Bank of Montreal 1998 Annual Report Download - page 28

BANK OF MONTREAL GROUP OF COMPANIES
FORWARD-LOOKING STATEMENTS
From time to time we make written and verbal forward-looking
statements, including in this Annual Report, in other filings
with Canadian regulators or the U.S. Securities and Exchange
Commission, in reports to shareholders and in other communica-
tions. These forward-looking statements include comments with
respect to our financial condition, the results of our operations
and our businesses.
However, by their nature, these forward-looking statements
involve numerous assumptions, inherent risks and uncertainties,
both general and specific, and risks that predictions, forecasts,
projections and other forward-looking statements will not be
achieved. We caution readers of this Annual Report not to place
undue reliance on these forward-looking statements as a number
of important factors could cause actual future results to differ
materially from the plans, objectives, expectations, estimates and
intentions expressed in such forward-looking statements.
These factors include, but are not limited to: fluctuations in
interest rates and currency values; regulatory developments; the
effects of competition in the geographic and business areas in
which we operate, including continued pricing pressure on loan
and deposit products; changes in political and economic condi-
tions including, among other things, inflation; and technological
changes. We caution that the foregoing list of important factors is
notexhaustiveandthatwhenrelyingonforward-lookingstatements
to make decisions with respect to Bank of Montreal, investors and
others should carefully consider the foregoing factors as well as
other uncertainties and events.
Forward-looking statements appear in shaded boxes throughout
the Management Analysis of Operations. They are referred to
using the heading “Outlook” in Revenue Growth on page 28;
Productivity on page 30; Credit Risk on page 46; Liquidity Risk
Management on page 48; and Capital Management on page 49.
In addition, an outlook with regard to the Economy and Global
Developments is included, starting on page 51.
MANAGEMENT ANALYSIS
OF OPERATIONS
This section of the Annual Report provides management’s
discussion and analysis of the financial performance and
financial condition of Bank of Montreal for the years ended
October 31, 1998 and 1997. The analysis focuses on our
strategies and financial results and is organized around
ten primary measures that we use to monitor our overall
financial performance and condition. The analysis is based
on our consolidated financial statements, which are pre-
sented later in the Annual Report, beginning on page 68. All
dollar amounts are expressed in Canadian dollars unless
otherwise stated.
BANK OF MONTREAL GROUP OF COMPANIES
EXPENSE-TO-REVENUE RATIO OF 66.5%
Our expense-to-revenue ratio increased 210 basis points in 1998 to 66.5% as revenue growth
of 1.4% was more than offset by expense growth of 4.7%. Our internal target is to improve
productivity by reducing the expense-to-revenue ratio by 2% per annum.The reduction was
not achieved in 1998 as a number of the drivers of reduced revenues had a relatively low level
of associated expenses which resulted in a deterioration in the expense-to-revenue ratio. These
included revenues from impaired loans and equities and bonds of lesser-developed countries
,
U.S. card revenues and the lower contribution from Bancomer. In addition, the decline in
trading revenues was not matched by a similar decline in expenses. The reasons for the lower
revenue growth are outlined on page 26,with expe nse growth discussed in more detail below.
Expense Growth at Lowest Level in Nine Years
Our secondary measure of productivity is year-over-year expense growth.Expense growth in
1998 was 4.7% compared to 16.8% last year. Contributing to expense growth this year were
increased business volumes resulting from a strong North American economy, increased
spending on strategic development and the foreign exchange impact of a lowerCanadian dol lar.
Strategic development spending in the year was directed to the initiatives highlighted on the
left of this page. The increase in the Canadian/U.S.dol lar exchange rate impacted U.S.-based
expenses reported in 1998 resulting in additional expenses of $69 million. Expense growth
was offset by the impact of a $75 million charge recorded in the fourth quarter of 1997 for
accelerated depreciation related to technology changes and costs to improve the efficiency of
our credit process, as well as a decline in revenue-driven compensation.
CONTRIBUTION TO EXPENSE GROWTH (%)
For the year ended October 31 199 8 199 7
Strategic development spending 2.1 4.9
Foreign exchange impact 1.5 0.2
Charge (1.6) 1.3
Revenue-driven compensation (0.8) 5.3
Ongoing business volume growth, partially offset by productivity improvements 3.5 5.1
Total expense growth 4.7 16.8
If we examine expense growth in traditional non-interest expense categories (see table below),
expense growth was lower in 1998 than 1997 in all categories.Salar ies and employee benefits
increased 1.6% in 1998, compared to 14.7% in 1997, due largely to reduced variable compen-
sation
in 1998. Premises and equipment expenses increased 6.2%, reflecting additional costs
arising from our various expansion efforts, including mbanx and call centres. Communications
expense increased 7.8% in 1998,reflecting the continued push into alternate delivery channe ls
such as telebanking. The increase in other expenses of 11.3%, compared to 15.6% in 1997,
was largely related to business development spending.
NON-INTEREST EXPENSE (year-over-year % increase)
For the year ended October 31 1998 19 9 7 19 9 6 1995 1994
Salary and employee benefits 1.6 14.7 10.6 11.3 7.9
Premises and equipment 6.2 26.0 6.9 13.3 3.4
Communications 7.8 12.4 5.6 15.5 9.1
Other expenses 11.3 15.6 4.4 17.3 27.7
Total non-interest expense 4.7 16.8 8.3 13.1 10.5
Note: For more information see Table 8 on page 59.
The expense-to-revenue ratio in 1997 was 64.4%, with revenue growth of 15.1% offset by
expense growth of 16.8%.Expense g rowthin 1997 reflected the benefits of productivity improve-
ments which were more than offset by strategic development spending and the $75 million charg e.
PRODUCTIVITY
STRATEGY:
To achieve operational efficiency
through a combination of effec-
tive cost management and strong
revenue growth.
MEASURE:
Expense-to-revenue ratio, calcu-
lated as non-interest expense
divided by total revenues, is our
primary measure of productivity.
The ratio is calculated on a
taxable equivalent basis.
STRATEGIC DEVELOPMENT
SPENDING
Strategic development spend-
ing of $300 million in 1998
was directed to the following
initiatives.
mbanx – expansion of virtual
banking unit
Telephone banking– expansion
of delivery channel services
Cebra – development of inte-
grated digital commerce solutions
Pathways-Financial Growth
CentresTM – development of
educational delivery channels
See operating group sections
for additional detail regarding
these initiatives.
9897969594
EXPENSE-TO-
REVENUE RATIO (%)
66.5
64.4
63.4
64.3
62.0
9897969594
NON-INTEREST EXPENSE
AND ANNUAL GROWTH
4.7
16.8
8.3
13.1
10.5
4,833
4,613
3,949
3,646
3,223
Non-interest expense ($ millions)
Annual expense growth (%)
OUTLOOK
Expense growth in 1998 of 4.7% was lower than in 1997 because of reduced spending on strategic
development and lower business volume expense growth. Management expects to manage expense
growth in relation to revenue growth in order to achieve productivity improvem ents.
30
TMPathways-Financial Growth Centre is a trade mark of Bank of Montreal.
BANK OF MONTREAL GROUP OF COMPANIES
CAPITAL MANAGEMENT
STRATEGY:
To maintain a consistently
strong capital position, while
earning appropriate returns
on capital to support long-term
shareholder value.
MEASURE:
The Tier 1 Ratio is our primar y
measure of capital adequacy.
The Office of the Superintendent
of Financial Institutions, Canada
(OSFI) defines this measure
as Tier 1 capital as a percentage
of risk-weighted assets.
Note: Formore information see table on page 50.
9897969594
REGULATORY CAPITAL
RATIOS†
9.7 10.4
9.1
9.4
9.5
Total Capital Ratio (%)
Tier 1 Ratio (%)
7.3
6.8
6.7
7.0
7.2
Note: Formore information see table on page 50.
9897969594
ASSETS-TO-CAPITAL
MULTIPLE
16.0
18.0
19.0
17.6
17.7
CAPITAL MANAGED IN LINE WITH STRONG BALANCE SHEET GROWTH
Capital is defined as investor resources, typically shareholders’ equity plus subordinated debt,
available to provide support for our risk-taking activities.Capital is a strategic resource, which
requires a disciplined management program to ensure efficient and effective deployment.
A consistently strong capital position enables us to:
■Ensure the quantity and quality of capital is adequate to cover the economic risks arising
from our business operations;
■Meet or exceed the expectations of the market;
■Optimize our capital usage; and
■Exceed minimum regulatory requirements at all times.
Approach:
In managing our capital, we need to balance the needs and requirements of stakeholders,
including shareholders, regulators and rating agencies. Accordingly, capital management
is
an integral part of our risk management strategy.
Management of our capital takes into account economic, regulatory and legal entity
requirements. Capital is managed at two levels – the consolidated Bank level, and the line
of business level.
At the consolidated Bank level, total capital determines the amount of risk that we can
assume and we work to ensure that regulatory and legal capital requirements are met. For
internal
management purposes, our focus is equity capital. At the line of business level,
equity is managed on an economic basis. Equity is allocated to support the economic
risks associated with a particular transaction, activity or line of business. Its primary use is
evaluating investment decisions and measuring performance through RAROC.
Improved Capital Ratios
Our Tier 1 Ratio increased to 7.26% in 1998 from 6.80% in 1997, while risk-weighted assets
increased 12.4%. This was made possible by active balance sheet management, with various
initiatives undertaken in 1998 to optimize our balance sheet, including the securitization
of corporate loans, mortgages and credit cards. Approximately $9.7 billion of assets were
securitized in 1998 (see page 50 for a description of the securitizations and their impact),
which helped to moderate risk-weighted asset growth to a level more supportable by
internally generated capital. Another 1998 initiative was the issuance of preferred shares,
which resulted in an increase of $650 million in Tier 1 capital. The Tier 1 Ratio improved by
79 basis points as a result of these initiatives.
We also use secondary measures for monitoring regulatory capital requirements, namely
the Total Capital Ratio and the assets-to-capital multiple, both defined by OSFI. OSFI requires
banks to meet the minimum capital requirements of 4% and 8% in terms of Tier 1 and Total
Capital Ratios respectively,and also requires them to not excee d an assets-to-capital multiple
of 20. Our Total Capital Ratio, the ratio of total capital to risk-weighted assets, was 10.38% as
at October 31,1998. This was up from 9.66% at the end of 1997, due primarily to the strength-
ening of the Bank’s Tier 1 Ratio mentioned above and the issuance of subordinated debt.The
assets-to-capital multiple is the multiple of adjusted assets (including guarantees and letters
of
credit) to total capital. Our assets-to-capital multiple as at October 31, 1998 was 16.0,
improved
from 18.0 at the end of last year. The reasons for the improved multiple are the
same as noted
above for the improvement in the Total Capital Ratio.
In 1997 our Tier 1 Ratio increased to 6.80% from 6.71% in 1996. This improvement was
driven by an increase in Tier 1 capital of 18.7%, offset by the impact of a 17.0% increase
in
risk-weighted assets. Tier 1 capital increased through retained earnings growth and the
issuance of $400 million of preferred shares. Risk-weighted asset growth was moderated by
various balance sheet risk management initiatives, including our first asset securitization.
OUTLOOK
Capital ratios in 1998 were managed in line with strong balance sheet growth. Management expects
to continue to maintain the Tier 1 and Total Capital Ratios above 7% and 10% respectively, in line
with OSFI expectations.
49
†Defined in the Glossary on page 92
Strategy
Measure – identification and
definition of primary measures
Discussion of results
Supporting measures
or other data
Outlook
Strategy
Primary measure
definition
Process overview
Supporting
information or data
Results and
accomplishments
Outlook
Financial Performance
Financial Condition
INDEX
Financial Performance
21 Shareholder Value
23 Earnings Growth
25 Profitability
26 Revenue Growth
30 Productivity
31 Operating Group Review
32 Personal and Commercial
Financial Services
34
Electronic Financial
Services
36 Harris Regional Banking
38 Investment and
Corporate Banking
41 Portfolio and Risk
Management Group
Financial Condition
43 Enterprise-wide
Risk Management
49 Capital Management
51 Economic Outlook and
Global Developments
54 Supplemental Information