Earnings Call: Q4 2014

Dec 2, 2014

All participants, please stand by. Your meeting is about to begin. Please be advised that this conference call is being recorded. Good afternoon, and welcome to the BMO Financial Group's Q4 2014 earnings release and conference call for December 2, 2014. Your host for today is Ms. Sharon Haward-Laird, Head, Investor and Corporate Communications Investor Relations. Ms. Haward-Laird, 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 short 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. Also with us this afternoon to take questions are Frank Techar, Chief Operating Officer, Cam Fowler from Canadian P&C, Mark Furlong from U.S. P&C, Gilles Ouellette from Wealth Management, and Darryl White from BMO Capital Markets. We will end the call with comments from each of our group heads and from Frank Techar on our fiscal 2015 outlook. On behalf of those speaking today, I note that forward-looking statements may be made during this call. Actual results could differ materially from forecast 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 both a reported and an 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. Additional information on these adjusting items, the bank's reported results, and factors and assumptions related to forward-looking information can be found in our annual MD&A and our fourth-quarter earnings release. With that said, I will hand things over to Bill. Thank you, Sharon, and good afternoon, everyone. BMO's fourth-quarter results conclude a good year in which the bank delivered $4.5 billion in net income, with earnings per share up 6% from last year. This performance reflects a well-executed customer-focused strategy and the momentum we've demonstrated over a number of consecutive quarters. We've clearly strengthened our position in the market and become more competitive. In 2014, earnings reached another high with great execution from our operating groups. Our largest business, Canadian P&C, had strong annual earnings growth of 11%. Personal and commercial banking in the U.S. demonstrated improved trends in revenue and earnings growth in the second half of 2014, and both P&C businesses had strong organic growth in loans and deposits. Wealth Management had another good year with over $800 million in earnings while completing the acquisition of F&C. With the expansion of our asset management platform, we've strengthened our position as a globally significant money manager. Despite Q4 being the slowest quarter in 2014 for Capital Markets, the business generated over CAD 1 billion in earnings for the year, with strong returns and good progress on our U.S. strategy. Capital Markets and Wealth Management continue to provide valuable diversification to our business mix. The investments we've made cumulatively in our businesses since 2009 contributed in a significant way to this year's results and are having a compounding effect that's evident in our growth. Over the period, we've nearly doubled annual earnings and increased book value per share from approximately $32 to $48. This performance reflects a deliberate and consistent strategy grounded in moving ahead of our customers' expectations. Having completed the integration of our expanded U.S. platform in 2012, we've shifted from a heavy emphasis on conversion to ramping up how we go to market to increase product categories per customer and bring new customers to BMO. We've recently refreshed and expanded brand support across our entire North American footprint. This investment is designed to build and maintain industry-leading customer loyalty over time, to continue to increase market share, and drive revenue growth as a consequence. I'll now touch on a few financial highlights. Tom Flynn's remarks will focus on the fourth quarter, and I'll provide my perspective on the year as a whole. Net income was CAD 4.5 billion or CAD 6.59 per share. Revenues were up 9% to CAD 16.7 billion, and return on equity was 14.4%. Credit performance was good, with higher provisions largely reflecting lower recoveries compared to last year. Surjit will comment on credit later in the call. We ended the year with a very strong capital position, which gives us the flexibility to balance growth opportunities with the return of capital to shareholders to maximize long-term value. Our common equity Tier 1 ratio was 10.1%, reflecting a quick rebuilding of capital following the F&C acquisition. We achieved this through good internal capital generation while managing earning assets prudently. Today, we announced a dividend increase, lifting our annual dividend to $3.20 a share. We also announced our intention to renew a normal course issuer bid, subject to regulatory approvals. We view share buybacks as one useful part of our overall capital management approach. Turning to the operating groups, Canadian P&C had record net income of over CAD 2 billion this year, with 2% operating leverage. Total loans were up 8% and deposits were up 10%. Personal and commercial deposit growth was robust, reflecting the success of management actions we've taken to grow this side of the balance sheet. Efficiency improved 90 basis points this year, as we've effectively balanced cost control with investments in the business. In personal banking, we're expanding our customer relationships and increasing products per customer. We're building an integrated and seamless customer experience by accelerating our digital and physical channel capabilities. Mobile transactions continue to grow, roughly doubling from last year. In commercial banking, we continue to enhance sales force productivity and are targeting growth opportunities by region, segment, and industry. U.S. P&C net income was $636 million in source currency, 3% ahead of last year. Total loans were up 7%, with continued double-digit growth in Core C&I loans, up $4 billion or 18%. We also grew checking deposit balances by 9%. Our large-scale commercial banking business continues to build on its strengths, focusing on new client acquisition, increasing share, and extending our corporate payments reach. We continue to improve our product and channel capabilities to make our banking experience more responsive and intuitive. We enhanced our mobile banking platform this year, enabling customers to book appointments in the branch from their mobile device, and mobile users grew by 18%, while mobile banking deposits were up 60%. We finished the year with momentum, delivering Q4 pre-provision, pre-tax earnings growth of 5% from a year ago, and operating leverage of 1.3%. BMO Capital Markets reported earnings of $1.1 billion for the year with a strong ROE of 19%. Revenue was up 10%, reflecting diversified growth across the business, led by investment in corporate banking, where revenues increased 16%. There was good progress in our U.S. midcap-focused strategy with market share gains in investment banking as well as equity sales and trading. During the fourth quarter, Tom Milroy announced his decision to retire. Tom has been an exemplary leader whose vision, execution, and client focus have made him highly respected among colleagues and clients. Under his leadership, BMO Capital Markets has solidified itself as a leader in Canada and a strong competitor in the U.S. Concurrent with Tom's retirement, we announced the appointment of Darryl White as Group Head of BMO Capital Markets. Darryl joined BMO in 1994, progressing through various senior positions until his most recent role as Head of Global Investment in Corporate Banking. He has been a key member of the Capital Markets Executive Committee and has played an important role in shaping our strategy, and as Sharon said, is with us on the call this afternoon. Wealth Management posted net income of CAD 848 million, in line with last year, which included a significant security gain. There was strong underlying growth across the business, with earnings up 15%, excluding the security gain, driven by good organic growth and the acquired F&C business. We continue to differentiate our global product offering through innovation to meet every aspect of our clients' evolving investment needs. BMO recently became the first Canadian bank to launch exchange traded funds in the Hong Kong market. Looking ahead, we'll continue to invest in our distribution to bring our strong manufacturing capability to North American, European, Asian, and other select global markets. To wrap up, looking back at our performance against our medium-term objectives, our annual EPS growth has averaged 9% for the past three years, in line with our target growth of 7%-10%. Our capital ratios are strong and exceed regulatory requirements, and ROE was within our target range, although below 15% this year on stronger capital levels. We fell short of our operating leverage objective due to higher-than-planned expenses. We continue to target 2% operating leverage and believe work done in 2014 will yield benefits in the coming year. As we head into 2015, the environment in which we're operating provides both opportunities and challenges. The progress we made in 2014 and the momentum across our operating groups gives me confidence looking forward. We have an advantage business mix, geographic diversification, and a workforce with a deeply ingrained commitment to customers, all of which provide attractive opportunities for growth. You will hear more on our outlook from Frank and our business heads at the end of the call. But on behalf of our more than 46,000 employees, I want to thank our customers for their loyalty. With that, Tom, I will turn it over to you. Thanks, Bill, and good afternoon. Bill has covered the annual results, so my focus will be on the quarter. Turning to Slide 9 to start. Q4 EPS was $1.63, up 1% from last year. Net income was $1.1 billion, up 2% from last year, which included $121 million security gain. Our results reflect the benefits of a diversified business model with continued momentum in both P&C businesses and in Wealth Management. Capital Markets results in the quarter were below trend, as I will discuss in a few minutes. Adjusting items are similar in character to two prior quarters, with this quarter including F&C integration costs of $9 million after tax. Revenue was up 8% from last year to $4.3 billion, driven by growth in all operating groups, particularly Canadian P&C and Wealth Management. Net interest income was up 9% year-over-year, driven mainly by volume growth, the stronger U.S. dollar, and purchase performing loan revenue. Net interest income was up 3% from the prior quarter due to higher margins, volume growth, and the impact of the U.S. dollar. Non-interest revenue was up 8% from last year, with increases across most categories. Security gains were significantly lower as the prior year included a pre-tax gain of $191 million in Wealth Management. Q4 expenses reflect spending associated with business and regulatory activities and some seasonal uptick. Expenses were up 14% from last year. Approximately half of the growth was due to non-operating type items, as shown on the slide. The effective tax rate of 16.8% was down from Q4 of last year and up from the prior quarter. Moving to Slide 10. Our common equity Tier 1 ratio was 10.1%, up 50 basis points from Q3. Higher capital levels improved the CET1 ratio by approximately 35 basis points. Risk-weighted assets declined by $4 billion in the quarter. As shown on the slide, changes in methodology and book quality improvements drove the reduction, with these partially offset by the impact of business growth and FX. Moving now to our operating group performance, starting on Slide 11. As Bill mentioned, Canadian Personal & Commercial Banking net income for the year exceeded $2 billion. Q4 net income was $526 million, up 14% year-over-year, with 7% revenue growth and positive operating leverage. Total loans were up 5% and deposits were up 9% from the prior year. NIM was up one basis point from Q3. Expenses increased 6% year-over-year and 2% from Q3 due to continued investment in the business and higher variable compensation consistent with business growth. The efficiency ratio improved from last year to 50%. Moving to US P&C on Slide 12. Net income was USD 163 million, up 48% from last year, which had relatively high credit losses and up 3% from Q3. Revenue of USD 705 million was up 3% from last year, driven by strong commercial loan growth and higher deposits, partially offset by lower NIM. Loans were up 9% year-over-year, with continued strong growth in core C&I balances of 21%. Revenue was relatively stable quarter-over-quarter, despite a net interest margin decline of nine basis points, which was due to continued competitive pressures on loan spreads and strong loan growth. Expenses continued to be well managed and were modestly higher, providing operating leverage of 1.3%. Turning to Slide 13. BMO Capital Markets net income of CAD 191 million was down year-over-year and from a strong Q3. Q4 results include a CAD 28 million after-tax charge for the adoption this quarter of the funding valuation adjustment and were impacted by weaker market conditions as well as lower client activity. The funding valuation adjustment, or FVA, reflects the funding cost or benefit associated with non-collateralized derivative positions. Revenue growth was 2% year-over-year as higher corporate banking revenue, equity underwriting fees, and security gains were partially offset by lower trading and the funding valuation adjustment. Expenses were up 9% from last year or 6% excluding the impact of a stronger US dollar, driven mainly by higher employee expenses. Moving on to Slide 14. Wealth Management net income was CAD 253 million, down from last year, which included a security gain of CAD 121 million. Excluding this gain, net income would have been up 28%. Quarter-over-quarter, net income was up 18%. Traditional wealth earnings were up 25%, excluding a CAD 23 million after-tax impact from the settlement of a legal matter and a security gain last year, reflecting good performance from F&C and organic growth. Q4 insurance results include CAD 44 million after tax related to the impact of beneficial changes in actuarial reserves. There was also continued growth in the underlying insurance business. Expenses were up year-over-year and were above trend due to a few factors, including the legal item I mentioned earlier. Assets under management and administration were up 44% or 17%, excluding the impact of F&C, driven by market appreciation, the stronger US dollar and growth in new client assets. Turning now to Slide 15. The corporate segment had a net loss of CAD 39 million compared to a net loss of CAD 22 million in Q4 of last year and CAD 55 million last quarter. The year-over-year decline reflected above-trend revenue this quarter, offset by lower credit recoveries and higher technology and regulatory expenses. To conclude, our results demonstrate continued execution on our plans and priorities, and for fiscal 2014, we delivered record net income. With that, I'll hand it over to Surjit. Thank you, Tom, and good afternoon, everyone. Starting on Slide 18, specific PCLs were CAD 170 million, CAD 40 million higher than in the prior quarter. This was due to lower recoveries in the purchase portfolios. Excluding the impact of the recoveries, PCLs actually improved this quarter. in Canada, Personal & Commercial losses were stable quarter-over-quarter, while in the U.S., commercial losses were lower. Looking at the full year's results, total bank PCLs were 19 basis points. In Canada, Personal & Commercial PCLs decreased from 31 basis points in 2013 to 28 basis points, reflecting stable economic conditions. PCLs for the U.S. Personal & Commercial group decreased from 61 basis points to 34 basis points as a result of the improved economic environment. Moving to the next slide. Formations of CAD 534 million, up CAD 77 million, largely due to one commercial account in the U.S. Our GIL ratio for the quarter was stable quarter-over-quarter at 67 basis points and down from 91 basis points last year. In summary, our credit performance over the past year was good. Through active management of our portfolio, we have made good headway in reducing our impaired loans. The portfolio remains well-diversified and is of high quality. Looking forward, I expect continued good credit performance. I will now turn it over to the operator for the question and answer portion of today's presentation. Thank you. We will now take questions from the telephone lines. If you have a question and you're using a speakerphone, please lift your handset before making your selection. If you have a question, please press star one on your telephone keypad. If at any time you wish to cancel your question, please press the pound sign. Please press star one at this time if you have any questions. There will be a brief pause while participants register. Thank you for your patience. First question is from Gabriel Dechaine from Canaccord Genuity. Please go ahead. Good afternoon, Bill. I just want to touch upon some of the comments you were making about this year's revenue and expense performance and how you fell short of your operating leverage targets. The 10% growth in adjusted expenses was the big driver there. Wondering if you can shed some light on what investments were included in there that are going to help drive that number lower and what your expectations are for next year. I think the point of my comment, Gabriel, was to reinforce the commitment to continued target of operating leverage in the 2% level. I think this year, the deviation from that, in part, was a reflection of investment that we have been making in both technology and in making the capacity of the organization to deal with regulatory burden in a much more efficient way. A much more productive way will pay off in future years. As you know, there's been a big ramp-up in the industry of expense on that side, and we're really looking for some abatement of expense through a more efficient process. Then obviously the management of channels, so the modernization of the way we face the market in our branch systems, how they work with the call centers, and most importantly, the rapid changes taking place in mobility. I think our expenses came in higher than we had started the year anticipating. We accomplished a great deal, and that's really the basis for renewing the commitment to operating leverage improvement. Tom, you might want to comment briefly on a couple of the expense areas that would have been out of ordinary expectation. Sure. The total expense growth that we had in the year, as you mentioned, is 10%. FX contributed 3% of that and the acquisition of F&C, 1%. So net of those items, more ordinary operating expense growth was in the 6% zone. That was driven partly just by normal expenses in the business, and also by a higher level of investment in technology that we had in the current year. With some of that related to regulatory items and some of that related to things that we're doing, both to enhance our processes so that we're more lean in our operations and also able to respond to client needs in a quicker way. Some of the technology spend was also associated with things we are doing in the digital space. As Bill said, we feel good about how those investments will position us for next year. Okay. I guess it's something that isn't unique to Bank of Montreal, but the outlook for revenue growth is not the strongest, mostly due to declines in Canadian consumer borrowing. A lot of banks are talking about pulling back on expenses, and we haven't seen that this year. Just wondering what we can hang our hats on to hope for better expense performance from any bank next year. Is there anything you can add there? Well, I think your point on Canadian Personal & Commercial is a good one in that I think we've shown very good anticipation around where there would be changes in the revenue growth. We're hoping to continue to grind out market share growth, but we had good operating leverage performance in Canadian P&C for the year and are operating the business with that same perspective for next year. I think that's the area where the revenue sensitivity is the greatest and where the focus on managing the operating leverage is also for us an important marker. Okay, thanks for that. A little follow-up for Surjit Rajpal. If I look at the accretable yield this year, or Tom Flynn, it was a total of CAD 238 million. I think it was last year or the year before you'd given some indication of where you expected recoveries on impaired loans to trend down over the next year. Could you maybe give an indication of where you expect the recoveries on purchase performing loans to end up next year, and how that should trend over the next couple of years even? Let me start. I'll answer the first part of the question, and then I'll pass it on to Tom Flynn. There are two elements. There were recoveries in the purchased credit impaired portfolio, and I think in previous quarters I'd indicated that that component of the portfolio has come down very significantly. Right. Now it's less than CAD 500 million. Most of that portfolio is performing. More than 50% of that portfolio is performing. The only benefit that we can get out of that portfolio is, we're not going to be selling too much of that going forward. I think we're going to let a lot of it run off naturally. Having said that, we have recorded this at lower than legal balances when we bought the portfolio. So there is some upside left in the portfolio, but it's rather small given that, as I said, more than half of it is performing, and so you're talking about a portfolio of about CAD 200 million where there is some upside. With respect to the performing portfolios, we have taken some opportunistic sales in the last quarter, which we didn't pursue this quarter. That portfolio is here to stay because we would like to manage that as part of our regular program. There's no real push for us to sell that. We've absorbed that portfolio. We just carry it separately because of accounting reasons. But actually that's very much part of our core book now. With respect to the accretion, I'm going to ask Tom to answer that question. On the accretion, the amount of credit mark that will be amortized in the future is about CAD 200 million. It's a little bit higher. The revenue recognized in any quarter is a function of the regular amortization plus acceleration of the amortization as a result of payoffs. The payoffs are obviously variable. I think probably something under half of the CAD 200 million will come through the revenue line in the year. Exactly where it will be will depend on what level of payoff and refinancing activity there is. Right. Then I guess there would be the PCL item as well. Anyway, that's fine. Thanks a lot. Thank you. The next question is from Robert Sedran from CIBC. Please go ahead. Hi, good afternoon. Tom, we talked a fair bit on the last conference call about some pretty aggressive risk-weighted asset management that helped more or less offset the impact of F&C on the ratio. Now we've got a pretty good beat on what organic capital generation is, but is there more of this opportunity left to optimize the risk-weighted assets and actually generate more capital for deployment or return? Thanks for the question. A few things. Like you said, both last quarter and this quarter, we had good performance on the risk-weighted asset side, and it did reflect active management, including some risk reduction. I would say the risk reduction part of the improvement with this quarter has run its course. We did take the opportunity, given F&C, to look at positions that we didn't think were earning a sufficient return. With that, liberated some capital, and in the current quarter, that contributed about 3 billion of RWA reduction. I think that piece is essentially behind us, and we feel good about it. We have had some methodology changes over the last couple of quarters. Those, as you know, can come and go. Sitting here today, I would say we're not expecting anything really out of the ordinary looking forward. The rate of capital accretion that we've had over the last couple of quarters is above trend. Maybe I'm being too cynical, but oftentimes we see those methodology changes, and we think it's the regulator doing something, and it always seems to drive capital levels lower, not higher. Was there a net impact of these methodology changes, or was it just model refinements that are working in your favor? This quarter and last quarter, the biggest single methodology change relates to moving a part of our portfolio that has been calculated on a standardized RWA basis towards AIRB. The part of the portfolio, the U.S. portfolio, is moving more slowly to AIRB. The majority of the methodology adjustment just reflects us moving to the Basel III advanced method of calculating RWA for that part of the portfolio as the models have matured to a greater extent. Okay. Got it. Thank you. Thank you. The next question is from Brian Klock from Keefe, Bruyette & Woods. Please go ahead. Good afternoon. My question is on slide 17 in the Surjit section, the loan portfolio overview. Just trying to think about the slide shows about $5.9 billion in oil and gas related exposure in the loan book. Thinking about with WTI here under $70, I guess, should we think about that $2 billion of growth that you have had in that portfolio over the last year? Should we think about the outlook maybe slowing for that loan growth? I guess maybe talk about maybe the expectations about the credit performance in that portfolio. Thank you for the question. In terms of expectations for growth, in the past few years, there has been a lot of investment in this sector. The portfolio has grown in keeping with those investments that companies have made. With respect to the outlook, our portfolio at $5.9 billion, our portfolio is roughly 2% of our total loans. This is an important part of our portfolio. We do a lot of business with these companies, and we have always known that these are somewhat cyclical. You do have oil cycles that come and go, and we have been in this business for a long time. Let me give you a little bit of a feel for what this portfolio is about. About 40% of this entire portfolio is borrowing base. Yes, borrowing base is determined based on prices that you assume from time to time when you change. That is less than 1% of our portfolio is borrowing base, to put another way. The other large chunk of that portfolio is really to investment-grade companies that are either in the oil and gas business and some in pipeline and midstream businesses. That is again, largely investment grade. The smallest piece of our portfolio is in the services sector, and that is largely in Canada, which is in Alberta and not at the wellhead, but for companies that do maintenance and roads and housing and such like that are tied to the performance of the sector. When I look at this sector, firstly, I think the amount is not that large. Secondly, I think some of these companies do have the resilience. We have got investment-grade portfolios in our company that have a lot of resilience. The borrowing base companies, you should look at borrowing base lending as, well, it is a secured lending, and it is probably, in my view, one of the better forms of asset-based lending because there is oil in the ground, and temporarily, when oil prices do go down, these companies are able to withstand and over a period of time, dig themselves out. If there is any negative migration, if there is a continued decline in oil prices and it is sustained for a period of time, they will always come back with prices going back up or even remaining stable over a period of time. The exposure that we have roughly is two-thirds in Canada and a third in the U.S. The Canadian side does benefit from a lower Canadian dollar. The Canadian dollar goes down with oil prices, and that also provides a natural hedge for some of the costs that the Canadian producers have. That plays out as a positive. A long way to say I am not terribly concerned about the portfolio. Of course, oil prices need to be watched closely because they have much broader implications than just for this $5.9 billion portfolio that you point out. There are positives, of course, in a lot of areas. From a consumer lending standpoint, with gas prices going down, there are many geographies that are going to benefit. The U.S. is going to benefit, Europe is going to benefit, not Russia, though. The emerging economies are going to benefit. Latin America cannot do that well. When you look at it from that perspective, I think there's a lot of good that will come out from low oil prices that could benefit us in other sectors. I hope I've answered your question. No, I think that's great color. Thanks, Surjit. Just to follow up on that, I know you did talk about the servicing portion of that. Can you quantify how big that servicing portfolio is? That would be a little over 10% of the overall portfolio, and it's very small names, and as I said, largely in the Alberta region and not at the wellhead. So great. It sounds like right now it's still a little bit too early with WTI just kind of dropping just recently, but with the borrowing base, with your price deck pretty conservative, you feel pretty good right now. Actually, there's nothing that's showing up on your impaired loan formation at this point. No. In fact, at this point in time, there's nothing. I was examining our migration. There's been as much positive migration as there's been negative, so it's actually neutral right now. There's nothing to worry about today. But as I said, it all depends on how long the prices remain low. Great. Thanks for your time. Appreciate it. Thank you. The next question is from Darko Mihelic from RBC Capital Markets. Please go ahead. Hi. Actually, Surjit, so while we're on the topic, there's impaired loan formation and then there's watch list. Maybe you can talk, has anything actually hit the watch list? As a follow-up, at what price of oil do you get concerned about this portfolio? Good question, Darko. The watch list is, I hate using the word that I've used before, minuscule. There's hardly anything in the watch list. It is rather tiny. The sector has performed extremely well to this point in time. Now, going forward, if oil prices, as you say, remain depressed, there will be some strain on some of these loans, and there will be some negative migration. Hard to tell what it'll be like, and it's also hard for me to tell you what price I'll get totally concerned at. We run stress tests from time to time, and we've done a number of them on a regular basis with respect to this sector. The results of the tests that we've conducted do not cause me any concern at prices that we had done in the past as low as $60. I'll leave it at that, but we continually will keep looking at our portfolios. Okay. Thank you. Maybe just a question on the expense. The expense, the bump up that we saw in the quarter, you sort of mentioned it, and this is a question obviously for Tom, but you mentioned that it was partly seasonal and partly related to regulatory. I guess what I'm wondering is, a lot of it showed up in equipment premises and so on. I'm just trying to get a feel for the run rate of expenses and if the regulatory/technology costs are in fact fluid, or should we think of it now as sort of a new run rate of expenses, in particular in that line item? Just because it caught me off guard a little bit, and I struggle to see why it wouldn't sort of remain elevated going into 2015? Okay. I'll try to answer that. The expenses we did characterize as being a little elevated in the quarter. Some of that relates to the legal item that we mentioned. There's some higher spend that not uncommonly goes along with the fourth quarter. We didn't try to put too much emphasis on that point, but it is a part of the story. Heading into next year, the first thing I'd point out, just as a sidebar, is that in Q1 of every year, we do record a higher level of expense for eligible-to-retire employees, and that is about CAD 70 million of mix in Q1, and it's been at that level for the last few years. So it's just a Q1 event. Looking through that for the year, I would say we expect regulatory expenses to continue to run at a higher level next year. That's partly because we're going through a change as an industry, and people are making adjustments as a result. We do think there will be relief on that front in the future, but it won't be next year. I would say, as an organization and as Bill said earlier, we're focused on managing expenses in a reasonable way, keeping a close eye on the relationship between revenue and expense. I do think that the good operating performance really in both P&C businesses this year is a testament to that. P&C Canada, 2% for the year, and U.S. P&C in the quarter, 1.3%, and they've done a very good job of managing their expenses through the course of the year. Okay. Thanks, Tom. Thank you. The next question is from Mario Mendonca from TD Securities. Please go ahead. Good afternoon. Surjit, can we go back to the oil and gas type questions? You referred to the 40% portion of the loan book that you called it borrowing based. Is that the same as what some oil and gas guys refer to as reserve based lending? That is correct. The 50% that you said went to the investment grade lenders, or borrowers rather, is that more the covenant type lending? Yeah, that would be covenant type lending as well as lending to midstreams and pipelines. That didn't go entirely to investment grade lenders, but the vast majority of that lending is investment grade to investment grade companies. You referred to the duration over which very low oil prices could have an effect. What are you referring to there? Like about 12 months so that the trailing 12-month tests become an issue? It's more than that. It also depends if the change in prices is at. When the prices first started dropping, most people thought it was a shock. It was called the oil shock. Are they going to be sustained down there? One doesn't know. When we do a price deck for these borrowing bases, we have a different price outlook for every year. So when I talk about how low prices will be, it depends on how long they stay because the present value of the cash flows for each year, depending on the different price level. Okay. Would it be unfair to ask questions about the price deck and where a lot of these loans had got priced, like in the $80, $90 range? Or is that a reasonable question to ask? It's not something we disclose, but they were definitely not done at the high range that you talk about. They were done at higher levels than currently trading, obviously. But we don't normally disclose the level of our price tag. Now, just a related question. Ignoring the loan book now and just thinking about Capital Markets revenue, M&A and underwriting. This is going to change year to year, but in any given year, what proportion of that Capital Markets revenue would actually relate to oil and gas? Could it be as high as 50%, or would that be overstating things? Mario, it's Darryl White speaking. That would be overstating things. If you look at our Capital Markets revenues, I can't give you the total as a percentage of our revenues that relate to energy, but I can give you some examples in the businesses that could be affected, you might argue, that could be affected going forward. Our equity Capital Markets revenues, for example, our underwriting business in Canada would be about 1% of our total Capital Markets revenues, and our commodity trading revenues would be about 1% of our Capital Markets revenues. Our M&A revenues would be a little bit more than that. So when you add up all of the Capital Markets revenues that we would have, they would be in the single digits for sure as a percentage of total Capital Markets and probably in the low single digits. Sorry. When you refer to 1%, you're referring specifically to energy as a proportion of the equity Capital Markets revenue, or are you saying equity Capital Markets revenue is only 1% of the total? No, I was referring to energy equity Capital Markets revenues as a percentage of Capital Markets revenues. Total capital markets revenues. I got it. Is that helpful? Yeah, it is. So 1%, and M&A you said was slightly greater than 1%. Correct. Then a sort of follow-up question. Going back to Surjit perhaps, or Tom Flynn. If we do in fact see oil prices stay low for some time, at what point might that start to play out in the RWA? Or is it just not large enough to really move the needle? Yeah, it would not be large enough to move the needle. The reason for that is, again, a lot of these loans, I said 40% of them, as you call them, reserve based, they are secure. The capital that gets allocated to secured loans is much lower based on the loss history of these loans. I do not think it will be material. Okay. Thanks very much. Thank you. The next question is from Sumit Malhotra from Scotiabank. Please go ahead. Good afternoon. First, just a point of clarification for either Tom or Darryl. On the funding valuation adjustment. Tom, I think in your prepared remarks, you referred to the $39 million cost this quarter as the cost associated with adoption of the FVA. Is that correct? That's correct. How does this item impact you on an ongoing basis? What I mean is it going to be, like we've heard over the last few years with the CVA or the DVA, something that can have an impact depending on how credit markets move quarter to quarter? Or is this something that's more one-time issue in nature? Just looking for some color on how this moves on a go-forward basis. Sure. Just to reinforce one point you made, the charge in the quarter is outsized and reflects the adoption of this new practice, which has become a market norm, which is why we're recognizing it in the current quarter. In terms of regular quarterly movement in the number, we're not expecting it to be significant quarter to quarter. So it could be in the order of, in an ordinary quarter, plus or minus CAD 5 million, and it's a function of how the nature of the book changes, so how our exposure to uncollateralized derivatives would move quarter to quarter, and a function of the relationship between our funded bond credit spread and our CDS spread. So those are the variables that impact it, but it shouldn't be a significant item quarter to quarter. In more volatile markets, we wouldn't expect it to be the kind of item that CVA can be for the industry. That's helpful. Thank you. My second question is for Bill. Bill, in referencing your return on equity target and the fact that you came in slightly below in 2014, you pointed specifically at the continued buildup in capital ratios, which is something we've talked about a lot. When you think about that 15% mark, and I know this is a medium-term target, but when you look at 2014, you had a very favorable PCL ratio, very strong Capital Markets, and at least from my seat, it doesn't seem like the amount of capital you're going to have to hold is going to change significantly. In keeping that 15% target, what are you envisioning as the key component that gets BMO above that 15% level going forward? Well, there's a couple of areas where we expect to see the business grow, and grow with reasonably good margins. I've talked about investment in corporate banking in the U.S. The return on equity of Capital Markets clearly has been strong, and that's while we have been building the U.S. business with an investment in talent on the banker side and on the advisory side, and the revenues have been following. We've seen good growth in 2013, 2014. We expect to see continued growth in 2015, 2016, and 2017. So in that area, I think that will be a net contribution. U.S. investment banking, the business mix will change and more advisory and fee income. In P&C U.S., as Mark has talked about the business, we have earned our way through pricing declines in the market, which are natural, and continued low interest rates, which have a dampening effect on the value. Not on the value, but on the current return on the deposit base. Our own view is that those headwinds, including the runoff portfolios, have abated, and that that business should be able to show good ROE revenue growth and income growth, again, contributing to the improvement in ROE. Because coming out of a period of time like the last five or six years, you have I think an inherent conservatism in both the granting of credit and in the estimation of the amount of capital required in those portfolios. I think both of those will be a favorable trend going forward. Then the ongoing cost of all of the regulatory change that has taken place, and this was a worldwide phenomenon in the last six or seven years, as I alluded to in I think my first answer, we're just going to get a lot more efficient in managing that expense. We have a large U.S. business. We've invested in order to maintain our capability in the face of that regulatory change. A lot of the work that we've done, I think will be applicable in the long run in the Canadian market as well. So spend once and use twice. In the same way that we've maintained a commitment to an operating ratio improvement of 2%, we think that will flow through to the return on capital as well. If I summarize stronger results in U.S. Capital Markets and P&C and improved efficiency across the franchise gets you to that 15%. Yep. Correct. Thanks for your time. It's my pleasure. Thank you. The next question is from John Aiken from Barclays. Please go ahead. Catherine, Bill, I guess a follow-on to Sima's question. With the capital levels that you're at, what do you think the message the board is trying to convey to the market with the dividend increase as well as the renewal of the NCIB, considering that there actually were no repurchases on the last program? Well, I think it's a message of consistency with everything that we've said about the management of capital. We're back above 10%, which I've indicated as the range that we wanted to get back into. We did that very quickly, considering that we made a CAD 1 billion plus acquisition in 2014, that was all goodwill, effectively all goodwill. When you look at 2014 versus 2013, we bought back CAD 700 million worth of stock. They're basically in alignment. I would say that they would be good competitors with each other from the perspective of value creation or being accretive. I think that the message is exactly what we have said on virtually every call, that we want to have strong capital because we believe that we're going to generate good organic growth, and that's going to give us the best return on capital. We're going to increase our dividend consistent with the growth in earnings, and we're within the range. We also know that having a dividend increase every second or third quarter on a fairly regular basis is valued by shareholders. We happened to have two this year. I think last year we had one. On a fairly consistent basis, adjusting the dividend up. When we look at the investment horizon, if there are good acquisition opportunities, they can be balanced off against the buyback. We want to have that capability in place. In 2013, we used it to great effect. In 2014, we made an acquisition that I think will turn out exceptionally well in the long run. It's looking good right now. In 2015, we have the flexibility that we want to fund organic growth, to manage the dividend as we've been doing it, to acquire businesses that are complementary, and to buy back shares where we think it's accretive. So the message is entirely consistent with both our stated intent and the things you've observed us do. Okay. Thanks for your thoughts, Bill. Thank you. The next question is from Peter Routledge from National Bank Financial. Please go ahead. Hi, I'll go to Surjit just on the oil price issue again. Surjit, if in a year we're still CAD 65 price of oil, based on your judgment, based on your experience with stress testing, what will Canadian consumer delinquency and loan losses look like? That's an interesting question, but a hard one for me to answer at this point in time. There are positives and negatives of low oil prices. I think the one thing that we'd like to get a fix on is if oil prices remain low, what impact does it have to the regions, particularly in Alberta, of that change? How much does the manufacturing sector pick up as a consequence of a lower dollar that always accompanies an oil price decline? It's hard for me to jump all the way to consumer delinquencies at this point. But clearly, we are mulling all that in our heads, looking at all kinds of scenarios. We'll get a better fix as time progresses, but there will be positives that come out of it as well. Yeah. Thanks for that. I'd like to go back to Bill on capital. You've been pretty prescient on getting capital or taking your capital ratio a little bit higher than at least some observers have thought. 10% sounds like that's your run rate target. We've got the, or not OSFI, but the Department of Finance putting in the recapitalization regime next year probably. Then the FSB doing the TLAC proposal, granted for G-SIBs, but I don't imagine OSFI will fail to notice that. Is that 10%, does that incorporate the expectation that those two changes are coming, and you think that 10% will sustain through them both? Well, we moved to the 10% in belief that that is the right level for the CET1 ratio. With respect to all of the other things that might happen, I think that we are essentially reaching the end of global cooperation on new standards, new regulations, and new provisions. At this point, I don't expect, quite candidly, I don't expect any major changes. What I think you will see is the full cost of higher capital levels working its way into the market in pricing. As well, I think the next wave is going to be probably a broader encirclement of non-banks in the capital and liquidity regime, which I think will also be long-term positive to pricing. I think that we, certainly among the Canadian-based banks, have moved to the higher capital levels in a pretty effective way and have found a way to continue to earn good returns. I think, basically that is what is going to happen across the industry. Okay. That is very clear. Thank you. Thank you. The next question is from Steve Theriault from Bank of America Merrill Lynch. Please go ahead. Thanks very much. First question, maybe for Cam Fowler. Good operating leverage again this quarter. Loan growth just under 5% is the weakest of the four quarters that we have seen for you. I am noting a decline in mortgage balances, flat commercial. Maybe just walk us through, Cam, the trends you saw for Q4. Talk a bit about your outlook for next year. Specifically, are growth rates that had been well above industry average maybe not repeatable next year, or should we look at Q4 as a bit more of an anomaly? Okay. Thanks, Steve, for the question. I will cover both sides. On the personal side, as we expected, loan growth did slow, and we were 4% in Q4, which was clearly not where we were in the first half of the year. But I think, consistent with the market. Up to Q3, we did lead the market, as you know, on lending and on personal loans. The activities we feel quite good about in our own business. Looking ahead to 2015, I would expect a similar performance and mid-single digits on the mortgage side. On the commercial side, we are a little bit lower quarter-on-quarter on the lending. We do have some seasonality in that number traditionally in Q4, but the activities in that business are strong. The pipelines in that business are strong. We feel quite good about the growth on the commercial side, and pleased with year-on-year at 10%. On the deposit side, we are pleased. We have been focused on this in both personal and commercial for several quarters now. The personal deposit growth at 10% is pleasing. That is not just the term side, that is everyday banking and some of the core things we watch in terms of the health of the business. Very pleased with the personal side, and commercial deposit at 7% is good. We expect, I think that things did slow a little bit on the loan side in Q4. I would expect that we will be able to keep our momentum in the mid-single digits on loans, high single digits in deposits through 2015 and perform well on both an absolute and relative basis against the market. Okay. In commercial, you are not seeing any spike in competition that is suggesting you might pull back or anything of that nature? No, not beyond what I have described in the last quarter. There is competition and it is healthy. Okay. Thanks for that. Second question for Darryl, please. Looking at the interest rate trading for this quarter reported at $21 million, am I right in adjusting that FVA? Does that go through that line, and should we be looking at more of $60 million for that line item this quarter? Yes, Steve, you are exactly right. So if you add the FVA, you would get to exactly 60, which is itself a pretty steep decline from what you would have seen in the quarter prior at 90, which is itself a result and a fallout of the fairly extreme market volatility that we saw in the middle of the quarter, which affected the quarter for us quite broadly. But your math is exactly right. You could take the 21 and add the 39. The below run rate number for this quarter, let us call it on an adjusted basis. That is obviously partly a function of the widening or the volatility in mid-October. But how much of it would you say is due to reduced client activity versus maybe the desk losing some money with corporate spreads gapping out for a period of days? It's almost all, Steve, reduced client activity. If you look every quarter, we have maybe a couple of days of losses on our desk, and this quarter would be no different. It would be literally a couple of days, and certainly nothing outsized. So the answer to your question is it's reduced client activity. If you sort of think about the quarter relative to the quarter prior, we had CAD 139 million of less revenues overall ex FVA impact. When you look at the volatility that crept into the quarter towards the end of September, we saw the VIX jump up to, you guys will have noticed, around 26 was the highest level it's been in two and a half years. As a result, markets for the full quarter volumes in the market were down very substantially. If you look across, not just you're referring to interest rate trading, but fixed income broadly, M&A, debt equity underwriting, loan syndication, both Canada and the U.S. When we look across our businesses in the markets we participated in, they're down, volumes are down about 20%-25%. Okay. I guess appreciating that the dust is somewhat settled on volatility. Thinking about next year, and I guess having seen November, does it feel like we're going to see sort of trading more like first half of 2014 or second half of 2014? Yeah, it's tough to say. As you say, we're only a month into the year, and the month doesn't make the year. But we can say that looking forward we're comfortable in a way that we weren't in the middle of the last quarter. Any Capital Markets businesses can be affected by volatility. November certainly feels better than what we experienced in Q4. But I wouldn't say it's quite to the level that we experienced in, for example, Q2, Q3 yet, but it's one month, and we've got 11 more to go. Okay. Thanks very much. Thank you. The next question is from Meny Grauman from Cormark Securities. Please go ahead. Hi, good afternoon. Just a question about the U.S. Capital Markets business, specifically on trading and underwriting. Wondering whether you saw any trends in the U.S. that were different from what you saw in Canada, any divergence there in terms of client activity or in terms of just the general direction of performance? No. Thank you for the question. No, it is very similar, in fact, to what we saw in Canada. We saw to different degrees, M&A volumes in the market in the U.S. in the mid-market that we participate in down in the quarter. We saw equity new issue volumes down in the quarter, high yield down in the quarter, and loan syndication new issue, also down in the quarter in the U.S. So it was consistent from geography to geography with different variations depending on the product. And then just turning to the loan book. There's quite a bit of discussion about that $5.9 billion direct oil and gas exposure. I'm wondering if we look at the loan book as a whole, sort of on a second order basis, I'm wondering if you can give us any sort of indication. Is there any sense of what the exposure is to areas that are not direct oil and gas, but that are highly vulnerable to persistent declines in oil prices? Is there any ballpark idea of, is that a number that you kind of think about? Do you think about it in those terms? I think I tried to indicate that there are positives and negatives from oil price declines. It's difficult to look at them. I can't go through every element with you, but clearly there'll be positives and negatives. But we do look at it on that basis. At the macro level, we look at geographies that'll get impacted, then we look at industries, and then we look at clients. So we do that sort of analysis, and when we do our origination work from a lending perspective, we are very cognizant of those factors. Beyond that, I don't think I can add anything today. No, fair enough. Thank you. Thank you. This concludes the question and answer session. I would now like to turn the meeting back over to Ms. Sharon Haward-Laird. Thank you. As we said at the outset of the call, each of our Group Heads will now provide some comments regarding their outlook for 2015. We will start with Cam Fowler, Head of Canadian P&C. Thanks, Sharon. 2014 has been a record year for Canadian P&C, with NIAT at above CAD 2 billion for the first time. This momentum we have in the business reflects our continued focus on anticipating customer needs, enhancing our distribution capacity, and driving our sales force productivity, and the result has been above-market balance sheet growth. In 2015, I expect we will deliver continued good revenue growth similar to 2014. I would expect above-market balance sheet performance, stable margins, and positive operating leverage. We are continuing to invest in the business to sustain growth in this dynamic environment. The key focus of our investments include our digital priorities in online and mobile, productivity through process renewal and sales force expansion, and the continued growth of our payments businesses. I am confident, as I said earlier, that we will be able to continue our growth and sustain performance that is strong on both a relative and absolute basis. Over to Mark. Thanks, Cam. We started the year with the view there would be an inflection point for US P&C, and it certainly was. Overall, I'm pleased with our performance this year, particularly in the second half when we delivered improved revenue and net income growth. Despite low interest rates and a highly competitive environment in the U.S., we were able to maintain our net interest income at last year's level due to consistently strong loan growth throughout the year. We're diversifying our sources of revenues in areas where we have significant opportunity to grow market share, including business banking and our treasury payment services, and investing in our mortgage, our home equity, and our credit card platforms, which will generate top-line benefits late in fiscal 2015 and into fiscal 2016. We're continuing to be extremely diligent in managing our expenses. We expect to continue this momentum into 2015, and our growth over the next couple of quarters will look a lot like the last couple of quarters. As we move into fiscal 2016, we expect growth to continue to improve with some assistance from rising rates. At this point, let me turn it over to Gilles. Thanks, Mark. 2014 was a great year for Wealth Management with net income over CAD 850 million. We had good business growth in the traditional wealth and insurance, at the same time completing the F&C acquisition and investing in our distribution platform. We expect to maintain this momentum by focusing on integrating the F&C platform and capitalizing on the cross-sell opportunities to continue to strengthen our distribution, and also to realize the benefits from our investments in the U.S. We think we'll benefit from strong asset growth this year of 44%, which was 17% ex F&C. We're well positioned for growth in 2015, and we're pretty confident that momentum is going to continue. Over to you, Darryl. Thank you, Gilles. On the Capital Markets side, when we look back at 2014 as a full year, despite a very slow Q4 driven by the client activity that we discussed, we had a 3% full-year net income growth with good contribution from our U.S. business and an overall ROE of 19.2%, which was up from 18% in fiscal 2013. Looking forward, we expect to see continued growth based on our expectations for GDP growth in North America broadly and the opportunity to continue to grow our U.S. market share. Taking the geographies and the businesses together, we're very comfortable with the direction of our mix. Assuming constructive markets, we feel very comfortable with our 2015 growth prospects. Turning it to you, Frank. Great. Thanks, Darryl. Just a few brief reinforcing comments to close the call today. The first one is this: as we end a good year, we're all focused on one thing as a group, and that is sustaining momentum in each of our operating groups and our businesses. The second one would be, as Bill and Tom said earlier, we're confident that our continued investment in areas that will support revenue growth as well as process enhancements will lead to productivity improvements next year. As Bill said earlier, we have an advantaged business mix, geographic diversification, and a customer vision that provides attractive opportunities for growth in the current environment. The third thing I'll just leave you with is we're all confident that 2015 will be another strong year for BMO. As this is our last call of the year, I'd like to wish everyone the best for the holidays, and we look forward to seeing you in January at our Investor Day featuring our Canadian P&C and Wealth Management businesses. That's it. Thanks and good afternoon. Thank you. The conference call has now ended. Please disconnect your lines at this time, and we thank you for your participation.