Barclays 2012 Global Financial Services Conference

Sep 11, 2012

When EVP and Chief Financial Officer of BMO, and prior to this was Chief Risk Officer. I think that when you got the promotion, I asked you who on the board you upset to have the transition on there. Tom will take the occasion to make a few prepared remarks, and then we will revert back into the Q&A session. Tom, welcome. Thank you, John. It is good to be here in New York. I will make a brief presentation. I will take about 7 minutes, and then I am happy to take your questions. Before I begin, please note the caution regarding forward-looking statements on slide 2. You will find additional details in the public filings of BMO Financial Group. I will make some brief comments about the bank, highlighting reasons why we think BMO is an attractive investment, and then we can move to the general Q&A session. Bank of Montreal is a North American universal bank serving over 12 million customers. We are the eighth-largest bank in North America by assets and the ninth-largest by market cap. Year-to-date, approximately two-thirds of our revenues were generated in Canada and the other third in the U.S. BMO is well-diversified with a retail-focused business mix. We have strong retail businesses in Canada and the U.S. Midwest, with nearly CAD 200 billion of customer deposits and 1,600 branches, 925 in Canada and 650 in the U.S. Retail banking is the largest contributor to total bank net income. Within this segment, commercial banking is a strength. We rank second in commercial loan share in Canada, and in personal banking, we have a lending share of approximately 11%. In the U.S., we have strong deposit market share positions, number 3 in Wisconsin, number 2 in Chicago, and number 3 across our Midwest markets. Our commercial business is strong, and we are well-positioned for a business-led recovery. Our Private Client Group manages and administers total assets of CAD 445 billion. This business provides a broad offering of wealth management and insurance to a range of client segments, from mainstream to ultra-high net worth and institutional clients. Over 75% of the bank's operating group adjusted revenues and income come from these retail businesses. Our fourth business group, BMO Capital Markets, provides products and services to corporate, institutional, and government clients. We operate in Canada as a bulge bracket firm and with a mid-market focus in the U.S. Moving now to a few comments on strategy and areas of focus. We are pleased with the benefits from our acquisition of Marshall & Ilsley a year ago. This expansion of our North American footprint occurred at the right time, at the right price, and in the right place. Integration is progressing, as we noted in our investor day a few months ago, and synergies are expected to be CAD 400 million higher than what we expected at the time that the transaction was announced. We have also been growing our wealth management businesses with a number of individually smaller strategic acquisitions over the past few years. The importance we have placed on giving customers increased advice and confidence has helped us to carve out a distinctive position in the marketplace and is a key to accelerating our profitable growth. Our brand strategy places the customer front and center of what we do. BMO's vision is to be the bank that defines the great customer experience. We also have an ongoing initiative related to improving productivity, and we're targeting productivity on both the revenue and the expense side of the equation. A few examples include using new, smaller format branches which have lower capital investment requirements, lower operating expenses, and higher net promoter scores and faster break-evens, an expanded online banking platform that has received high marks from both customers and analysts, eliminating layers of management between senior management levels and our customers, and automating and leaning out core processes. We're making good progress on this front. In the third quarter, BMO's adjusted expenses declined sequentially, and year-to-date expenses over the first three quarters of the fiscal year increased by a modest 0.9% after adjusting for acquisitions and the impact of a stronger U.S. dollar. Moving to a few comments on our Q3 results. Bank of Montreal had a strong Q3. Net income was CAD 970 million, and adjusted income was CAD 1 billion, up 18% from last year, and adjusted EPS was up 11% to CAD 1.49. Return on equity was 15%, and the capital position is strong with a Basel III common equity ratio of 8.3%. We recently increased BMO's quarterly dividend to CAD 0.72 per share. This increase reflects our strong capital position, confidence in our continued ability to generate sustained earnings growth as well. We also moved our target dividend payout ratio to between 40% and 50%. This change is consistent with our objective of maintaining capital flexibility and also reflects a balanced approach to capital management within a B3 operating environment. Looking quickly at operating group results, personal and commercial banking net income of CAD 453 million was up 5%. There was good loan growth with personal lending up 6.3%, and we had market share gains in all loan and deposit categories. Personal and commercial U.S. adjusted net income was US$143 million, up 37% year-over-year and 4% sequentially. We're seeing good growth in core C&I loans, with volumes up 10% since the beginning of this fiscal year and a good pipeline. Private client group adjusted net income was CAD 115 million, an increase of 8% year-over-year, and BMO Capital Markets delivered good income of CAD 232 million in the quarter, up 3% quarter-over-quarter, showing the benefit of a diversified business mix. We continue to feel good about our business and differentiated levers for growth. There's upside in our U.S. business. We have continuing benefits from our acquired businesses in P&C U.S. and PCG. The acquisition has added significant scale and gives us strong market share positions. We have also invested in our capital market businesses in the U.S. and expect to see stronger returns in this business over the next few years. We have a strength in commercial banking north and south of the border. Our strong commercial banking share provides leverage in a business-led recovery and reduces exposure to consumer deleveraging. We're confident in our ability to perform strongly against peers and the continued success of our large P&C Canada business. We're zeroing in on productivity and are focusing on becoming a more efficient bank. Lastly, we have a strong capital position. With that, I'd be happy to take your questions. Great. Thanks, Tom. I think that, again, I'll be selfish and kick this off. One of the historical knocks, rightfully or wrongfully against BMO had been the lack of growth in Harris, and I know that's a market perception, but the acquisition of M&I really was a very significant game changer. As you're progressing along with the integration of the stage in the game, what's the outlook for additional acquisitions in the U.S. or additional acquisitions in the greater platform? Job one in the U.S. is to finish the integration of M&I. We closed the acquisition last July. We're very pleased with how things are going on the integration side, and performance to date is ahead of our business case. We're happy with the financial results, happy with the business results, and still working hard at completing the acquisition, and we're on track for that. Looking ahead into next year, we want to continue to grow the business, focus firstly on organic growth, and secondly, as we talked about at our investor day, we'll consider smaller bolt-on type acquisitions in the markets that we're in, where we're not number 1 or number 2 or number 3 in the market. Right now, we're number 1 in the Wisconsin market, number 3 in deposit share in the greater Midwest area, number 2 in Chicago. We've got very strong positions, and what we'd like to do through time is to add into the markets where we're smaller. We don't see a need at this point to do another large acquisition like M&I was for us, and we're not really focused on that. We're very happy with the transaction, which basically doubled the size of the U.S. bank, added significant scale to it, and with that, we think will result in stronger returns and a better efficiency ratio in the business. Couldn't be happier with the deal to date, but with the bigger, stronger platform, the focus going forward for the foreseeable future will be on smaller transactions. And then with M&I specifically, it was a positive lift in terms of your expense synergy targets. But my understanding is the systems integration is taking place this month. But looking at M&I specifically, what are the broad levers for growth? I mean, the expense reductions are definitely going to benefit. But where is BMO looking for growth in the various avenues that you have on the U.S. platform? I will talk generally about the U.S. platform, and we do think we have got good opportunity to grow in the U.S. So in the Personal & Commercial banking business in the U.S., we do expect to get a lift on the income side from the cost savings that will come in, and we are ahead of schedule on realizing synergies, and there is more to come once we are finished with the conversion. Second area of focus for growth would be core commercial lending. Both Harris and M&I had a strong mid-market commercial lending business, and we have seen good growth in that business year to date with 10% growth. Pipelines are good. And there is no particular focus for the growth. We are generally covering the mid-market space. Although we have increased our business and asset-based lending and in auto lending, and we are seeing good results there. We have an indirect auto portfolio, which has done very well from a credit risk perspective, and we are increasing the number of firms that we do business with there and think that we will see some upside on the revenue side, although pressure likely on the spread side. And then leveraging some capability that we have built on the technology side, we think we can do more on the treasury management and deposit side for our core commercial clients. And we have got a good technology platform supporting what we call treasury management products, which is basically cash management for our commercial clients. And we are putting energy into helping our customers in that area and think we have got a very competitive offer. And in general, we tend to be stronger on the loan side from a share perspective than the deposit side, and so we are trying to leverage our relationships to get more of the deposit business off of the back of a good lending relationship. On the wealth management side, as we talked about at our investor day in Chicago a little while ago, we are focused, amongst other things, on leveraging the higher net worth and mass affluent customers in our branch banking business by selling them more wealth management products. And both Harris and M&I had good solid wealth capabilities. And we are doing a better job of basically marrying up the wealth products and capabilities that we have got with the customer base that we have on the banking side. And if you look at the segmentation of our customer base in Harris and also, although to a slightly lesser degree, M&I, the customers are of above average affluence. So it's sort of a customer-rich body to look to sell wealth products into. We've been developing some new products, have had very good early success, and we're going to roll out some capabilities that we think will do well across the network. More generally in the U.S., I'd mention our capital market business as well, and we've been investing in our capital market business over the last three or four years in terms of adding people and strengthening the degree of alignment between our origination and research and sales and distribution. We're in a position now where we've got a team in place that we think is a good team. We've strengthened the alignment across the different parts of the organization, and we think that we'll get some upside next year and beyond as we basically see the payoff from the investment that we've made with that coming as a result of the teams having been together for a longer period of time and sort of gelling as teams, and also, hopefully, a bit of a lift in the markets. Are there any questions from the floor? Tom, focusing on loan growth in the U.S. Seems like loan growth is probably ahead of expectations at this point, given what you might have expected a year ago. I guess, A, is that your view as well? B, if it is, does that change the expectations for the U.S. operation over the next 12 months or so? I have a second question. Okay. The loan growth story is a bit of a complicated one in the U.S. because we've got parts of the portfolio that we want to grow and are growing, and we've got parts of the portfolio that we want to run off, and we're running those off. We're pleased with the growth that we've had in the core commercial part of the portfolio. We're up 10% year to date, as I talked about, and feel good about the pipelines and really do think that we've got a strong capability in that part of the portfolio. We're also ahead of where we thought we would be a year ago in that part of the portfolio. We're also ahead of where we thought we'd be in running off some commercial real estate related portfolios. That's kind of a good news, bad news situation. The good news is we wanted to run parts of that portfolio down. We're doing that because we think from a portfolio mix perspective, the M&I portfolio was somewhat overweight commercial real estate, and so we wanted to reduce the percentage. The good news is that we're remixing the portfolio in the way that we want. The bad news is that the runoff has come a little more quickly, and with that, the revenues have been slightly impacted. But overall, we're very pleased with the performance of the portfolio and are expecting basically more of the same. We think we've got a good ability to compete on the commercial side. We're very focused on that. Personal growth is tougher, just given the environment. Feels like we're holding our own, but with consumers de-leveraging, a difficult environment to grow in. On the commercial real estate side, we'll continue to reduce the parts of the portfolio that we want to reduce, although there is a core commercial real estate part of the portfolio that will continue. Separately, you mentioned kind of the market share on the loan and deposit side of things. I'm kind of curious more on the trends in market share in the U.S. here, a year plus into the integration here. Are you gaining share, stabilizing, losing share? Yeah. I'd say it's hard to tell. I quoted market share numbers on the deposit side, and there we've been gaining. We used to be number three in the Chicago market from a share perspective, and we've moved that up to number two, which we're very pleased with, and that reflects good hard work and focus in the business. Harder to get reliable loan share numbers that I can speak to. I've not seen those for our business. I'd say we feel good about the portfolio, feel good about the growth, but can't quote hard share numbers for you. Yeah. Following up on that question about market share. I thought M&I was the number one deposit market share in Wisconsin, and I thought you said number three. Is there some loss of market share in the M&I territory? If I said three, I misspoke. We're number one in the state of Wisconsin, number two in the Chicago market, and number three in the Midwest markets generally where we compete. The number three position includes other states where we're active. Okay. Can you also give us an update on the Phoenix and Florida markets, where M&I had had some issues in commercial real estate, and how you view those markets now? Sure. I will take that in two parts. One, the commercial real estate, and then secondly, the business. On the commercial real estate side, I would say we feel comfortable with the risk. M&I had done a good job working those portfolios down pre-transaction, and we have continued that and took a prudent credit mark at the time that we closed the transaction. In general, the credit experience since we have closed has been positive, and it has been positive generally in the portfolios and in the P&L, which you have seen. There is work to do, but it is progressing. We are ahead of schedule, and we feel very comfortable with the situation. In terms of the business, both of those markets have had tough downturns given what has happened in the economy and in the housing markets. We are giving the businesses time to establish themselves under the Bank of Montreal umbrella and under the BMO Harris brand. We will see how it goes, and we are watching their ability to compete in the local markets. I was just wondering if you could give us some information on the wealth management group, and maybe in response to, do you have a goal for a percent of revenues that you would like that to be or think that that would be a proper level? Anything you can on, obviously, there has been a lot of changeover in integration going on with the managements of the investment teams. Do you have anything that you could talk about for retention of business, new flows that might be coming in there? Along with that same thing is how is the integration of Milwaukee and Chicago coming together and the plans for further integration of those investment groups? Okay. Sure. On the wealth side, the wealth business is now a little under 20% of our total revenue. We are targeting for that business to grow at a faster rate than the bank overall and expect to achieve that through organic growth, where naturally the growth rates in wealth are higher than in banking in this environment, and also through allocating acquisition dollars to the wealth side. We like the business. We do well in it, and we want to continue to grow it. Our wealth business is quite broad-based. In Canada, we have got one of the largest brokerage businesses with about 1,500 brokers across the country. We've got one of the leading direct brokerages, and we've got a large mutual fund business, an ETF business that we started from scratch about three years ago and now has CAD 7 billion in assets under management and has had just tremendous growth and tremendous capture of the new flows into the ETF space in Canada, and private banking. In the U.S., the focus is more private banking and asset management and then dealing with the mass affluent through the M&I and Harris banking businesses, as I've talked about. So like the business, feel good about our ability to compete, and we're doing, we think, a good job, and we'll look for continued growth. In terms of impact of integration, the integration is going well on the wealth side. We've made the kinds of changes that you would expect in the context of an acquisition. Haven't had, that I'm aware of, significant turnover on the asset management side itself. From a flow perspective, have seen sort of a normal kind of a flow pattern in the business. So I'd say we're pleased with the effort that we've had underway to put the businesses together. I think we've got a stronger business as a result, and we aren't seeing any negative consequence from that. Our wealth business is concentrated in North America, but we have, over the last couple of years, bought some businesses outside of North America. We bought an asset manager in Hong Kong a couple of years ago called Lloyd George Asset Management. They manage emerging market equities. We bought a firm called Pyrford, which is based in London three or four years ago. Earlier this year acquired a small private banking business in Hong Kong. The basic idea behind those acquisitions is to try to increase our manufacturing capability and to leverage our distribution. So we've got good wealth distribution flows as a result of our distribution systems in North America, and we're trying to capture some more of the manufacturing margin by rounding out our distribution capabilities through these acquisitions, which aren't significant individually financially. But we've generally been pleased with the results that we're getting from them. Can you comment on the housing market in the Midwest and also in your Canadian markets? Thanks. Sure. In the Midwest, I think we're seeing housing stabilize. We've all seen the housing market data that's been coming out month-to-month. The recovery in the U.S. Midwest hasn't been as sharp as it has in some of the other markets, but it does feel to us like it's bottoming. In some of the Midwest markets, the downturn wasn't as severe. Wisconsin, as an example, it didn't have the highs and it didn't have the lows, and it sort of made its way through the downturn without a whole lot of disruption. The Chicago market sort of was a late entrant into the downturn, but then had an average size downturn, give or take, relative to the rest of the U.S. A little slower recovering than some other markets, but it looks like it's forming a base here, and our expectation is that we're not going to bounce up quickly from where we are, but that we've got a solid base that has been established, and we'll sort of work our way out of it over time. So it's feeling better than it has for some time. In the Canadian market, the market hasn't had a downturn, as people generally know. House prices have been firm and trending up. The government has taken steps to cool the housing market, which we, as a bank and the industry generally, have been supportive of. Our expectation is that mortgage growth will slow over the next few years relative to what we've had over the last 3-5 years as the market cools. But that we won't have a significant correction in price. From a supply to demand perspective, we think most of the markets are in pretty good supply. So we haven't had a situation in Canada, as far as we can tell, and we've looked at it a lot, where a lot of supply has been built on spec. We think there's pretty good balance between the markets. So absent a very significant downturn in the economy or a significant spike in rates, both of which we think are unlikely, we think we're into a situation where prices will stabilize. We think that's a good thing for the market, and activity levels will decrease somewhat, which we also think will be a good thing for the market, and credit will be fine. So if credit theoretically is going to be fine in Canada, even if you do have a bit of a downturn here, I would suspect that there would be a negative impact on the top line, just from a— if prices go down, essentially mortgage production could grind to a halt, and you actually have negative growth in mortgages, so lose out on some net interest income there. What levers does BMO and I guess the industry in general have to pull in that revenue environment on the expense side of things? How quickly can you pull back on expenses to kind of offset that revenue challenged environment? Okay. Our base case expectation on the revenue side is that we'll continue to have sort of a 2%-3% low growth recovery. Rates will stay low, and growth will slow in the mortgage market, but we'll still have some growth. 5%, if we're lucky, growth, maybe a little less in the mortgage market. In that kind of a scenario or the scenario you painted, which would be a more negative scenario, we're focused on productivity. As we see things at Bank of Montreal, independent of whether mortgage growth is 0% or 5%, it's going to be lower than it has been over the last five years. To drive the bottom line, we need to look at productivity. Across our bank, we're looking at expense management and productivity generally, which includes looking for other sources of revenue growth. Across the organization, we're looking at our management layers and what we call spans and layers and looking to make sure that we don't have too many layers of management relative to the businesses that we're running. We're looking at where we've got expenses against the revenue opportunities that we've got and where we've got more expense than we think we need, given the revenue opportunity, we're looking to reduce our expenses. We're looking at what we call our core processes, and between our technology and operations group and our business groups, we've identified 10 big processes in the organization. As an example, our mortgage servicing and onboarding process, which would be a big process in the Canadian business. We've got teams focused on looking at those processes to make them more lean and more automated to reduce costs. We've got a program to roll through those big processes over the next few years. You don't pull that lever in a short period of time, but we're focused on being very deliberate about pulling that process by process over the next couple of years. Expense management is also being used in what we call procurement and real estate. On the real estate side, we're using more smaller branches, which have better economics, and customers like them because they've got higher energy levels and they're sort of a friendlier environment for some people to do business in urban environments. We're looking at increasing the density within our offices using a new format that includes using more remote work site locations. We've got basically shared space for people who are traveling or don't need to be in the office all the time. We've got a program to roll out basically an increase in density in our office tower footprints. We're managing our procured expenses generally in a tighter way. You don't pull any of those levers in a way that results in a big change in a big complicated organization. But we're focused on, I would say, all of those levers in an organized way across the bank, and in a formal kind of a way that we've said to ourselves will be in place as a formal program for a three-year time horizon. We do think that you saw some of the benefits of that in the expense numbers in Q3 and also Q2 with expenses down by a nick quarter-over-quarter and basically flat year-over-year, which we think is good. I haven't looked at this, but I'm going to throw this out because I asked TD this one time, and they didn't have an answer. On your purchase of M&I, obviously M&I had about a 75% RWA prior to their purchase by you. Most Canadian banks I think are around more in the 30%-35% kind of RWA to total assets. TD, after making their purchase in the U.S., didn't have a change in their RWA percentage when you would have thought with that large addition of the U.S. bank would have had a big increase. What has been the impact of M&I's assets on your RWA at your company? Directionally, it would be consistent with the premise behind your question. I don't have the exact numbers. I think at the time we closed the M&I deal, the RWA was about CAD 45 billion, and our total RWA is around CAD 200 billion. The weighting of RWA to assets would have absolutely been higher for M&I than it is for the overall bank. So it would've been an increase in sort of that ratio, but would not have been that significant. It might have moved it by three points or something like that. So not a significant item. We do think through time that there's a lift that we'll get on the M&I RWA, and that's because a portion of the portfolio is higher risk, and that's why we took a big credit mark, and that's why we're working parts of the portfolio off. Those higher risk assets attract a higher risk weighting and a higher than one risk weighting. So through time, we'll reduce those assets, which will provide some RWA relief. It won't be dramatic in any period, but it's a tailwind from an RWA and a capital growth perspective. Tom, following along on that question, BMO has done very well, obviously, in the Basel III pro forma Basel III capital ratio. That's from the internal generation of capital, but as well as management of risk-weighted assets and very prudent trying to reduce where you can. Is there much more room available, or have we seen the rationalization of the RWAs about as far as we can go? I would say we've made that. We've been very happy with the progress that we've had on the capital ratio and with RWA, and there is some upside that remains. After we announced the M&I acquisition, the Basel III fully loaded common equity ratio was 6.6%, and we're now at 8.3%. Very significant increase in the ratio over about five quarters. More significant increase in the ratio than you could extrapolate off of. That's come from good earnings, some reductions in RWA, and some capital management actions that we've taken. Going forward, I would say the big levers for RWA reduction will relate to counterparty credit risk under Basel III. Under the Basel III rules, we have about CAD 12 billion of RWA for counterparty credit risk, and that's reflected in our 8.3% common equity ratio. Through time, that RWA will come down significantly, and it will take time, but we'll work it down as we move some of the derivative business that we do to exchanges and clearing houses. Also, as we increase the amount of collateral that we're holding with counterparties against exposures that we've got. So there's lift in that area that will be meaningful but not dramatic, I would say. Then, on the RWA side, we still do have some higher risk-weighted assets tied to the parts of the loan portfolio that are being worked out, and I talked about that earlier, but there's a source of lift from that that we'll get as well. So we expect the ratio to continue to improve, but the improvement won't be as dramatic as we've seen over the last five quarters. I think we'll wrap up with one final question. In front. I guess just going back to Arizona for a second. Given that housing prices have improved pretty significantly in the Phoenix market specifically, I'm just wondering if the loss content has come in significantly better than you had expected at the outset of the M&I deal. Yeah, I would say the answer to the question is yes. We took a prudent mark initially in December 2010 when we did our due diligence. We refreshed the mark on close in July of 2011. Since closing, the credit performance has been meaningfully better than forecast. In the last two quarters, we've had income of about CAD 118 million pre-tax coming from better performance in the M&I impaired portfolios. There we're basically marking to market the impaired portfolio and good solid contributions to income coming from better performance and people working hard to work out the portfolios. As well on the M&I performing portfolio where the accounting is kind of complicated, but you have to amortize the credit mark, and then you take provisions as they come. We've had positive income coming into the income statement, but not in our adjusted income every quarter since we closed. So we're meaningfully ahead of the game on credit from the time that we closed the transaction and feel very comfortable with the position we're in. Great. Well, Tom, thank you very much.