Earnings Call: Q1 2012

Feb 28, 2012

Good afternoon, and welcome to the BMO Financial Group's first quarter 2012 conference call for February 28, 2012. Your host for today is Viki Lazaris, Senior Vice President of Investor Relations. Ms. Lazaris, 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. The call is scheduled to run for one hour. Also with us this afternoon to take questions are BMO's business unit heads, Tom Milroy from BMO Capital Markets, Gilles Ouellette from the Private Client Group, Frank Techar, head of P&C Canada, and Mark Furlong from P&C US. At this time, I caution our listeners by stating the following on behalf of those speaking today. Forward-looking statements may be made during this call. They are subject to risks and uncertainties. Actual results could differ materially from forecasts, projections, or conclusions in the forward-looking statement. Information about material factors that could cause results to differ and the material factors and the assumptions underlying these forward-looking statements can be found in our annual MD&A and in our first quarter report to shareholders. With that said, I will hand things over to Bill. Thank you, Vicki, and good afternoon, everyone. As noted, my comments may include forward-looking statements. BMO produced record first quarter net income of $1.1 billion, kicking off the year with very strong earnings. Our focus on customers and investing prudently in the business is serving us well, and this is reflected in both our financial results and the momentum of the bank. Operating group performance in the first quarter was better than initially expected as markets recovered from the depths of early December. Our Capital Markets-related businesses, which were particularly impacted by negative market sentiment early in the quarter, experienced improved market conditions in January. Credit performance, a long historic strength of BMO, contributed to earnings growth. We continue to make steady progress on the integration of the acquired M&I business, and the benefits evident so far confirm that we are on track. We remain focused on living up to our reputation for treating customers extremely well and ensuring our new customers can draw on the strengths and abilities of the whole company. The largest of the platform conversions will take place at the end of the year, and we're pleased with the synergies obtained to date, reflecting the work of a focused and capable integration team. The combination of our two banks has created a competitive platform from which to grow personal, commercial, and wealth business in the U.S. Turning to the financial results, reported net income increased 34% year-over-year to CAD 1.1 billion or CAD 1.63 per share. Adjusted net income was up 19% to CAD 972 million, representing CAD 1.42, 8% ahead of last year. Adjusted revenue growth was 9%. BMO's ROE on an adjusted basis was 15%, improved from 13.9% in the fourth quarter. Improving the bank's productivity is an area of broad focus, and the entire BMO organization is participating in this effort. You'll note the charge taken this quarter for restructuring in our Capital Markets business. Innovation and productivity are themes we're stressing with our customers and we believe will be important contributors to North American competitiveness, and it's an area of focus for the bank. Core credit performance improved in the quarter with provision for credit loss down substantially, and we were effective in the collection of impaired loans. Surjit will take you through our credit performance in detail later in the call. BMO continues to be well-capitalized with a pro forma Basel III common equity ratio of 7.2%. I'll now take you through the highlights of our operating groups. P&C Canada's reported net income for Q1 was CAD 446 million and on an actual loss basis, up 5.4% from the fourth quarter. This business continues to perform well with volumes higher across most products. We continue to innovate in the execution of our strategy, achieving higher net promoter scores and increasing share of wallet. We're also confirming our confidence in business growth by committing to increase the credit we make available to small and medium-sized businesses so they in turn can innovate, expand, and create jobs. For consumers, especially homebuyers, we're actively encouraging them to borrow smartly by considering a mortgage with a shorter amortization period. Our low-rate mortgage was recognized by the Canadian Mortgage Trends as 2011 Mortgage of the Year. This product, which carries a maximum amortization of 25 years, is unique in the marketplace and rewards customers who make responsible borrowing decisions. Moreover, it will help Canadians enter retirement without the burden of mortgage debt. In P&C U.S., reported net income was USD 135 million in source currency. On an adjusted basis, net income was USD 152 million and reflects a good contribution from the acquired business and solid organic revenue growth. These results were impacted as anticipated, considering new interchange regulations, higher credit losses under BMO's expected loss methodology, and margin pressure. Our commercial business, a key area of future growth, experienced a good quarter. I'm very encouraged with commercial banking business loan growth of USD 1.1 billion since the third quarter, up 14% annualized. This growth in key segments was partially offset by paydowns and declines in CRE and other runoff as expected. Our market position in the U.S. and leading customer loyalty is a competitive advantage. BMO Harris Bank is taking an active role in the marketplace, providing original products that are relevant and matter to customers. For example, our consumer insights identified that parents are searching for help in providing financial education to their children, and in the fall, we launched helpful steps for parents addressing this need. This initiative marked the first time we utilized the BMO Harris Bank brand across our entire footprint. In the Midwest region, we've positioned for the uptick in the economic environment. Midwest economy continues to grow at a higher rate than the national average. The unemployment rate, 8.1% in December, is expected to decline gradually this year and should continue to outperform the national average. Overall, we believe that the recovery underway in the U.S. will lead to gradually more favorable economic and market conditions throughout North America. Our businesses, customers, and shareholders will benefit from this. Private Client Group's first quarter net income of $105 million reflects solid growth in our traditional wealth business, offset by the impact of unfavorable movements in long-term interest rates in our insurance business. Performance this quarter was dampened by softer equity market conditions. We continue to attract new client assets with AUM and AUA of $435 billion, up 2.3% quarter-over-quarter. Our customers continue to value insurance as a part of our total wealth offering, and we're generating higher premiums and sales of life insurance products, which represent a strong source of future growth and profitability. Last week, we announced the expansion of our wealth management capability in China with an agreement to acquire the maximum allowable interest in China's COFCO Trust Co. With AUM of approximately US $5.7 billion, COFCO Trust provides BMO with a leading entry point and greater flexibility to offer a wide variety of wealth management products directly or through third parties in a market that is large and growing. Further, this purchase complements our investment management capabilities with Fullgoal in Shanghai and Lloyd George Management in Hong Kong. BMO Capital Markets delivered first quarter net income of $198 million, improved from Q4, although down from a very strong quarter a year ago. The current quarter signaled a return to more normal levels of volatility in client flows in many parts of our business, particularly in the latter part of the quarter. The pipeline for advisory and fee business remains very healthy. Global Finance magazine recently named BMO Capital Markets the best investment bank in Canada and for the third consecutive year, the world's best metals and mining investment bank. To wrap up, each of our businesses is well-positioned. Our balance sheet is strong, a source of confidence for our customers, and we are confident that our customer-focused strategy will continue to differentiate BMO. At the same time, we're working hard to improve operating leverage and ensure a competitive cost base that directs spending to support our highest priority, our frontline employees, and every interaction we have with our customers. Before I pass it over to Tom, I'd like to acknowledge Viki Lazaris, BMO's Head of Investor Relations. Effective April 1, Viki will be leaving IR to assume the leadership of BMO InvestorLine. During her six years at the head of Investor Relations, Vicki's raised our level of professionalism, earning the respect of colleagues and the street alike. I know that you're all going to join me in thanking her both for her contribution and to encourage her, let her know that we have a great deal of confidence in her success coming at BMO InvestorLine. With that, Tom, I'll turn it over to you to go through the Q1 results in a little more detail. Thanks, Bill, and good afternoon. Some of my comments may be forward-looking. Please note the caution regarding forward-looking statements at the beginning of the presentation. I'll start on slide seven. BMO had a strong quarter with results benefiting from our businesses executing on their strategies, improved credit performance, and acquisitions. Reported net income of CAD 1.1 billion was up 34% from last year. Adjusted net income was CAD 972 million, up 19% year-over-year, and adjusted EPS was $1.42, up 7.6%. Adjusted ROE was 15%, and our capital position strengthened in the quarter. Adjusted revenue was up 8.5% from last year and 2% from last quarter. BMO Capital Markets drove the quarter-over-quarter increase with improved trading revenue. Adjusted results absorbed a negative impact in our insurance operations from lower long-term interest rates of CAD 47 million after tax, or CAD 0.07 per share. Lower adjusted provisions for credit losses reflected improved performance across portfolios, including a recovery of CAD 88 million after tax for M&I purchased credit-impaired loans. Results in the quarter also benefited from a lower effective tax rate. Adjusting items in the quarter reduced income by CAD 137 million or CAD 0.21 per share. Adjustments, all on an after-tax basis, include a CAD 114 million credit mark-related benefit on the acquired M&I performing loan portfolio, cost of CAD 43 million for acquisition integration, CAD 136 million gain from run-off structured credit activities. These activities are consolidated now under IFRS, and the results primarily reflect market-driven valuation changes that are included in trading revenue. Improved credit market conditions in Q1 resulted in a gain being recognized compared to a charge in Q4 of 2011. The next item is a restructuring charge of CAD 46 million related to our Capital Markets business. This was taken to better align the cost structure with the current and future business environment. As Bill mentioned, this is part of the broader effort underway in the bank to improve productivity. Lastly, amortization of acquisition related intangibles of CAD 24 million. All adjusting items are recorded in corporate services except to the amortization of intangibles. Moving to slide eight, adjusted revenue was CAD 3.7 billion, an increase of 8.5% year-over-year, largely driven by acquisitions. Quarter-over-quarter adjusted revenue was up 2% from higher trading, partly offset by lower long-term interest rates impacting insurance results. As shown in the graph on the right, the adjusted total bank margin, excluding trading, was 221 basis points, up eight basis points sequentially, driven mainly by Private Client Group and Corporate, partially offset by P&C US, where the benefits of increased deposit balances were more than offset by spread compression. Turning to slide 9, adjusted expenses of $2.4 billion were up $37 million or 1.6% quarter-over-quarter. Q1 expense includes $71 million of stock-based compensation in respect of employees eligible to retire, which is expensed in Q1 of each year. Excluding these stock-based compensation costs, adjusted expenses declined 1%. Adjusted expenses were up $329 million from a year ago, largely due to acquired businesses that added $317 million. Turning to slide 10, we show the income contribution from M&I. The acquisition added adjusted earnings of $215 million in total and $100 million to operating groups. As previously mentioned, corporate services adjusted net income includes an $88 million after-tax recovery on the M&I purchased credit-impaired loan portfolio. This recovery was primarily due to the gain from the repayment of loans at amounts in excess of their recorded value. The after-tax benefit to reported earnings of the credit mark on acquired performing loans was $114 million. As reviewed last quarter and shown in the table, accounting for the performing loan credit mark involves a portion of the credit mark being reflected in net interest income over time, specific provisions being booked as incurred, and adjustments to the collective allowance. Reported income from this in Q1 was similar to Q4. As shown on slide 11, capital ratios remain strong with the common equity ratio at 9.6% and Tier 1 ratio at 11.7%. The capital impact of IFRS will be phased in over five quarters. The impact was under 10 basis points in Q1 and is approximately 60 basis points in total. Risk-weighted assets were largely unchanged quarter-over-quarter as higher RWA under Basel 2.5 rules were primarily offset by lower RWA due to the transition to IFRS, improved risk assessments, and lower Basel 2 market risk RWA. Equity ratio strengthened to 7.2% in the quarter, and we remain well positioned for the Basel III regime. Moving to slide 13, P&C Canada net income was $446 million. On an actual loss basis, net income was up 5% quarter-over-quarter. Revenue and net income was down year-over-year, mainly due to a one-time securities gain in the prior year under IFRS. Net interest margin of 290 basis points was relatively flat quarter-over-quarter. Year-over-year expenses were higher due to 2011 initiative spending, including higher frontline staffing levels. Quarter-over-quarter expenses were up due to stock-based compensation for employees eligible to retire. Moving to slide 14, P&C US Q1 revenue and net income more than doubled from a year ago, reflecting good contribution from the acquired business. Adjusted net income was USD 152 million. Revenue of $771 million declined quarter-over-quarter due in part to the expected impact of lower interchange revenue. Revenue was also impacted by spreads. NIM was down nine basis points quarter-over-quarter as the benefit of increased deposit balances was offset by spread compression. In addition, provisions for credit losses under BMO's expected loss methodology were higher in Q1 than in Q4. Turning to slide 15, Private Client Group net income was $105 million, down $39 million from a year ago. Insurance results were impacted by a $56 million net income decline year-over-year due to lower long-term interest rates. Excluding insurance, Private Client Group revenue growth was 20% year-over-year, with good contribution from acquisitions and higher than usual asset management revenue from a strategic investment. As Bill mentioned, performance this quarter was dampened by softer equity markets. Looking forward, we expect conditions to improve, driving better volumes. Turning to slide 16, BMO Capital Markets net income of $198 million was up 39% from Q4 and lower than a very strong Q1 a year ago. Stronger revenue was mainly driven by higher trading revenue, primarily in interest and equity trading, as market conditions improved through the quarter. Expenses were down 1.2% year-over-year and 0.5% quarter-over-quarter. On slide 17, corporate had reported net income of $223 million and adjusted net income of $62 million. Quarter-over-quarter adjusted net income was better by $129 million. Adjusted revenue and expenses were fairly stable quarter-over-quarter. The stronger credit results reflect a recovery on M&I purchased credit-impaired loans and better performance in other portfolios. To conclude, we're pleased with the strong start to the year and feel good about how our businesses are positioned looking ahead. With that, I'll turn it over to Surjit. Thanks, Tom, and good afternoon. Before I begin, I'd like to draw your attention to the caution regarding forward-looking statements at the beginning of this presentation. Today, I'll focus my remarks on a few areas of interest and will refer you to pages of the deck for further details. I would like to start with our first quarter provision for credit losses, which as outlined on slide 25. As Tom and Bill both mentioned, our provisions that you see on that page are CAD 141 million or CAD 91 million on an adjusted basis. To better understand our performance, I'll differentiate between our legacy and our acquired book. Our legacy book, which is shown in the top portion of the table, continues to perform well with a declining trend in provisions over the last 18 months. First quarter provision was CAD 233 million, down from CAD 281 million in the fourth quarter. We are now almost down to pre-recession levels, with virtually all business lines contributing to the improvement. Our acquired portfolio can be broken down into two segments, the purchased impaired segment and the performing segment. On the purchased credit impaired or PCI segment, there was a reversal of CAD 142 million. The strong performance of this portfolio was largely driven by early repayments of both commercial and consumer loans. Going forward, there will be variability in this segment as we work through these PCI loans. The purchase performing portfolio has losses of CAD 31 million in the current quarter. We expect formations and losses to continue in this part of the portfolio, but we believe these are adequately provided for through the marks taken at acquisition. There of course, will be timing differences between when the losses occur and when we recognize the mark through income, as Tom explained. Finally, as shown at the bottom of the table, we also have an increase of our collective allowance by CAD 19 million this quarter, largely to support building of the allowance for the U.S. acquisition. Clearly, we are encouraged by the resiliency of the U.S. economy and the recent signs of improvement. Our formations, which are shown on slide 27, have reduced this quarter, and our legacy portfolio formations are down from quarter 4 and in line with formations in earlier quarters of last year. The purchase portfolio contributed CAD 259 million to formations this quarter. CAD 27 million of these formations are covered by an 80/20 FDIC loss share agreement. The remainder is roughly evenly split between consumer and commercial. As I mentioned earlier, these loans are adequately provided for by the mark we took at acquisition. We have improved our formations disclosure to provide retail formations on a gross basis with clear segregation of the retail and commercial drivers. Next, I would like to talk briefly about the Canadian household debt levels and housing market. We touched on this last quarter, but I think it's appropriate to revisit. We are closely monitoring and remain attentive to potential interest rate increases in the medium term, slow wage growth, slight edging up in the unemployment rate, strong overseas investor participation in the housing market, and a sizable condo pipeline in key markets like Greater Toronto and Vancouver. However, we believe the risks in our consumer book are manageable. Our prudent underwriting standards have been maintained through the cycle, and we continue to outperform peers on loss ratios across every consumer product portfolio. Our residential mortgage portfolio long run loss rate is less than 2 basis points. Our Canadian consumer portfolio of CAD 122 billion is well secured, with 78% secured by residential real estate. Of the total mortgage portfolio, 70% is insured, and the average loan to value of this segment is about 63% after adjusting for current house prices based on Canadian house price indices. On the uninsured portfolio, the average loan to value is 54%. In our HELOC portfolios, the average loan to value is 54% and 94% of our loans are in first position. The majority of the remaining are behind a BMO first mortgage. The installment portion of our HELOCs, which is more comparable to mortgages, is about half of our portfolio. The remainder of the consumer portfolio is split between cards, auto finance, and other personal loan products. These portfolios have been performing very well, and the unsecured portion is only 13% of the Canadian consumer portfolio. As part of our ongoing management discipline, we stress test our portfolios using different scenarios ranging from moderate to extreme. Under an extreme stress scenario with high unemployment rates, a significant decline in housing prices, rapid increase in interest rates, and resulting GDP reduction, our overall losses would increase but remain well within our ability to absorb. We continue to monitor the risks facing the Canadian real estate and credit markets, but overall, we are comfortable with our Canadian consumer exposures. Before I wrap up, you will notice that in the quarterly MD&A, we have expanded our disclosure on our European exposure, including gross exposures and structured investment vehicles. While there continues to be uncertainty and economic strain in Europe, we believe our exposure is not outside, is well secured and manageable. Our geographic exposure is subject to solid country risk framework incorporating economic and political assessments, limits on exposures, regular monitoring, and we are mindful of second-order impacts in our assessment of individual transactions. We provide a summary of the European exposures on slide 28. Our net direct exposure to the five high-risk countries of Greece, Ireland, Italy, Portugal, and Spain is quite modest at just under CAD 200 million, including unfunded commitments of CAD 48 million. It primarily consists of exposures to banks for trade finance and trading products. Net direct exposure to the remaining 12 eurozone countries is CAD 4.7 billion, and for the rest of Europe, another CAD 3.6 billion. The majority of the exposures is to highly rated countries and consists primarily of tradable cash products, short-term trading instruments, and derivative products. In closing, I would say that I'm very pleased with our performance this quarter. The underlying credit trends have moved in a positive direction, although we remain cautious in our outlook in light of several factors that are contributing to the global economic uncertainty. Thank you. We will now turn over to the operator for question and answer for the portion of today's presentation. Thank you, Mr. Rajpal. We will now take questions from the telephone lines. If you have a question and are using a speakerphone, please lift your handset before making a selection. Please press star 1 at this time if you have a question. If at any time you wish to cancel your question, please press the pound sign. There will be a brief pause while participants register, and we thank you for your patience. The first question is from Steve Theriault of Merrill Lynch. Please go ahead. Thanks very much. Couple quick questions on the quick side I think. First for Frank. Frank, last quarter you said you'd be working hard to deliver a positive operating leverage for the full year 2012, and appreciating for all that Q1 is a bit of a tough quarter seasonally. As we sit here roughly four months into 2012, is that still an achievable goal for the full year? Separately, I noted some pretty good growth in commercial deposits this quarter. Are you taking share there that's offsetting some of the loss in share in personal? Yeah. Thanks, Steve. On your first question with respect to expenses and productivity, we're not standing aside from what I said last quarter. We're working really hard to get to positive operating leverage in all subsequent quarters this year. The expectation is that if we don't hit positive operating leverage by the end of the year for the full year, we're going to be very close. We think that the trends that I was expecting last quarter are going to hold. We're going to see our revenue growth improve as we go through the remainder of the year. My expectation is we're going to end up in the low to mid-single digit range on revenue growth, and we're managing our expenses tightly. Obviously, this first quarter, as you mentioned, was a little anomalous because of the compensation impact in Q1. We have had some flow-through of some of the investments that we've made in previous quarters that hit in Q1 as well. We are going to continue to invest in our frontline capabilities, but at a more moderate pace. We think we can manage that. We're going to try to hold our sales forces, the investment in our sales forces that we've made over the course of the last year or so, and we think there's a way forward to get to that objective that we've set. All I can say is stay tuned on that front. Relative to commercial deposits, it's one of those areas that we have been focused on over the last year or so. We've been strong, as you know, from a commercial lending perspective for a long time. Our market share and commercial deposits is not commensurate with our natural share. We put some initiatives in place over the course of the last few years, including adding some sales force in our cash management segment. When I look at our growth over the last year or so, it has been very strong, as you noted. The share performance year-over-year is strong. We're number 2 in our commercial deposit share performance year-over-year, and we think we're on the right track. I'm optimistic that we're going to continue to improve in that product category. Great. Thanks very much, Frank. Just one quick one, if I might, for Tom. You mentioned that asset management revenue benefited from a strategic investment. Can you talk to us quickly on the size and nature of that, please? Sure. That was revenue that we recorded in our PCG division. It relates to an equity investment that we have in a company. A few years ago, we sold part of our U.S. mutual fund business, took back equity as a part of that transaction, and have done well through that. In the quarter, the net income impact from an unusually high level of income in the company that we have the investment in was about $20 million. But it is somewhat recurring? There's absolutely a recurring equity pickup, but their income was unusually high this quarter. Okay. Thank you very much. Thank you. The next question is from Sumit Malhotra of Macquarie Capital Markets. Please go ahead. Good afternoon. My first question is regarding slide 21 of the presentation. Could be for Surjit or Tom. Just looking at the commercial loan balance in the U.S., there is a comment, your second comment under commercial that says the growth was offset by pay downs and declines in CRE and runoff portfolios. Can you give me an idea how much of the $30.1 billion balance would you say relates to what you would call portfolios that you are expecting to run off? I know you had placed some of the CRE impaired portfolio in corporate or is housed in corporate. So how much of the $30.1 billion relates to portfolios you expect to run off? Sumit, this is Surjit. I will answer the last part of your question, and then I will ask others to perhaps deal with other segments. With respect to the real estate portfolio, at the time of acquisition, that portfolio was roughly $10 billion. Through the mark and through pay downs as well as loan sales that we have undertaken, that number is now down to seven. But that includes the mark, let me tell you. So there has been a reduction as a consequence of that. There have been other pay downs as well, and perhaps Mark or Tom want to talk about those. This is Mark Furlong. We have kind of a lower middle market portfolio. It is down about $500 million in the quarter, and that was kind of an intended shrinkage. The big part of the portfolio, a little over $17 billion, is the kind of the core commercial banking business. That portfolio continues to show some very nice growth. That is the comment, up $1.1 billion. I guess what I just want to get clear here is that, and correct me if I am wrong, when the M&I transaction closed, I believe the bank told us that the bulk of the impaired CRE book that you were looking to run off was being housed in corporate services such that we would be able to see the true trend in how the book you want to grow is actually performing. What I just want to be clear of is when we look at this number every quarter, do you think that represents the base we should be looking at to see what kind of growth the bank is achieving in commercial? Or is there more of this portfolio that you expect to run off? I think it is a pretty good base. There will probably be some commercial real estate out of here that we will continue to let some refinance out, some opportunities where we think that is a good risk diversification strategy. But this is pretty close to a good base to look at. Now in here we have a portfolio that we call run-off that is performing, but that we think over a period of time will wind down or restructure into something, but currently performing. But this is the portfolio that we run through P&C that we watch closely and that we are trying to grow, and the bulk of the portfolio is related to relationships we want to grow. Fair enough. Then last one for me, Mark, you might get involved here again, and also directed to Tom. If I look at your non-compensation expenses in the quarter on an all bank level, obviously I appreciate the increase that you have in Q1 for the benefits. But if we look at non-compensation, usually we see a peak from the bank in Q4 and then a decline to begin the new year. You were down about 2%, but Mark's segment had an increase as did some of the others. Would you say, and you had referenced this last quarter, Tom, should we expect the level of non-compensation expenses at the bank to continue to trend lower as the year goes forward? Or do you expect we will see the normal pattern of growth? I'll say a few things in response to that. The first is that in the P&C US segment, we did have a litigation provision in the quarter that was about $15 million. That item basically accounted for the increase in expense that you see. It was largely offset by a securities gain. Not a big impact on the bottom line, but it does explain the expense change. In terms of the total bank compensation related expense, I wouldn't say that we're expecting any fundamental changes in the trend. We had the $71 million in the quarter as we do every quarter, give or take, or sorry, every first quarter. That inflates the Q1 expenses, but there's nothing else unusual going on other than the focus on productivity. We talked about that last quarter, and we talked about it this quarter as well. We expect over time that that will show some benefits in the compensation related expenses and generally in expenses. I'm right to say it's $100 million you've talked about of the $300 million synergies target that you expect the run rate by the end of this year will be $100 million for the US business? Yep, that's correct. Thanks for your time. Thank you. The next question is from John Aiken of Barclays Capital. Please go ahead. Good afternoon. Just a quick clarification for Surjit on the home equity line of credit. Surjit, I think that you stated that the loan to value on the HELOCs currently is at 54%? Sorry. Yes, I did. Okay. Surjit, do you have any back of the envelope for, or quick calculation as to how much of the commitments are actually drawn on the HELOC? I am assuming that they are not all at 100% drawn. Yeah. I think the number. Roughly about half of it, I would say, is one. Okay. Thank you. I am actually surprised it has taken this long to get to this question. On the corporate segment, Vicki did an excellent job walking me through the cash component of the recoveries in the impaired portfolio. What was it in the quarter that actually drove these repayments? Is this something that might actually be recurring going forward? Or is the experience in the first quarter a bit of an anomaly in terms of the repayments that were received? Let me start. The repayments that we received, a lot of them, as you know, the 142 is entirely with the purchase credit impaired portfolio, and a lot of the 142 relates to repayments. I think the way you got to look at it is it is very difficult to predict pay downs. While we were quite happy with the pay downs, typically in distressed pools, I think the early repayments come from clients who have the ability to refinance. That tells you that I do not know, the pace may not be sustainable, but clearly it helped us this quarter. Does that answer your question? Yes, it does. Thank you very much, Surjit. Thank you. The next question is from Mario Mendonca of Canaccord Genuity. Please go ahead. Good afternoon. A question probably for Tom Milroy. The trading number was obviously pretty good. I think it was characterized by Bill as returning to normalized conditions. How would you characterize Q2, if you can? Does it feel normal again? Or what I am really trying to get at is, was there anything in this quarter either from a mark-to-market perspective like CVA or DVA that would have benefited the quarter? Yeah. Thanks, Mario. I actually do think the trading revenues in this quarter were probably back to levels we would expect to in that range to see for the rest of the year. There was negative mark-to-market in Q4, which we didn't experience in Q1, which was obviously that's helpful. The quarter was characterized the latter half of seeing the high levels of volatility and the stress generally in the market leave. That enabled us to actually get back to business. We saw improved client flows, instances of wider bid-ask spreads, active new issue flows, more stable funding costs, and generally better overall market conditions. As I look at it, in every quarter we have mark-to-market activity, but this felt to us like it was a quarter where we were coming back to more normal ranges. Helpful. Question for Surjit. You talk about the stress testing you did on all your books, HELOC, and what have you. Your comment was that you think that the bank is that the losses while higher would be well within your ability to absorb. I need a little more clarification. When you say absorb, do you mean absorb without having to raise capital or absorb in your earnings without earnings declining in a material way? I'm not sure what absorb means. Is it absorbed from a debt perspective, a debt holder's perspective, or more from a common equity holder's perspective? Let me put it in some perspective for you. Let me give you a scenario which will give you some sense of what I mean by what I said. If unemployment rates, for example, went up to 9.5%, if housing prices declined by 25%, and interest rates moved up by, let's say, 50 basis points, and the GDP declined by a little over 2.5%. In that scenario, our losses would over a period of two years double the base. That's what I mean by it would be totally manageable. It would go up from, let's say, something like 40, 41 basis points to about 85, 87 basis points in that scenario. Just to be clear, that was unemployment at 9.5%, housing down 25%, rates up 50 basis points and GDP down 2.5%? That's correct. This is all over what? A 12-month period? This is over a 24-month period. Twenty-four. Okay. That's helpful. Thank you very much. Thank you. The next question is from John Reucassel of BMO Capital Markets. Please go ahead. Thank you. A question maybe for Tom Flynn or Frank Techar, just trying to understand the CMHC decision to ration bulk insurance. Is it your understanding, is this a temporary or is this a permanent shift in that? How is that going to impact the way you manage the balance sheet or not? What is the potential impact on funding costs or your ability to absorb loan growth or other things? It's Tom, John. A few comments on that. The first would be that we don't see this as having a big impact in the near term on our business. There are other providers in the market who are able to offer insurance and under existing insurance that we have, we have the ability to substitute new product in as existing product matures and rolls over. So not expecting a big impact in the near term. Obviously can't speak to CMHC's plans for future actions. Ultimately our expectation would be that if there's a higher cost to funding for some portion of the portfolio there would be an adjustment to market pricing that we would hope offset that. Okay. That's helpful. Then just for Surjit Rajpal, just when you talk about the losses going up, you're talking about the entire portfolio, it's not just the personal side of the, its commercial lending, personal lending, the whole bit. Is that when you talk about these losses? You're referring to the stress? Yes. The stress is entirely on the consumer portfolio. What would happen, presumably, in those scenarios, there would be some commercial losses. What would you expect on there? I do not have an estimate offhand of that one. Okay. Yeah. Okay. Thank you. But clearly the scenario would result in losses elsewhere as well. Sure. Thank you. Thank you. The next question is from Brad Smith of Stonecap Securities. Please go ahead. Thanks very much. Just two quick ones. On slide 25, the CAD 142 negative provision relating to the credit impaired purchase loans. Would I be correct in assuming that the other side of that transaction or that entry would have been an increase of CAD 142 million in the carried value of those loans? No, the majority of the 140 comes from payoffs of loans. So in effect, it would be cash. Oh, it would've gone to cash. Okay, great. My second question relates to the supp pack on page 39. When we're looking at the changes in the allowance, consolidated allowance for credit. The recoveries there are $223 million. In the quarter, they were up about fourfold. The write-offs were elevated from the fourth quarter and are the highest level that they've been since I can remember. Can you talk a little bit about what led to that increase in recoveries, what the likelihood of it repeating itself would be, and what happened that caused write-offs in a quarter where otherwise it sounds like credit was improving to go up so much? Thank you. Thank you. The next question is from Darko Mihelic of Cormark Securities. Please go ahead. How about I wait for the answer first? Thanks, Darko. We're just taking a minute here. Darko, I'm trying to focus on the numbers. I'm trying to focus on the page you pointed out. When we move to the next question, I'll get back to you. Okay. Darko, if you want to ask your question, we'll get back to Brad's question. Okay. Thank you. I guess my question is regarding slide 8. It's probably a question for Tom Flynn. Can you walk me through the mechanics of the increase in the net interest margin on an adjusted basis to 221 from 213? When we go through the supp pack and through your written materials, it looks like it's coming from two areas, PCG. First of all, that equity investment, is that being recorded through the NII line? More importantly, I suppose my question drills down to what's happened in corporate. How did you get such a big increase in the margin quarter over quarter? One of the things that we noted in the balance sheet is an awful lot of Federal Reserve deposits, but that's typically not something that would have high margin associated with it. So any help on the margin improving and what the outlook for the margin would be, would be very beneficial for my model. Thanks. Sure. It's Tom. I'll take that on. On slide 8, we show the adjusted margin ex trading up 8 basis points to the 221. The biggest single driver of that relates to the higher investment asset management revenue in P&C Canada that we referred to earlier. The accounting for this is a little counterintuitive, but we do take that income through net interest income, and that increased the margin by about 4 basis points in the quarter. The Canadian retail business including the P&C business and the wealth business increased the margin by 2 basis points quarter-over-quarter. The residual piece in corporate wasn't that big, and I'd say more than anything, just reflected random activities in the quarter that weren't individually significant. There was nothing really unusual going on from a corporate perspective. Looking forward, next quarter we won't have the benefit of the PCG higher investment pickup. That was 4 basis points. That number all else equal will drop by about the 4. In terms of the margin outlook in the retail businesses for the last few quarters, we've talked about some pressure on margins in both Canada and the U.S. Canada reversed this quarter on that front, but we think the longer-term trend is intact, and so we'd expect some pressure on margins in the retail businesses over the next few quarters. Thanks very much. That's helpful. Thank you. The next question is from Cheryl Pate of Morgan Stanley. Please go ahead. Hi. A question probably for Frank. I am just wondering if you can lay out for us your base case for housing in terms of home price appreciation for the year, and how that fits into the expectation for mid to low single digit revenue growth and the composition of mortgage growth within that segregated into new versus renewal activity. Thanks, Cheryl. Sorry, you cut off just a little bit when you were asking your question. This was about the contribution of mortgage growth to our overall revenue expectation. Was that it? Right. And how you think about that in relation to your base case for home price appreciation this year. Yeah. Well, I think to start, our expectation is that home price increases are going to moderate over the course of the year. We started to see that, I think, in this quarter. I think we will continue to see that. House price activity in general, our expectation is will slow but will still be appropriate for the marketplace. There's going to be growth. I just think it'll be at a slower pace than we've seen in 2011. We were pretty clear about our objective, which is we've been at 2% mortgage growth for quite some time now, and our expectation is we can grow that a little faster. We're going to have to take some business from others as the market is slowing around us. So that's how I'm thinking about it, and I don't think that's changed from the last few quarters. We plan on doing that through the activation of the investment in our sales force, our mortgage specialist sales force, which continues to grow. Obviously, we've been innovative over the last couple of years with respect to some of our products, and in particular, our five-year fixed rate, 25-year amortization product, which has been in the marketplace for almost two years now. We think that's a product that is good for Canadians, it's good for Canada, it's good for our customers. And we intend to continue to promote it in this environment. It's a product that we believe addresses all of the risks that are currently being debated about whether or not there are consumer debt levels that are too high in Canada and the possible fallout from economic slowdown and rising interest rates. It helps our customers pay less interest. It mitigates their interest rate risk for five years. It helps them retire debt-free by paying off their balance faster, and it works against market price appreciation. In fact, it helps with the issue that you've raised, the house price appreciation because the shorter amortization reduces the maximum purchase price people can afford. So we think that this product that we've been pushing for the last couple of years fits right into the sweet spot of what we need in the country, and it will help our balance growth as we move forward. Thanks. That's helpful. Can you just give me a sense of sort of where the volumes are coming from, new versus renewal, or is it sort of fairly evenly split? Yeah. New versus renewal. This past quarter was a little unusual because we did go out for this limited time offer on our low-rate product, the 2.99 offer. We saw an increase in new in the first quarter. It was about 50/50 from an application perspective. There's been a big shift in volumes going to fixed versus floating over the last couple of quarters. It's now three quarters fixed versus a quarter floating, and a year ago it was close to being the reverse. We're seeing some change in consumer behavior for sure. How does the current portfolio layout fixed versus floating on a sort of total basis? I don't have that number right in front of me, Cheryl. I think it's about 50/50 though. That's my recollection. Okay, great. Thanks so much. Maybe we will just take a break before the next question and go back to Brad Smith's question and Surjit. Brad, on page 39, I take it you are referring to the large pickup in the recoveries. That recovery number includes the 142 for the purchase credit impaired, and that is what is the big difference there. I can go into it in greater detail if you call me offline. We will take the next question, operator. Thank you. The next question is from Gabriel Dechaine of Credit Suisse. Please go ahead. Hey, good afternoon. Just on the, I'm just wondering why we should be treating that as core. To put that on a positive spin, it's a reflection of obviously improving credit conditions. Just wondering what that says about potentially improvement on the expense line later this year or 2013 on anything related to lower credit adjudication costs, all the credit management process, if that outlook has improved at all. Just to follow up on Darko Mihelic's question on the margin there, just wondering about the Canadian segment NIM that was up 2 basis points. I understand you're expecting that to maybe reverse in the coming quarters, but what was going on this quarter? How much was the deposit growth outpacing asset growth factoring into that? It's Tom Flynn. I'll take the first part of the question related to the recovery on the purchased credit-impaired loans. I think the simple reason why we think it makes sense to include that in the core earnings is that the impaired loans are accounted for in the same way if you purchase the loans versus if you don't. So there's no fundamental difference in the accounting for impaired purchase loans versus regular impaired loans. In both cases, you look to value the loans and you take any change in value through the P&L. This quarter, as we've talked about, the strong majority of the 142 relates to actual payoffs on loans that were marked down, and so that's a true gain. We do adjust for the credit mark related accounting on the performing loans, and there are two reasons why we do that. The first is there's an inherent mismatch between the timing of the revenue recognition and the PCL expense recognition. We amortize a portion of the credit mark into income over time, more or less on a straight line basis. As we've talked about before, we expect the losses will emerge somewhat later. So the last couple of quarters, we've seen meaningful income coming from that item. Through time, we think that the number will be closer to flat. The other reason we adjust for that is if we didn't, it would distort some of our ratios, including revenue growth, productivity, and net interest margin. On the question related to expenses on the impaired, I'd say it's too early to expect any pickup on that. We're still working the portfolios. People are doing a very good job realizing on the value as we saw this quarter. I think the expense reduction story there will be more one that we'll talk about next year. And on the Canadian margin, I'll turn it over to Frank. Actually, next year, if you can elaborate a bit on that then, for the lower credit costs. I think I'd be reluctant to speculate really on what the expense might do more than a year out. Assuming the economy continues to recover and the impaireds go down, both purchased and regular, there will be some savings that will flow, but that's a ways out. Okay. Gabriel, it's Frank. Relative to the margins in P&C Canada, the reported number was up 2 basis points. I characterize that as our margins remained relatively flat. And you were on target. The positive in the quarter was we have a favorable product mix. Our deposits grew faster than our loans in the quarter, and that was offset by the continuing competitive pricing pressures, and the low interest rate environment putting pressure on our deposit spread. So essentially, those two things offset. We did have a couple of very small, minor non-core items that weren't correlated to the balance sheet growth that hit also in the NII line. So I characterize it as a quarter where we saw our margins remain relatively flat. As I said earlier, my expectation is there's pressure as we go through the remainder of the year to the downside on margins for us. The commercial pricing trends are still good or got worse? I call them rational. Okay. Spotty in places, maybe irrational in places, but overall, nothing systemic that is causing us a big concern at this point. Thanks. Thank you. The next question's from Peter Routledge of National Bank Financial. Please go ahead. Yes, I have two. First one is for Bill. It relates to Gabriel Dechaine's question. On your dividend payout ratio on an adjusted basis, you're at 49%, near the middle range of your target. When the board thinks about the dividend, are they thinking about it in relation to the adjusted number, or do you pull out the purchase credit-impaired piece? The earnings available to the common are driven by the reported. Over time, it's our expectation that with the exception of the amortization of intangibles, those two numbers are going to converge. Yeah. I think that the way that we think about it is more conditioned by the work stream that remains in 2012 on the integration than on anything else. That's really the timing. We have a lot of work to do. By the end of the calendar year, you're going to see a lot more clarity. We're going to see a lot more clarity around the earnings level, and we'll see that convergence. I think your question is really pointing towards timing. Yeah. You're right. The bank's earning power is starting to show up nicely against the dividend, and it's reflected in the payout ratio. So all other things being equal, when we're satisfied that we've followed through on the integration the way we're planning to, then we'll be in a position to look at it. Okay. Just one more, perhaps for either Frank or Surjit. Just on the Canadian mortgage business. The CMHC has de-emphasized bulk insurance, but as I understand, there's still a high LTV mortgage comes up, they'll still write insurance on it. So from BMO's perspective, would you rather have a high LTV mortgage where the consumer's already buying mortgage insurance at the get-go over a low LTV product where you couldn't necessarily get bulk insurance on that? That's an interesting question, I would say. This is Surjit. Yeah. We have never relied too much on the CMHC from a risk mitigation standpoint. My answer to that question would be that we would underwrite to our standards. Yeah. Depending on a client's needs, and wouldn't be driven by what can be is insurable or not. That's the way I would approach it. Frank, anything from your perspective? I would just echo that comment. I think we're indifferent. We're comfortable with our underwriting standards and have been in either category. Okay. Thanks very much. That's very clear. Thank you. The next and final question is from Brian Klock of Keefe, Bruyette & Woods. Please go ahead. A quick follow-up on the Canadian mortgage market, and this is for Frank, I guess. Frank, I think you said that you're aiming to try to get back to a sort of 2% year-over-year mortgage growth for Canadian mortgage. I guess it sounds like, and maybe I'm thinking too much about the impact of this CMHC hitting its limits, and what that could mean, but isn't there also somewhat of a trend, given the high debt-to-income ratio for the Canadian consumer, that we should see some swelling in that whole mortgage pipeline. I'm just wondering, I guess, is there something you're seeing, or are you saying that you think you can hit your targets by just the market share takeaway with the innovative products? Yeah. I think, Brian, I guess very simply, we saw mortgage balance growth in Canada of about 7% in 2011. Our portfolio grew by about 2%. All I'm saying is, I think we have room to grow in the context of what we think the market growth is going to be in 2012, which might be a little slower than 7%, but it's going to be higher than two. We have the opportunity to do more business, and that's what we're shooting for. Okay. Last question, I know that I guess we talked about this last quarter at the end of the fourth quarter call. I guess the concern outside is still that the condo market in Canada is somewhat frothy, I guess. Can you talk about the Canadian condo market? Are you guys ready to disclose what your exposure is to the Canadian condos or even in the major metro markets? Just any color you can give us, that'd be great. Yeah. Why don't I share some of it with you? We are very comfortable with the level we have. Our total condo exposure is CAD 10 billion. And of that, the insured portion is 5.2, and the uninsured portion is the balance. I'll tell you why I'm comfortable. When I look at the higher risk segments of the condo market, we are not that very much involved in that segment. I'll go through three segments that would cause me concern in particular. One would be the jumbo mortgages, which are greater than a million dollars. In that segment, we have sub CAD 300 million of exposure. As you know, in that segment, while there's a higher down payment requirement, there is still a possibility of a larger decline with the higher value condos when actually markets do turn. Having said that, our loan-to-value there is very low. It's 55%. So that gives me comfort from the standpoint of the jumbos. The next segment that I think one looks at, which I think I'm not as concerned about, but people ask why we should be concerned about and compare it to the alt-A in the U.S., which is the one where there is limited availability of financials or verification of income. In our case, that's largely the non-resident or the new immigrant program. In that, again, our exposure is under CAD 1.5 billion. The loan-to-value there is, again, in the low to mid-50s. In fact, when I look at that portfolio right now, that portfolio actually is performing better than the remaining part of our portfolio from a delinquency standpoint. If that gives you any sense of the selection process that we've gone through in making a determination during adjudication. The third segment of the portfolio I think one needs to look at is the investor portion of that portfolio. There we are under CAD 3 billion. Our loan to value is in the high 50s. It is about 58, 59 loan to value. When I look at it overall, I do not believe be concerned. From a geographic standpoint, I think the portfolio is scattered exactly where you would expect it to be, in the two big metropolitan areas where there are more condos, and that is largely in Toronto and Vancouver, you have more of those. So it tracks where the condos are. Thank you very much. That is actually very helpful. Thanks, Surjit. Thank you. There are no further questions registered at this time. I would like to return the meeting over to Ms. Lazaris. Great. Thanks very much, Jason. I would like to thank everyone for joining us today, and if you have any further questions, the IR team is available to take your call. Thanks, and have a great afternoon. Thank you. The conference is now ended. Please disconnect your lines at this time, and we thank you for your participation.