Bank of Montreal (BMO) Earnings Call Transcript & Summary

Okay. Great. So we'll begin the next session with Darryl White, the CEO of BMO. And before we begin, I just want to remind everyone that Darryl's comments today may include forward-looking statements. Actual results could differ materially from forecasts, projections or conclusions in these statements. Listeners can find additional details in the public filings of BMO Financial Group. Darryl, thank you for coming again.

Happy New Year. Thanks for hosting.

Always a good time to catch up and discuss maybe some questions we have left over from the fourth quarter, and I have a few. So I'm going to dive right into way some specific ones for Bank of Montreal. I think it's clear 2024 was a challenging year in terms of provisions for credit losses. So I want to start chipping away at some of that and discuss a little bit the outlook. And one of the things that was clear and resonated in the fourth quarter call was that PCLs have sort of peaked at Bank of Montreal. So I think maybe one of the things that I'd love to discuss is how abrupt could the change be in terms of, if they peaked, could we see significant drops? And maybe related to that question, when I think of a typical PCL cycle, I think of a rise, a big spike and a significant decline because of recoveries. And so presumably, you may be building a recovery pool here, as well you did in '24, maybe you're still building it in Q1. So maybe you can walk us through the expectation. I think you guys still -- I know you've maintained a high PCL for Q1 and Q2. But maybe you can just walk us through how you see that developing and maybe talk about the potential for recovery.

Sure. Sure. So maybe I'll start by bringing us back to, I think, the key themes that we messaged in Q4. A month has gone by since then, so things can change. So I'll try to give you a little bit of update relative to that. And then I think the best way to think about it is then within the businesses, impaired outlook, performing and prospect for recovery, I think, was the last part of your question. So within that frame, the 2 key messages that we put out at the end of Q4 were number one, that we did think that we had reached a high point that would be relevant to both the impaired provision as well as the total provision. A month has gone by, I would say today, we stand by that. So we're confident that, that was the right call then. And the other key message that our CRO put out was that we thought for the full year 2025, in terms of giving full year guidance, that we would probably end up somewhere in the same range that we ended up for the first -- for 2024, which was 47 basis points on the impaired. And so if you put those 2 comments together, what you get to is perhaps a similar outcome, but with a very different shape because through the course of '24, we started low and we ended up high and through '25, what that implies is we think that we start to come down through the year, and we maybe end up on average in a similar place, but we get there in a different way. If I unpack that a little bit for you by line of business, when we look at capital markets relative to where we were in the last half of last year, there, I think you'll see a pretty significant drop pretty quickly. I'd like to get to your speed question. There, we had some credits. They were pretty isolated. There was a handful. We had some larger provisions. We think for the most part, those situations are fully resolved. And at the same time, we don't see a lot of net new coming into that book. So I think there, we'll see a reasonably steep drop, not to 0, but to a low level more quickly. On the other hand, in -- if I look to places where I think credit continues to worsen, there, I would point to Canadian retail unsecured. We're seeing continued migration, more insolvencies. And there -- not dramatically, but there, I think we'll see some offset to the point that I made on capital markets, which was relatively positive, which brings me to the bigger part of our portfolio, which is the commercial. And in commercial, I think both in Canada and the U.S., similar to capital markets, relative to where we came from in Q4, we're trending positively, meaning lower provisioning outlook for impaired. But there'll be variability in commercial quarter-to-quarter because it's a big book, lots of credits as we go through the year. So net, relative to what we said in Q4, we stand by our comments in Q4 with that sort of unpacking by line of business and by geography as the sort of incremental help that we can give to investors in terms of what we're seeing in the marketplace. On the -- that's on the impaired. On the performing, I do expect that as long as we continue to see negative migration that we'll continue to build. And we do continue to see, as I said earlier, a little bit of negative migration in the portfolio. It doesn't mean we're going to continue to see the same level of impairments, but we will continue to build prudently. I don't think we'll build at the level that we did in Q4, which was a pretty significant build, but we'll have some build as we go through the year, and we don't expect to see releases as we go through the year on the performing. Last part of your question was recoveries. I guess on recoveries, I'd say this, we do not embed a forecast of recoveries in our outlook. We don't embed that expectation because when you take a provision on an impaired loan, you take it based on your best estimate at that moment in time against that credit as to the probable outcome. And you don't bake into that, well, there's some prospect that we might get a recovery. So that's not in the forecast that I gave you, i.e., an expectation of recovery. There may be some, there may be not, but we don't build it into the forecast. And remember, workouts, just because you take an impaired loan, you don't then ignore the client. You continue to work with them, and there may be a recovery down the road. And sometimes those take 3 or 4 or 5 quarters. And sometimes they take 3 to 5 years. But that's the way we think about the prospect of recoveries when we give you guys outlook comments.

All fair. Just the way I think of recoveries is in the heat of the moment in Q3, for example, or Q4, your loss given default would be somewhat elevated. And as things get better, you look back and you say, you know what, we were probably a little bit too aggressive on the value of that asset or so on and so forth. So that's why I envision and think about recoveries.

Yes. And I'm not picking on your theory. I'm just specifying that in that moment that you're describing in Q3, we make our best available judgment at the time based on best available information at the time. History will always show somebody could have been more conservative or more aggressive in that moment in time. And if over time, the circumstances are different, then yes, you realize a recovery, but we don't take an impairment on the basis that we expect a recovery.

Right. So maybe just one last -- and this is sort of a bit of a philosophical question for me because covering -- I've covered your bank for a long time. And for a long time, the view was always sort of pitched as we are superior on credit quality. But this last cycle, maybe not and maybe not even the prior one. So how important is that to you as the CEO? And does this -- do you want to really press on your credit risk folks that this was unacceptable and this needs to change? Or is it so idiosyncratic that really nothing changes?

So superior management of credit over time is explicitly stated in our strategic priorities as a key enabler to our strategy. Like that's fundamentally my answer to your question, and I stand by that, and that's a really important tenet to BMO's thesis and to our strategy overall. When I look at -- and we disclosed this over the course of 34 years. In 29 out of those 34 years, we outperformed our peers on credit losses and not by a bit, by a lot. We had an average of 36 basis points of credit loss against a peer average of 48. And in 29 out of those 34 years, we were better. And so last year was 1 of the 5. And so to kind of just give people some perspective on whether I thought there were some unique circumstances in '24 that drove that outcome, and we've talked a lot about this with investors as to what drove it. I'm happy to go into it if you want to. But I absolutely do believe that they were unique to our particular set of circumstances with a fairly narrow list of credits relative to tens of thousands that performed according to model, according to expectations. And so over the course of time, as we go through this mending period, as I've described it in other forums, I absolutely maintain that superior management of credit over time is a very key component to the Bank of Montreal thesis, and we're working to keep that front and center.

Okay. So the other thing from the Q4 call that really piqued my attention, and there was a little bit of question on this in the call as well, but I wanted to go back to the -- there was a visual in your earnings presentation on your sort of your ROE improvement and the path to ROE improvement. And the steps involved to reach them, maybe you can talk a little bit about -- there's that big bucket in the U.S., which is part PCL. But I really want to dive into not the PCL part, but the other improvement that's expected out of the U.S. business. How you get there? And one of the things that you left kind of open ended was the timing of the improvement. So I wonder if you can just unpack a little bit for us today.

Yes, I can do that. So for those who didn't see it in the fourth quarter, what Darko was referring to is, we put a new visual in our investor presentation, which was very deliberate and intentional. And what you should take from that is it top priority. So this is -- my first point is this is the #1 priority in our system right now is what we call the ROE rebuild. There's 500 basis points of improvement in that, which when we get it done, is a truckload of value creation over the course of time. I'll get to your timing point in just a moment. There were 4 blocks to that rebuild. We had a visual. We didn't put numbers to them. But if you stare at it closely enough, you can see that the size of the blocks are a little bit different. You can get your ruler out, that's deliberate. And they were the U.S. segment itself, as you pointed out, inclusive of credit normalization in the U.S. segment. I'll come back to that. They were the operating leverage that we drive at the total bank level. They were the normalization of credit other than in the U.S. segment at the total bank level, meaning Canada mostly. And then the last bit was capital optimization, so 1, 2, 3, 4. And if I just bring you back to the U.S. segment, there, you have credit normalization. I've just talked about this. That applies in very large part to the U.S., but also in other businesses as well for us. There is more to it, as you just pointed out, in the U.S. segment improvement to than credit normalization. Remember, at Bank of the West, we achieved -- in fact, we overachieved our cost synergies, but we're just getting on our horse on the revenue synergies. The environment flattened out on us for the last 1.5 years. The environment is better, and we are executing better against that environment, both in the retail businesses and in the wholesale businesses. We're starting to see net new customer growth, both retail and commercial. That's been true for the last 6 months. I expect that to be true as we go forward. And we're seeing more interconnected businesses on our One Client agenda in the United States than we ever have before against a more constructive backdrop. We put in the window $450 million to $550 million of revenue synergies for that acquisition. We're getting going on that. We're now on track, and we think we're going to be able to deliver that over the course of the timing that I'll get back to on your timing question. And we've got positive operating leverage expectations in the rest of our U.S. businesses as well. So that's what -- there's a lot of accountability. There's a lot of measurement. There's a lot of systematic work that will drive that outcome. We don't need -- by the way, let me make one last comment on the U.S. before I get to the rest of the ROE. We don't need our U.S. bank to get to 15% ROE for our total bank to get to 15% ROE. I need the U.S. bank to get to 12% to 13%. If I get the U.S. to 12% to 13%, I get the total bank to 15%. We're going to hold ourselves accountable over the course of a longer period of time in the U.S. to get to 15%. We're designing plans to do that. But when I get to 12% to 13%, assuming I get right, everything else we're doing in Canada, we also get the total bank to 15% or above. That's the way the plan works. The PCL normalization in the rest of the bank is very simple. That assumes we don't get back down to 10 or 15 or 20 or some unusually low number as we had years ago, but we get it back down into the mid-30s, which has been our long-term average that I talked about before. We've got positive operating leverage expectations of all of our businesses. And I'll remind people here, it kind of got a little bit lost, I admit, in the credit story last year for us. But we've been very diligent over time about delivering operating leverage. The only year we've missed it in recent memory was, in fact, back in 2023 when everybody missed it. Last year, we drove positive operating leverage despite everything else that was going on in the bank. This year, I expect to as well, early days in the new year, but the early signs are good that we'll be able to deliver on that as well. And then the last bit is that capital optimization, which is the trickiest bit. We've done this before. If you go back to -- I remember sitting here with you in 2019 when we said we've got capital optimization plays in place. We recycled capital out of low returning, not right to win markets. We put it into places where we thought we could win. We had balance sheet velocity moving very quickly into the COVID period. And then we ended up with an ROE for 2 years running that was above 15%. So I know that we've got the blueprint to do this, and I know that we can do it again. That's the hardest bit. Within the hardest bit of that last bar, the easiest bit is the share repurchase program that we announced, which we expect to get our approvals here sometime towards the end of the quarter, and you should expect us to be in market on that. And then the rest of that, which is probably sort of the last bit of the improvement, is on that capital recycling and pressure testing and reallocating capital to places that we can get done. And we already have plays in motion to get there. Now the timing is important, last point. When we all talk about medium-term objectives and goals as we put out in these conversations, we talk about 3 to 5 years. And so on the one hand, I think I've got something pretty unique at BMO relative to most right now, which is 500 basis points of ROE value creation, which we're very confident that we can deliver. On the other hand, it's not immediate. It's not overnight. On the 3 to 5 years, assuming there isn't a major dislocation in the markets or the economy, our goal is to get there on the earlier end of that range.

And what would it -- what can get in the way to get you to 5 years? What would be the biggest risk to your...

I think a market dislocation that would cause revenue ambitions to flatten. By the way, when I say that, we don't have extraordinary revenue growth expectations in our plan. We don't need to grow our revenues by 10% annually or anything crazy like that in order to get to what I've described to you. But if we return to an environment where there was no loan growth, for example, for a couple of years as we experienced in commercial U.S. last year and for part of the year before, that would push it out further.

So 500 basis points within 3 years, feels like it could be lumpy because PCLs are a big component of that, right? And so we could see a big improvement in year 2, let's say. Is that a fair...

Yes. You know, look...

This is the last year of elevated PCLs, I would say.

Look, over the course of -- if you imagine quarter after quarter after quarter for 3 years, is it going to be exactly steady with the same amount with a positive income? No, of course, not. That's not the way the world works. There could be things that could throw it up. But if you draw a line through it, I think that's exactly what you should expect on average, which is a gradual build. It doesn't happen overnight, but the plans are in place, and we're confident over that time period.

Okay. And on the Bank of West synergies, you talked about the $450 million to $550 million, and you just started on that and you're working towards it. And you mentioned something in there, you're now seeing customer growth in the franchise. Have you done any benchmarking against peers? And can you give us an idea of...

Yes. So if you look at acquisitions done well in U.S. banking, you tend to see attrition rates out of the gate for the first year because people are uncertain or there's a conversion or they get attracted between the period of announcement and closing by an alternate provider in the sort of 10% to 20% range, which is what you would normally put in your model. We bottomed at 10%, which is really good. I think JPMorgan's advertised that they retained 90% of the First Republic customer base, just as an interesting point-to-point benchmark. But on average, when you look at it, we sort of retained about 90% of the client base, which was good. And as of about the middle of last year, you saw that trough and you started to see the build. And both commercial and in retail, we went into net new acquisition mode. And it builds slowly and it builds over time. The brand awareness in California year-over-year for us is up 20%. It's very material. If you spend any time in those markets, I think we're a little hard to miss, both digitally and physically in the marketplace. And the client sell and the density is becoming more interesting every day. So we're gaining -- the market flattened out on us. But while the market was flattening out on us, we were investing in that outcome. So now if we see some more constructive tailwinds in the market, we're there in a more prominent way than we were before in order to take advantage of that, both digitally and physically.

And one of the other things -- and sorry to harp on this, I'll get off this topic soon, I promise. But you mentioned, look, in the capital side, the NCIB is easy. I get it. That's easy. We can all model that. Let's talk about the tough part in capital and allocating capital correctly. What -- can you maybe give us -- describe a few ideas here and what you can do in capital allocation?

Sure. I referenced earlier because I can't help it. We go back to 2019, and we said to you that we've got a toolkit and we're going to operationalize it. It involved both inorganic and organic opportunities. We always think about those things as growth, but in fact, they happen every day as we talk about capital recycling. So if you look at us then, we recycled capital out of our EMEA business in Europe, which we sold, out of our non-Canadian energy business, out of our reinsurance business, out of our private bank in Singapore and Hong Kong, and we put them into places where we thought we could drive better returns, and we did. And our peak return was 18% in the first quarter of 2022. That playbook, we haven't lost it. It's right there, and we're using it and we're sort of drumming that back up with a lot more rigor right now. So you can imagine plays like that. We're a lot more concentrated today in North America. So some of those further afield plays are not available to us. But even within North America, you can run that play all day long. And you can double-click all the way down to the client level given the technology and the data analytics that we have today that we didn't then, that you can then recycle capital more quickly on everyday client activity. You've got 50,000 or so loans in a commercial business. You've got loans that are maturing every single day. You can get automation down to the point where you can 6 months ahead of time, know exactly what's going to renew and what's not. That wasn't available to us or anybody else 5 or 6 years ago. You can do that pretty quickly and with high velocity organically and you can run all of the other plays to say, if I do an overlay, your banks that are coming up on the stage today in Canada, they're all everything to everybody in every geography in every corner of this country. In the U.S., that doesn't need to be the case. You can do an analytic to say, in markets where we go to market with only one of our product lines, it might be commercial here, it might be retail there, it might be wealth there, does that actually make any sense? Does that drive high returns over time? The probability when you do the assessment is no. So what if we actually shifted some -- this is not a big deal, Darko, but just to give you an example, shifted some of those sort of stranded assets into places we can densify like in California and continue to build that. And I think about what happened in Harris Bank in 1984, we went in, we were one of many scrapping around all the street corners. And then you fast forward a couple of decades later, and we're the #2 bank in the region, second only to JP, and that was done through a period of densification with all businesses going to market together, branding, awareness, technology, talent. We're doing that in California now. So we've got the blueprint to run these capital allocation plays in a more integrated coordinated way, which is kind of that last, I'll call it, 50, 60 basis points of the 500.

Okay. And that's very good color. I appreciate that because I was thinking more along the lines of RD portfolio sale or the indirect auto. I was thinking more along those lines.

That's part of it. That's part of it. Those were choices that we made that we thought we could redeploy that capital availability into things like that. I gave you other examples today, but those...