Bank of Montreal Earnings Call Nuggets: NIM Impact and RWA Reduction

Bank of Montreal (NYSE:BMO) recently reported its second quarter earnings and discussed the following topics in its earnings conference call.

NIM Impact

Gabriel Dechaine – Credit Suisse: My first question is for Frank. Just on the NIM trend, I guess I’ll get the ball rolling on NIM. In Canada, I guess, you’ve had some strong deposit growth in the high-interest savings account, and that’s got new customers into the Bank, but also caused some to switch out of checking into the HISA. I’m wondering how big of an impact that had, and is this part of a persistent issue we should expect in coming quarters? I’ve got one for Surjit, just on Page 17 of your presentation there, if you can help me just to understand a bit more the composition of two loan portfolios; the CRE/investor-owned in Canada, that’s C$10.7 billion, and in the owner-occupied commercial mortgage, C$2.1 billion. Really what the C$10.7 breakdown is like between developer and REITs or whatever, and then the owner-occupied as just an example of what that could be?

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Frank Techar – President and CEO, Personal and Commercial Banking Canada, BMO Bank of Montreal: It’s Frank. I’ll take the first one. As you pointed out, our margin this quarter was down a little bit more than we expected; 6 basis points. It was a few basis points more. The primary reason was stronger growth in our low-margin, high-interest savings account. We have been repositioning our deposit lineup over the last few quarters and we did see some balanced movement from core checking products to high-interest savings accounts. So, to your question, I’m not concerned about this as we’re in flight with some plan changes that are going to address the issue over the coming quarters. It wasn’t a big surprise and I’m not expecting it to be a big impact going forward. Overall…

Gabriel Dechaine – Credit Suisse: Why not? Sorry, like what’s – like because you had promotional pricing and that’s going away or why wouldn’t you be…?

Frank Techar – President and CEO, Personal and Commercial Banking Canada, BMO Bank of Montreal: Well, we’re adjusting some of the features to the product set that we believe will mitigate some of the movement that we’ve seen. Overall, just to the NIM question as long as I have the floor, I haven’t changed my view on NIM as a result of the answer to your question. Consistent with my comments last quarter, I expect to see moderating NIM declines of up 2 to 4 basis points for each of the next couple of quarters, and my expectation is we’re going to see that reduce even more as we go into 2014 in the 1 to 2 basis point per quarter range. I will just say and reinforce what Tom earlier. We’ve seen note sequential decline in our loan spreads and our loan spreads have been relatively flat now for three quarters and this was due to our very strong growth in higher spreads commercial loans and slower growth in our residential lending and I expect those trends to continue so from confidence perspective that, coupled with stronger deposit growth. If you give me confidence that these moderating trends are going to show up in future quarters…

Surjit Rajpal – EVP and Chief Risk Officer, BMO Financial Group: Gabriel, this is Surjit. Your question on the CRE investor-owned mortgages, the builder component of fed is not a very large component. It’s roughly, let’s say, about 25% or so. And even within that builder component the condo part which we’ve looked at in the past is a very small portion. On the high rise side it’s about 800 and the total is about 1 billion. So, that’s as far as the builder portion is concerned. The investor-owned portion is very well diversified across different segments. With respect to your owner-occupied commercial mortgage, owner-occupied commercial mortgage is one where the person who actually takes the mortgage is also using it for their own business purposes, generally. So, that categorizes as a separate category. So, this reflects the…

Gabriel Dechaine – Credit Suisse: (indiscernible) factory, I guess. Sorry.

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Surjit Rajpal – EVP and Chief Risk Officer, BMO Financial Group: Yeah.

Gabriel Dechaine – Credit Suisse: Actually, just the investor-owned, like that’d be REITs or something like that I guess or…

Surjit Rajpal – EVP and Chief Risk Officer, BMO Financial Group: Yeah. That could be REITs as well. But it will be a combination of even businesses across various industries that have borrowed on a mortgage basis for real estate that they actually use for their business purposes. So, it’s very well diversified book, and it could be a combination of office, factories, everything, all kinds of real estate.


RWA Reduction

Steve Theriault – Bank of America Merrill Lynch: A couple of questions. First, for probably, Tom. Tom, so you mentioned that risk-weighted assets shrinkage this quarter which was a little surprising, can you give us a little detail around some of the model refinements, some of the changes in collateral that came through this quarter? And maybe more importantly, is there more of this coming down the pipe for you guys or was it just that coincidental culmination of a number of things that came together just coincidentally all at the same time?

Thomas E. Flynn – EVP and CFO, BMO Financial Group: Sure, it’s Tom. I’ll give you some color on this. The reduction in RWA was about C$3 billion in the quarter related to both having lower risks in the portfolio and also some changes in our risk calibrations. So, on the lower risk in the quarter point, our securitization risk-weighted assets were down close to C$1 billion. Most of that related to reductions in our legacy run-off structured credit positions and also a bit of a positive migration in those portfolios. Given the new capital rules related to derivatives, we have been spending time looking at collateral management, and also working to move some of our business into (CCPs), and those two things contributed around C$1 billion dollars in aggregate to the reduction in RWA over the course of the quarter. Our average stressed bar was down a bit in the quarter and so that contributed to lower market risk, and that was mainly just lower volumes and some of the portfolios. And then lastly, we had a credit card securitization related transaction that reduced the RWA in that area. And then, in addition to those items, which I would characterize as items related to simply having lower risk in the portfolio and as a result lower RWA, there were some changes in our risk assessment that resulted in lower RWA. And to the point around expectations going forward, I’d look to the capital build that we’ve had over time, and we have had very good strength in the capital ratio over the last couple of years, probably stronger than we’ll expect going forward because we do have good volume growth in the portfolio. But we do expect the capital ratio to continue to grow quarter-by-quarter on average, not quite by as much as we saw this quarter, but the trend should be a positive one.

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Steve Theriault – Bank of America Merrill Lynch: And is that most of Links and Parkland in those items? Have they – what are they running at now? I know they’re probably 80% lower than what they were at the peak.

Thomas E. Flynn – EVP and CFO, BMO Financial Group: They are more like 90% plus lower. There’s a very good story around that. The Links and Parkland assets are down to approximately C$200 million at the current point, and we expect that they will be gone in short order. So, that part of our RWA will be shrinking further, although the current number is very low.

Steve Theriault – Bank of America Merrill Lynch: Second one is for Mark Furlong. The synergies now have mostly come through, but the efficiency ratio is for the most on an adjusted basis is still kind of hanging around close to 60%, again on an adjusted basis. One thing, I wanted to ask, Mark, is how much of the run rate synergies have been or being reinvested versus flowing through to the bottom line? Is it, we’re talking a quarter or is it more like really three quarters, it’s hard to tell? Then the second part was, again on efficiencies. Can you give us a bit of an outlook for second half of the year as sort of 60% from this quarter or 57% from Q1 more indicative of what you’d expect?

Thomas E. Flynn – EVP and CFO, BMO Financial Group: On the synergies, we’ve talked about progress over time and as we look at our tracker on synergies, we are now around the 85% mark in terms of realizing on the expense reductions that we targeted from the transaction. We feel good about those. The reductions are coming through in a variety of areas, including in Mark’s business, but also in our U.S. wealth business, which with the combination of Harris and M&I is a good size. We’ve done a good job managing that business through the transition, and also from our technology and operations and corporate areas. So the synergy has come through in a variety of areas. We do have reinvestments and we have talked about that for a number of quarters. The reinvestment relates to taking advantage of opportunities that we see in the market. Mark, will elaborate on this if he wants, but the two in particular in that business have been on the Commercial side and the mortgage side where we had good results and the market opportunity is good.

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Mark F. Furlong – President and CEO, BMO Harris Bank, N.A.: So to answer the second part of the question, the goal is to get the efficiency ratio into the mid-50. So, I am not sure that we will get there by the end of this year. Really the driver from this point on is going to be the revenue side. We’ve taken most of the expenses we’re going to take out of any real substance and so now it’s really top line growth. So that’s kind of what we will fight the second half of the year. We see really good volumes across all the businesses, but we’re facing the same pricing challenges you see all across the U.S. banks, but good momentum in the rest of the business though. But we may – I don’t know that we’re going to get to the mid-50% by the end of this year, let’s see.

Steve Theriault – Bank of America Merrill Lynch: And then in terms of that coming through the revenue line, I presume you certainly need some assistance from just better market conditions.

Mark F. Furlong – President and CEO, BMO Harris Bank, N.A.: That’s a good question. I think certainly great economic tailwinds are always wonderful, but I would say that again back to start out with the same pricing pressures you see affecting other U.S. banks, they are affecting us, but we’ve had good volume and expect to see good volume on the C&I side. That growth has been strong. Now we’re six or seven quarters in a row and great activity all throughout the businesses and all throughout the markets. On the commercial real estate, we really haven’t landed on one of those quarters where you see the growth yet. But in the first half of 2013, we booked over C$1.2 billion of commitments. So we’ve only funded a quarter of those. When you get pay-downs in that portfolio, of course, we will begin to see some momentum because we still see some very good opportunities that we have this quarter and going into the fourth quarter. On the consumer side, that’s more a function of we’re selling 60% or so of what we produced, that’s down a little bit of what we originate. That’s down a little bit from where we were a couple of quarters ago. And so what we portfolio, this isn’t quite enough to keep up with the amortization but we’re up 6% linked-quarter, the home equity side, our fundings are up 15%, commitments are up 10%, the auto side originations are up 5%. Really, the metrics on the sale side across the board, pretty much without exception in both the Personal business and Commercial business are strong. So, we’re seeing the good volume growth and expect – and see no reason why we wouldn’t continue to see it. Economic tailwind would make that even better. For example, where you saw the release on housing that Case-Schiller came out with earlier, and nice to see a big market like ours in Chicago would be up 7.8%. The challenge in Chicago, of course is, it’s still down quite a bit from the peak, but the great thing is that momentum wasn’t there a year ago, and so that will be another positive reinforcer and wealth creator in Chicago there will be a big part of our base to grow from too. So, probably a little long-winded answer, but just trying to give you a little bit of perspective on different pieces of our business and why we feel good about it.

A Closer Look: Bank of Montreal Earnings Cheat Sheet>>