2016 Financial Performance Review

Transcription

1 2016 Financial Performance Review This section provides a review of our enterprise financial performance for 2016 that focuses on the Consolidated Statement of Income included in our consolidated financial statements, which begin on page 139. A review of our operating groups strategies and performance follows the enterprise review. A summary of the enterprise financial performance for 2015 appears on page 64. Highlights Net income was $4,631 million in 2016, up $226 million or 5% from the previous year. Adjusted net income was $5,020 million, up $339 million or 7%. Reported and adjusted net income growth reflects the benefit of strong BMO Capital Markets results, the BMO Transportation Finance acquisition, solid organic business growth in the P&C businesses and operating leverage. Results were lower in Wealth Management, largely due to the prior year benefit of a gain on sale, as well as the write-down of an equity investment net of a gain on its subsequent sale in 2016, and lower insurance results. Corporate Services results were also lower. The impact of the stronger U.S. dollar increased adjusted net income by $60 million or 1%. On a net revenue basis (1), revenue increased $1,409 million or 8% in 2016 to $19,544 million, and adjusted revenue increased $1,491 million or 8% to $19,628 million. Adjusted revenue excludes a cumulative accounting adjustment in the amount of $85 million recognized in Revenue growth reflects the benefits of our diversified business mix and successful execution against our strategic priorities. The increase was mainly due to revenue growth in the P&C businesses, which benefited from the acquired BMO Transportation Finance business and organic growth, and in BMO Capital Markets, with a decrease in Wealth Management and Corporate Services. The impact of the stronger U.S. dollar increased adjusted net revenue by $345 million or 2%. Reported non-interest expense increased $815 million or 7% to $12,997 million in Adjusted non-interest expense increased $725 million or 6% to $12,544 million. Adjusted non-interest expense excludes acquisition integration costs, the amortization of acquisition-related intangible assets and restructuring costs. Reported and adjusted expenses increased primarily due to the impact of the acquired BMO Transportation Finance business, business growth and investment and the stronger U.S. dollar, partially offset by the benefits of divestitures. Provisions for credit losses totalled $815 million in the current year, up from $612 million in 2015, as higher provisions in the P&C businesses and BMO Capital Markets were partially offset by higher net recoveries in Corporate Services. The effective income tax rate in 2016 was 19.2%, compared with 17.5% in The adjusted effective income tax rate (2) was 19.9%, compared with 18.0% in The higher reported and adjusted effective tax rate was attributable to a higher proportion of income from higher tax rate jurisdictions and lower tax-exempt income from securities. (1) See page 38 for a description of net revenue. (2) The adjusted rate is computed using adjusted net income rather than reported net income in the determination of income subject to tax. 36 BMO Financial Group 199th Annual Report 2016

2 Foreign Exchange The U.S. dollar was stronger compared to the Canadian dollar at October 31, 2016 than it was at October 31, At October 31, 2016, the Canadian dollar traded at $ per U.S. dollar, compared to $ per U.S. dollar at October 31, BMO s U.S.-dollar-denominated assets and liabilities are translated at year-end rates. The average exchange rate over the course of 2016, which is used in the translation of BMO s U.S.-dollardenominated revenues and expenses, was higher in 2016 than in Consequently, the Canadian dollar equivalents of BMO s U.S.-dollardenominated net income, revenues, expenses, recovery of (provision for) credit losses and income taxes in 2016 increased relative to the preceding year. The table below indicates average Canadian/U.S. dollar exchange rates in 2016, 2015 and 2014 and the impact of changes in the average rates on our U.S. segment results. Changes in the exchange rate will affect future results measured in Canadian dollars and the impact on those results is a function of the periods in which revenues, expenses and provisions for (recoveries of) credit losses arise. If future results are consistent with results in 2016, each one cent increase (decrease) in the Canadian/U.S. dollar exchange rate, expressed in terms of how many Canadian dollars one U.S. dollar buys, would be expected to increase (decrease) the Canadian dollar equivalent of our U.S. segment net income before income taxes for the year by $11 million in the absence of hedging transactions. References in this to the impact of the U.S. dollar do not include the U.S.-dollar-denominated amounts recorded outside of BMO s U.S. segment. Economically, our U.S. dollar income stream was largely unhedged to changes in foreign exchange rates during the year. During 2016, we hedged a portion of the forecasted BMO Capital Markets U.S. dollar net income. These hedges are subject to mark-to-market accounting, which resulted in a $3 million after tax loss in 2016 that was recorded in our BMO Capital Markets business. We regularly determine whether to execute hedging transactions to mitigate the impact of foreign exchange rate movements on net income. See the Enterprise-Wide Capital Management section on page 70 for a discussion of the impact that changes in foreign exchange rates can have on our capital position. Changes in foreign exchange rates will also affect accumulated other comprehensive income primarily from the translation of our investment in foreign operations. Each one cent increase (decrease) in the Canadian/U.S. dollar exchange rate, expressed in terms of how many Canadian dollars one U.S. dollar buys, would be expected to increase (decrease) the translation of the unhedged portion of our investment in foreign operations by $150 million. Effects of Changes in Exchange Rates on BMO s Reported and Adjusted Results 2016 vs Canadian/U.S. dollar exchange rate (average) Effects on reported results Increased net interest income Increased non-interest revenue Increased revenues Increased provision for credit losses (3) (5) Increased expenses (265) (598) Increased income taxes (20) (33) Increased reported net income before impact of hedges Hedging losses in current year after tax (3) (21) Increased reported net income vs Effects on adjusted results Increased net interest income Increased non-interest revenue Increased revenues Increased provision for credit losses (11) (15) Increased expenses (253) (578) Increased income taxes (21) (34) Increased adjusted net income before impact of hedges Hedging losses in current year after tax (3) (21) Increased adjusted net income Caution This Foreign Exchange section contains forward-looking statements. Please see the Caution Regarding Forward-Looking Statements. BMO Financial Group 199th Annual Report

3 Revenue (1) Revenue increased $1,698 million or 9% in 2016 to $21,087 million. On a basis that nets insurance claims, commissions and changes in policy benefit liabilities (CCPB) against insurance revenue (net revenue), reported revenue increased $1,409 million or 8% to $19,544 million. Adjusted revenue differs from reported revenue largely due to a cumulative accounting adjustment in the amount of $85 million recognized in 2016 in other non-interest revenue, related to foreign currency translation, largely impacting prior periods. Adjusted revenue, net of CCPB, increased $1,491 million or 8% to $19,628 million, including a $345 million or 2% impact of the stronger U.S. dollar. Reported and adjusted revenue increased due to revenue growth in the P&C businesses, which benefited from the acquired BMO Transportation Finance business and organic growth, and in BMO Capital Markets, with a decrease in Wealth Management and Corporate Services. BMO analyzes revenue at the consolidated level based on GAAP revenues as reported in the consolidated financial statements, and on an adjusted basis. Consistent with our Canadian peer group, we analyze revenue on a taxable equivalent basis (teb) at the operating group level. The teb adjustments for 2016 totalled $510 million, down from $524 million in Canadian P&C revenue increased $328 million or 5% to $6,968 million as a result of higher balances and increased non-interest revenue. U.S. P&C revenue increased $1,033 million or 29% on a Canadian dollar basis and increased $628 million or 22% on a U.S. dollar basis, primarily due to the benefit of the acquired BMO Transportation Finance business, as well as organic loan and deposit growth. Wealth Management revenue, net of CCPB, was $4,345 million, compared to $4,509 million in the prior year. Revenue in traditional wealth was $3,923 million, compared to $4,057 million a year ago, as solid underlying growth in our spread-based and fee-based revenue was more than offset by the prior year benefits of a gain on the sale of BMO s U.S. retirement services business, the impact of divestitures and the write-down of an equity investment net of a gain on its subsequent sale in There was underlying growth in our insurance businesses, although net insurance revenue decreased, primarily due to higher beneficial actuarial assumptions and asset-liability management changes in the prior year. BMO Capital Markets revenue increased $495 million or 13% to $4,362 million, reflecting improved trading revenue performance, strong mergers and acquisitions advisory activity, higher lending revenues and the impact of the stronger U.S. dollar, partially offset by lower net securities gains. Corporate Services reported revenue declined $283 million and adjusted revenue declined $201 million. Both reported and adjusted revenue declined due to above-trend revenue in the prior year, which included a recovery under a legal settlement, as well as lower impaired real estate gains and lower purchase accounting revenue in the current year. (1) Commencing in 2015, insurance claims, commissions and changes in policy benefit liabilities are reported separately. They were previously reported as a reduction in insurance revenue in non-interest revenue. Prior period amounts and ratios have been reclassified. Insurance can experience variability arising from fluctuations in the fair value of insurance assets and the related liabilities. The investments which support actuarial liabilities are predominantly fixed income assets recorded at fair value with changes in the fair values recorded in insurance revenue in the Consolidated Statement of Income. These fair value changes are largely offset by changes in the fair value of policy benefit liabilities, the impact of which is reflected in insurance claims, commissions and changes in policy benefit liabilities. The discussion of revenue on a net basis reduces this variability in the results, which allows for a better discussion of operating results. For additional discussion of insurance claims, commissions and changes in policy benefit liabilities, see page 41. Taxable equivalent basis (teb) Revenues of operating groups are presented in our on a taxable equivalent basis (teb). Revenue and the provision for income taxes are increased on tax-exempt securities to an equivalent before-tax basis to facilitate comparisons of income between taxable and tax-exempt sources. This adjustment is offset in Corporate Services. Revenue and Adjusted Revenue (1) Net interest income 9,872 8,763 8,292 8,487 8,749 Year-over-year growth (%) 13 6 (2) (3) 17 Non-interest revenue 11,215 10,626 9,931 8,343 8,354 Year-over-year growth (%) Total revenue 21,087 19,389 18,223 16,830 17,103 Cdn./U.S. dollar translation effect Year-over-year growth (%) (2) 14 Impact of Cdn./U.S. dollar translation effect (%) Adjusted net interest income 9,872 8,764 8,292 7,830 7,970 Year-over-year growth (%) (2) 10 Adjusted non-interest revenue 11,299 10,627 9,931 8,309 8,070 Year-over-year growth (%) Total adjusted revenue (2) 21,171 19,391 18,223 16,139 16,040 Year-over-year growth (%) Total adjusted revenue, net of CCPB (2) 19,628 18,137 16,718 15,372 14,866 Cdn./U.S. dollar translation effect Year-over-year growth (%) Impact of Cdn./U.S. dollar translation effect (%) (1) Commencing in the first quarter of 2015, insurance claims, commissions and changes in policy benefit liabilities (CCPB) are reported separately. They were previously reported as a reduction in insurance revenue in non-interest revenue. Prior period amounts and ratios have been reclassified. (2) Adjusted revenue for 2012 and 2013 excludes the portion of the credit mark recorded in net interest income on the purchased performing loan portfolio and income or losses from run-off structured credit activities recorded in non-interest revenue, which are recorded in Corporate Services. 38 BMO Financial Group 199th Annual Report 2016

4 Net Interest Income Net interest income increased $1,109 million or 13% to $9,872 million in Net interest income increased 10%, excluding the impact of the stronger U.S. dollar, due to the acquired BMO Transportation Finance business and organic volume growth. BMO s overall net interest margin increased 8 basis points to 1.59%. Net interest margin excluding trading increased 3 basis points from the prior year. Higher net interest margin was primarily due to the acquired BMO Transportation Finance business. Average earning assets increased by $43.3 billion or 7% to $622.7 billion, or increased $30.8 billion or 5%, excluding the impact of the stronger U.S. dollar, due to organic loan growth and the acquired BMO Transportation Finance business. The main drivers of BMO s overall net interest margin are the individual group margins, changes in the magnitude of each operating group s average earning assets and changes in net interest income in Corporate Services. Changes are discussed in the 2016 Operating Groups Performance Review section starting on page 45. Table 5 on page 126 and Table 6 on page 127 provide further details on net interest income and net interest margin. Net interest income is comprised of earnings on assets, such as loans and securities, including interest and dividend income, less interest expense paid on liabilities, such as deposits. Net interest margin is the ratio of net interest income to average earning assets, expressed as a percentage or in basis points. Average Earning Assets and Net Interest Margin Net Interest Income and Net Non-Interest Revenue* ($ billions) Net Revenue ($ billions) Net Revenue by Country (%) Average earning assets ($ billions) Net interest margin (%) Net interest income Net non-interest revenue Adjusted net interest income Adjusted net non-interest revenue Total net revenue Total net adjusted revenue Canada United States Other countries Average earning assets increased 7%. Higher net interest margin was primarily due to the acquired BMO Transportation Finance business. Net non-interest revenue and net interest income growth reflects growth in the P&C businesses, including the acquired BMO Transportation Finance business, and in BMO Capital Markets. *Numbers may not add due to rounding. The P&C businesses and BMO Capital Markets drove net revenue growth. Net revenue in the United States increased primarily due to the acquired BMO Transportation Finance business. Change in Net Interest Income, Average Earning Assets and Net Interest Margin For the year ended October 31 Net interest income (teb) Average earning assets Net interest margin Change Change (in basis points) % % Change Canadian P&C 5,060 4, , , U.S. P&C 3,528 2, ,447 81, Personal and Commercial Banking (P&C) 8,588 7, , , Wealth Management ,898 23, (1) BMO Capital Markets 1,509 1, , , Corporate Services (839) (776) (8) 45,400 45,301 nm nm nm Total BMO reported 9,872 8, , , U.S P&C (US$ in millions) 2,663 2, ,569 65, nm not meaningful BMO Financial Group 199th Annual Report

5 Non-Interest Revenue Non-interest revenue, which comprises all revenue other than net interest income, increased $589 million or 6% to $11,215 million in On a basis that is net of CCPB, non-interest revenue increased $300 million or 3% to $9,672 million. Excluding the impact of the stronger U.S. dollar, non-interest revenue net of CCPB increased $159 million or 2%. Adjusted non-interest revenue largely excludes a cumulative accounting adjustment in the amount of $85 million pre-tax recognized in 2016 in other non-interest revenue, related to foreign currency translation, largely impacting prior periods. Adjusted non-interest revenue, net of CCPB, increased $383 million or 4% to $9,756 million. Reported and adjusted non-interest revenue increased due to good performance in the P&C businesses, including the benefit of the acquired BMO Transportation Finance business, and in BMO Capital Markets, as well as the impact of the stronger U.S. dollar. Trading revenues increased $205 million and are discussed in the Trading-Related Revenues section that follows. Lending fees increased $122 million, due to growth in the P&C businesses loan portfolio, lending activity in BMO Capital Markets and the impact of the stronger U.S. dollar. Underwriting and advisory fees increased $114 million, due to growth in activity levels, primarily in mergers and acquisitions and equity underwriting, and the impact of the stronger U.S. dollar. Deposit and payment service charges increased $64 million, due to growth in both Canadian and U.S. P&C and the impact of the stronger U.S. dollar. Securities commissions and fees increased $23 million. These revenues consist largely of brokerage commissions within Wealth Management, which account for about two-thirds of the total, and institutional equity trading commissions within BMO Capital Markets. The increase is due to higher client activity in BMO Capital Markets and the stronger U.S. dollar, partially offset by lower securities commissions in Wealth Management. Investment management and custodial fees remained essentially unchanged from last year, as business growth and the impact of the stronger U.S. dollar were offset by the impact of divestitures. Mutual fund revenue decreased $13 million from strong results a year ago. Both investment management and custodial fees and mutual fund revenue were also negatively impacted by the lower Canadian equity markets on average and the impact of the weaker British pound compared to the prior year. Insurance revenue increased $261 million from a year ago, largely due to lower long-term interest rates increasing the fair value of insurance investments and underlying business growth, partially offset by lower reinsurance premiums. The increase in insurance revenue was largely offset by higher insurance claims, commissions and changes in policy benefit liabilities, as discussed on page 41. Given the extent to which insurance revenue can vary and that this variability is largely offset in CCPB, we generally focus on analyzing revenue net of CCPB. Insurance revenue, net of CCPB, decreased $28 million as growth in the underlying business was more than offset by prior year benefits from higher actuarial assumption changes and above-trend changes in our investment portfolio to improve asset-liability management. Securities gains, other than trading, decreased $87 million due to lower net securities gains in BMO Capital Markets and Corporate Services. Investments in associates and joint ventures decreased $67 million primarily due to the write-down of an equity investment net of a gain on its subsequent sale in Other non-interest revenue, which includes various sundry amounts, decreased $28 million due to the prior year gain on sale of BMO s U.S. retirement services business, the cumulative accounting adjustment related to foreign currency translation and a recovery under a legal settlement in the prior year, largely offset by lease revenue from the acquired BMO Transportation Finance business. Card fees and Foreign exchange, other than trading were relatively consistent year over year. Table 3 on page 124 provides further details on revenue and revenue growth. Non-Interest Revenue (1) Change (Canadian $ in millions) from 2015 (%) Securities commissions and fees Deposit and payment service charges 1,141 1,077 1,002 6 Trading revenues 1, Lending fees Card fees Investment management and custodial fees 1,556 1,552 1,286 Mutual fund revenues 1,364 1,377 1,065 (1) Underwriting and advisory fees Securities gains, other than trading (51) Foreign exchange, other than trading (6) Insurance revenue (1) 2,023 1,762 2, Investments in associates and joint ventures (32) Other (5) Total BMO reported (1) 11,215 10,626 9,931 6 BMO reported, net of CCPB 9,672 9,372 8,426 3 Total BMO adjusted (1) 11,299 10,627 9,931 6 BMO adjusted, net of CCPB 9,756 9,373 8,426 4 Insurance revenue, net of CCPB (6) (1) Commencing in the first quarter of 2015, insurance claims, commissions and changes in policy benefit liabilities (CCPB) are reported separately. They were previously reported as a reduction in insurance revenue in non-interest revenue. Prior period amounts and ratios have been reclassified. 40 BMO Financial Group 199th Annual Report 2016

6 Trading-Related Revenues Trading-related revenues are dependent on, among other things, the volume of activities undertaken for clients who enter into transactions with BMO to mitigate their risks or to invest. BMO earns a spread or profit on the net sum of its client positions by profitably managing, within prescribed limits, the overall risk of the net positions. On a limited basis, BMO also earns revenue from principal trading positions. Interest and non-interest trading-related revenues increased $272 million or 27%. Excluding the impact of the stronger U.S. dollar and the result of hedging a portion of U.S. net income, trading-related revenues increased $258 million or 25%. The following amounts exclude the impact of the stronger U.S. dollar. Interest rate trading-related revenues increased $234 million or 55%, primarily due to increased client activity across most businesses, partially offset by the impact of the disposition of our municipal bond trading business in October Foreign exchange trading-related revenues were down $15 million or 4%, driven by decreased client activity. Equities trading-related revenues decreased $12 million or 2%, reflecting modestly lower activity with corporate and investor clients. Commodities trading-related revenues increased $7 million or 12% due to increased client hedging activity in energy products. The Market Risk section on page 95 provides more information on trading-related revenues. Trading-related revenues include net interest income and non-interest revenue earned from on and off-balance sheet positions undertaken for trading purposes. The management of these positions typically includes marking them to market on a daily basis. Trading-related revenues also include income (expense) and gains (losses) from both on-balance sheet instruments and interest rate, foreign exchange (including spot positions), equity, commodity and credit contracts. Interest and Non-Interest Trading-Related Revenues (1) (Canadian $ in millions) Change (taxable equivalent basis) from 2015 (%) Interest rates Foreign exchange (4) Equities (1) Commodities Other (2) Total (teb) 1,732 1,486 1, Teb offset (6) Reported total 1,291 1, Reported as: Net interest income Non-interest revenue trading revenues 1, Total (teb) 1,732 1,486 1, Teb offset (6) Reported total, net of teb offset 1,291 1, Adjusted net interest income, net of teb offset (16) +100 Adjusted non-interest revenue trading revenues 1, Adjusted total, net of teb offset 1,291 1, (1) Trading-related revenues are presented on a taxable equivalent basis. (2) Includes nominal revenues from run-off structured credit activities and hedging exposures in BMO s structural balance sheet. Insurance Claims, Commissions and Changes in Policy Benefit Liabilities Insurance claims, commissions and changes in policy benefit liabilities (CCPB) were $1,543 million in 2016, up $289 million from $1,254 million in 2015 due to lower long-term interest rates increasing the fair value of policy benefit liabilities and the impact of growth in the underlying business, partially offset by decreased reinsurance liabilities. The increase was largely offset in revenue, as discussed on page 38. Given the extent to which insurance revenue can vary and that this variability is largely offset in CCPB, we generally focus on analyzing revenue net of CCPB. BMO Financial Group 199th Annual Report

7 Provision for Credit Losses The provision for credit losses (PCL) was $815 million in the current year, up from $612 million in There was no net change to the collective allowance in the year. The increase in PCL was due to higher provisions in the P&C businesses and BMO Capital Markets, partially offset by higher net recoveries in Corporate Services. PCL as a percentage of average net loans and acceptances was 0.23% in 2016, up from 0.19% in On an operating group basis, most of our provisions relate to Personal and Commercial Banking. In Canadian P&C, PCL increased by $46 million to $542 million in 2016, reflecting higher provisions in both the consumer and commercial portfolios. U.S. P&C PCL was $257 million, up $138 million from 2015, largely reflecting higher commercial provisions, mainly due to the acquired BMO Transportation Finance business. BMO Capital Markets recorded provisions of $81 million, an increase of $55 million from the prior year, mainly due to higher oil and gas provisions. Corporate Services net recoveries of $74 million increased $38 million from the prior year. On a geographic basis, the majority of our provisions relate to our Canadian loan portfolio. Specific PCL in Canada and other countries (excluding the United States) was $547 million, compared to $498 million in Specific PCL in the United States was $268 million, up from $114 million in Note 4 on page 153 of the consolidated financial statements provides PCL information on a geographic basis. Table 15 on page 134 provides further PCL segmentation information. Provision for Credit Losses New specific provisions 1,386 1,278 1,413 Reversals of previously established allowances (228) (210) (228) Recoveries of loans previously written off (343) (456) (624) Provision for credit losses (PCL) PCL as a % of average net loans and acceptances (annualized) Provision for Credit Losses by Operating Group (Canadian $ in millions) Canadian P&C U.S. P&C (1) Personal and Commercial Banking Wealth Management 9 7 (3) BMO Capital Markets (18) Corporate Services, including T&O (1) Impaired real estate loans (16) Interest on impaired loans Purchased credit impaired loans (58) (86) (252) Purchased performing loans (1) 5 82 Provision for credit losses (1) Beginning in the first quarter of 2016, the reduction in the credit mark that is reflected in net interest income and the provision for credit losses on the purchased performing portfolio are being recognized in U.S. P&C, consistent with the accounting for the acquisition of BMO Transportation Finance, and given that these amounts have reduced substantially in size. Results for prior periods have not been reclassified. Certain comparative figures have been reclassified to conform with the current year s presentation. 42 BMO Financial Group 199th Annual Report 2016

8 Non-Interest Expense Non-interest expense increased $815 million or 7% to $12,997 million in Adjusted non-interest expense excludes restructuring costs, the amortization of acquisition-related intangible assets and acquisition integration costs. Restructuring costs were $188 million in 2016 as we accelerate the use of technology to enhance customer experience and focus on achieving operational efficiencies. Restructuring costs were $149 million in 2015 primarily due to restructuring to achieve operational efficiencies. The amortization of acquisition-related intangible assets was $160 million, $163 million and $140 million in 2016, 2015 and 2014, respectively. Acquisition integration costs were $104 million, $53 million and $20 million in 2016, 2015 and 2014, respectively. Adjusted non-interest expense increased $725 million or 6% to $12,544 million or 4% excluding the impact of the stronger U.S. dollar. Reported and adjusted expenses increased primarily due to the impact of the acquired BMO Transportation Finance business and business growth and investment, partially offset by the benefits of divestitures and our focus on disciplined expense management. The dollar and percentage changes in expense by category are outlined in the Non-Interest Expense and Adjusted Non-Interest Expense table. Table 4 on page 125 provides more detail on expenses and expense growth. Performance-based compensation on a reported basis increased $176 million or 8%, and on an adjusted basis increased $161 million or 8%, due to improved performance across most operating groups, the impact of the stronger U.S. dollar and the acquired BMO Transportation Finance business. Other employee compensation, which includes salaries, benefits and severance, on a reported basis increased $125 million or 3% and on an adjusted basis increased $59 million or 1%, due to the impact of the acquired BMO Transportation Finance business, partially offset by divestitures. Premises and equipment costs on a reported basis increased $256 million or 12% and on an adjusted basis increased $227 million or 11%, primarily due to higher costs related to technology investments, as well as higher real estate-related costs and the impact of the stronger U.S. dollar. Other expenses on a reported basis increased $258 million or 9% and other expenses on an adjusted basis increased $278 million or 10%, primarily due to the acquired BMO Transportation Finance business and the impact of the stronger U.S. dollar. BMO s reported efficiency ratio improved 120 basis points to 61.6% and the adjusted efficiency ratio improved 170 basis points to 59.2% in On a net revenue basis, the reported efficiency ratio improved 70 basis points to 66.5% and the adjusted efficiency ratio improved 130 basis points to 63.9% in All operating groups have shown improvements in efficiency and operating leverage, with the exception of Wealth Management. Canadian P&C, BMO s largest operating segment, improved its reported efficiency ratio by 70 basis points to 49.6%, resulting from revenue growth and disciplined expense management. U.S. P&C s reported efficiency ratio improved 360 basis points to 62.5% and its adjusted efficiency ratio improved 320 basis points to 61.0%, due to organic revenue growth and disciplined expense management, as well as the acquired BMO Transportation Finance business. Wealth Management s reported efficiency ratio, on a net revenue basis, increased 230 basis points to 76.8%. The adjusted efficiency ratio, on a net revenue basis, increased 240 basis points to 73.9%, primarily due to the prior year benefits of a gain on sale of BMO s U.S. retirement services business in 2015 and the write-down of an equity investment net of a gain on its subsequent sale in BMO Capital Markets reported efficiency ratio improved 510 basis points to 59.1%, due to strong revenue growth and disciplined expense management. On a net revenue basis (1), reported operating leverage was positive 1.1% and adjusted operating leverage was positive 2.1% year over year, in line with our medium-term objective of generating above 2% average annual adjusted net operating leverage and our ongoing focus on improving efficiency by driving revenue growth and maintaining disciplined cost management. (1) This ratio is calculated excluding insurance claims, commissions and changes in policy benefit liabilities (CCPB). The efficiency ratio (or expense-to-revenue ratio) is a measure of productivity. It is calculated as non-interest expense divided by total revenue (on a taxable equivalent basis in the operating groups), expressed as a percentage. The adjusted efficiency ratio is calculated in the same manner, utilizing adjusted revenue and expense. Contribution to Growth in Non-Interest Expense and Adjusted Non-Interest Expense (%) Significant businesses acquired Canadian/U.S. dollar translation effect, excluding acquisitions Other Total adjusted non-interest expense growth Impact of adjusting items (3.5) Total non-interest expense growth BMO Financial Group 199th Annual Report

9 Non-Interest Expense and Adjusted Non-Interest Expense Change from 2015 (%) Performance-based compensation 2,248 2,087 1,939 8 Other employee compensation (1) 4,894 4,835 4,294 1 Total employee compensation 7,142 6,922 6,233 3 Premises and equipment 2,357 2,130 1, Other 2,761 2,519 2, Amortization of intangible assets Total adjusted non-interest expense 12,544 11,819 10,761 6 Adjusting items Total non-interest expense 12,997 12,182 10,921 7 Non-interest expense growth (%) na Adjusted non-interest expense growth (%) na (1) Includes restructuring costs in 2016 and na not applicable Efficiency Ratio by Group (teb) (%) Efficiency Ratio Canadian P&C U.S. P&C Wealth Management BMO Capital Markets Total BMO Total BMO, net of CCPB Adjusted Efficiency Ratio Canadian P&C U.S. P&C Wealth Management Wealth Management, net of CCPB BMO Capital Markets Total BMO Total BMO, net of CCPB Provision for Income Taxes The provision for income taxes reflected in the Consolidated Statement of Income is based upon transactions recorded in income, regardless of when such transactions are subject to taxation by tax authorities, with the exception of the repatriation of retained earnings from foreign subsidiaries, as outlined in Note 23 on page 192 of the consolidated financial statements. Management assesses BMO s consolidated results and associated provisions for income taxes on a GAAP basis. We assess the performance of the operating groups and associated income taxes on a taxable equivalent basis and report accordingly. The provision for income taxes was $1,101 million in 2016, compared with $936 million in The reported effective tax rate in 2016 was 19.2%, compared with 17.5% in The adjusted provision for income taxes (1) was $1,249 million in 2016, compared with $1,025 million in The adjusted effective tax rate in 2016 was 19.9%, compared with 18.0% in The change in the reported and adjusted tax rates from year to year was attributable to a higher proportion of income from higher tax rate jurisdictions and lower tax-exempt income from securities. On a teb basis, the reported effective tax rate for the year was 25.8%, compared with 24.9% a year ago. On a teb basis, the adjusted effective tax rate for the year was 25.9%, compared with 24.9% a year ago. BMO partially hedges, for accounting purposes, the foreign exchange risk arising from its foreign operations by funding the investments in the corresponding foreign currency. A gain or loss on hedging and an unrealized gain or loss on translation of foreign operations is charged or credited to shareholders equity. For income tax purposes, a gain or loss on the hedging activities results in an income tax charge or credit in the current period that is charged or credited to shareholders equity, while the associated unrealized gain or loss on the foreign operations does not incur income taxes until the investments are liquidated. The income tax charge/benefit arising from a hedging gain/loss is a function of the fluctuations in exchange rates from period to period. Hedging of foreign operations has given rise to an income tax expense in shareholders equity of $10 million for the year, compared with an income tax recovery of $167 million in Refer to the Consolidated Statement of Changes in Equity on page 142 of the consolidated financial statements for further details. Changes in tax rates and tax policy can have an impact on our earnings. See the discussion in the Critical Accounting Estimates section on page 113 of the impact that a reduction in U.S. income tax rates would have on our net deferred tax asset, income and the CET1 Ratio. Table 4 on page 125 details the $1,864 million of total government levies and taxes incurred by BMO in The increase from $1,651 million in 2015 was primarily due to a higher provision for income taxes. (1) The adjusted rate is computed using adjusted net income rather than reported net income in the determination of income subject to tax. 44 BMO Financial Group 199th Annual Report 2016