Please standby, your meeting is about to begin. Please be advised that this conference call is being recorded. Good morning. And welcome to the BMO Financial Group's Q1 2020 Earnings Release and Conference Call for February 25, 2020. Your host for today is, Ms. Jill Homenuk, Head of Investor Relations. Ms. Homenuk, please go ahead.

Thank you. Good morning and thanks for joining us today. Our agenda for today's investor presentation is as follows: We will begin the call with remarks from Darryl White, BMO's CEO; followed by presentations from Tom Flynn, the bank's Chief Financial Officer; and Pat Cronin, our Chief Risk Officer. We have with us today Cam Fowler from Canadian P&C; and Dave Casper from U.S. P&C.; Dan Barclay is here for BMO Capital Markets; and Joanna Rotenberg is here for BMO Wealth Management. After their presentations, we will have a question-and-answer period, where we will take questions from prequalified analysts. To give everyone an opportunity to participate, please keep it to one question. Darryl will then close the call with concluding remarks. On behalf of those speaking today, I note that forward-looking statements may be made during this call. Actual results could differ materially from forecasts, projections or conclusions in these statements. I would also remind listeners that the bank uses non-GAAP financial measures to arrive at adjusted results to assess and measure performance by business and the overall bank. Management assesses performance on a reported and adjusted basis and considers both to be useful in assessing underlying business performance. Darryl and Tom will be referring to adjusted results in their remarks, unless otherwise noted as reported. Additional information on adjusting items, the bank's reported results and factors and assumptions related to forward-looking information can be found in our 2019 Annual Report and our first quarter 2020 report to shareholders. With that, said I'll hand things over to Darryl.

Thank you, Jill and good morning, everyone. Today, we reported a very strong and balanced Q1 performance with earnings of $1.6 billion up 5% including revenue up 8% and pre-provision pre-tax earnings up 16%. All of our businesses contributed delivering good performance consistent with business potential and with clear momentum in key areas of competitive strength. In Q4, we expressed to you confidence going into the new year with optimism around stabilizing economic environment overall client sentiment and of course our own business plan. Today's report supports that view. For the quarter, we delivered operating leverage of 4.6% with every business above 2%. Efficiency improved a significant 270 basis points year-over-year with a strong total bank revenue performance and disciplined expense management. And we remain committed to an expense growth rate of 2% or better for the year. The strength of our operating performance allowed us to earn through elevated provisions. Overall, portfolio credit quality remains good with some pressure in two areas and we expect provisions to come down from this quarter's level. Pat will discuss provisions in more detail in his remarks. Capital remained strong at 11.4% even after absorbing regulatory changes in the quarter. Our U.S. segment continues to deliver against healthy expectations. U.S. PPPT was up 10% with a particularly good contribution from capital markets. This quarter every one of our businesses contributed to achieving our objective of consistent long-term financial performance executing against clear customer-driven competitively differentiated strategies. Starting with Canadian P&C. We had another strong quarter with net income growth of 8% and PPPT growth of 10%. Robust loan and deposit growth contributed to overall strong revenue growth of 7% resulting in the highest operating leverage in Canadian P&C in the past 12 quarters at 3.6%. We're seeing steady market share gains across almost…

Okay. Thank you, Darryl, and good morning, everyone. My comments this morning will start on slide eight. Q1 reported EPS was $2.37 and net income was $1.6 billion. Adjusted EPS was $2.41, up 4%, and adjusted net income of $1.6 billion was up 5%. As Darryl said, results in the quarter reflect good performance across our businesses with pre-provision pre-tax earnings growth of 16%, operating leverage of 4.6% with each operating group above 2%. Good revenue growth and operating leverage helped us comfortably earn through higher credit losses in the quarter. Adjusting items this quarter are similar to past quarters and are shown on slide 25. Turning now to revenue, net revenue of $6 billion was up 8% from last year, reflecting strong performance in BMO Capital Markets, Canadian P&C and BMO Wealth Management. Expenses increased 3% largely reflecting higher employee-related expenses given strong revenues, and higher technology costs partially offset by the benefits from productivity initiatives. We continue to make good progress on efficiency with total bank efficiency at 60.3% in the quarter. As a reminder, expenses in the first quarter of each year include costs related to stock-based compensation for employees who are eligible to retire. This expense was $90 million in Q1. Excluding these costs, the efficiency ratio would have been 58.8% in the quarter. We are on track to deliver the expense savings from our Q4 restructuring charge in line with prior guidance. As a reminder, the expected annualized run rate savings in Q4 of this year are approximately $300 million with full year benefits in the income statement of approximately $200 million. These savings will contribute to achieving our 2% or better expense growth target for the year. Moving now to slide 9 for capital, the common equity Tier 1 ratio was 11.4%, unchanged from…

Thank you, Tom and good morning, everyone. Starting on Slide 16. The total provision for credit losses this quarter was $349 million or 31 basis points. While our impaired provisions are elevated this quarter, the overall credit quality of our lending books remain sound and we do not see any indications of broad-based credit weakness. Consequently based on current business conditions, we expect our loss rate on impaired loans to revert to more normal levels in the coming quarters. The increase in impaired provisions this quarter was primarily due to higher losses in U.S. Commercial, largely due to normal quarterly loss variability as well as from specific weakness in transportation finance. In addition, our corporate lending portfolio has experienced higher losses this quarter, concentrated entirely with oil and gas accounts. Apart from oil and gas lending and transportation finance, our other lending portfolios exhibited stable credit metrics and low losses in the quarter. Turning to the specific credit performance in the businesses. Canadian consumer impaired loan provisions decreased $7 million quarter-over-quarter to $103 million, which at approximately 26 basis points is lower both compared to last quarter as well as last year. Also as shown in the supplementary financial information package, Canadian consumer delinquencies decreased both compared to last quarter and to Q1 of 2019. Canadian commercial PCL on impaired loans increased to $35 million from $24 million last quarter. There were no specific industry trends or themes observed. And at approximately 16 basis points this quarter's PCL rate reflects solid credit performance in Canadian commercial consistent with the long-term average for this business. U.S. consumer PCL on impaired loans was $16 million, down slightly from the prior quarter. U.S. commercial PCL increased to $116 million due to one larger loss and elevated provisions in the transportation finance sector, reflecting…

Thank you. We will now take questions from the telephone lines. [Operator Instructions] And the first question is from Meny Grauman with Cormark Securities. Please go ahead.

Hi, good morning. Pat I just wanted to follow up on the credit side of things. You gave a good detail but I'm just wondering more big picture, what gives you confidence that what you're seeing is not the beginning of something more significant. Can you talk about transportation in particular? And then just overall key indicators that give you confidence in that better outlook for the rest of the year.

Sure. Thanks for the question, Meny. Yes, and I would definitely say that this quarter in our view is an anomaly. And as I said in my comments, we expect the PCL to normalize starting in Q2 and then running for the balance of the year. And the reason that we believe that is when we look across the various portfolios, first of all starting with the consumer books in particular, both Canada and the U.S. consumer books continue to be very solid. I think when you look at the PCL numbers and the delinquency rates, there's no reason for us to conclude that those low losses won't continue for the balance of the year. Canadian commercial at 16 basis points again, a very solid quarter. We see no sector weakness or underlying decay, in the credit metrics. So, we expect Canadian commercial to stay within that range, over the balance of the year. When I look at Capital Markets, the story really is just U.S. natural gas. Outside of nat gas, we had virtually no PCL in any other sector in capital markets, this quarter. And then with respect to nat gas, we do expect that to moderate over the course of the year. When we look at, our portfolios from the bottom-up in both Houston and in Calgary, we see the PCL rates coming down in Q2, Q3 and Q4. They won't be zero of course. But I think if you look at -- to the two goalposts of zero and where we were this quarter, somewhere in the middle of that range, is probably a pretty good forecast for the balance of the year. So that really just leaves U.S. commercial. And of course, TF, as I mentioned, is a spot of weakness. But keep in mind…

And just, as a follow-up. We've heard from other banks that talked about coronavirus. I'm just saying, it's too early to tell. But just, to clarify, when you talk about the outlook, you're assuming no issues from that emerging risk, I would say.

Yeah. I would say, first and foremost, Meny that, it's probably too early to tell. I think for the moment, our first concern is, obviously with the health and safety of our employees, in Asia. And the other affected regions. We're obviously very focused on business continuity as well, to ensure that we've got continuity in all of our regions in the event it gets worse. We are looking very closely at the tail risks within our mark-to-market books. And we're not seeing any short-term impacts there either, from COVID-19. And we're running things fairly close to home, in those books. And then lastly, in the credit portfolios, that of course will take probably longer to play out. It will depend a little bit on, how severe it gets and how long it lasts. But, when we look at first order effects, we don't see concentration in sectors that would have severe impact. Certainly for things say like, cruise ships where we have no exposure at all that give us some comfort that the first order impacts are probably relatively minor. Of course, second order impacts from things like supply chain, disruption and slowing economic conditions, broadly will take longer to play out. And so we'll probably -- it's too early to tell. We would see that as we drift through the balance of the year. And then you might see some of that show up, in the performing provision as well. It probably in the short-term will show up in changes in macroeconomic forecast, to the extent that our economics group decides to change that. And -- but longer-term, it's probably too early to say.

Thank you.

Thank you. The next question is from Steve Theriault with Eight Capital. Please go ahead.

Thanks very much. Just sticking with Pat, for a second.

Hey Steve we lost you.

Sorry, can you hear me okay there?

Yeah. We got you now.

Apologies, so sticking with Pat, you did not put too fine a point on it, but you mentioned mid-20s a couple of times. So that is intended to be sort of your thoughts on the full year PCL rate or the remainder of your PCL rate?

No, to be specific, that's for the remainder of the year. And obviously there can be quarter-to-quarter variability as you saw, this quarter that's pretty normal. But on average for the balance of the year we would expect to see something around that range for the next three quarters.

Okay. And it sounds like, what we're hearing is there was an idiosyncratic loss. Was that the -- was it the construction item or the services industry item we see in the provision schedule? And is there any detail you can give us on that? Was it fraud related? Or was it just something else?

No. And you're right it was in the construction sector. It was not fraud related. It was a client actually that we've had in the bank for many decades, in a fairly idiosyncratic part of the construction sector. And so, not really something we would see applicable to the rest of the sector. And they just ran into some specific difficulties. We tried to work our way through with them, but unfortunately that led to a PCL, in the quarter. And you see that in the -- there's a bit of a spike in GIL in that sector, as well. That's really just that one name that I'm talking about. And then, we actually exited our exposure there. And so, we don't anticipate any further PCL from that. And we would expect that GIL balance to actually go down next quarter.

Okay. Thanks. And then, Tom if I could, you talked through the margin, in the U.S. And obviously good news that the margin only being down one basis point. But you talked about strong deposit growth. You talked about competition. The deposit growth actually looks a little weaker than the last few quarters. So was it that deposit growth was coming off? Or was it more the mix of the deposit growth? Maybe just some color there.

Yeah, sure. So I'd say we are very happy with the margin in our U.S. P&C business. We had guided on our last call to a decline in the upper single digits and in fact we came in at down one. And the big drivers there were a better pricing environment in the market. And when I say better, better than what we had seen off of the earlier fed cut. And then as well we had our loans growing at a higher rate of deposits. So on the margin, the relative rate of growth is important and deposit growth exceeded loan growth and that helped the margin. And those were the big two drivers. And looking forward for the balance of the year, we do expect to be in a better place than we had thought. And so give or take we think the better margin holds through the balance of the year.

Okay. That’s helpful. Thank you.

Thank you. The next question is from Scott Chan with Canaccord Genuity. Please go ahead.

Thanks very much. Just sticking to the U.S. side. I see loan growth was pretty strong up 12% in total. Are you still sticking to your high single-digit loan growth target in fiscal 2020? And if you are maybe talk about why we think there's going to be deceleration throughout the year? Thanks.

So this is Dave. Yeah, I think we would still stick to that. I think I said at the last quarter high single digit. I also said, I thought it would probably exceed -- it has in the past exceeded the market as we continue to grow in the areas that we have not been in the past. So I expect that to continue. I don't see any variance from that. We were off a little bit in the first quarter, still growing but not as much but I see that continuing to pick up in the rest of the year.

Okay. Thank you.

Okay.

Thank you. The next question is from Ebrahim Poonawala with Bank of America. Please go ahead.

Hi, good morning guys. First just wanted to follow-up, Pat very quickly on the oil and gas portfolio, I'm sorry if I missed it. Have you disclosed how much of the book is nat gas related versus oil?

Yeah. We estimate that you can work off of roughly less -- a little less than 1% of total business in government loans comes from U.S. natural gas. And you can measure it on the basis of revenue or production that's revenue. And that's a pretty good estimate.

Got it. And just in terms of when you talk to a lot of banks exposed to the shale sector in Texas energy space, it feels like we're going to see maybe 12 to 24 months of just cleanup going on as kind of the capital sources for some of these companies have dried up. Like is your comfort around that book a function of like you've done a deep dive and you don't expect any one-off lumpiness over the next few quarters? Like what's driving that? Because when I hear some of your peers in the U.S. they kind of talk about potential for more volatility at least over the next year as some of this flow through the pipe?

Yeah. So we're certainly not forecasting when we think about loss rates or prospects for the sector increases in natural gas prices. There's likely to be some upward migration on that price, but fairly modest over the course of the next couple of years. So I think we're consistent there. Our view on losses coming out of the U.S. natural gas book in the next couple of quarters is as I said based on a bottoms-up analysis of our book. And so we look at not just the cash flow of our various clients, but their ability to liquidate assets in the event of a bankruptcy process and look at our asset coverage relative to loan value. And so it's a fairly detailed analysis. Obviously there can be surprises in there, but the number that I gave you that range that I gave you earlier is our best estimate at this time based on a reasonably detailed bottoms-up analysis of that U.S. book.

Understood. And I guess just a separate question, Tom around I think you said Capital Markets last four quarters the average being $320 million and that's kind of what you view as the earnings power for that business. Does that imply that you don't expect quarters like what we saw last year like a sub-$300 million quarter? Was that the message in there? Or I just want to make sure I understand that correctly.

Yeah. I'll say something briefly and then I'll hand it over to Dan Barclay. So we do see the $320 million as just being reflective of the earnings potential of the business. We've invested in the business over time and yeah we've had very strong performance in the U.S. And so we're comfortable at that level. But I'll hand it over to Dan to give a little color to that.

Sure. Thanks Tom. And I appreciate the question. As we look forward, I think Tom has highlighted that the key piece. As we have made the investments across the U.S. as well as adjust on some of our cost structure, what you see is that the move up into the next level of earning potential. As Tom mentioned the last three quarters average works out to be about $320 million. We, obviously, had a very strong quarter this quarter above that at $362 million. And so that's what we see going forward strength in most of the businesses in the U.S. both on the market side and the banking side and the corporate lending side all client driven. When we look at the pipelines and what we've seen to date that continued on to Q2. And so, yes I think we're confident that that's where we can see the business going forward.

Got it. And just since we have you Dan, is the U.S. business where you want it to be? Like just if you can may briefly talk about any investment spend or market share opportunity that you're looking at actively given some of the retrenchment of maybe the European players. Just how do you think about the U.S. business, where it stands today?

Yes. I think consistent with where we've been at the quarter and at this quarter, last quarter and at Investor Day last year, we continue to push forward to drive and double our market share in the U.S. We've made all the substantial investments and so now, it's into the scaling process around that. We do have multiple investments in most of our product lines, both people and banking. You saw the acquisition we made in Clearpool this quarter. You'll remember back the KGS acquisition we made 18 months ago. All of those are investments that are continuing to grow and will bear fruit over time. And so, I do have good confidence in our U.S. business and the growth that we see there.

Got it. Thank you for taking the questions.

Thank you. The next question is from Gabriel Dechaine with National Bank Financial. Please go ahead.

Good morning. Thanks Pat for your thoroughness in the explanation of this quarter's credit trend. But one of the frequent pushbacks I get from investors on the bank's growth in the past few years in the commercial book is 15% type growth. It's good on one hand, but the worry is about the credit quality down the road. What kind of confidence do you have or that what we see this quarter described as idiosyncratic losses or one-offs or whatever won't start popping up a year or so from now following this strong period of the commercial growth we've had in the bank both in Canada and the U.S.? And if Dave or Cam want to pipe in that's great too.

Well, thanks for the question and I'll start and then Dave and Cam can jump in. And it's a good question. I understand the concern. The growth rates in 2019 were clearly high. I can tell you that the PCL you're seeing this quarter in U.S. commercial, I would say virtually none of that came from any account that was added in 2019. The majority were a vintages including that lumpy loss that I talked about that are quite a bit older. That one goes back decades. And so, in our view, it's not correlated. I'll give you just one other stat. We look quite closely at the weighted average probability of default of new additions to the U.S. commercial loan book and compare it to the weighted average probability of default in the broader portfolio. And in every quarter going back to Q1 of last year, new additions have been significantly better credit quality than the average in the portfolio. And so, on that basis would not expect to see PCLs -- certainly haven't seen it this quarter in terms of it being from recent vintage and would not expect it over the course of the next 12 to 24 months.

So, let me just add to that. This is Dave. It's a great question on the U.S. and it's a natural question with the growth we've had. Let me say a couple of things. Number one, the growth has been pretty deliberate over a 10-year period and has largely been in areas where we haven't been in the past, where we know the business and most of the business that we're doing is where you've got assets behind it. I feel really good about the growth and would never apologize for it. On this quarter, this was a particularly lousy quarter for PCL. And trust me; our team does two things really well. They take care of their clients and they win new business. They're really good at that. They hate losing money. And they absolutely are beating themselves up a little bit this quarter, as we all are because, it's a tough quarter, especially when you lose a 40-year customer that you've supported for a long time. That's tough. But, as I look forward, as I look into the next quarter and the rest of the year, I've got the under on where Pat's got his PCL. I think, we're going to do very well, as we generally do and we'll see. You're right to be skeptical. We're going to prove you wrong and -- as we have. I think it's just a really good business. It continues to be a good business. And I'll stop there. Cam may want to add a little bit on the commercial side.

It's Cam speaking. I'll just say, on the Canadian commercial side, I'll remind you on this call we've talked about a strategy that's focused on capacity creation and on diversification. So, it's important to remember like one of the big drivers of the strong growth that we're seeing in Canada is, we have so much more capacity out there, either in terms of hires we've made particularly in GTA, or in the capacity we've created through the digital tools where Darryl mentioned earlier we're now -- we've now put $1 billion through our automated lending platform, so, a lot more capacity being deployed towards existing customers and prospects. And two reasons, I'd say around the confidence side. Number one, its seven sectors in five regions where we're seeing strength by strength I mean double digit. So, that's as broad and diverse as I think you can be in our country, number one. And number two, further to Pat's comments on both spread and weighted average probability of default, the newer business we're putting on is stronger than the existing book. So, for those reasons we're feeling confident.

And Gabriel, it's Pat just one more time. We'll hit this issue head on as well in the investor event that we're holding that I'm sure you're aware of coming up. It will be a combination event between the commercial segments and risk to walk you through exactly why we've been comfortable with growth rates and why the risk profile of the portfolio remains consistent with our appetite over the course of the last few years.

I look forward to that. I think there's a lot of people wondering how -- when most if not all banks are finding it hard to grow, but you're doing so and improving credit quality at the same time. Thank you.

Thank you. The next question is from Sumit Malhotra with Scotiabank. Please go ahead.

Thanks and good morning. First question is for Tom. I think, it's for Tom. Just to go back to your transportation finance purchase, it was about five years ago now. Not to put you on the spot. I know when you bought this portfolio it was about $12 billion. I don't think it's all housed in the transportation section of your loan book breakout. Do you know approximately where this portfolio size is now a number of years after that purchase?

Yes. The portfolio now is about $12.8 billion. And I haven't looked at this number for a while, but I think at the time of purchase, it was closer to $10 billion than to $12 billion. So it's grown at a gradual rate over time and we didn't expect it to be a fast grower. It's a mature business and a good one from an ROE perspective. And so, it's performed largely in line with expectations. We're happy with business. And I could go on here, but I'm looking at Dave and so maybe I'll let him add a few comments.

Yes. The only thing I would add to it, I think those numbers are right. And the business is largely housed in our commercial business in the U.S. and probably 10% of it in our commercial business in Canada. I would say and I think you've seen this before this team has been -- is by far the most experienced team in the industry. That's what we've liked the most about it. They've been through the cycles, they've seen the cycles they generally can predict the cycles. And in times like this and this was -- this I think will be a shorter cycle. But a number of our competitors get in when things are really good and get out quickly. And we've seen that recently a couple have gotten out and that just makes it better for us. We've got the best team to run this through the cycles and I'm very, very happy with it.

And this is more of an industry question. It's probably for you Dave. I mean as you said you're not going to apologize for the loan growth. And sequentially it does seem to be a bit normal not to put too much emphasis on 3 months. We also have seen a decelerating trend in the Fed data when it comes to C&I loan growth in the U.S.? In your opinion is that a reflection of the industry to margin trends? Or has there been perhaps some deceleration in commercial activity in aggregate across the U.S.?

Yes. I do think there's been particularly maybe in the last quarter -- last fiscal quarter a little bit of a slowness, a little bit of concern on uncertainty on a whole number of fronts. We could go through them all. I've actually seen that -- put the coronavirus aside, I've seen that actually pick up of late. There seems to be a little bit more certainty in the U.S., as far as a number of issues that have worked their way through. So I don't expect that to continue and I expect the economy will probably pick up and we'll do as well. So that Fed data is good to watch, but I would expect it to be a little bit better. That's my own personal view.

Yes. That's good. I was going to switch over to Cam Fowler, if that's okay. I mean for as good -- as strong the momentum in your business is you probably don't get enough questions. One of the factors that I think has really been helping your out-performance on revenue the last couple of quarters has been the favorable trend on net interest margin compared to some of your peers. I could go into some of the factors, I think that's driving it mix deposits. But I'd rather hear from you maybe from a pure business perspective. Is there something in the way that your business and your team has approached growth across your product base that is driving that outperformance in margin which seems to be pretty significant again this quarter?

Thanks for the question. Thanks for the chance to chat for a little while as well. I think you've probably answered it for me. In Investor Day in 2018, we talked really specifically about the Canadian P&C business and we talked about outsized growth in deposits in payments and in commercial. And you can see roughly two years on, we are taking market share in all of those categories. And so to me that mix and the quality of mix point is the single biggest driver. It is really important that deposits are moving like that. It's really important that payments are moving like that. So that to me is the biggest driver.

Last one for you. Do you -- have you seen any change in the competitive environment in commercial because it does seem to be some difference in tone from the individual banks as to where their outlook on commercial loan growth in 2020 lies.

I would say that, it's a little different by region and by sector. And to the point, I made earlier about the diversification of our growth, it does feel a little different everywhere. I would say on the whole that we would expect some moderation towards the back half of the year like in Q3 and Q4, but -- and that's an absolute comment. From a relative perspective, I would expect us to be firmly in front.

Thanks for your time.

Thank you. The next question is from Robert Sedran with CIBC Capital Markets. Please go ahead.

Good morning. Just sticking with the Canadian business, I wanted to ask about the payments in the credit card side. And I'm not sure if it's for Cam or for Tom or perhaps for both. But you do see good outstanding growth in the credit card business, but I see the card fee line is down in the supplemental at the all bank level. So, I guess, for Cam which cards or which category of cards are the ones that are doing best for you, that are performing best for you? And then perhaps some explanation as to why that card fee line is down please?

Sure. That card fee line will come back. Two things that are at play, I think in this quarter are a little bit on the interchange pressure side and a little bit on the Quebec legislation side, but I do expect things to improve on the back half of the year. Our best performing -- it's a pretty well-rounded performance on the card side in that the entire book's moving as we expected it would based on some investments we've made on marketing proposition and data. Where I'm maybe most pleased of late has been the growth on the small business suite that we launched just a little over a year ago four, five new cards and capabilities, which has been a smaller base, but fastest-growing within the book. But on the round, I think it's stronger across the entire book and I would expect there to be a little better in the back.

I was under the impression that we were going to see some pressure on the card fee line in the second half of the year, but I guess for you you're saying that's not the case.

I think that there will be different forms of pressure I just think that we have momentum that will see us through it.

Okay. Thank you.

Thank you. The next question is from Mario Mendonca with TD Securities. Please go ahead.

Good morning. Pat just first just a quick clarification. You referred to the -- you referred to the Canadian commercial PCLs ratio at about 16 basis points. Is that right?

That's correct.

And then I think you also said that was consistent with your long-term average. And the reason I'm asking is, I would get a very different number when I look at the industry. And so what I'm curious about is what time period are you looking -- are you -- have you taken into account the periods when the commercial real estate was a problem?

Yeah. Like, we're -- I certainly I'm not going back to the financial crisis. I think our books are quite a bit different. And in particular commercial real estate is quite a bit different in terms of our mix at least here at BMO versus what it was then. When you look at that level, I would say it's relatively consistent with what you would have seen through kind of 2016, 2017 and early 2018. We went into a very strong credit period as you know late 2018 and 2019. And that was as about as good as credit conditions can get for commercial portfolios and we saw that both in Canadian and U.S. commercial. And so I think we've been flagging for a while that would likely to drift up from those very benign points that we saw then. But drifting up to a 16 basis point level to me is very consistent with what you would expect to see from a reasonably well-diversified commercial portfolio with the size of ours.

And so the long-term average that I would come up, but I imagine others would see something similar would be something closer to 50 basis points, but that's including some very, very rough times in commercial real estate. Is your point here that you would look at those periods and say, they're not representative of BMO's current business mix and practices?

Yeah. I guess maybe I wouldn't read too much into the consistent with long-term averages. We could debate on what the right long-term average is. My main point was at 16 basis points that's a really good number from a loss rate. Whether you look at versus really rough times or even relatively benign times that's a really good loss rate for a commercial portfolio. And clearly in really rough times like a financial crisis it can get worse, but I don't expect that to occur in the next year, which is why I'm comfortable that we'll see that kind of a level continue for the next three or four quarters.

Okay. And then real quickly when I -- going back to COVID-19, when I look at your loan mix, it does -- there are a number of categories here like manufacturing, transportation, finance. What I think of as some of the largest categories in your loan book, when you think -- when you stress test, I imagine you've started doing some stress testing for COVID-19, would it be fair to say that a lot of your largest categories would be to say sort of in the crosshairs of a meaningful slowdown in this type of growth cross-border?

I – well, I guess, first of all, I would say, it's really hard to tell and it's far too early to say. Secondly, I don't know that I would even agree with that assertion because those segments as you say are quite large. They're also extremely diverse and particularly manufacturing and services as you mentioned, those encompass so many sub-verticals some of which as you point out might be in the crosshairs many others will not. And so you're really seeing a large sector that's a collection of a lot of sub-sectors. And it's an unfortunate way that we have to group it, but I think it doesn't lend itself to the characterization that you're making.

Okay. That's very fair. And then just finally when you talk about margins in the U.S. and looking for stability in margins in the U.S., presumably you're not contemplating any rate cuts. And the reason I'm asking it this way, because again going back to this virus issue, there are a number of economists out there calling for the U.S. to get more aggressive on rate cuts to -- sort of as an insurance policy against the slowdown caused by COVID. So when I ask you -- what I'm asking here is, you're not contemplating anything of that nature when you're referring to stable margins in the U.S.

Hi, Mario. It's Tom. Two things. Number one, that's correct. So the outlook of stable-ish assumed no cuts. And then second point, if we did have another Fed cut, the impact would be in the zone of a couple of bps.

Understood. Thank you.

Thank you. The last question will be from Darko Mihelic with RBC Capital Markets. Please go ahead.

Hi. Thank you. Good morning. My questions are for Pat. Pat when I hear you speak about transportation finance and the natural gas segment, it sounds to me like there's been a significant increase in credit risk. And therefore, what we should see is movement into stage 2 a lifetime loss recognized against it. And then going forward, if they do fall into impaired well we'll see a stage 3, but the net impact should be much less in the future. I can't tell. When I look at page 28 of your supplemental, it doesn't look to me like that's occurred, so I'm confused a little bit. And perhaps you can also help me understand a little bit with respect to what happened this quarter. So in other words, how many of the files that hit this quarter came immediately from stage 1 into stage 3? And how many of them were actually in stage 2 last quarter?

Yeah. I guess, it's – we probably don't have enough time to go into a file-by-file decomposition. I would say, you did see some of the stage 1 and 2 migration this quarter. And I can tell you of those balance increases in both stage 1 and stage 2 roughly about 60% was credit migration 40% was balanced growth. But from 1 to 2, there was a concentration in that migration in oil and gas and transportation finance and then a bit in some of the other sectors as well. And so it's certainly not broad-based. What you might have seen this quarter in provisions as well keep in mind that some of those PCLs can come from things that are already in stage 3, where we took a provision in a prior quarter and then that provision was increased in this quarter due to factors like we've gone a long way through a liquidation process and the outcome turned out to be slightly worse than we thought. And that was the case this quarter as well. We actually saw some PCLs coming out of stage 3 and then as well some that went from stage one and into 3.

So is it fair to say that you have already migrated a significant proportion of these accounts into stage 2 and that is what gives you comfort going forward that even if they fall into stage 3 you've already got a significant reserve against natural gas and transportation finance? Or is that not the case?

No, that is the case. And I look at something like say the watch list in the oil and gas space. The watch list in oil and gas actually went down in this quarter versus Q4. So that to your point that is, because we moved it into impaired status and took the provisions that we thought. It doesn't guarantee, as I said earlier that, we don't see further provisions coming. There is potential for more migration. It will be concentrated in U.S. gas, but things are fairly stressed there. But outside of that, as I said, we don't see a lot and that's what gives me some comfort around the guidance that, I've given for the next couple of quarters on what those losses could look like.

Okay. And last question then. Is there – can you maybe provide a bit of a quantum in terms of if I have a stage two provision against a natural gas or a transportation finance and it were to migrate to stage 3, what's the quantum of difference? Is it that the increase in the PCL once it hits stage 3 would be another 10%? Would it be 50%? Do you have any sort of rough idea? Or any – what we've seen so far is maybe perhaps looking at the historical. Can you give us an idea? I mean, that ultimately is what's going to give us comfort that the future provisions really should be light given the fact that you're going from stage 2 to stage 3. And the difference between the two is nominal? Or is it not nominal?

Yeah. I mean, it's really going to be case-by-case as you would imagine. Stage 2 tends to be a bit more – quite a bit more formulaic in terms of the provision. When it gets to stage 3, we actually start to look through the details of asset value, asset coverage, sale valuations and things like that in the – for that particular name. And so it's hard to draw a parallel the way you're looking for.

But your experience so far? Do you have any kind of insight you can share?

Yeah. Generally, speaking I would say, the provision that we take in stage 2 is probably not that dissimilar to what you might see. On average over the longer term for the provision will ultimately take in stage – once it gets into impaired.

Okay. That's helpful. Thank you.

Thank you. There are no further questions registered at this time. I would now like to turn the meeting over to Darryl White.

Okay. Thank you, operator. In summary, I want to come back to where I started. This was a very good quarter for BMO at 4.6% operating leverage. And when I look across all of our businesses, all of our businesses performed well closer to their longer-term potential. We're seeing new levels as you heard through the call of earnings run rate expectations, particularly from our wealth and capital markets businesses. You also heard that PCL was elevated, but we earned through it and we expect it to come down next quarter and for the balance of the year. We're investing and driving revenue in key competitive growth areas, while maintaining our commitment to 2% or less expense growth for the year, with continued progress on our efficiency ratio. Everyone at BMO understands that being more efficient makes us more competitive and even better positioned to drive long-term strong relative financial performance. Our commitment to our clients and our purpose is unwavering. Recently, we sadly lost one of the greatest champions of that purpose. So on behalf of all of us at BMO I want to take a moment to formally acknowledge the passing of a great friend, a great business leader and a true statesman Mr. Jacques Menard. He was an architect of the Canadian broker-dealer industry, a figurehead for our bank in its home province of Québec and a model of purpose-driven leadership for all. He will be greatly missed. Thank you all for participating in today's call. We look forward to speaking to you again in May. Thank you.

Thank you. The conference has now ended. Please disconnect your lines at this time. Thank you for your participation.