Calm amid a po­lit­i­cal storm: BMO’s big bet on the U.S.

The Globe and Mail (Alberta Edition) - - REPORT ON BUSINESS WEEKEND - CHRISTINA PEL­LE­GRINI CAP­I­TAL MAR­KETS RE­PORTER

U.S. Pres­i­dent Don­ald Trump is try­ing to un­leash the an­i­mal spir­its of Amer­i­can com­merce with his prom­ises of lower taxes and lighter reg­u­la­tions. Set free the na­tion’s en­trepreneurs and busi­ness own­ers, say the pro­po­nents of Trumpo­nomics, and growth and in­vest­ment will soar.

No one yet knows whether he will be able to get his eco­nomic agenda through Congress, es­pe­cially as his pres­i­dency be­comes fur­ther em­broiled in con­tro­versy over his fir­ing of the head of the Fed­eral Bureau of In­ves­ti­ga­tion. But Bank of Montreal is mak­ing a bet that re­gard­less of the po­lit­i­cal drama in Wash­ing­ton, the good times will carry on for Cor­po­rate Amer­ica – and the bank will be able to profit from a resur­gence in con­fi­dence among medium-sized com­pa­nies that have now fully re­cov­ered from the fi­nan­cial cri­sis.

Af­ter an ex­tended push into the United States, in­clud­ing a post-cri­sis hir­ing spree and the ac­qui­si­tion of a merger-ad­vi­sory bou­tique in 2016, BMO has built a U.S. in­vest­ment bank that ri­vals, in some re­spects, what it has in Canada. It has about the same num­ber of bankers on both sides of the bor­der; its eq­uity an­a­lysts cover 580 U.S. stocks, com­pared with a lit­tle more than 300 Cana­dian ones. The bank says its abil­ity to help com­pa­nies raise eq­uity and debt is the same in both coun­tries. And it’s gen­er­at­ing al­most as much in fees from ad­vis­ing on merg­ers and ac­qui­si­tions in the United States as it does at home.

Yet the United States ac­counted for 35 per cent, or $1.5-bil­lion, of the bank’s to­tal rev­enue from cap­i­tal mar­kets in 2016, hov­er­ing around that per­cent­age since 2014. Prof­itabil­ity is lower: last year, the unit con­trib­uted $259-mil­lion in net in­come, or 20 per cent of the group’s to­tal earn­ings.

» Se­nior ex­ec­u­tives at BMO say that its U.S. cap­i­tal mar­kets arm is on the verge of a growth spurt, as it looks to ride a strong econ­omy that has pushed U.S. unem­ploy­ment down to 4.4 per cent, the low­est since 2007. Within five years, BMO es­ti­mates that half its cap­i­tal-mar­kets rev­enue could come from the United States, and if it man­ages to keep its costs in check, it should be more prof­itable growth.

“We know that we can op­er­ate in Canada with the same num­ber of peo­ple and gen­er­ate more rev­enue,” Bill Downe, BMO’s chief ex­ec­u­tive officer, said this week dur­ing an in­ter­view. “We should be able to do that in the United States.”

If BMO’s cap­i­tal mar­kets divi­sion in the United States is go­ing to catch fire, you’d think it would need a spark from within. But the bank hasn’t drawn up a new game plan. In­stead, it says it can fuel growth just by do­ing what it’s done for years.

While its Chicago-based U.S. retail and com­mer­cial bank, BMO Har­ris Bank, has a siz­able foot­print in the U.S. Mid­west, its cap­i­tal mar­kets ef­forts are not de­fined by ge­og­ra­phy, but by sec­tor spe­cial­ties. BMO fo­cuses on mid-sized com­pa­nies with mar­ket val­ues of be­tween $200-mil­lion (U.S.) and $5-bil­lion that op­er­ate in any of seven sec­tors, among them be­ing com­mod­i­ty­based in­dus­tries such as en­ergy, mining and food and agri­cul­ture.

“Clients have repeatedly told us, both in in­vest­ment bank­ing and in trad­ing prod­ucts, ‘Don’t try to be ev­ery­thing to us. We don’t need an­other JPMor­gan,’ ” Pa­trick Cronin, the new head of BMO Cap­i­tal Mar­kets, said in his first in­ter­view since he took the job in Novem­ber. He re­placed Dar­ryl White, who will suc­ceed Mr. Downe to be­come the bank’s CEO on Nov. 1. “We’re go­ing to fo­cus on what we’re re­ally good at.”

Though BMO’s fo­cus is nar­rower in the United States than it is in Canada, where it is among the top three among in­vest­ment banks in eq­uity and debt sales, the fee pool within its reach in the mid-cap space in the United States is three times the size of the en­tire fee pool in Canada, Mr. Cronin says. In­creas­ing its av­er­age mar­ket share across prod­uct lines to as much as 3 per cent from roughly 1.5 per cent “isn’t a huge stretch,” he added.

BMO isn’t the only large Cana­dian in­vest­ment bank that’s re­ly­ing on the United States to fuel growth. The cap­i­tal-mar­kets di­vi­sions of Royal Bank of Canada and Toronto-Do­min­ion Bank are aim­ing to earn more south of the bor­der. Cana­dian Im­pe­rial Bank of Com­merce, for its part, is in the fi­nal stages of gain­ing a much-needed U.S. beach­head as its ac­qui­si­tion of Chicago-based com­mer­cial bank Pri­vateBan­corp Inc. closes next month.

While a re­cent wave of megadeals has kept some Cana­dian bankers busy, there’s only so much run­way for growth in Canada, where the econ­omy has been more slug­gish, there has been a drought in the the num­ber of com­pa­nies go­ing pub­lic and many large cor­po­ra­tions are loyal to the banks they al­ready work with.

Even if BMO is suc­cess­ful with its U.S. cap­i­tal-mar­kets ex­pan­sion, some ques­tion whether the op­por­tu­nity is large enough to move the nee­dle for a bank that earned $4.6-bil­lion (Cana­dian) last year.

“Th­ese banks are so big now that it’s very hard for them to do any­thing that has a mean­ing­ful im­pact, out­side of large ac­qui­si­tions,” said Rob Wes­sel, a man­ag­ing part­ner at Hamil­ton Cap­i­tal, a Toronto-based as­set man­ager that fo­cuses on the global fi­nan­cial sec­tor. “I wouldn’t ex­pect the bank an­a­lysts to change their earn­ings es­ti­mates over this ini­tia­tive. My guess is they’ll prob­a­bly just watch.”

Cana­dian banks haven’t al­ways had a smooth ride south of the bor­der. The large do­mes­tic banks that main­tain sig­nif­i­cant U.S. busi­nesses, in­clud­ing BMO, have all had their share of stum­bles over the years, when cor­po­rate loan losses or bad trades piled up in their Amer­i­can units.

But it’s also a mar­ket in which in­vest­ment bank­ing has been up­ended by steep fines and a stiffer reg­u­la­tory regime since the cri­sis. Many large Euro­pean­based banks are in the process of re­treat­ing from the United States, while the mega-Amer­i­can banks are tak­ing a sec­ond look at their client bases as they grap­ple with a higher cost of cap­i­tal. In the process, some com­pa­nies are be­ing or­phaned, spurring them to look for a new bank.

“They are shun­ning away clients, es­pe­cially in the mid-mar­ket, that do not drive vol­umes and mar­gins for them,” said Roy Choud­hury, the Amer­i­cas bank­ing and cap­i­tal-mar­kets leader at Ernst & Young in New York.

It’s not just the Cana­dian banks that are try­ing to seize growth in the U.S. mid-mar­ket, how­ever. “We see a lot of the re­gional banks in the U.S. ex­pand­ing their foot­print into this mar­ket. We see some ex­pan­sion from Ja­panese banks, es­pe­cially in the New York area,” he said.

Said Mr. Cronin: “Other firms shrink ag­gres­sively and ex­pand ag­gres­sively. As firms be­come less ag­gres­sive, there are op­por­tu­ni­ties.”

For Mr. Downe, how­ever, what sep­a­rates BMO from all the other banks is its fo­cus on those seven sec­tors. His early-ca­reer ex­pe­ri­ence as an en­ergy banker in Hous­ton “was re­ally, for me, ev­i­dence that if you spe­cial­ize by in­dus­try sec­tor, you can be very rel­e­vant to clients based on the depth of your knowl­edge,” Mr. Downe added. “I think our long track record in the mar­ket has left a clear brand po­si­tion for the bank.”

Such spe­cial­iza­tion can have a sharp edge to it, leav­ing an in­vest­ment bank heav­ily ex­posed to nar­rower parts of the econ­omy. (TD, for ex­am­ple, built a cor­po­rate lend­ing busi­ness with tele­com firms – which briefly killed the bank’s earn­ings power when the sec­tor went through a vi­cious down­turn in the early 2000s.) Still, Randy Stuewe says BMO’s in­tel­lec­tual horse­power is what has earned his busi­ness for years.

As CEO of Dar­ling In­gre­di­ents Inc. of Irv­ing, Tex., Mr. Stuewe has re­tained BMO bankers to ad­vise on three key ac­qui­si­tions over the past decade that trans­formed the com­pany, which col­lects ined­i­ble ma­te­ri­als from the an­i­mal slaugh­ter process and re­pur­poses it into food, feed and fuel.

“Every Jan­uary to March, you see every one of the in­vest­ment banks come through, all ask­ing you for an idea so they can go work on it. With BMO, they’re al­ways bring­ing us ideas,” Mr. Stuewe said. “It means they have built an ex­per­tise in our in­dus­try.”

That ex­per­tise and coun­sel is what Mr. Stuewe counts on. And in re­turn, he has in­cluded BMO in the fi­nanc­ing ar­range­ments for those three deals, putting BMO along­side heavy­weights Gold­man Sachs and JPMor­gan on a stock sale in 2013.

“They might not have what I re­fer to as a top-end ex­e­cu­tion on bonds or eq­uity, but the rea­son we are go­ing to go is­sue stock or debt is be­cause they got the deal done. And they need to be re­warded,” he added. “You don’t need [BMO] if all you wanted was ex­e­cu­tion. But it still comes back to re­la­tion­ships.”

Mr. Stuewe has known the BMO bankers since the early 1990s, a decade be­fore he be­came the CEO at Dar­ling in 2003.

But the re­la­tion­ship be­tween the bank and Dar­ling wasn’t al­ways so smooth. Mr. Stuewe says when Dar­ling hit a rough patch in 2002, BMO Har­ris Bank was among the first of its lenders to run for the exit signs. “We al­ways tease them. We al­ways say, ‘you guys were the first to run and we al­lowed you back in,’ ” Mr. Stuewe said.

“They all just cringe. They never like to hear that story. But it comes down to, do you trust them?”

For years, the bank has worked to break down bar­ri­ers that have ex­isted be­tween dif­fer­ent prod­uct groups, such as eq­uity and debt cap­i­tal mar­kets and cor­po­rate lend­ing. To do so, BMO has been “tak­ing a more holis­tic view” of its re­la­tion­ships with clients, Luke Seabrook, chief op­er­at­ing officer at BMO Cap­i­tal Mar­kets, said in an in­ter­view.

“When you have the trust that it’s go­ing to be mea­sured more broadly, it cre­ates a dif­fer­ent dy­namic. It takes time and it is a cul­tural thing.”

In prac­tice, that means look­ing at a debt is­suance, for­eignex­change hedge and an in­ter­e­strate swap as one trans­ac­tion for BMO rather than three – and pric­ing it as a pack­age.

“There’s still peo­ple in the mar­ket­place who will take the view that th­ese are three dis­tinct trans­ac­tions, done by three dif­fer­ent groups, each group will have a re­turn hur­dle that they’re look­ing to make and by the time you add them all up, you’re un­com­pet­i­tive when you price it,” added Mr. Seabrook.

Mr. Cronin con­curs. “You’ve put too much mar­gin into the prod­uct,” he added.

“Whereas if you look at it holis­ti­cally, price it as a pack­age and as long as the pack­age over all has a suf­fi­cient level of prof­itabil­ity, most of­ten times we find that we’re much more com­pet­i­tive than we would have oth­er­wise been.”

J.P. MOCZULSKI/THE GLOBE AND MAIL

BMO Cap­i­tal Mar­kets head Pa­trick Cronin, left, and Luke Seabrook, the divi­sion’s chief op­er­at­ing officer, pose at the First Cana­dian Place cor­po­rate head of­fice in Toronto. Both aim to push for ‘a more holis­tic view’ of BMO’s re­la­tion­ships with clients.

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