Bank of Montreal (BMO) Earnings Call Transcript & Summary

Okay. We'll just dive right into the next session here. I have Darryl White, the CEO of Bank of Montreal. Before we begin, I just want to remind you all that Darryl's comments today may include forward-looking statements. I know I could have recited it from memory, but actual results could differ materially from forecast, projections or conclusions in these statements, and listeners can find additional details in the public filings of BMO Financial Group. Sorry, I had to throw my glasses on there, age is catching up to me.

Darryl, so the discussion we've had all day today, there's a lot of discussion around capital, the change to the DSP widened, increased. And then in your particular instance, you raised capital as a result. So the question that's on everybody's mind is did you raise enough if the DSP has increased later on this summer to the full 4%?

So thanks for having us. The short answer is yes, raised enough. The long answer, it goes like this. If you go back Darko to...

I think we're having trouble with the mic.

Am I audible?

Is it working now? Can you say a few words?

Is it working now?

Doesn't sound like it's working now. Is it working now?

You want me to shout.

There we go. It just is -- I was louder. I tend to be loud as a person generally, so maybe that's what it was. Sorry.

You're drowning me out? Not really. Okay. So I think what I said before was the short answer is, yes, it's enough. The long answer goes something like this. So if you go back, Darko, to when we announced our proposed acquisition of the Bank of the West, which happened to be on December 20, 2021, we said at the time what we would always do when we model acquisitions, which is the pro forma capital ratio that we solved for was above the then regulatory minimum but inside of the 50 basis points of buffer that you would build as an internal target. So for us at the time, that was between 10.5 and 11. Interestingly, as you go through the fullness of 2022, with all of the puts and takes, the things that we didn't see coming, the things that we did see coming, we didn't have the Canada recovery dividend. We didn't have the priced in -- the capital provision we took for a lawsuit in November. We, on the other hand, had better business performance, better internal capital generation than we thought. We had really effective risk transfer. We had really effective hedging on our transaction itself. When on an all-round trip to the end of the year, we were tracking to almost exactly where we said we're going to be i.e., in that range of 10.5 to 11 should the transaction close in the first quarter. And so that's kind of my way of saying I was very happy with the team's performance on capital management. Now what changed? OSFI on December 8 announced that they're going to move and you've heard all about that, I presume, today. So OSFI moved 50 basis points. We responded. We responded, I think, decisively and quickly. I'm glad we did. The decision -- the alternative might have been, well let's just wait and see and wait and see is not a very good strategy because who knows what was going to happen over the holidays, over the month? Nobody saw Ukraine coming at this time last year. So we made that decision. We've locked it in and pro forma that capital raise. So to come all the way back to your question, where does it take us? We have said we will be above 11.5 in the second quarter of this year, assuming the transaction is closed. So above 11.5 in the second quarter of this year, and I emphasize above, and then we'll be traveling to 12 through the back end of the year. So I'm pretty comfortable with that trajectory. And I think it's the right plan for us regardless of what comes next from a regulatory perspective.

And does this change -- I mean, OSFI's decision to make these changes, does it change anything else for you, like the size of your buffer, future acquisitions? How you manage capital return, the dividend payout ratio? Anything else that is altered here now in the wake of that?

Yes, nothing other than the obvious, Darko. I mean, I don't think -- just listening to you and your list of alternatives there on size of the -- like size of the buffer, I don't think you would be responsible stewards for shareholders if you said I'm going to prefund some other potential change. I don't think that's the right way to manage the business. But you do need to have the buffer so that you can sort of manage and be agile within whatever might change, whether it's from the regulator or anything else for that matter. So no, I don't think it changes size of the buffer. The obvious would be if there was a next acquisition on the doorstep and there's not. But if there were, well then, of course, you have to model to the new conclusion, not the old conclusion, and that might make it more difficult to fetch or it might make it more difficult to fetch at the same return. So you have to adjust for that. That's really the only thing I can think of.

Okay. In your answer, you mentioned that one of the things or one of the tools you have to get towards 12 is significant risk transfer. Your bank seems to be using it a bit more than others. Can you maybe talk about the rationale for using them, your use of them? Are there limits? And what are the other impacts of doing these SRTs?

Yes. So first of all, I don't know if we use them more than others. That's hard to know. I think everybody is in the business to some extent. I can tell you about our track record though, and it's not new. We've been in the business of doing risk transfers for 4, 5 or 6 years now so it's a technique that we think is valuable within limits, and I'll go to that in a minute. So if you think about it, there's different ways you can do these things. You can do outright loan sales, so that's obvious. You can do an outright loan sale from your portfolio, or you could do a synthetic securitization. There, you might be selling the loss, sale and the loss, if there's to be a loss on the loan so it's insurance as it were. The benefit of that is you maintain the customer, you get relief on the RWA and you also get relief on the PCL in the event of loss, right, including in your calculation of performing PCLs. So there's a lot of benefits there but it does come at a cost. And the cost is some foregone spread revenue. When we've looked at the transfers we've done over the last couple of years on synthetic securitizations, the net of those 2 has been very positive in terms of the ROE because you release a little bit of capital, you give a little bit of spread, ROE-accretive to our overall agenda, so far, so good. And that's worked pretty well for us. And I'm quite proud of the way our team performs when they need to on that. Remember, we have an advantage in the size and the scope and the quality of the mix of our commercial and our capital markets loan book. So when you start with that book, which I think I've talked about on this stage many times, so I'll skip it, you actually have a lot of opportunities. So investors like the quality of the portfolio that they can get from us. And so it's worked well for them and for us. Going forward, are there limits? I mean, naturally, our appetite to do these types of transactions is not unlimited. Neither is the market's appetite to do them. So we'll look at it as the case may be, as the need may be, I should say, as we go forward. But as I look at 2023, for example, I don't think it should be much different from 2022. Like we don't -- for example, we don't see any need in our capital plan right now to say we've got to really crank this up and do more and more and more in order to meet those targets that I talked to you about before. No, it's more business as usual now for us.

Okay, great. So we touched on Bank of the West. Maybe is there any kind of update you can provide us on, I don't know, whether it be timing or any other thought processes or anything else that may have changed as a result of the equity issue? Or I'll just leave it open ended and let you respond.

Yes. So it's pretty much status quo in terms of what we have said, what we've been saying over the last several, I guess, quarters now. If you go back to December of 2021, when we were in the first quarter of 2022 fiscal, we said we thought it was going to take something like a year. Here we are in the first quarter of 2023 fiscal, and we're saying we're confident that we'll see a closing in the first calendar quarter of the year. Could that be in the fiscal quarter? Well, time is kind of running out on that but it's getting close. But it does feel like we're getting pretty close to the finish line is what I would say, and we stand by those comments that we've made before in terms of our expectations of approvals and closing. There's a gap between approval and closing based on the way the M&A contract works, but it's not that wide. So you get your approvals and then not too long later, you're able to close the transaction, so we'll go ahead and do that. As soon as we have approvals, the discussions with our regulators are all very positive, and there's nothing I'm aware of that suggests there should be a problem. I can say that. That's different from guaranteeing an approval because, of course, somebody could make one up tomorrow. But as I look at it today, all is well. And if all of that plays out the way I expect it to, as I've just described now, that will move us in a position to do a conversion. Our conversion date will be in September. And we'll be able to do the full technology conversion and customer conversion then. But make no mistake, on legal day 1, which should be sooner than later, we own the franchise, we have the people, we have the customers. And we're running the business, and we're beginning to execute the integration plan, which we're absolutely ready to do any time.

And it seems like the environment has changed quite a bit. It's just amazing what happens in 1 year. So is there any view or one of the things that I've picked up on has been very subtle is revenue synergies were discussed early last year and sort of faded in the discussion towards the end of the year. I don't have too much concern over expense synergies. Those are a little more straightforward. But what could you tell us on possible revenue synergies? And has anything changed?

Yes. So what I'll tell you on -- well, revenue synergies and just about anything else, is what we're going to do is once we own the asset for a little period of time, we will come back to you, to the market to give you an update on everything. Do we stand by all of the assumptions that we put into the model when we told you what we told you on synergies, on accretion, on revenue or cost synergies? I'd like to do that in a very fulsome way having lived with it for a little bit of a period of -- not a long period of time, a couple few months. And then we'll give a very fulsome update to investors. As I sit here today, if I'm a betting man, I think we're going to round trip pretty closely to where we've been. We did say when we announced the transaction that we thought it was in the range of 10% earnings accretive. That was based only on the cost synergies, by the way, reminder. That was cost synergies, revenue synergies, not in. We did come out a few weeks, a couple of months later, and we did declare our view of revenue synergies. That wasn't a number that was based on some average of precedents or anything like that. That was absolutely bottoms-up as we went through all of the business opportunities. So we'll rescrub that when we do the assessment of the business when we own it. I don't have any reason to believe -- well, it might have faded into the background, Darko, that's probably just because we haven't been talking about it very much. It's not because we have any less confidence in it. It's -- we'll look at it again. We think those opportunities are going to be real. They take a little longer to get to. Cost synergies come quickly. Revenue synergies take 3 to 5 years until you can fully mature them. If anything, I might have a hunch today that they'll be even better than we thought. But hold that thought and we'll come back to everybody once we own the asset for a couple of months.

Okay, great. We've had some discussion up here about the vulnerabilities in Canada with respect to mortgages. We know we're a little more commercial-oriented but you still have a mortgage book. So happy to dive into just asking your view on the vulnerabilities in Canada, and specifically, how you see it through your mortgage book. Can you provide us some statistics to give us comfort that these higher mortgage payments that people are making are A, not excessively higher, and B, not going to impact and create an impaired scenario defaults and inure losses in the mortgage book?

Yes, so thank you for recognizing that we do have a mortgage book. Our folks who are running our retail business in Canada would be quite excited to hear me say what I am going to say right now, which is that by our math, over the last 7 quarters consecutively, we have actually had the highest revenue growth. I didn't say mortgage, all products together in Canadian retail banking. BMO, highest revenue growth, 7 quarters running in Canadian retail banking. So I'm very proud of our team on that. Now let me come to your question. On mortgage growth -- pardon me, on mortgage risk and vulnerabilities, look, I don't know what everybody else has said when they've come on the stage. I suspect it's been well answered. And here, I might not say something that's particularly different. When you look at the layers of protection that are available, as you know, Darko, they're pretty substantial. And everything from not only the savings that are still, we think about 30% higher than they were pre-COVID, the structure of the market, the structure of the books, the loan to value, the insured component, you start to get down to exposure levels that are, we think, for a period of time here, like a year, pretty small. And we look at triggers as well. I'm happy to talk about that if you want. But when we go through that assessment, sometimes people ask me, all right, well, you get through all those layers of protection. There's always a tail. And of course, yes, there's always a tail. And the way we define the tail, just to sort of drive home the point here is when we say, where are the people who are most vulnerable? Well, if you're uninsured, if you have a FICO score of 680 or less and if you have a loan-to-value of 70 or higher, well, you're obviously most exposed. That is about 1% of the book. And when you layer on another criteria and say, how many of those are actually maturing in the next year? It's so de minimis, it's laughable, like I had to check the number. It's like $20 million. $20 million in mortgages. And so once you get there, the world is in a very bad place, admittedly. So you have to think about what would be going on in the world to get into the pain that's happening. But for the rest of the book, it takes a lot to get through those layers of protection. I'm not suggesting at all. I don't want you to get me wrong that we're not going to see any delinquencies. We're not going to see any insolvencies. What I can say is we don't see them today. We're stable today as we were last quarter. And as I look through most of 2023, I think we'll be pretty stable, and you might see a little bit of creep up as we go into the late part of '23 and '24. But based on that Pareto that I just took you through, I don't think it's that significant.

And do you think there's any substantial changes coming? I mean -- so we're suspecting that house prices could fall a little further. Resale activity is declining. Is there anything that you see in the horizon in the next year or so that would create or could possibly create a problem for the overall economy that really stems from these high payments and the consumer, basically, a big chunk of their payments going to paying your mortgage and not discretionary spending? So I'm dovetailing this into a discussion on credit reserves because one of the things that we see is in your forward-looking indicators, we don't see a big jump in unemployment. There's no expectation there. And you actually have an expectation of pretty decent GDP growth actually. So the question then is, these risks exist but your bank doesn't seem to have a negative outlook. Can you maybe square that for me? I mean, from your point of view as the CEO, do you kind of push people to adopt a more conservative view and build reserves from here? Or do you think the economy is fine, and we don't need to build reserves from where we already have them?

Yes. So let me just clarify. We're not out here saying we have a super rose-colored glasses view of the world, and we have a positive outlook. Our former -- I think our host view, by the way, on economic growth in North America this year is 0, so it's neither positive nor negative. It's sort of right on the fence. That might mean you have a couple of quarters of slight negative GDP growth, and you might have a couple of quarters of positive GDP growth, for example. And then when we price into our reserve builds, you know how the process works. We've been talking about it for 3 years now. It's a very rigorous process. And the fundamental linchpin in the decision-making as you go through relative to where you were before, is relative to when you made your last formal audited governed decision, has your view on the outlook fundamentally changed? What was it then? What was it now? And when you look at the weightings, when you look how we increased through the course of 2022, our weightings on probability of recessions, up they went, up they went, up they went. So we actually have a pretty conservative outlook, I think, already in our forecasting. Now you started this question asking about the consumer and the risk of exacerbating, I think, or procyclically getting an economic downturn, should they be having trouble making their mortgage payments? We don't think that they actually start having trouble making their mortgage payments until you might get unemployment up to considerably higher than where it is today. I mean, it is the trigger. We put 7% in one of our scenarios. Personally, I think it might even have to be higher than that. In the meantime, they make their mortgage payments. But if you look at the Bank of Canada data and you look at the higher cost for a lot of borrowers, and let's say a borrower is paying $5,000 more a year in mortgage payments than they were paying before, now remember, that hasn't clicked in for most people yet because most of the book is fixed. But for those that are affected and the variable, if the average Canadian household is paying $5,000 more than they were before, that's 5% of household net income. I think that's significant. It's not going to tip over the mortgage payment. It's not going to tip over the losses in any bank, but it is money that's not being spent on something else.

So do I hear from you then that there's a potential that you may push for -- I mean, we got -- we've received your PCL guidance for the year. But I think it was more around impaired losses. So do you adopt a view going forward that you build reserves from here a bit more because there is a concern of the vulnerability?