Bank of Montreal F1Q09 (Qtr End 1/31/09) Earnings Call Transcript

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Bank of Montreal (NYSE:BMO)

F1Q09 Earnings Call

March 3, 2009 12:30 pm ET


Viki Lazaris – Senior Vice President of Investor Relations

Bill Downe – President and Chief Executive Officer

Frank Techar – Head of P&C Canada

Russel C. Robertson – Interim Chief Financial Officer

Thomas E. Flynn – Chief Risk Officer, Executive Vice President


Jim Bantis – Credit Suisse

Darko Mihelic – CIBC World Markets

Andre Hardy – RBC Capital Markets

Michael Goldberg – Desjardins Securities

Brad Smith – Blackmont Capital

[Miriam Mandulka] – Genuity Capital Markets

Robert Sedran – National Bank Financial


Good afternoon and welcome to the BMO Financial Group’s first quarter 2009 conference call for March 3, 2009. Your host for today is Viki Lazaris, Senior Vice President of Investor Relations. Ms. Lazaris, please go ahead.

Viki Lazaris

Good afternoon everyone. Thanks for joining us today. We’re in St. John’s, Newfoundland today where we held our AGM this morning. Presenting on the call today are Bill Downe, BMO’s CEO, Russel Robertson, our Chief Financial Officer, and Tom Flynn, our Chief Risk Officer.

The following members of the management team are also here this afternoon to answer questions; Tom Milroy from BMO Capital Markets, Gilles Ouellette from the Private Client Group, Frank Techar, Head of P&C Canada, Ellen Costello from P&C US, and Barry Gilmour, Head of Technology and Operations.

After the presentation, the management team will be available to answer questions from pre-qualified analysts. To give everyone an opportunity to participate we ask that you please ask one or two questions then re-queue. We’re planning to keep the call to one hour.

At this time I would like to caution our listeners by stating the following on behalf of those speaking today. Forward-looking statements may be made during this call and there are risks that actual results could differ materially from forecasts, projections, or conclusions in the forward-looking statements. Certain material factors and assumptions were applied and drawing the conclusion or making the forecasts or projections in these forward-looking statements.

You can find additional information about such material factors and assumptions and the material factors that could cause actual results to so differ in our caution regarding forward-looking statements set out forthwith in our news release from this morning or on the investor relations website.

With that said, I can hand things over to Bill.

Bill Downe

Thank you, Viki and good afternoon everyone. As noted, my comments may include forward-looking statements. For those of you who have already had the chance to review our first quarter numbers, you’ve doubtlessly recognized the contrasting elements in our results.

Clearly the solid performance of our core businesses is not reflected in the Q1 bottom line and income number as reported. Our core businesses are performing very well in today’s recessionary economic environment. In particular, the Canadian retail business continues to make steady quarter-over-quarter progress in meeting its customer service objectives. This progress is driving market share growth and financial performance and is anticipated to be reflected throughout the remainder of the year.

Lower revenues and corporate services coupled with increased PCLs primarily on U.S. real estate muted our first quarter results and the continued strength of our business. In fact, excluding the capital markets environment charges this quarter we earned $1.09 cash per share.

This morning we declared a quarterly dividend of $0.70 unchanged from the first quarter. This represents an annual rate of $2.80 per share. Over 15 years to the end of fiscal 2008 our dividend grew at a compound annual rate of 11.3%.

Some people have suggested that given tough economic times today that the rate of growth was perhaps too quick but few foresaw this economy and hindsight is always informative. Even acknowledging that however, the long-term target payout ratio is just that, long-term.

Current earnings have been impacted by loan losses that have escalated to much higher levels, although still consistent with this stage of the credit cycle. At the same time there have been valuation changes related to the capital market’s environment. But we recognize the strength in our core businesses and their continuing progress.

As I stated to our shareholders this morning, given our strong capital position, core earnings power, and the importance that our shareholders attach to the dividend, in the absence of a more negative outlook for the economy or the bank, we believe it’s appropriate to pay the current dividend.

We’ll be managing levels of capital utilization and expenses aggressively and continue to grow revenue with a view to returning the payout ratio to within the long-term target.

Let’s now turn to the bank’s financial results in slide five. Net income for the first quarter of fiscal 2009 was $225 million compared to $255 in Q1 '08 and $560 in Q4 '08.

In the first quarter we took the view that our priority in this economy was to strengthen our balance sheet and we acted accordingly raising approximately $1.6 billion in tier one capital in the quarter. As a result, our tier one capital ratio at the end of Q1 was 10.2% and our tangible common equity to risk rated assets ratio was 7.8%, among the highest, if not the highest, of the Canadian banks.

This provides a strong measure of confidence in the bank's resilience while also positioning us to take advantage of any opportunities for growth arising in the current environment.

Turning to our operating groups in slide six, P&C Canada reported strong Q1 results both in absolute terms and relative to our peers. Net income was up 12% year-over-year and down 2% versus Q4 '08. Cash productivity was stable at around 56% with positive operating leverage of 3.5% in the quarter. Continued improvement in our net promoter score and objective measure of customer loyalty and market share figures underline the success of our customer focus strategy.

In personal banking, loans increased 21% over Q1 last year with market share up 80 basis points. Deposits rose 3% with market share including term investments up 22 basis points. While mortgage balances were down due to the ongoing runoff of the third party portfolio, balances from proprietary channels increased.

In commercial banking, loan growth was 6% over Q1 last year and market share was up 56 basis points. Deposit growth was over 7%. Cards and payment revenue were up 24% as balance continued to rise due to volume growth and higher Moneris revenues.

We’re continuing to make the bank more visible in the market place. We have a clearly defined and differentiated brand promise centered on helping our customers make sense of their finances and we’re seeing benefits from this.

P&C U.S. generated Q1 net income of $27 million U.S. and we continue to hold our own in a very challenging environment. Significant deposit growth is proof that the Harris name represents stability in the Chicago market. In addition we are seeing new customers refinancing their mortgages at Harris and we look forward to serving these customers more broadly in the future.

We continue to see elevated loan losses in our P&C U.S. business. Market conditions continue to be extremely volatile through the first quarter due to concerns related to the U.S. real estate market and global recessionary pressures. Specific provisions increased approximately $127 million U.S., $162 million Canadian from a year ago, the majority of which is booked in our corporate segment under our expected loss methodology.

If there’s a glimmer of encouragement in all of this, even at these elevated levels we're outperforming our U.S. peers. We continue to view the current environment as a great opportunity for Harris, the natural home for Midwest businesses and individuals, to expand its customer base.

We’ll be opportunistic, we’ll be looking for good business at good price and there’s no rush to make significant acquisitions in this weak economic environment.

Private Client Group’s business was affected in the quarter as we expected by reductions in managed and administered assets. In Q1 net income was $57 million down from both comparative quarters. On a positive note net new client assets are increasing and as expected we are focusing on adjusting spending and resource allocation in the current environment.

In the current quarter we enhanced our wealth management offering by acquiring AIG's Canadian Life Insurance business. Combined with BMO and [Burns] we can now provide clients with both the investment and tax efficient insurance solutions they need.

In capital markets we posted net income of $179 million after $348 million of capital markets environment charges. This compared to a loss in Q1 last year and net income of $290 million in Q4 '08.

We benefited from higher trading revenue as well as strong performance in our interest rate sensitive businesses and higher equity underwriting. This offset softness in M&A and market-to-market losses on merchant banking.

The Q1 results underline the importance of the diversity of this business. Collectively and individually our core businesses are performing well or at least holding their own despite difficult markets. Our job is to manage through these times and position the bank to benefit when the economy emerges from the recession.

In Canada real GDP is now expected to contract 2% in 2009. We remain hopeful, however, that the current downturn will be milder than the last two recessions. We expect the economy to turn up later this year in response to aggressive monetary easing, sizable fiscal stimulus, the weakness of the Canadian dollar, and firming U.S. demand.

From a broad economic perspective, we expect the U.S. economy to continue to contract in 2009. Unemployment is expected to climb another two points. A modest recovery could begin at year end in response to the fed’s zero rate policy, to direct lending programs, the fiscal stimulus package, and more stability in the banking sector. However, we don’t expect a rapid recovery.

As I said this morning at our AGM, just as the economy of the United States has led the world into this correction, the size and the flexibility of its economy will set the pace for recovery in the rest of the world. As a Canadian bank with the majority of our assets based in North America, we’re well positioned to benefit from the recovery as it takes place.

Before I turn to Russ, I want to make it very clear where management’s attention lies today. We’re continuing to insure that our strong customer focus which is winning us business at the front lines remains front and center throughout the organization.

We continue to closely manage risk. We are insuring that everyone understands the importance of managing costs in the current environment, and we're preparing the bank to capitalize on business expansion coming out of this recession as this could represent a once in a decade growth opportunity, and with that I'll turn it over to Russ.

Russel C. Robertson

Thanks Bill, and good afternoon. As some of my comments are forward-looking, please note the caution regarding forward-looking statements on slide one. On slide three you can see the reported first quarter earnings were $225 million or $0.39 per share compared to $0.47 since last year. On a cash basis, earnings were $0.40 per share and our Tier One capital ratio remains strong at 10.21%.

While core businesses perform well in this environment, credit costs remain elevated as expected at this point in the cycle, and lower revenues and corporate services significantly impacted reported results.

On slide four, revenue at $2.4 billion was down 13% quarter over quarter. Strong performance in P&C Canada, and good under lying performance in BMO Capital Markets was offset by Capital Market's environment charges and lowered revenues and corporate services.

Private client group results are also negatively impacted the market conditions reflected in reduced brokerage revenues and mutual fund fees due to weak equity markets.

Year-over-year revenues increased 21% on a reported basis. P&C Canada revenues were up due to volume growth, improved margins, and higher revenue from cards and Moneris. The stronger U.S. dollar increased revenue by $87 million quarter-over-quarter and by $170 million year-over-year.

Net interest income was $1.3 billion in Q1, up $117 million year-over-year driven by volume growth in all of the operating groups. Net interest income is down $82 million from Q4 as lower revenues and corporate services more than off set margin increases in P&C and Capital markets.

The lower corporate revenues we reported this quarter were largely due to the negative carry and asset liability interest rate positions. There was an unprecedented drop in short term interest rates in the last few months as the U.S. and Canadian Central banks dropped their overnight interest rates.

In general our customer variable floating rate loans re-priced based on prime are one month BA in Canada and one month LIBOR in the U.S. Term wholesale funding for our loan book generally re-prices based on the swapped three month BA in Canada and three month LIBOR in the U.S.

This negative carry is expected to continue over the next few quarters, however, given current market conditions, we can see a scenario in the second quarter where corporate revenues will improve approximately $75 million from declining three month BA and LIBOR rates and actions being taken that positively impact our assets and liability positions.

The remaining shortfall in corporate revenues is driven by mark-to-market losses on hedging activities and the cost of prudent actions taken to further enhance our strong liquidity position. I might add that we continue to manage our liquidity position in a prudent fashion, as the majority of our estimated fiscal 2009 funding requirements have now been met.

In addition, our liquidity position remains sound, as reflected by our cash and securities to total asset ratio and level of core deposits. Looking more specifically at margins, total bank margin was down 20 basis points quarter-over-quarter. The decrease is largely attributable to higher funding and liquidity costs as just discussed.

On a group basis in P&C Canada the increase over both comparative quarters was due to higher volumes and more profitable products, favorable prime rates relative to BA rates, and pricing initiatives in light of rising long term funding costs.

As a reminder, we booked interest on tax refunds in the higher mortgage refinancing fees in Q4 last year. Margins and P&C U.S. were up eight basis points year-over-year, and five basis points quarter-over-quarter, mainly due to better deposit spreads.

In capital markets the year-over-year, and quarter-over-quarter improvement is attributable to stronger revenue driven by higher spreads and our interest rate sensitive businesses where we were able to take advantage of market conditions.

Turning to slide six, non-interest revenue was impacted in the quarter by Capital Market's environmental charges in both capital markets and Private Client Group totaling $528 million pre-tax, $359 million after-tax, or $.69 per share. This compares to the prior quarter charge of $45 million pre-tax or $.06 per share.

BMO Capital Market's pre-tax charges total $511 million consisting of three charges. First, a charge of $214 million pre-tax for mark-to-market valuations on counter party credit exposures on derivative contracts, largely as a result of corporate counter party credit spreads widening relative to BMO similar to prior quarters.

Second in charge of $248 million pre-tax is for exposures related to our credit protection vehicle. The decline in fair value was due to the deterioration and credit quality of the under lying portfolios in the quarter and increase in credit spreads given current market conditions.

Realized losses will only be incurred should losses on defaults in the underlying credits exceed the first loss protection of on a tranche.

The final item, a charge of $49 million pre-tax for mark-to-market evaluations on our holdings of non bank sponsored asset backed commercial paper upon completion of the Montreal core on January 21st. They reclassified $14 million loss from other comprehensive income to securities losses, and recorded a further $35 million decline in fair value also against securities losses.

Our $323 million of notes is now carried as estimated fair value of $145 million or $0.45 on the dollar. Our Private Client Group also recorded unrealized charges of $17 million pre-tax related to auction rate securities that were purchased by the bank.

This charge relates to decline in fair value between the time we committed the purchase of securities and the time the securities were actually purchased, obviously, these charges and the lower revenue in corporate, have a negative impact on our productivity ratio.

We do not view the Q1, '09 productivity ratio is indicative of the run rate for the bank. In fact our P&C businesses improved their cash productivity ratios quarter-over-quarter with positive operating leverage.

Turning to slide seven, expenses were up 14% from a year ago. The stronger U.S. dollar and the impact of acquired businesses increased severance costs were two thirds of the increase. The remaining third of the increase was primarily related to higher salaries and benefit costs and higher business development costs.

The quarter-over-quarter increase was 1%. This quarter included a $45 million charge for stock based compensation costs for employees eligible to retire which is booked annually in the first quarter. Excluding this charge and the impact to the stronger U.S. dollar, expenses are down almost 4%.

Expenses in Q1 also include higher severance costs in BMO Capital Markets and higher benefit costs across the groups. We have been active in examining all our costs from discretionary through all of our processes and are looking at ways to streamline the organization.

Our focus is on simplifying our business by looking at our layers of management and any undue complexity, this is consistent with our focus on our customers and we also are targeting taking out unnecessary steps in fulfilling customer needs.

We believe a lot of efficiency can be created through simplification and also by managing attrition.

On slide nine, you'll see that our risk weighted assets were $193 billion, and our Tier One capital ratio was 10.21% for the quarter. Our Tier One capital ratio remains strong increasing 44 basis points over Q4 primarily due to the net capital issuance during the quarter.

We also adopted a new Basel II requirement on November 1, 2008, whereby investments and non consolidated identities and substantial investments excluding insurance subsidiaries are deducted 50% from Tier One capital and 50% from Tier Two capital.

The impact for BMO was minimal reducing Tier One capital by approximately ten basis points. The foregoing capital ratios do not reflect the acquisition of AIG's Canadian insurance business announced in January. This acquisition is expected to reduce Tier One by less than 15 basis points and the total capital ratio by less than 25 basis points.

Approvals are proceeding on course and the acquisition will likely close before June 1st. Increasingly the ratio of tangible common equity to risk weighted assets is becoming the preferred measure of capital adequacy.

Canadian banks have strong tangible common equity to RWA ratios and at 7.8% BMO's ratio is one of the strongest.

To conclude, the reported earnings reflect the difficult conditions in the credit and capital market environments. Our core businesses delivered good revenue growth with a focus on costs management. We are pleased to report our Tier One ratio grew to 10.21% and our balance sheet and liquidity position is strong.

Finally, as highlighted in our press release, we have shown adjusted earnings per share of $1.09 after adding back the capital market's environment charges. I think the $1.09 is a reasonable proxy of core earnings. We anticipate that our negative carry on funding will moderate which will off set any softening in trading revenues.

With that I will turn things over to Tom.

Thomas E. Flynn

Thanks Russ, and good afternoon. Before I begin, I draw your attention to the caution regarding forward looking statements. I'll start with the key risk messages for the quarter.

First, as expected, given the weak economic conditions, loan losses remained elevated in the quarter. We expect this to continue with performance through 2009 and 2010, ultimately depending on how the economy and the housing market in the U.S. perform.

Second, in general our credit portfolios are performing in a solid fashion considering the environment. We have continued to out perform in retail credit and Canadian commercial and corporate portfolios have held up well. As I will talk about later, the U.S. developer book is showing signs of strain given the state of the U.S. housing market.

Lastly, capital market conditions led to some mark-to-market volatility in our results, as Russ has commented on. It is worth noting that our strategies for managing our off balance sheet vehicles remain on track.

I’ll start now on slide three. We provide a breakdown of our loan portfolio as context for the discussion on credit conditions. Note that the U.S. loan book represents less than one-third of the most total loan portfolio. The graph on the right gives the mix of our Canadian loan book. Fifty-seven percent of assets in this portfolio are stable consumer loans. Of this total, 88% is secured. On the commercial side, 94% of advances are secured. Our U.S. portfolio mix is 40% consumer with the commercial and capital market exposures making up the larger portion.

Slide four provides details of our U.S. loan book, which we have shown before. The U.S. consumer portfolio is fairly evenly spread across first mortgages, home equity and auto loans. Each of the portfolios here have experienced a pick-up in loss rates, given the environment, although these are not large in the context of the overall bank. Of the three, the home equity portfolio has shown the most stress. The U.S. commercial real estate portfolio represents a small portion of the total loan book. It is approximately $4.1 billion in total or 2.6% of the total bank loan balance.

Within the sector, developer exposure is $1.3 billion. We continue to actively monitor and manage this part of the portfolio. On slide five, the graph on the left shows that impaired loan formations during the quarter totaled $712 million, a 12% decrease over the last quarter. The geographic and the industry segmentation shows that the majority of formations are from the U.S. and within that, the developer portfolio is experiencing the most strain.

Manufacturing portfolios also have some pressure. We did not have any large single name formations during the first quarter. On the right side, you can see that gross impaired loan balances totaled $2.7 billion at the end of the quarter, with the U.S. representing the majority of this amount. Drilling down, the sector segmentation shows that the largest concentrations are in the commercial real estate sector. Within Canada you can see that the consumer lending segment, which has been fairly stable, continues to be the largest component of the impaired loan balance at 43%.

Manufacturing represents the largest commercial component at 24%. The manufacturing impaired accounts are widely spread across a number of industries. Slide six provides a review of our total provision for credit losses segmented across lines of business. The specific provision for credit loss was $428 million in the quarter, higher than Q4, which was $315 million. The Canadian consumer business showed an increase largely due to a credit card fraud that impacted banks in many different countries, while our Canadian commercial business was stable.

In our U.S. consumer line of business, the provision was slightly lower than last quarter. A U.S. commercial business had an increase in provisions, largely as a result of the developer segment which has been impacted by the state of the U.S. housing market and actions we are taking to manage our exposure in this area.

This quarter’s provision for U.S. commercial is above the anticipated run rate for this segment for the balance of the year. The U.S. capital market segment also had higher provisions with the increase being driven by the commercial real estate and manufacturing sectors. The commercial and corporate provisions this quarter were broadly based rather than concentrated in a small number of accounts.

Turning to slide seven, you can see a segmentation of the provision by geography and sector. Within Canada, the provision was $111 million. The consumer segment continues to be the largest part of that amount. The U.S. provision was $317 million. U.S. commercial exposures to the real estate market and to a lesser degree manufacturing, account for the majority of the U.S. provisions.

On slide eight, we provide a view on our retail credit performance relative to peers in Canada. The key point here is that BMO's consumer loss rates continue to be better than peers. Our losses are the lowest of the peer group across the key products, and for mortgages, where losses are just a few basis points, we are right in line.

On slide nine you will see that in the U.S. it’s a similar story. While losses have increased given the environment, we have a strong position relative to peers. Slide ten provides an update on some topical issues. First, as shown in prior quarters, we have modest exposure to U.S. sub-prime mortgages. This amount is largely unchanged from last quarter, as is the delinquency level.

Second, our U.S. securitization conduit continues to be managed down and credit has performed in line with expectations. Over 90% of the assets are internally rated investment grade. Although there has been some migration within some of the portfolios, we have not brought any pools onto our balance sheet over the last three quarters.

Next on the credit protection vehicle apex, we continue to view the risk of substantial realized loss beyond the mark-to-market charges we have taken to below, given the first loss protection we have, and the quality of vendor line credit portfolio. We provided detailed information on this last quarter and have updated the key information in the chart here. As Russ mentioned, the charges in the quarter reflect a combination of wider credit spreads and credit migration in the portfolios.

Turning to the structured investment vehicles, as you know, we provide senior ranked funding to facilitate the orderly windup of the SIVs. We continue to expect that the subordinate capital notes will protect our senior funding from loss and view the market value of the underlying assets as being impacted by market illiquidity. There’s not been a significant change in the overall situation here during the quarter.

That concludes my presentation and we can now move to the Q & A.

Question-and-Answer Session


(Operator Instructions) The first question is from Andre Hardy – RBC Capital Markets.

Andre Hardy – RBC Capital Markets

The first one is probably for Tom. When I look at your specific allowances relative to gross impaireds, they’re at about 15%, and if we go back a few years, those used to be over 30. So what’s changed in the mix of impaired loans that give you so much confidence that you’ll recover about 85% of what you’ve lent?

Thomas E. Flynn

I’ll give you a bit of a detailed answer to that question. The total allowance for credit loss is sitting at about 65% and that includes the general allowance. And as you know the total allowance ratio trends down during a recession and we’re seeing that again in this recession. Our specific coverage ratio would be around 15%. Our impaired loans, which total about $2.7 billion, include approximately $800 million of corporate and commercial loans where we’ve classified the accounts as impaired, but we do not expect to take a loss. And if you exclude those amounts, the specific coverage ratio would move up to about 20%.

In addition, this quarter and last year we’ve taken significant write-offs against our impaired loans. This quarter we wrote off about $330 million against commercial and corporate loans and in '08 we wrote off $540 million. Write-offs have the effect of reducing the coverage ratio because you write off both the provision that you have and the impaired loan, and so they have a downward effect on the ratio. So I think you need to consider write-offs as you assess adequacy of this specific.

And the last thing I’d say is that we have a very active and I think robust process for arriving at our specific provisions and the allowance. We have a bottom up process where the credit people that are involved in managing our impaired accounts estimate the amount of impairment that we have, and we take the impairment that comes up from that process. It’s a rigorous process. We run through all of the impaired commercial and corporate accounts, at least quarterly, and we’ve got good confidence in the teams of people that we have managing the process. So we’re comfortable that overall the allowance that we have is adequate for the impaired loan balance that we’ve got.

Andre Hardy – RBC Capital Markets

Okay, and would it be fair to say that because more of it is real estate backed there’s more security and you should recover more? Is that part of the equation as well, or am I wrong there?

Thomas E. Flynn

I don’t think that’s a significant portion of the equation. The majority of impaired loans that is real estate related would relate to our U.S. developer book. That book is secured, which is a factor. And we’ve also been active in writing down those balances, which would reduce the coverage ratio.

Andre Hardy – RBC Capital Markets

Okay. And then I just have another one. You know treasury obviously got hurt by what happened in the interest rate environment. Capital markets had a big gain buy the sounds of it that related to interest rates. Were those truly independent events? Or what we’re seeing is immense distortion because of how you allocate interest expenses and revenues?

Thomas E. Flynn

I would say they are, to a large degree, independent events in the capital market business. As has been said, we had a position on that benefitted from the positive slope of the yield curve. And in our corporate area we were negatively impacted by the very significant decline in short term interest rates during the quarter.

To give you some numbers BA is declined by 175 basis points in the quarter, LIBOR by 350 basis points. And those declines really were precipitated by the fall-out from the Lehman collapse. That sharp decline in short term rates had a negative impact on corporate revenue given our asset liability book.


The next question is from Darko Mihelic – CIBC World Markets.

Darko Mihelic – CIBC World Markets

My question relates to Apex and what it revolves around is the continually declining attachment point for tranche one and presumably the similar impact that that’s having on the attachment point for all of the other tranches.

And so it seems as though it creates sort of a bit of a vicious circle that as you have down grades or default activity within one tranche it lowers the attachment point for all of the other tranches.

So I guess what's the worst case scenario we can look at, how low can your attachment point go as a result of deterioration in say tranche one and two and further to that, now that you've actually drawn on the liquidity what would it take to actually have a provision against that liquidity line?

Thomas E. Flynn

I'll take a crack at that, I think the first point to make is that the attachment points for the different tranches are independent. And so we have had a decrease in the attachment point on the weakest tranche as you pointed out but that does not cause any of the other attachment points to decrease, so they are independent events.

The decrease in the quarter reflected deterioration in the portfolio. The way we mark this position to market, the marks are sensitive to the weakest tranches because that is where we have the most risk and so we had a fairly healthy write down this quarter mark down. And that reflected the reduction in the protection on the one tranche that we talked about.

We have funded a portion of the senior funding facility and there's no expectation that we will have any provision against that facility given the first loss protection that's in place and also the other investors who hold senior notes in the vehicle.

Darko Mihelic – CIBC World Markets

Okay so the attachment points that are dropping, those are all, they're independent of one another. Does the fact that perhaps does it have any impact on the detachment point?

Thomas E. Flynn

It – there's no

Darko Mihelic – CIBC World Markets

It should if you're

Thomas E. Flynn

No the attachment points and the detachment points for each tranche are independent of the other tranches. There are some credits that are in both tranches, there isn’t a significant amount of overlap but there is some, so there can be a degree of correlation but they're independent.

Darko Mihelic – CIBC World Markets

So at what stage does the attachment points, I mean for right now you're comfortable with this portfolio and one of the things you continually sight is the fact that you have such great subordination of risk or in other words a high attachment point.

But at what level do you become concerned I mean if these attachment points keep dropping?

Thomas E. Flynn

Well last quarter we provided additional detail on this vehicle and we've summarized it here. And we said that two of the tranches have lower levels of first loss protection and our exposure to those two tranches is $450 million and we have more risk against those two tranches.

The other tranches have first loss protection in excess of 13.5% and we said then and we remain today very confident that we won't have realized losses on those other tranches.

Dark Mihelic – CBC World Markets

So if those other tranches got to 10% would you start to worry?

Thomas E. Flynn

Well higher is clearly better, but the level of corporate defaults that would need to occur given that the majority of this portfolio is an investment grade. In order for us to have realized losses on those tranches that have 13% plus first loss protection, would be beyond loss rates that have been experienced historically so fundamentally we're comfortable with the position that we've got there.


The next question is from Jim Bantis – Credit Suisse.

Jim Bantis – Credit Suisse

When I look on slide six of Bill's opening comments we talk about 21% personal loan growth in the past year and a significant gain in market share of roughly 80 basis points. Maybe Tom or we can talk maybe about, sorry just trying to think of the risk associated with ramping up this loan growth ahead of the deterioration that we've seen in terms of unemployment, bankruptcy, maybe you can give us a little bit of background whether this was secured or unsecured, the nature of the lending in that regard?

Bill Downe

I'm going to start because there is clearly an element of mix in the growth and Frank is going to take over and provide a little more commentary because we have looked carefully at the underlying risk and what we might see as emerging trends from there.

But I think one of the things right off the bat that will turn out to have been to our benefit was exiting the mortgage broker channel in Canada when we did. Our experience in the U.S. was that experience losses were much higher in that channel, we had less visibility of the clients and you have less of the relationship.

So I think that shift will be beneficial to us and at a very high level what we're seeing in terms of delinquencies in Canada while they're certainly a little bit higher than they have been, it's still they're still at levels, even on a relative basis within the Canadian market that we find encouraging and Frank I'll let you expand if you'd like.

Frank Techar

Okay, Jim, just a couple of points, some of which have already been said the percentage of secured loans in our portfolio is 88% and that's been relatively consistent over time. So we're comfortable with the structure of the assets that we're putting on the books.

The other thing I would just say is we have not changed our underwriting standards over this period of time. We have been as you know, focused quite heavily on changing the experience in our branches and changing the offers that we have with our customers and I think that has had an impact on the growth as well.

But clearly the intent over time has been to change the mix in the balance sheet and as Bill mentioned our mortgage growth has not been strong, but we have improved the quality of the assets we believe over time, as a result the focusing on some of these other product categories. And I think you've seen the result of that in the increased margin that was up strongly in this particular quarter.

So we like the quality of the assets that we have, and as Tom showed on one of his other slides we continue to be first in losses in all consumer lending categories and our expectation is that is not going to change as we go through any changes that might occur in the cycle.

Jim Bantis – Credit Suisse

Got it. Thank you. So when I look at the growth number of 21% Frank, it includes the residential mortgages?

Frank Techar

It does not, Jim.

Jim Bantis – Credit Suisse

It does not okay then so when we talk about being 88% secured in terms of the portfolio mix, and this contributing to that ratio, this would include auto loans and other loans that got collateral against it?

Frank Techar

That is correct.

Jim Bantis – Credit Suisse

Got it, okay so I'll follow up a bit offline on it and maybe just and with respect to Tom. You highlighted a credit fraud event that impacted other banks as well as yourself. Could you quantify the amount that it relates to PCLs this quarter?

Thomas E. Flynn

Yes the amount was around $25 million.

Jim Bantis – Credit Suisse

And what was the nature of the breakdown in the risk management system that relates to this event?

Thomas E. Flynn

It was not a breakdown of the risk management system, one of the parties that we do business with, was the victim of a fraud and banks that did business with this third party including ourselves had losses as a result. And so we were on the receiving end of an event that a company we do business with had.

Jim Bantis – Credit Suisse

Understood. Difficult to manage against fraud.


The next question is from Michael Goldberg – Desjardins Securities.

Michael Goldberg – Desjardins Securities

I'd like to get some comparable numbers with fourth quarter impact of asymmetric hedges. First of all, the hedge against your own loan portfolio and secondly, the impact of the lower value of your own issued debt. So the first one was $133 million in the fourth quarter and the second was $89 in the fourth quarter; what are the comparable numbers for the first quarter?

Russel C. Robertson

With respect to the CDFs, the gains of $133 million, the comparable number in Q1 is $48 million. The other one, the 89, I’m not familiar with; where would I

Michael Goldberg – Desjardins Securities

That was the benefit to your earnings of your own issued liabilities going down in value, your HFT liabilities.

Russel C. Robertson

That was $22 million.

Michael Goldberg – Desjardins Securities

And a more general question for Bill. Under what circumstances would you reduce the dividend?

Bill Downe

Michael, I think I was pretty clear this morning in the comments that I made at the annual meeting, and the reason I was as full in my commentary as I know that many of the retail shareholders are so interested in the topic, and it comes back every time to the confidence we have in the core earnings of the bank, and unless we see a big downward change in the trajectory of the economy and that’s always a possibility, or something that related specifically to the bank, I think our comfort level is really defined by the core strength of the earnings.

And really, I mean I think what you’re asking me is to draw a line and I think it would be a very difficult thing to do, in an environment such as the one we’re operating in.

Michael Goldberg – Desjardins Securities

Okay and getting back to the $712 million of gross formations, how much of that would have been secured by hard assets?

Thomas E. Flynn

I don’t have a precise number for you there, but the vast majority of our portfolio, as you know is secured, it would be in excess of 80%, and I have no reason to think that the ratio wouldn’t be similar for the assets that were captured by the formation number.

Michael Goldberg – Desjardins Securities

Can you get back to me on that?

Thomas E. Flynn



The next question is from [Miriam Mandulka] – Genuity Capital Markets.

[Miriam Mandulka] – Genuity Capital Markets

Quick question on Apex as well. I’m beginning to understand, Tom, from – and this is coming from the very good detail you’ve provided us that real, actual losses are still somewhat remote, but it seems to me that the accounting could still get a little bit messy here.

And what I’m getting at is the $815 million, the note, the medium term note, the subordinated one, it’s written down by about 50% right now, so based on what happens to credit spreads, it’s conceivable that that note could, the whole $2.2 billion, could go away at some point, if credit spreads moved high enough.

Could you help me understand what the consequences would be, and again I appreciate it’s more from an accounting perspective, but what the consequences would be to BMO, if that note went away given that BMO has the majority of the senior and it’s actually being drawn now?

Thomas E. Flynn

I’ll try to address that. We are exposed to $815 million of the $2.2 billion of notes that the trust has issued and we’ve also got $1 billion senior funding facility. We take marks on the $815 million. As you know, the marks are a function of credit spreads and the performance of the underlying portfolio, and if credit spreads continue to widen and if there was migration in the portfolio, we would have additional marks, but there wouldn’t be any necessary consequence from that. We would take the marks that it was appropriate to take, we would reduce the carrying value of the notes, but nothing from an accounting perspective would –

[Miriam Mandulka] – Genuity Capital Markets

Could I clarify? If that note is written to zero though, the $2.2 billion, then all that’s left is the senior and BMO has the majority of the senior, so does BMO at that point not have to consolidate the full exposure? Specifically, BMO’s entered into credit default swaps with the swap counter-parties and to offsetting swaps with Apex. Does that entire structure then essentially make it onto BMO’s balance sheet, when you’re just left with the senior notes?

Thomas E. Flynn

I guess a couple of things. The first would be that we wouldn’t expect the notes to go to zero. If they did go to zero, which would be hard to imagine

[Miriam Mandulka] – Genuity Capital Markets

But they’re down by 50%, Tom.

Thomas E. Flynn

Yes. If they did go to zero, we would not consolidate the vehicle because we don’t have the majority of the expected loss because we only hold about 37% of the $2.2 billion in notes that Apex has issued.

[Miriam Mandulka] – Genuity Capital Markets

But that – sorry, the reason I’m struggling with this is that we’ve just assumed that the $2.2 billion is written off to zero, so all that’s left is the senior and BMO has the majority of the senior, so I’m not sure why you would refer to the $2.2 billion, in explaining why this wouldn’t be consolidated if the $2.2 billion has just been written off.

Thomas E. Flynn

If we were taking mark-to-market charges and wrote it down, we would just write down the notes. The accounting is based on the expected realized credit losses, and as we’ve said we don’t expect the realized credit losses to consume the amount of notes that have been issued by Apex.

[Miriam Mandulka] – Genuity Capital Markets

Just sort of a different question. On the PCLs, there’s the increase you’ve shown us, there was, again, very good disclosure there on the presentation where you show the increase in the PCLs, they seem to be tracking that 30 to 89 day bucket that – and, again, this is not something that you provide yourself, more FDIC – the FDIC provides this disclosure, that 30 to 89 day bucket in the U.S. is moving fairly quickly and I guess what I’m getting at is to what extent can we look at that 30 to 89 day bucket which is, I think up to almost $800 million now, is that a decent trend we can look at to gauge how PCLs will emerge in subsequent quarters or does it sort of go into that bucket then come out so it really doesn’t play much of a roll?

Thomas E. Flynn

I think you’d have to look at the relationship over time between that bucket and the actual, specific provisions that we’re taking, and the two would for sure be correlated, but there’s not a direct drive relationship and some of the loans that move into a delinquent status would pay up and go back to a regular performing loan, so I’d say there’s a correlation, but not a hard driving relationship.

[Miriam Mandulka] – Genuity Capital Markets

I’ll stop soon, then. So if there’s a correlation there and if that 30 to 89 day bucket doubles, which is essentially what happened this quarter, does that mean that PCLs could double then because of that increase or youre saying the slope of that relationship is not one essentially; is that what you’re telling me?

Thomas E. Flynn

Yes, the slope would not be one, and on page six of the slides that I used, you can see that our consumer provisions were actually down a little bit this quarter compared to Q4 for the U.S. business, and so I think it’s a fine thing to watch, it will give you a sense of what’s going on in the portfolio and over time, there would be a correlation, but it wouldn’t be approaching one at all.

[Miriam Mandulka] – Genuity Capital Markets

So consumer was down but commercial was up by, what three times; it was about three times higher? That’s the one that’s sort of driving that bucket is what I’m getting at.

Thomas E. Flynn

Okay, I thought it was a retail bucket that you were referring to.

[Miriam Mandulka] – Genuity Capital Markets

No, it’s a commercial bucket.

Thomas E. Flynn

My comments related to there being a correlation but not a driving connection would remain the case. The bulk of that big increase that we had in the commercial business in the U.S. was tied to the developer portfolio and there we’ve got the portfolio being impacted by the state of the housing market and during the quarter, we did a lot of work on managing loans that were either impaired or in need of attention. And that work, I think, resulted in a level of specifics for that category that is higher than what we expect on our run rate basis for the balance of the year.


The next question is from Robert Sedran – National Bank Financial

Robert Sedran – National Bank Financial

Bill, I just wanted to touch on the issue of capital allocation. You mentioned the benefit of hindsight, when I look at the target payout ratio range I know you're above it now, but when earnings growth resumes and let's assume that the world does play out as you're expecting and the payout ratio starts to come down, are you still comfortable that 45 to 55 is an appropriate range for a cyclical industry? Or are you likely to favor something in the 35 to 45 range once the earnings are there and allocate more either to buybacks or acquisitions or something else going forward? You think that 45 to 55 is still the right number?

Bill Downe

Rob, that's such a hypothetical. The range was established at a time when you looked at acquisition values, we were parsing through acquisition candidates going right to the final round and the value gap we saw in so many cases was just too great and the capital of the bank was starting to build faster than we saw reinvestment opportunities. So I think it would depend on the environment and the values that could be realized.

I think – once again this is a hypothetical, but if you were in a hypothetical situation where earnings came back to higher levels, we felt they were good acquisition targets, I think we'd make it clear to the shareholders of our intention to make a change at that time and then operate within it.


The next question is from Brad Smith – Blackmont Capital.

Brad Smith – Blackmont Capital

My question relates to the financial institution's exposures that you have. I noted in the annual report when you published it that you had about $24 billion worth of exposures there and I see again reference to your exposures in your note to shareholders of $18 billion. I was just wondering if I could get a little bit of a breakdown on the $23.8 billion of financial institution exposure in your commercial corporate book, in terms of bank versus non-bank or any other insight that you can provide.

It just seems that it's a rather large amount relative to the overall book and so I just wanted to get some clarification. It's also growing quite rapidly I guess is the thing that has attracted me to that.

Bill Downe

Brad, we have provided a breakout on that in the past and Tom has a chart that he can refer to and just give you a little sense of it.

Brad Smith – Blackmont Capital

Okay great, thanks.

Thomas E. Flynn

A couple of points; the first that I would make is that the funding that we are providing to the SIVs included in the financial institutions bucket as is position that we have in Apex. So if you take those two things out, the total exposure goes from the $24 $25 billion number down to about $17. And almost all of the growth that occurred year-over-year relates to funding the SIVs and to Apex.

So I'll speak off of sort of the reduced $16 $17 billion number, within that I would say number one, that the portfolio is very highly diversified across both sectors and individual names. We don't have any individual names in excess of $400 million and only have two or three that would be in excess of $300 million. Banks would represent around $3 to $4 billion of that, we're well diversified. Eastern European banks have been topical recently and our non-trade related exposure to Eastern European banks would be under $150 million and our total including trade finance where we're secured would be under $400 million so we don't have big exposures there.

We do include our exposures to prime brokerage and hedge fund in this category. They are very small in aggregate, they're under $1 billion and we've not had any issues with those portfolios over the last year and they're managed on what we think is a pretty conservative basis and I think I'd leave it at that. It's a large portfolio but it is highly diversified across industries and individual names.

Brad Smith – Blackmont Capital

Okay and I noted that there was – I'm not sure if you provide this in your quarterly or not, but can you give us any color on the impaireds related to that line item?

Thomas E. Flynn

The impaireds include just a couple of items from memory, we had last year an exposure to a company that was in the business of buying distressed mortgages, and that was classified financial institutions because a bit of an investment company. That amount is down to about $140 million today, 1-4-0 and then we had one small bank exposure that was about $40 million that we put into impaired a quarter or two ago.


Thank you there are no further questions.

Thomas E. Flynn

Okay, since we've gotten through the questions before I turn it back to Viki, I really don't have closing comments that I'd like to make today other than to say I know you have had a full day with two banks releasing and there's been also quite a bit of commentary through the course of the annual meeting.

But please if you have follow ups we'll be around tomorrow and you can circle back there. As I reflect on where we stand and really the – what has transpired over the last 24 months, I take enormous confidence from the strength of the capital base of the bank, the level of liquidity, the flexibility that we have to deal with opportunities and challenges in 2009, and take enormous confidence from the fundamentals of the core operating businesses and with that Viki, I'll turn it over to you to close.

Viki Lazaris

Thank you very much everyone for joining us this afternoon. And if you have any further questions please call the IR team, we'll be around. Thanks a lot have a great day.


Thank you, the conference has now ended. Please disconnect your lines at this time and thank you for your participation.

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