Barclays Annual Global Financial Services Conference

Sep 14, 2011

Slides

John, next up, BMO Financial Group. Very happy to have Tom Flynn here. He's CFO, in the role, I think, for just six months, so have the very detailed questions on the P&L ready for him. Anyhow, Tom, thank you very much and we look forward to your presentation. Thank you, John, for that introduction. Brief as you promised, and it's good to be back to the conference this year. Good morning, everyone. When I spoke here a year ago, I outlined our U.S. growth strategy as we look to build scale in our Midwest footprint. At that time, we had steadily grown our U.S. business over the course of a decade with nine individually relatively small acquisitions, employing a methodical approach designed to ensure the right fit and the right price. As I indicated a year ago, we thought the valuations were starting to become more reasonable, providing attractive opportunities to meaningfully expand. Today, a year later, I can tell you that with the acquisition of Marshall & Ilsley that closed in July, we were successful in identifying and crystallizing a key step in our U.S. strategy. We had a strong core bank in the U.S. a year ago, and clearly the M&I transaction builds on that strength and improves scale. I'll be covering two main topics this morning. First, I'll outline BMO's investment story, which is underpinned by a strong and stable foundation, a diversified business mix, sound risk management, strong capital, an attractive dividend, and what we believe are differentiated levers to grow in what looks like a lower growth environment. Second, I'll take you through each of our four businesses in more detail, reviewing their key priorities and performance. Before I begin, please note the caution regarding forward-looking statements. For your information, further details about such statements are available in our public filings. All financial numbers in this presentation, unless otherwise noted, are in Canadian dollars. An investment in BMO is underpinned by a strong and stable foundation and a history that goes back almost 200 years in Canada and 125 years in the United States. The earnings power of the bank has supported our commitment to shareholders. BMO has the longest-running dividend payout record of any company in Canada at 182 years. We have an attractive dividend yield supported by our target payout ratio of 45%-55%. Our year-to-date financial results underline BMO's momentum and earnings power. For the first three quarters of the year, revenues increased 10% from 2010 to CAD 9.8 billion, adjusted net income exceeded CAD 2.4 billion, 16% above last year. Adjusted EPS increased 13% to CAD 4.02, and ROE was 16.1%. The adjusted income numbers add back acquisition-related integration expenses and the amortization of intangibles. I'll now provide an overview of the markets where we do business in North America. In Canada, we operate in three markets, Western, Central, and Atlantic, with a total GDP of CAD 1.5 trillion. Both the West and Atlantic regions are economically driven by natural resource industries. In Central Canada, the emphasis is more on manufacturing, similar to our U.S. market. Canada's unemployment rate is 7.3% and compares favorably to other countries. The Canadian housing market has remained resilient, supported by record low mortgage rates, healthy growth in jobs and immigration, and a sound policy framework. Our fourth large market is the U.S. Midwest, where our core operations cover six state areas. Markets in this footprint include Chicago, Milwaukee, St. Louis, Indianapolis, Kansas City, and Minneapolis-St. Paul. The Midwest economy is doing well in the U.S. context. Unemployment in the Midwest has been running below the U.S. national average since March 2010. In June, it was at 8.4%. Year-over-year wage gains in five of the six states have exceeded the national average. Looking forward over the next five years, our economics group expects growth in the Midwest to exceed the national average. Together, these four markets form a T centered in the heart of North America, an enviable footprint and market presence aligned geographically with industries and sectors where we have deep knowledge and proven capabilities. BMO is diversified by business mix. Our businesses generated CAD 12.2 billion in revenues and CAD 2.8 billion in net income in 2010. Personal and commercial bank in Canada is our flagship business and the largest contributor to the bank's revenue and earnings. We serve more than 7 million customers through a national distribution network offering a full range of products and services. We hold a strong number 2 market share position in commercial lending for loans of CAD 5 million or less. Our P&C U.S. business was significantly expanded with the acquisition of M&I. We've built on our strong established base to create a leading Midwest regional bank renamed BMO Harris Bank. Our 680 branches provide a significant footprint in our core U.S. market, where we have over 3 million customers and strong retail deposit market share positions, number 1 in Wisconsin, number 3 in Chicago, and number 3 across our Midwest markets overall. Private Client Group, which is our wealth management business, serves the full range of client segments with a broad offering including full service and direct brokerage, mutual funds, institutional asset management, private banking, ultra-high net worth, and insurance. Assets under management and administration are CAD 152 billion and CAD 277 billion respectively, with recent acquisitions adding CAD 153 billion in client assets, largely from M&I. Together, these businesses represent the bank's North American retail operations and are expected to contribute over 75% to revenues and net income. BMO Capital Markets is our fourth operating group, providing a full range of products and services to corporate and institutional and government clients. We operate from 26 offices on five continents. We have a full offering of investment and corporate banking services, including equity and debt underwriting and M&A, as well as a full suite of sales and trading products with leading equity research. Our approach to risk management is to provide appropriate and independent oversight of risk. Our objective is to have a leadership position in integrated risk management consistent with our strong credit history. This slide highlights our strong performance over the last two decades compared to peers. During the recent downturn, our credit measure was elevated relative to the Canadian peers, given the size of our U.S. loan portfolio. We have performed well comparing like portfolios in the U.S. to U.S. peers. Our total loan book is CAD 207 billion, with 68% of loans in Canada and 28% in the U.S. The U.S. mix is 37% consumer, with the remainder commercial. M&I added CAD 29 billion in loans and is diversified across industries. The M&I portfolio has been subject to extensive due diligence, and we've established what we believe to be a prudent credit mark to fair value the portfolio. Capital management at BMO has always been a discipline with consistent improvement, prudent approaches used to the deployment of capital. BMO has a strong capital position. Our Basel II common equity ratio was 9.1% at the end of the third quarter. Our Tier 1 ratio was 11.5%. Our pro forma Basel III common equity ratio was estimated at 6.6% at the end of Q3. We remain confident in our ability to meet the Basel III 2019 requirements by the beginning of 2013. In the global economy, there are still major challenges to work through. Clearly, the situation in Europe is cause for concern for everyone. That said, we believe in the underlying resiliency of the Canadian and the U.S. economies. We also have confidence in the future performance of our business and the results that we'll generate even during a period of potentially slower economic growth. We think we have attractive levers for growth in the current environment, and here are some examples. Commercial lending has always been a differentiator for BMO. We have a number 2 position in Canada and a very strong business in our P&C US group. We intend to grow here by leveraging our established lending relationships to build deeper share of wallet, growing fee income, attracting more commercial deposits, and using our proven model to take share. Our strength in commercial should serve us well as we expect more credit growth in this area than in the personal side of the business. Our BMO Capital Markets business in the U.S. represents a second source of leverage in a low-growth environment. We've made significant investments in this business over the last few years, including upgrading talent and sharpening sector expertise, building out and expanding coverage of U.S. institutions with strength and equity research and distribution. In the Wall Street Journal's annual Best on the Street research survey, BMO Capital Markets had six top 5 finishes, which placed us fifth overall. We're investing in our U.S. fixed income platform. The retooled U.S. capital market business is well-positioned to take advantage of opportunities and to improve returns. A third growth driver will be the lift achieved from the integration of M&I. On July the 5th, we closed the acquisition, transforming our U.S. retail operations by adding scale and capabilities. Taking the best from both banks will build a much stronger bank overall. We expect to generate in excess of CAD 300 million in pre-tax cost synergies with full realization on a run rate basis by the end of 2013. I would add that we are applying greater rigor generally to the management of expense at the bank, not just in areas related to the integration. I'll now provide a brief update on the integration of M&I. The integration is moving forward as planned. The management team is in place with all top and level 2 leadership positions confirmed prior to or on close. We've identified and are actively managing major integration risk. The integration governance structure is managed through a dedicated project management office with clear objectives for the integration of operating units, system integration, capturing synergies, as well as branding and branch conversions. We're successfully harmonizing risk processes and integrating BMO's strong credit discipline. Our new U.S. retail brand, BMO Harris Bank, has been well-received. Let me now turn to our operating group priorities and performance, but first, a word of explanation. For segmented reporting purposes, BMO charges expected loss to the operating groups to provide an indication of the risk the business has underwritten. The difference between expected loss and actual loss is charged to corporate. Let's start with Personal and Commercial Banking Canada, which has a track record of strong performance over the past 2 years, holding top-tier positions in both revenue and net income growth. This strong performance reflects a number of key priorities, including building capacity by expanding specialized sales forces and distribution channels, improving our processes and technology to free up frontline capacity and reduce operating costs, and leveraging our strengths and relationships to increase share of wallet. In the first 9 months of fiscal 2011, P&C Canada revenues were up 5% to CAD 4.5 billion. Net income was up 13% on an actual loss basis. We're pleased with our performance so far this year, which reflects momentum in the business and also the investments that we are making in it. Turning to the U.S. Personal and Commercial Banking business, our priorities are to, firstly, successfully integrate M&I, taking the best of the best from both organizations, which will create a much stronger bank. Secondly, to improve performance through managing sales productivity, managing costs, and optimizing our expanded distribution network, maintain strong customer loyalty, and our goal on the commercial side of the business is to be the undisputed leader in commercial banking in the Midwest. Revenues were US $1.4 billion in 2010 and are US $1.2 billion year to date. Net income and source currency is up 27% to CAD 204 million, reflecting improved NIM and higher deposit balances. For the total bank overall, our third quarter included 26 days of M&I results, given the day that the acquisition closed on. This added CAD 117 million to revenue and CAD 32 million to adjusted net income in the quarter. Over the past 10 years, Private Client Group has steadily increased its earnings contribution to the bank and today contributes almost 20%. Key priorities for this business include effectively partnering across business segments to maximize cross-sell opportunities and, in particular, leveraging our personal and commercial client base to drive growth, which we've done very well in Canada and think there are opportunities to replicate in the U.S. We're also selectively investing to expand our business. For example, our new ETF family recently surpassed CAD 3 billion in AUM. We've increased the number of investment advisors and private bankers, and we've enhanced our insurance offering. Revenues were CAD 2.2 billion in 2010, net income CAD 460 million. Year-to-date revenues are up 13% to CAD 1.9 billion, with net income of CAD 374 million, up 13% from last year, with very strong year-over-year growth of 35% in our traditional wealth business and lower results in insurance. BMO Capital Markets has an established track record of success. Key priorities for this group are to align capital and capabilities with client opportunity, to focus on strategic sectors, and to strengthen our business in the U.S., as mentioned earlier. Year to date, net income increased 28% to CAD 771 million. ROE was 22.9%, up from 18% last year. As we look ahead, BMO is focused on executing against its key priorities, which are shown on the screen. Our businesses are well-positioned to deliver in a differentiated way in the current environment. Thank you for your attention, and I'd now be pleased to answer any questions. Tom, thank you. I didn't think we'd catch up all in one presentation, but anyhow. Any questions from the floor? I have three questions related to commercial real estate, and this results from the heavy commitment of the M&I loan book to commercial real estate. Yeah. The first question, I was wondering if you could talk a little bit about the composition of the CRE loans that you got in the M&I purchase. Tell us a little more about those loans. My second question is, in the quarter you just reported, you moved some commercial real estate loans out of the M&I portfolio, but also out of the high-risk portfolio to corporate. I was wondering if you could talk a little bit about that and whether that implies those relationships are- Yeah running down. Third is whether there is a broader opportunity in commercial real estate here with the withdrawal of some competitors in that market and with values being somewhat stressed. Okay. Thank you for those questions. To deal with the first, in the U.S., our commercial real estate portfolio is a little under $10 billion. Roughly 75% of that came from M&I, and they had a concentration in commercial real estate, as some of you will know. We feel comfortable with the exposure that we have to a meaningful degree because we have taken what we believe to be a prudent credit mark against the acquired commercial real estate that M&I had. We did detailed due diligence at the time that we were doing due diligence in December, established a credit mark at that time, came out and updated that credit mark in our third quarter. The mark in the third quarter, in total, not just against the commercial real estate, was about $3.5 billion, which was in line with our number that we came up with in due diligence. We think that the mark protects us to a meaningful degree from the risk in the portfolio. The portfolio is diversified across developer and investor-owned. Investor-owned is ballpark three times the size of the developer portfolio, and the portfolio is diversified across the footprint that M&I has. I think the number is that 45% of the investor-owned is in the state of Wisconsin, which has been impacted like every other state by the downturn, but to a lesser degree. To comment on what we moved to corporate, we moved around $1.5 billion of M&I commercial real estate to our corporate segment out of the operating business and around $1 billion of our legacy Harris commercial real estate to commercial. The thinking here was that we are planning on exiting that part of the portfolio, and the move had two big benefits. The first is that it will allow our risk management workout people to focus on the portfolio and to manage it down in a deliberate way, which we are confident that they will be able to do effectively. Secondly, it basically removes the distraction that could result for the people running the business if we had those loans in the business segment. As we see it, we've liberated the business management team to focus on the go-forward business, and we've put the CRE that we're working out into the right hands with the risk people focused on it in corporate. It will take time to work this portfolio out, and it will trend down towards zero over a period of 3-4 years, give or take. Last question related to the opportunity in CRE. It's true that spreads are wider and many players have backed away from the market, and there's refinancing to be done, so that presents an opportunity. Our current posture with respect to the sector is that we're being selective. With the acquisition of M&I, we've got a portfolio that is not small. We're comfortable with it. We don't think it's outsized, but it's not small. Our focus is on winding down the runoff parts of it and selectively expanding with our core clients. The total size of the portfolio will decline somewhat as we run off the part of the portfolio that's in corporate. It's not, I would say, a significant area for growth given the position that we've got. How big is your delinquency in agri credit lending in the heartland of Middle America? Is there any kind of collateral management, as well as how can you help farmers in this weather conditions and a bad economy in terms of their lending purposes? Yeah. I just want to make sure I got the question related to delinquencies in ag lending. Ag lending. I don't have exact numbers for you, so I can't be precise. But what I would say, it has not been a big problem for us from a loss perspective at all. Generally, we like the business, and Bank of Montreal and Harris Bank both have very good agricultural lending practices. It's true on both sides of the border, it's an area of strength for us, and M&I had a good business in that area. So we feel very comfortable with our ability to be an effective competitor in the area. It is one of our focus sectors, and it hasn't been an issue from a loss perspective to date. We talked on our Q3 conference call about the cyclical nature of or the seasonality rather in the portfolio. As we look at our commercial portfolio and think about growth, the fall part of the season is one when inventories are building and drawdowns increase on lines. So currently, we've got relatively low utilization from the ag part of the portfolio, and we expect that to build up as it normally does at this point of the calendar. Could you possibly comment on the strategic value of the old M&I Arizona and Florida branches and systems, which were originally created to follow the snowbirds down to those areas, and that's been a lot of the issues that caused that bank to become available to you. Yeah. I will comment on that at a high level. M&I had operations in both Arizona and Florida. The position in Arizona is concentrated in Phoenix, where the share position is number 4, number 5 with about 50 branches. Our view is that we need to reposition that business to focus much less on commercial real estate, which was an area of focus for them in the market generally. We think that given the footprint that we have got there, and also the existing business that Bank of Montreal did in that market through its wealth management business, where we have been active for a number of years, it is a market that will work for us longer term. Again, the credit mark helps with dealing with the issues that existed in the portfolio, and we have got a good management team there that we have confidence in, and we see a period of working through a tough environment and a sustainable business there. In Florida, the footprint is smaller and we are in more markets. Over time we will be looking at the ability to create branch density and we will think about whether we have got the right position in the right markets. The snowbird strategy is one that sounds great in theory and on paper. Our experience has been that it is actually not a big driver of results. It is an important capability to be able to have for a part of the market. Fundamentally, when you are in those markets, you need to be able to compete locally to be successful. Tom, a follow-on to that question is that there has been a lot of discussion out of BMO in terms of the expense synergies that are coming out of M&I, and I think that is fairly well-recognized. But in terms of looking 5, 7, 10 years out, what is the outlook for revenue synergies? The one thing that I am of particular interest is on the Private Client side of the business because the M&I, that was a flavor of the acquisition that I think gets swept under the rug. Yeah. I am happy to comment on that. We have externally talked much more about the cost synergies and very little about the revenue synergies because the market probably rightly takes a show-me attitude with respect to those. But we do think that there are good opportunities for revenue synergies from the transaction. On the wealth side, this transaction really significantly increases the size of our wealth business. M&I had around 150 billion of combined AUM and AUA, so a good-sized wealth business. We have been in the private banking and the institutional asset management business in the U.S. for a long time and have a good business. So we see opportunities at a high level just from taking, again, the best capabilities from both organizations and also looking to distribute product that we manufacture through a bigger distribution system. As an example of that, M&I had a mutual fund business. We did not. We think there are opportunities from a distribution capability there. We have a good investment management capability in our Harris operation, and we think there are opportunities to leverage M&I distribution there. From a cost perspective, there are some opportunities on the private banking side as well. Our model was to serve the mid and upper end part of the market well with a relationship coverage model, but to service smaller accounts through a centralized approach. M&I didn't have that centralized approach for its smaller accounts. Over time, we'll look to basically consolidate the administration and management of the smaller accounts into a centralized model, which will free up capacity for M&I frontline people to generate more revenue growth. We think there's a revenue lift there, and there's also a cost saving because we can service those accounts centrally on a lower cost basis. On the banking side of the business, there are good opportunities. One of the biggest that we see is in treasury services or cash management for the commercial market. We have a good capability and just a bigger distribution network to leverage that over. We think that that's going to be a good opportunity for us. Then, again, when you have two banks that each had strengths and a good core business, and you put them together and you take the best people, the best products, the best processes, the best systems, we think there's good leverage in that, and we feel good about it. One final comment I'll make, which is a soft one, but it's actually a very important one, is that there's been really great buy-in to the transaction from the M&I workforce. That bank went through a difficult period through the downturn, as many others did. It was harder to play offense for the bank given the issues that it was dealing with. With the transaction, the bank is back to playing offense and people are charged up about competing in the marketplace. There's a huge amount of leverage that comes from unleashing the potential and the energy of a big employee base, and the reception has been fantastic and has exceeded our expectations. Yes, sir. Could you share with us the bank's thinking regarding the appropriate size and structure of capital at your U.S. Bank subsidiary, including the role or potential role of hybrids and double leverage? Sure. I guess our fundamental approach has been that the bank needs to be and has been appropriately capitalized and well capitalized. We've had that approach both at our bank operating company and at our bank holding company, where under old rules, which are being phased out, there was the ability for foreign banks to have less capital in the holdco, and we did not take advantage of that because we thought it was appropriate to keep the entity well capitalized. Our capitalization has been focused on core common as opposed to non-common capital. We have a small REIT preferred that we've issued in the U.S. entity, and we're unlikely to increase that in any meaningful way. So I'd say the focus is on keeping a strong core capital, which is what is most important to regulators and most important generally to the market. From a double leverage perspective, we raised capital for the acquisition of M&I. It was fully financed with stock. So we feel comfortable, obviously, with the overall capital position of the bank and each of the parts along the chain down to the operating bank. Could you comment on the impact of the Canadian dollar being at parity or above parity with the dollar and what it does for the opportunities in your business? Sure. So the Canadian dollar is trading around par, was above par a little earlier in the year. Before becoming the CFO, I was the CRO for about three years. Pre-crisis, the Canadian dollar was very strong as well. We kept on waiting for the fallout to come in the Canadian manufacturing base because of the strength in dollar. Every quarter we'd wait for it, and the reality is we didn't see a significant fallout and haven't to date either. We asked ourselves why, and our conclusion was that Canadian industry had to become more competitive given global competition. An adjustment process took place over a decade plus with industry becoming more competitive, rationalizing operations, moving some production. With that, the industrial base was able to withstand the strong dollar in a way that surprised us on the upside. And that's the general statement. There are industries that get affected at times, but overall, the industry has held up remarkably well, and we're not seeing significant weakness in that at the current time. Thanks. Just on dividends, you've had a flat dividend for three years. Can we expect once you meet Basel III, I guess it says Yeah has that kind of been the issue? When does dividend growth come, I guess? We've had a flat dividend for, as you say, about three years, maybe a little more. Our view on this is that we have the highest dividend payout policy of the Canadian banks at 45%-55%. We're in that range currently. We've got an attractive yield. People don't need to wait for an attractive yield. They've got it today, which in a low-rate environment, we think is a big plus for the stock and for our investors. We don't plan on increasing the dividend in the near term. It's partly a function of Basel III, as you've suggested, and we want to make progress against the Basel III standards before we increase the dividend. I do believe the bigger point is that the current yield in absolute terms and relative terms is attractive. This sort of dovetails off the last question. Do you anticipate a SIFI surcharge for BMO and/or a domestic capital overlay from your domestic regulator above and beyond what might be required for Basel specifically? Yeah. We're not expecting a G-SIFI surcharge for sure, and we're not on the list and wouldn't expect to be. The question of whether Canada adopts a D-SIFI approach is still an open question, and the answer to that is not clear. It's too early for us to comment on that. When you acquire these U.S. banks, would you change the assumptions on your pension funds and the rates of return of the mix, or they simply stay where they are basically located? I'm quite sure, and we can confirm this to you offline, that M&I did not have a defined benefit pension plan that would give rise to that issue. It was a defined contribution arrangement, so there was no issue in that regard. Maybe this is for your former hat rather than your current one, but your thoughts as you've collected the exit commercial real estate portfolio as to the comparative merits of working it loan by loan for an extended period of time versus how developed the vulture market is for quicker exits from some of these credits. Yeah, our position on that is that we're not a forced seller, and we won't sell at prices that we think aren't reflective of value. The plan is to work this out over a period of time, which will be years. So our expectation is that we'll be working a lot of the portfolio out. We'll take advantage of opportunities to sell pieces when they present themselves, and we think the value represents fair value. M&I, as you may know, had been quite active at selling into the market and really did do a very good job of working down its real estate exposures over about a two-year period. So we've got a very developed capability on the bulk sale side, and we continue to stay close to the market. Some of the most senior people at M&I who were involved in that activity and did the good job managing it down are still with us today. So the approach is basically to be flexible, to be opportunistic, and to be focused, excuse me, as we say, on two things. The first is managing the portfolio down, which we want to do, and the second is doing a good job from a value perspective. I think we have time for one final question. Well, John, so you did leave the door open on your Chief Risk Officer role. I was looking at the slide in your presentation where BMO has gone through the cycle again, and provisions have been declining. You've done a very good job illustrating how well you've done in the U.S. against your peer group. Is this something that you think they can extrapolate over the acquisition and be able to continue that outperformance given your risk adjudication workout and everything else like that? Yeah. Over a long period of time, BMO has a track record of outperforming peers on credit loss, and we view ourselves as having a conservative credit position. From a risk appetite perspective, we say that we want to have a level of loss that is below peers. That's our fundamental philosophy, and as we integrate M&I, we're bringing our risk disciplines and philosophies to their business. We'd expect to operate on the same basis that would see us outperforming U.S. banks like portfolio to like portfolio. We need to go through the process, obviously, of working out the legacy portfolio. We've got the benefit of the mark to do that. But the go-forward approach will be to keep the traditional BMO approach. Great. Tom, thank you very much for your time. We really appreciate the presentation. Thank you.