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

BMO capital-markets head Pat Cronin, left, and Luke Seabrooke, 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.

J.P. MOCZULSKI/The Globe and Mail

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.

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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 commodity-based 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 from roughly 1.5 per cent to as much as 3 per cent "isn't a huge stretch," he added.

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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 European-based 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.

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"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, foreign-exchange hedge and an interest-rate 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."

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About the Author
Capital Markets Reporter

Christina Pellegrini is a reporter at The Globe and Mail and a regular contributor to Streetwise, covering capital markets, the exchange business and market structure.She writes about the capital markets divisions of BMO, CIBC and National Bank; independent brokerages such as Canaccord Genuity; and the Canadian operations of foreign dealers including JP Morgan, Goldman Sachs, Credit Suisse and Citigroup. More

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