National Bank Financial Markets 17th Annual Financial Services Conference

Mar 27, 2019

Fowler, Head of North American Personal and Business Banking for BMO Financial Group. Before we begin, I have been asked to tell you that Cameron Fowler's comments today may include forward-looking statements. Actual results could differ materially from forecast, projections, or conclusions in these statements. Listeners can find additional details in the public filings of BMO Financial Group. It was the only one where I have to do the forward-looking statement, so expect Is that right? a lot of forward-looking statements. All right. Some Does that mean I can say whatever I want now? Carte blanche. Plus, you're out of the different area code and all that. How about we kick things off with the big picture progress, I guess, on some of the objectives that you set out at your last Canadian P&C Investor Day. There were a couple big targets, upper tier NIAT growth and sub 45% NIX ratio. How comfortable are you vis-a-vis those targets at this stage? Especially considering the ever-evolving macroeconomic backdrop we're getting. Terrific. Okay. Good morning, everyone. Thanks for having me here. You're welcome. I appreciate the opportunity. We are excited about the business today as we were at Investor Day. Profitable business, 30% ROE. It is 40% of the bank's NIAT. Importantly, this stat surprises people sometimes, 80% of the clients that we have in our wealth business come via the personal and commercial business. We are a well-connected and integrated set of businesses. A number maybe that we are more proud of than others is 160 basis point improvement in our efficiency ratio over the last few years. The Investor Day conversation was about building on those things, as you say, top tier NIAT, we saw that to be 7% or 8%. Continuing with that improvement on the efficiency ratio to getting sub 45 over the next few years, then 1 million new customers in personal and continued double digit on the commercial side, which we have been doing. So far so good. I would say, I think the start to the year was a good one. A few things I would say on the growth on the personal and commercial side is primarily a capacity-based one, where we have been focused on getting more relationship managers into action. We have hired 100 new commercial relationship managers over the last couple of quarters. On the personal side, 100 new advice-based sales folks on the financial planning and mortgage side. We feel really good about the capacity deployment. On the commercial side, as everybody here knows, we are number 2 in the market on the commercial side, with 19+% on loans up to CAD 25 million market share. Our deposit share is a little bit lower. It is closer to 13%. What is interesting as well for the number 2 player in the market, we are not particularly as strong as we should be in the Ontario market, where we are number 4. A lot of that capacity that we have hired in the commercial business has been focused on Ontario and Toronto specifically, where we have been seeing 15%, 20% growth on both deposits and loans. We feel good about the progress so far. Diversification for the commercial business is probably the most important thing that we have going on right now. We have always been strong in CRE, we have always been strong in ag, we have always been strong in Aboriginal banking. We have lots of other number ones, but we have been looking for sectors where we can diversify our lending and get deposits and gain share in Ontario. Those areas have been technology focused, healthcare focused, manufacturing focused, and in all of those, we are seeing good, strong double digit. On balance, I would say since Investor Day when we last spoke, so far so good. Okay. I want to actually, before I move on, a little bit on nuts and bolts, because I hear banks talk about the commercial growth on the loan side and then wanting to get more deposit momentum from their commercial clients. How do you do that? It is easy to lend money, maybe not as much ease to get them to give you the deposits. What is the magic formula there? I do not think there is one. I definitely do not think there is one. I think you often land where you started. By that I mean, we started as a lending bank, first bank in Canada. We were a commercial bank lending to the government, funding the railway, creating the currency. We have always been doing this, and we have not always been asking for the deposit, I would say, from a simplest form. The next most important thing is ensuring that you are creating the platform for deposit growth, which to me is some combination of training, incentive, and technology. For us, we have been focused on the first two, I suppose to be sure, but treasury payments, online banking for business type capabilities that people are able to sell, able to talk to, and they are recognized for doing so. That is probably been the biggest thing for us. We were, I think, 8-ish percent commercial loan growth on the first quarter, and we built momentum through the back half of last year, and I expect we should be able to keep going. I would say our teams believe, and our customers would say that the biggest change in our deposit capability has been the technology. Okay. Margins are always a topic of focus. We had a really nice rebound in late 2017 into 2018, and you are still expecting margins to expand this year, after across the group, what we saw as pretty flat performance. What is behind that outlook for, call it single digit margin expansion over the next three quarters? Yeah. Has it dampened at all recently? No, I would say it's not dampened. We've been flat-ish. We were up one on the year, down one on the quarter. The main driver of being down one on the quarter was prime BA compression, which we didn't see towards the end of last year, didn't expect as much. That stabilization plus the balance growth we're seeing in the categories that we'd like to see it, coupled with historical long-term rate rises flowing through, I think all contribute to an expectation that would be 3% to 5% for the back half of the year, X any rate movement up or down. I guess you're in a bit of a unique situation where you're running off a legacy third-party mortgage book, replacing it with higher margin proprietary mortgages. Is that playing into it as much? That's true. I don't think that's particularly big. I think the bigger driver is commercial loan, commercial deposit, retail deposit, some strength in payments. Those things are bigger than this one because that third party, it's true, we are not originating on the third party side, barely at all. We've got a bit of it in the book, but the mortgage margins aren't particularly large compared to these other ones anyways. Okay. Before I get into the mortgage origination strategy at the time, keeping it with the margin story here. With the five-year pulling back, is there a lag between when mortgages get repriced to reflect a new five-year rate environment, such that you can actually see a bit of a mortgage uplift in that book? Or does that get eaten away on the deposit side? I think both are potentially true, but on the former, it's pretty modest. Okay in terms of the way you feel that. Okay. On the strategy front, though, with mortgages, I understand the decision, was that late 2017 to start running off these third-party mortgages? Have you done anything in advance to gear up the proprietary channels to pivot more in that direction? Or is it just those were running parallel anyways? I'd say they were linked decisions. 8 or 9 years ago, we said, "Look, we like the proprietary channel on home financing. We like it because we can control the brand, we can control the experience, we can focus on getting primary customers, less channel conflict," so we moved away from brokers. And we've been on this path for quite a while. As you say, in 2017-ish, we made a couple of decisions that was linked to our primary customer aspirations, that was linked to capital deployment, et cetera, which was there were a couple of areas of indirect auto that we weren't that happy with, the really long terms and the LTVs that weren't, to us, matching up. We pulled back a little bit there and we said we're going to do a lot less on the third party. We did that because we wanted to deploy capital into areas where it was, A, primary customer, and B, better returns. At the same time, linked, we were investing in growing the proprietary mortgage sales force. Our financial services managers that are in the branches and the mortgage specialists that are the mobile sales force that will meet you anywhere. Those forces were up about 10% last year, and they're up about 10% so far this year. Our view on the main lens on the home finance side is that we consider it to be one of the three anchor products that make real primary customers with deposits and with payments. We are the least exposed to the Canadian housing market, as everyone in the room will know, relative to our peers. That said, it's a really, really important source of primary customers for us. If the markets come down from 6 or 5 and 4 into the 3 zone, it's important to us that we are at or above market, including our proprietary mortgages and the amortizing HELOCs. We look at those together as the same product. That's where we are right now. I expect we'll be a little bit up on the market. A little bit of share is fine, but we're not looking to lead the charge too much there. Okay. Speaking of HELOCs, your book's about CAD 32 billion. Over half of it's the amortizing variety. That's the book. What have the growth dynamics been between the amortizing and the non-amortizing? I suspect the amortizing has been growing faster, but if you can quantify that. Yeah. The book is about CAD 32 billion against 100 odd on the overall result on the mortgage side of the book. The split 57/43, the amortizing's growing at about 7% and the revolve is about negative 3% or negative 4%. To me, that's a really interesting point around consumer behavior linked to your earlier points and some of the things I heard in the prior conversation, later cycle, what's happening, how are consumers behaving? We look at that consumer-driven move to amortizing mortgages as a smart behavioral decision on the consumer's part. You and TD are the only banks that disclose this amortizing component of the HELOC book. It's another bank's embedded in their mortgage book. Do you think the growth dynamics are fairly similar across the industry? That is, amortizing is growing, driving growth of, quote unquote, mortgages? I would guess to the extent that those who have full HELOC product offers and they have both the amortizing and the revolving, that the amortizing would be growing more quickly. Okay. Do you have any expectations on the upcoming mortgage season? Any green shoots that are getting you more optimistic here? I would say there is reason for optimism. There is activity everywhere. We expect moderation in Vancouver and some moderation in Toronto ex condo. Other bits of the country are moving as well. I bet it stays in the three-ish range, though, with maybe a little bit of upside to that in this particular part of the season. The other trend that is going on that everybody will know is the spring mortgage season is a little bit less defined all the time, and that over the last several years, there has been more activity in the autumn and Okay other things. So you are a little less dependent on that sort of 12-week period than in the past. Moving back to the commercial book, I have asked other banks this question, and it is something that has always puzzled me, that we are in a two-ish percent GDP growth environment. Your banks have been delivering double-digit commercial loan growth for a number of years now. How does that make sense? Just from a growth to multiple of GDP. It is something you would see in a Not all banks have No delivering double-digit loan growth. But it's something you'd see in an emerging market, not right It's true. I think it's a hard one to answer. I would say one, at the simplest level, commercial lending business investment's one, but one driver of GDP, not the only one. Consumer spending is like 55% of GDP. Government spending is like 25% of GDP. So there's a lot of other forces at play shaping that, number one. Number two, the macro things that our business customers and others are thinking about, employment, rates, utilization, et cetera, they're all really positive, as is tone right now. So to the extent that you can be diversified across many industries, and to the extent that you have strength in underwriting through cycles, and to the extent that you can demonstrate that you've been with customers through cycles, I think it will continue. Our commercial pipeline is as high now as it has ever been, for example. How long can it last? What is the outlook? It is very difficult to say, but with this geographic and vertical breadth, it is difficult to see a precipitous slowdown, although it is well possible that things do slow down. You have the free pass on forward-looking statements here. Yeah. I will not use it just yet. I may need it later. But digging a bit more specifically into commercial lending, we are asked more questions about CRE in particular. It is the biggest component of the loan book for most banks. So, what is in it? How big is it in relation to the commercial, the C in P&C loan book and what is in it, basically? Okay. The number 2 commercial loan book, where I said at the beginning we're number 1 or number 2 in a bunch of categories. We're probably 3 or 4 on CRE overall. We have great strength in pockets, but overall 3 or 4. It's 8% of the total BMO loan book. 30% of that is REITs. 50% of the 8%, so fully half of it is in the business that I run, Canadian P&C. That represents, I would say, something in the order of 7% of the total loans in my business, and it's probably in early 20s, 21, 22, 23% of total commercial loans in that. Okay. Within the CRE book itself, it's a quarter builder/developer, three-quarters investor-owned. A relatively conservative split, I would say, from that respect. On the builder/developer side, when there's talk of late cycle and when you're monitoring things closely as we do, you're watching Vancouver, you're watching Toronto, you're certainly watching this segment. To give you an example of how well-placed I think we are, of that 25% in the builder/developer, less than CAD 1 million of that is in condos, for example. To the extent that we are in those are pre-sold, very conservative LTVs, and really just a few big names with whom we've worked through time in Vancouver and Toronto, primarily. Stepping back from the whole thing, how do I feel about it? The CRE book for us is growing at about the same rate as the overall book, both in the I think our overall commercial loan growth in Canadian P&C was about 14%, and the CRE book within that is about the same. Is there something like when we The commercial real estate market, it's big. People get worried about it from time to time, has been a source of concern in the U.S. Alternative players that are making it more competitive. That's the U.S. Is there something to be said about Canada being more concentrated within the banks, and therefore, that's a bit of a risk mitigant? I think there is. I think more concentrated within the banks. I am sure it is true of many of the banks, but it certainly is with us. Back to the point about a few very well-established names with whom you have traveled through cycles is, to me, a really important thing. These are not new people that we are doing business with. Okay. As such, we do not find ourselves changing covenants or adjusting the way that we are participating. Credit cards. Are you happy with how your business has been performing? I am. I am happy with our cards business in that it is moving in the right direction and well-positioned. We are about 5% new account growth, and I think we were three-ish on the quarter, three-ish revenue and balances on the quarter. The energy that we have in this business right now in a few areas. First, pretty heavy push on the digital and marketing side. Fully, 40% of our new cards come via digital. We are number 1 or number 2 in all product categories for digital sales. We lead on the card side. That is a really powerful tool for us, coupled with digital marketing. That has gone really well. We have been focused on higher yield, bigger opportunity segments. We have been pushing in particular on small business for reasons obvious, I guess. We have a pretty large small business base. It is an important segment in the Canadian market. It is growing. It's a little safer from an interchange perspective, and so that particular set of products has been growing at about 40%, and I see that to be a much bigger part of things going forward. Then, we lead on the travel rewards card. Our World Elite is the most recognized Visa or Mastercard in the market. That's good. Controlling the experience from a reward and recognition perspective is pretty important. So growing that proprietary rewards program is a really important thing for us for two reasons. Number one, we are, as everybody knows, a very large and important partner of AIR MILES. It's a huge part of our books. Canadian love that product. We did slow down with them a little bit in the last couple of years, in part because of decisions they made around rewards expiry. They've made a couple of adjustments around currency, but those have been very minor and have not had an impact on performance. They're now back to where they were from a performance perspective and from a brand perspective. So that's good for us. But we're very interested in matching that capability with strong performance in the areas that we can control, proprietary rewards and travel, or in the higher margin, small business, and other areas. Things will pick up in 2020 with the- Competition, you mean? Competition will pick up in 2020 with the new Air Canada partnership. We'll be there to participate. The focus on digital, the focus on marketing, the focus on small business, the focus on our own proprietary product are not by accident. It's to prepare. Last time we had one of these moments, 2014, when TD and Aeroplan did their thing, we came out up on the other side of that one, and we intend to compete well again. I used to be, I guess, a bit more critical of growth late cycle. That was in 2014, mind you. But it is still a great business. If you look at the credit metrics, delinquency rates are pretty darn good. Payment rates are kind of moving upwards. It is mind-boggling. Canadians are behaving sensibly, and this will continue to be a growth market. For us, where we have an opportunity to take a little share in a few segments where we have not been as strong, it is tremendous. Okay. Let us wrap up on tech spending. BMO, like many other banks, has quantified how much it spends on technology. Do you think that we are cresting in terms of those numbers, or is it still a double-digit growth category? Is that how you measure? Well, I will wait till you answer. I think the world will benefit from a more nuanced discussion on tech spending. It is such a critical part of what is going on in financial services. It is the driver of any discontinuity that we are seeing on the retail side. It is the driver of any real disruption that you can see on the cost base side. I think right now it is a little bit confusing because people are putting numbers out like 2 or 10 or 9. To me, the bigger question is: what is the rate of technology spend relative to the rest of your spend? For us, we are double digits on the tech side and quite low single digits on everything else. So your cost curves are diverging like that, and I think that is an important thing. The next most important question is: what are you spending it on? Three main buckets, typically. New development, like change the bank type things, number one. Number two, maintenance. Number three, infrastructure, architecture, et cetera. Everybody divides things into those buckets, approximately. For us, on a CAD 2 billion spend, it is roughly a third, a third, a third. But the more important dynamic within that is we have spent the last three or four years quite heavily focused on the last one, on infrastructure and architecture. All the banks have legacy platforms that have taken us this far. You have a decision to make about whether you carry on with those platforms or you replace them. We have moved to a multi-tier architecture, as most leading players in the world will have done, which gives you an abstraction from those systems and allows you to connect very quickly to customer-facing apps or external by just having that services base layer in the middle. That took a while to get done. That is done. The growth now in spend is in the first bucket, in the customer-facing, employee-facing areas, where we are much more quickly able to deploy things because you are not connecting front-end applications to 1,400 apps in the back. You are connecting to one. You are not connecting external vendors, whether it is artificial intelligence or blockchain or specific analytics capabilities or engines that you want to use from external players, fintechs. To all of these systems, you are connecting to one. So it is really important to us that we got that done so that we can move to quicker and cheaper deployment. You said, what do you measure? We measure the compression of deployment, so time to market. Have you moved from inter-year to inter-quarter to inter-day? Getting to the point where you are updating customer-facing digital applications every day or every week is really important, and that is what we do. The other thing that we measure is the cost per unit. Is it coming down? Apart from being faster, is it getting cheaper to deploy? And for us, it is. The final thing I would say is we shouldn't measure just the CAD 2 billion and is it growing faster than the other cost base, and you shouldn't just measure which of the three buckets of spend are getting the most energy. You should do those, but you shouldn't just do that. You should measure what gets deployed for the amount. Because somewhere between what we spend and what someone like JPMorgan Chase spends, there is diminishing returns. And there is not very much energy on that right now. It is right now at a very clumsy, it is a scale game. You need to spend a lot. But nobody knows yet what the difference between the 2 and the 10 is, and I think that to the extent that you can be measuring speed to market cost per unit, growth type measures for your deployment, you are going to be better off. Specifically, do I expect the 2 to recede or the growth rate to recede? I don't have a real ambition for that to happen right now. What I do have an ambition for is the compression of the release cycle and the unit cost so that we are just about to launch a bill pay product. It is an artificial intelligence-based product where anyone in this room can text or email us your bill. That is all you have to do. We will read it. We will use OCR to recognize the numbers. We'll use artificial intelligence to figure out how it relates to you. We'll pick the account. We'll get it paid. That's really useful. We couldn't have done that before, but that's going to be an everyday application for customers that will be life-changing. We wouldn't have been able to do it if we didn't spend time on the architecture first and if we hadn't been able to bring the unit cost down as well. That's kind of a long answer, but that's how I'm thinking about it. Well, that eats up our time here. Cam, I hope you have a good rest of the day, and thanks for coming to Montreal. Thank you. Good luck. Thanks, everyone.