Bank of Montreal (NYSE:BMO) Q3 2023 Earnings Call Transcript

Bank of Montreal (NYSE:BMO) Q3 2023 Earnings Call Transcript August 29, 2023

Bank of Montreal beats earnings expectations. Reported EPS is $2.78, expectations were $2.28.

Operator: Good morning, and welcome to BMO Financial Group’s Q3 2023 Earnings Release and Conference Call for August 29, 2023. Your host for today is Christine Viau.

Christine Viau: Thank you. We will begin the call today 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 are Ernie Johannson, Head of BMO North American Personal and Business Banking; Nadim Jirji, Head of BMO Commercial Banking; Dan Barclay, Head of BMO Capital Markets; Deland Kamanga, Head of BMO Wealth Management; and Darrel Hackett, BMO U.S. CEO. 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.

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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. And with that, I’ll turn the call over to Darryl.

Darryl White: Thank you, Christine, and good morning, everyone. I’d like to start this morning by acknowledging the ongoing devastating wildfires impacting British Columbia and the Northwest territories. We’re committed to doing our part to help make sure the families, businesses and communities get the support they need, including financial relief for options and options for those affected. Also, today, I’d like to welcome Darrel Hackett, our U.S. CEO, to his first investor call. Darrel has been with BMO since 2004, most recently as President of BMO Wealth Management U.S. His track record of dedication to our clients’ success, extending leadership and commitment to eliminating barriers to inclusion will be a key contributor to the ongoing success of BMO U.S. Turning to the quarter.

Our performance continues to reflect the strength, diversification and active management of our businesses in an evolving environment. This quarter, we reported earnings per share of $2.78 impacted by onetime items that we will discuss. Pre-provision pretax earnings were up 6% from last year and all bank revenue was up 22%, driven by record results in Canadian Personal and Commercial Banking, supported by double-digit deposit growth and good contribution from the Bank of the West. Credit performance is normalizing in line with our expectations with higher provisions this quarter compared with historically low levels. Our balance sheet remains strong, reflecting our long-standing track record of superior risk management. We further strengthened our capital position with a CET1 ratio of 12.3%, an increase from Q2 and the impact of the closing of the AIR MILES transaction.

For the year-to-date return on equity was 12.6% and return on tangible common equity was 15.8%. As we discussed last quarter, we’re taking action to adjust to market forces that are creating near-term headwinds for the industry and negative operating leverage for us this year. We have a proven track record of disciplined expense management while making targeted investments where we have the best opportunities to support our customers and deliver sustainable growth. Our approach has delivered positive operating leverage in each of the last five years and continuous improvement in our efficiency. Our results this quarter included severance costs in each of our businesses related to workforce reductions representing approximately 2.5% of our total FTE, which is complementing and incremental to our ongoing Bank of the West integration program.

We’re undertaking these changes to enable us to accelerate our efficiency initiatives and align investment with customer and market opportunities. We expect the impact of these initiatives, combined with the expense synergies still to come from the Bank of the West to result in a return to positive operating leverage for fiscal 2024. Our U.S. segment has consistently contributed to the bank’s earnings growth and efficiency improvement. This quarter, for the first time, pre-provision pretax earnings in the U.S. exceeded $1 billion double where we were four years ago. We have a differentiated position in the U.S. market, ranking in the top 10 of diversified banks while benefiting from the strength of BMO’s trillion dollar North American balance sheet.

And we’re positioned to accelerate our long-term growth strategy as we complete the acquisition of the Bank of the West. Conversion is on track for the upcoming Labor Day weekend. We’re bringing the best of both companies together for our employees and ensuring a smooth transaction for our customers who will benefit from the greater convenience, speed and product options of a broader company with deeper resources. Employees and customers are embracing our entry into the market, and we’re already seeing a strong response to our offers and campaigns having opened thousands of new accounts, and that’s the full rollout of product capabilities and marketing post conversion next weekend. In addition, we’ve added hundreds of active clients in our trading businesses and continue to complete one client transactions between commercial and capital markets.

We know that brand recognition is one of the most powerful factors in attracting new customers, and our brand campaign reinforces the scale and the strength of BMO. While BMO may be new to parts of California, we’re letting customers know we’re not new to banking, and we’re here to stay. We’re confident in the power of our integrated North American franchise and our strategy to help clients make real financial progress. Canadian P&C delivered another quarter of strong performance with Personal and Business Banking breaking through $2 billion in revenues for the first time and continuing to grow market share. Leading customer acquisition and strong customer onboarding has been a key contributor to our growth. Our new to Canada segment, for example, is up 40% over last year.

We’re focused on meeting customers where they are, including our branch inside Calgary’s Gateway Newcomer Centre, where our teams provide specialized guidance and resources. In addition, this quarter, we closed the acquisition of AIR MILES, Canada’s longest standing most recognized loyalty program with 10 million active customers representing half of Canadian households. We’re leveraging BMO’s strength in innovation and digital to expand and enhance the program and are already seeing early success in attracting new collectors and partners. In U.S. P&C, we grew revenue 51%, reflecting the addition of the Bank of the West. While loan demand has been muted across the industry, we’re continuing to add customers and deepen relationships. This quarter, we launched BMO V-PAYO, an integrated payable solution, expanding a product capability within Bank of the West to all U.S. clients.

It’s a great example of working together as one unified bank and building our position as a leader in B2B payments. We’re committed to actively fostering a culture that gives people space to innovate. BMO was the only financial institution named among the top 30 companies on Fast Company’s best Workplaces for Innovators list, and we were recently recognized by J.D. Power ranking first in customer satisfaction with online banking in Canada. These are testament to how BMO’s digital-first strategy and industry-leading experiences are exceeding our customers’ evolving expectations. In BMO Wealth Management, we continue to deliver results and extend our leadership in the ETF market. This quarter, we further expanded our innovative suite of active exchange-traded funds to provide investors with more choice and portfolio customization.

BMO Capital Markets had a solid performance, including good revenue contribution in the U.S. even as client activity remained below historical trends. We have key momentum in key areas, ranking in the top 10 in global and North American M&A and adding products and capabilities in our U.S. rates business. Examples of how we’re continuing to provide new added expertise and products in support of our clients’ needs. Our purpose to boldly grow the good in business and life guides all we do. This quarter, we were included in Corporate Knights listings of Canada’s best 50 corporate citizens with top quartile scores in board, gender diversity and executive racial diversity, the only Canadian bank named to the list. In addition, we received a top quartile sustainable revenue score, reflecting our commitment to sustainable financing and responsible investing.

As we look ahead, we’re all aware of the macro headwinds facing the industry. These external forces are influencing the environment we’re all operating in, and I believe they could persist for some time to come. Against that backdrop, what sets BMO apart is the strength of our team and the emphasis that we’ve placed on dynamically managing our business to control the forces that we can control. We’re taking action to reduce our cost base while making investments to drive high performance for the long term, including realizing the synergies from Bank of the West. I’m confident that our unique and differentiated North American growth strategy sets us apart on both sides of the border. We have the scale across our Canadian and U.S. franchises to continue to support our customers advance our digital strategy and make meaningful differences in the communities that we serve.

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 9. Third quarter reported EPS was $1.97, and net income was $1.5 billion. Adjusting items are shown on Slide 38 and include acquisition-related impacts for integration costs, and amortization of intangibles, which decreased net income by $370 million and $85 million, respectively, as well as a $131 million after-tax charge related to tax measures enacted by the Canadian government that amended the HST definition for Financial Services. The remainder of my comments will focus on adjusted results. Adjusted EPS was $2.78 and net income was $2 billion, down 4% from last year. Our results this quarter were impacted by severance costs and legal provisions, which reduced net income by $245 million and earnings per share by $0.34 on a combined basis.

Revenue increased 22% with good organic growth in each of our operating groups and the benefit of acquisitions. Expenses increased 33%, primarily due to the impact from acquisitions. PPPT of $3.1 billion was up 6%, driven by strong growth in our Canadian P&C business, contributions from our Bank of the West acquisition and higher results in BMO Capital Markets. Total PCL was $492 million, including a $159 million provision for performing loans compared with a total provision of $136 million in the prior year. Piyush will speak to these in his remarks. Turning to Slide 10. The acquisition of Bank of the West concluded $167 million to net income, $1.1 billion to revenue and $749 million to expenses. We are pleased with the Bank of the West second quarter post-closing results as their contribution remains in line with our expectations.

We are highly focused on successfully executing our systems conversion and brand unification this weekend, which will complete the full integration of Bank of the West within our U.S. segment. As we have shared with you since the announcement, our confidence level in achieving the cost synergies remains very high. To date, we have been tracking ahead of our expectations on cost synergies and with the benefit of additional analysis over the last two quarters since we closed the transaction, we believe there is potentially more upside, including third-party expenses and technology costs. We plan to give you a final post-conversion update when we report our fourth quarter earnings on all relevant metrics. Moving to the balance sheet on Slide 11.

Average loan growth was 22% year-over-year or 21% on a constant currency basis, including Bank of the West, and good growth across our businesses. Sequentially, period-end loans were down 1% or flat on a constant currency basis. Consumer loans were higher, driven by mortgage growth in Canadian P&C while business and government loans were lower as growth in BMO Capital Markets in Canadian P&C was offset by lower commercial loans in U.S. P&C. We expect loan demand in the U.S. will remain muted through the end of the year, continuing the trends that we have seen during the last two quarters, while modest growth is expected to continue in Canada. Average customer deposits increased 22% year-over-year from Bank of the West and higher balances in Canadian P&C and BMO Capital Markets.

Sequentially, period-end deposit balances were stable and up 1% on a constant currency basis, with strong growth in term deposits in Canada, offset by declines in our U.S. P&C and Wealth Management businesses. Turning to 12. The continued strong deposit growth in Canada is the result of continued success in customer acquisition, new products and digital investments across our retail and commercial businesses and we have seen signs of term migrations starting to slow. In the U.S., trends have stabilized and going forward, our enhanced digital platform, combined with a larger retail branch network and our advanced treasury management capabilities addressing the needs of our commercial clients, especially post conversion, should help us grow our deposit base.

Turning to Slide 13. On an ex-trading basis, net interest income was up 25% and net interest margin was up 7 basis points from the prior year, driven by Bank of the West and strong balance growth and margin expansion in the underlying businesses. Year-over-year growth was partially offset by the impact of higher low-yielding asset balances for liquidity purposes. Net interest margin was up 2 basis points from last quarter, driven by higher margins in Canadian P&C, partially offset by lower margins in U.S. P&C and Wealth businesses. In Canadian P&C, NIM increased by 7 basis points, driven by wider deposit margins as well as higher loan margins and favorable change in our loan and deposit mix. In U.S. P&C, NIM was reduced by 16 basis points sequentially, driven by lower deposit balances and margins as well as lower loan margins.

We continue to expect relative stability in our overall margin as the benefit of reinvestment of equity and non-maturity deposits at higher yields offset pressures from higher deposit costs. Although we may see some NIM tightening in Canada over the next couple of quarters based on strong pricing competition in loans and deposits. In the U.S., we expect a more stable outlook. Moving to Slide 14. Expenses increased 33% from last year, mainly due to Bank of the West and higher severance costs. Sequentially, expenses were down 1%, excluding the impact of severance costs, three more days in the current quarter and the addition of two months of results from the acquired AIR MILES business. As we predicted earlier in the year, the expense trends are improving based on our decision to curb expense growth earlier in the year and reinforced by the dynamic expense management actions we have taken this quarter to moderate growth and meet our commitment to positive operating leverage and improved efficiency.

This quarter, we incurred severance costs to accelerate operational efficiencies across the bank while we continue to align resources to areas that will support long-term customer growth. We expect this to drive expense savings of approximately $200 million in fiscal 2024 and run rate savings of approximately $250 million by early 2025. In addition, we have identified further actions to optimize real estate, technology and procurement costs. Next quarter, we will record an impairment charge of approximately $45 million for real estate reduction opportunities that will generate future savings. The estimated cumulative run rate benefits from the severance costs and these additional actions are estimated to exceed $400 million at an annualized basis.

Combined with the targeted cost synergies at Bank of the West, we expect these will result in positive operating leverage in 2024 and help us continue to invest in our businesses while keeping our expense growth at acceptable levels. We expect our expense trends to start reflecting these benefits starting in the first quarter of 2024 once the conversion related activities this quarter are behind us. Turning to Slide 15. Our capital position remained strong with a common equity Tier 1 ratio of 12.3%, up 10 basis points from the prior quarter. Internal capital generation shares issued under the dividend reinvestment plan and lower source currency RWA, primarily reflecting change in assets were mostly offset by the AIR MILES acquisition and the impact from acquisition integration costs and tax-related charge in the current quarter.

Moving to the operating groups and starting on Slide 16. Canadian P&C delivered net income of $923 million, down 4% from the prior year. Pre-provision pretax earnings grew 10% every year, offset by higher provisions for credit losses. Record revenue of $2.8 billion in the quarter was up 10%, driven by 10% growth in net interest income, reflecting both strong balance growth and higher margins as well as 11% growth in noninterest revenue due to higher card fees as well as the acquisition of AIR MILES. Expenses were up 10% versus prior year, reflecting the impact of severance costs and inclusion of AIR MILES. Loans were up 7% year-over-year, with 8% growth in residential mortgage lending and 7% in commercial loans and were up 1% from the prior quarter.

Deposits increased 12% year-over-year and 3% sequentially across both retail and commercial businesses with strong growth in term deposits. Moving to U.S. P&C on Slide 17. My comments here will speak to the U.S. dollar performance. Net income was $489 million up 10%, mainly due to the contribution from Bank of the West. Pre-provision pretax earnings growth of 22% was partially offset by higher provisions for credit losses. Revenue was up 51% year-over-year, driven by Bank of the West. Sequentially, revenue was down 3% due to lower deposit margins and lower loan balances. Expenses increased 82% year-over-year primarily due to the impact of Bank of the West and up 4% quarter-over-quarter, primarily due to severance and higher advertising costs as we prepare to roll out our unified brand across our U.S. markets.

Loans were up 53% from the prior year driven by the Bank of the West and declined 1% quarter-over-quarter primarily in commercial. Deposits increased 41% year-over-year and declined three sequentially. Moving to Slide 18. BMO Wealth Management net income was $304 million down from $325 million last year. Wealth and Asset Management net income was $223 million compared with $264 million in the prior year. Contributions from Bank of the West and growth in new client assets were more than offset by lower net interest income and higher expenses. Insurance net income was $81 million compared with $61 million in the prior year driven by favorable market movements in the current quarter. Expenses were up 15%, mainly due to the impact of Bank of the West, investments made in the business last year and severance costs in the quarter.

Moving to Slide 19. BMO Capital Markets net income was $316 million, up 18% year-over-year. Revenue in Global Markets was up 7%, reflecting higher trading activity. Improved client activity in investment and corporate banking and the prior year markdowns on loan underwriting commitments resulted in a 35% increase in revenues year-over-year. Expenses were up 17%, driven by higher performance-based compensation and legal provisions. Turning now to Slide 20. Corporate Services net loss was $159 million compared with $187 million in the prior quarter and net income of $7 million in the prior year. To conclude, we acted with pace this quarter to accelerate operational efficiencies that are necessary to align our operating performance with our long-term commitment to positive operating leverage, and we will continue to exercise disciplined expense management going forward while remaining focused on our long-term growth strategies.

The strength of our North American franchise supported by the underlying diversification of our businesses we’ll continue to create a significant differentiation for BMO as the banking industry continues to evolve. I will now turn it over to Piyush.

Piyush Agrawal: Thank you, Tayfun, and good morning, everyone. Our risk performance continues to reflect strong risk management discipline across the bank against a backdrop of significant monetary tightening and other macroeconomic headwinds. Starting on Slide 22. The total provision for credit losses was $492 million or 30 basis points. Impaired provisions for the quarter were $333 million or 21 basis points up 5 basis points from prior quarter, consistent with the expected normalization in loss rates. Moving to Slide 23. Performing provision for credit losses of $159 million for this quarter primarily reflected portfolio credit migration, which is a natural outcome of the higher interest rate environment. Over the last five quarters, we have added consistency to our allowance to reflect risks in the economy.

Our $3.4 billion of performing loan allowance provides good coverage of over 3.4x on trading four-quarter impaired losses. Turning to the impaired loan credit performance in the operating groups. Canadian Retail impaired loan losses were $174 million or 33 basis points, up 1 basis point from last quarter. For residential real estate secured lending, we continue to view the risk from higher rates and modest given our high credit quality borrower base and low LTVs. Delinquency rates and losses remain low and based on data over the last couple of quarters, customers renewing are able to absorb the impact of the higher interest rates. In U.S. retail, impaired loan losses were $55 million or 41 basis points, up 9 basis points from second quarter, primarily due to unsecured credit losses.

Turning to our Corporate and Commercial businesses. Canadian commercial impaired loan provisions were $35 million or 13 basis points, up 9 basis points from very low loss levels in Q2. U.S. commercial impaired losses were $64 million or 16 basis points, up 10 basis points from prior quarter, driven by a large provision in the retail trade sector. Our Capital Markets businesses continue to experience low impaired loan results with a loss of $1 million this quarter. On Slide 24, bank-wide impaired formations of $917 million increased $74 million from second quarter. Gross impaired loans was $2.8 billion, up $186 million from prior quarter. The gross impaired loan ratio of 44 basis points remains below pre-pandemic levels. On Slide 26, we provide an overview of our commercial real estate portfolio.

The portfolio is well diversified across geographies and property types. Throughout market cycles, we have maintained consistent and disciplined underwriting standards and client selection. The office sub-segment, which represents 1% of our overall loan portfolio is monitored closely and is diversified across urban and suburban areas with no concentration in any particular city. As expected, we have seen negative migration in this portfolio, though impairment and losses remain low. Overall, we are comfortable with our commercial real estate portfolio given the care for the client selection, strong credit structures and credit quality. As we look ahead, we continue to monitor closely the macro environment. If the economic outlook unfolds in line with consensus estimates, we expect impaired loss rates to remain within low to mid-20 basis points consistent with this quarter’s performance.

Given the quality of our portfolio, high allowance coverage and strong risk management capabilities, we remain well positioned to manage current and emerging risks. I will now turn the call back to the operator for the Q&A portion of the call. Thank you.

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Q&A Session

Operator: [Operator Instructions] Our first question is from Ebrahim Poonawala from Bank of America. Please go ahead.

Ebrahim Poonawala: I guess maybe Tayfun, first question, just unpacking what you said on the net interest margin. If I heard you correctly, CAD NIM could see tightening, U.S. expect more stabilization, that’s opposite of what I would have thought. I would have expected the U.S. pressure to continue on deposit pricing, some promotions that you might run for systems integration with Bank of the West. And in Canada, the back book re-pricing should serve as a tailwind to the NIM going forward. So clearly, I’m missing something, if you can elaborate on what the dynamics are, both on the asset and the deposit side driving that NIM outlook.

Tayfun Tuzun: Sure. I will make some comments. And then also turn it over to Ernie and Nadim for what they’re seeing in the U.S. and Canada. So I’ll start at the enterprise level, Ebrahim. We actually feel very good about how we are positioned today. Our NIM expanded a couple of basis points. We are guiding for more stability in the foreseeable future. And I like where the rates are today, clearly, we are benefiting from higher longer rates. And we are, I think, pretty well positioned to deal with whatever the monetary authorities do in Canada and the U.S. So at an enterprise level, I think our NIM positioning looks very good in the current environment. Coming down to Canada and the U.S. In Canada, this quarter, we have seen deposit spread wide and some loan spread widening.

And I think our business managed their spreads very well during the quarter. But at the same time, we are aware of rising pricing competition, both on deposits well as loans, especially as the quarter came to an end. And we’re cognizant of how that may impact our NIM going into the next couple of quarters, thus the comment about some tightening in Canada. In the U.S. — in Canada, obviously, we also have benefited from good deposit growth relative to loan growth during the quarter. That’s always very helpful. In the U.S. the pricing competition continues clearly. There’s no let down yet, and we’re not necessarily anticipating a significant change, I think, in general migration towards term deposits will continue. We are though switching to a more growth mode, both in our personal deposits as well as commercial deposits, which will be helpful, which will support some of that stabilization.

We are also expecting better loan spreads in the U.S., which also is helpful. And then overall, the corporate interest rate risk management related support that is provided by the rollover impact of our non-maturity deposits is helping the U.S. P&C business. So I think both of these expectations are in line with what we are seeing in the market as well as our overall risk management approach. With that, any comments, Ernie and Nadim.

Nadim Hirji: Sure. I would just say it characterized that loan volumes are down, of course, both sides of the border, but there is a divergence. So in Canada, we’re still seeing loan volume demand and more opportunities for deposit growth, but the competitor sets are different as well. So the Canadian banks are still fighting for market share. They’re still fighting on structures. And so we’re not seeing as much pricing discipline in Canada. On the other hand, the U.S. with specialty regional banks tightening up on capital and liquidity, we are seeing structures now tightening. We are seeing banks taking lower holds, and that is leading to stabilization in our margins. And spreads within the loan book so that’s why we’re seeing a bit of a divergence.

Ernie Johannson: And then on the deposit side, let me just make some about U.S. first and Canada. So in the U.S., we’re seeing some actual good performance relative to peers on our retail book. That’s a function of both the legacy BMO side as you like to say as well as the Bank of the West platform. We’re seeing some good success in terms of stabilizing the retail deposit in the Bank of the West market and offering out promotions, et cetera and capabilities that are being well received by our colleagues there and our customer base. So as we think about that, coupled with that digital deposit taking, I’m really confident in our U.S. growth strategy around deposits continue to be at peer or above peers in the marketplace. And then if I switch gears and go to Canada, we are in top tier market share growth consistently in deposits in the retail side of the Canadian business.

That’s driven by our leading acquisition. We have record new customer acquisition in Canada. That strong digital sales capability, branch conversations that are focused on full relationships. We are seeing that shift a bit to turn. But as Tayfun mentioned, it’s slowing down and it’s plateauing. And so we’ll continue to see that happen over the next little while. But overall, really confident in our ability to continue to drive growth in the deposit side going forward.

Ebrahim Poonawala: Got it. And just very quickly, Tayfun, on capital. Remind us the impact from FRTB floor factor increases in 1Q ’24 to CET1 and separately, if the U.S. Basel and game NPL were to pass as is. It seems like the burden on IHC — foreign bank IHC is going to be quite meaningful, both in capital markets and otherwise how impactful is that to the most U.S. operations?

Tayfun Tuzun: Sure. Thanks for the question, Ebrahim. In terms of the impact of FRTB, we think that the impact will be very, very modest into Q1. The work still continues, and we have some additional details that we need to finalize, but we are not expecting big impact into Q1. Darryl, would you like to comment on the U.S. side, the regulatory developments in the U.S. side?

Darryl White: Yes. I’m just going to clarify for people we’re going to have to get used to this. When Tayfun said, Darryl, he’s referring to Darrel Hackett first call here. And so, it’s a great question, Ebrahim, for him to take as far as the overall environment is concerned in the U.S.

Darrel Hackett: Yes. Thank you for the hand off here, and hello, everybody. In terms of Basel III in game, first, it’s really important to remember that we’ve operated in the U.S. as a significant entity for nearly 40 years. And we’ve effectively begun our journey to being a Category 3 U.S. bank nearly two years ago when we announced the acquisition of Bank of the West. Earlier this year, with the approval and close of Bank of the West, we became a U.S. entity with more than $400 billion in assets, making us a top 10 U.S. bank. So given this, we are uniquely well positioned among our peers and we’ve already been maintaining strong capital ratios in our U.S. regulated entities. So, while the Basel III in-game proposals are still in early stages, we feel really prepared, very well prepared for what’s to come, and we expect the current proposals to only have a modest impact on our current journey.

Operator: Thank you. The following question is from Meny Grauman from Scotiabank. Please go ahead.