Bank of Montreal (BMO) Earnings Call Transcript & Summary

Well, good afternoon, ladies and gentlemen. We're going to start the session off. Very pleased to have Tayfun Tuzun, CFO of Bank of Montreal. Tayfun, welcome back. We're always pleased to have you.

Thank you. Thanks for having us.

So I'm going to start the line with what I presume is taking up a lot of your time recently is the Bank of the West acquisition. Can you give us an update in terms of how the integration is going? And like how the business [indiscernible]?

So now that the conversion is behind us, I will tell you that we'll be very happy to give you an update. By all means, we had a very good week at BMO last week. Conversion took place over the later weekend. And by all means, [indiscernible] social media. I think we have achieved the best outcome that we could have achieved and could have expected. Our teams have done a very good job in identifying where we needed to allocate the resources and where we need to double up on resources and technology, given the intensity of the transfer of [indiscernible] on to ours and in customer service, the focus and allocation of resources on to call centers, et cetera, the combination have resulted in a great outcome that we [indiscernible] very smoothly. You have to realize that there were [indiscernible] before this one, one full-dress rehearsal in August. So there was a lot of preparation. But at the end, we are very, very happy with the outcome. We are on platform now [indiscernible] unified the brands. We are no longer Bank of the West or BMO Harris. We are BMO in Canada. We are BMO in the U.S. We have launched a very active brand marketing campaign in California. We will probably keep it at high level of share of voice in California for a few quarters because, frankly, they don't know BMO in California. And given our history, given the scale that we operate in the U.S., all the safety and [indiscernible] issues in U.S. banking, our profile is a very attractive one. And we intend to leverage that towards fullest extent. And with the conversion behind us, our teams can now focus on that exactly delivering the outcomes that we shared with you and with our investors when we [indiscernible] the transaction. And one additional comment that can all be happy to get into the details about our expectations, both on the cost synergies and the revenue synergies. But one change since the announcement, which was in December of '21, is the change in OS environment and especially the regulatory environment with the added constraints on capital in the next few years, with the added constraints and liquidity and also the heightened regulatory environments that is moving even Category IV banks onto a more stricter operating platform. We feel that the advantage that we gain by acquiring Bank of the West and operating at a larger scale is even more productive. As you know, we operate at a much higher capital constraint [indiscernible] capital requirements of 1.5% starting in November. Our liquidity constraints are at a higher level compared to our U.S. regional peers. And we already had made the commitment to elevate the regulatory platforms because we're moving from Category IV to Category III. So all of those were already in place even before the U.S. regulators had signaled and announced the intended changes, which we believe are going to put a few constraints on the ability to grow for our U.S. peers, while we don't have [indiscernible] coming back to Bank of the West, level of excitement about larger footprint and larger balance sheet, bringing also the power from our parent company, I think, is to be meaningfully value creating for our shareholders going forward. So that altogether, I think that -- I think we have right to feel very good about the transaction.

You could unpack that probably for an entire session. But -- and I'll get into the expense synergy points in a moment. But the scale that you bring up is very interesting and not terribly surprising to the benefit. How important was Bank of the West acquisition for the -- in the U.S. to get that level of scale and then talk about the other ancillary benefits you mentioned in terms of the increased footprint? Talk about what business does the Bank of the West brings to the U.S. table?

So it clearly was a very important transaction for the future of our U.S. franchise. But more importantly, I think the timing of being able to execute this transaction is going to be more instrumental going forward. What we did not want to do was to add more [indiscernible] operating performance of our, I guess, U.S. banks. As you know, leading into December '21 when we announced the transaction, the performance metrics of our U.S. franchise have changed very significantly. When we started operating at 15%, 17%, 18% ROE [indiscernible] the efficiency ratio down to the low 50%, so it was the right time for us to add that scale. Adding the scale by itself maybe would not have been as effective as it now will be. But having made that comment, we all know and even for these regulatory changes, the cost pressure has significantly elevated the advantage of scale, whether it's technology, whether it's marketing or other discretionary expenses and the ability to put out a larger sales force into the business [indiscernible] $400 billion bank than $1 million. The longevity of the profitability and the outlook for profitability get significantly enhanced with size. And also, again, in the near term, we will operate with this expanded size. We need to show our investors that can deliver the promised financial outcomes. But we can grow more than this and the scale enables us to do that. Now you have top 4 banks in the U.S. and we are right in that next category with West Bank, [indiscernible], et cetera. And our ability to compete with them and with banks of smaller size clearly is a lot more enhanced. Let's be honest. Although we are talking about our U.S. presence, we operate our businesses North-South. So we have a $1.2 trillion balance sheet that we bring to the U.S. with the strong profitability in Canada. So you put all this together, I think the future is quite bright for BMO in the U.S.

And then can you talk about the synergies that you're expecting to where that's coming from on both the revenue expense side? And if you can talk as much as you can [indiscernible] to the last quarter in terms of likely [indiscernible]?

Yes. So when we made the announcement about the acquisition, we were very specific and clear about synergies. We said we expect to capture USD 670 million, and we will do so in the first 12 months following the closing date so that we will start here with the full run rate of those synergies. We have kept that commitment still even more strongly. And also during the earnings call, we signaled that our work in closing is indicating that cost savings is probably going to exceed that USD 670 million. So that is a positive development. In terms of revenue synergies, we had a couple of updates for our investors back in 2022. We mentioned that we expect $450 million to $550 million in revenue synergies for Bank of the West in a 3-year, 3- to 5-year time frame. And then we came back actually, I believe, at the end of last year, and we said that even pulling the timing of that back a little bit will translate into a $2 billion PP&E on a run rate basis as we exit 2025. And what we have seen so far since the closing, the elevated productivity, the rollback of the west branch is once we started banking programs, establish our performance targets and sales practices and also started enhancing their digital tools plus the cost -- the revenue synergies that started almost day 1 across our commercial banking and capital markets business, committed transactions, whether it's bond issuance, M&A advisory business or even just transactional interest rate risk management out foreign exchange products, et cetera. And also the conversations and the engagement at commercial [indiscernible] growing us commercial side have really increased our confidence in the commitment that we made to these revenue synergies. Now admittedly, the current macro environment is weaker than we would have anticipated when we announced the transaction. So we may see a quarterly delay in achieving these outcomes. But we are still confident that the level of outcome that we anticipated, whether it's measured in PP&E or revenue synergies is real. And we intend to get there. We'll get there faster if the environment allows us. But at the moment, I think the more important part is that we are increasingly confident of the revenue synergies in connection with the higher cost synergies, I think the transaction is hitting both financial targets, obviously, supporting our [indiscernible].

When we talk about the macro or the operating environment that you're currently in, can you talk about in terms of deposits funding, the pressures [indiscernible] year, how that's building through our presence -- yes, what Bank of the West may or may not provide for you that you didn't have previously?

So I'll answer that question both from the Canadian side of the border [indiscernible] the U.S. side. The Canadian side from a balance sheet perspective has been a lot predictable, a lot more stable deposits have been growing in Canada and also have been growing in Canada since basically the end of COVID. I think, in general, Canada, we may successfully avoided the turmoil that we experienced these in the U.S. On the U.S. side, immediately following the initial stages of the turmoil in early point, we have seen actually a positive [indiscernible] into our U.S. business. We've seen some weakness towards the end of April into early May. That may have also coincided with the tax season to tell exactly what the cause was. Since the early part of May, it's been a lot more stable. Our end-of-period comps are a lot more favorable. And we know that we are operating on one platform. Our projection and our guidance for deposit is growing before we suspect that it will go in our commercial business as well as [indiscernible] business. We think combination of having doubled our branch count and also supporting a larger branch counts [indiscernible] national deposit platform and us, I think, a competitive advantage [indiscernible] fully leverage that. And on the commercial side, we have a very advanced treasury management platform that operates on South to the West clients have converted to that platform. It gives them extended [indiscernible]. And I think it gives us the ability to attract new users. So we are quite optimistic at deposit perspective. We [indiscernible] pricing, price competition continues to be very fierce. It's not a balance issue. On the loan side, there is a difference between Canada and the U.S. In Canada, we have continued to experience loan growth, more so on the personal side, both mortgages and cards have been growing in Canada. But also commercial loans [indiscernible] at a more modest level, but on a quarter-over-quarter basis, we have been on a growth mode. In the U.S., it's been more challenging to grow loan demand over quarters and overall has come down in the U.S. over the last couple of quarters. And I suspect that may continue to be the case for a few more quarters until it's a bit more clarity around the fed rate decisions, inflation outlook, although, in general, the level of optimism regarding [indiscernible] think it's growing. I think our clients will need a few more tangible clarifications before they partly invest in their business and our business will look like that. But overall, I think we feel that our business is positioned well even for this environment. We look forward to, again, going into [indiscernible] both in Canada and U.S. impressing our clients' needs.

Can you expand a little bit more on the online deposit gaping system that you're implying in the U.S. and whether or not it's actually being fully enacted because I think the last time that I heard it was [indiscernible].

Yes. Last time I was here actually [indiscernible] a little bit. The time was not right. So we invested in that platform pre-COVID. As you know, we have a very, very strong commercial business in the U.S., that tends to outperform our peers in loan growth. And given the fact that at that time before we acquired Bank of the West, we had a smaller personal business. We wanted to enhance our deposit-generating capabilities with an advanced [indiscernible] as platform. The platform was put in place. It became a bit dormant during COVID because nobody needed to activate national platform. But as we came out of COVID towards the end of last year, way before the deposit terminal started in the U.S., we started getting ready, turn on the engine basically which is a national, both term and transaction-generating platform. We have the ability to reach out nationally to clients without having to be [indiscernible] our own base. It continues now and it's in place. It's activated. It enables us not only to go on and [indiscernible] this purely digitally, but it enables us now to test this thin branch business model in Personal Banking because when we acquired Bank of the West, we basically expanded our branch network from the Midwest all the way to California. Bank of the West's retail management was a lot more intensive in California. There's a thin distribution of branches and states in between. Now bringing this deposit platform, visual platform and covering it in branch network is a very good business model for us to test in real, and we're quite optimistic on mining the ability for our clients to use both the branch network as you go to the branch as you need to, but take full advantage of digital capabilities will give us a competitive advantage.

And I think before I throw it open to the audience for their questions, I wanted to ask you about U.S. retail banking versus Canadian retail banking because you are an American coming from the U.S. system, dropped into [indiscernible] you've got a unique perspective in terms of the differences. Can you speak about the universal bank model in Canada and whether or not you think U.S. banking [indiscernible] in Canada.

Yes. Very different business models resulting in different performance metrics. In Canada, for those investors who are here who are more U.S.-oriented, the branch still is the main outfit where we conduct business, whether it's sales, service, less service these days as digital banking has clearly improved all geographies. When the customer comes to the branch and still connect with the customer across different products. Mortgage continues to be an anchor product in Canada, unlike the U.S. where we lost that a decade ago. When the customer on a proprietary basis, acquires a mortgage at a branch, now you have basically that full relationship open, credit cards, [indiscernible], personal lines, mutual funds, ETFs, insurance. So the lineup of products and services now that you offer to the client and willingness to actively engage with the bank to acquire these products is significantly different than what we experienced -- what my experience has been in the U.S. We have given up on mortgage being the anchor product a while ago in the U.S. The credit card business is a lot more concentrated in the U.S. and we have the big 3 or 4 credit card originators capturing a large portion of that market. Investment products tend to be very clumsy, connecting to the private banking, but it's not as a direct linkage. We have a lot of opportunities to cross-sell between private banking and retail banking, but the lineup of products is not quite the same, insurance and ETFs and mutual funds. So deposits are really the main drivers when you talk about client acquisition in the U.S., you go to checking accounts. That's the anchor product. Well, in Canada, that's a more enhanced experience. Our goal is we carry the experience from Canada into the U.S., although the [indiscernible] may not quite enable you to penetrate that relationship as widely and as deeply as you can in Canada, you have a set of digital capabilities and the deep experience that we bring back from Canada to be able to connect with our retail client base. We also, although not necessarily in the same manner, we have a lot of focus on connecting the wealth business with private banking business, have a premier bank position that bridges that gap and addresses that mass [indiscernible]. And again, I mean, I don't want to every time go to Bank of the West, but the new Bank of the West platform enhances our ability to do that as well.

Well, I'm going to ask if there's any question from the audience. This is your chance to ask about Canadian housing because I'm massively long Canadian housing myself, and I don't want to hear any bad news about it. Okay. Well, on credit risk, BMO strategically has over-indexed itself on commercial. And as you alluded to earlier, you've been very successful being able to grow that book of business as well as the acquisition -- acquisitions you've taken on. How do you feel about the outlook for credit and commercial? And then the flip side to that is you talked about lower growth expectations lending in the U.S. on the commercial side. How long do you think it would take to revert back to being a strong driver of growth?

Yes. So I mean our commercial focus has always been there. We have not necessarily -- it's not a near-term phenomenon. We've always been more commercially focused. And we have a long history of credit performance. We have data in our disclosures going back 30-plus years. And we have outperformed our peers in terms of credit experience in that commercial book. There are a lot of questions coming into COVID, whether COVID would change that picture, understand the COVID process work differently than initially anticipated. But regardless, I think good commercial bankers with deep credit underwriting experience [indiscernible] to the business, a very diversified manner. So I'm quite [indiscernible] future performance in commercial will match our past performance in maintaining a level of credit that outperform our peers. As we look at it, our Chief Risk Officer, Piyush Agrawal at the call, my expectation is the normalization that we are seeing today [indiscernible] into the next number of quarters. We have defined a normalized level of impaired provisions somewhere between low 20s and mid-20s basis points -- so that's actually compared to my previous experience in the U.S. regional banking, that's a wonderful level of -- it's a great level of credit performance. We're not -- look, I mean, I think on either side of the border, we are seeing significantly outsized or red flag performance in any industry. Commercial real estate clearly capped a majority of the attention. We have spent a significant amount of time on commercial, have about $67 billion in commercial real estate, $11 billion came from Bank of the West and the portfolio is divided 51% in Canada, 49% in U.S. The largest asset class is multifamily, and I think 70% of that is in Canada. And as you know, the demographics in Canada and population growth continues to support multifamily. So it's a relatively healthy asset class. The second asset class is industrial that also continues to do well. The third one is office. We have about a little over $7 billion in office. And I think about 65%, 70% of that is in the U.S. but we have reunderwritten every loan above $10 million. We have a pretty granular portfolio. We actually disclosed the top [indiscernible] cities, and there were no cost [indiscernible] there. So -- and also at Bank of the West, yes, we have taken on more California exposure there. But remember, sort of -- we have [indiscernible] that we took a credit mark and we established [indiscernible] provision. So overall, we feel things are going to normalize. But I think the range is going to be still within our historical performance ranges, and we should not see any outsized credit underperformance. In terms of when loan growth turns in the U.S., look, I mean, I think if the more optimistic help work about softening comes true, if inflation is effectively under control, such that the Fed can declare an end to this rate cycle, those are clarifications that will help our customers make longer-term decisions. And so a more muted inflation outlook should take some pressure off of consumer balance sheets. Relative to that now, you have a [indiscernible]. So we have to be cognizant of that oil prices tend to keep headline inflation numbers in the forefront. My hope is that core inflation will continue to show signs of [indiscernible] such that, again, the Fed declares and then we can move that cycle, which should help loan growth.

[indiscernible] I guess the number of questions you have [indiscernible].

That is correct. Yes. Yes. We are not confident about our energy portfolio. It's been actually a very...

So Tayfun, I wanted to -- you talked about the restructuring items that last quarter, not in the vein of what this is going to be for savings going forward or even the fact that restructuring charge -- the philosophy behind the restructuring charge and not liking it as non-core, which, again, investors can treat it however they want. But I think this is a pain in the Canadian industry and notably from what BMO has actually done in the past. And can you talk about your rationale for this and -- is this a change in cost fee? Or am I just making a mountain out of a molehill?

Yes. Look, I mean, I think I don't know if I would necessarily describe it as a change in our philosophy. But we've been very transparent about the circumstances that led to this decision. At the very end of last year, as we look ahead to 2023 and assessed revenue growth prospects, we saw a more muted revenue compared to 2021. In '21 and '22, we significantly expanded our sales force. We accelerated some of the technology investments, which led to a higher expense growth, but we also had higher revenue growth, which are operating leverage -- as when we basically put a pause on that expansion at the end of November and December last year, revenue growth has declined faster than [indiscernible]. And we have an outstanding commitment to operating leverage, which then into the spring and in our second quarter and [indiscernible]. When we came to the third quarter and as we assessed the next local 6 quarters, we felt uncomfortable having operated in a negative operating leverage [indiscernible] for 2 quarters in a row. We had to make a change, and it just happened to be in line with the revenue outlook. And therefore, we took the action when we needed to take the action, and we believe it was [indiscernible]. In the form of how we disclosed this, look, we own it. We are very transparent about it. This is part of our -- why we run our business. It's dynamic expense management. We didn't see a reason why we should adjust for it because our [indiscernible] own it, our functions own it, and we just want it to be transparent because ultimately, the savings that are associated with this charge is also going to flow through the income statement for [indiscernible]. So we felt like this was the right decision. I'm not sure it's necessarily a change in the plots of it, but I think the way we run the company today with full transparency with our investors, we thought [indiscernible].

And then we tie the benefits of this and the expected benefits of the West, can you talk about your new confidence in terms of being able to generate positive operating leverage moving forward?

I'm very confident that we will generate positive operating leverage next year. And we have been very transparent about the impact of Bank of the West, but we are also not shying away from establishing an expense discipline at what I would call this distinction is disappearing quite fast, but the old legacy BMO. So we are making that commitment because we have to make sure we still have a long-term efficiency ratio target to get to mid-50s. We need revenue to help for that. But I think as we look forward to '24, the ability to contain the efficiency ratio is very important to us. And I think we have shown even this quarter, our numbers were actually -- we had negative operating leverage, but it was a very negative operating impact leverage picture compared to our peers. And although the fourth quarter -- we'll get through the fourth quarter, there's some post conversion expenses that are going through, but you'll get to that run rate in early part of '24, and that we'll be able to show you the progress that we make fairly clearly. But in terms of the positive operating leverage for the year, I feel very confident about that.

We have a time for one last question. This is your last chance.

It's really more about the consumer, right? Because I assume that it is the -- their discretionary spending [indiscernible]. And so what are your views on your consumer book and sort of -- it's relationship to rates. And as we sort of move forward into '24, where do you see like a real make breakpoint?

I assume the question is more on the Canadian consumer, right? Okay. So look, the rate impact in Canada is very clearly coming through mortgage and the mortgage stress is real. Although timing of it for BMO is later out to '25 and '26. But overall, the way I describe the stress on consumer is less about bank credit because I believe that banks are well protected because there is very low default risk with high FICO scores and LTVs around 55%, 56%, a lot of room for banks. This is more of a consumer health within the macro picture question. And as such, it is real that especially in cities like Vancouver and Toronto, the rate impact on household balances is putting stress. But we have fairly detailed financial analysis that looks across the portfolio of our mortgage borrowers, monitors the unsecured credit that our mortgage borrowers have with us, credit cards. We're not seeing a distinction in the credit behavior of those borrowers who may be experiencing more rate pressure through their mortgage. So credit card performance is actually, I think, if I'm not mistaken, to attend better than mortgage borrowers. But also appears to be the case more systemic in Canada is that unlike [indiscernible] in the U.S., the Canadian consumer, especially at the upper end of the income distribution is still preserving a decent amount of assets. They may have moved some of those assets into more liquid investments because rates have made it more attractive [indiscernible] become more attractive. But there is still a reasonable amount of cushion left on the balance sheet. And I believe some of that movement into liquid assets is really in preparation for potentially a higher mortgage payment down the road, whether it's a higher payment or a down payment that is maybe a bit more higher than they originally intended. So from now, it appears that the consumer is able to support yourself. And if the employment picture continues to be healthy and there is continued cash flows in attachment to a relatively healthy portfolio, we should see a stable picture. But I'm not disputing that there is stress in the system because the larger and larger portion of cash flows, income goes towards mortgage payments. That's the reason why I highlight the impact of oil price and headline inflation because although we focus on core inflation numbers from a monetary perspective, from a growth perspective, we need to keep that headline inflation still in check.

I think you have perfectly timed. We'll end it here and get off to [indiscernible]. Thanks always, Tayfun. Great conversation.

Thank you.