Bank of Montreal (NYSE:BMO) Q1 2023 Earnings Call Transcript

Bank of Montreal (NYSE:BMO) Q1 2023 Earnings Call Transcript February 28, 2023

Operator: Good morning, and welcome to the BMO Financial Group Q1 2023 Earnings Release and Conference Call for February 28, 2023. Your host for today is Christine Viau. Please go ahead.

Christine Viau: Thank you, and good morning. We will begin the call with remarks from Darryl White, BMO’s CEO; followed by Tayfun Tuzun, our Chief Financial Officer; and Piyush Agrawal, our Chief Risk Officer. Also present to take questions on our group heads, Ermi Johannson from Canadian P&C; Dave Casper from U.S. P&C; Dan Barclay from BMO Capital Markets; and Deland Kamanga from BMO Wealth Management. As noted on Slide 2, forward-looking statements may be made during this call, which involve assumptions that have inherent risks and uncertainties. Actual results could differ materially from these statements. I would also remind listeners that the bank uses non-GAAP financial measures to arrive at adjusted results. Management measures performance on a reported and adjusted basis and considers both to be useful in assessing underlying business performance.

Darryl and Tayfun will be referring to adjusted results in their remarks unless otherwise noted as reported. I will now turn the call over to Darryl.

Darryl White: Thank you, Christine, and good morning, everyone. We had a very good start to the year with record revenue, adjusted earnings per share of $3.22 and net income of $2.3 billion for the first quarter. The benefit of our balanced and well-diversified business model was front and center again this quarter with record revenue and PPPT in our P&C businesses and significantly improving momentum in BMO Capital Markets. The strategic investments we’ve been making in talent and technology are driving good growth in each of our businesses. Risk remains well managed with strong performance across our portfolios. Each of our operating groups delivered return on equity above 15%, even with the higher regulatory capital levels.

Our P&C businesses continued to deliver positive operating leverage, while negative operating leverage at the all-bank level this quarter reflected the particularly strong revenue performance in capital markets in Q1 last year, as well as the impact of investments we’ve made over the past year to drive growth. We expect expense growth to moderate through this year with continued momentum in revenue. We remain committed to delivering positive full year operating leverage on a BMO stand-alone basis as we have for the last five years. While the macroeconomic environment remains uncertain, we’re well situated to win in any environment. With inflation still at high levels, we expect rates to remain elevated, slowing the economy in the near term, real GDP in both Canada and the U.S. is expected to rise only modestly this year, and we expect central banks to hold off from reducing policy rates until 2024.

We’ve made deliberate strategic choices to change the shape of our business and further strengthen our performance. We’ve continued to bolster our capital position in light of the new regulatory capital requirements while supporting customer growth, and we expect our CET1 ratio to be above 11.5% in the second quarter now that the Bank of the West acquisition has closed. The completion of our acquisition of the Bank of the West on February 1 is a historic moment for BMO and the natural next step in our North American growth strategy. We’ve — we’re excited to welcome thousands of new employees and 1.8 million customers to the BMO family as we come together with a shared vision to drive progress for our customers and communities. I personally spent a lot of time in market and the energy level and enthusiasm of the teams and the customers I’ve met is palpable.

Together, we double our U.S. footprint, meaningfully expand our scale and solidify BMO’s position as a leading North American Bank. We’re now a top 10 bank in the United States with a top five position in multiple MSAs. We’ve expanded our premium commercial banking franchise, which also ranks in the top five in North America, adding complementary verticals and talented bankers in areas like agriculture, food and beverage and wine, and adding new expertise in technology and health care banking. Our enhanced presence is further augmented by a national strategy that extends across the country, with digital retail and payments platforms that serve customers across all 50 states as well as a leading national specialty businesses such as transportation and equipment finance, leasing, RV marine and asset-based lending to name a few.

Our one client and North-South integration enables our teams to support clients with our differentiated cross-border expertise as well as wealth and capital markets capabilities. We’re taking this opportunity to fully unify our brand, bringing the strength of BMO to new and existing markets and communities. Over many years, our U.S. segment has been a key contributor to the growth of our business and our success with a strong foundation and a long track record of combining organic growth with highly successful acquisitions. Through effective integration, strong leadership and our focus on building client relationships, we’ve delivered consistent market share gains across our businesses. We’ve steadily increased the contribution from the U.S. significantly improved ROE and efficiency to be accretive to the overall bank, all underpinned by superior risk management.

The closing this month follows a year of collaboration that positioned us to hit the ground running. In fact, we executed our first One Client transaction on February 1. And in just 28 days, we’ve already delivered on opportunities across our combined teams to deepen client relationships, and expand product offerings and the momentum is building. Once fully cost synergized, we expect the U.S. to contribute approximately 45% to the bank’s earnings on a pro forma basis, up from 27% five years ago, which helps fundamentally increase the size and the performance of the bank overall. By the end of 2025, we anticipate that the Bank of the West acquisition will add over $2 billion U.S. in run rate pre-provision pretax earnings to BMO. Turning back to our Q1 results in our operating groups.

In Canadian P&C, revenue and PPPT were both up 9% this quarter with strong consumer and commercial loan growth and deposit growth driving market share gains. Our performance reflects strategic investments over the last few years and the expansion of our sales teams and technology that have improved our sales-to-service ratio, delivering top-tier digital sales and drove customer acquisition. Just yesterday, we announced an exclusive partnership with immigration.ca, a leading provider of immigration resources and essential tools aimed at helping newcomers establish their financial life in Canada. This partnership complements our existing new start and smart progress programs to help customers make real financial progress and support a smooth transition.

In U.S. P&C, PPPT was up 12% over the last year as we continued to gain momentum in customer growth and satisfaction. We’ve introduced several new automated solutions in commercial banking to improve efficiency and deliver best-in-class client and employee experiences. And in partnership with Blend, we introduced a fully digitized mortgage refinancing process, boosting convenience for customers. In BMO Wealth Management, while lower markets reduced revenue compared to last year, our ongoing investments in talent and technology are delivering strong growth in new client assets. We’re driving progress for our clients by investing in innovation such as the launch of BMO Investor Line ESG Insights tool that helps investors make informed decisions that align with their strategies and with their values.

For the 12th consecutive year, we were number one in net ETF inflows and received the most awards of any ETF provider at this year’s annual fund data awards, reflecting our leadership in delivering strong risk-adjusted performance for our investors. BMO Capital Markets diversified businesses displayed growing momentum with the second highest quarter of revenue ever and PPPT of $636 million. The investments we’ve made in areas like expanding our U.S. rates business, adding radicals carbon credit and emissions trading capabilities and expanding electronic trading through Clearpool, are addressing real client needs and contributing to the growth that we need now and for the future. Clearpool is a good example of how we’re building on acquisitions having expanded into Europe within the last year, while tripling BMO’s electronic trading revenue.

In addition to our financial progress, we’re continuously advancing our purpose commitments and are consistently recognized as a global leader in sustainable business practices and financing activities. I want to recognize the incredible contribution by BMO’s employees this year, who, during our employee-giving campaign rallied together to contribute over $31 million to the United Way and thousands of other community organizations across North America, a new BMO record. This culture of community giving is equally embedded in the culture of our new colleagues at Bank of the West, and I look forward to the good that we will be able to grow together. As we all look forward to a successful integration, we’re equally focused on continuing to drive performance in all our businesses.

We’re starting this year from a position of strength. My confidence in our future has never been higher. I’ll now turn it over to Tayfun.

Tayfun Tuzun: Thank you, Darryl. Good morning, and thank you for joining us. My comments will start on Slide 10. First quarter EPS was $0.30 and net income was $247 million. Adjusting items are shown on Slide 37 and include the impact of fair value management activities related to the acquisition of Bank of the West, which this quarter decreased net income by $1.5 billion as well as a $371 million tax provision related to the tax measures enacted by the Canadian government. The remainder of my comments will focus on adjusted results. Adjusted EPS was $3.22, and net income was $2.3 billion, down from $2.6 billion last year. Total revenue increased 3% year-over-year reflecting strong growth in net interest income, partially offset by lower fee income and securities gains.

Expenses were up 9% year-over-year reflective of investments made in sales force expansion and technology in 2022 and the impact of compensation increases for our employees during last year. PPPT was lower year-over-year and up 6% sequentially or up 14%, excluding the impact of seasonal expenses recorded in every first quarter. Performance in our P&C businesses continue to be very strong with year-over-year pre-provision pretax earnings growth of 9% in Canada, and 12% in the U.S. driven by continued loan growth and margin expansion. Capital Markets performed well with strong quarter-over-quarter revenue growth and wealth management results were lower, reflecting the continued muted market environment. Total PCL was $217 million, including a $21 million provision for performing loans compared with a total recovery of $99 million in the prior year.

Photo by Gabrielle Henderson on Unsplash

Piyush will speak to these in his remarks. Moving to the balance sheet on Slide 11. Loan growth was 15% year-over-year and 2% quarter-over-quarter. On a constant currency basis, business and government loans increased 15% from the prior year with strong growth across all operating groups. Consumer balances were up 9% reflecting diversified growth in the P&C businesses and in wealth. Average customer deposits increased 8% year-over-year and 2% sequentially as we remain focused on growing our core deposit base. Looking ahead, we expect full year average loan growth to be in the mid-to high single-digit range, reflecting strong diversified pipelines and matching similar growth rates in deposits. Turning to Slide 12. Net interest income on an ex-trading basis was up 21% from last year driven by strong balance growth and margin expansion.

Net interest margin ex-trading was up 11 basis points from last year and down 7 basis points from last quarter. There was temporary volatility this quarter related to the balance sheet positioning ahead of the closing of the acquisition. Higher net margins in our P&C and Wealth Management businesses raised our NIM by 2 basis points quarter-over-quarter. In Canadian P&C, higher deposit and loan spreads were partially offset by deposit mix, reflecting strong growth in term deposits. In U.S. P&C, where our margin widened by 43 basis points year-over-year, higher deposit spreads were partially offset by lower loan spreads, higher risk transfer costs and the impact from changes in product mix. Offsetting these increases were two temporary items in the current quarter that lowered our quarterly NIM by 4 basis points.

First, higher cash balances ahead of the closing of the Bank of the West transaction; and second, temporary deposit interest expense in capital markets that was fully offset in other noninterest income with no impact to total revenue. A discrete permanent increase in liquid assets for regulatory liquidity requirements lowered our margin by 2 basis points. Other factors during the quarter included a 1 basis point for the impact of risk transfer transactions quarter-over-quarter. The year-over-year expansion in our NIM has been a major driver of our PPPT growth in our P&C businesses. And as we move beyond the temporary factors over the next couple of quarters, we expect the BMO stand-alone NIM to resume expanding during the second half of the year as deposit spreads begin to stabilize.

With the addition of Bank of the West balance sheet, we expect the widening NIM to be a core relative strength for BMO. Post-closing, we expect our NIM to widen by approximately 10 basis points for both the second quarter and the full year. Moving to our interest rate sensitivity on Slide 13, a 100-basis point rate shock is expected to benefit net interest income by $542 million over the next 12 months. Rate sensitivity for the quarter is elevated as our short-term liquidity was elevated for the Bank of the West closing. We will provide an update on combined sensitivity, including Bank of the West next quarter. But overall, we believe we are well positioned for the current environment. Moving to Slide 14. Expenses were up 9% from the prior year or up 6% excluding the impact of the stronger U.S. dollar and higher performance-based compensation mainly reflecting the follow-through impact of targeted investments during the last year, including sales force expansion, technology and marketing as well as inflation rather than added expenses this quarter.

These investments have been disciplined and strategic and have helped fuel our revenue growth and created efficiency gains in our business. Expenses were down 1% sequentially, excluding the impact of stock-based compensation for employees eligible to retire and seasonality of benefits that is recognized in the first quarter of each year which together approximated $260 million this quarter. Our commitment to positive operating leverage continues to drive our dynamic management actions. Coming into this year, as you can see in our quarter-over-quarter trends with the capacity that we have in place, our incremental investment needs have moderated. As a result, with a follow-through impact of last year’s investment subsiding after the second quarter, we expect our year-over-year expense growth to moderate in the second half of the year.

Moving to Slide 15. Our capital position remains strong with a common equity Tier 1 ratio of 18.2%, excluding the impact of the management of fair value changes related to the Bank of the West transaction, the CET1 ratio increased approximately 180 basis points due to our common share issuance, strong internal capital generation and a reduction in risk-weighted assets partially offset by the onetime impact of the tax measures. Source currency risk-weighted assets were lower, mainly reflecting the benefit from risk transfer transactions, model updates, and changes in book quality. Synthetic risk transfer transactions this quarter added approximately 35 basis points to our CET1 ratio compared to last quarter. The cumulative incremental capital of 120 basis points generated by the fair value management actions since announcement last December will be offset by higher goodwill at closing.

As discussed previously, we remain confident that our CET1 ratio will remain above 11.5% in Q2 and continue to build to 12% by the end of the fiscal year. Turning to Slide 16. We updated our assumptions regarding the acquisition of Bank of the West, excluding purchase accounting impacts, which will be finalized before the end of the second quarter. At announcement, we expected the transaction to be 10% accretive to fiscal 2024 or 8%, excluding transient items related to purchase accounting. Based on our internal plan, we expect accretion in 2024, excluding transient items, to be approximately 7%. The reduction is in part due to stronger BMO stand-alone performance and a revised Bank of the West outlook, mainly reflecting the impact of the later-than-anticipated closing and conversion dates.

We continue to expect the future benefit from annualized expense synergies and to be approximately USD670 million and initiatives to be fully executed by the end of the first year after closing, which is now the start of the second quarter of 2024 with the realization of those savings building over the next 12 months. Merger and integration costs, which are excluded from adjusted net income, are now estimated to be USD1.5 billion and the expectation that they will be fully incurred by the end of the second year after close. As Darryl said, we are very optimistic about our future growth with Bank of the West, leading to a very meaningful PPPT lift. Moving to the operating groups and starting on Slide 17. Canadian P&C delivered net income of $980 million, down 2% from the prior year due to higher provisions for credit losses with strong pre-provision pretax earnings growth of 9%.

Revenue was up 9% from the prior year. Net interest income increased 14% reflecting strong balanced growth and higher margins. Expenses were up 9%, reflecting investments in the business, including sales force expansion and in technology and higher salaries and decreased 1% sequentially. Average loans were up 12%, with 11% growth in residential mortgage lending and 16% in commercial loans. Deposits increased 11% year-over-year and 3% sequentially with strong growth in term deposits. Moving to U.S. P&C on Slide 18. My comments here will speak to the U.S. dollar performance. Net income was USD 521 million, down 3% due to higher provisions for credit losses with strong pre-provision pretax earnings growth of 12%. Revenue was up 12% with 22% growth in net interest income due to strong loan growth and margin expansion of 43 basis points year-over-year.

The decline in noninterest revenue was mainly due to commercial deposit fees which during higher interest rate periods is largely offset in net interest income as well as lower operating lease revenues. Expenses increased 11% due to higher employee costs and technology investments and remained relatively flat sequentially. On the balance sheet, average loans were up 10% from the prior year, reflecting very strong commercial growth of 11%. Average deposits declined 4% year-over-year and increased 1% from last quarter. Moving to Slide 19. BMO Wealth Management net income was $278 million, down from $316 million last year. Wealth and Asset Management net income was $208 million, down $54 million as growth in net interest income and new client assets were more than offset by weaker global markets and lower online brokerage transactions.

Insurance net income was $70 million compared with $54 million in the prior year. Expenses were up 4% mainly due to the impact of investments made in the business in fiscal 2022. Turning to Slide 20. BMO Capital Markets net income was $510 million compared to a particularly strong $712 million in the prior year. Pre-provision pretax earnings were $636 million, up 43% quarter-over-quarter, reflecting good performance in the current market environment. Compared with the prior quarter, revenue in Investment and Corporate Banking was up 12% due to higher corporate banking revenue and investment banking activity and Global Markets was up 29% on higher client activity. Expenses were up 5% due to higher operating costs and continued investments in the business, partly offset by lower employee-related costs.

Turning now to Slide 21. Corporate Services net loss was $195 million compared to $132 million in the prior year. Net losses in Corporate Services will continue to be higher than our normal range for the next quarter or two due to the moving parts associated with the Bank of the West transaction, including the impact of the prior build-up of excess capital that is now being deployed in the business post-closing. We expect Corporate earnings to normalize towards the end of the year. To conclude, we had very good operating performance with record quarterly revenues to start the year. The results demonstrate the advantage of our well-balanced, diversified business mix, which will now be meaningfully enhanced with the addition of Bank of the West starting this quarter.

Overall, we continue to focus on managing our company dynamically with a keen focus on continuous efficiency improvements while investing for growth. Our larger presence in the U.S. significantly enhances our opportunities to grow while leveraging our existing platform for more optimal resource allocation. I will now turn it over to Piyush.

Piyush Agrawal: Thank you, Tayfun, and good morning, everyone. We are pleased with our risk performance this quarter. Key portfolio metrics remain strong despite rising rates and continued high inflation. This quarter’s performance continues to reflect strong risk management discipline across the bank. Starting on Slide 23, the total provision for credit losses was $217 million or 15 basis points, down $9 million or 1 basis point from prior quarter. Impaired provisions for the quarter were $196 million or 14 basis points flat to the fourth quarter. The strong impaired loan performance is due to low formations, which continue to be below pre-pandemic levels. We do expect impaired provisions to return to more normal levels over time.

Moving to Slide 24. The $21 million provision for credit losses on performing loans reflected increased uncertainty in credit conditions and growth in certain portfolios largely offset by portfolio credit improvement, including benefits from the risk transfer transactions. We remain comfortable that a $2.5 billion of performing loan allowances provides good loss coverage. Turning to the impaired loan credit performance in the operating groups. Retail impaired loan losses were $135 million in Canadian P&C and $13 million in U.S. P&C. The quarter-over-quarter increase in embedded PCL is consistent with the expected normalization trend in delinquency rates in unsecured consumer loans and credit cards, which still remain below pre-pandemic levels.

For real estate secured lending, we continue to view the risk from higher rates as modest, given a high credit quality borrower base and low LTVs. As you can see on Slide 27, the riskier segment renewing over the next 12 months is nominal given our portfolio quality. In our commercial and corporate businesses, we saw strong credit performance. In Canadian commercial, we reported impaired loan provisions of $19 million or 7 basis points, down 3 basis points from last quarter. Our U.S. commercial business had impaired loan provisions of $35 million or 11 basis points, also down 1 basis point from last quarter. Our Capital Markets business had a net recovery of $3 million driven by zero new formations this quarter and some modest reversals. Despite the rising rates in inflation, our wholesale credit quality remains strong and impaired rates below pre-pandemic levels.

On Slide 25, bank-wide impaired formations were $521 million and gross impaired loans balance was $2 billion or 36 basis points. Both formations and the gross impaired loan rates continue to be well below pre-pandemic levels. Looking ahead, the coming quarter PCL will have a onetime adjustment for Bank of the West opening allowance. And in terms of overall impaired PCL, including the Bank of the West loan portfolio, we expect impaired loss rates to trend in the high teens to low 20 basis points, which is in line with our combined pre-pandemic experience. To conclude, we are well positioned to manage current and emerging risks given the quality of our portfolio, high allowance coverage and strong risk management capabilities. I will now turn the call back to the operator for the Q&A portion of this call.

See also 15 Biggest Airplane Manufacturing Companies in the World and 15 Biggest Payment Companies in the World.

Q&A Session

Operator: The first question is from Ebrahim Poonawala from Bank of America. Please go ahead. Your line is now open.

Ebrahim Poonawala: Good morning. Maybe, Tayfun, just starting on the expenses. When you think about adjusted expense growth 9% year-over-year. I’m sorry if I missed any specific guidance, but I heard you say, it should moderate from here. Just talk to us in terms of if you can put some numbers around what you expect expense growth maybe in the back half of the year or for full year ’23 that we should expect ex Bank of the West impact?

Tayfun Tuzun: Sure. Thanks for the question, Ebrahim. I think the expense growth year-over-year, excluding the impact of foreign exchange was 7% and excluding the impact of higher performance-based comp, it was 6%. As you know, we have a firm commitment to positive operating leverage and coming into the year, the investments that — the speed of investments that we’ve made in the business last year has slowed down because we do — we have created the capacity that we need to meet our growth targets. So as such, and you can look at the quarter-over-quarter change, which was actually down, excluding the seasonal uptick. So, as we look ahead, we see maybe another quarter of these types of expense growth numbers because we will be lapping last year’s expense trends.

And once we cross into the second half of the year, I expect on average, you’re going to see 3%, 4% drop in our year-over-year expense growth, which then gives us the ability to continue to commit to positive operating leverage for the year.

Ebrahim Poonawala: Understood. And I guess with the Bank of the West expense savings, I believe you mentioned 95% savings by ’24, but should we get to that point by the end of fiscal year ’23 in terms of once you do the systems conversion on Labour Day by the end of October, you should have most of the savings in the numbers as we think about 1Q ’24.

Tayfun Tuzun: Sorry Ebrahim, let me remind you that when we announced the transaction, we said that we will capture 100% of the expense synergies within the first 12 months following the closing date. And we intend to do the same still. But now that the closing date has moved to February 1 from the original assumption of three months before that when we announced the transaction, it just shifted the date of the full capture. We intend to enter the second quarter of ’24 with a run rate and with 100% of the cost savings, just exactly the same that we announced back last December.

Ebrahim Poonawala: Got it. And just one last one on deal-related, Tayfun. You mentioned carrying more liquidity, which had a drag of 2 basis points on the margin this quarter. Anything else that we should be mindful of in terms of capital stress testing, liquidity requirements coming out of the deal that you have to do or manage to?

Tayfun Tuzun: No, I think there is no — on NIM, no impact from capital stress testing. They were a total of 4 basis points of temporary factors. One of them relates to the build-up in liquidity and one of them is in our capital markets business, which is fully compensated in NIR. The liquidity — the permanent 2 basis point liquidity was just related to our normal update of our deposit modeling assumptions, and we just happened to have updated them this quarter, which has changed the liquidity — the liquid asset balance on our balance sheet, but none of this relates to any capital stress tests.

Ebrahim Poonawala: But nothing around the treatment of the U.S. entity changes in a meaningful way post deal versus prior to the deal.

Tayfun Tuzun: Yes, this is not. No. No.

Ebrahim Poonawala: Thank you, for taking my question.

Operator: Next question is from Meny Grauman from Scotiabank. Please go ahead. Your line is now open.