CIBC 18th Annual Eastern Institutional Investor Conference

Sep 25, 2019

Okay. Our next participant is Dan Barclay. He is the Chief Executive Officer of BMO Capital Markets. He has been in that role since, I guess, almost a year now, but he has been with BMO since 2003. Welcome to Montreal, Dan. Great. Thank you, and thanks for having me. I want to start with a bit of a strategic outlook question. You have got a presence in both Canada and the U.S., and I wonder if you can talk to me about the difference between having a presence in Canada and the U.S., and having a North American platform. Sure. When I think about that question Is that microphone on? I'm not sure the microphone's on. Guys, have we got the microphone on? Are we good? Oh, we may be getting a Got to push something? Try turning it on. How's that? That work? Sorry, everybody. People in the room, I think, can hear you. We can maybe Sorry. Set, we're live. That is simple. There we go. I think of that question really around the conversation of client centricity, of putting your client at the center you do. Most of the way, we have organized our businesses around what client needs. If we think about the investment and corporate banking side, we have businesses that need a global aperture, something that you need to think about the world globally. A good example would be energy. What happens in Saudi Arabia greatly impacts what happens in the North American energy business. We are organized globally in energy and in mining. There are other businesses where you do not need a lot of global insight. I will use real estate as a good example. Our real estate teams would be a Canadian team and a U.S. team. They are highly coordinated. They talk to each other, but they do not really, from a client point of view, need to work across the border. They can work domestic. We have other businesses where we do run them North American. Think industrials, think food and ag, those things we run on a North American basis because the inputs and the impacts are cross-border. If we move to the market side of the business, think about equities in this crowd. There are actually different needs in different markets to have product specialists. Canadian equity trading group versus U.S. equity trading group. Are they highly coordinated? Do they know what is going on? Yes, but they do not need to be fully integrated. When I think about that lens overall, we try to manage them as a client need is, and then be specific around that. The other piece that comes out is where do you get your synergies? We try to put in place now the synergies where it makes sense, or the systems where it makes sense to cross that border. If you think about the way, what is a simple one? Some of our electronic trading stuff. What we use, I think people are aware we imported Clearpool into Canada this year. We use that same system in the U.S. It is the foundation of our electronic trading, and it works in both markets. Would you say that the support functions, whether it's operations, whether it's risk and the rest, are North American in nature, or are they similarly you've got a U.S. support function and a Canadian support function? Again, it depends on the marketplace. For a risk point of view, we run all risk globally. It's one team, one structure. Doesn't matter if it's market risk, credit risk, or otherwise. It runs on a global basis because that's really the nature of how we manage that risk stuff. If we think about the finance teams, the finance teams are actually by geography and by legal entity, and so they'd be different. The systems behind them both are global, but the actual people are regional. Do you feel like there's more here that can be done, or are you pretty much where you'd like it? Where we are today, I'd say we're exactly where we want to be on a North Americanization basis. We think of ourselves as North American bank with global reach. That's how I framed it for our teams overall. I think we have the right pieces in place now. I think there's still some synergies both within Capital Markets as well as when others of the bank, and that's really the next leg of our journey there. Okay. Just following on that topic, the idea of corporate culture is one that we don't talk a lot about in the BMO Capital Markets side. But I think especially in today's market, in today's era, we're bank employees as much as anything. How do you think about the connectivity of BMO Capital Markets with the bank itself? Again, I'll come back to a client centricity point. One of the things that's changing today is client expectations of what we deliver. Once upon a time, a long time ago, you could be a single product, single relationship, and that's all that matters. Today, when we think about the client relationships, the way they measure us or the report card they'd use to see if we're delivering good service has changed dramatically. If at one time you could have said the investment bank was just investment bank, then you added the corporate bank, now you've got markets, and now we're moving into wealth or the commercial bank in terms of what we do. In some of our bigger client relationships, what we call our franchise clients, we'll actually have the entire bank delivered for the client. It's particularly pronounced in the private side, but you could have a corporate loan to a public company. You could have the holding company with a loan out of commercial, and then the individual wealth would be managed by wealth. Once upon a time, none of them would talk to each other, and now it's integrated coverage. We talk to them all the time. So that evolution of client expectations has changed a lot, and I can see that continuing on for quite a while. So the evolution in client expectations has changed, but how do you change the delivery model to incent people to do it? Incentives is a tough word, because I think really what we think about is behaviors rather than incentives. We've tried places where you create deep incentives to make behaviors happen, and they may or may not work. They usually come up with answers that you're uncomfortable with at the end. First place is behaviors, right? How do you think? What do you do with client risk? Do you put them at the front of your process? Do you put them at the back? Is it just a P&L conversation? We try to actually work on the behaviors that are culturally set first. Second is organizational structure. Today, if you think about our corporate bank, it used to be in two places. Then we created a merged leadership team, and then we created industry group teams that actually sit inside the industry groups today. They're not separate. They're not a separate product. They're actually part of that coverage effort. Similarly now, if you think about what's a good example, our interface with commercial. Our commercial bank in the U.S. has a substantial presence. It's a great opportunity for Capital Markets. We started off with some overlap. I'll use M&A as my example. We brought a firm called Greene Holcomb Fisher, which was a mid-market M&A specialist, was brought on board entirely to help deepen our relationships with our commercial customers and open up opportunities. That's turned into be a home run. But if you think about it from an organizational point of view, they sit in Capital Markets. Their client base is actually in commercial. That's a good example of where we've organized in a different way to try and drive different outcomes. I was actually going to ask about the cooperation between that part of the bank and the commercial side in the U.S. Does your industry specialization or industry expertise in any way focus on areas that BMO in the commercial side is strong? Are there that level of synergies, or is it just cooperation where you can get it? Inside the investment and corporate banking part of Capital Markets, we're all purely industry focused. We have some regional focus. Think Montreal, we have a great office here, a very powerful franchise. But really, we're focused around industry groups. The commercial bank has both industry specialties and geographic, and they manage to both places. In the places where they managed industry groups, we're almost perfectly aligned now. We don't have exact 100% alignment. We're getting closer and closer. But it is a conversation Dave Casper and I have on a regular basis, is making sure we line up better and better. We do joint pipeline and opportunity meetings together now. If you think about the food and consumer group in Dave's world and the food and consumer group in my world, they meet regularly to review client lists, opportunity sets, and what they could do go forward. Okay. If I have my numbers right, the U.S. franchise is about 50% of the corporate loan book. It's about a third of earnings. Do you see an opportunity to increase the fee generation and just the depth of relationship in the U.S. side, or is that more a difference in the market? I'll answer this question in two different ways. One is when I think about our corporate loan book, think of it as client acquisition. As I said earlier, we talk about this corporate report card or the client report card of the one bank. We work off the universal banking model, and so if you went to a U.S. corporate and said, "All I want from you is M&A services," they would say, "I don't expect that from you. My report card says you're going to show up with a competitive lending product, competitive cash management, as well as a competitive M&A product." That report card drives us into that relationship. That relationship starts really with the loan. In different parts of the bank, the loan is a very profitable thing all by itself. With large corporations, the nature of competition, the profitable relationship has to cover your full product suite. To build the right relationship, you're into a credit relationship, you try to build the ancillary services of treasury, and then you're into underwriting and other higher margin services. But that wallet or that client opportunity set is really where you drive your ROEs and you drive your returns. When I think about the loan book, I think both the corporate loan book as well as the commercial loan book in terms of that opportunity set. It's not really the right way to look at it for now. Is it just a question of it'll take time to deepen it, or is it Yeah, we think about we made a 15-year deep investment in the U.S. in particular. We are now at the place where I think that is a scalable platform. We have achieved critical mass in almost everything we needed to do. It is not full scale in the U.S., that is not what we are trying to be. But it is critical mass now to build those cross relationships and full function relationships. We have the relationships, we have some balance sheet, and we have the product capability. Those pieces go together to drive that return relationship. In my mind, there is still going to be more investment in the U.S., but it is really now less for the amount of margin you will generate than we had in the past. Okay. You are a bank that is not been shy about making tuck-in acquisitions or acquisitions that give you a different capability in the U.S. or in Canada for that matter, in your area. I guess one of the more recent ones was KGS-Alpha. Can you just give us an update on how it is going and maybe remind people exactly what it is that you have done down there? Sure. I used to run the M&A business for a while, so I always dream of acquisitions that come with 100% of what you want. Often what you do is you buy some, and you do not want it all. KGS is one of those very unique things, where we had an MBS, ABS business. It had a top 10 market position in the U.S., and that is all they did. They needed balance sheet, and they needed global reach, and that is what put them in a place where they were attracted to us, and we were attracted to them. It is a great opportunity, though, when we took a look at our U.S. franchise. We have been building it organically for a while. It was improving, but not at a pace we were comfortable with. KGS came for sale. We acquired it, and I think of that as my acceleration strategy. That would have taken us 3, 4, 5 years to build, and we were able to do it really in one step. The performance has been exactly what we would like from it. They are ahead of plan, ahead of our acquisition case. They are getting the balance sheet they need. They are rolling out new products. We are adding market share, and they are getting a global reach. You think about what we are selling in Asia or in Europe that we never sold before because we did not have the expertise to the product. It has turned out well and well ahead of financial projections. Can you talk about the risk in that business? The risk in that business is slightly different than some of our others. One of the things as we went through that acquisition process, taking effectively a new and much broader product suite onto our platform. To get the models right, to get our risk management right, took a little bit of time. But today we have it back where we would expect it to be. Okay. We talked about the corporate book in the U.S. How is it different in the Canadian side in terms of the opportunity and the depth of relationship, I would imagine is probably It's a bit of a different market. Can you compare and contrast for us? I use a conversation around Venn diagrams. If you think about the expertise you have somewhere and the client suite that you would do or could build profiles inside one loop, you take that by different relationships, you take it by different products. The beautiful thing about Canada, with the history, the nature of the relationships, the multiproduct experience, is those Venn diagrams have enormous overlap. When you think about the network effect that goes on inside that set of Venn diagrams or those cascading rings and the Venn being the middle, is exceptional in Canada. So it's that network effect that drives a lot of why we all have exceptional returns and business models here in Canada. In the U.S., you're building those Venn diagrams. When we hired Greene Holcomb, I will use that as an example, what their sweet spot for client set was did not perfectly overlap with commercial. Over time, you machine it so they get to be much more overlap in terms of change in both places and opportunity sets. If you think about our U.S. platform overall, we are in that process today of creating that overlap of that network effect. Sometimes you hear us call that alignment, where we get to better and better alignment. That process takes time, especially when you build someone new. Imagine a new investment banker coming on, joining the platform. He has got a client set that maybe you did not lend money to before, and so you now got to actually extend loans and the rest and build that stacking set of relationships. In the U.S. today, our best relationships are identical to Canada. Our best industry groups are identical to Canada. Same revenue model, same relationship model, same opportunity set. In other places, we do not yet have all that full alignment, and that is what we are now creating. Okay. We have talked today, in a few different instances, about some of the macro uncertainty, whether it is interest rates, whether it is global trade, whether it is political. Your corporate book has been growing rapidly, Yep despite some of that uncertainty. Can you talk a little bit about whether you are seeing any behavior from your clients that might indicate things are set to slow down, just as they become a little more cautious in the environment? Especially on the corporate side, they tend to be more globally aware of what is going on. Then also, whether you are changing your standards or changing your practices at all, considering some of the uncertainty out there right now. When we think about our overall book, I hope people realize at BMO, we're a very conservative organization. We believe in a very big and diversified portfolio, and so don't want to over-leverage any one sector or any one client in any way. Nothing's changed in any of our underwriting standards as we go forward, and we underwrite for a full cycle. So both what we expect and we don't expect. There's literally nothing in our book today where I'm seeing broad credit degradation. In fact, if I looked over the last few years, even though we grew the loan book as fast as we did, we actually were increasing credit quality, particularly in the U.S. And that increasing credit quality was really driving up more into the triple B and investment grade credits, where our book wasn't as robust before. In that growth and experience place, we're not seeing anything. There's a couple places we're watching, of course, oil and gas in Houston in particular. We're watching. We've had some formations there. Nothing that we think is truly deep or challenging for the book, but really it's idiosyncratic with individual companies and an industry that's going to go through some adjustments in the next little while. In terms of demand for credit? We have slowed our demand growth consciously since the first part of the year. Mostly that was really our ability to digest how much can we grow. As I said earlier, as you think about a new client relationship, you extend credit, then you've got to build the rest of the relationship and make it more fulsome. There's just a certain amount of capacity that you can do that on. I think market receptivity, the way we do business in the U.S. is very high. If I wanted to grow the book faster, I could. I'm not nervous about the type of clients. We're not chasing clients. We've got clients who want to do business with a relationship bank. But we've tempered it now so that we can get the benefit of what we've invested in so far. Once we've started to get the full benefits of that, then we're going to re-look at how we want to grow there. You're not really seeing any actions on the part of the customer base to say, "I don't like the way things are looking for the next 12 months. I'm going to delay. I'm going to wait." It's more your decision to slow things down a bit and digest what you've done rather than the customer pulling back? Yeah. If we went to an aggregate, overall U.S. marketplace, there's definitely a slowdown in business investment, and there should be then a slowdown in credit growth and a slowdown in opportunity set. In our place where, if you think about our corporate banking book being 50-odd billion in the U.S. compared to the scale of that marketplace, we're an infinitesimally small player. I don't mean that in a negative way to us, just we're small. When we're growing, we're taking market share, we're growing into a much bigger portfolio. If you think about in a Canadian context, where you're at your market share, and we're all in the spots we're in, then the aggregate market moves become very, very big. When you're a smaller player growing share, which would be the case for all of our Capital Markets businesses, even if market conditions are trending a bit lower, if you're grabbing share, you can actually have an outsized performance. Okay. Just to sort of stay on the lending side for the moment, the leveraged loan market in the U.S. Sure. How do you think about your exposure to that business? I think, and I'll speak only from a Capital Markets point of view. I think people often misunderstand that we're a distributor of risk, not an owner of risk. If you think about a leverage finance transaction coming into the firm, whether that's a leveraged loan or a high yield bond, we underwrite the risk, and then we distribute it, and we don't keep it on our whole book. The aggregate transaction volume we do, I don't have it off my head, but we distribute all of that except for a small piece, which is in LBO, you need a line of credit for a revolver, for short-term liquidity needs. We've got about a $1.7 billion book for that. The average hold size, south of $25 million. That's broadly distributed and diversified both by sector, by credit quality, by region, by industry, and so we look at it as that. On top of it, we actually manage tail risk on that by selling insurance. We've taken the tail off of that book as we go forward. Our history of exposure there is we have very little in terms of historical losses, and we would project go forward based on the nature of that book that we don't anticipate a lot. The misunderstanding is real, by the way, because I think people assume that you are taking on a fair bit Correct of risk in that business. But you're saying this is basically a fee-generating business for you Correct not an accrual book. Yep. Interesting. Okay. Are you seeing anything in that market, even from a fee-generating perspective? It's just going to keep going for a while, or are you seeing signs that things may be slowing down? The overall leveraged loan credit market is probably a little more volatile than other markets. In terms of investor appetite, investor appetite has gotten substantially larger. The business is substantially larger than it was 10 years ago. But it goes through a little more volatility in terms of credit and then appetite. There are periods of indigestion in that market that are probably a little more regular than the equity market or the investment grade market. But they are really small periods as you go through. Okay. Think back to last December, there was a real big pullback in that marketplace. All firms went through that. Today, it is not as robust as it was two, three months ago, but there is no reason it could not be more robust two, three months from now. I want to talk a little bit about technology. The technology spend across the bank, there has got to be a lot of mouths looking to be fed. Yep. A lot of projects going on. There are obviously a lot of needs on the technology side and the BMO Capital Markets organization as well, from a front office perspective and from a risk perspective. How do you think about the importance of technology, and how high a priority is it within the bank to send money to the BMO Capital Markets organization? Sure. The first place is the way we allocate our technology dollars is on a bank-wide basis based on returns. Whenever we look at where we're going to spend what is a fixed resource, we want to do it in the most efficient way we can. Obviously, there's a business balancing to that, and Capital Markets has a number of opportunities for that. I generally think of technology in two things or two ways to think about our technology spend. The first is how do I generate new opportunities, new revenue, new sources of a business? Investing in a good example, Clearpool. Bringing Clearpool to Canada was an investment to create a new revenue line, new revenue opportunity. We also look at it in terms of how do we create cost savings and efficiency. That's really driving out, whether it's manual processes, automation, bots, the whole gamut. Really, I know in Capital Markets, our projects are just as compelling from a return point of view as they are elsewhere in the bank. There's got to be an element of the tech spending, though, that's just a tax on the business, right? You have to spend the money, or can you always have that financial benefit associated with some of these things? There's got to be an element of it, I have to do them, and I'm not really going to get a benefit from them. Yeah. I think for all banks, there's a piece around the regulatory spend, which you could call a tax. Ironically, I think we're starting to think of it as an enablement tool. I'll use a good example. The amount of investment all the banks have made now in AML. Huge investment over the last decade. As we went through that process, what we actually found was you start off with a manual response, you start to automate, you start to build systems, you start to build creativity. People have seen that the bank moved into the cannabis space. The only reason we go into the cannabis space in the place that we went was because the control systems that we built, ironically, for regulatory outcomes, allowed us to have a better insight and risk management system that we could actually execute in that space. It's those two things. If you think about, yes, it was a cost, and it wasn't a productive cost in terms of it doesn't generate new revenue or lower your expenses. You could argue that was a tax. In the end, it turned out because it was a mandatory spend, we created opportunity to do something different later. I think we're seeing more and more of that, where we make those investments into technology to pay somewhere else. AI is a great example. The more we learn about AI and how it applies to our systems, the more newer places we can take it. Some of the AI is in our control environment. Now we can use it in the business opportunity environment. Do you think technology is a potential competitive advantage then in the capital market space? Not just in Canada, but on your global competitors as well. Is it an area where you feel like if you invest properly and smartly, you can actually create advantage? I do believe we can create advantage. I think in our mind, when we think about technology today, think about some of the lenses that we look at. Let's use customer experience. We put out a new research portal that hopefully everyone here has had the joy of using. The investment in that was to make- They don't know about those other research departments. Sorry, Dan. Sorry. Now you went and told them, though. But that was an example that we put investment dollar in to improve the experience. Yeah. I'm sure RBC is doing the same thing in terms of the way it invests in technology. We have other things where we're doing trade processing in a different way, and it's about designing efficiency in the back office, but also changing that client experience. If you think client experience as a journey, you don't often hear that from a capital markets person, right. We usually just talk about the trade. Now we're using the same vocabulary that the retail bank or the commercial bank uses in analyzing our end-to-end processes around client experience, employee experience, how do we work with our vendors, all that's coming together. That's all technology. I swing a little bit on the competitive advantage. I think we do it well, but I also think it's minimum table stakes for all of us today. Okay. I want to talk a little bit about market risk. It feels like you've had some of the lower volatility on your trading line than a number of your peers. Is this an area where you think you can take more risk? We can. The nature of how we think about the risk capital we put up, and that's really what drives those numbers, is we're very focused on client-driven business versus trading business. The dynamic of how and when we put extra capital in or where we lean into the marketplace is really what our clients want to do. Other banks have a different approach to that, right, in terms of how they want to take risk and how they want to generate those trading dollars. We look at risk in the aggregate. What I often say is we have more capacity than we use, and it's typically because we don't see the risk-return opportunity in the marketplace to do so. There will be times in different markets, particularly think like steepening yield curve, where we'll put more risk into the market and make more money. Is it the frontline staff that just doesn't utilize it, or is it you guys sort of pulling it back because you're not comfortable it might get utilized most profitably? I would say it's an overall risk culture at BMO. We have the same dynamics that we've had for a long time. We're a very conservative bank. We run our Capital Markets business conservatively. We like diversification. We like client penetration. When we think about risk management, it's the same thing. Everything on risk decisions we make today is both frontline, it's market risk. We make decisions together. They're not competing factions or anything. Those days are long gone behind us. We put out what we think is the appropriate risk for the market conditions we're in collectively as opposed to one versus the other. Okay. I want to spend a couple of minutes talking about expenses. You've had an interesting year in terms of an aspirational target put out at Investor Day in terms of where you'd like the efficiency ratio to get to. Pretty sizable, I guess you can't call it a restructuring charge because you just booked it through earnings, but a pretty sizable restructuring, I guess. Yep earlier this year. When you think about expenses in this business, how are you progressing towards where you want to get to? Every one of the business units at BMO is driven to deliver operating leverage. Capital Markets the last few years wasn't what it was supposed to be in terms of delivering its share of operating leverage. As we started to think about some of the market conditions you talked about, change, revenue growth rates, what we see out there, we saw the world starting to taper. In that environment, when revenues are starting to flatline or taper a little bit, if you're going to deliver operating leverage, you have to make choices. We made some hard choices around our expenses. Across the business, it wasn't any one business in particular, to kind of right-size that expense base so that we could deliver the operating leverage for the shareholders. I don't often think about efficiency ratio when it comes to a Capital Markets business, simply because I feel like if the marginal NIAT dollar is what I'm looking for, not necessarily an improvement on the expense line, you can get a little too focused on expenses and then run out of revenue pretty fast. Correct. When you think about hiring and personnel and the rest, and maybe if there's a difference in Canada versus the U.S., like is one kind of in stable mode and the other in growth mode? Is one shrinking to feed the other? How do you think about that dynamic? We look at all our businesses in the context of where they sit, so Canada versus U.S. Obviously, our biggest upside's in the U.S. Whenever we think about efficiency ratio, people get trapped often thinking it's an expense ratio. It's not. It's a relative relationship between expenses and revenue, so growth and growth. You just need to have a different trajectory for each. The primary driver for us in the U.S. is market share growth. As we grow more market share in investment and corporate banking, we grow market share in our global markets businesses, we add product densification. We'll have faster revenue growth than we will expense growth. That's the primary driver for us of productivity, and for those that didn't see Investor Day, we're targeting a sub 60% efficiency in Capital Markets. The other piece is making sure the revenue engines don't change. Right? We'll continue to grow the corporate loan book at a measured pace. We're continuing on the hiring plan we have at a measured pace. Really what we think is happening is we made a large set of investments over the last 2, 3 years, and now we're going to reap the benefit of those investments. Okay. Got about 30 seconds left here. You want to have any closing remarks, closing thoughts on the outlook for the business? Sure. As you think about Capital Markets inside the framework of the Bank of Montreal, we're part of the diversification of its earnings stream. We've been a reliable, relatively low volatility earnings stream. We'll continue to keep that. Things to watch from us will be to continue to grab market share, particularly in the U.S. We're also focused on market share in Canada, just it's a different delta in terms of what you can get. And really, you get to hold us accountable for delivering on those promises, so thank you. Excellent. Well, thanks for your insights and thanks for visiting this year. Sure. Thanks for inviting me. I appreciate it.