Earnings Call: Q2 2014

May 28, 2014

Good afternoon, and welcome to the BMO Financial Group's Q2 2014 earnings release and conference call for May 28, 2014. Your host for today is Ms. Sharon Haward-Laird, Head Investor Relations. Ms. Haward-Laird, please go ahead. Thank you, and good afternoon, everyone. Our agenda for today's investor presentation is as follows. We will begin the call with remarks from Bill Downe, BMO CEO, followed by presentations from our Chief Financial Officer, Tom Flynn, and Surjit Rajpal, our Chief Risk Officer. After those presentations, we will have a short Q&A period where we will take questions from pre-qualified analysts. To give everyone an opportunity to participate, please keep it to one question and then requeue. Also with us this afternoon are Frank Techar, Chief Operating Officer, Cam Fowler from Canadian P&C, Mark Furlong from U.S. P&C, Tom Milroy from BMO Capital Markets, and Gilles Ouellette 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. Additional information on adjusting items, the bank's reported results, and factors and assumptions relating to the forward-looking statements can be found in our annual report and our second quarter report to shareholders. Now I will hand things over to Bill. Thank you, Sharon, and welcome to everyone on the call. BMO's second quarter results demonstrate continued momentum and strong performance across the operating groups. Our largest business, Personal and Commercial Banking in Canada, did really well with net income growth of 14% year-over-year. Commercial loan growth remained robust in Canada and the U.S. Our large North American platform provides attractive growth opportunities, especially in the current environment. Wealth Management and Capital Markets also had strong results in the quarter, both posting double-digit revenue and earnings growth. In sum, our business group performance resulted in positive operating leverage and good balance sheet growth, with earnings per share up 13% from last year. Today we announced a dividend increase reflecting the success of our business strategies, which are grounded in the work we do for customers, taking deposits, facilitating payments, providing credit, helping them make better decisions with better information, and to have confidence in the decisions they make. A few highlights from our second quarter, both reported and adjusted net income were $1.1 billion. Pre-provision, pre-tax earnings reached $1.5 billion, up 11% from a year ago, and earnings per share were $1.63. Revenue grew 9% from last year, contributing to positive operating leverage of 1.2%. Credit was stable in the quarter and Surjit Rajpal will provide more detail later in the call. BMO's common equity Tier 1 ratio was 9.7% at the end of April. With the strength in our common equity Tier 1 ratio heading into 2014, we had the flexibility to announce the acquisition of F&C in the first quarter, which closed on May 7th. In an environment where capital expectations from banks have been increasing internationally, we believe as a general principle that moving back to a common equity Tier 1 ratio between 9.5% and 10% is appropriate and provides flexibility. Turning to the operating groups, Canadian P&C continues to demonstrate momentum with net income up 14% to $482 million. Strong organic balance sheet growth continued, driving revenue growth of 6%. Combined with disciplined expense management, operating leverage was 3.3%. The business has delivered operating leverage above 2% for three consecutive quarters and has shown solid improvement in the efficiency ratio. U.S. P&C net income was USD 150 million in source currency. Revenue was stable quarter-over-quarter, largely due to robust commercial loan growth, which lifted total loans up 7% from a year ago and 4% sequentially. Expenses were well controlled while we invest for future growth and absorb increased costs from a higher level of regulatory engagement. Our commercial banking team continues to excel with growth across the core C&I portfolio as well as in commercial real estate. BMO Capital Markets reported strong results with net income over $300 million. Revenue growth was 14%, reflecting strength in both investment and corporate banking and trading products. Return on equity increased to approximately 21%. These results reflect continued solid contribution from the U.S. business, where earnings are up 15% in the first half of this year. Wealth Management also had a strong quarter with net income up $200 million, up 36% year-over-year. Assets under management and administration were up 17% to over $600 billion. The acquisition of F&C significantly increased our client assets, which will be reflected in our third quarter. F&C is the proud manager of Foreign & Colonial Investment Trust, founded in 1868 as the world's first publicly listed pooled investment vehicle. The addition of F&C advances BMO Global Asset Management's strategy and growth trajectory. Today, our asset management business has 24 offices in 14 countries across five continents, serving an increasingly global client base. Our multi-discipline teams are headquartered in Toronto, Chicago, Hong Kong, and London, with a network of investment specialist boutiques strategically located across the globe. Our strengths span asset classes with a broad range of investment solutions across various geographies, including equities, fixed income, and multi-asset solutions such as target date funds and liability-driven investing. To wrap up, strong operating group performance resulted in another quarter with consistent earnings over $1 billion. For the quarter and year to date, continuing business momentum is reflected in positive operating leverage and good balance sheet growth. With our consistent strategy in areas of operational focus, we are confident that this will continue into the second half. With that, Tom, I will turn it over to you. Thanks, Bill, and good afternoon. I will now take you through our results, starting on slide 8. We delivered EPS of $1.63 this quarter, which was up 13% year-over-year. Net income was $1.1 billion. Year to date performance is also good, with revenue growth of 9% and EPS growth of 10%. As Bill said, our operating group results are strong. Canadian P&C continued to demonstrate momentum and Wealth Management and Capital Markets made strong contributions to our earnings growth. Good loan growth in U.S. P&C contributed to stable quarter-over-quarter revenue. Similar to last quarter, the only adjusting item in Q2 is the amortization of the acquisition related intangibles. Revenue was $4 billion in the quarter, up 9% from last year. Looking at the components of this growth, net interest income was up 5% year-over-year, driven by volume growth, revenue from the purchased performing loan portfolio, and the impact of a stronger U.S. dollar, partially offset by lower net interest margin. Net interest income was down 2% sequentially, largely due to fewer days. Non-interest revenue was up 13% from last year, driven by higher non-interest revenue in almost all categories. Non-interest revenue was down 2% from Q1, primarily due to lower underwriting and advisory fees, trading revenue, and fewer days. Q2 expenses were $2.6 billion, up 8% year-over-year. The increase reflects business growth, the impact of a stronger U.S. dollar, and higher employee and technology costs related to a changing business and regulatory environment. Expenses were down from Q1, primarily due to costs related to employees eligible to retire in the first quarter, lower severance costs, and fewer days. The efficiency ratio improved 80 basis points from the prior quarter to 63.5%. Some peers calculate the efficiency ratio excluding certain costs, including claims related to the insurance business, which are outlined on the slide. On a similar basis, our Q2 efficiency ratio is much lower at 58.8%. The effective tax rate was 16.5%, down from last year. The rate was 24.4% on a TEB basis, which is relatively in line with prior quarters. Moving to slide 9. Our common equity Tier 1 ratio was 9.7%, up approximately 40 basis points from Q1 due to lower source currency risk-weighted assets and increased retained earnings. Risk-weighted assets declined CAD 5 billion from Q1 due to reduced market risk exposures and lower credit risk, which was primarily due to improved risk assessments, the favorable FX movement in the quarter, and these were partially offset by updates to calculation methodologies. As a reminder, the F&C acquisition will impact our third quarter CET1 ratio by approximately 75 basis points. Moving to our operating group performance in the quarter, starting on slide 10. Canadian Personal & Commercial Banking demonstrated continued momentum with revenue growth of 6% and net income of CAD 482 million, up 14% from last year. Organic balance sheet growth was strong with personal loans up 9% and commercial loans up 10%. Personal and commercial deposits were up 10% and 9% respectively. NIM was down three basis points from last quarter due to changes in mix, including loan balances growing more than deposits. Expenses were up 3% year-over-year, in part reflecting ongoing work to simplify core processes and investment in the business, which will continue over the balance of the year. Expenses were down 4% from Q1, primarily due to lower employee costs, including fewer days. Our execution focus is driving strong operating leverage in the business. It was 3.3% in the current quarter, and the efficiency ratio improved 160 basis points from last year to 50.2%. Moving to U.S. P&C on slide 11. Net income was $151 million, down from Q1, which had a low level of PCLs. Pre-provision, pre-tax earnings increased 4% quarter-over-quarter. Revenue of $691 million was down 3% from last year as loan growth, driven by sustained double-digit growth in core C&I loans, was more than offset by lower NIM and mortgage-related revenue. Revenue was stable quarter-over-quarter, despite the impact of fewer days. The net interest margin declined primarily due to strong commercial loan growth. Loan and deposit spreads remained fairly stable. Expenses are being managed closely and were relatively flat year-over-year and down quarter-over-quarter. Turning to slide 12. BMO Capital Markets had a good quarter with net income of $306 million, up 17% year-over-year and 10% from Q1. Revenue growth of 14% reflects the benefits of our diversified business mix, including continued good contribution from the U.S. segment. Expenses were up 14% from last year due to higher employee-related expenses and costs related to a changing business and regulatory environment. Expenses were down 5% sequentially due to lower severance costs and costs related to employees eligible to retire in Q1. As Bill mentioned, the ROE remains strong at 20.8%. Moving on to slide 13. Wealth Management net income was CAD 200 million, up 36% year-over-year. Strong performance in traditional wealth continued with net income up 23% and revenue up 11%, driven by growth in client assets. The underlying insurance business continued to perform well, with income significantly higher than last year. The prior year results were impacted by movements in interest rates. Expenses were up 7% year-over-year, primarily due to higher revenue-based costs. Assets under management and administration were up 17%, driven by market appreciation, the stronger U.S. dollar, and growth in new client assets. Turning now to slide 14. The corporate segment had a net loss of CAD 58 million, compared to a net loss of CAD 11 million a year ago, and CAD 41 million in the prior quarter. The declines were primarily due to lower credit-related recoveries, partially offset by lower expenses in the current quarter. To conclude, we had good results across our operating groups this quarter and for the first half of the year, and are heading into the second half of the year with good momentum. With that, I will hand it over to Surjit. Thank you, Tom, and good afternoon, everyone. Our credit performance was good this quarter, reflective of continued improvement in the U.S. economic environment and stable conditions in Canada. Starting on slide 17, excluding recoveries in the purchased credit-impaired portfolio, specific PCL has improved by $9 million. Recoveries in the purchased credit-impaired portfolio were down $72 million from prior quarter, as the remaining portfolio is considerably smaller and almost half is performing. In Canada, commercial losses were in line with expectations. Consumer losses increased from their low levels of Q1, but are down 5% year-over-year and 10% year-to-date. Losses in the U.S. consumer portfolio were flat, while U.S. commercial losses increased $31 million. This increase was due to a few large accounts compared to last quarter, where recoveries fully offset new reservations. Moving to the next slide. Formations were $509 million, down $133 million from the prior quarter. The decrease was broad-based, with reductions in commercial and consumer in both Canada and the U.S. Gross impaired loans also decreased this quarter to approximately $2.3 billion, reflecting improvements in the U.S. portfolio. In fact, over the past year, U.S. gross impaired loans have decreased by approximately $500 million, or 24%. In conclusion, given the quality of our portfolio and our strong risk management practices, I expect our credit performance to remain good. 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 are using a speakerphone, please mute your handset before making your selection. If you have a question, please press star one on your telephone keypad. To cancel the question, please press the pound sign. Please press star one at this time if you have a question. There will be a brief pause while participants register. Thank you for your patience. The first question is from Rob Sedran from CIBC. Please go ahead. Hi, good afternoon. Actually, just first a quick clarification for you, Tom. When you talk about 75 basis points for F&C, is there an operational risk-weighted asset component to that, or is that all the goodwill that comes with the deal? There would be an operational risk component to the capital number, but the biggest number obviously is the goodwill. Okay. My question actually is on trading and Tom Milroy, I guess. There has been a number of notable moves, not just in the overall number, but the components equity and foreign exchange are both quite strong. Can you perhaps comment on what specifically worked well? On a related note, maybe this flips back to Tom Flynn, the tax rate seemed a little on the low side on a reported basis, but the TEB tax rate seemed closer to normal. Is the tax issue related to the trading this quarter? Okay. Rob, Tom Milroy. I will take the first question, and thanks for the question actually, because I was hoping I would get to talk because it was a really strong quarter that is built on the solid foundation of the first quarter, and we feel really good about the business and about how we are benefiting from the diversified business mix that we have. When you look at the trading numbers, let me talk first the rates, then I will get to equity and FX. You saw the big swing between interest rate and equity. Interest rate trading was really a function of I would say, two major factors. One was our own name spread, which narrowed, which has a negative impact on P&L. Generally in the space, we had much lower issuance, particularly in the government area, and less activity. That is what happened in that piece. In terms of equity, we benefited from several large client-related transactions combined with strong equity market performance, low equity volatility, and we experienced higher retail note issuances. They all combined with the swing you saw in equity. If you go to the FX trading line, which also was strong, it was really a result of higher client activity. In particular, the weaker Canadian dollar helped our export clients. We saw a lot of activity as they were doing more business. That was a plus. The other thing was that we benefited from good performance from our FX business in China, where with the band and the RMB, they were able to post some pretty good results. It's Tom Flynn. I'll just go to the consolidated bank tax part of the question. I think you really led to the answer in your question. The TEB tax rate for the bank was about 24.4%, very much in line with a typical number. The effective tax rate is somewhat low this quarter at 16.5%, and that simply reflects the higher level of TEB revenue and capital markets flowing through to the tax rate and the comments that Tom mentioned. Thank you. Thank you. The next question is from Sumit Malhotra from Scotia Capital. Please go ahead. Good afternoon. The question relates to Canadian P&C and wanted to start off first with your outlook on loan growth. BMO has obviously had some of the stronger consumer loan growth in the sector over the past couple of years now, and it seemed, at least on the consumer side, to slow pretty noticeably. Hoping you can give us an update on what you are seeing here and whether or not that relates to perhaps a slowing in some of the third-party mortgage activity the bank has been involved with. Thanks, Sumit. It is Cam Fowler speaking here. Thanks for the question. The first thing I would say is this is clearly a strong quarter for us. We are pleased on the net income, the revenue that is driving it, and the balance sheet growth, both sides of the business. Also pleased with the operating leverage third quarter straight. The consumer lending piece specifically, while it is true that things are a little bit lighter quarter on quarter, feel that is primarily driven by a slower mortgage market, in part driven by weather. We ourselves were a little bit later starting this year in the mortgage season, Sumit. That said, activities are back up to the volumes we would expect, and I think we will close the season quite well, and I expect Q3 to be stronger and that we would finish the year quite well on the personal lending side. We have, just to your specific point with respect to third party, stayed involved in this to some degree or other over many years. We have dialed this down slightly in recent quarters. But I think primarily this is more the force on activity in the market. Just to take the temperature a little bit here, Cam. Obviously BMO has had faster than industry growth on the consumer side and particularly in mortgages for 2 or 3 years now. Is it your expectation, I know you do not have the full picture on what your competitors may or may not be doing on the pricing side, but is it your expectation that you will revert back to above industry average growth in the near term, or do you feel it is more in line now? Pipelines are strong. We think that the home finance strategy that we've been undertaking for the past three years, which is pretty focused on what's best for Canadian consumers, shorter amortization, lower LTV, the fixed rate. The distribution system is pretty efficient at having these types of conversations with our customers and our prospects now. So, I expect that we can continue to be a little bit better than the market. Thanks for your time. Thank you. The next question is from Steve Theriault from Bank of America, Merrill Lynch. Please go ahead. Thanks very much. If I could just start with a quick follow-up for back to Tom Milroy on the equity trading. You mentioned several large client-related transactions. So I guess those are equity derivative transactions, I guess? And I'm wondering if those are the total return swaps that the bank undertakes and if there's any seasonality to that line of business. Let me answer it. It is in the equity derivative area, but I wouldn't say it's seasonal, it's client driven. You end up, depending on what your clients are doing, that line will go up and down. Okay. If I could ask Tom Flynn, I saw in the notes you mentioned a change in calculation methodology. I apologize if you went through this in your commentary, but that's partly what was an offset in the risk-weighted asset category. Another bank this quarter flagged updated risk parameter updates. Is that similar to what we're seeing here from you today, and could there be more to come on this front? If you could just give us a little more granularity there. I'm not sure what was going on elsewhere, but every quarter, as you know, you go through processes related to looking at your models and your risk positions. This quarter, there was a change related to that work. I would say it was nothing out of the ordinary. We wouldn't expect anything out of the ordinary in this area going forward. Okay, so it was a more normal course. It wasn't a review centered on retail or commercial or anything specific, doesn't sound like. That's correct. Okay. Thanks, Tom. Thank you. The next question is from Gabriel Dechaine from Canaccord Genuity. Please go ahead. Good afternoon. The first question I have is on the purchase performing loans. That's a $15.5 billion portfolio and it's performing, so the NII is going through corporate, correct? That is correct. Okay. As far as the U.S. goes, I guess a two-pronged question here. Can you quantify the mortgage gain on sale that you had this quarter and what it was a year ago, and what's kind of a normal number? On the U.S. NIM trajectory, a little bit weaker than I was expecting, not on a sequential basis, nothing to get all worked up about. On a year-over-year basis, it doesn't look like the trend's getting better. I know, Mark, you've talked in the past about the pace of NIM compression improving over time, and I'm wondering if that's still on track or if some of the loan growth we're seeing is actually above average. The loan growth we're seeing is the offset to that is that NIM is going to stay lower for longer. Okay. Thanks for the question. I'm going to go to the last one first, the NIM question, and see if I can go at both those. I think one was what's happening with NIM, and the other one is what's happening with loan growth. Is that a good way to translate it? Yeah. You're a lot more straightforward than I am. I want to answer your question correctly. On NIM, my outlook's improving. We previously thought we'd have about 4-8 basis points of NIM compression this quarter. We now think prospectively maybe it's 2-4 basis points, and there will be variability in between quarters. Those quarters that have really strong loan growth, that strong loan growth will affect margin by a few basis points would be my guess right now. But overall, when we look at that loan growth, it's driving revenue growth, and we like the diversity, we like the credit quality, and the new relationships we're adding. In terms of prospectively and loan growth, if that was part of the question, too. I think this was a really strong quarter, so I don't know that every quarter will look like this, but we like the pipeline in C&I and business banking. We have a strong position in our biggest markets in both of those. We feel good long term about those. We're putting up double-digit loan growth in C&I and commercial real estate, as well as in our business banking. You can't bet on one quarter on its own, but if you looked at prospectively, we expect that we'll have good, solid loan growth prospectively when you look across year-over-year numbers. Did I get to where you wanted to get to on those two questions? Yeah. Maybe I'll requeue for the other one, but the mortgage gains would be something I'm interested in too. Gabriel, it's Frank. On the mortgage gain question. Q2 2013 the gains were $19 million, and this quarter $7 million. Just to be really specific. Somewhere in between there normal, or how should I look at that? Well, as you know, it's volatile quarter to quarter but within this range. Okay. Thank you. Thank you. The next question is from Peter Routledge from National Bank Financial. Please go ahead. Hi. Thanks. Question for Surjit. Surjit, I think credit is probably about as good as we've seen it. I suppose in your job you always got to ask yourself, well, how could it get worse? I actually don't want to ask you that. What I want to ask you is how likely is it in your mind that it stays this good for an extended period of time? What's the argument that this lasts for two or three years? I think the argument that this could carry on for a while is that the recovery this last cycle has been very slow, and the economies still are improving. The U.S. is improving, Canada is stable. Barring something happening that no one can predict, I think this may carry on the way it is for some time. Given our two principal markets, I think we are very positive on the U.S. still. Yeah. Canada, there seems to be no reason to be really concerned about. I think this can carry on for a bit. For you to change your mind on that, what would have to change in the broader environment? What are you looking at? I think at this point in time, I would say it has to be a sudden or a shock event. I cannot think of anything that would cause things to get off the rail other than some event on the geopolitical front that I cannot really foresee at this point in time. But you are right. The question you were planning to ask me and you did not ask, at this point in time, I think things are good. But at some point in time, the cycle will change, but it does not seem like it is on the horizon right now. Yeah. Fair enough. Thanks for that. Thank you. The next question is from Doug Young from Desjardins Capital Markets. Please go ahead. Mr. Young, your line is open. Sorry, I had you on mute there. The first question is just on the U.S. PCI purchase credit impaired book, and I think if I recall back in Q4, you guided to $100 million pre-tax for 2014. I think we are at $162 million year to date, so over the first two quarters. I am just wondering if you have an update in terms of your thoughts on a glide path for that portfolio. Let me give you a little bit of flavor. I think in my remarks, I did say the portfolio is small. It's about $600 million right now, and roughly half of it is performing. That leaves us with a very small portfolio, and the accompanying mark is $12 million. The variables you're dealing with are very different from what they were, let's say, six or 12 months back. I do expect recoveries, and the recoveries will exceed the mark because when we bought the portfolio from M&I, M&I had already taken some reservations against that portfolio. If my guidance was not good two quarters back, it was because it's very difficult to time some of the sales and the workout that happens with these accounts. Now, given that the portfolio is small, I think there's not too much left in it, but I would think in the next quarter we'd have a decent quarter. I think the recoveries will exceed the mark, but then the portfolio will have come down slower. I would suggest that for the balance of the year, it is going to be less than the first part of the year, clearly. A lot less. Is it conceivable by the end of next year that there is no further adjustments on this portfolio? Is that fair to assume? Highly likely, but it all depends. Okay. Highly likely that we won't have much of it left by then. Okay. Just a quick follow or just second question. On the F&C transaction, just wondering if you've finalized all the purchase price details. I would imagine you're going to, in your adjusted numbers, back out associated amortization. I just wondering if you have a sense of what that impact would be on a quarterly basis. Hi, it's Tom Flynn. Given that the acquisition just closed a couple of weeks ago, we're still working on finalizing the purchase price, so we don't yet have the amortization number. Our plan is to back it out, like we back out the other intangible amortization that we've got. We'll also have some integration charges. They won't be that significant in the context of the bank, but we'll be incurring those over the next few quarters, and the plan would be to adjust for those as well. Okay. Thank you. Thank you. The next question is from Darko Mihelic from RBC Capital Markets. Please go ahead. Hi. Thank you. A couple of questions. The first is, I'm wondering with respect to the expense control in the Canadian P&C, or maybe perhaps you can speak about this in the context of an operating leverage. Can you just remind me what kind of operating leverage are you looking for the balance of this year? What do you think is a more sustainable level? Then I have a follow-up question with respect to loan growth, please. Darko, it's Cam Fowler. Thanks for the question. With respect to operating leverage, we expect revenue to continue along a similar trajectory and our expense profile is relatively consistent. Operating leverage in line with an average of what we've done in the last few quarters. Perhaps not quite what happened this quarter, but not far off the two before that. Just to be clear, expense growth in the 2%-3% range is normal, because as I recall, if I sit back and think about the previous couple of years, there was an awful lot of initiative spend at Bank of Montreal within Canadian P&C. The sense that I'm getting is somehow that slowed or stopped. Am I wrong in that thinking? I think that thinking is not quite right. What I would say is we continue on a similar revenue trajectory. I think expense as you've laid out is in the range 2%-3%, maybe a little more or a little less from time to time. We've been on a relatively consistent track with respect to investment building the business in the last three or four years. Spikes here or there, but the platform renewal continues. We just work very hard to ensure that it's paced in such a way that we don't have any blips. But I think, positive operating leverage in the two-ish range is decent guidance. Okay, thanks for that. Then maybe just to follow up on the loan growth questions. Two things. First, with respect to the mortgage promotions, I guess this year you're a little bit late with the promotion. My sense is that the other banks seem more competitive this year than last. They may not have actually copied the product, but they certainly are getting more aggressive with rates. Even today, I think we saw Scotia with a more aggressive rate offer. Can you speak to whether or not that's having an impact? Then similarly, last year when we looked at your commercial loan growth versus peers, you were clearly ahead. Now it seems as though many of the Canadian banks are also putting up impressive commercial loan growth numbers. Is there more competition now in commercial? If it is that also affecting the overall margin in the Canadian P&C business? Okay, thanks. Let me start with the first one. It's possible there's a little more competition in the home finance market this year than last, but I don't think to a large degree. I think we're all observing a slightly later start, a slightly slower market for reasons that we've all talked about. If I look at where activity went to through the quarter, it's picked up, as I said, to the levels that we'd expect. If I look at the pipeline that we are, say, looking to close, I don't think that there's a disproportionate amount of competition hitting that that would affect our outcome. So yes, there's competition, but I think we'll bear up just fine against it and it wouldn't affect the results. Moving to the commercial loan side, I would still characterize the competition out there as healthy. We have a large and strong franchise. We've been focused on diversification. Our pipelines are really very strong. I can't comment specifically on what others are doing. I wouldn't say there's disproportionate pressure from any one player in any particular region. We're confident that we'll keep up our momentum in a meaningful way on the commercial business. Thank you for that. That's good color. Then just lastly, can you speak to credit cards? A lot of noise being made by competitors. We continue to see Bank of Montreal somewhat in a different position on the credit card scene. Is there anything on the horizon, or should we just view the credit card portfolio as one that's not going to be an area of strong growth for Bank of Montreal? I wouldn't like you to view it that way. I think the cards business is an important one. It's critical to our growth aspirations. It's critical to our loyalty aspirations. To be sure, it's an area that we haven't perhaps done as well in in past years. Past four quarters, we've had a great deal of emphasis on the business, and I think we're starting to see some pretty pleasing results. We've focused on renewal of the team there. The platform's new. We've had product renewal. We've had a very large focus on the premium segment. We're looking right now at some positive metrics. We're originating across all card categories at double digit. We're acquiring in the premium segment at multiples of last year. We acquired more premium cards in the first half of this year than we did all of last year. One-fifth of those are new to bank. Other metrics like balances, active accounts, net retail sales, they're all up. So we consider this to be good momentum in a business that's really critical to us, and I expect the back half of the year to be stronger in cards. Okay. Thanks for the color. Thank you. The next question is from Meny Grauman from Cormark Securities. Please go ahead. Hi, good afternoon. First question is on capital, and you are targeting a CET1 ratio of between 9.5% and 10%. That seems a little bit higher than the thinking before, and then some of your peers have mentioned this quarter. I am wondering what the change is, what is driving, I guess, this extra conservatism. Thanks for the question, Manny. I would characterize it as a pretty consistent as opposed to a change in trajectory for BMO. If you think about the last five years, we moved our capital ratio up ahead of the market. We are very clear going back really all the way to 2010 about where we thought CET1 numbers would start to pan out. The reason why we were very comfortable entering into a discussion to acquire F&C Asset Management, which was really a significant company and is going to be a significant contributor, is we finished 2013 with the ratio at 9.9%. And since that time, you can just see the level of discussion more broadly in the U.S. and Europe around where capital levels will finish. I think there are a number of jurisdictions where they're talking about levels above the 10%, and I think it has a lot to do with mix of assets in specific geographies in bank portfolios. I think at the 9.5%-10% range, the balance is about right between having the flexibility to do things when the opportunity arises and capital levels that are not too high to allow banks to competitively intermediate credit in the market. What we're talking about, I think, is just clarity around the range that in the ordinary course provides the maximum flexibility to take advantage of opportunities and at the same time be efficient for shareholders. The way that we can balance that is between dividend share buybacks, acquisitions, and what we're hoping for is a little faster economic growth in the developed world, which probably means that in 2015 and 2016, absorption of capital retained from growing the balance sheet. Just to follow up on the discussion of loan growth and margin. I understand the trade-off between the two, and the question is, why would you prefer to sort of err on the side of loan growth at the expense of margin versus the other way around? How would you explain that trade-off? I guess, let me answer the question generically. I think you're asking a relatively generic question. It's really a matter of mix and in certain loan categories, and I would say the commercial loan business while the margins in the market have reset, they still represent a very attractive return on capital, and that's the sector of the market that's growing. So, in a single asset class your question might prevail. Are you trading margin against volume? But when you talk about the business mix, what we're talking about is growing the whole balance sheet and optimizing the return to the shareholders on capital. So I think there it isn't a discrete trade-off in a single product in a single market. It's the overall balance sheet growth. And we're fortunate that with the business mix that we have and the capabilities we have, that we can demonstrate strong performance in commercial banking on both sides of the border. Thank you. You're welcome. Thank you. The next question is from Mario Mendonca from TD Securities. Please go ahead. Good afternoon. First, for Tom Flynn, a cleanup question. To what extent did interest recoveries in the U.S. aid the margin? Last quarter was something like 3 basis points. Yeah. It was sort of a measurable number last quarter. This quarter, it really did not have an impact on the margin. Okay. Then a follow-up question to this loan growth in the U.S., and this is probably best for Mark Furlong. C&I loan growth, commercial real estate loan growth quarter-over-quarter. I appreciate we are talking about a base that is relatively small, but that quarter-over-quarter growth is pretty significant. I am not so much interested in what is going on with the margin because I follow the explanation you are offering here that the margin has been reset or the rates have been reset. Is there anything going on on terms that would have driven such a significant growth in a given quarter? This is Mark again. Good question. In the sector for commercial in the U.S., that is not the area that is under structure changes on deals both in C&I or commercial real estate. There has been different periods of good competition on price. In cases I can tell you where we have seen structure changes, which are not a lot, then we just do not participate in it. The growth that we have had has really been across all of our sectors and across all of our geographies. I am talking about the last, say, rolling 3 to 5 quarters. If one quarter, one sector, or one geography did not grow, then it grows the next quarter and something else maybe does not grow for a quarter. When you look year-over-year, all of them have had growth. The growth has not been weighed down by one sector or one market or one of anything. It really has been broad-based across the portfolio. Then, you have to recall that when we were going through a merger and integration, you necessarily get some of that internal distraction. We had some of it too. Then, it is learning new rules and learning new credit process and the team coming on. That causes a slowdown in part of the business that then, of course, picks up once everyone gets comfortable. I think what you are really seeing now is a company kind of coming into the seasoning of a team working together really well. It feels like we have been in the same company for years and years now. Everybody understands process and understands what is acceptable in the credit box, and you just have this great chemistry working across the business. That is what I think you are seeing in the commercial and the business banking units really in particular. Now, Mark, you have characterized the pricing this time around on the new business, the new commercial loans coming on as being lower than what is on the books now, and that is one of the explanations why the margin has come down. I think that is clear to me. Could you offer a similar comment on covenants in terms of the new business relative to what is on the books today? We do, as you can imagine, in an environment where there is good risk management process, we do period reviews. We actually just finished a review for the risk teams looking at a couple of the sectors of our portfolio. We just have not been subject to structure changes in the segment that we go after in commercial banking or in business banking. The stuff I read about in the U.S., it is the far higher end, largest syndicated loans made in the U.S. That is a different group that you read about things like covenant-lite and things like that. That really has not made it into the commercial sector and not into the business banking sector either. I would tell you that the changes to structure have been very modest in the piece of the business that I am responsible for. That is clear. Thank you. Thank you. The next question is from Sohrab Movahedi from BMO Capital Markets. Please go ahead. Hi there. Just a couple of questions. Just on that last one with Mark. Maybe Surjit, the three or so I think you said commercial accounts in the U.S. P&C that drove the PCLs up quarter-on-quarter. What was the year of origination for those accounts? Offhand, I do not know, but they were not very recent. They're not reflective of more recent lending standards. No. And really from two accounts, I can't draw many conclusions. In the commercial area, you will generally have a few accounts that contribute to them. And unless you see a pattern with a lot of smaller losses, it's difficult to make an assessment. This was just the normal variability that you see in commercial. Nothing out of the portfolio characteristics that I can point to and say, "Look, I should be more concerned about that portfolio." I think Mark makes a good point. The portfolio that he has in commercial is very well diversified. These are small holds in a very large number of accounts and very well diversified across industry groups, and the leverage is not very high in them too. Very comfortable with that portfolio. Okay. And then Mark, just to clarify, maybe coming at the U.S. just a little bit differently. If I think of this concept of pre-tax, pre-provision earnings, Q2 2012, the U.S. in native currency was $262 million. Q2 2013, it was $258 million. Q2 2014 is $240 million. Where do you think that will trough? Let me go at this a little differently and see if I can help. I think you're going to see year-over-year earnings growth. I think we'll have maybe some kind of bounce around a little bit in pre-tax, pre-provision earnings a little bit, but I think we're going to see year-over-year net earnings growth. I think as I talked about margin, I gave a little bit of an indication of we see some tempering in that in terms of what's going on with net interest margin. Albeit it kind of depends a little bit on the quarters of really strong loan growth. But looking prospectively, feel pretty good about where net earnings are going on a year-over-year basis. Is that a way to go at answering that? I think it helps for sure, but it almost feels like the bottom line, which has been right around 150 million to 160 million, has basically been driven through the credit cost line. I am just trying to get a sense of when does the above the line start contributing to the bottom line? Okay. Well, fair question. That is this sustained earnings growth, and sustained, I should say, loan growth. As you saw, the runoff portfolios are becoming relatively immaterial at this point in time. Margin is beginning to stabilize, and we feel pretty positive about top-line growth kind of looking prospectively from this quarter on. Okay. Can I just ask one last question then? Promise it will be the last one. When you think about the U.S. franchise, and if you think about it from a profitability perspective, what will winning look like? Maybe, Saurabh, since Mark has had the opportunity to answer two of your questions, I will go for the third. There is no question that the commercial banking business that we have in the U.S. is demonstrating traction in a way that we are very satisfied with. We think that, as Mark said, with the runoff disappearing, it is going to be more clear the value of the business that we have. But the bank is in a fundamentally different position today than we were prior to the recession in that we now have a very large retail branch system. There is no question that we are in a historically low interest rate environment. The five-year treasury rate still reflects a level far below the average, and you can take any period of whether it is 50 years or 30 years or the last 10 years. I think everybody gets a lift when administered rates rise, which they inevitably will, and some inflation shows up. We have 700 bank branches, and that is more than twice what we had not too many years ago. But more importantly, we have invested much more heavily in the brand in the last three years than the rate of investment previously. There is a lot of operating leverage in the retail bank. I think that the definition of success is that we continue to be market leaders as we have been in commercial banking in Canada. In the U.S., there is no reason why within our concentrated footprint we would not be the number one or number two commercial lender. When retail banking, the economics of retail banking improve marginally, you get some reasonable economic growth. The strength of our brand, the value of that core deposit base, I think, is going to be very evident. I think we are relatively patient around the recovery in interest rates in a period of stronger economic growth. Many of the provisions of Dodd-Frank that were very hard on banks that had benefited from some of the things that Dodd-Frank squeezed out, we were not susceptible to. We did not have very many areas where we had to make adjustments because we had really built our brands, both in the acquired footprint and the legacy footprint around the best interest of the customer. I think you are going to see the value of a concentrated footprint in a very healthy market over the next three to five years and some quite surprising operating leverage in the business. For us, I think that would be the definition of success. Okay. Thank you. You are welcome. Thank you. This will conclude today's question and answer session. I would now like to turn the meeting back over to Ms. Sharon Haward-Laird. Thank you everyone for joining us today. If you have any follow-up questions, we would be happy to help you in investor relations. Thanks, and have a great afternoon. Thank you. The conference has now ended. Please disconnect your lines at this time, and thank you for your participation.