMO Capital Markets adjusted net income was CAD 322 million, up 12% from last year. Revenue was CAD 1.2 billion, up 13%, driven by strong performance in the investment and corporate banking business, including a good contribution from the U.S. business. Revenue in our trading products business was down from a strong level a year ago. Expense growth of 8% reflects higher costs associated with business growth, including higher employee-related costs. Operating leverage was 4.7% and efficiency was 57%. Provisions for credit losses were relatively stable compared to last year and up from last quarter. Wealth Management on slide 13 had adjusted net income of CAD 272 million, up significantly from a year ago. The business benefited from good underlying operating growth in both traditional wealth and insurance and our continued focus on expense management. Adjusted earnings growth in traditional wealth was high in part because of the investment write down a year ago. Underlying business growth was also good at 17%. Insurance earnings were up 8% from last year. Adjusted expenses increased just 1% from a year ago as higher revenue-based costs were largely offset by the benefit of productivity initiatives. Assets under management and administration were up 13% due to improved equity markets and favorable foreign exchange. Turning now to slide 14 for Corporate Services. The adjusted net loss was CAD 90 million compared to CAD 98 million a year ago. Results improved due to above-trend non-TEB revenue, which was largely offset by higher expenses from a below-trend level a year ago, and credit provisions were lower. To conclude, our businesses continue to grow, and these results demonstrate again the benefits of our diversified business mix. With that, I will hand it over to Surjit. Thank you, Tom, and good afternoon, everyone. Starting on slide 16, our PCLs were CAD 259 million, or 28 basis points, up from 19 basis points in the prior quarter. Year-to-date PCLs are at 23 basis points. The quarter-over-quarter increase was primarily due to higher corporate and commercial losses in Capital Markets and U.S. P&C. Looking at Canadian P&C, provisions for consumer and commercial were up modestly from the prior quarter and remain relatively stable. Provisions in U.S. P&C increased CAD 30 million quarter over quarter. Most of the increase was in commercial, reflecting normal variability in a commercial loan portfolio. Capital Markets PCL was CAD 46 million, resulting from two accounts in unrelated industries. Last quarter, we had a recovery of CAD 4 million, primarily from the oil and gas sector. On slide 17, formations of CAD 752 million, up from CAD 509 million in Q1. A small number of loans in oil and gas, transportation, services, and wholesale trade accounted for most of the increase. Gross impaired loans increased by CAD 203 million with the impact of a strong U.S. dollar representing over a third of the increase. The GIL rate was up three basis points to 63 basis points for the quarter. Turning to slide 18, the performance of our Canadian residential portfolio remains strong. Delinquencies are relatively flat quarter over quarter, and our loss ratio remains low. In GTA and GVA, we have not seen any deterioration in performance, and both portfolios demonstrate better loan-to-value delinquency and bureau scores compared to the national average. In summary, economic conditions continue to strengthen, and the credit environment remains benign. We continue to expect losses in the mid 20 basis points, subject to quarterly variability. I will now turn it over to the operator for the question and answer portion of today's presentation. Thank you, sir. If you have a question, please press star one on your telephone keypad. If you're using a speakerphone, please pick up the handset before pressing star one. You may cancel a question by pressing the pound sign. Please press star one if you have a question. There will be a brief pause allowing you to register. First question is from Ebrahim Poonawala from Bank of America Merrill Lynch. Please go ahead. Good morning. Good afternoon. I guess just the first question, Surjit, if I can start with, I think you ended your comment saying economic conditions are strengthening and you expect credit outlook to remain benign. If you could sort of help us on both those issues in terms of where in the economy you're seeing strength and how is that sort of translating to your business. Secondly, when we talk about sort of a benign credit outlook, obviously there's been a lot made out of the issues around Home Capital. How do you sort of look at that? In your seat, how do you sort of assess risk to the mortgage market and to your portfolio, both resi and non-resi for the rest of the year? Well, that, Ebrahim, is a very broad question, and I'll try to attempt to answer it as best as I can. From my perspective, when I talk about the economic environment getting stronger and a benign credit environment, it really is helping us in terms of all our portfolios. The reason I bring up the issue of variability in commercial is there will be times when for business reasons, certain clients of ours do not do well. They would not do well regardless of the benign economic environment because some of them do get impacted by competitive factors that come into play in their various industries. For the past year, we've been talking about oil and gas being a very strained sector, and that seems to be something that's sort of not entirely behind us, but largely behind us. Even though I've seen this quarter an increase in the formations in the oil and gas sector, I'm still extremely comfortable with that portfolio because if you look at the GILs, they've actually come down. When I look at that portfolio from the point of view of how our clients are doing and how the borrowing base determinations have gone in the spring borrowing season, we've had most of our customers have, to the extent we've finished that process, have their borrowing bases either go up or remain steady with only, let's say, about low single-digit customers where their borrowing bases actually go down. So that sector has done really well, and that has been a sector of concern for the last several quarters, if you will. The broad issue with respect to what you've noticed in this quarter, and I guess what's prompting your question is the fact that we've had 28 basis points relative to the 19 basis points last quarter. We haven't seen any pattern in any single sector that would cause us to sit up and say, "Look, we need to worry about this on a basis that's disproportionate." I say the same thing about the Canadian housing market, which I said in my remarks, is still continuing to perform well. So what do I worry about? I like to see things from a stress perspective. To that extent, we stress all our portfolios that are of size, and then we see how they perform under stress. When we do that, I have no reason to be uncomfortable with any particular sector at this point in time, and the benign credit environment is certainly helping us. What wouldn't be a benign credit environment would be one where the economy stops growing and interest rates go up rapidly, both happening in unison. We don't see that happening, but we do stress all our portfolios on the basis of conditions that we don't see or foresee in the short term. I hope that gives you some flavor. No, that's helpful. I'm just trying to sort of assess in terms of what the downside risks to your point are to the economy, and how do you sort of, given all the moving pieces and the noise, how do you handicap the downside risk to the economy as you think about at least the next couple of quarters or for the rest of the year? So that's helpful. Sorry, go ahead. No, go ahead. No, you said couple of quarters in the next year. In a benign environment, to expect mid 25 basis point losses is a very reasonable number. It is not excessive at all. It is a very reasonable number. When you look at our long-term average, and we have had probably one of the best track records from a PCL perspective of anyone. It is about 40 basis points or so over a 30-year period. To look at 25 basis points or mid-20s as something relevant to a benign environment is entirely reasonable, which is why that is the guidance I have been giving in the past and continue to give at this point in time as well. Understood. If I can switch to capital for a second. We saw decent internal sort of capital generation this quarter. I think if we can just talk about in terms of how do you see capital build and if there are any other capital relief trades sort of in the pipeline over the next few quarters. Then just talk about capital deployment priorities between buybacks. You talked about sort of enhancing the U.S. franchise. I am wondering if M&A is an option in the U.S. for now. It's Tom. I'll answer that. A few things. Number one, we're pleased with where the capital ratio ended in the quarter at 11.3%. Clearly at that level, we're in a very strong position, and we feel good about that. We increased the dividend in the quarter, which reflects the capital position and if not more importantly, the income growth that we've had. As we think to the future and capital deployment, a couple of things. The first would be that we have renewed our normal course issuer bid. The approval for that was received during the quarter. Given the capital ratio, it wouldn't be unreasonable to expect some level of activity in the program over the balance of the year. As it relates to growing the business, our first use of capital is always to grow our businesses organically. As we've talked about before, we do expect to generate net capital after doing that. On the M&A side, I'd say we continue to consider opportunities, and we've shown that we'll be responsive to them as it makes sense, but there's nothing really specific to say about the current environment or what we're looking at at the current time on that front. Got it. Thank you. Thank you. The next question is from Meny Grauman from Cormark Securities. Please go ahead. Hi, good afternoon. Just a question about operating leverage in Canadian P&C. After six straight quarters of positive operating leverage, you delivered a negative operating leverage, and I'm wondering if you believe that you will be able to deliver positive operating leverage going forward in Canada without resorting to another restructuring charge. If you look at the data, the cynical view suggests that you have restructuring charges and then the operating leverage turns positive and then it kind of dies out. I am wondering how you read that data and what your perspective is on that. Sure, Manny, thanks for the question. It is Cam Fowler speaking. We feel there is some strong underlying growth in the quarter on the balance sheet side. You can see that in particular on the commercial business, retail deposits as well. It did not translate as well into revenue this quarter. A couple of reasons for that. Number 1, rate headwinds, and number 2, we are a little softer on the card side, as you will see specifically in NIR and specifically within NIR interchange. We were a little bit lighter on revenue. On the NIX side, you could see that we were up a bit at 4.8%. We are, as I have said on this call many times, undertaking quite a bold transformation of our Canadian banking system. The approach we have been taking is to self-fund that. That means we have a structural cost program where we look for opportunities to remove costs from the traditional base and reinvest portions of that into two areas primarily, our digital capabilities, number 1; number 2, more on advice-based sales. For the past six quarters, as you point out, we have synchronized those movements, and they have resulted in positive operating leverage. We did not synchronize it perfectly this quarter, and I think that can be expected from time to time. With respect to my outlook, I do not think we should take the cynical view on this one. There was a charge. This portion of the business, the Canadian bank, participated in the charge, and we will achieve the anticipated benefits associated with that. That charge is actually a small part of the broader change going on in the Canadian bank. With the magnitude of role changes and digital investments going on, much of what we do happens through redundancy and turnover, et cetera. Stepping back from it all and the broad battery of changes we have going on, the specific answer would be I do expect to return to positive operating leverage in the back half of the year. We will do that through some modest improvements in revenue, I would expect, and some improvements on the NIX side, but that we will have it back together in Q4. Hope that helps. Thanks for that. If I could just ask a quick question on housing. In the MD&A talk about the recent actions with Intergovernment, and you say that you expect it to moderate the overheated GTA housing market. I am just wondering if that is purely a forward-looking view or are you seeing any evidence? I know it is still early, but are you seeing any evidence that you could point to that says that we are seeing some slowdown in the GTA housing market? Yeah, two things. First, I would just reiterate the point that Bill made off the top, which is against the backdrop of the broader industry. Our book is smaller relative to peers. That is true nationally, it is true in Toronto in particular. It is difficult to judge right now what the impact of the various changes that have been announced will be. But I will say much like we experienced in Vancouver, where we were growing at market-ish, changes happened in the market. We felt that in our pipeline and in our growth to follow. We are starting to see signs of that in Toronto here, where you will have seen the news that sales are down in the mid-teens, listings are up 45%, 46%, prices are growing at a rate half of what they were. That is a couple of weeks of data, not a month. But early indicators are that we will start to see some softening. From my own perspective, that is good. Softening in the Toronto market is a good thing, and it looks like that may be where we are headed. Thank you. Thank you. The next question is from Steve Theriault from Eight Capital. Please go ahead. Thanks very much. I have a couple questions for Dave. Before, Cam, while we have you, just going back to the expenses on the restructuring front, is the full run rate now in your division? I think the statement was made that it was mid-2017 from the previous restructuring charges, that would be fully in flight. Are you fully in flight at the end of Q2? Is there still a little bit more to come? We're very near, and we'll certainly enjoy the full benefit through the course of 2018. Okay. Thanks. For Dave, two things. First, on the margin, not up as much as expected. Maybe you can help us by splitting out the 3 basis points of improvement between the benefit from the Fed rate hike, the loan margin compression, slower C&I growth, and any other meaningful components. If you can dovetail that into an outlook for the second half, that would be great. Okay. Well, I would say net, as you know, we're 3 basis points. We got probably a little bit more than double that this time around due to the rate increase which we had for the quarter, offset by a couple of things. By the way, included in that, included on the positive side, would be a reduction in our indirect auto, which had lower spreads. Those are the positives. The negatives would be we did not have the interest rate recoveries that we've had in the past. We didn't see those this quarter. Those go from quarter to quarter. It's hard to predict that. We would also have some continued diminution in the spread, mostly in the commercial book. That kind of lays out where you would see it. I would say the outlook, absent any rate increase, we have been guided in the past, and I wouldn't change it much, a couple of basis points down in a quarter. But with a rate increase, that would obviously be beneficial to us. Does that help? Yeah. So of the 3 would be, you said double, so 6 positive from the Fed and the indirect auto, then I guess 3 negative from the lack of recoveries, the C&I, maybe a couple other things? What I'd say is the benefits were the rate increase as well as a reduction in the indirect auto portfolio offset by what we talked about before. Okay. On C&I specifically, guidance from some of your U.S. competitors has been, I thought, pretty bearish while they reported Q1. I wanted to ask about your outlook, what you're seeing on the ground with respect to C&I. Obviously, the growth has decelerated quite quickly. Maybe you could update us on what you expect through the rest of the year. Sure. Again, I guess just to take you back to kind of level set, we have had in the U.S. really very strong and well above industry commercial growth for the last couple of years, mid-teens organic. Absolutely it has come down. We have seen the same thing that other banks and what you've heard from the industry. That said, I'm still pretty positive about the longer term, and certainly by the end of the year. Our clients are, for the most part, pretty enthusiastic. They are perhaps slowing a bit, just waiting to see what might happen. Generally they're enthusiastic and feel good about the economy, and we would also feel good. I would say specifically to your question, if you looked at our year-over-year loan growth on the commercial side, I would expect growth in the mid to high single digits, which would be down from what we've experienced in the past. I think certainly up from what we've seen so far, and I would expect to be at or above the industry. Just one final thing. That sounds reasonably constructive. But as I look through the numbers, if we were to assume that C&I balances remain flat through the end of October, given that's been such a big positive delta for your division, would that entail, do you think, negative revenue growth through the second half in sort of that bear case versus mid to high single-digit growth levels? Well, if we had flat growth for the entire year in commercial? For the rest of the year. Yeah. Well, it'd be hard to have positive growth if that part of the business, which is a very large part of the business today- Yeah had no growth. It would be tough to have positive growth in the whole business, absolutely. I don't expect that to happen. Okay. That's fair. Thanks for the time. Thank you. The next question is from Nick Stogdill from Credit Suisse. Please go ahead. Hi. Good afternoon. Just sticking with Dave, my question's on the transportation business in the U.S., and I was hoping to get a bit more color on both the growth and credit outlook as some other companies have talked about softness in the U.S. trucking and transportation market. I know a couple of quarters ago you did talk about there being some overcapacity in that industry, but that it appeared to be stabilizing. Maybe just an update there. Then related to that, there was some PCLs on the transportation line that have been trending up, and I think that was expected, but just maybe a little more color on what's driving that. Sure. Why don't I cover the first part, and I'll let Surjit talk about the PCLs if there's anything specific I can add. The transportation business is actually doing quite well. The overall industry, and when I talk about the industry, I'm going to talk about new Class 8 truck sales. Class 8 are the large trucks that you see. What this business does is it finances largely those purchases, and that's a business that they've been in and now we've been in for 35 or 40 years and have a very large market share. That business, the new truck sales, probably was down 20% in 2016, not for us, but for the industry, and probably expected to be 10%-15% down for fiscal 2017. That's naturally brought our new business down with it. By the way, not nearly as much as the industry. As we look forward, and particularly into the back half of 2017 and into 2018, we're seeing a couple of things. We're seeing new truck sales start to pick up, but more importantly, in driving our customers, we've seen pretty good growth in spot rates, which is the rates that people will pay truckers to haul their traffic. Those spot rates have gone up significantly over the last couple of months, and we expect those to continue to grow. We've seen less supply in the market, particularly with new trucks. Just that they haven't been as many, and now that's starting to pick up. The demand supply is working, I think, starting to work more in our favor after a number of quarters where we'd move the other way. That said, it's a really good, strong business. We continue to grow the market share there, and I've been really happy with it to date. Does that help on the color? Yeah, that's helpful. Thank you. Just on maybe the credit with Surjit, I noticed the formation transportation as well this quarter, maybe the color on that as well. Yeah. I'll give you first color on the PCLs in the transportation finance business. What we've seen in the past two quarters is that there's been a slight tick down in the PCL rate in our transportation finance business in the U.S. So after the fourth quarter of 2016, it's been coming down slightly. I agree with David in that the outlook certainly is bearing itself out. You're right, you do read a fair number of articles in the newspapers about overcapacity, but the reality is that sales are going up. Having said that, you do notice a number of increase. You do see a higher formation in the transportation line. What I want to tell you about that line is it actually does not relate to the transportation finance business that we bought from GE. This is actually legacy business that we had, and in fact, is not even truck related. So the PCL that we have and the formations are actually quite different and distinct, legacy and not truck related. Okay. Thank you. Thank you. The following question is from Robert Sedran from CIBC. Please go ahead. Hi, good afternoon. I just wanted to follow up first with an answer that Tom gave regarding the buyback. Tom, I am curious on the DRIP because we have been adding, looks like about 3 million shares a quarter for the last couple of quarters. Is the likelihood that you will start buying those shares in the market rather than issuing from treasury? I am curious as to why that has not been happening already, especially after the big jump in the ratio. Yeah, sure. I guess a couple of things. The first is that given the difference between when we declare the dividend and pay it there is quite a lead time related to the signaling on whether or not the DRIP will be on or off. We left the DRIP on for the quarter that is just passed given that the declared dividend that was paid in the quarter occurred quite a while ago now. Looking forward, the DRIP discount is off as I think you know, and I would assume that we are satisfying the remaining shares that we need to issue for the DRIP by buying in the market as opposed to issuing from treasury. So that source of dilution will stop. Okay. Thank you. So the potential for a buyback would be a net buyback then, not just to help offset some of that. I think that is a reasonable view. We do have some issuance as you know from options. It is a smaller number, but I think there is a reasonable prospect for a net reduction over the back half. Okay. Thank you. I just wanted to ask about the card fee line. It's the lowest that it has been in quite some time. Curious to know what's going on there, and if you can give a sense of which side of the border it's happening on as well, please. It's Cam speaking. Thanks for the question. It's happening on the north side of the border in Canada. Almost all of this is the Canadian business. Almost all of it is obviously interchange related, and specifically industry interchange related. The business is to me performing broadly well. I think I've guided to low single digit balance growth and mid plus single digit revenue growth. We're not there this quarter on the revenue, but I expect we'll return there for Q3 and Q4. Can I ask Cam why, if it's interchange pressure, you'd expect the revenue growth to return? What's the source of the interchange fee pressure this quarter? Well, you'll know that the industry's changing, and the networks have undertaken a voluntary reduction to get to a lower blended rate in the last year and a half, 2 years than they were before that. Two things happen. Number 1, buying behavior changes quarter to quarter, so your mix on interchange can change, and we've had a dose of that this quarter. In addition the networks do what they need to do to ensure that they're coming in the range that they need to come into. That can move around a little bit each quarter. This quarter we had a little more of it, and I expect things to even back out. Okay. Thank you. Thank you. The following question is from Gabriel Dechaine from National Bank Financial. Please go ahead. Good afternoon. First question I have is on the Basel I floor. It popped up again today about 2 billion of RWA. Not much, but between that and some of the actions, at least visible ones we saw you take this quarter like that RMBS deal, which I think was more capital related in relation to the floor, it appears you're still around the floor, and you weren't breached it this quarter. It's a recurring issue. How much more flexibility do you have to deal with that? At what point does it become a revenue issue, as in you have to start limiting growth or shedding assets? It's Tom. A few things. I guess off the top we tried to guide to an expectation that the floor could be operative in any quarter going forward, even though it wasn't last quarter. The floor is managed as a part of managing our overall capital position. It's not a huge surprise to us that it's back given that was a possibility, and we were just a little below it being operative last quarter. The capital ratio still grew and grew by about the amount that we would expect in a typical quarter. On that front, we've guided, as you know, to on average over time a 10 to 15 basis point bump per quarter. There is some ongoing ability to manage around the RWA growth. There's a little bit of a cost to that, and we did have a question on that last call. But I'd say it's not significant in the context of the earnings and really not that significant overall. We're viewing the floor really just as one of many parts of managing the capital ratio and treating it that way as we grow the business and manage the overall capital position. So it doesn't sound like you're going to be balance sheet constrained, or if so, in any material way. Oh, I'd say the common equity Tier 1 ratio is 11.3. Okay. And that RMBS, was that capital motivated, and is that testing the waters for more to come? It was principally driven by capital consideration. There is some potential on the funding side, but the driver really was on the capital side. Okay. My next question is on credit for Surjit Rajpal. Everybody is kind of focusing on Canada, the big bad housing issue, and the credit signals to me at least are looking a little bit more worrisome south of the border. We are seeing some weakening of credit card delinquency data, auto sales and used auto prices and retailers experiencing some difficulties. Now these are early stages, and they might right themselves over the next few months. Who knows? But it does not look great. Your comments though sound pretty confident. You do not sound too worried. Is that really a statement that these exposures are pretty small for BMO, and that is why you are not worried as opposed to general market commentary because they are small, like cards are not a big business in the U.S. for you. Auto lending, you have shrunk it, and I do not think your retailer exposure is that big either. Is that what the basis of your comments are from? That, Gabriel Dechaine, is largely the reason for my comfort. Having said that, you are right. There are some segments that in the U.S. they are watching for. There are issues with some companies on cards, on student loans that could be an issue there and in auto as well, subprime auto. We watch developments in those areas as well, but those are areas that we are not focused on and are small for us. In fact, we are not in two of those three areas in any big fashion at all. But you are absolutely right in your assessment. But your comment, if you were talking about the broader market, are you any more worried today than you would've been six, eight months ago? You're talking about worried about the consumer market in the U.S.? Yeah, the U.S. generally because if there is a problem somewhere, there's always contagion concerns, right? No, I am not terribly worried about the U.S. market. I think the outlook in the U.S. and all the rhetoric around spending and the outlook which is borne to some extent in the equity market and the shape in which they are in, I think is all pointing positive and so I'm not terribly concerned. Nor are we seeing anything in the economic parameters that would cause us to feel differently at this point. Thank you. Thank you. The next question is from Sumit Malhotra from Scotia Capital. Please go ahead. Thanks. Good afternoon. Surjit, I think you are right, 28 basis points of PCL is not that different than you had guided us to. But I still got to ask you a couple on credit anyway. The first one just for transportation finance. Oftentimes when a bank acquires a portfolio, we see a cleanup, if you will, of the book initially, and then it starts to season. I know you said in a previous answer that the uptick in formations was not related to that book. But is some of the increase in U.S. NPL or formations related to the, I will call it the seasoning of the transportation finance portfolio? The transportation finance business, you got to understand, is a cyclical business, and we recognize it as a cyclical business when we actually bought it. And the uptick that you saw in the first few quarters after we bought it was a result of there was a lot of overbuying in the industry, and we knew it was at the top of the cycle. And I think what David explained is that part of the cycle is slowly coming to an end, and we are going through a more stable period, and that the overcapacity is slowly getting lifted. So I think that is where we stand as far as the transportation business is concerned. So it is not out of line in terms of what a cyclical business would experience. And then just on business or corporate and commercial provisions on the whole, with the exception of the oil and gas swinging from a recovery to a provision, most of the buckets where we see the increase, the service industries, wholesale trade, it's not issues or areas of your portfolio that in my view the market's been overly concerned about. In your view, is there anything tying some of these increases that we see on specific industry lines in corporate and commercial together or is this just a couple of one-offs that went in the wrong direction this quarter compared to what they've done in the past? I think there are a couple of one-offs, and that always happens. There are idiosyncratic reasons for companies going sideways, and in every portfolio we expect that to happen. Despite our best judgment, some companies don't do as well through the years. That's part of the reason. Part of the reason also when you look at it on a netted out basis, the issue of recoveries also comes into play. The recoveries are also a factor in terms of where our PCLs finally land. I've been explaining this to you. There's two elements. One is the variability in commercial, and the other one is the recoveries, which over the past several years you were accustomed to seeing large numbers come our way, and those numbers have shrunken because we do have a much smaller portfolio from the point of view of an impaired book. That's what gets you back closer to the 25 basis point range. That's right. Which is why, see, you got to now look at it in a normal environment, unimpacted by what we experienced for a number of years in the past. Okay, I'm going to close with a two-parter for Cam Fowler just on revenue in P&C Canada. First off, on consumer loan growth, it was down sequentially in Q2. That's not surprising. I think we saw the same thing a year ago. Usually we see a healthy uptick in real estate-related lending in the second half of the year. In the wake of some of the changes in the market of late, do you expect that second half rebound in consumer loan growth or real estate loan growth is still a likely occurrence or has that been dampened somewhat? Then just on the credit card issue, does this any way relate to lower spend in the back of some of the, let's just call it the Air Miles news late in 2016? Thanks, David. I'll start with the second one. A little bit, not a lot. The story is primarily linked to the interchange standpoint. I will say the performance in our Air Miles book is not as strong as it has been in large part due to what has gone on with that important partner to us over the past year. Our customers really value that program, and it's not gone smoothly. So my expectation is that that one turns itself around and will improve. It's certainly not helping, but it's not the story here. With respect to the former, two points. Number one, it is fair to say that Q2 consumer loans ex-mortgage are a little bit lighter. There's some seasonality in there, as you say. But I would say there's also participation choice there. CSCs are down, and I've talked about that on this call through the course of the past few years, and we've made choices there where we would like to be more selective and perhaps less active in the longer amortization higher LTV business. That put us in the negative growth category on CFC. Offsetting that, there's positive growth in other areas that we're focused on, HELOCs, EOS, et cetera. So there's more health there than perhaps what the surface number looks like. It is not a number that's very large, and it's not a number that I would want to be very large, to be honest at this point, but it's right where I think we would want it. Your final point is in light of what's going on with housing, what are my expectations for the back half of the year? I think we'll wait and see on that one. There is clearly some slowing down in the biggest story in the market, which is Toronto, and we're an at-market participant in that. So there could be, and I would expect there to be maybe a point or so reduction in balance and limited impact on revenue in the back half of the year. The focus for us, as I said earlier in the call though, is to make sure that we're keeping the commercial loans and commercial deposits growing at high single digits as they are now and have been in the past, and keeping that retail deposit growth as high as possible at 8%. If we can, keep the checking account growth at double digits. That's good color. Thanks for your time. Thank you. The last question for today is from Doug Young from Desjardins Capital Markets. Please go ahead. Hi, good afternoon. I guess I'll stick with Cam. Two questions, I guess, Cam. Are you noticing any increased competition in the commercial market in Canada? I've heard anecdotal points around it. Just want to get some color from yourself. I guess on the non-interest expense line, it sounded like there was a mismatch in terms of it was chunkier than you would've expected. Can you size what the chunkiness was in the technology and sales force expenditure this quarter? Thank you. Sure. Answer number one with respect to commercial competition is yes, that it is up. It is not a story, I don't think, that is different than the past four or five quarters. Linked to all the themes we have been discussing on this call and the view on housing and the opportunity relative to the consumer, the commercial business is more attractive. So yes, more competition, but the growth that we are seeing at high single digits loan and deposit is happening across the country. There is not a division that is struggling in that regard and deposits and loans across many verticals, actually. So it is healthy there is more competition, but I don't think it is inhibiting in any way our ability to compete as one of the largest players. Your second question was with respect to mix. We are up CAD 4.8. That is CAD 40 million. Circa half is on the digital investments. Bill said off the top of the call where our digital focus is. Point number one is on architecture so that we can compress our release cycles and our unit costs. Point number two is on data so we can have more context in our conversations with regulators and customers. Point number three is on the digital experience, and we had a bunch of releases in that regard this quarter. Point number four is on digital process. So we are focused in all of those areas. The measurements we are most interested in, Bill alluded to a couple of them are digital penetration, which for us is really important. We are at about 50% right now, and we would like to get to 70%. We are up from 30% just a couple of years ago. Then digital sales is another one. 16% now. I expect we will be at 18% or 19% digital sales by the end of the year, which is up from 12% two years ago, and we are traveling to 30%. So we need to spend that money to hit those numbers. Hitting those numbers gets our multi-channel engagement up, and when our multi-channel engagement is up, our loyalty is up, and that is how this system works. Just on the commercial competition, is that part of what is driving some of the NIMs down? I know you did not mention it, but is there any pressure from the commercial competition, or do you expect that to unfold over the next year? It's difficult for me to predict the next year, but I don't think it's a meaningful driver on the NIM right now. The NIM right now is really more of a cards mix. Okay. Thank you. Thank you. This concludes the question and answer session. I'll turn the meeting back over to Ms. Jill Homenuk. Please go ahead. Thanks, everyone. I appreciate you joining us today. Enjoy the summer, and we'll talk to you again in August. Thank you. The conference has now ended. Please disconnect your line at this time. We thank you for your participation.