Q4 2002 CONFERENCE CALL - Personal banking information slides/3/1/Q4...Q4 2002 CONFERENCE CALL CORPORATE PARTICIPANTS ... annual results will show a considerable improvement in BMO's

FINAL TRANSCRIPT

Q 4 2 0 0 2 C O N F E R E N C E C A L L

C O R P O R A T E P A R T I C I P A N T S Susan Payne BMO Financial Group - Senior VP of Investor Relations

Tony Comper BMO Financial Group - Chairman and CEO

Karen Maidment BMO Financial Group - CFO

Michel Maila BMO Financial Group - Head of Corporate Risk Management

William Downe BMO Financial Group - Deputy Chair

Ronald Rogers BMO Financial Group - Deputy Chair

Frank Techar The Harris Group - President and CEO

Gilles Ouellette Private Client Group - President and CEO

Yvan Bourdeau Investment Banking Group - President and COO

Lloyd Darlington Technology and Solutions in E-Business - President and CEO

Robert Pearce BMO - Personal and Communication Client Group

C O N F E R E N C E C A L L P A R T I C I P A N T S Jamie Keating Merrill Lynch - Analyst

Robert Wessel National Bank Financial - Analyst

Melanie Ward RBC Capital Markets - Analyst

Michael Goldberg Desjardins Securities - Analyst

Quentin Broad CIBC World Markets - Analyst

Heather Wolf Goldman Sachs - Analyst

Susan Cohen Dundee Securities - Analyst

Ian De Verteuil Nesbitt Burns - Analyst

P R E S E N T A T I O N

Operator

Welcome to the BMO Financial Group Fourth Quarter 2002 Financial Results Conference Call. During the presentation, all participants will be in a listen-only mode. Afterwards we will conduct a question and answer session. At that time if you have a question, please press the one followed by the four on your telephone. As a reminder, this conference is being recorded Tuesday, November 26, 2002. I would now like to turn the conference over to Susan Payne, Senior Vice President of Investor Relations, BMO Financial Group. Please go ahead, ma'am.

Susan Payne - BMO Financial Group - Senior VP of Investor Relations

Thank you, Operator. Good afternoon, everyone. Thank you for participating in today's conference call. This afternoon's overview of our fourth quarter results will be provided by Tony Comper, our Chairman and CEO; Karen Maidment, our CFO; and finally Mike Maila, Head of Corporate Risk Management. After Mike's presentation, all the Members and the Management Committee will also be available to answer your questions. Bill Downe, Deputy Chair; Ron Rogers, Deputy Chair; Frank Techar who joins us from The Harris Group; Gilles Ouellette from the Private Client Group; from Investment Banking Group, Yvan Bourdeau; Lloyd Darlington who heads up Technology and Solutions in E-Business; and Rob Pearce from the Personal & Commercial Client Group in Canada. At this time I would like to refer our listeners to our Investor Relations web site at www.bmo.com to view our forward-looking statements and the risk factors pertaining to these statements. Now, I'd like to hand the floor over to Tony.

Tony Comper - BMO Financial Group - Chairman and CEO

Thanks, Susan. Good afternoon, everyone. I'd like to make a few introductory comments starting with the overall observation that we had a solid year in a challenging market environment concluding 2002 with a good fourth quarter. These results reflect the ongoing strong performance from our Personal & Commercial Operations both in Canada and the U.S., lower provisions for

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FINAL TRANSCRIPT BMO Financial Group Q4 2002 Earnings Conference Call

credit loses, and continued focus on containing costs. If we exclude the nonrecurring items, cash earnings per share for the year were $2.91. That's an increase of 8.6% from last year. Net income for the fourth quarter was $423 million, and that's up from $109 million a year ago. We met our annual targets and the key measures of cash earnings per share growth, cash return on equity and tier one capital despite the weak credit environment and very soft capital markets. And once more the annual loan loss provisions of $820 million were in line with the guidance that we gave you in April and down $160 million from 2001. That's a top tier performance among our Canadian peers. Expenses rose 1% from a year ago, if we exclude nonrecurring items and the costs of acquired businesses, and were flat for the fourth quarter after adjusting for those nonrecurring items, acquired businesses, and severance costs. This bodes well, I think, for continued progress in reducing expenses. We believe that when all the results are in, annual results will show a considerable improvement in BMO's relative performance in our Canadian peer group. The most significant contribution to performance came from our Canadian and U.S. Personal & Business Banking Operations, which demonstrated real strength throughout 2002, achieving a 23% increase in net income for the year, with strong growth in volumes and improved productivity ratio of 60%. During the fourth quarter, net income for this group grew 32% from a year ago, and revenue grew 10%, with strong expense control resulting in a productivity ratio of 59.7%. In the U.S., the retail and small business loans increased 23% from the fourth quarter of 2001. In Canada, market share and retail banking increased 35 basis points to 13.7% from a year ago, and market share for small business loans up to $5 million increased 61 basis points, year-over-year, to 19.5%. That brings us really close to our goal to move from second to first in this key target market. Highlight of the year for the Personal & Commercial Operations was the successful launch of our Pathway Connect Technology to our Canadian branches and call centers. The installation of this fully integrated state-of-the-art technology platform, plus complementary customer knowledge and decision support software is proceeding at the rate of about 100 branches a month with planned roll out completion for January 2003 on track. We really believe that this massive investment in sales and productivity tools for our employees, plus the introduction of 1,000 new sales people into branches over a 12-month period ending in January 2001, and a concerted overall effort to create a stronger sales and service culture, really positions BMO well for the future. Moving now to the Wealth Management Operations, earnings in the private client group rose 12% from a year ago, excluding nonrecurring items. Expense growth was only modestly above revenue growth in spite of acquisition costs and the weak environment for equity related businesses, while assets under management and administration increased $33 billion, or 14% from a year ago. For this group, 2002 was a year marked by

continued expansion of the Harris Wealth Management Platform, as we announced four U.S. Wealth Management acquisitions totally $676 million, and also made excellent progress in integrating the acquisitions into our existing platform. The group is now poised for growth when market conditions improve. We turn now to Investment Banking Group. Year-over-year revenues fell substantially more than expenses due to net securities losses and weaker trading-related activities. Nonetheless, net income in this group improved year over year due to a much lower provision for credit losses. I think a really encouraging story of the year for this group is the very substantial reduction of risk-weighted assets, and that's the culmination of four years of behind-the-scenes efforts. If we go back to 1999, we have reduced risk-weighted assets by $29 billion. In addition, we've identified approximately $7 billion of non-core assets that will mature over the next three years. And as they mature, we'll replace then with higher-return assets. Over the coming years, therefore, our risk-weighted assets will remain relatively stable, while our ability to increase returns will improve. We've based our 2003 business plan on the practical reality that capital markets have proven stubbornly sluggish and recovery in business investment is by no means assured. Consistent with our ongoing and determined execution of our growth strategy, we're going to continue to invest in those businesses in both Canada and the U.S. that contribute most to our current and future strengths and to our prospects for revenue growth. Excluding nonrecurring items, we are targeting earnings-per-share growth of 10% to 15% and that's on both a reported and a cash basis, and we're targeting return on equity of 14% to 15% or a cash ROE of 15% to 16%, as you can see on the slide. In addition, we're targeting a tier-one capital ratio of at least 8% and a provision for credit losses that is at or below the 2002 level of $820 million. Mike Maila will give it a bit more insight on the asset quality, but let me just say that BMO's exposure to industry groups that are currently under stress--and that includes communications, power, and power generation--represent a very small part of our overall loan portfolio and specific allowances for impaired loans in these industries, as in other sectors, are adequate. That is consistent with the prudent approach to credit risk management that BMO has maintained for many years now and will continue to maintain as a leader in credit risk management. Throughout 2003, as we execute our transnational growth strategy of investing in our core Canadian operations while expanding selectively but substantially in the U.S., the number one priority for this leadership team will be productivity improvement, the twin requirement to increase revenues while driving down costs. As we did in 2002, our approach will balance short- and long-term investment needs with the necessity to substantially improve efficiency. While protecting customer-related expenses that are essential to increase sales and protecting strategic initiatives which

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are designed to promote future growth, we're going to continue to streamline functions to achieve greater operational effectiveness. The only difference is that in 2003 productivity improvement will be the top priority for every unit of this enterprise. In concluding my opening comments, I want to emphasize that this leadership team is devoted to increasing returns to shareholders. After a lot of perseverance in making the changes necessary to improve performance while steering a steady course, BMO is now showing strength in a time of adversity. This organization's trademark prudence, focus, and discipline have served shareholders well, placing BMO in an excellent position to take full advantage of a market turnaround when it occurs. Now much work remains to be done to further improve performance, but I believe our recent results would indicate that we are ready, willing, and capable of doing precisely that. Over to you, Karen.

Karen Maidment - BMO Financial Group - CFO

Thanks, Tony. As Tony mentioned, this was a strong fourth quarter in a solid fiscal 2002. The fourth quarter met our expectations, and we achieved our performance targets for earning's growth and ROE. BMO's fiscal 2003 targets are based on improved financial performance next year. We anticipate solid performance from Personal & Commercial to continue and the investment banking and private clients results to improve as growth in the U.S. economy is expected to pick up next year. And in Canada, economic growth factors are expected to remain healthy. Also, with the CBOs now fully written off and behind us and other investment write-downs also behind us, IBG is well positioned for improved results relative to fiscal 2002. Lastly, the decisions to reduce staffing levels will reduce our costs going forward. However, some of these savings will be offset by a higher tax rate and increased pension costs next year. Please note that the results presented exclude nonrecurring items as identified in the MDNA and press release unless otherwise noted. Slide one shows a financial snapshot of our fourth quarter performance. Net income was $423 million, up $314 million from a year ago and up $63 million from last quarter. Reported net income was $398 million, the difference being the one time acquisition-related costs of $25 million after tax, classified as nonrecurring in the fourth quarter. The change in accounting for good will added $56 million to the bottom line for fiscal 2002 and $15 million to the fourth quarter. A couple of items worth noting this quarter: one being the lower tax rate of 22% and the other being severance costs of $50 million. These pretty much net out, and the remaining improvement largely reflects ongoing core results. With respect to income taxes, we are estimating the

effective tax rate for the Bank for 2003 to be approximately 31%, and we expect our actual tax rate to be closer to 28% to 29%. Cash ROE of 16.4% for the quarter reflects improvement over Q3, and our provisioning ratio for the quarter was 43 basis points. Finally, the tier-one capital ratio at 8.8% is up from Q3 primarily as a result of retained earnings growth partially offset by additional good will and intangibles. Slide 5 focuses on revenue growth drivers. Revenue growth continues to be a challenge for the bank. You can see that from this slide core revenue grew by 1.2% on a link quarter and 1.8% year over year. On a total-year basis, core growth was flat year over year. It was a challenging market environment for IBG and PCG with low interest rates negatively affecting spreads and low levels of client-driven activities that, in general, offset good volume growth in P & C, resulting in an overall flat performance. Slide 6 focuses on expense growth, which is a much stronger story. The Bank's core expenses grew, continue to be managed successfully consistent with the third quarter. Half of the growth in the link quarter and year-over-year basis is due to the severances of $50 million mentioned earlier; and versus last year, after allowing for severances, the year-over-year growth can be attributable totally to acquisitions. We're really pleased to see some of the good trends emerging as a result of the cost-management initiatives. This leads us to Slide 7, which shows our expense-to-revenue ration of 68.3% in Q4, which is down slightly from last quarter. The increase from a year ago reflects growth in the relatively higher cost wealth management business and severance costs included in Q4. Adjusting revenues and expenses for severance costs booked in Q4 gives you a productivity ratio of 66.1% and as Tony emphasized, the bank is focused on bringing this ratio down. Slide 8 illustrates the performance in personal commercial. Net income of $256 million was unchanged from Q3, and we are particularly pleased with the improvements in the productivity ratio. The productivity ratio closed the year at 59.7 for the fourth quarter. Market share in this group is another good news story. Volume growth has led to greater market share for total, personal, and small business loans. Slide 10 highlights the performance of our investment banking group, which has improved considerably on a link quarter and year-over-year basis. Net income increased by $138 million from Q4 of last year due to lower provisions and increased by $36 million from Q3 of this year driven by revenue growth that exceeded the increase in expenses due to revenue-driven compensation and severance costs. Slide 11 highlights the performance of our Private Client Group, which generated a solid performance in difficult market conditions. The acquisition of CSFB direct, now known as Harris Direct, was completed in the second quarter and Northwestern Trust in the third quarter of this year. Revenue and expense growth was higher

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As Slide 3 indicates, this accounts for 40% of fourth quarter formations of gross impaired loans. Notwithstanding our decisions with respect to these five loans, the rate of formation of impaired loans this quarter is down from the previous quarter, and as Slide 4 indicates, formations have been trending lower since Q2, both in dollar amount as a percentage of the portfolio.

because of these acquisitions. And we've included a slide on the impact of the acquisitions. I believe it's Slide 22. Moving to Slide 14 to promote a better understanding of BMO's U.S. Operations and consistent with our strategy, we will expand our disclosure in our U.S. results beginning in 2003. As when announced earlier today, Harris Bank Corp will deregister from the SEC. Harris Bank continues to operate as a multi-bank holding company and remains subject to the regulation by the U.S. Board of Governors of the Federal Reserve Bank. Harris Bank's Q4 press release will be the last such disclosure.

Turning to Slide 5, you can see that the consumer and commercial portfolios now account for 74% of the overall loan book. A comparable figure at the end of fiscal 2001 was 68%. The consumer portfolio, as Tony has mentioned, in particular has shown solid double-digit growth this year. And as Slide 6 shows, asset quality in this portfolio is being maintained. In fact over the past two quarters, the proportion of consumer loans, which are delinquent by 90 days or longer, has decreased noticeably.

One other change to note for 2003 is that we will begin recognizing compensation expense for new stock options granted after October 31 of this year. This expense is expected to be in the range of $0.02 to $0.04 per share next year. BMO is the only bank that has performance-based options. In fact, two-thirds of the senior management options are performance based and are exercisable only after certain market conditions are met. This aligns shareholder and management interests.

Finally, moving from credit to market risk, you can see from Slide 7 that our trading and underwriting performance during the quarter was profitable and against a backdrop of continued market volatility relatively stable. At this point, I'd like to turn the call over to the conference operator for the question and answer session. Operator?

One final comment on dividends, this year our dividend payout ratio was 44%. This was higher than our policy of 30 to 40%. Going forward, we will be reviewing our dividend policy and making an appropriate recommendation early in 2003. Thank you and over to Mike.

Michel Maila - BMO Financial Group - Head of Corporate Risk Management

Thanks, Karen. And good afternoon, everyone. Let me walk you briefly through the main highlights of our risk review for this quarter. As Tony mentioned, the provision for credit losses came in within our April guidance for the year, not withstanding a challenging credit environment. In light of that environment and given some continuing uncertainty with respect to the evolution of the U.S. economy next year, we have set our target for the provision for credit losses for fiscal 2003 at or below this year's level. Turning to Slide 2, you can see that the aggregate of our long portfolios in the five sectors which have been in the news of late--namely cable, power generation, telecommunications, auto manufacturing and supply, as well as airlines and air space--the aggregate of our loan portfolios in those five sectors represents less than 4% of the overall loan book. This reflects our steady focus on portfolio diversification both in good times and in not so good times. A conservative approach to classifying loans is impaired and the prompt identification of problem loans are two further priorities in our credit risk management practices. Accordingly, in view of the deteriorating economics of the power generation business in the U.S. and the United Kingdom, we transferred to impaired status this quarter five corporate loans totaling $186 million.

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FINAL TRANSCRIPT

Q 4 2 0 0 2 C O N F E R E N C E C A L L

Q A N D A Yeah. Those are the two unusual items this quarter, so the tax is at

22 percent, not a sustainable rate, but it's about 30 million lower than what we consider a sustainable rate. And the severance costs relating to about 500 employees is $50 million pre tax and about 30 after tax, so those two wash in essence. The remainder of the items are related to the core operations. So not related, but I think you can look at them as two unusual that are similar in amount. In terms of the pension, the funding itself, the pension plan will be funded, as we mentioned in our press release, fully in the next couple of months; $280 million in funding is going to take place over the next few months. And the pension expense was $68 million this year and I expect it to increase by about $70 million next year.

Operator

Thank you. Ladies and gentlemen, if you would like to register a question, please press the one followed by the four on your telephone. You will hear a three tone prompt to acknowledge your request. If your question has been answered and you would like to withdraw your registration, please press the one followed by the three. If you are using a speakerphone, please lift your handset before entering your request. One moment please for the first question.

Jamie Keating - Merrill Lynch - Analyst Our first question is from the line of Jamie Keating of Merrill Lynch. Please proceed with your question.

Thank you very much. Thanks for the good color.

Jamie Keating - Merrill Lynch - Analyst Operator Thanks very much. I hope you can hear me okay. A couple of

quick questions, if I may. Just from the management press release of the fourth quarter report, Page 3, the bottom of the page, there was a quick reference to what I think Karen was describing as the potential or the substantial offset of the income tax benefits in the quarter relative to the severance costs, whether those are related or not I don't know, but I wonder if I could get a little color on to what degree the offset was there, and again maybe a discussion as to whether they are indeed related to the quarter. The other question is also from the press release, if I could, the, again, reference was made by Karen to pension expenses for next year, and on Page 10 of the press release there's a discussion that the expenses rose by $68 million in the year and they rise again by the same amount. Can you just describe where the pension plan and the post-retirement plans are funded right now as at year end relative to obligations and assets, and just give us some color as to what's happening on any other assumptions other than just the return on the assets?

Our next question is from the line of Robert Wessel of National Bank Financial. Please proceed with your question.

Robert Wessel - National Bank Financial - Analyst

Yeah, good afternoon. I just have two quick questions actually. The first is with respect to the provision guidance for 2003 being at or lower than what you have. Can you put that target in the terms of a provision ratio and a range?


Thanks for your question, Rob. I'll get Mike to deal with it. Mike?


Tony Comper - BMO Financial Group - Chairman and CEO Robert, it's a function of loan portfolio growth, so if you look at 820, which is the top end of the guidance, and on the basis of the existing portfolio, that's about 55, 56 basis points. To the extent that you see loan growth of 3% to 5% percent, the basis points will drop accordingly.

Jamie? Tony. I'll hand it over to Karen to go into detail, but the tax and the severance are not related so that's to your point. Karen, do you want to talk to those items please?

Karen Maidment - BMO Financial Group - CFO Robert Wessel - National Bank Financial - Analyst

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Okay. And one of the second questions I had was do you forecast a material change in the composition of that number in 2003, i.e., say a large drop or material drop in corporate provisions offset by a rise in consumer? Are there any moving parts within that number that we should be aware of in terms of your forecast?


Robert, as I mentioned, I think, with reference to Slide 5, you can see that there has been a shift in the portfolio from corporate towards a greater proportion of consumer and commercial. So you're likely to see commensurate shifts in the provisions accordingly over time.

Robert Wessel - National Bank Financial - Analyst

Great, thank you.

Operator

Our next question is from the line of Melanie Ward of RBC Capital Markets. Please proceed with your question.

Melanie Ward - RBC Capital Markets - Analyst

Thanks very much. I had a question on the rate of recoveries and write-offs this quarter. They actually seem to be at a fairly low rate, so while you're new formations coming in weren't excessive, they did manage to jack up your gross in that impairment level. Can you comment a little bit on what's happening with your sales efforts of recoveries and write offs and how you see that progressing?


Melanie, it's Tony. Just a general comment and then I'll get Mike to turn to the specifics. In general the way in which we manage the non-performing loans is we look to where we're going to get the most value out of a loan, and so we would be reluctant to arbitrarily sell off a non-performing loan if we thought that over time we would actually realize more value by working on it and staying with the account. So that would explain why you wouldn't just see us necessarily automatically knee-jerk react to writing off some loans. But, Mike, can you give some more comment on that?


Yes, thanks, Tony. Melanie, in terms of the sales, we haven't had material loan sales this quarter unlike Q2. And with respect to the

recoveries, if you look at the supplementary package on Page 35, you will see that the recoveries this year are approximately $28 million greater than last year. But there is no particular pattern over quarter over quarter. It's a function of the success of our restructuring efforts in various portfolios and accounts, and that's not easy to predict.


Okay, thank you. And secondly, on your investment banking group risk-weighted assets now standing at about $56 billion, you had said there were seven billion that would be just normally running off over the course of the next few years. Is there a more aggressive target? I do know that they've come down fairly aggressively. Is that kind of the target taking seven billion off?


Yeah, that's about the target, Melanie. We think we've done most of the heavy lifting on that, so the first 29 was the kind of heavy-duty stuff and now it's kind of flattening out. But we're going to reuse that because we have a growth strategy as well in the lending business, which is more focused on our U.S. platform and growing of the client franchise in Harris Nesbitt. But, Bill, do you want to add any more comments to that?

William Downe - BMO Financial Group - Deputy Chair

I think that's right, Tony. The capacity that we have in that book now will allow us to continue to upgrade the assets, put pressure on the low-yielding assets and continue to deploy those assets in the faster growing areas--the mid market in both Canada and the United States.


But the fact of the matter there is that we think we've got the capital that underpins the investment banking business about right, so you will not see a concomitant increase in the capital that we've allocated to the investment banking business. We believe you got enough to support the strategy in the course that we're on right now.


Thanks very much.

Operator

Our next question is from the line of Michael Goldberg of Desjardins Securities. Please proceed with your question.

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Michael Goldberg - Desjardins Securities - Analyst

Thanks very much. I have a couple of questions. It looks like during the year, you're variable comp as a percent of brokerage underwriting and trading revenue is all over the map, at between 58% and 78% per quarter. Could you give us some idea of what this is likely to be next year? And secondly, of the 186 million power formations in the fourth quarter, how much were fourth-quarter fallen angels versus loans that were already non-investment grade? Thanks.


Okay, we'll take those in reverse order. I'll get Mike to answer your second question and then Yvan to handle the first one. Michael?


Michael, the answer is very little of that $186 million. Typically we like to classify early based on the number of indicators, and if you're referring to rating agency downgrades, they did not play any role in our decisions to classify those particular accounts.


Thanks, Mike. Yvan?

Yvan Bourdeau - Investment Banking Group - President and COO

With regard to the variable compensation, we tried to align as we have our specific driver for each of our LOBs. The performance in each quarter [with] the results that were driving it, it [pooled] for that specific line of business. So it's very much subject to the performance of the LOBs quarter by quarter, and they did vary quarter by quarter this year and that's explains the variance.


So can you give us some idea of sort of a target next year?


Well, you know, at the beginning of the outset of the year, we would think that we would have hopefully possibly a more consistent pattern. As you can recall in the Q2 and Q3, we had some debt investment security losses that affected our comp, and

that's one of the reasons why the variable comp varied in or throughout 2002.


Okay, and I'm still a little confused by Mike Maila's answer. Did you classify some of the Q4 fallen angels in the fourth quarter or not?


Let me clarify, Michael. In terms of definitions, if you're referring to fallen angels as rating agency downgrades from an investment grade to below investment grade, the answer stands, i.e., we did not downgrade those accounts because rating agencies were downgrading them.


Okay, thank you.

Operator

Our next question is from the line of Quentin Broad of CIBC World Markets. Please proceed with your question.

Quentin Broad - CIBC World Markets - Analyst

Yeah, good afternoon, and thanks again for moving a benchmark on reporting. You guys keep giving us more and more data and I appreciate it. Perhaps for Karen, in terms of the EPS growth expectation for '03, if I can just confirm first that if we use cash basis of 291, that's the base on which we'd grow 10% to 15% which means 320 to 335 next year, or this year?


That's correct, Quentin.


So using the information you've given us in terms of the tax rate moving to 28% to 29% versus 26.7, the option expense carrying it 2% to 4% impact for full year, the pension expense having an additional impact of about an annualized $0.10. That would, in effect, if you will, reduce EPS this year to 270 if my calculations are all correct. About $0.07 for tax, $0.04 for options and then $0.10 for pension, which means that you're really looking for a 191/2% to 24% comparable growth. So if you can just give us cents, is that, you've talked about expense savings is going to be

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the key or productivity ratio is the key, but you also mentioned, Karen, I think in your comments, still challenged on the revenue side and we're not expecting any massive decline in PCL, so where does this growth come from?


The growth comes from a couple areas but one of the areas that we had this year is the significant investment write-downs, particularly the CBOs, and those are behind us and we don't expect write-downs of securities to continue in that area. And that would be over a $100 million after tax. So a couple of ways to look at the targets for next year: one is you might say that Q4, as I said, is a pretty clean quarter, and it's $423 million. If you annualize that, that's about $1.7 billion, but then you have to adjust for the fact that our guidance is higher next year, so that brings us down a little bit, but that takes us to the low end of the range. Another way of looking at it is just look at this year's earnings and then adjust for the fact that the investment write-offs won't be there to the same magnitude next year, and again, that takes us to the low end of the range. The low end of the range in net income terms is around $1.6 billion. And so both of those, I think, take us to there and then really what we're shooting for is growth in our businesses. You look at the Personal and Commercial, we're expecting to continue to see the volume grow and the revenue there and the productivity improvement across the Bank to drive the earnings further forward. Again, the PCLs, what we've given you is the high end and if those are lower than the high end of the range, that'll drive the EPS up to the higher end of our guidance as well.


On the PCLs themselves, Mike, you talked about being at the 55 basis points and you did give us a road to a 40 to 50 basis point range, and you've chosen to move off that kind of range, which I think is, what Rob Wessel had asked you. I'm curious, in light of where we are in the cycle, the last four years you've generated about a $550 million average PCL and that's, I think, about what you book per the individual segments. You're at about 510 on a full-cycle charge. Where do you think we are in that full cycle expectation? Because I have to assume at some point you go lower because obviously you've been higher. So where do you think we are in light of the 820 maximum you've just provided us?


I'll just make one comment, Quentin, before I hand it over to Mike. The answer is it's somewhat unpredictable. While we've continued to see very strong growth in Canada, we haven't seen the pick-up in investment spending in the U.S. that is going to be necessary to support the growth. Now, our economics department is confident that with the massive monetary stimulus that we've put into the system, we should start to see that growth picking up and

there are some encouraging signs around in the labor markets and a few other factors. But it hasn't yet materialized so we do have a bit of an uncertain environment that we're going into and I'll get Mike to comment on therefore, what does it look like from a cycle point of view, Mike?


Yes, thank you Tony. The only thing I would add is confirm your numbers, Quentin, indeed the expected loss booked to the operating groups last year was $510 million. You're quite right. Clearly we do not believe the credit cycle is over, hence we would expect still to be north of that point next year or so. And at this point, this is how we see it. That's how we're comfortable positioning the guidance. We'll keep it under review and as the environment changes, we'll update that for you.


Great, thanks guys.

Operator

Our next question is from the line of Heather Wolf of Goldman Sachs. Please proceed with your question.

Heather Wolf - Goldman Sachs - Analyst

Hi, good afternoon. Two questions. First off, I'm curious why you decided to take your severance charges just via the income statement and not take a restructuring charge like some of your peers have. And secondly, with respect to expenses in the investment banking division, they were up quite a bit quarter over quarter. I'm assuming that that's from variable compensation. And I'm curious (A) If that's correct and (B) Why it is that you guys are posting noticeable increases in variable compensation while your competitors are posting decreases?


Okay, Karen and then I'll give you Yvan?


Heather, the severance costs--we didn't treat them as a non-recurring restructuring just because of their size. And also, we're continually managing headcount levels and so we didn't think it was appropriate to treat them as a below the line restructuring item. In terms of the comp on IBG, Yvan Bourdeau can address that.

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Yvan Bourdeau - Investment Banking Group - President and COO Tony Comper - BMO Financial Group - Chairman and CEO If you look, Heather, from a quarter to quarter, our expense increased by 20 million Q4 versus Q3. Fifty percent of that was due to variable comp going up and that's basically because we had a better quarter in Q4 than Q3. And the remainder was basically because of a severance or charge for our share of costs for laying off some of our employees.

Yeah, I'll get Yvan to do that, Susan. And by the way, just a corollary to the point I was making about our appetite for acquisition is, anything that we do will probably be in the smallish domain as opposed to anything consequential. So you just look at the pattern of what we've done and it will be similar to that, but smallish rather than largish. Yvan?


Heather Wolf - Goldman Sachs - Analyst

Thank you very much. Thank you, Tony. As you have noticed, compared to the third

quarter, our M&A advisory fee improved substantially in Q4 and probably most important is by the end of Q3 and certainly by the end of August in Q4, we saw a definite improvement in activities from our clients, both on the M&A front as well as on the restructuring front, and therefore, we're quite confident that we will have at least a sustainable level of M&A emanating in Q1 and moving forward in '03.


Thanks, Heather.

Operator

Our next question is from the line of Susan Cohen of Dundee

Securities. Please proceed with your question. Susan Cohen - Dundee Securities - Analyst

Susan Cohen - Dundee Securities - Analyst Thank you very much.

Thank you. After making four acquisitions in 2002, can you talk a little bit about your acquisition strategy for 2003?

Operator

Our next question is from the line of Ian de Verteuil of Nesbitt Burns. Please proceed with your question. Tony Comper - BMO Financial Group - Chairman and CEO

Yeah. I think the easiest way I can come at that, Susan, is to say if you look at the pattern of what we've been doing over the last two or three years, in terms of both organic growth and acquisition, you can probably expect to see us pursuing a similar pattern. And so we're opportunistically looking to continue to build up the wealth management platform in the United States. And so you've seen us picking off different entities that fit into one or the other of the buckets of the strategy for the Wealth Management Group, the Private Client Group, and then bolting them into the overall platform. And as I said at the last quarter, we're continuing to be on the outlook for product capability in the area of institutional equity sales and trading, including research. That's the one ingredient that we think kind of rounds out our product capability in the U.S. and so that will continue.

Ian De Verteuil - Nesbitt Burns - Analyst

On Page 14 of the supplemental pack, the non-interest expense--I see the salaries are about $50 million, which I guess is the severance. I'm wondering why the computer and equipment is up by the total of $50 million as well?


There are a couple of reasons, Ian--this is Karen--one is that we're starting to depreciate the Pathway Connect investment and so that bumps it up as well. The one-time costs related to the CSFB acquisition are in here, and so there's some integration related costs that are in that account.

Susan Cohen - Dundee Securities - Analyst Ian De Verteuil - Nesbitt Burns - Analyst

Thank you. And secondly, certainly investment banking shows some improvement this quarter because of the pick-up in M&A activity. Can you talk a little about your pipeline of M&A mandates and underwriting mandates?

So going forward, what would we expect on the salaries on the computer and equipment lines?

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Yeah, thanks, Jamie. I'll get Bill Downe to deal with your questions. Bill?


The Pathway Connect deprecation increased about $20 million a quarter, so I think that what you'll see is that increase staying in, but the remainder of the increase won't continue.


The concentrations, Jamie, in the acquisitions as you know have

been in the direct brokerage business and the management team has done an outstanding job of taking expenses out during this period of time when volumes are down. So I think that their target has been to get to a sustainable level of profit, irrespective of market conditions. And whether we'll see a pickup in revenue in, in two quarters or in three quarters or four quarters has an enormous amount to do with just market volume. We're seeing now individual days of big step ups in volume, but it's just a day or two at a time, not enough days to put together to reach the levels that we think we'll see one quarter out or two quarters out. So the time frame that we're comfortable with, with respect to the revenue showing up in these businesses, is probably still in a 12-month, 18-month frame. It could come sooner. With respect to the path of acquisitions, as Tony said, we have a pipeline of transactions. Today, it's about the same size as it was this time last year. I would say that the makeup probably is more weighted to the end of the private banking than the direct brokerage at this point, and as Tony said also, at very small end, the equity sales and trading side of IBG. So I don't know if that gives you a sense of the sensitivity of revenue but--


Thanks. The second question, I guess follows up on Quentin's point about the 2003 targets. I see how you get the EPS growth rate of 10 to 15, but when I go to the cash ROE, the 15% and 16% on our average book value of around $22, I get quite a bit higher number on EPS. Can you, Karen, sort of talk us through what--as opposed to getting 320 to 330? I'd be getting like more like 340 to the 360. Am I missing something there?


No, I don't think you are. I think the EPS numbers are really within the range that we're expecting. I need to follow up on that question because I can't give you the details on that.


Thanks.

Jamie Keating - Merrill Lynch - Analyst Operator Bill, what I was wondering was to the extent there's a conversion

factor here, and I may be off track on this, but taking a discount broker's account and making the transition to more of a wealth management account, if that's true, is that impacting this or is that off base?

Our next question is the follow-up question from the line of Jamie Keating of Merrill Lynch. Please proceed with your question.

Jamie Keating - Merrill Lynch - Analyst

Thanks very much. I'm looking at Slide 27, the acquisition detail, which I commend you on. I appreciate all this detail. It's helpful. I'm curious, from the perspective of what we spend on the acquisitions versus the revenue yield on this right now and specifically the earnings yield, I wanted to get sense from you, looking out into the next three or four quarters, how you expect those numbers to progress. And there are two specifics I'm hoping to talk about here, if I'm reading this right. PCG revenue in the quarter we just reported, I think, came off about 11%. I'm just curious to know about its sustainability or trend. But notwithstanding that, clearly the income turned around, expense came down more. And you drove some income off that. Can you just describe a bit about what the sustainability and the core scope of the business is flushing out into after changes made integration?


No. Well, first of all, the signs are very positive. We only have a few months of following through on referrals, but the signs are very positive with respect to our ability to expand that relationship. And as we have brought those clients onto the integrated platform, the salespeople in the branches are getting more prospects of the consequence of the cross selling activity that's going on. But it hasn't translated into big revenue increases yet. I think we're optimistic. We're as optimistic today as we have been at any point about the prospects of that.

Jamie Keating - Merrill Lynch - Analyst

Okay, thank you. Tony Comper - BMO Financial Group - Chairman and CEO

Operator

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Our next question is a follow-up question from the line of Quentin Broad of CIBC World Markets. Please proceed with your question.


Thanks. Just a follow-up, Bill, on acquisitions in the Guardian Group of funds. At the time, you guys talked about accessing the network, getting better distribution, et cetera. Could you just give us a sense of how that's gone in terms of your expectations and being able to access the independent network?


Yeah, Quentin. Tony, I'll get Yvan to fill in the details, but the bottom line is that I think we've been really encouraged by the progress that we've seen to date in terms of maintaining the relationships with the brokerage firms that we had anticipated, and in fact we seem to have growth. Gilles, do you want to--

Gilles Ouellette - Private Client Group - President and CEO

Yeah, we've been operating this for about a year now, and we're very happy with the results. The market has been in a very difficult year. There's been a lot of market share improvement. I think we've gone from 48 basis points up to 61, 62. So they've had an excellent year. At the beginning, I think there might have been some question about whether we have had some attrition. That hasn't materialized. So there's a lot of momentum over there. They've got a good performing family of funds, so we're very happy with the results.


Okay, and if I can have one further follow-up, or I guess, an embedded one. First, Mike, on your general allowances you've chosen to reallocate general allowances this quarter between Canada and the U.S. and is there anything we should specifically take away from that? And then secondly, just on your risk management, looks like you've reversed course in the U.S. profile of the last quarter in terms of your short term gap, and you're reducing your Canadian asset waiting in the short end, also. Just what are the expectations in terms of your gap management and implication for spreads going into 2003?


Quentin, this is Mike. With respect to your first point, as you know, the general allowance guidelines from us came into effect this year. As a result, we are doing a quarterly validation of the general allowance including allocation between the U.S. and

Canada. So you shouldn't read much into it specifically, except an ongoing process of validating the allowance and its allocation. With respect to what's happening with the gaps, essentially we have dispositions in the Harris Portfolio, several investment security portfolios, and what you see is essentially a lower sensitivity to falling U.S. interest rates at this point in the cycle. But generally what we try and do in structural risk management is to maintain high quality, stable earnings. In other words, maintaining our exposures within a narrow, stable range. So you'll see that on an ongoing basis.


Thanks.


Operator, we'll take our last question now on this please.

Operator

Miss Payne, at this time there are no further questions. I will now turn the call back to you. Please continue with your presentation or your closing remarks.


It's Karen. Ian, just going back to your question on the targets on the ROE, I'm not sure I fully understand your question, and you can call me after the call if you want to get further details, but if you look at the earnings this year, cash earnings were $1.456 billion on about $10 billion of equity, which gave us an ROE of 14.6. If you look at 2003, at the low end of the range, $1.6 billion of profits and if you assume a reasonable payout ratio, you've got about a $500 million increase to equity. So 1.6 over 10.5 is 15.2, which is within the range of 15% to 16%. So if you have any further questions, give me a call, but I think it's internally consistent.

Susan Payne - BMO Financial Group - Senior VP of Investor Relations

Thank you, Karen. Thank you for joining us today. As always, if you have any further questions, please either call Investment Relations at 416-867-6656 or email us at www.bmo.com /investor relations. Thank you, and good afternoon.

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