Bank of Montreal (BMO) Earnings Call Transcript & Summary

Last session before lunch. I'm happy to have Darryl White here, the CEO of Bank of Montreal on stage with me.

And Darryl, we've been kicking off these sessions pretty much starting with macro, thinking about the rate environment. And so wanted to maybe kick it off with you in the same sort of vein, thinking about interest rates, expectations are that they're going to fall, maybe fall aggressively, much more than what we had thought about maybe just 6 months ago. So, a, your view on the rate path; b, the impact for your NIM and NII, if you can?

All right. more aggressively than we thought 6 months ago, I think you said more aggressively than we thought 6 weeks ago, right? I guess it is fair. But look, on that, I will say that one December 13 FOMC meeting resulting in the exuberance that we saw, i.e., not only are there going to be no more increases, which was effectively set in that meeting, but rates are going to come, and they're going to be many, and they're going to be soon, that's a lot, right? Like that's a lot of a pivot at the same time. I think that the curbing of that enthusiasm that we've seen a little bit since is appropriate. And I'll tell you what my own view is, and we can put a range around it. But when we look at the puts and takes with the -- the good news that the soft blending narrative does appear to be a base case, that's great. But we're not there yet on controlling the ultimate outcome on inflation. And if I had to put [ opinion ] on it, our house call, I think, is and we'll end up being, we'll start to see those cuts begin in the middle of the year, not in March or whenever it is that people were jumping on to when the market rallied in December. And so let's assume that it's midyear. I think it will be a little bit earlier, Darko, in Canada than the U.S., and I can talk about why if you find that interesting. But we've sort of assumed that we'll see a cut in Canada, the Bank of Canada maybe around June. We might see the Fed go for the first time in July in each case to pick a round number. We'll probably see a 100-basis-point reduction through the balance of the calendar year. And then if that forecast ends up being right or close to right, the second part of your question, I think, was what are the implications for our outlook on NII, the short answer is like not much relative to our outlook expectation for '24. And the reason for that is because if that's right, you've got the transmission effect from those rate cuts. If there's 100 basis points from Canada and the first rate cut is in June, we're probably only going to see 75 basis points in that fiscal. And in the U.S., if we have 100 that starts in July, we're only going to see 50 in the fiscal, and the transmission is all going to be mostly in the fourth quarter anyway. So there could be some. But relative to our previous base case, not that meaningful. I will though, while we're on the question, tell you that I think that an important angle to this question is what's going on as a result of this rate view in the real economy because one thing for markets to position [ is ] a result of differential rate views. But I will tell you that in the real economy, I think that there -- I'm still very cautious. I was quite cautious, as you might recall in the late summer and the fall. And when I go through this period of time, I look at the spending patterns of the consumer through the holiday season. What you realize is the fact that a central banker tells you that I'm probably done raising rates and I might cut next year, that's one thing for a certain constituent of the capital markets, but it's quite another for somebody who's deciding whether they're going to put their foot on the gas and spend money and borrow money because if you just told me that it's likely going to be cheaper in June or July, then I'm going to wait. And so I think that that's an important -- I think that's an important point to make because I do wonder sometimes whether people get ahead of themselves and realize that, that full transmission mechanism does take a while. I think we're experiencing that right now. Like I think another way to put it, I think some folks' revenue expectations might be a little bit ahead of things for now. And then I think it picks up probably as we go through the year. In our case, we've anticipated that. We've been working through that. That's why we've put in place some of the self-help programs that we've got running, and I'm highly confident in those as well. But when I pull it all together, that's kind of my view on rates, very little impact on us for the year on our NIM outlook, and in particular, if I'm right about that, I think what you see happen is you'll recall, we don't really manage NIM to take positions aggressively. We don't try to hit home runs, and we don't get hit badly either. The proof of that is last year. If I look at the 4 quarters of 2023, with all of the volatility that there was in the market, the total dispersion on BMO's nontrading ex trading NIM was 11 basis points, went up a bit, went down a bit, went up a bit, went down a bit, 11 basis points in total on all-bank NIM. If I look forward to this year, I think you'd probably see a little bit of compression in the beginning of the year because deposit costs are still high. We haven't seen the fact that there's a forecast or a rate cut doesn't mean that there's going to be deposit costs easing until a bit later. And then we're probably managing to relatively stable for the full year. So we probably round trip, give or take, 5 basis points by the end of the year to where we are today.

And so picking up on that then, this sounds to me like NIM stable, really being impacted in the 2024. Maybe into 2025, we have a bigger concern on NIM if the rate environment continues to sort of decline. But I'm picking up on a sense that, look, loan growth isn't going to be great, the beginning part of the year. And specifically, I'm suspecting it's going to be consumer side, which isn't really BMO's jam. I think when I think of BMO, I think, more of a commercial side. So do you see a lot of strength still in the commercial side?

Yes, look, like we care about both the consumer and the commercial side. You're right, we are a little bit overweight on the commercial side. But I just think that at the end of the day, if I told you that in a transaction that you were considering undertaking, whether it was to upgrade your home or do a renovation or to buy a company, if you're a commercial or a corporate client and you don't need to do it today and the likelihood is -- like high likelihood is, if you do it in 6 or 9 months from now, it's going to be 100 basis points cheaper, what are you going to do? You're going to wait. And I think that's just a natural evolution of what we're going to see in both consumer and corporate behavior. It doesn't mean nothing is going to happen. I mean it's fine things are going on in the meantime. But to assume high, high growth rates in loan books off of an adjusted rate forecast of something that's going to happen 6 months from now, I think it's premature. And I think you're going to see it, but it's going to come later as the year goes on. Yes, that's good news for -- like it's particularly good news if that's right for 2025. Like life could get very interesting in 2025 if we're starting to see that sun come out.

And so I guess then -- so running full circle then to the sort of the expectations that we have for Bank of Montreal in 2024 is I get the sort of note of caution on NII, but at the same time, we're expecting some pretty significant expense reductions at Bank of West, almost 20% higher than the original estimate. And so I guess that sort of backfills. But I guess one of the things that comes up out of this is, so we're going to have tougher NII growth, maybe some expense -- or not maybe, but certainly sounds like very certain expense reduction. So what about revenue opportunities and revenue synergies? Is that also going to be delayed now because of the rate environment? Or do you see revenue synergies more on the fee side? Or maybe you can just flush that out for us a little bit?

Yes, sure. I just want to -- I'll get to your revenue question. I just want to touch on what you mentioned on the cost side. Yes, we've got a fair bit going on to, as we call it, self-help, and it's related, right? Like we saw -- we did make a call on this environment last summer, and we began our work on the cost. So we've got 2 things going on at the same time. You referred to it, Darko. We upped our -- to remind people, we upped our synergy target on the Bank of the West cost side from USD 670 million to USD 800 million. That's a 20% increase. That is pretty much locked and loaded. Like we said we're going to have that done by the end of the first quarter. That's 3 weeks from now. So in 3 weeks from now, I'm at the point where the fully -- full run rate of the $800 million is actually coming through. I think it's about 98% or 98%, 99% of it is actually running through as of the beginning of February, good. We also announced back in August a program that will deliver us about CAD 400 million. Sorry, I'm switching currencies here, but we always did the Bank of the West in U.S. And there, that takes the year to sort of start flowing all the way through our P&L. And by the end of the year, we think it is as well. So those 2 things combined, as we move through the year, become pretty powerful mitigants and buffers against what you're probably hearing is a more cautious revenue outlook for me. And then back to the other side of your question on the revenue side, look, I'm actually very encouraged there. The -- might there be some delays? I don't know. We've said there might be some delays, but we did say that we have USD 450 million to USD 550 million of synergies from the Bank of the West franchise in 3 to 5 years. And so right now, when we look at the activity, the overall market is a little bit tougher. But over the course of 3 to 5 years, I'm not going to give you a call on what the market looks like in 3 to 5 years. I don't know. But what I do know is, in the meantime, everything we thought was going to happen is happening. Like the branch productivity is going up. The sales-to-service ratios and the branches is going right up. I think Ernie talked about this a little bit yesterday. We're seeing thousands of transactions from the commercial franchise into the capital markets franchise today already. These are occurring as we speak. The conversion that occurred on Labor Day weekend was, by all accounts, absolutely world class. I'll give a shout-out to our team here as well. You look everywhere you can for customer friction through these conversions, and there always is. It's not an easy thing to go through. And ours was at the low, low, low end of the scale relative to any benchmark that we can find. The brand has been unified all the way from San Diego to Halifax. And we're also rebranding everything in the Midwest, by the way, that was formerly BMO Harris. It will be the same BMO everywhere. And those customer outcomes -- I haven't talked about wealth yet because in wealth, if you look at the penetration of our wealth product into our commercial book in the U.S., which, as you know, is a big sizable book, there, it's somewhere around 30%. The Bank of the West, it's low, low, low. So we've got an opportunity to port that technology and those sales techniques there as well. I'm very encouraged. So when you hear us say, well, it might be a little bit delayed, well, if something is delayed a quarter or 2 in 3 to 5 years, fine. Maybe there will be something I'll wake up to in a year from now, and I'll say I'm bringing it back forward a quarter till the thesis absolutely holds. And if anything, I'm getting more encouraged by it as we go forward.

And when I think about the revenue opportunities there, just maybe you can hand on like the top 1 or 2 opportunities. Is it more the commercial side? Or is it the consumer side? Or how do you sort of rank order this? Or how do you think of it when you look at the revenue opportunity?

So it is both. Like let's just start on the commercial side. If you look at the overlap in the businesses, we've got, in many cases, very similar businesses, but we don't have the customer overlap. You take food and ag, for example, where we have a very strong Midwestern-based food and ag business. They have a very strong Western-based food and ag business and a very high like 1 or 2 market share, for example, in the wine industry. We didn't have that. So totally complementary but the same overall sector. So you can drive synergies and better customer conversations, and then you can help with the technologies and the sales practices that we have, and the brand unification just kind of lift up the ambition effectively for the whole franchise. And there's -- I could scale that comment to hundreds of examples across the commercial franchise. And then in the retail franchise, that -- the franchise at the Bank of the West in retail was a good franchise. It's about 40 -- remember, the business is about 40% retail, 60% commercial, and that -- it was good. It was sticky, long-term customer, but the incentive on the sales side and the sales-to-service ratio in the branches, the amount of work that was being done in branch that had to do with servicing and fraud detection that doesn't need to be done in branch, we've pulled that into the way we do our system. We've given them analytics that we use for lead engines and proper customer conversations, and we're already seeing the productivity in that branch network now go up 2 to 3x relative to what it was. And then you layer on the digital and then the customer acquisition that's happening digitally. So you put it all together and the revenue opportunities are -- like they're going to be real on both sides of the business. And I know that because we're already seeing it. It's already coming through.

And so maybe just to quickly circle back on expenses, though. So you've had the program in Canada of -- you mentioned CAD 400 million of expenses. Does that get harder now going forward? Is -- are we in a new paradigm? Is it tougher to keep costs under control [ again ]?

The labor costs are tough, right? Like I think that's where we have to acknowledge when you have -- what's the average across your comp universe, 55%, 60% of the total cost structure of the banks is in people, right? And so when you have that as your base and you've got an environment where voluntary turnover has come down like way down from -- the peak was in, I think, Q2 of 2022. So there's a more manageable labor market. From the perspective of how tight it is and being able to keep and retain good people, we're in a much better place than we were then. But it's not like we're giving back the wage increases. Those are there, and they're there to stay. And so when I think about -- I think what you're asking is sort of a structural cost question as we go forward and forward and forward in the next, say, 3 to 5 years, the answer there is going to be increased, increased, increased digitization. And the better one can do on reducing manual work and increasing the automation of that work, the more you're going to see structural cost takeout. And that's a big part of our play over the next few years.

And structural cost takeout but without the use of further restructuring charges. I guess that's where a lot of people are kind of trying to...

Yes. So yes, you're probably -- and a bunch of us had these over the course of the last, whatever, a few months, right? Look, I remember saying to you years ago when we did a restructuring charge, I hope to not have to do this again, but that was at a time when we had been serial users of the technique, and it was 5 years. And the technique that we used, at least, I can't really speak for others, this time was very different because the cost was born in the businesses, right? We didn't do this. We'll take it at corporate, and you get a free pass, and you get to reload your cost base and then good for you. You had operating leverage. It's all shell game, if that's what you're doing. But if you're saying to a business, look, if you want to go through resetting the cost base on the employee side of your business and you want to actually take the charge in your business, including the implication that, that has for your incentive and your compensation, then we can have that conversation. We're not having any of those conversations right now, I should declare, because I feel like we actually have it right for the foreseeable future. But if we decide that we -- environment shift and there's a reset needed, we could do that. But when we do it, I will say, Darko, we do it with a view that you kind of get it done, you bear the cost of the business, people understand the implications of it, and you don't have an expectation that you're going to come back and do this regularly. That would be my view.

Okay. So I think to just shift the discussion to capital for a moment. It was a pretty big concern in 2023, built capital up. Once Q1 sort of passes by and you sort of see where your capital ratio lands with the expense synergies coming through, I kind of see a situation where your bank can generate more capital per quarter than in the past. And so it naturally leads us to think about a couple of things with you. One is your commitment to removing the discount on the DRIP and issuing shares for treasury. I've modeled Q4. But tell me, is that -- could it be earlier? How do you -- what's your thinking on capital?

It could be. So I'll unpack it for you though. So we're 12.5% on our CET1 at the end of Q4. So our current published number is 12.5%. We've declared that there's some stuff going on in Q1 with respect to the FDIC assessment and other regulatory change. Lots of people have these in Q1. I think Tayfun has explained that that's probably worth somewhere in the neighborhood of 25 basis points to the negative. We've also, on the other hand, got some risk transfer transactions that we did an RV transaction that you might have seen in December. That probably give me back mid-teens, call it 15, for argument's sake, to the positive. So if I'm just -- nothing else changes from a jump-off point, 12.5% is 12.4%, and I build from there as I go through Q1, Q2. How am I going to -- how we're going to think about this question on the DRIP, it is important question. We get it from shareholders all the time. I don't like it. I would want to have an office and as you could. You have to be sensitive to the overall environment and the regulatory overlay. And there -- to me, it's actually pretty simple. If I saw an outlook that said, we were going to operate at 12.5% comfortably or higher for the foreseeable quarters, not for next week or next month, but for quarters because you certainly don't want to undo a decision like this, and we had comfort that we were going to stay there without needing the DRIP to keep it there, we'll take it off. And so is that going to be earlier than Q4? There's a pretty good chance of that from what we see in our forecast, but we can't make that decision today. We'll be a lot smarter Q1's date, so we can have the conversation for the first time in Q2. And when we look at Q2, we'll say, where are we today? What's our expectation on the regulatory side? What's our expectation on our forecast and capital? And if it feels like I've satisfied that condition that I just told you about, we'll take it off. We'll wait another quarter.

Okay. Fair enough. And I'm just trying to contemplate in your answer there, what kind of condition would there be in the marketplace that you would need the DRIP to keep your capital ratio of 12.5%. Is this just the PCL? We'll get to credit quality in a moment.

It's a good question. I think it's pretty likely that the forecast is sustainably above 12.5%. But as we know, we never know. You could have various outcomes on the macro exogenous events. If there is a sense that the regulator is going to move again, I don't have that sense today. But all of those things, we'll bake into our calculus at the time, but there isn't anything particular that I have in mind that's dissuading me at this point.

Okay. Okay. And so maybe just switching over to credit quality then. I mean one of the things that we've noticed across the board is banks barely move the goalposts on the increase in provisions for credit losses and guidance for 2024. And in fact, when I look at your guidance for 2024, it still looks like it might end up being lower than longer-term averages. And so the question is, twofold, a, maybe help me understand why it's not rising faster, why it's normalizing so slow. And is there something specific in there for BMO that I'm just maybe not spending enough time on? Because I think of commercial real estate losses potentially coming. I see consumer losses coming in. Again, I understand your business mix. But maybe just walk us through your guidance for 2024, and essentially, the low level that we're seeing, what gives you confidence in that?