Bank of Montreal (NYSE:BMO) Barclays 2013 Global Financial Services Conference September 10, 2013 9:00 AM ET
Tom Flynn - EVP and CFO
John Aiken - Barclays Capital
John Aiken - Barclays Capital
Okay. Ladies and gentlemen, we’re kicking up the Canadian contents of the Barclays meeting -- Barclays Global Financial Services Conference, very pleased to have Tom Flynn who is the Executive Vice President and Chief Financial Officer of Bank of Montreal. I believe this is Tom’s second trip to our conference. We’re very pleased to have you. I believe Tom is going to make a couple of brief introductory comments and then we’ll open it to Q&A.
Thank you, John. It’s good to be back at the conference. I've been here, I think at least two times but maybe more times over the years and it’s good to be back in a good way to kick-off the post-Labor Day working season. I'll make some presentations. I’ll be fairly brief under 10 minutes just providing for those of you who are less familiar with BMO and overview of our company and then I’m happy to take your questions.
Before I begin, please note that forward-looking statements may be made during this presentation. Actual results could differ materially from forecasts, projections or conclusions in these statements. You can find additional details in the public filings of BMO Financial Group and the related caution on slide one.
Moving now to slide two. BMO Financial Group has a diversified North American universal bank. We provide a broad range of retail banking, investment banking and wealth management products and services to more than 12 million customers. BMO is the second largest Canadian bank measured by retail branches in Canada and the US. We’re the eighth largest bank in North America by assets and the ninth largest by market cap. Year-to-date approximately two-thirds of our revenues were generated in Canada and one-third in the US.
Our US strategic footprint is centered in the US Midwest states of Illinois, Indiana, Wisconsin, Minnesota, Missouri and Kansas. These states have a total population and GDP greater than Canada as a whole and we think it represents a significant opportunity for us. Taken together with our Canadian business, we have one of the biggest contiguous markets on the continent with more than 74 million people and GDP of about $3.7 trillion.
BMO is well diversified with a retail focused business mix. Year-to-date over 75% of adjusted revenues are from personal, commercial and wealth businesses. We have strong retail businesses in Canada and the US Midwest with 214 billion of customer deposits and approximately 1600 branches, 930 in Canada and 630 in the US. We benefit from strong deposit share positions in the US Midwest, number two in greater Chicago and number two in Wisconsin.
Personal and commercial banking is the largest contributor to total bank income and within this segment, commercial banking is a proven strength. We rank second in commercial lending share in Canada at 20%. In the US, our commercial business is also strong and growing. Our large commercial business positions us well for a business-led economic expansion.
Our ambition is to be the leading commercial bank in the Midwest and with our unique combination of local access to leaders, sector and product expertise and excellent treasury management services, we think we are well-positioned to do this. Segments to focus include corporate finance, diversified industries, financial institutions, food and consumer, auto dealership, equipment finance, agricultural and commercial real estate. Building on our vantage market share positions, our commercial businesses are doing very well in both sides of the border and looking ahead, we expect more growth to come from these businesses.
Our wealth management group manages assets of $174 billion and administers an additional $353 billion of assets. This business provides a broad offering of wealth management and insurance products to a range of client segments from mainstream to ultra-high net worth and institutional clients. We’ve built a strong wealth franchise with top tier wealth positions across our five lines of business and I’ll just roll through quickly what those businesses are for those of you who are less familiar with them.
Firstly, BMO Nesbitt Burns is a leading full-service brokerage business in Canada. BMO InvestorLine is our self-directed investing business. BMO Insurance provides life insurance and some structured insurance as well. BMO Global Asset Management, obviously that’s asset management and lastly, we have global private banking. Our wealth businesses contribute roughly 20% of the total bank revenue and over time we expect this to be the fastest-growing part of the bank with many opportunities to grow the business looking ahead.
Our fourth business group, BMO Capital Markets provides a range of products and services to corporate, institutional and government clients. The business is focused on mid-cap companies while delivering high-quality research, expert M&A advice and [first rate] execution in debt and equity capital markets. We've seen solid earnings growth from this business, a source of diversification in our retail focused business mix.
I’ll touch on a few highlights quickly from our third quarter. Q3 results were good with adjusted net income of $1.1 billion, up 12% from last year. Adjusted results adjust for acquisition-related items, like integration costs and elements of acquisition, loan accounting as well as certain other non-core items. In Q3, adjusting items were similar in character to prior quarters and netted to just $1 million.
My remarks will focus on the adjusted results going forward. EPS was up 13% year-over-year to $1.68 and return on equity was 15.6%. Results were quite good operating group performance, particularly in P&C Canada and PCG, our wealth business. There was good revenue growth 6% ahead of last year and expense growth was 5%, reflecting a level of operating investment in our business to position them for continued growth.
For the first nine months of the year, earnings of $3.2 billion and EPS of $4.65 were both up 7% and all operating groups were ahead of last year. Credit performance has been strong through the year as well. Our capital position remains strong, at the end of July with the Basel III common equity tier 1 ratio of 9.6%, the strongest of any of the Canadian banks under a fully loaded adoption of Basel III, which is what we use in Canada, and our ratio is 12% on a Basel III transitional basis. Under our normal course issuer bid, we've repurchased a total of 8 million shares in Q2 and Q3 of this year, and we expect to continue to be active with the program through Q4. Year to date we balance share buybacks with an attractive dividend to provide an effective return of capital to shareholders in excess of 60% of earnings.
Looking briefly at operating group results for Q3. P&C Canada had record net income of $500 million, up 8% from a year ago and strengthening year-to-date earnings to $1.4 billion. Revenue growth in the third quarter was 4% driven by a higher balance and fee volumes, partially offset by lower margins. Loan growth continued to be strong with total loans up 10% from last year and 3% from Q2. As I noted earlier, our commercial business is delivering. In Q3, loans were up 12%, deposits were up 15%.
Similarly in the US, our commercial business remained strong generating double-digit growth for seventh consecutive quarters in our core C&I loan portfolio. Q3 personal and commercial US net income was US$160 million, up 4% year-over-year. For the first nine months, earnings increased 7% to $520 million. Private client group net income was growing at $225 million for Q3 and year-to-date earnings increased 44%. Traditional wealth businesses had record results in Q3 with net income up 37%. Insurance results were also up significantly as a result of a $42 million after-tax benefit resulting from higher interest rates in the third quarter.
Assets under management were up 11% from last year. BMO capital markets net income was $281 million, up 13% year-over-year with revenue growth of 8%. Year-to-date net income was $867 million, up 23% with a notable contribution from our US business. Results reflect good execution of our strategies and the benefit of a diversified business mix.
To wrap up, we feel good about how our businesses are positioned looking ahead. Against the backdrop of relatively low consumer growth, we have good opportunities for growth across our diversified platform. Our strong commercial banking business, north and south of the border, positions us well in a business led recovery. We have good momentum in P&C Canada which is our largest business. In wealth, we are leveraging a strong franchise and market positions for continued growth. We have upside from an expanded and upgraded US platform and this is true across our US business, including banking, capital markets and wealth management.
And from an operational perspective, we are focused on efficiency across the bank and on customer experience to help drive revenues. And lastly, as mentioned, our capital position is strong. With that, I will be happy to take your questions.
John Aiken - Barclays Capital
Great, thanks Tom. I will take the opportunity to kick this off. The acquisition of M&I a couple years back, now [we saw] probably characterize still a transformation for the US P&C business particular, can you give us an update as to where we stand with the integration of various businesses between M&I and legacy Harris and essentially what milestone should we be looking for going forward to see how you continue to evolve the business?
Sure. So we continue to feel very good about the acquisition that we did. We think we bought at a good time in the cycle, announcing the transaction in December 2010 as we had visibility into the recovery. But asset values were still relatively depressed at the time and they have improved since. So overall we’re happy with how the transaction has gone, happy with how the businesses have been put together and very happy with the credit performance which has resulted in significant recoveries on the market, we took even the improvement in the economy since we closed. As we sit here today we’re largely done yet acquisition integration. We talked about synergies of $400 million, those are largely recognized to date and so there is some incremental upside but not that significant and we talked about 85% to 90% of the synergies being in the run rate results that we’re recording. With that, we've seen the efficiency ratio in the business drop, and at Harris Bank before the acquisition was done, our efficiency ratio was fairly high at 66%, 67% and we are now running year-to-date at about 60% in the combined business, which is obviously a much better number.
Going forward, we’re focusing on a few things. Number one is continuing to drive our commercial business and I talked a lot during my remarks both the commercial business, we’re trying to communicate that. As a bank, we’re strong in commercial and we’re overweight commercial, we think that's a good place to be given that consumers have high leverage and growth is likely to be larger in that part of the business. Our commercial business has been running at mid double-digit growth rates from a loan portfolio perspective for the last five or six quarters. We think that should continue, the pipelines are good, and so we feel good about that business and we are putting energy into it.
And the second significant area of growth is on the wealth side, and in our banking business, our clients skew above average from a wealth and an income perspective, and we’ve got a good wealth management capability and we’re putting a lot of energy into trying to deliver a full set of products and services to our banking customers by introducing clients who bank with us through people on our wealth management side. And we've seen good flows from banking to wealth and our experience is that when we transition the clients from the one segment to the other, the revenues go up very significantly as we basically cross-sell and sell more wealth management products. So that’s a big focus going forward. Longer term and this is beyond next year, we’ve talked about having an efficiency ratio target for the business in the mid-50s, down from about 60 right now. So we continue to want to move that ratio down through time, that will be through time.
And from a revenue growth perspective, we've got a couple of factors at play. Firstly, good growth on the commercial side from a volume perspective, relatively flat balances on the personal side given some runoff of higher risk portfolios and also low general consumer credit growth. And we do expect through next year continued margin pressure largely as a result of competition in the commercial space and low margin. So when you add that up, revenue growth for next year is likely to be in that segment pretty modest. We’re hoping for a positive revenue growth, but modest next year and then picking up beyond that off of the back we hope of higher rates in some [early fund emergence] side.
John Aiken - Barclays Capital
And Tom, I have to apologize because you are the first Canadian bank to present given the fact that you were chief risk officer in your previous role at the bank, I have to ask a question about the Canadian housing and the outlook. But I think that in a previous presentation that you had made whereby you coined the phrase that housing is a revenue issue for the Canadian banks, it’s not a credit issue. Can you expand upon what the [house] view is on housing and then what the outlook is?
Sure. I am happy to say that our outlook for housing hasn't changed through this fiscal year and we've been in the camp of believing that the measures taken by the government primarily but also the industry to cool the market would have the desired effect. And what we are seeing in the market is a solid market with a firm based on price but a market that’s cool. We think that’s a healthy thing given the move that it has had up. Recent data is actually showing good volume. So the market is cooled, it’s picked up a little bit from levels that dropped off. But I think bigger picture, we’ve got a market that has supply and demand pretty much in balance. We do not have any meaningful subprime component to the Canadian market and the Canadian banks don't take a risk to mortgages at and above 80% loan-to-value. We do write mortgages above an 80% loan-to-value but they're insured by a government entity, and we don't do home equity lending above an 80% loan-to-value. So from our credit perspective based on lots of stress testing we’re very comfortable.
And then the comment related to this thing growth issue versus a credit issue, basically I’d try to say that we’ve had a market that’s had a very good run over a period of time. Low rates have stimulated some activity for sure. And given that we think that growth is likely to be lower in the mortgage sector over the next three to five years than it’s been over the past three to five years. Like in the sort of 3%, 4%, 5% range or growing give or take in line with the nominal GDP and that’s a lower rate than we've seen, will give rise to somewhat lower revenue growth. But if we get rate starting to move up and we continue to have a good performance on the commercial side, we think that's just fine and actually healthy for the market.
John Aiken - Barclays Capital
Are there – unless I keep on continuing, is there any questions from the floor?
So can you just expand that on the consumer that you talked about housing, but just what’s the opportunity for growth in the consumer segment in Canada? And I guess how do you position that relative to the US, but really we hear from places like Target were opening stores in Canada that maybe they get the uptick that they thought they would get. So maybe talk about where you see the opportunity in the consumer segment in Canada? Thanks.
Sure. So on the consumer side, we’re expecting lending volume growth for the market overall that’s in line with nominal GDP to slightly higher for the overall consumer side. And that’s down from where it's been and the decrease basically reflects the impact of consumer credit having grown at a decent clip over the last 10 years and with that the consumer credit growing at a lower rate going forward, which we think is a healthy thing. We see good opportunities for performance in the consumer side, notwithstanding that and sort of relevant to that benchmark. And so for our consumer portfolio year-over-year growth was about 10% in the portfolio year-over-year, the mortgage business had good growth for us and we had an innovative product offerings that drove very good volumes. And our market share in mortgage is the lowest of any of our main product market shares and sort of under our natural weight. So we’ve been active in that market given that we are underweight and we’ve had good success with some innovative products.
We are quite focused on the wealth segment in the Canadian market as well and we do a good job trying to migrate again clients in our banking business who have wealth management needs into our wealth management business. We had a really good sales of mutual funds in what’s called in Canada the RRSP season which is a government-sponsored savings program that’s open for the first few months of the year, a record sales in that program to date and we’re focused generally on wealth products as consumers look to focus more on savings and a little less on credit growth. And then lastly, we do expect there to be activity in the credit card part of the market over this year and that’s as a result of transfer of one loyalty or affinity program from one bank to another bank that we think is going to give rise to a higher than normal level of client movement across different cards. And we've had a really good mass-market credit card program with a good mass-market loyalty program, and we’ve got a good share in that product. And we’ve been underway in the premium brand card space through time but we’ve got a good offering. And so we plan on taking advantage of the more active state of the market that is going to unfold here over the next few months to try to market a good product into a market that's got some opportunity for us.
John Aiken - Barclays Capital
Tom, in context of the expectations of the slower consumer lending demand, how do you address that in terms of the expense side? And BMO has done a very good job just cutting costs but going forward if we are going to look out, if we prefer to call it five years plus, how do you address distribution and what impact does this have for the branch network and how you roll out of it?
So it’s a good question. I touched on in my remarks how we’re focused across the bank on efficiency and productivity. And for the last couple of years at our bank, we’ve had a bank-wide focus on productivity improvement. And in retail banking business we’re focused on a few things. One is just generally trying to move resources from mid-and back office functions to the front lines and doing that by simplifying our processes so that it’s easier to do business internally and with that we've got greater capacity to deploy resources to the front lines. More fundamentally we are going through an exercise of redesigning our large core processes in the bank and as examples of that, we’ve completed the redesign of our mortgage processing operation in the bank. And so from the point where our customer walks in and makes an application for a mortgage to where they discharge that mortgage, we’ve re-done the processes that basically process those transactions. And with that we've freed up significant front line time, and we’ve improved the efficiency of the back office operations.
We’re right in the middle of rolling out what we call our commercial lending redesign program and that program similarly involves the redesign of the commercial lending processing that we have to support that business and we’re going to go through a number of other process categories. So I would say we’re taking a fundamental look at the core processes in the bank and looking to simplify them to make them more lean in a lean methodology sense and to add technology to them and actually it takes a little time for the benefits of those kinds of programs to show up because these are big processes, you need to invest in change and the benefits follow. And so the full benefit from these changes is not close to being baked into the result at the current time.
On the channel side and the technology side, we’re investing in mobile and we’re investing in alternative and lower-cost ways to serve our customers. We’re not shutting branches, so we continue to operate with our branch network. But we are optimizing it by opening branches that are more customized to the local environment. So for example, in urban centers we’re opening sort of small funky light area, open feel good kind of branches that generate high traffic and feel like a real retailing experience as opposed to a traditional banking experience, and we’ve had good results with those. And basically we’re trying to reduce the square footage of the branches we've got given that flows there aren’t as high as they have been and we’re very actively working to have a good mobile capability, which we do have, good online banking capability. And we’re sort of promoting with our customers channels that are lower cost to us and generally preferred by that. So I would say we’re actively sort of on that trend which is a big one in the industry.
John Aiken - Barclays Capital
Along with that shifting channel preference generally away from branches, although bricks and mortar will always exist, what is the outlook for the legacy branches? Is it part of your refreshes that to go through and take a look at the all the branches and go through and if that is the case, how long the process will that be? I cannot believe it can be – I can’t believe it will be actually quick.
Well, it won’t be quick. I would say you are right on that. We’ve got about 1600 branches in North America and the process I think will take quite a bit of time to play out and we don't think branches are going to go away. But we think that the way consumers use them will continue to change and lots of consumers shop online today. They talk to different people, but when the rubber hits the road on a personal transaction that they want to do, most people still want to deal with an individual. So you need to have a physical distribution system to do transactions that are important to people at the points that they are ready to transact and have a good online capability to help them sort through the issues for themselves and to be on their radar screen.
So my expectation would be through time and this is five to 10 years, you won’t see a big change in the number of branches but you will see the square footage come down. And that’s what we’re focused on doing it. It’s lowering the square footage where there's costs and trying to create branches that feel good to customers and that are more retail oriented and we will introduce those changes in sort of a gradual way through time. And I think what we are doing is largely in keeping with what the industry is doing with probably a bit of a larger push on the urban branch design and we think that’s a significant effort on the online – in the online area.
Thank you. Hi Tom, how are you?
If I read this slide right, your capital markets business is the second largest contributor to earnings, did I get that correct? So it’s interesting we are talking about housing and mortgages in the US and this is a big business for you guys. How do you approach this, how do you think about it, how do you try to position it, given its importance to the earnings of the bank, how does the regulator look at this especially in the context of your capital? If done in a certain way it can consume – it can be more capital of its business?
So I would say we are happy with the capital market business. You can look at it different ways, it is the second largest group that we've got, generating about 25% of the bank’s income. But the way we think about it, the wholesale business does represent about 25% of the total and we’re happy with having a retail-dominated business mix with a strong capital market business to supplement that. From a growth perspective we like the capital markets business to give or take through time grow in line with the overall bank, and we’ve worked over the last five to seven years to decrease the weighting that capital markets has in the overall business and we've done that through two things; one, targeting lower organic growth from the capital market business and then secondly, looking to make acquisitions in other parts of the business. And as a result of that, we have grown the business but it’s grown at a lower rate. And given that strategy that we’ve executed we’re happy to have the business grow from this point forward and maintain about the same relative position in the overall mix that it’s got.
Most of the growth in the business comes from outside of Canada because we’ve got a strong share positions in Canada. They vary obviously by product but on average we’re number two or number three in Canada and have a full-service offering. And over the last few years we’ve invested in the US business, not from acquisitions but basically by adding talent and strengthening the alignment between different parts of the firm, so that, for example, we've got good equity research, equity sales and trading and investment banking across different industries. And the US business is a decent size one for us, its revenues are about $1 billion and the productivity ratio is still relatively high, because we've added people and expenses and we believe there is a revenue lift that will come. So we do think we've got good operating leverage that’s inherent in the US business. We've got confidence in the trends in that business. So there is sort of disproportionately -- disproportionate outside on the US side as we normalize the revenue potential off of the expense base and then beyond that we’d expect the business to continue to grow with the overall company and add about 25% of the total from an income and a capital perspective, we don't see ourselves as having any particular pressure from our rating agency or a regulatory perspective. And we do think that diversification is a good thing.
I guess one add-on which no [IR] head of capital markets would always finish with, the ROE in our capital market business is about 19% year-to-date, 18% to 90%. The bank ROE is 15%, 16%. So it is a very good business for us and it has been a fairly stable business through time. Clearly there is a market element to it and a potential volatility but if you look at it through 10 years has produced good stable earnings and a pretty attractive return on equity.
We believe we are.
Can you talk about mortgage risk weighting and I think one of your competitors had to adjust their mortgage risk weighting, that was driven by regulators but I believe you are at the top end of the range but I guess it is a concern in the market, so if you could speak to that.
Sure. I will say a few things. I guess the first would be that in general we’re comfortable with our mortgage risk weightings. And from time to time banks make adjustments to the risk weights on all asset categories and those adjustments occur for a variety of reasons, you update models, you get new data, you have a regulatory review, what have you. But I think the general view at our bank and in the market would be that the risk weights are reasonable given the riskiness of the product, and we’re not expecting at this stage any significant upward pressure from a risk weight perspective. And when you say have do you reconcile that to the concern that does exist in places related to Canadian housing, I think[ it encircles] back to the structure of the Canadian market and the essence of any exposure above 80% loan to value.
And the risk weights have not been disclosed. So they are -- you can get from our sup pack numbers that get you into its own. But we haven’t given a prospective number. For our mortgage portfolio about 59% of that portfolio is insured, and again the insurance is backed by the federal government and the loan-to-value on the uninsured part of the portfolio on average is 59. So just a few traditional numbers to reinforce our risk view on the portfolio.
John Aiken - Barclays Capital
Tom, sticking with the regulatory and the capital regime, can you give us some context about what the potential for the leverage ratio means for BMO and also what other risks are you looking at from a regulatory perspective coming on the pipeline?
On the leverage ratio, we believe we’re in a good shape, we’re above the 3% Basel level. The exact calculation has not been finalized yet and so we haven't disclosed the number because we don't know how to calculate that number at present. But from what we do know at the present time we don't expect to have an issue from a leverage ratio perspective. We think our ratio compares well to our competitors in the Canadian market, and if you look at in the existing ops fee leverage ratio which is called the asset to capital ratio, our ratio is a good one relative to peers. So (inaudible) very clearly isn't over on the leverage ratio and different regulators in different jurisdictions have different points of view on it. But from what we can tell to date we don't think it's going to be a constraint for us.
In terms more generally of things that might be coming on the regulatory side, from my perspective there’s just a continuing debate about the whole suite of reforms that have been undertaken as a result of the downturn. And notwithstanding what we see as very significant changes that have been made in the areas of capital and liquidity and risk management there’s still a number of people calling for further strengthening of bank balance sheets and our hope is that we will settle into a mode where we’re implementing the reforms that have been put forward and with that we'll end up with a much stronger system than we had before. But clearly there’s still a public debate going on about what different people think is appropriate and there are open questions as a result of that.
John Aiken - Barclays Capital
Maybe we have time for a one final question. I am lucky, Tom, I guess it comes from me. With after M&I grabbed the whole bunch of headlines, but I think it was on underneath the radar screen for a little bit with BMO, as you made some acquisitions in the wealth management side, I was wondering if you could talk to the strategy for wealth management in the US but also what you’re doing in other regions most notably Asia?
Yes, happy to that. So we feel very good about the performance of our wealth business and the prospects for it. The business doesn't get as much attention as some of our other businesses but it is significant, it represents about 20% of the bank’s revenue. It has been growing nicely. Year to date our results are up significantly in the quarter, in the quarter wealth business was up 37%. So business is well run, we’ve got a good share positions and it’s an area that we want to grow going forward. Over the last five years give or take we've done a number of acquisitions outside of North America. We had acquired two asset management firms that have an emerging market orientation, one based in Hong Kong and one based in London. The firms are named Preferred and Lloyd George and we’re very happy with how those acquisition have gone. And with those acquisitions, we basically tried to do two things; one, participate in the flows that the companies have had and will have by virtue of their basic business, and then secondly, plug their product into our distribution both retail and institutional. And we’ve got strong distribution on both sides and we’re able to accelerate the asset growth that the companies have as a result of that.
We've also been expanding our private banking business in Asia and earlier this year bought a private banking business based in Hong Kong and also having operations in Singapore. And we want to continue to grow in that part of the world. We’re mainly a North American bank but we are one of, I think it’s three North American banks to have a fully incorporated China bank. So we’ve got a full banking operation incorporated in China. We’ve got a good wealth business there that basically participates in individuals with wealth in Asia looking to diversify how they manage their affairs and often transfer a portion of their wealth into North America. So we feel good about the flows and looking ahead, we want to grow the wealth businesses organically for all of I think the obvious reasons. And then with the work that we've done around M&I which basically doubled the size of the US banking business, increased its competitiveness in the markets that we’re focused in, the wealth area will be more of a focus from an acquisition perspective going forward. And within that the main focus is on asset management where we again have a good capability and secondly, private banking or high net worth.
John Aiken - Barclays Capital
Well, Tom, thank you very much for your thoughts. Ladies and gentlemen, please join me in thanking Tom for his presentation. GE coming in next in this room.
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