Bank of Montreal (BMO) Earnings Call Transcript & Summary

So thanks for being here.

Thank you for having us.

I wanted to start off by talking about credit because it is the big question, probably not a big surprise that we would start here. And maybe just to lay it out there in terms of the big question on investors' minds, and that's really, is BMO a credit outlier this cycle? I think on the call, you were very clear to say no. But I want to give you an opportunity here to address that directly and to go into a little more detail in terms of what gives you the confidence to be able to say that. And then I have a few follow-ups on that.

Okay. So it's the appropriate place to start, naturally. Let me put a little bit of contour around what we had to say on the call. And the first place I'll start is to reinforce the fact that at BMO, we've prided ourselves for decades on being superior. We write it out. We write it down. We put it out there on being superior managers of risk over the long term. And in fact, it's stated as one of our top 5 strategic priorities, so we take it very seriously. That goes to how we think about originating, how we think about underwriting, how we think about portfolio management through the cycle, how we think about workouts over the course of credit cycles. And when I look at it, mainly in the context of the performance that we've exhibited this year, I have to remind us of a couple of things. Over the course of time -- and I am going to get, by the way, to the specific outcomes that we've exhibited in the last couple of quarters. But I just want to make sure it's put in the right frame, and I think really important to the conclusion that I offered on the call and why I'm confident in it, is that when you look at our performance over the course of time measured in decades, in fact, and we disclosed this, over the last 33 years, we've outperformed our peers in 29 of them. Not this year. So we've had 4 years where we didn't. This year will be #5. And in this particular year, difficult as it is, and it has not met our expectations, we've been clear about that, and it hasn't met yours. I just want to put it in perspective. Our year-to-date impaired credit losses are 40 basis points. And the average of our peer group among the big 6 is 33. If I were to narrow it to the big 5, it's 36. So it's higher than that peer group. But to put in perspective, relative to our business mix, which I'm going to get into, with wholesale being a higher weighting of our business, it's not that different. Now that doesn't trivialize the outcome that we've had so far this year. And definitely, we expect better of ourselves. So that brings me to the question of how we got here and where we think we're going, which is effectively the conversation we had on the call. When we look at the concentration, if there is a concentration of where the impairments have presented, we've studied this very carefully. And at first, you might think, well, is there a concentration by geography in the United States? Is it in California because you bought a bank? Or is it in the Midwest? Or is it somewhere else? And the answer is no. The answer is no. Is there a concentration by industry sector, Cree or otherwise? And the answer is again no. And you look at various ways to try to identify concentration patterns. What you find is something different from that, which is also very interesting and very instructive, and it helps us inform how we perform going forward, which is -- you may have heard us say on the call that 15 accounts accounted for 50% of all of the wholesale losses that we have in our wholesale portfolio. So we have tens of thousands of unique accounts within the wholesale portfolio, and 15 of them have presented the outcome that is different from our expectations and different from your expectations. What do those have in common, if they're not those concentration areas that I've talked to? They exhibit, not all, but many of the following characteristics. Vintage, some underwriting that occurred in the sort of 2020, '21, '22 sort of pandemic era. They had higher leverage levels at underwriting than were probably sustainable, given the fact that there was some artificial fiscal stimulus, richer balance sheets than one would appear. There was some underwriting that occurred against the expectation of consumer preferences that were present during the pandemic that obviously weren't present thereafter. And in some cases, we had higher hold sizes than we probably should have. And that's not ideal. But when I look at that outcome and we ask ourselves, would we have done something differently? The answer is, of course, we would have across that number of names. But it's 15 names in the context of tens of thousands. And our outcomes so far this year would have been better had we done different things, different escalations, whether we would have taken the same hold amount upfront for a new customer, stuff like that. What we then did was we took those learnings and we said, all right, if I apply that as an algorithm and as a screen against the rest of the portfolio, the next tranche, the next tranche, what do I see? I don't necessarily see impairments. But I see some accounts where the combination of those factors or some combination of those factors are present at the same time. In which case, what interventions will we take perhaps earlier than we might have with this set of 15? And that can involve moving to watch list quickly. It can move -- it can involve moving immediately to impairment as well. And so we do that all the way across the portfolio. And we then used that, because I think you also said in your question, how does it give you confidence that this is where you go from here, we then use that to say, we were I think very clear with the market to say, we don't think this bulge is over yet. We think it probably goes a little bit higher in Q4, and we do think it's temporary because we do see that cycle completing. And I would say to you, probably in the next 6 months or so, we'll look back and say most of this is behind us because it's been a very diligent exercise to understand it. So we didn't want to be here. The loss given defaults outcomes were higher than we would have expected. Some of that is circumstantial. But we understand it very clearly, and we understand how to bind it, and we understand how to be able to get to the other side of this cycle. And is it different from peers? It is different from peers. It is different from peers because the business mix that we have, which is skewed more heavily to commercial and more heavily to the U.S. and commercial, is different from peers. And over the long, long, long run has proven to be a pretty good advantage for BMO. But in this more narrow sliver of time right now for a select number of accounts, it's been more difficult.

Because that's the real debate out there, I think, in terms of, okay, if BMO's not an outlier, then sort of the next logical question, is it sort of a canary in the coal mine? Is it -- are you just showing something that is going to eventually catch up to some of your peers? Because I think it came out across on the call, we're saying here, we appreciate business mix is different, but we're looking across U.S. banks, Canadian banks, we really don't see these types of issues. You talk about COVID being some of what's sort of to explain some of this. And we're not really hearing that from other management teams. So there's a question of, is there something to explain the timing here at BMO? Is it just we're seeing something sooner and it might catch up with your targets?

It's hard to know. I mean we do get asked the question. You look at previous credit cycles. And we often get asked, BMO seemed to be a little bit earlier to recognize and then earlier to recover on the back end of that. I can't sit here and tell you today that I know that, that will be the case. What I know is that when we see risk, we take action quickly. I do know that. You can't be conservative for the sake of being conservative. You have to rely on the data, and we do, do that. And it is the case that you shouldn't expect all of the other Canadian banks to have exactly the same experience that I described if they don't have the same business mix with respect to, in particular, U.S. wholesale credit. So that is different from the rest of the Canadians. Whether the outcomes that we're exhibiting will end up being different from the U.S. market broadly, let's say, when you look at the regionals, time will tell. Like I can't predict that as I speak today, but what I can predict for you is that we know where we think this is going for our book. And we know that we'll be back to our superior credit performance, which we've exhibited for 34 years, as soon as we get through this bulge in the cycle. Credit -- always, credit is cyclical. The cycle is temporary. The underpinning performance of the business is enduring.

And on the call, there was some discussion of not having some -- I mean, I think you addressed it here, but I just want to be clear. On the call, it seemed that there was some lack of confidence in the ability to provide guidance in terms of impaired PCL ratios.

Yes. It's not so much lack of confidence as it is if you look at -- as I've tried to describe to you how narrow and short the list is, and even if I add the next few that we'll present that we think we'll present in that list, it's so small relative to the tens of thousands of credits that it's hard to predict. It's just fundamentally hard to predict, and you can have a circumstance that accelerates very quickly. We've talked about some of those that have been fairly public that relative to Q2 and then all of a sudden in Q3, they're in a different circumstance. The model doesn't predict that very well, and nobody's model does in wholesale credit. So it's not so much a lack of confidence. It's just that we certainly didn't want to be in a position to say, we know that shareholders might expect us to -- or hope, I should say, our analysts might hope that we would say, on this date on the calendar at this minute, it will peak at this level. That's impossible. That's false precision. What we can do is put a range around our expectation and tell you that that's what we would expect. And that's why I've said here today, we think that that's complete in terms of most of it being in the rearview mirror within the next 6 months.

And so the corollary, the follow-up question really becomes, how does this sort of experience impact growth going forward? And you talked about some of the characteristics. The question is does this sort of -- does this event mean that you have to scale that growth? Well, maybe let's start here, at a different spot. I mean, people look at these credit losses and say, okay, like they just -- they were too aggressive in their expansion in the U.S. I mean I think you addressed that this is not Bank of the West. But could it be just BMO being more aggressive than was, in hindsight, prudent in terms of pushing on commercial and corporate lending in the U.S. over the past few years?

Yes, it's a good question. And there's a lot in it because you have to remember and as managers, you have to be careful that when you tackle an issue that you wished you had done a bit better job on, some of it was in your control and some of it wasn't, that it doesn't become the only issue in the organization, particularly when you think it's known and time bound. Because underlying that, what we need to remind people is if you look at the operating performance of the business -- I'll come to the U.S. in a second, Meny, but the operating performance of the business, there are some very, very good signs of health within the overall organization. If you're able to put this credit issue over here just for now, at 5.2% operating leverage in the quarter, it was double our peer average. If you look at our year-to-date deposit gathering, which I view as a key metric for health of organizations, it's best among our peers. And it's above the peer average in the U.S. When I look at U.S. operating metrics, when we look at balanced growth, when we look at protecting the downside on NIM margin, we've got a slide in our presentation that shows that we're beating the regional peers quite well on those sort of generalized health metrics. So you do have to be careful in your question to say, as a result of making sure that we put our arms tightly around a credit outcome that we weren't particularly happy with, that we spoil that momentum because there's very real momentum that we want to continue on. I think I made the point on the call that when we sort of ask ourselves the question, well, it's pretty simplistic to say that we grow too fast. And therefore, it's as simple as the blunt instrument that, therefore, the chickens come home to roost. Well, when we look at in U.S. commercial, U.S. wholesale, where the growth was faster than market and where it wasn't, the places where we took share, in some cases, very well and quite aggressively, included ABL, sponsor finance, sponsor lending, vendor dealer finance, some of our specialized businesses. That is not where the losses are presenting. So the conclusion isn't you're getting what you paid for there. The losses are actually presenting in the sectors where we are kind of growing much closer to market. And therefore, the reasons that I discussed earlier. So if I put it all together and assuming we're right about the trajectory of that curve going forward, when I get myself a quarter or 2, 3 out, our mandate is to continue to deliver that operating performance that we know we're good at because it's happening below the surface and then have the tailwind of those credit outcomes behind us.

So maybe to ask it a different way, have you made any changes to the way you underwrite in the U.S.?

So when you have an outcome like this, you sort of -- you have to figure out whether there's changes that you made. You also have to be careful that you don't swipe the entire page with one brush because I just told you that for the vast, vast, vast majority of credits and for the vast majority of sectors, we're not actually experiencing losses that surprised us or surprised the market. Where we have, we are looking at things like should single-name hold limits in the instance of initial underwriting be a little lower than they are? Are there certain dynamics around the credit underwriting that ought to trigger an escalation in terms of approvals? Like making changes that apply to treating the particular circumstance, as opposed to trying to treat the entirety of a portfolio and risking the question that you asked me earlier of slowing down the momentum, is what we're doing. It's quite surgical.

So I think that's an important point, just to highlight that. So you're highlighting a problem that, in your confidence, is very specific. This is not a broader issue.

That's exactly right. Yes.

Okay. And then talking about the U.S. because this credit issue came up Q2 and then extended into Q3, Q1. We were talking about just -- we weren't talking about credit, but we were talking about the ability to execute on Bank of the West was slower than what you initially had expected on the revenue side. And for the obvious reasons, we've seen the rate situation play out in the U.S. And obviously, you do a deal when you do a deal, and that's -- and so you need a little bit of luck there, and maybe you didn't have it this time. But just to highlight that again, sort of putting credit aside, in terms of just an update on your outlook for the U.S. business. It feels like many Canadian investors are souring on U.S. exposure, so maybe help us get a little bit more balance here. Like where are we making a mistake in terms of going down that road?

Yes. So a fair question. So maybe what I'll do, if it's helpful, is reframe the U.S. thesis because that's the question I realize is in the water. And then I can come back to where are we on the Bank of the West execution because it's part of it for us, of course. When you step back and look at the core strategy to have a strong, profitable, very competitive Canadian bank that generates excess returns and then makes decisions as to where to invest those excess returns, and in our case, for the most part, we believe that's the United States, we absolutely continue to believe that, that's intact. And this is a long-run strategy. This is a long-term strategy. It's a coincidence that we're sitting here today to the day on the 40th anniversary of the day that we closed the acquisition of Harris Bank in 1984. When we closed that acquisition, we were the 32nd largest bank in the United States. We had $8 billion of assets. Today, we're the 10th largest and we have $450 billion of assets. And over the course of the long run, we believe that has paid well and will continue to pay well. And when we look at the growth that we've employed over that period of time, about 60% of it has been organic, i.e., take share from banks that don't have the same capabilities, and about 40% of it has been the acquisitions that you see. I'll come to the one you've got in a minute. I never begin or end the day without reminding myself that the U.S. has a $35 trillion GDP. And Canada's is $2.7 trillion. And California is where we've put a stake in the ground is $3.2 trillion. And so when we look at that against the backdrop of the way we have set up our bank, Meny, the way we've set up our bank, which has been very deliberate over the course of 40 years, we've now got a circumstance where we're operative in 2 or 3 of the 5 largest MSAs in the country, in 14 of the 25 largest MSAs in the country, in 32 states. And by the way, in the 14 of those 25 MSAs, just that without even looking at the rest of the country is 10x the GDP of Canada. So the question I really ought to ask myself and my team and my board is, are we set up over the long run to be really competitive in a market that, overall, I would not bet against the United States? There are probably financial institutions who will say, that's a tough pot, right? But when I look at the setup that we've got and the way we've built it over the course of those 40 years and the way we continue to invest in times that are muted growth, like we've had in the U.S. banking market over the last year. Where we're adding capacity, we're adding teams, we're adding the capability to win, the market is more constructive to bring on revenue, well, when you don't have to then bring on much cost to bring that revenue, I'm very satisfied with it. And the reality is, it's almost half of our bank's income and it's completely integrated. So I acknowledge the popularity index on investment in the U.S. is not very high right now. But I think you have to be very careful to not paint that with one brush. And done right, which we think we have for the most part and we'll continue to do over the course of time, we think it's a very sound strategy. Now to your sort of -- I think you were asking the update on the Bank of the West question that's sort of buried within all of that. Look, I've said this before. We sat here on this stage exactly a year ago today on the day after we completed the technical integration. And that was a success. We won a Celent award for the success of that integration. The technology teams know what they're doing. The branding teams know what they're doing. If you've been in California, we flooded the market. The recognition and the consideration for us has gone up, and we started to add customers after that period where you have attrition post acquisition. We're now seeing the inflection point. So all of that is very exciting, and it's going very well. And we've kept all of the top talent that we wanted to keep. Where are the challenges and what hasn't yet gone according to expectations? They are around the revenue side. And there, look, you are right. Sometimes, you get unlucky on timing. We closed that acquisition on February 1, 2023. And 6 weeks later, Silicon Valley Bank tipped over and First Republic and on it went. And the destabilization effect of that over the entire market has gotten better today. But it persisted for over a year, right, because you had the confluence of higher deposit costs, materially higher than you would have expected at the time. You had funding costs that were impacting a bit your lending margins. And then you also had this flattening of demand that is flat, flat, flat over the consumer business over the course of the last 18 months when the long-term average is 4% to 5%. So we've been living with an environment that the revenue pie has been pretty significantly depressed in the market overall, relative to what we thought it was going to be. If you were betting that, that will be the U.S. banking market to the end of time, that will be a difficult outcome from us. That's not our bet. The number of clients that are telling us that this waiting period that they're in for 2 things, for the rate cut cycle to begin, which I think we're on the precipice of, as well as the U.S. election, which is really quite something within the U.S. commercial market, we find relative to what happens through the course of Canadian elections. We saw this in 2016, this pent-up, I'm going to wait, I'm going to wait, I just want to know what the outcome is. I want to know what the policy outcome is of an election, one way or another, before I get back into the business of capital formation and demand for banking products, that's the phase that we're still in right now. So as we come out of that phase, my expectation is we're going to be able to deliver on those revenue promises without having to materially increase the cost base, i.e., more leverage. And we've said before, we think that the consequence of all that is we will get there. We don't have -- nothing's changed on our expectations, and nothing's changed in our confidence level. It's a timing issue. And we, therefore, as -- we pushed out our expectation of that full delivery of the revenues from the end of '25 to the end of '26.

So that's why -- I think that's an important point in terms of you're confident that it's still timing. There's nothing more structural going on here. As the quarter has gone, nothing's telling you that, that thesis is still not going to play out.

All the health metrics we look at, branch productivity, the increasing cross-sell of the products into commercial, into wealth, those numbers are ticking up as every day goes by. And therefore, the answer to your question is yes. There's nothing that's fundamentally changed in terms of our expectations, other than we pushed out the timetable. Not on the cost synergies, by the way. They're done. They're -- we exceeded those. They're in the bag. On the revenue side, we've got some work to do to make sure that we get all of that done as well, and we'll get there.

I wanted to stick to U.S. but talk about the capital markets. Maybe we can also touch on wealth. But you have a sizable presence in the U.S. capital markets business. You built that out. This quarter, there was a lot of talk about the upsurge in dealmaking in the U.S. Obviously, we can see Goldman Sachs share price as a proxy for that. Looking to results, we didn't really see a lot of that excitement come through in terms of your U.S. capital markets business. And I guess the question is, why that is? And what lessons do you draw from that?

Yes. So there, it's like -- we're not trying to beat Goldman Sachs in the United States. And so just to remind people, what we are trying to be is we've got a really competitive capital markets business in Canada that I think can be even more competitive than it is. And we've got lots of plays that we're investing in to make that true. And our U.S. business, which is about half of our overall capital markets business, you kind of have to look at where we've chosen to play. If you look at the results you saw from the U.S. banks, somebody told me, I haven't checked this. But somebody told me, if you look at year-to-date M&A volumes, you are basically up 25% in absolute deal volumes. But you're down 25% in number of deals, so it's the year of the mega-deal. That's not the space we play, right? We play more into that upper middle market. When that market is active, we play a lot better. And in the meantime, the businesses that we've chosen to build, i.e., we're not going to chase that business and have the capital that you need and the expense that you need to chase that business, but the places we've chosen to build in that mid-market are running pretty well. And when I look at, for example, the investments that we made, and we think we've come to sort of the end of an investment cycle, and now we're going to be in a harvest cycle for a while in the capital markets business, it gets pretty interesting. Because you look at the rates business, for example, 5 years ago, rate securitization, we weren't very prominent. Right now, we're top 3 in rates. We were #1 ranked in rate strategy and in institutional investor in the United States. If you look at the securitization business across CMBS and otherwise, we've got a top 3 position there. When those markets are active, you'll see an uptick in performance from us that you might not from others, right? So what you saw is certain markets uptick that we're not big participants in. When you see these businesses where we've taken very clear leadership positions uptick, you will see outperformance from us. And in the end, we made a commitment to shareholders that we wanted to get the PPPT of our capital markets business to be, A, at $625 million per quarter or better and, B, consistent. Like we didn't -- we don't like the notion of really big swings. And of course, you are going to have some swings in capital markets business. And that's actually what we've done. If you look at the last few quarters, we put out there a pretty tight band. And we've stayed within it in terms of managing the volatility of that business, and I think there's upside from there.

That's very clear. I want to talk about something we don't normally talk about. But guidance, if I look at EPS revisions, consensus EPS revisions for BMO, both '24 and '25, definitely, BMO looks like an outlier in terms of the magnitude of the downward revisions. So we came into the year very, very clearly, overly positive in terms of the earnings power of the bank and the expectations for '25. And we've had to revise that number down, and maybe dramatically is overstating it, but we have had to revise more than others. The question is, what happened here? How much of the blame do you put on me? How much do you...

It's all on you. None of it's on you. The -- so I saw the chart you put out. Was it yesterday or the day before?

Yesterday.

So I think it's a good chart. I don't blame you. The numbers are accurate. I looked at the decline from -- I think you drew it from the beginning of Q2, the end of Q1, right?

That's right.

And that's a pretty appropriate time to draw it because there was an inflection point from there for us, particularly on credit. And I looked at the revision from then to now, and I came to the conclusion that not quite but almost 100% of the revision is due to credit. Almost 100% of the revision is due to the credit outcomes that we have had that wouldn't have been in either our guidance nor your models at the end of Q1. And so the flip side of that is that the operating performance, the PPPT delivery and the operating leverage that we committed to at the end of Q1, when we had negative operating leverage in Q1 and we said we would be positive for the rest of the year. We were positive in Q2. We were positive in Q3. And we think we're going to be positive in Q4. It's in line. So I don't mean to oversimplify your question, but the numbers don't lie. The entirety of the downward revision in those estimates, consensus estimates, you and all of your colleagues, is credit. And we're being very clear here today that we don't think that's over, but we do think that it does come to a closure point sometime in the next 6 months.

I wanted to talk about ROE. It's something I'm talking to all of your peers about in terms of medium-term ROE targets and how you get there and the building blocks of that. You have an ROE target of 15% plus. And so the question really is, over a period of undershooting that, do you still have confidence that you're able to get there? That's still a valid target? And sort of -- and how do you get there?

Yes, it's the -- that's the right -- I actually think it's the most important question. So undershooting, yes, a portion of that undershooting is the same answer we keep coming back to. It's the credit, but not all of it. And so what you need to hear from me is that I actually have a plan and I have a line of sight as opposed to, yes, we think that's a reasonable target and we'll probably get there. So I'm telling you, we have a plan and we have a line of sight to get to 15% ROE. What does it include? And what do you have to deliver on, not just believe? It includes a normalization of credit. It includes delivering 2% operating leverage in the business, taking the efficiency ratio, which we have improved over the last year by 300 basis points, down to 57%. It includes bringing it to 55%. It includes improving the ROE and the performance in the U.S. business, which is not just PCL. It's that revenue delivery that we -- I won't revisit it all but that we talked about earlier in this conversation. And it includes the work that we're always doing on how we look at capital recycle. And so when we do that, we believe, and we believe that with conviction, that over the medium term, we get the 15% ROE that we've held out there. It's not just something we put out and we hope to get to. It's something that we have a clear plan to address. Now could the environment swing us again? I suppose. But based on our outlook on the environment, that's the formula we know that we need to execute against to get there. And there's pretty significant value creation, as you know, if you look at the difference between an 11% ROE and a 15% ROE. We've been there before, right? We got to the 15% across all of our U.S. businesses in 2022, for example. It wasn't long ago. We've got the toolbox.

I wanted to talk about the outlook for commercial loan growth on both sides of the border. Obviously, you're very well positioned to speak to that. In the U.S., the question often comes up. The role of the U.S. presidential election, do we need to get beyond November to see a material improvement?

I think we do. I think we definitely do. Like it's not 20% of the conversations I have with U.S. borrowers. It's 80% or 90% of the conversations I have with them, where we say yes to your question, that we do. And I think then, and that's why we withhold our sort of generalized guidance on things like loan growth outlook until the end of our fourth quarter because then, when we're talking to you all in the first week of December, we've got the election behind us. We've got those conversations with our clients. We can understand how much of the pent-up demand, we think, is going to be released. We assess the competition vector from private credit in particular, and then we come to a view. Having come from flat for the last 18 months, I'll go way out on a limb and say to you today, I don't think it's going to be flat. It's going to grow with all of those things coming in our favor, including almost certainly by then some of the beginning of the rate cut cycle with the Fed. But I can't yet tell you whether I think it's going to be 1% or 2% or 8% next year. We'll clarify that for you at the end of the fourth quarter, but I do expect some expansion.

And then in terms of Canada, where we've been a lot more resilient, what are you hearing from your customers?

Generally confident. Like I would say, generally, the Canadian customer on the commercial side remains confident. There's some tails in areas where folks are more concerned than others. Generally confident. If there's a but to it, it's whether or not the rate cycle in Canada has been soon enough to catch that kind of tail end of consumer that was levered and had run out of the excess liquidity from the pandemic. And then is the rate cut today just too late for some of those? Because as we know, the rate -- the impact and the transmission effect of the rate cycle in Canada is faster generally than it is in the U.S. because of short-term mortgage impact. So that's good. Like that's generally good. But I do think we're going to see some uptick in unemployment in Canada. And I think the governor was clear about the right decision today to say that the balance of risk has shifted to that, right? It has shifted to that we get too much impact on inflation and we don't protect the employment picture enough. So we do hear -- coming back to the commercial borrower question that you asked, we hear that from our commercial customers, saying like that's the consumer segment, if they're exposed to that consumer segment that they're worried about. But I'll come back to the beginning of my question. In general terms, there is a -- with appropriate caution, there's a general level of confidence.

I think that's all the time we have. It's always great speaking to you, Darryl, so thanks so much.

Thanks.

Now I think we have a lunch break, and then we'll be back with American Express.