Earnings Call: Q2 2011

May 25, 2011

Good afternoon, and welcome to the BMO Financial Group second quarter 2011 conference call for May 25, 2011. Your host for today is Viki Lazaris, Senior Vice President of Investor Relations. Ms. Lazaris, please go ahead. Great. Thank you, operator. 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 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 try and keep it to one or two questions, and then re-queue. 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, who heads P&C Canada, Ellen Costello from P&C U.S.. 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 statements. Information about material factors that could cause results to differ and the material factors and assumptions underlying these forward-looking statements can be found in our annual MD&A and our second quarter 2011 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's second quarter results were very good. We delivered net income of CAD 800 million and earnings per share of CAD 1.34. Somewhat slower revenue growth in some businesses was balanced by strong revenue growth in others, and we generated a solid 5.5% increase in total revenue from a year ago. We continue to demonstrate progress across the bank, and we are confident that this good performance will be sustained through the second half of the year. For the year to date, net income is ahead 12%, revenue growth is 8.1%, and we are executing well against our strategic priorities, supported by the investments we are making in the business. Our plans to integrate Marshall & Ilsley with Harris Bank are on track as we move towards closing. We have a clear view of the opportunities and how to capitalize on them across the breadth of our businesses. We are confident about the results we will generate with the addition of M&I, and I will speak more on this topic shortly. ROE continues to improve sequentially and reached 16.7% in the second quarter on a strong capital base. in the quarter, our Basel II common equity ratio strengthened to 10.67%. Provisions for credit losses continued their overall improving trend down significantly both from last year and from Q1. Specific PCLs were 42 basis points of average net loans and acceptances compared to 59 basis points in the second quarter of 2010. Impaired loan formations were also down significantly both year-over-year and compared to the first quarter. Surjit Rajpal will provide more color on credit later in the call. As we anticipated this quarter, expenses grew faster than revenues. This short-term negative operating leverage reflects significant investments in people, premises, and technology that allows us to deliver a customer experience that is both distinctive and distinctly BMO in person, online, and on the phone. What we offer is differentiated, an advantage in growing the business. We are adding frontline staff, increasing training, enhancing technology and distribution, and developing educational tools for retail clients. As an example, in the last year, we have added over 700 employees in customer-facing retail areas, including new branches, our client contact center, specialized sales force, and other programs to support strategic growth priorities. As a result, total bank expenses in the second quarter on an adjusted basis were 9.2% above the year-ago level and in line with management's expectations for the first half of the year. These expenditures will continue to drive improvement in both top line and customer loyalty scores across our businesses. I should note that we are very closely monitoring movements in the economy and in each of our groups to ensure that our spending level remains in step with our business and economic forecasts. We remain committed to achieving medium-term operating leverage of 1.5% on an adjusted basis. I will now touch briefly on the performance of our business groups, and Tom Flynn will provide more details later in the call. P&C Canada's net income was CAD 401 million, with solid revenue growth attributable to volume increases across most products. On an actual credit loss basis, the group's net income was up 16%, with losses improving year-over-year in consumer and commercial portfolios. Expenses were elevated in the quarter as expected due to investment in the business, but we expect the rate of expense growth will moderate in the coming quarters. Importantly, we have maintained productivity in the low 50s as we have advanced our strategic agenda. P&C U.S. revenue rose 11% in US dollar terms, lifted by last year's acquisition, higher deposit balances, and improved spreads. Reported net income was down slightly from last year, but up 4.1% from a year ago on a core basis. Private Client Group results were affected by the unusually high claims in the reinsurance business, masking excellent operating performance from our other wealth businesses. Net income, excluding insurance, increased 41% compared to last year and 24% from Q1. BMO Capital Markets net income was a healthy CAD 235 million with an ROE of 21.4%. Q2 results were lower year-over-year, reflecting a decline from a very strong trading environment in 2010, somewhat offset by higher M&A and debt underwriting this year. Since we announced the acquisition of M&I in December, I've been out meeting with M&I employees and customers, and so has the senior management team. These meetings have confirmed our confidence in how good we believe this acquisition will be for our customers and shareholders. We've connected with around 3,000 M&I employees in Indianapolis, Madison, Wausau, Minneapolis, St. Paul, Kansas City, Phoenix, Sarasota, and Milwaukee, and with customers from across M&I's businesses. This is a high-quality customer base, and I can tell you that the reaction to BMO has been very positive. This is evident in M&I's customer retention numbers, which have been good. Employee turnover remains low. M&I employees are energized by the potential offered by expanded markets and capabilities, as well as the benefits of being part of a strong organization. They're excited about joining a company that, like M&I, puts a high priority on customer loyalty. They can't wait to get started and are thinking ahead already about the opportunities. This week, American Banker and its annual survey of bank reputation ranked Harris number one among the largest bank holding companies with material retail presence in the U.S. It's notable that both Harris at number one and M&I at number six were ranked prominently in this measure of public perception of banking. In 2010, our combined personal, commercial, and wealth management business in the U.S. reported $185 million in earnings on an expected loss basis. For the first full quarter in 2011, after completion of the acquisition, we expect a positive contribution from M&I, excluding integration costs. In the medium term, our aspiration is that these combined businesses will generate $1 billion in earnings annually. We remain on track towards a closing in the third fiscal quarter. An important milestone was achieved last week when M&I shareholders voted overwhelmingly to approve the transaction. We're looking forward to adding these new BMO shareholders. We continue to refine our expectations with respect to capital requirements. Our Basel III estimated pro forma common equity ratio, including M&I, remains strong at 6.9% as at April 30, 2011. We've also been working hard on synergies and now expect to deliver cost synergies in excess of $300 million, an increase of $50 million over our target. We're continuing to challenge the organization to increase the ultimate realized expense synergy. As you may have seen, we introduced the brand name for our U.S. retail business, BMO Harris Bank. We've had a positive response in the market since the introduction. This business is being positioned to mirror our Canadian model and organizational structure. One of the attributes of the Harris Bank has been its similarity to Canada in terms of employee culture and customer orientation. This is also evident across M&I and is contributing to a spirit of collaboration as integration planning teams work together. We look forward to announcing the closing of the transaction before the end of our third quarter. Now I'll pass it over to Tom to take you through the second quarter financial results in 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 will start with the financial highlights on slide 8. Net income was CAD 800 million, up 7.5% from last year. Earnings per share were CAD 1.34, and return on equity increased to 16.7%. Pre-provision, pre-tax earnings were CAD 1.2 billion. This was a good quarter with earnings at a new high for the bank. We are introducing adjusted results this quarter and moving away from cash EPS. Adjustments will include such items as amortization of acquisition-related intangibles, acquisition-related costs, and changes in the general allowance. This positions us to report results clearly in future quarters after the acquisition of M&I. Adjusted net income and EPS were CAD 804 million and CAD 1.35 respectively in the quarter. Net adjustments this quarter were very small at CAD 4 million, or CAD 0.01 per share. Adjustments, all on an after-tax basis, include amortization of acquisition-related intangibles of CAD 9 million, M&I integration planning costs of CAD 17 million, a charge to revenue for hedging FX risk on the M&I acquisition of CAD 8 million, and a CAD 30 million release of the general allowance. Except for the amortization of acquisition-related intangibles, all adjustments were booked in corporate. Year-over-year, adjusted revenue was up 5.9% and adjusted expenses grew 9.2%. As Bill noted, credit costs improved meaningfully in the quarter. Results were impacted by unusually high reinsurance claims from the tragic earthquakes in Japan and New Zealand. This reduced earnings by CAD 47 million after tax, or CAD 0.08 a share. BMO's capital position strengthened in the quarter, increasing by 52 basis points for the common equity ratio and 80 basis points for the Tier 1 ratio. Turning to slide 9, I will touch briefly on the drivers of revenue growth. Net interest income was CAD 1.6 billion, up CAD 98 million or 6.4% year-over-year. We had solid growth in our retail businesses, driven by higher average earning assets and in corporate services. Quarter-over-quarter, net interest income was essentially flat, with decreases in BMO Capital Markets and P&C Canada partially offset by increases in the Private Client Group and corporate. Second quarter revenue was reduced by the impact of fewer days relative to Q1. Total bank net interest margin, excluding trading, was up 11 basis points year-over-year. There was a modest increase in P&C Canada, driven by higher spreads in personal lending and solid increases in P&C U.S. and PCG from higher spreads and volumes on loans and deposits. Quarter-over-quarter, total bank net interest margin, excluding trading, was up 8 basis points. The increase was driven by higher volumes in PCG, improved deposit spreads and product mix in P&C U.S. and higher net interest income in corporate, partially offset by lower net interest margin in P&C Canada due to continued low interest rates in a competitive environment and to changing mix. Non-interest revenue was CAD 1.6 billion, up 4.6% from a year ago, largely due to growth in securitization revenues and securities commissions and healthy increases in mutual fund revenues and underwriting and advisory fees. These were partially offset by lower trading revenues, which were strong last year, and the earthquake-related reinsurance claims. Quarter-over-quarter, non-interest revenue was down 7% due to lower trading and insurance revenues. The weaker USD reduced revenue by 1% quarter-over-quarter and 1.6% year-over-year. Moving to slide 10. Year-over-year expenses increased to CAD 193 million or 10.5%. On an adjusted basis, expenses were up 9.2%. As Bill mentioned, expenses have increased given strategic investments we are making to support our focus on improving the customer experience and to drive top-line growth. These investments relate to initiatives largely in our P&C businesses, such as increasing frontline sales force, expanding the distribution network, and online technology enhancements. In addition, higher performance-based compensation and the impact of acquisitions, including the Rockford-based bank and M&I integration planning costs increased expenses year-over-year. Quarter-over-quarter expenses decreased CAD 23 million or 1.1% and were flat after adjusting for the impact of the weaker USD. Increases in some areas, including M&I integration planning costs of CAD 25 million, were offset by lower employee compensation, largely due to the annual cost of stock-based compensation for employees eligible to retire that is expensed in the first quarter. To summarize on the expense side, the bank continues to invest in and deliver on its strategic priorities. At the same time, as we move forward, we are focused on an appropriate relationship between revenue and expense growth. Slide 11 details capital and risk-weighted assets. Our common equity ratio increased 52 basis points to a very strong 10.67%. The improvement was driven by growth in shareholders' equity and a 6.6% decrease in RWA. Lower RWA resulted from the impact of the strengthening Canadian dollar and lower non-retail RWA, reflecting in part a continued reduction in non-core activities. Pro forma Basel III common equity ratio and Tier 1 capital ratios are very strong at 8.6% and 11.5% respectively. After incorporating the estimated capital consequences of the pending M&I acquisition, capital remains strong. The bank's pro forma Basel III common equity and Tier 1 capital ratios would be approximately 9.4% and 11.9% respectively. On a Basel III basis, the pro forma common equity ratio is estimated to be 6.9% after including M&I. Our pro forma common equity ratio is well aligned with the Basel III threshold of 7%. Moving now to slide 14. P&C Canada net income of CAD 401 million increased 1.7% year-over-year. Higher revenue driven by volume growth across most products and an improved net interest margin was partially offset by higher expenses and higher credit losses based on BMO's expected loss methodology. Quarter-over-quarter results were reduced by three fewer days in the quarter and lower spreads. Net interest margin decreased seven basis points due to continued low interest rates in a competitive environment, resulting in lower mortgage, commercial loan, and term deposit spreads. Margin decline was also attributable to the impact of unfavorable product mix. Expenses increased CAD 7 million or 0.7% quarter-over-quarter, primarily due to higher initiative spending and employee costs, partially offset by the impact of fewer days. Year to date, the productivity ratio is 51.7%. Loan growth was solid with personal loans up 6.6% and commercial loans up 7.1% year-over-year. Moving to slide 16. P&C U.S. net income of CAD 43 million was down CAD 2 million from a year ago. Organic revenue growth was offset by higher provision for credit losses and an increase in costs associated with impaired loans. Year-over-year, the inclusion of the Rockford acquisition increased revenue by CAD 19 million and expenses by CAD 15 million. Net income increased 4.6% in source currency quarter-over-quarter. Revenue increased 1% driven by increased spreads, which offset the impact of lower balances. Turning to slide 17. The Private Client Group net income was CAD 101 million, down CAD 14 million or 13% from a year ago. As noted earlier, net income was impacted by CAD 47 million after-tax and reinsurance claims from the earthquakes in Japan and New Zealand. Earnings in PCG excluding insurance were up CAD 29 million or 41% as we continue to see growth across our wealth businesses. Revenue increased 15% driven by higher assets under management and administration up CAD 35 billion or 14% in source currency. This includes CAD 5 billion from the closing of the Lloyd George acquisition in the quarter. Turning to slide 19. BMO Capital Markets delivered net income of CAD 235 million in the second quarter, down CAD 25 million or 9% from results in a strong market environment of a year ago. ROE was good at 21%. Revenue declined 9%, largely due to lower trading revenues from higher levels last year. This was partially offset by stronger advisory fees and increased securities commissions and debt underwriting fees. Quarter-over-quarter net income was down 8% from a strong first quarter. Revenue declined 1% due to lower trading revenues and a more challenging environment. Year-to-date capital markets earnings were CAD 492 million, up 4%, and ROE was 21.6%. Lastly, slide 21 shows corporate services. Net income was CAD 21 million, up CAD 91 million year-over-year. Provision for credit losses was better by CAD 86 million, including CAD 42 million reduction in the general allowance. Revenues were CAD 148 million better than a year ago, primarily due to higher interest from the settlement of certain income tax matters, lower TEB adjustments with the operating groups, the unfavorable impact of hedging activities in Q2 2010, and higher securitization related revenues largely related to a credit card securitization. Expenses were CAD 88 million higher year-over-year due to higher technology investment spend, M&I integration planning, and higher employee expenses. In conclusion, we're pleased with the results. We delivered another good quarter of earnings, an ROE of 16.7%, and capital continues to be strong. With that, I'll turn it over to Surjit. Thanks, Tom, and good afternoon. Before I begin, I draw your attention to the caution regarding forward-looking statements. First, let me say that from a risk perspective, our performance this quarter was good. We are pleased with the positive trends that are evident both with impaired formations and with provisions in Canada and the U.S. This reflects economic conditions in general, including an easing of problem asset levels. The pace of economic recovery is slow, and therefore, we expect there will be some quarterly variability within the overall positive trend. Looking now in more detail, I'll start with slide 26, where we provide a breakdown of our loan portfolio. The portfolio is diversified both geographically and by portfolio segment. 78% of our loans are in Canada and 17% in the U.S. P&C Consumer represents 64% of the Canadian portfolio, and these are 87% secured. Our U.S. portfolio mix is 44% consumer and 56% commercial and corporate. The U.S. consumer portfolios are relatively evenly spread across first mortgages, home equity, and auto loans. The U.S. C&I portfolio is well diversified and is performing reasonably. The weakness in the U.S. commercial real estate sector remains a drag on the overall speed of economic recovery and is a sector we continue to focus on very closely. While there are signs of improvement, it will clearly take time for the sector to fully recover. This portfolio is approximately $2.8 billion U.S. On slide 27, we provide information on impaired loan formations. Formations were $147 million for the quarter, showing good improvement from $283 million in the first quarter and $366 million in the second quarter of 2010. Canadian formations were CAD 39 million, down CAD 120 million in the first quarter, with the largest decrease experienced in manufacturing and commercial real estate. The U.S. portfolio continues to account for the majority of formations at $108 million, but is down significantly from the $163 million in the first quarter. The commercial mortgage and consumer sectors account for the largest portion of this decrease. Gross impaired loan balances are down at CAD 2.8 billion compared to CAD 3.1 billion in the first quarter. Slide 28 details the provisions for credit losses in each business. The consolidated specific provision was CAD 187 million, down from CAD 248 million last quarter and CAD 249 million a year ago. Total provisions at CAD 145 million include a CAD 42 million reduction in our general allowance. Moving now to the business segments details that are shown in the table to the right. P&C Canada provisions are moderately lower quarter-over-quarter, but down significantly from a year ago. P&C U.S. provisions are also down this quarter, benefiting from lower provisions in commercial real estate, investor-owned, and residential mortgages. There were no provisions in the capital markets portfolio this quarter. Turning to slide 29, we provide a segmentation of the specific provision by geography and sector. The Canadian provision was CAD 98 million, down from CAD 116 million last quarter and CAD 139 million a year ago. The consumer loan and credit card segments continue to be the largest drivers of Canadian provisions at 40% and 35% of the total respectively. The U.S. provision was $90 million, a reduction from $132 million last quarter and $123 million a year ago. The retail sector accounts for just over half of the U.S. specific provisions. To conclude, I know all of you are very interested in the progress we are making in risk with the M&I integration planning and the opportunities that lie ahead as we move beyond close of the transaction. I expect much more to come on that during our third quarter call in August, and I am looking forward to updating you then. That concludes my presentation, and we can now move on to the Q&A. Thank you. If you have a question and you're using a speakerphone, please lift your handset before making a selection. If you have a question, please press star one on your telephone keypad. If at any time you wish to cancel your question, please press the pound sign. There will be a brief pause while the participants register for questions. Thank you for your patience. Our first question is from John Aiken from Barclays Capital. Please go ahead. Good afternoon. Quick question on lending volume growth within Canadian P&C. Outside of the CAD 1.3 billion-CAD 1.4 billion in card that was securitized, we are actually starting to see our lending volumes decline. I was wondering if you could give us a little sense as to what's going on specifically with the Canadian retail and commercial portfolios, please. John, it's Frank. First thing I'd like to say is that in P&C Canada, we had a really solid quarter again this quarter. As you've noted, that was on the back of just really good solid balance sheet growth, generally in line with our expectations. To your point, we are seeing a bit of a slowdown in the consumer loan volumes. I don't think this is a surprise to anyone. We've been talking about it for the last couple of quarters. In particular, we've seen a slowdown in our credit card activity, not only the transaction volumes but also in the balances, the revolving balances that our customers are holding. So there's definitely a change in customer preferences going on the consumer side of the business. On the commercial side, the volume growth for loans has been really strong again this quarter for us, in excess of 7%. We are still really optimistic about our ability to compete and the activity levels in the marketplace seem to be holding up. I think we have talked in previous quarters about this being a bit of a business-led recovery coming out of the recession, and we continue to see that playing out in our business. Thanks, Frank. I know there was a lot of commentary in the prepared remarks about expenses and spending on initiatives was in line with plan. But we have seen three quarters where P&C Canada has actually had negative operating leverage. How much capacity do you have to pull back on expenses if we start to see our revenue growth continue to moderate like we have over the last little while? Yeah, I think you are right, John. The elevated expense growth levels that we have seen over the last few quarters have been planned. I think I have been pretty clear about that was the intent. We are investing in our business, and we are really confident in our strategy and our ability to execute against that. So our plan for the future is to continue to invest in the business. I think you will have seen over the last couple of quarters that the expense growth has moderated a little bit. I think we were over 12% back in Q3 and in the high eights last quarter, and now we are down to eight. My expectation is we will see a little bit of moderation in our expense growth as we go through Q3 and Q4. We are always looking at the top line and trying to keep that relationship on some solid footing. I will just be clear that the expectation for this fiscal year is we are likely to end up in a negative operating leverage position. The objective for us for this year in P&C Canada was to maintain our productivity ratio in the low 50s. So far, year to date, we have been able to do that. I would expect we will end up there at year-end as well. Great. Thanks, Frank. Thank you. Our next question is from André-Philippe Hardy from RBC Capital Markets. Please go ahead. Good afternoon. I have a question probably for Bill Downe. I was surprised that you kept the guidance for the possibility of a share issue of up to CAD 400 million, given capital ratios are better than expected and a pro forma everything ratio that is almost where OSFI wants you to be in almost 2 years. Can you talk about why you kept the language in your press release, please? Sure, André-Philippe. Thanks for the question. We are encouraged by the capital levels, and as you know, we've provided a lot more granular view around capital and Basel III as we've come through the period since the end of the fourth quarter. We're relatively close to confirming when the closing date is, and we'd prefer to confirm the final conclusion on capital to when we conclude that date. It's a relatively short period of time now. But are you signaling anything by leaving the text in there? Or it is just- No We don't want to change anything until it is closing? No, we are not signaling anything. Okay. Quick one for Frank Techar on margins. I understand the reasons you have mentioned why the margins came down sequentially. Do you expect them to stay at these levels or some of these trends to reverse in upcoming quarters? Yeah. Thanks, André. I think I'd start on the margin question by just saying that in the last couple of quarters, we were really expecting to see some softening in margins. As you know, we didn't in the P&C business. This quarter we did. I think I talked in previous quarters about the fact that we are going to see some volatility based on a couple of factors. This quarter, there were a couple of anticipated spread drivers that changed a bit more than we expected. This really gets to your question. The first one being the competitive pressure is heating up a bit more than we would've expected, and we're seeing that probably play out the most on the commercial business. My expectation is going forward, we will continue to see that. From our perspective, we feel good about our ability to compete. We saw good volume growth again this quarter. As you know, we've been investing in this business not only adding sales force but in other areas as well. We're highly confident that we can compete on the commercial side. The second thing that happened, and I touched on this briefly already, is we are seeing changing customer preferences, in particular with credit cards. With that higher spread product, we're just not seeing the volumes as we would've anticipated. The mix in our balance sheet, at least, is changing, and I wouldn't expect that to change as we go through the next couple of quarters. My expectations would be that customers are going to change their preferences in the near term. I think they are listening to the conversation that's playing out in the public space about consumer debt levels, and they're still feeling conservative at this point in time. The last thing on spreads is I think we would've all anticipated a bit of relief from a rate increase perspective. Because interest rates have remained very low, we're still seeing customer preferences focused on lower spread variable rate mortgages when we would've anticipated this perhaps would've changed by this point in the year. There's a number of factors that have just added up in Q2. We are seeing that volatility for BMO play out in this quarter. By the sounds of it, until interest rates rise, you're not expecting a big change in your margins. Wouldn't anticipate it, André. I think I would hold to the comments that I've had in previous quarters. We'll see some volatility moving around sort of the levels that we're at at this point. Thank you. Thank you. Our next question from Robert Sedran from CIBC. Please go ahead. Good afternoon. I note the revised synergies from the M&I transaction, but unless I missed it, I didn't notice any difference in the expected accretion or dilution. Has any of that changed, or are we expecting the pre-synergy view to have come down to offset the greater synergies that you're now expecting? It's Tom Flynn. Our synergy expectation for the second year would be modestly higher than it was when we announced the transaction. Then we talked about roughly 2%-2.5% accretion, and we'd be a little higher than that currently based in part on synergies and in part on a lower equity raise. Still being dilutive in the first year? Mildly. Okay. Just to follow up on the reinsurance business. Bill, a couple of years ago, you had talked about changing the risk profile of the bank so the shareholders were exposed more to risks that involve client-facing and franchise-building businesses. When I think about earthquakes on the other side of the world, how does the reinsurance business fit with that philosophy? Just following up on that, we've had a bit of a bad run in North America with tornadoes and wildfires and various floods. Does BMO have any exposure to any of that? I'll let Gilles Ouellette respond to the second part of your question, Rob. The first part of it is it's entirely consistent with the customer-facing businesses. It's complementary to the creditor life business. It's really bounded by a limit to the loss that can occur in any period that is consistent with the size of the business. The incidents of the two earthquakes were extraordinary in terms of the historic view. But the loss was within the tolerance we have for the business. I'll let Gilles speak a little more specifically. Yeah, Rob. This is a business that we've been in for more than 20 years. We insure life and property and casualty. As Bill mentioned, this is a business that complements our credit insurance. It's a cyclical business, but over the long cycle, we've gotten from this business a return in excess of the industry returns, which is around 14%. What happened in this tragic event in the last quarter, these two events, the one in Japan and the one in New Zealand, they represent two of the top nine industry losses. It's unprecedented. We've never seen anything like that. As far as this business, obviously we don't like the kind of volatility. We're not used to this kind of volatility, but this is the first time that's happened. We're going to look at the business. Generally speaking, over the length of the cycle, we're comfortable with the business. Jill, it sounds like the Q3 impact from whatever may have happened in this quarter doesn't sound like it's material? No, it isn't. Okay. Thank you. Thank you. Our next question from Michael Goldberg from Desjardins Securities. Please go ahead. Thanks. A question about the operating leverage. Can you give us some examples of how the investment spending that you're doing is paying off, or how you expect it to pay off? Also, while you indicate that you expect your operating expenses to moderate, you also set a medium-term objective of getting back to a positive operating leverage of about 1.5%. How long is it until the medium-term? I'm going to let Frank, Michael, provide you with a couple of examples. I think you and I have had to answer this question before about when the medium-term is. I guess it's in the 2 or 3 to 5-year range. It's not a wait and see. We have a view around the pattern of expense going forward, and we're quite thoughtful about the rate at which we schedule those expenses. Maybe Frank, you can talk a little bit about a couple of the areas where, and I think I referred to some of them in my introductory comments, where we're seeing some of the benefits. Yeah. Thanks, Michael. I'll start by saying if you ask the question about medium-term, I might look back a couple of years as well because for the last two years, the P&C Canada business we've had operating leverage in excess of 5%. We've talked about a 3% medium-term target for P&C Canada, and we've exceeded that for a couple of years. I think we've been clear about the fact that this is the year we're going to invest, so that we're going to have a result that's going to be materially different from what we've seen over the last couple. I think that's consistent with where we are relative to our strategy. I'd say negative operating leverage is not going to be the norm going forward. But for this year, we are committed to continuing to invest in the business and we're going to stay the course. Relative to the other part of your question about some examples where we are seeing some benefits, I'll just pause on the FTE side of the business. We have added over the course of the last year over 1,000 people in P&C Canada. The vast majority of those are frontline-facing resources. So mortgage specialists, financial planners, commercial account managers, contact center people as Bill mentioned earlier, core bankers in our branches. We do have and continue to have the smallest distribution network, so adding these resources clearly is going to pay off for us in the future as we continue to ramp up. I'll just give you one example that's occurred in the quarter relative to a specific initiative that's been pretty visible in the marketplace, Smart Steps for Parents, which we're pretty proud of. In one month we had 80,000 unique visits to that site which as you know doesn't have a lot of direct top-line growth potential in the offer itself, but it's consistent with our customer promise and we think will help us in the future relative to the growth of the business. This is something that our customers have been asking for a long time, help with teaching their children about money early on, and we're the first one in the marketplace to provide it. We think it is going to be a huge success going forward, not only with the parents but with children as they start their banking business hopefully with BMO. Thank you. Thank you. Our next question is from Mario Mendonca from Canaccord Genuity. Please go ahead. Good afternoon. First a question on capital. This comes from page 23 of the supplement. Tom, when you were talking about, or maybe it was Surjit, when you were talking about the decline in RWA, you referred to currency and the runoff of that non-core book. I want to understand this $5.5 billion or so decline in corporate including specialized lending about halfway down the page. I don't suppose that certainly can't all be currency. Secondarily, how would that tie into any other sort of balance sheet line item that would show a similar sort of decline? It's Tom, Mario. I'll start. Surjit may want to jump in. The decline really has two parts. Currency is a significant part of it, and the other part of it relates to the reduction in a few larger exposures that we had in the portfolio. One of which in particular had a higher risk weighting attached to it. I wouldn't say it's reflective of the performance of the overall portfolio for that half of what drove the result. It was more tied to a relatively small number of exposures. And certain exposures that were particularly capital intense. In one instance, a higher risk-weighted exposure. Would you say currency was about a half of that then? Roughly. Okay. A different type of question then perhaps for Frank. When you were talking about the decline in credit cards, you referred to customer behavior and a few other things, and those were interesting comments. Perhaps could you just speak to whether you think this is an industry phenomena or if there's anything in the quarter that might specifically relate to BMO? Or do you really feel that this is something we'll see across the industry? Yeah, it's a little bit of one of those trick questions, Mario. But our view is this is an industry phenomena. We believe that customers have been paying attention to this debate. We believe that they're feeling like they're not out of the woods yet relative to their financial situations and the economy and the growth in the economy in general. Post-holiday season, we saw a change in the usage on our credit cards, and we've seen a clear change on the revolving balances, and we don't think it's us. We'll find that out, I guess, as we go through the next few months. Thanks very much. Thank you. Our next question's from Steve Theriault from Bank of America. Please go ahead. Thanks very much. Start with a question for Ellen, if I could. Ellen, last quarter you said you expected the NIM to be relatively stable due to pricing pressure and I think less loan repricing. But again, the NIM was up quite substantially this quarter. Can you talk to how the NIM has developed versus your expectations, and talk to us about your outlook for the remainder of the year? Thanks for the question, Steve. I do think the longer-term outlook is for it to be flat and under some pressure for two reasons: pricing pressure in the commercial loan market and also in the consumer side, especially in direct auto. Also, and Frank touched on this, low interest rates are a factor. What happened in this quarter is we had a drop in some low-yielding loans that we exited. You might notice the balance sheet is down to $11.7 billion from $12.1 billion last quarter. And those low-yielding assets and the new originations that we had contributed to that lift, mostly on the loan side. The other half of the equation is our deposit mix changed as we've been pursuing more core deposits, which bring us better spread into the net interest margin. So those are the two big factors. Is there substantially more lower-yielding assets to drop off? I think we are close to done on that. Something we have been working on is to improve the yield on the overall portfolio through this last cycle. Okay. Just something else. I noticed the last four quarters, the ATM count in the U.S. is down. Is that just rationalizing post Amcore, or is there something else of interest going on there? Actually, it should be up. There might be a problem with the number. We will take a look at it and come back to you. Okay, I'll circle back. For Tom Flynn probably, there's obviously a lot of noise in the corporate services line this quarter and most quarters. Can you refresh us on what you might consider a reasonable run rate of earnings drag in corporate services maybe excluding the credit loss component? Sure. Corporate moves around, as you've said, partly because of credit and partly just generally because of what is in there. This was a particularly good quarter for the segment. I'd look at something like negative CAD 50 million to negative CAD 100 million as being a more typical number for what we'd expect. That's helpful. Thank you. Thank you. Our next question's from Sumit Malhotra from Macquarie Capital. Please go ahead. Good afternoon. First one is a numbers question for Tom Flynn as well. A lot of talk, obviously, on the decline in the Canadian P&C net interest margin. Top of the house NIM actually up about 8 basis points quarter over quarter. Maybe comes back to corporate services again. This line has been very volatile, and I think there's some commentary here about interest on tax refund or something to that extent. How much of the CAD 75 million quarter over quarter improvement in NII this quarter related to what seems to be a one-time type item? Yeah. The consolidated bank margin was up quarter over quarter and year over year as well. The biggest driver of that was from corporate as your question sort of went to. Ballpark half of the change quarter over quarter, a little less than half of the change quarter over quarter would've related to the better performance in corporate. Is that specifically that one item you flagged in the report to shareholders? Yes, it is. Okay. Thank you for that. This one is probably for Bill or Ellen. Looking at the M&I results, if I go back, I guess it's been about six months since the acquisition was announced. We've seen the loan portfolio for M&I decline by about 11%. I realize there's a couple of things going on. Obviously, you've talked about the difficult environment to grow the loan book in the U.S., some repositioning on the part of the company. I'll offer some of my own caveats, but then I'll turn it over to you. When you see a double-digit decline in six months for a company that you're on the verge of acquiring, does that concern you? If not, why? Well, Sumit, thanks for the caveats up front. The focus around portfolio management at M&I is on the commercial real estate book. In that regard, I think they've been effective in the management, and the numbers are consistent with what we would have expected. I also think that from a customer retention perspective, they've done well. The customer loyalty there is very deep, and the feedback that we've had has been positive. On the commercial lending side, I think it's more driven by customer need than anything else. Until we close, I think it's hard to open new customer relationships. We're looking forward to hopefully within the month, being a little more proactive in seeking new business. It isn't inconsistent with, one, the strategy around the management of commercial real estate and our expectations. To the same extent then, if they're managing that credit side of things. Six months ago, we talked about a $4.7 billion gross mark on the credit book net of the allowance, which has remained relatively the same. Safe to say, well, maybe it's not safe to say. Any changes in your thoughts on the credit outlook for the company? The experience that they've shown quarter to quarter, again, is consistent with our expectations, and we haven't seen anything that would cause us to be uncomfortable with the mark that we set on December 17th, we thought was appropriate. Thank you for your time. You're welcome. Thank you. Our next question is from Gabriel Dechaine from Credit Suisse. Please go ahead. Hi. Good afternoon. Just a follow-up on that line of questioning. Maybe the reason you didn't increase your dilution forecast for the deal, is that because the additional synergies that you're expecting from the deal, you're going to plow that back into branding or whatever because of maybe some market share losses in Wisconsin? Where I thought you were going, I was going to ask Tom to answer the question around dilution. But no, I think that as I said to Sumit, the asset declines are pretty consistent with what we would've expected. In our integration planning is an appropriate level of marketing and promotion that has to go with both the closing to reassure customers that the high-quality experience they have will be continued. Also there is a significant amount of built-in expense around the brand name and the attendant signage. I think once again, the planning that we're doing is confirming what our initial expectations would be. I would say the only difference is that I would say we would be less defensive in our feeling about the traction that the combined bank is going to have in the market than we might've been four or five months ago before we had a chance to be in the market and talking to customers. In my opening remarks, I made the comment that we've had a very positive response. We've had a positive response in the media, in local markets. We've had a positive response in town halls with employees. In our own marketing in those states by BMO marketing people has confirmed that the customer response is very strong. So I think it's in line, and as I said, we're comfortable with it. Okay. Just to maybe be a bit more, I ask you to look into your crystal ball or whatever. When you look at the business you're acquiring, then I see the 2% sequential decline in loans. Admittedly, there was a bit of a one-timer there in the U.S., but when would you expect or hope to see on a pro forma basis your loans in the U.S. start to grow? Mid 2012, late 2012, or sooner? I know that Tom Flynn has answered this question on previous calls about asset levels and the extent to which we see continuing recovery in the U.S. That growth in the core commercial book, both BMO and M&I customer base, will be positive and hopefully will essentially offset the intended decline in the commercial real estate book. I think we will get two benefits. One, I think we will see better returns from those loans as that older commercial real estate book comes down and new commercial credits come in. But the quality of the underlying book with better diversification will be there. Going into 2012, we are very much forward-looking, and I am expecting that the year will be a good one. Great. Thank you. You are welcome. Thank you. Our next question is from Brad Clark from KBW. Please go ahead. Good afternoon. I'm here. Okay. Just want to make sure you can hear me okay. I guess maybe to follow up, you guys have talked about it a little bit. Question for Ellen Costello on the U.S. loan portfolio, and maybe it's partly for Tom as well. I guess part of the reduction in the U.S. footprint there was a $3 billion drop in end-of-period balances in the U.S., with half of that coming out of the BMO Capital Markets group and the other half coming out of the Harris mostly P&C Consumer loan portfolio. You kind of talked earlier, and I just want to make sure, I guess maybe add some more color just to make sure I understand that what drove that large decrease in BMO Capital Markets. And is there anything in the consumer that's related to just how much that's related to the Amcore runoff versus other just weak demand for consumer loans in the U.S.? Thanks for the question, Brian, and I'll start and then pass it over to Tom. On the consumer side, what you're seeing is, and it's probably true of many of our peers, any new originations that we have coming in on the mortgage side are being onsold, so they're not staying on our balance sheet. That plus regular amortization that you would expect on those books is bringing the level of outstandings down. We have been consistently originating enough to offset the declines in our indirect auto book, and I expect that pace will moderate a little bit. Otherwise, those are the reasons on the consumer side. On the commercial side, I touched on some of the low-yielding exit clients that we had moved out of the portfolio. We have a very strong pipeline of originations of new customers establishing banking facilities ahead of need, anticipated growth. We are confident in the second half of the year that we're going to see some lift in loan outstanding from that activity. Tom? Great. Thanks for the color. Maybe just one follow-up question for Surjit. Thinking about the significant improvement in GIL formations in the quarter, there was the negative general provision. I guess, ex that, the specific provisions are down after being somewhere in the neighborhood of $250 million for the last three, four quarters. Do you think we can kind of reset that specific provision to a much lower level given where the NPL or the GIL numbers are coming in today? Yeah. Let me tell you. We've said in the past, and I think I said it in my formal remarks as well, that while we see the economic recovery, it's a little slow. We will observe some variability quarter to quarter. This quarter was really a good quarter. If you look at page 31 on the supplementary package, that gives you a breakdown of where our PCLs are. There is an element of variability that gets introduced when you have a commercial and corporate business. I think I mentioned to you in the Capital Markets side, we've had absolutely no PCLs for a long time. In fact, for three, four quarters in a row, we've had nothing at all from that side. So there will be an element of variability. I would say yes, we do see it improving in the future, but with the caution that there will be variability. Okay. Thanks for taking my questions. Thank you. Our last question from André-Philippe Hardy from RBC Capital Markets. Please go ahead. Thank you. I just wanted to follow up with Gilles Ouellette on reinsurance. Can you please help us understand what kind of trigger points there might be before you are exposed to catastrophes? Or attachment points, I guess is a better word for it. Yeah. André, the business we are in has relatively low attachment points. In the last few years, every year we have obviously an allowance for these. In the last few years, we have been able to absorb the losses and not really feel it through the P&L. It is just that this year, as I mentioned earlier, this was two of the top nine catastrophes of all time, which is why we have had a kind of major hit. Generally speaking, in the past years there has been incidents every quarter or every second quarter. Even though it has gone through our P&L, we have not really felt it. But is there something you can give us, maybe if cumulative catastrophes in a year exceed, I do not know, $20 billion, $40 billion, that is when BMO's reserves would prove to be too low? André, we have a cap on these, right? Each one of these treaties has a cap. For this year, for example, this year in the worst case, there might be, and this is not based on the events that happened, but rather on prospective events, there might be another $40 million. That is the maximum. That is unlikely. That is for a variety of reasons, unlikely to happen. Does that help you? It helps me understand the tail risk. Thank you for that. But I guess I am trying to understand better when your reserves might not be enough. I can follow up offline if you prefer. Okay. No problem. Thanks, André. Thank you. There are no further questions registered at this time. I would like to turn the meeting back over to Ms. Lazaris. Thank you. Thanks everyone for joining us today. If you have any further questions, please give us a call in the IR department. Have a great afternoon. Thank you. The conference has now ended. Please disconnect your lines at this time, and we thank you for your participation.