RBC Capital Markets Canadian Bank CEO Conference

Jan 8, 2019

pickups, and then of course, everything that we've got going on domestically. You can see how you get there from a macro conclusion perspective. But the question that's harder to get to is the connect between that and the underlying real economy. One of the great benefits of working at a universal bank is you have a diverse set of meaningful juxtaposition to what we're seeing with our clients in the underlying real economy. So effectively, and the dissection is not this simple, as you all know, but if you look closely at the behavior of the customer in the personal business, in the small business segment, in the commercial business, the environment remains very good. The underlying performance of those companies that we deal with is very good. Credit quality is not being affected to any extent, as we look at it today, and spending patterns continue, and unemployment continues to decline. So there's a real dichotomy in my mind. I would say what I've just said in both Canada and in the U.S. So when I talk to investors, you talk to investors, you start with that comment I made at the beginning of my response, which is, well, the world is slowing down. I think what the markets are having trouble interpreting, understandably so, is, well, is the world slowing down to a dead halt, or is it slowing down to something that is just in fact a little bit slower than it was last year? Our forecast for U.S. GDP growth this year is 2.4%. Is that slower than it was last year? Yeah, it is, but it's also higher than it was in 2017. In fact, it's higher than most years since the global financial crisis. So when we look at the impact of that growth rate on, particularly in our case, in our underlying U.S. commercial business, for example, we're continuing to see good performance there. So there's a real disconnect, you know that. I don't know exactly how it plays out, but you have to be very careful to look at the impact on the different business segments. On the ones that are more impacted, you have to ask yourself a question on sustainability. One of the early impacts might be that interest rates don't rise. Yeah. How important is that to you? Not that important, because we are at a stage in the cycle where we are passing along more of the beta anyway, as you know. We have said that if you look at our Canadian business, for example, and our Canada P&C business, if we had a rising rate environment, if you got a couple of rate increases in this year, we might see 1-2 basis points of NIM expansion per quarter. If we do not, it might be, let us say, zero or one. The impact is there, but I would say it is not that significant because of where we are in the cycle. You touched on commercial growth in the U.S., which is a big topic, and you have had an incredible year last year, in the U.S. bank. Yeah. Tax reform aside, still a very strong year in the U.S. business. Can you talk to what drove that and what your expectations are for 2019, given what we just talked about with respect to rates and the strength of the U.S. economy at 2.4% GDP? In U.S. commercial in particular? Yes, please. Sure. Thank you for putting it in perspective because we indeed did have a good year last year. Our U.S. earnings rose at a rate of about 26% last year, and now we've got 28% of our total bank earnings coming from the U.S. Underneath that, what's driving it, and I think what you're getting at is my view on sustainability in the environment that we're now in. I'm very excited about this business and the performance that we've had in this business, because if you unpack it, many of you have paid close attention to this, others of you may be newer to it. You pointed out tax reform. That 26% growth rate that we had in the U.S. last year, if we strip away tax reform, we're still in the mid to high teens in terms of our pre-PPPT growth. That is a really good story. The question that ought to be answered is why is that happening, and how do we make sure that we continue that into the future? The reason that that's happening is if you consider the business that we have in the U.S., which is not an experiment, it's a real commercial business that produces over CAD 1 billion of NIAT at this stage, and it's growing at the rate that we've just described. We've got our core footprint in the commercial business of six or seven states in the Midwest. Then we've got what we call our national franchises and our expansion. When I dissect and look at the new accounts that we took on last year, almost two-thirds of them are coming outside of the core Midwest footprint. There's a national expansion, as it were, occurring. What does that mean? It means good old-fashioned taking of market share in a really big and important market called the U.S. When I look at the market structure in the U.S. for commercial lending, this is really important. We haven't talked about this a lot before. In commercial lending in the U.S., the Fed data says there's about $4.3 trillion of loans outstanding. When I look at our businesses that are lending into their definition of that market, we have about, use round numbers, $75 billion of loans to that market. So a little less than 2% market share. You look at market structure in the U.S. About 25 banks occupy 50% of the market share, and the other 50% is occupied by hundreds, if not thousands, of banks. Then I say, "Well, where do we stack up in that hierarchy?" Because it is important to have the expertise and the scale and the spend and the ability to get to market, and compete with anybody. We're the seventh largest in that. So you've got the four bulge brackets. You've got JP and Citi and Wells and BofA. I think the other two that are ahead of us are PNC and USB. Everybody else has a lower share of market than we do. Then I ask myself the question, "How do I like that positioning?" I love it, because it's very difficult for those four at the top to continue to grow at the rate that we've been growing. It's very difficult, if you're way down in that hierarchy, to grow because they're not able to take share because they don't have the investment capabilities. So when I look at where we are, it feels to me like a sweet spot. When I look at last year, having outperformed the market in every quarter, it's not because the benefit of tax reform, it's not because we've crawled up the risk curve. The credit quality remains very consistent. The performance remains very good. To my mind, there's no reason that we can't continue to accelerate our relative performance in that market going forward, as we have in the past. Now, if the economy slows down, we'll slow down with it. Sure. The trajectory that we've demonstrated is the result of great bankers taking share, not just riding the sales of an attractive market. Now, some might argue you're taking share by pricing. Let's say credit quality, no change. Can you talk to pricing spreads in the U.S. and the commercial lending? Speak to commercial real estate as well. I think that's something that I often get asked about in terms of your positioning. Right. Yeah. Good question. Pricing is not at the heart of our strategy. If you look at the commercial banking business in the U.S., the heart of the strategy is the relationship business. Sometimes it's passed on over generations. It's a relationship where the banker is the first call on most of the activity that goes with respect to the client. In many cases, it's a bilateral relationship. It's not a market share gain for pricing. The new customer acquisitions, when we dissect it and we look at new customers versus existing customers, we don't see that we're attracting particularly on price. We're attracting on service and professionalism and delivery and the full product shelf that some of those smaller players that I talked about earlier can't get to. You asked about CRE. For us, I don't think CRE is the story. We've got growth in CRE for sure. For us, when we look across our books, Canada, U.S., CRE is less than 25% of the bank. We've been arguably under share in CRE, so there's been a little bit of a catch-up there, but we remain a little bit underweighted relative to the peer set. It hasn't been the core focus of the growth strategy. If you look at the growth strategy, it's across segments. Particularly in the U.S., it's across segments. It's really diversified. My interpretation, it sounds like you're still excited on the U.S. in terms of the commercial side. Touch on the retail side, if you can, on the U.S. business. We're seeing a bit of a turnaround. I hate to use that word, but- Yeah Maybe you can touch on your outlook for 2019 on the retail side. You can use that word. We are seeing a turnaround. In fact, I would say 2018 was a turnaround year for us in the U.S. retail business. We started to emphasize our go-to-market strategy on deposits. In particular, our personal deposits, including the broker channel, were up 9% last year. We have an amazing franchise on the deposit side. We started to think hard about where we want to participate more versus less, as opposed to on versus off, but more versus less on the lending side. I think what you are seeing is more small business, little less on the mortgage side. We are not pushing as hard as we would have there. It is very difficult to compete and have a profitable product in the mortgage and jumbo mortgage. For our clients who are interested, we are there for them, and we will stand by them in that product. You are seeing a bit of a shift in the mix on the lending side, and a really attractive, aggressive push on the deposit side. In the meantime, and you wouldn't have seen the benefits of this yet, we relaunched our online banking platform in the fall of last year. That is in the process of rollout right now, and the early returns on that are really good. When you break it down, the numbers are small in terms of the contribution to the whole, but they are positive, and the turnaround is really attractive to us. Those deposits are really important, by the way, because otherwise I cannot fuel the commercial growth that I talked about Right 2 minutes ago. Let's switch gears and head back to Canada and think about the Canadian business here. We can dive into a bunch of different topics, but let's just start with overall results last year. In 2018, relative to peers, I think your revenues are a bit lighter than peers last year. We typically see Bank of Montreal as really in the Canada P&C space as really being relatively smaller sort of exposures. What are your plans and aspirations for this segment in 2019? Specifically, maybe touch on the mortgage side of the business and then the commercial side. Yeah. I think 2018 was an interesting year for us in the Canadian P&C business. It's a bit of a different story from our U.S. story because we spent 2018 really investing, and you might have heard Cam talk about this yesterday, really investing in the business and making some decisions in terms of how we're going to accelerate, in particular on digital. You see the results now in terms of our digital sales and adoption. They're at or pretty close to the top of the charts in almost every category. The returns do follow after that. You asked about the mortgage business. We don't participate as aggressively as some do, in particular in the broker channel and third party. That's a decision that we made two or three years ago, and we haven't changed our view on that. The margins aren't where we'd like them to be. Unless the economics change, I don't think you'll see a pivot from us in that particular area. But in the personal business overall in Canada, I think you'll see us this year accelerating our ability to take share in that business, in particular because we're investing more heavily, and we have invested in the digital agenda, and now we're also investing more heavily in the frontline agenda. With respect to our frontline staff, our sales, we're hiring aggressively, and we're putting people in place to take advantage of the dual offering and meeting the client anywhere they want to be met. I'm particularly excited about that. All of that leaves behind the market-leading positions that we continue to have in the commercial segment in Canada. We sometimes forget at Bank of Montreal to talk about the commercial segment in Canada, because we talk so much about it in the U.S., and we talk about the personal in Canada. But for a bank of our size to have the number two market share in commercial lending in Canada, and having defended that against a pretty aggressive push by some of our competitors, is also something that we're pretty proud of, and I think that'll continue as well. What is the view on the commercial side in Canada? Again, the question is, it is late cycles. Is now the time to be growing this book aggressively? Or do you refute that and just say, "Look, the economy is strong. We are the number 2 player in commercial in Canada, and it is just drive on and continue with double-digit growth in commercial in Canada. Yeah. I think you have to look at your credit quality. When we look at the credit quality and the debt service ratios, we are not seeing a change in the book. For the time being, I think what might slow us down, Darko, if anything will, it would be that we have a concern on credit quality, and we decide to tap the brakes. At this point, that is not our position. Despite the fact that we have a number 2 market share in the country, there are still areas of opportunity. There are still areas that we are under-penetrated, and those could be, in some cases, geographically. In other cases, it could be in sectors where historically we have not been pushing as hard as others. Technology, healthcare would be examples where we have got real investments, and we are excited about growing in those areas. So at this stage, there is not a change in strategy or our go-to-market thrust, because the market is clearly in demand of the product, and we are doing a good job with it without bending the credit curve. Pricing spreads in that business to- Pretty stable. Pretty stable. Yeah. Pretty stable. Okay. Then maybe just switching gears, because you talked about credit quality just gently there. Last year was the first year under IFRS 9, and here we are today seeing some volatility. Perhaps you are going to get economists lowering forecasts in Q1 and Q2 and going forward. So my initial thought was Stage 1 and Stage 2 losses will have to rise in 2019. What is your view on that? Do you think that starting in Q1, we should see higher provisions for credit losses just simply because of the economic outlook? Or is there something else fundamentally here that we should be thinking about? I think you're going to have a very tricky time sorting out the answer to that question because just being blunt, I think when you have a new accounting policy that takes effect, then it takes effect initially in a benign environment, then you start to see the disclosure in an environment that is, let's say, not so benign relative to the volatility question that we had earlier. I think it's really hard because then you're going to have your clients, Darko, are going to start looking at the performing. I think there's a couple of challenges that will occur. In the case of the IFRS 9 guidance on performing, there's a lot of assumptions that go into what falls into the performing. It could be anything from your assessment of volatility, to credit migration, to probability of recession, to oil. Different institutions might have different inputs, and they might have different weightings. You, I think, will end up with a comparability challenge. That challenge will be rectified over time, I think, because then you have a baseline from every institution, then you assume quarter after quarter after quarter, they use the same judgments. I think you'll be able to look back and decide whether you want to use that as a forward-looking indicator of credit turn. I guess my caution would be, my instinct tells me I would be pretty careful to not use what you'll see in the first quarter from the banks writ large as a forward-looking indicator of credit because it's dropping, unfortunately, at a point in time where the assumptions are so variable, and the assumptions may not be consistent from one place to the other. I would pay attention to it after you've got a few quarters in the book and see if there's variability. I think it'll be pretty hard out of the gate. I would be more comfortable guiding people to continue paying attention to specifics because at the end of the day, you've got accounting policy on performing that is not changing the ultimate outcome of any particular credit. It's an accounting policy. On specifics, you've got specific occurrences, and you know exactly what's going on in the book. On that, I'll take it as an opportunity to remind people, one of the things that I worry a little bit less about than perhaps some, if we are getting later in the credit cycle, is we've done a lot of work on looking at our performance. Over the last 30 plus years, we've had a lower PCL on specifics than all of our peers. In fact, we've averaged about 39 basis points over that period of time, 30 plus years of data relative to a peer average that I think is about 53 or 55. It's true in almost every single year. If we are heading into a more difficult credit cycle in 6 months or 12 months or 18 months from now, and I'm not saying we necessarily are, I feel pretty good about our ability to perform in that environment as well. I wouldn't get too distracted by IFRS 9 performing in the meantime. That does open the door to a follow-on question, which is excellent performance historically. We can't refute that. Function of underwriting mix, perhaps. IFRS 9 does sort of introduce the ability for a management team to create overlays. We can sit back, and we can look at the management team, and we can say, "Aha, bank number one looks like this management team is getting cautious, and bank number two over here isn't looking so cautious going forward into 2019." Is that a fair way to think of it? Should we try and- I can see why you would go there. The short answer is we'll see. I think your forensics would have to be so clear that you would have to be able to juxtapose bank one versus two versus three versus four and say, "What was your process to arrive at this conclusion on volatility, and this conclusion on credit migration, and this conclusion on a recession risk or oil? What was yours, and what was yours? Then how did you weight them one by one, by one, by one?" Is that necessarily an indication that one was taking a more cautious view than another? I actually think it's going to be pretty hard, Darko. I can see why people will focus on it, but I'd be cautious on it because I think it could be more of a distraction than it's worth. Fair enough. Switching gears. Overall, a big theme for the last couple of years, especially with Bank of Montreal, given some restructuring charges, has been efficiency- Yep operating leverage, if you allow that term, as well as technology spend. We saw, actually, it was very interesting last night, the tech demo. Maybe you can touch on tech spending, trying to be efficient going into 2019, and some of the levers you can pull and some of the levers that you can't pull, to help get to your targeted earnings. Yeah, I think we've been really clear on this. We've said that this question is really core to our agenda. You've put the pieces together that matter. For us, the way those pieces add up, we looked at, I'll use your example of 2018. In 2018, we said we were going to increase our tech spend in the range of 10%. We increased it right around 10%. The year prior, by the way, it was about 13%. We did that, and in the meantime, over the course of the last three years, we've been committed to a medium-term target of 2% operating leverage. How do you do that? The way you do that, and by the way, in 2016, we had 2% operating leverage. In 2017, we had 2% operating leverage. We fell a little bit short of that in 2018. But if it weren't for the market movements at the end of the year and some marks in our insurance book, we would've been darn close. We're on the same trajectory going forward, and we've committed our efficiency ratio to get to 58% by the end of 2021. How do you do that when you've increased your tech spend in the way we have, is the cost control everywhere else. If you keep your overall costs, our overall costs grew at a total bank constant currency level around 4% last year, while our tech spend was at 10%. That means everything else was growing around 2%. That's a really important discipline, and in some cases, it's growing a lot higher than 2% because you're making investments. In other places, you have to make choices. As a management team, that's what we're meant to do. That's the playbook going forward. That's not going to change. If we have to make toggles to any of those as we go forward because the environment changes, we'll do that. But in a consistent, constructive environment, that's what we're going to continue to do. Our commitment to shareholders was to get CAD 1 billion of productivity out by the end of our program. We're well on our way to doing that. We're on track, and we'll be giving you updates as we go through the course of this year. It was interesting yesterday at the tech demo, we had Brett here giving us some demonstrations. Then during that, there was an announcement of a financial crimes unit being set up at your bank. Maybe you can touch on that. Sure. Why do we have that, and what are we supposed to think about that? Yeah. Okay. I am actually pretty excited about this. I am excited about financial crimes. The reason I am excited about it is when we look back at what is most people would agree is probably the biggest threat to banks, to our bank, to the industry. If it is not number one, it is number two, if you look at anybody's disclosure. It is the evolution of the cyber threat. If you look at the way financial institutions have been historically set up, we began studying this question in the middle of last year in the summertime. We had a view that we had to understand how the threat was evolving and how the institution was set up in order to capture the threat as it came along. We made a decision that there was a mismatch. I think frankly, there is a bit of a mismatch in the industry, and it will evolve as we go forward. The mismatch is the following. If you consider how the threat evolves and you look at physical security, you look at cybersecurity, and you look at fraud. You are seeing a complete migration where those are conflating from the perspective of the threat actors. So 10 years ago, most fraud, probably 90% of fraud, was not cyber. Somebody figured out a way to get your credit card at the restaurant. Today, 90% of fraud is cyber. Physical security was something that was thought of as just guards and branches. If you look at the world at large, physical security today meets cyber everywhere you go. The fires in California, insurance fraud because people are phishing for your information. People are scoping around North Toronto with devices that can get your key fob out of your kitchen without coming in the door and taking your car and driving away. So physical meets cyber. Cyber meets fraud. Yet when you look at the way the financial institutions are generally set up, you have got fraud over here, you have got physical over here, and you have got cyber somewhere in the middle. What you sometimes also have is internal fraud teams and external fraud teams, as if they are two different things, right? Because most of the time, they are connected. So what we said is, no, there has to be a unit that is combined, and all three of those things are combined. So the core at the center of it is cyber. We said, number one, cyber at the core. Number two, complete integration. So co-location, one team acting together. Number three, world-class leadership. We went out and sought a fellow by the name of Larry Zelvin, who was the Director of Cybersecurity for Citibank and had built the fusion centers for the U.S. government and the White House. He is starting with us on Monday to lead that unit that I have just described. I am pretty excited about it. Nobody should ever stand up and say a financial institution is bulletproof because the threat is a global threat, and it will continue to escalate every day. Our job to protect our customers, that is what this is all about, is protecting our customers and their data, is to make sure that we are responding to that threat with something that is world-class, and that is what we are trying to build. Okay. Fair. That, sort of leads over to the regulator. I am not sure. We rarely hear from OSFI about cyber threats, and we know they are present, we know they are in the background sort of watching over your shoulder, but we would never really know what push or shove OSFI is giving you on the cyber side. One thing we do see from OSFI is the pushing and shoving on the capital side. We saw them increase the buffer by 25 basis points in December. I would just like your thoughts on the buffer, whether or not it changes anything for Bank of Montreal, and when would it change? When, for example, if they changed it again in June, up or down, how does it change the way you approach managing your capital? Okay. Well, first of all, I just want to say that the folks at OSFI do a good job with all of us on cyber. I will say what we announced yesterday was not OSFI induced. It was entirely our initiative, which we are very proud of. On the buffer, look, the short answer, Darko, is I do not see any impact in terms of how we manage the business. The distance between the buffer and how we look at our capital ratios, and then how we look at allocation going forward, whether it be internal, external opportunities in terms of how we invest the capital, for the time being, I would say no impact. I think this is a short story. When does it impact your bank? How do you think you will react when you see OSFI reduce the buffer? If we saw OSFI reduce the buffer, I also would say there'd be no impact because we wouldn't chase them down, right? Just because there's a buffer at a lower level, we make our decisions as to where it's prudent to manage capital based on regulatory guidance, yes, but also where we think we should be allocating capital for shareholders and for clients. I don't think it would make any difference either way. Which leads to the U.S. business, which we get a lot of questions on with respect to. You've got great growth prospects. We talked about it earlier, commercial and retail both turning in the U.S., but often the question goes back to, well, especially given the current market volatility and reduction in valuations, do you look at that as an opportunity to deploy capital in the U.S. and add on to your bank and presence? Yeah. You're asking the M&A question? Absolutely. Okay. In a covert way. Let's just be clear. Yeah, look, I'm sorry I'm going to bore you with the answer. We're always on alert, and we look at opportunities that come in. Valuations have really moved around a lot, right? If you look at the valuations, particularly in the U.S. market, since before the presidential election, we all know what's happened, and now we've seen a bit of a round trip. Valuations are one part of the equation, but the bigger part of the equation has always been, and we've been consistent to say this, has been whether something is on strategy and whether there's a cultural fit and whether we can integrate, and we don't move at all, and we certainly don't move very quickly if something doesn't check all of those boxes. I would say there's nothing imminent at this point. We're always interested in looking at the acquisition file. The acquisitions we've done, we've been very proud of. I wouldn't have undone anything that we've done in the U.S. If you look at the acquisition of Marshall & Ilsley, we doubled our branch plant. We were able to build a commercial franchise outside of the Midwest that I talked about a moment ago. The acquisition of the transportation finance business in Dallas has been a great acquisition for us. Things like that, if they come along, but they really do, I mean it when I say this, I don't mean to bore people, but they really do have to fit those criteria. When and if they do, we'll update you, but in the meantime, we carry on and the majority of the capital's allocated to organic growth. Okay. At this stage, I'm going to turn to some of the questions from the audience. First question that's been voted up is, when should we expect annually or annual restructuring charges to subside? All right. I have to be consistent. I was asked this question at one of your competitors' conferences in the fall. Okay. All right. I will say here what I said then, which is you should expect them to subside, but I will not go so far as to say never again. We have got a lot of work going on right now. We had some catch up relative to our peers. I freely admitted that with respect to our efficiency agenda. We have lagged our peers for too long, and we are investing in that catch up pretty aggressively right now. We may or may not come back for a restructuring charge. If we do, I think we would be pretty close to saying you will not see this happen in a very long time. There is nothing imminent, but if we did, it would be that context. On that, I do not have much more to offer. That is what I have been on the record saying, and that is what I will be consistent with. Let us go to number 2 then. What areas in Canada does BMO feel it can more aggressively grow? Asset management, mortgages, credit cards, et cetera. If you look at the Canadian market, it is difficult to pick an asset class and say you can grow there when you are one of the big four, big five banks, because we all have high shares in almost all products. I would say to you, when we look at the asset management business, as asked in the question that you just asked, we have over a 20% market share in ETFs in Canada. We are going to try our best to grow that, but I cannot say outsized growth relative to our competitors because we are number one in the market. In the commercial business, we are number two in the market. Could we increase our share faster than others in some of our personal lending businesses? I think we could. So that is an area that you could look to. In our traditional wealth management, I think you can look at opportunities there as well because we've got fantastic opportunities. This question was phrased in Canada. If you look at our full service brokerage, if you look at our discount brokerage, if you look at our private banking offerings, then you look at the interlocks between them, you look at the interlocks between them and our commercial bank, what you conclude is they're great businesses. They don't have enough cross-referral, and they don't have enough opportunities as between them, and those teams are starting to work together like never before. I'm pretty excited about that too. I think you'll see us capture some share in Canada there as well. But as we all know, it's pretty hard to have step function share capture in the Canadian businesses when, to be fair to my competitors, everybody's pretty well-equipped. But those would be some places, Darko, that we're leading in. As I think about that question, you've come out with a goal of adding 1 million primary customers. Yeah. Presumably, that would be like checking. Yeah. You would think the deposit side would be an area where Yeah. So that goal, I am glad you recognized it as primary customers. I had somebody else ask me if there were 1 million commercial customers, and I said, "Well, that would be quite something." Yeah, it is on the personal side, and if you think about that 1 million, somebody asked me, they said, "Boy, that seems like an audacious goal." Well, there are about 2 million in play every year, right? Every year in the personal business in Canada. That could be new Canadians, it could be new adults, it could be switchers from bank to bank. We said 1 million over five years, so there is 10 million in play over the course of five years, and we have said we want to capture that. We have got real defined strategies. It is not just a number that we pulled out of the air. We have got our defense community that we are working really hard on. We have got Bank at Work, and we have got new Canadians, and our business in China is a great feeder stock to new Canadians in particular. When we look at the complement of skills where we differentiate relative to the market, what we will find is as we look forward, we look into the medium term. Nothing we are seeing in the markets is changing the way we are managing our businesses. I am excited about the platform. We have really invested over the last two to three years in the platform that we have got, in the talent that we have got, in the technology that we have got. What we talk about at our bank, and we started talking about in the middle of last year, you heard it at our investor day in the fourth quarter, is how do we accelerate that performance in many of our businesses? We are continuing with that as a focus. The market overlay will be something that will have some impact, hopefully short-term, but in the medium to long term, I feel really good about the trajectory of our businesses and the strategy that we have set. It is all about execution, really. It is. There is not a new mousetrap here. It is about really good execution against that asset stack that I have talked about in every one of these meetings. All right. Thank you very much, Darryl, for your participation. Thank you.