Barclays Global Financial Services Conference

Sep 10, 2013

Slides

Okay, ladies and gentlemen, we are kicking off the Canadian content of the Barclays Global Financial Services Conference. Very pleased to have Tom Flynn, who is the Executive Vice President and Chief Financial Officer of Bank of Montreal. I believe this is his second trip to our conference, and we are very pleased to have him. I believe Tom is going to make a brief introductory comment, and then we will open up to Q&A. Thank you, John. It is good to be back at the conference. I have been here, I think at least two times, but maybe more times over the years, and it is good to be back and a good way to kick off the post-Labor Day working season. I will make some presentations. I will be fairly brief, under 10 minutes, just providing, for those of you who are less familiar with BMO, an overview of our company, and then I am happy to take your questions. Before I begin, please note that forward-looking statements may be made during this presentation. Actual results could differ materially from forecast projections or conclusions in these statements. You can find additional details in the public filings of BMO Financial Group and the related caution on Slide 1. Moving now to Slide 2. BMO Financial Group is a diversified North American universal bank. We provide a broad range of retail banking, investment banking, and wealth management products and services to more than 12 million customers. BMO is the second-largest Canadian bank, measured by retail branches in Canada and the U.S. 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 one-third in the U.S. Our U.S. strategic footprint is centered in the U.S. Midwest states of Illinois, Indiana, Wisconsin, Minnesota, Missouri, and Kansas. These states have a total population and GDP greater than Canada as a whole and we think represent a significant opportunity for us. Taken together with our Canadian business, you have one of the biggest contiguous markets on the continent, with more than 74 million people and GDP of about $3.7 trillion. BMO is well-diversified with a retail-focused business mix. Year-to-date, over 75% of adjusted revenues are from personal, commercial, and wealth businesses. We have strong retail businesses in Canada and the U.S. Midwest, with CAD 214 billion of customer deposits and approximately 1,600 branches, 930 in Canada and 630 in the U.S. We benefit from strong deposit share positions in the U.S. Midwest, number two in greater Chicago and number two in Wisconsin. Personal and commercial banking is the largest contributor to total bank income, and within this segment, commercial banking is a proven strength. We rank second in commercial lending share in Canada at 20%. In the U.S., our commercial business is also strong and growing. Our large commercial business positions us well for a business-led economic expansion. Our ambition is to be the leading commercial bank in the Midwest, and with our unique combination of local access to leaders, sector and product expertise, and excellent treasury management services, we think we are well-positioned to do this. Segments of focus include corporate finance, diversified industries, financial institutions, food and consumer, auto dealership, equipment finance, agricultural, and commercial real estate. Building on our advantage market share positions, our commercial businesses are doing very well on both sides of the border, and looking ahead, we expect more growth to come from these businesses. Our wealth management group manages assets of CAD 174 billion and administers an additional CAD 353 billion of assets. This business provides a broad offering of wealth management and insurance products to a range of client segments, from mainstream to ultra-high net worth and institutional clients. We have built a strong wealth franchise with top-tier wealth positions across our five lines of business. I will just roll through quickly what those businesses are for those of you who are less familiar with them. Firstly, BMO Nesbitt Burns is a leading full-service brokerage business in Canada. BMO InvestorLine is our self-directed investing business. BMO Insurance provides life insurance and some structured insurance as well. BMO Global Asset Management obviously does asset management. Lastly, we have Global Private Banking. Our wealth businesses contribute roughly 20% of the total bank revenue, and over time, we expect this to be the fastest-growing part of the bank, with many opportunities to grow the business looking ahead. Our fourth business group, BMO Capital Markets, provides a range of products and services to corporate, institutional, and government clients. The business is focused on mid-cap companies while delivering high-quality research, expert M&A advice, and first-rate execution in debt and equity capital markets. We have seen solid earnings growth from this business, a source of diversification in our retail-focused business mix. I will touch on a few highlights quickly from our third quarter. Q3 results were good, with adjusted net income of $1.1 billion, up 12% from last year. Adjusted results adjust for acquisition-related items like integration costs and elements of acquisition loan accounting, as well as certain other non-core items. In Q3, adjusting items were similar in character to prior quarters and netted to just $1 million. My remarks will focus on the adjusted results going forward. EPS was up 13% year-over-year to $1.68, and return on equity was 15.6%. Results reflect good operating group performance, particularly in P&C Canada and PCG, our wealth business. There was good revenue growth, 6% ahead of last year, and expense growth was 5%, reflecting a level of operating investment in our business to position them for continued growth. For the first nine months of the year, earnings of $3.2 billion and EPS of $4.65 were both up 7%, and all operating groups were ahead of last year. Credit performance has been strong through the year as well. Our capital position remains strong at the end of July with a Basel III common equity Tier 1 ratio of 9.6%, the strongest of any of the Canadian banks under a fully loaded adoption of Basel III, which is what we use in Canada. Our ratio is 12% on a Basel III transitional basis. Under our normal course issuer bid, we have repurchased a total of 8 million shares in Q2 and Q3 of this year, and we expect it to continue to be active with the program through Q4. Year to date, we balanced share buybacks with an attractive dividend to provide an effective return of capital to shareholders in excess of 60% of earnings. Looking briefly at operating group results for Q3, P&C Canada had record net income of CAD 500 million, up 8% from a year ago, and strengthening year-to-date earnings to CAD 1.4 billion. Revenue growth in the third quarter was 4%, driven by higher balance and fee volumes, partially offset by lower margins. Loan growth continued to be strong, with total loans up 10% from last year and 3% from Q2. As I noted earlier, our commercial business is delivering. In Q3, loans were up 12% and deposits were up 15%. Similarly, in the U.S., our commercial business remains strong, generating double-digit growth for seven consecutive quarters in our core C&I loan portfolio. Q3 personal and commercial U.S. net income was U.S. 160 million, up 4% year over year. For the first nine months, earnings increased 7% to CAD 520 million. Private Client Group net income was strong at CAD 225 million for Q3, and year to date, earnings increased 44%. Traditional wealth businesses had record results in Q3, with net income up 37%. Insurance results were also up significantly as a result of a CAD 42 million after-tax benefit resulting from higher interest rates in the third quarter. Assets under management were up 11% from last year. BMO Capital Markets net income was CAD 281 million, up 13% year over year, with revenue growth of 8%. Year to date, net income was CAD 867 million, up 23%, with a notable contribution from our U.S. business. Results reflect good execution of our strategies and the benefit of a diversified business mix. To wrap up, we feel good about how our businesses are positioned looking ahead. Against the backdrop of relatively low consumer growth, we have good opportunities for growth across our diversified platform. Our strong commercial banking business north and south of the border positions us well in a business-led recovery. We have good momentum in P&C Canada, which is our largest business. In wealth, we are leveraging a strong franchise and market positions for continued growth. We have upside from an expanded and upgraded U.S. platform, and this is true across our U.S. business, including banking, Capital Markets, and wealth management. From an operational perspective, we are focused on efficiency across the bank and on customer experience to help drive revenues. Lastly, as mentioned, our capital position is strong. With that, I would be happy to take your questions. Great. Thanks, Tom. I'll take the opportunity to kick this off. The acquisition of M&I a couple of years back now was probably characterized as truly transformational for the U.S. P&C business in particular. Can you give us an update as to where we stand with the integration of the various businesses between M&I and the legacy Harris? Essentially, what milestones should we be looking for going forward to see how you continue to evolve the business? Sure. We continue to feel very good about the acquisition that we did. We think we bought at a good time in the cycle, announcing the transaction in December 2010 as we had visibility into the recovery. But asset values were still relatively depressed at the time, and they have improved since. Overall, we're happy with how the transaction has gone, happy with how the businesses have been put together, and very happy with the credit performance, which has resulted in significant recoveries on the mark that we took given the improvement in the economy since we closed. As we sit here today, we're largely done the acquisition integration. We talked about synergies of $400 million. Those are largely recognized to date. There's some incremental upside, but not that significant, and we've talked about 85%-90% of the synergies being in the run rate results that we're recording. With that, we've seen the efficiency ratio in the business drop. At Harris Bank, before the acquisition was done, our efficiency ratio was fairly high. It was 66%, 67%, and we're now running year to date at about 60% in the combined business, which is obviously a much better number. Going forward, we're focusing on a few things. Number 1 is continuing to drive our commercial business, and I talked a lot during my remarks about the commercial business. We're trying to communicate that as a bank, we're strong in commercial and we're overweight commercial, and we think that's a good place to be given that consumers have high leverage and growth is likely to be larger in that part of the business. Our commercial business has been running at mid-double-digit growth rates from a loan portfolio perspective for the last five or six quarters. We think that should continue. The pipelines are good, and so we feel good about that business and we're putting energy into it. The second significant area of growth is on the wealth side. In our banking business, our clients skew above average from a wealth and an income perspective, and we have a good wealth management capability, and we are putting a lot of energy into trying to deliver a full set of products and services to our banking customers by introducing clients who bank with us to people on our wealth management side. We have seen good flows from banking to wealth, and our experience is that when we transition the clients from the one segment to the other, the revenues go up very significantly as we basically cross-sell and sell more wealth management products. That is a big focus going forward. Longer term, and this is beyond next year, we have talked about having an efficiency ratio target for the business in the mid-50s, down from about 60 right now. We continue to want to move that ratio down through time, but it will be through time. From a revenue growth perspective, we have got a couple of factors at play. Firstly, good growth on the commercial side from a volume perspective. Relatively flat balances on the personal side, given some runoff of higher-risk portfolios and also low general consumer credit growth. We do expect through next year continued margin pressure, largely as a result of competition in the commercial space and low margins. When you add that up, revenue growth for next year is likely to be in that segment, pretty modest. We are hoping for a positive revenue growth, but modest next year and then picking up beyond that off of the back, we hope, of higher rates and some relief on the margin side. Tom, I have to apologize because you are the first Canadian bank to present, and given the fact that you were chief risk officer in your previous role at the Bank of Montreal, I have to ask the question about Canadian housing and the outlook. I think that in a previous presentation that you had made with us, you coined the phrase that housing is a revenue issue for the Canadian banks, not a credit issue. Can you expand upon what the house view is on housing and what the outlook is? Sure. I am happy to say that our outlook for housing hasn't changed through this fiscal year, and we have been in the camp of believing that the measures taken by the government primarily, but also the industry to cool the market, would have the desired effect. What we are seeing in the market is a solid market with a firm base on price, but a market that is cooled a bit, and we think that is a healthy thing given the move that it has had up. Recent data is actually showing good volume. The market cooled. It has picked up a little bit from levels that dropped off. I think bigger picture, we have got a market that has supply and demand pretty much in balance. We do not have any meaningful subprime component to the Canadian market, and the Canadian banks don't take risk to mortgages at and above 80% loan-to-value. We do write mortgages above an 80% loan-to-value, but they are insured by a government entity, and we do not do home equity lending above an 80% loan-to-value. From a credit perspective, based on lots of stress testing, we are very comfortable. The comment related to this being a growth issue versus a credit issue, basically tries to say that we have had a market that has had a very good run over a period of time. Low rates have stimulated some activity for sure. Given that, we think that growth is likely to be lower in the mortgage sector over the next three to five years than it has been over the past three to five years. Likely in the 3%, 4%, 5% range, so growing give or take in line with nominal GDP, and that is a lower rate than we have seen, will give rise to somewhat lower revenue growth. But if we get rates starting to move up and we continue to have good performance on the commercial side, we think that is just fine and actually healthy for the market. Are there, unless I keep on continuing, is there any questions from the floor? Can you just expand upon the consumer then? You talked about housing, but just what is the opportunity for growth in the consumer segment in Canada? I guess how do you position that relative to the U.S.? But really, we hear from places like Target who are opening stores in Canada that maybe they are not getting the uptake that they thought they would get. Can you maybe talk about where you see the opportunity in the consumer segment in Canada? Thanks. Sure. On the consumer side, we're expecting lending volume growth for the market overall that's in line with nominal GDP to slightly higher for the overall consumer side. That's down from where it's been. The decrease basically reflects the impact of consumer credit having grown at a decent clip over the last 10 years, and with that, consumer credit growing at a lower rate going forward, which we think is a healthy thing. We see good opportunities for performance in the consumer side, notwithstanding that and relative to that benchmark. For our consumer portfolio year over year, our growth was about 10% in the portfolio year over year. The mortgage business had good growth for us, and we had some innovative product offerings that drove very good volumes. Our market share in mortgage is the lowest of any of our main product market shares, and we're under our natural weight. We've been active in that market given that we're underweight and we've had good success with some innovative products. We're quite focused on the wealth segment in the Canadian market as well, and we do a good job trying to migrate, again, clients in our banking business who have wealth management needs into our wealth management business. We had really good sales of mutual funds in what's called in Canada, the RSP season, which is a government-sponsored savings program that's open for the first few months of the year. Record sales in that program to date, and we're focused generally on wealth products as consumers look to focus more on savings and a little less on credit growth. Lastly, we do expect there to be activity in the credit card part of the market over this year, and that's as a result of a transfer of one loyalty or affinity program from one bank to another bank that we think is going to give rise to a higher than normal level of client movement across different cards. We've had a really good mass-market credit card program with a good mass-market loyalty program, and we've got a good share in that product. We've been underweight in the premium brand card space through time, but we've got a good offering. We plan on taking advantage of the more active state of the market that is going to unfold here over the next few months to try to market a good product into a market that's got some opportunity for us. Tom, in context of the expectation of a slower kind of lending demand, how do you address that in terms of the expense side? BMO has done a very good job in terms of cutting costs. Going forward, if we're going to look out even further, call it 5 years plus, how do you address distribution and what impact does this have for the branch network and how you roll that out? Yeah. It is a good question. I touched on in my remarks how we are focused across the bank on efficiency and productivity. For the last couple of years at our bank, we have had a bank-wide focus on productivity improvement. In the retail banking business, we are focused on a few things. One is just generally trying to move resources from mid and back-office functions to the front lines, and doing that by simplifying our processes so that it is easier to do business internally, and with that, we have got greater capacity to deploy resources to the front lines. More fundamentally, we are going through an exercise of redesigning our large core processes in the bank. As examples of that, we have completed the redesign of our mortgage processing operation in the bank. From the point where a customer walks in and makes an application for a mortgage to where they discharge that mortgage, we have redone the processes that basically process those transactions. With that, we have freed up significant frontline time and we have improved the efficiency of the back-office operations. We are right in the middle of rolling out what we call our commercial lending redesign program, and that program similarly involves the redesign of the commercial lending processing that we have to support that business. We are going to go through a number of other process categories. I would say we are taking a fundamental look at the core processes in the bank and looking to simplify them to make them more lean in a lean methodology sense, and to add technology to them. It actually takes a little time for the benefits of those kinds of programs to show up because these are big processes you need to invest in change and the benefits follow. The full benefit from these changes is not close to being baked into the results at the current time. On the channel side and the technology side, we are investing in mobile and we are investing in alternative and lower-cost ways to serve our customers. We are not shutting branches, so we continue to operate with our branch network, but we are optimizing it by opening branches that are more customized to the local environment. For example, in urban centers, we are opening sort of small, funky, light, airy, open, feel-good kind of branches that generate high traffic and feel like a real retailing experience as opposed to a traditional banking experience, and we have had good results with those. Basically, we are trying to reduce the square footage of the branches we have got given that flows there are not as high as they have been. We are very actively working to have a good mobile capability, which we do have, good online banking capability, and we are sort of promoting with our customers channels that are lower cost to us and generally preferred by them. I would say we are actively sort of on that trend, which is a big one in the industry. Along with that shifting channel preference, generally away from branches, although bricks and mortar will always exist. What is the outlook for the legacy branches? Is their part of your refresh is that to go through and take a look at the old branches and go through and if that is the case, how long a process will that be? Because I can't believe it'll be actually quick. Well, it won't be quick. So you're right on that. We've got about 1,600 branches in North America. The process, I think, will take quite a bit of time to play out. We don't think branches are going to go away, but we think that the way consumers use them will continue to change. Lots of consumers shop online. They talk to different people, but when the rubber hits the road on a personal transaction that they want to do, most people still want to deal with an individual. So you need to have a physical distribution system to do transactions that are important to people at the point that they're ready to transact, and to have a good online capability to help them sort through the issues for themselves and to be on their radar screen. My expectation would be through time, and this is 5 to 10 years, you won't see a big change in the number of branches, but you'll see the square footage come down, and that's what we're focused on doing. It's lowering the square footage where there's costs, and trying to create branches that feel good to customers and are more retail-oriented. We'll introduce those changes in sort of a gradual way through time. I think what we're doing is largely in keeping with what the industry is doing with probably a bit of a larger push on the urban branch design, and we think a significant effort in the online area. You have a question. Do we have a microphone? Sorry. Thank you. Hi, Tom. How are you? Hi, good. If I read the slide right, your BMO Capital Markets business is the second-largest contributor to earnings. Did I get that correct? That is correct. Or was the first half. That's correct. Yeah. So, it's interesting, we're talking about housing and mortgages in the U.S., and this is a big business for you guys. How do you approach it? How do you think about it? How do you try to position it? And given its importance to the earnings of the bank, how does the regulator look at this, especially in the context of your capital? Because if done in a certain way, it can be a more capital-intensive business. Yeah. So I'd say we're happy with the BMO Capital Markets business. You can look at it different ways. It is the second-largest group that we've got, generating about 25% of the bank's income. But the way we think about it, the wholesale business does represent about 25% of the total. And we're happy with having a retail-dominated business mix with a strong BMO Capital Markets business to supplement that. From a growth perspective, we'd like the BMO Capital Markets business to give or take through time, grow in line with the overall bank. And we've worked over the last five to seven years to decrease the weighting that BMO Capital Markets has in the overall business, and we've done that through two things. One, targeting lower organic growth from the BMO Capital Markets business. And then secondly, looking to make acquisitions in other parts of the business. As a result of that, we have grown the business, but it's grown at a lower rate. And given that strategy that we've executed, we're happy to have the business grow from this point forward and maintain about the same relative position in the overall mix that it's got. Most of the growth in the business comes from outside of Canada because we've got strong share positions in Canada. They vary obviously by product, but on average, we're number 2 or number 3 in Canada and have a full service offering. And over the last few years, we've invested in the U.S. business, not from acquisitions, but basically by adding talent and strengthening the alignment between different parts of the firm. So that, for example, we've got good equity research, equity sales and trading and investment banking across different industries. And the U.S. business is a decent size one for us. Its revenues are about CAD 1 billion, and the productivity ratio is still relatively high because we've added people and expenses, and we believe there's a revenue lift that will come. We do think we've got good operating leverage that's inherent in the U.S. business. We've got confidence in the trends in that business. There's sort of disproportionate upside on the U.S. side as we normalize the revenue potential off of the expense base. Then beyond that, we'd expect the business to continue to grow with the overall company and add about 25% of the total from an income and a capital perspective. We don't see ourselves as having any particular pressure from a rating agency or a regulatory perspective. We do think that diversification is a good thing. I guess one add-on, which Tom Milroy, our Head of Capital Markets, would always finish with. The ROE in our capital market business is about 19% year to date, 18%-19%. The bank ROE is 15%-16%. It is a very good business for us, and it has been a fairly stable business through time. Clearly, there's a market element to it and the potential for volatility, but if you look at it through 10 years, it's produced good, stable earnings and a pretty attractive return on equity. Jason, you want to add? Well, we believe we are. Can you talk about mortgage risk weightings? I think one of your competitors had to adjust up their mortgage risk weighting. I am not sure if that was driven by regulators or not, but I believe you are at the top end of the range. I guess it is a concern in the market, so if you could speak to that. Sure. I will say a few things. I guess the first would be that, in general, we are comfortable with our mortgage risk weightings. From time to time, banks make adjustments to the risk weights on all asset categories, and those adjustments occur for a variety of reasons. You update models, you get new data, you have a regulatory review, what have you. I think the general view at our bank and in the market would be that the risk weights are reasonable given the riskiness of the product. We are not expecting, at this stage, any significant upward pressure from a risk weight perspective. When you say, how do you reconcile that to the concern that does exist in places related to Canadian housing, I think the answer falls back to the structure of the Canadian market and the absence of any exposure above the 80% loan-to-value. And- Can you remind us again what the risk weight is? The risk weights have not been disclosed. You can get from our sub pack numbers that get you into a zone, but we haven't given a precise number. For our mortgage portfolio, about 59% of that portfolio is insured, and again, the insurance is backed by the federal government, and the loan-to-value on the uninsured part of the portfolio on average is 59. Just a few additional numbers to reinforce our risk view on the portfolio. Tom, sticking with the regulatory and the capital regime, can you give us some context about what the potential for the leverage ratio means for BMO? Also, what other risks are you looking at from a regulatory perspective coming down the pipeline? In the leverage ratio, we believe we're in good shape. We're above the 3% Basel level. The exact calculation has not been finalized yet, and so we haven't disclosed a number because we don't know how to calculate that number at present. But from what we do know at the present time, we don't expect to have an issue from a leverage ratio perspective. We think our ratio compares well to our competitors in the Canadian market. If you look at an existing OSFI leverage ratio, which is called the asset-to-capital ratio, our ratio is a good one relative to peers. The debate clearly isn't over on the leverage ratio, and different regulators and different jurisdictions have different points of view on it. But from what we can tell to date, we don't think it's going to be a constraint for us. In terms more generally of things that might be coming on the regulatory side, from my perspective, there's just a continuing debate about the whole suite of reforms that have been undertaken as a result of the downturn. Notwithstanding what we see as very significant changes that have been made in the areas of capital and liquidity and risk management, there are still a number of people calling for further strengthening of bank balance sheets. Our hope is that we'll settle into a mode where we're implementing the reforms that have been put forward. With that, we'll end up with a much stronger system than we had before. But clearly, there's still a public debate going on about what different people think is appropriate, and there are open questions as a result of that. I think we have time for one final question. Well lucky you, Tom, I guess it comes from me. After M&I grabbed a whole bunch of headlines, but I think what's fallen underneath the radar screen for a little bit with BMO is you've made some acquisitions on the wealth management side. I was wondering if you could talk to the strategy for wealth management within the U.S., but also what you're doing in other regions, most notably Asia. Yeah. Happy to do that. We feel very good about the performance of our wealth business and the prospects for it. The business doesn't get as much attention as some of our other businesses, but it is significant. It represents about 20% of the bank's revenue. It has been growing nicely. Year to date, our results are up significantly. In the quarter, the core wealth business was up 37%. The business is well run. We've got good share positions, and it's an area that we want to grow going forward. Over the last five years, give or take, we've done a number of acquisitions outside of North America. We've acquired two asset management firms that have an emerging market orientation, one based in Hong Kong and one based in London. The firms are named Pyrford and Lloyd George, and we're very happy with how those acquisitions have gone. With those acquisitions, we basically try to do two things. One, participate in the flows that the companies have had and will have by virtue of their basic business. Secondly, plug their product into our distribution, both retail and institutional. We've got strong distribution on both sides, and we're able to accelerate the asset growth that the companies have as a result of that. We've also been expanding our private banking business in Asia, and earlier this year, bought a private banking business based in Hong Kong and also having operations in Singapore. We want to continue to grow in that part of the world. We're mainly a North American bank, but we are one of, I think it's three North American banks to have a fully incorporated China bank. We've got a full banking operation incorporated in China. We've got a good wealth business there that basically participates in individuals with wealth in Asia looking to diversify how they manage their affairs and often transfer a portion of their wealth into North America. We feel good about the flows. Looking ahead, we want to grow the wealth businesses organically for all of, I think, the obvious reasons. With the work that we've done around M&I, which basically doubled the size of the U.S. banking business, increased its competitiveness in the markets that we're focused in, the wealth area will be more of a focus from an acquisition perspective going forward. Within that, the main focus is on asset management, where we, again, have a good capability, and secondly, private banking or high net worth. Great. Well, Tom, thank you very much for your thoughts. Please join me in thanking Tom for his presentation.