Bank of Montreal (NYSE:BMO) Q4 2022 Earnings Call Transcript

Bank of Montreal (NYSE:BMO) Q4 2022 Earnings Call Transcript December 1, 2022

Bank of Montreal misses on earnings expectations. Reported EPS is $3.04 EPS, expectations were $3.06.

Operator: Good morning, and welcome to the BMO Financial Group’s Q4 2022 earnings release and conference call for December 1, 2022. Your host for today is Christine Viau. Please. go ahead.

Christine Viau: Thank you, and good morning. We will begin today’s 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 are Ernie 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 two, 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 noted — otherwise noted as reported. And with that, I’ll turn the call over to Darryl.

Darryl White: Thank you, Christine, and good morning, everyone. Today, we announced adjusted earnings per share of $3.04 for the fourth quarter, closing out another strong year where we delivered record net income of $9 billion and EPS of $13.23. This year, we continued to execute on our strategy to strengthen and grow each of our diversified businesses to deliver sustained performance. Of note, including 2022, we’ve achieved consistent pre-provision pretax earnings growth and met our commitment to positive operating leverage in each of the last five years. Over that period, our efficiency ratio has improved by over 600 basis points to 55.8%. And we remain committed to delivering positive operating leverage and efficiency improvement going forward.

We’ve achieved these consistent results against a rapidly changing economic backdrop that included the worst health challenge of our time and a wide range of interest rate and market conditions. For 2022, PPPT was up 7%, building on 19% growth last year. And operating leverage was 1.3% as we increased our investment in our business to drive revenue growth and absorb the higher impact of inflation. Return on equity of 15.2% this year remains above our midterm target, even while building capital through the year in advance of the acquisition. Our proven track record of dynamically managing our business and maintaining our strategic focus to deliver resilient operating and credit performance through market cycles gives me confidence that we are built to sustain performance in any environment.

Turning to our operating group performance this year. We continue to benefit from our balanced and well-diversified business model. Investments we’ve made in our flagship North American Personal and Commercial Business, Banking businesses, together with the benefit from rising interest rates, drove strong revenue growth that more than offset lower results in our market-sensitive businesses. In Canadian P&C, PPPT was up 15% this year with an efficiency ratio below 45%, as we continue to strengthen and invest in our flagship retail and commercial banking franchise. We’ve expanded our sales force and equipped them with digital tools that support them in developing full customer relationships. We offer highly competitive suite of products and features that help customers make real financial progress, including BMO insights, savings amplifier account, Same Day Grace as well as BMO Visa Eclipse, offering flexible rewards on everyday purchases.

Combined with our award winning marketing and digital capabilities, these have led to strong customer acquisition, adding nearly 200,000 core net new customers this year. US P&C had its strongest year on record with PPPT up 16%, reflecting robust revenue growth and strong operating leverage. In Commercial Banking, we continue to expand and strengthened our presence in attractive markets such as Florida and Texas. We’ve added new functionality to our leading treasury and payment solutions platform, including enhancing the onboarding experience and digitizing billing, resulting in significant time savings for customers and employees. In addition, we’ve maintained our number two deposit share across our core branch footprint. And we’ve expanded access and reduced fees for underserved customer groups.

With a return on equity of 18% and an efficiency ratio of 48%, we have the foundation and the momentum to execute the next step in our North American growth strategy, building a leading US regional bank together with Bank of the West. We expect the transaction to close in the first quarter of calendar 2023. Upon closing, we will significantly increase our US footprint, providing access to major new markets and offering improved convenience and capabilities across our national customer base. In BMO Wealth Management, we’ve made significant progress in transforming our North American platform over the past several years, divesting of lower-return businesses and positioning us to leverage our strength and accelerate future growth. Despite challenging markets in 2022, we delivered underlying revenue growth for the year, reflecting strategic investments in talent, technology modernization and expanded investment capabilities that resulted in a record year for net new asset growth.

BMO Capital Markets diversified businesses delivered resilient performance in a difficult environment with $2.3 billion in PPPT this year. We’ve maintained peer-leading market share in M&A in Canada and strengthened our position in key categories in the US, building a strong foundation that will enable accelerated growth as market conditions improve. Our competitive performance in 2022 was driven by our leading winning culture and an empowered team aligned to achieving our strategic priorities. We’ve elevated our focus on one client leadership, bringing the full suite of BMO’s products, services and advice to our clients and further strengthening collaboration and partnership across businesses. For example, over 80% of new investor line clients have a prior retail banking relationship with us.

We’ve also enhanced product and coverage models to holistically serve our client’s commercial banking, capital markets and wealth management needs together. We’ve also made significant progress advancing our digital-first approach, aimed at enhancing employee and customer experiences to drive revenue and efficiency. We’ve invested across our businesses to modernize technology, expand the use of cloud and employ data-driven analytics. For example, in Canadian P&C, we’re delivering open banking solutions that enable commercial clients to integrate their banking and accounts payable and receivable systems through innovative partnerships, such as FISPAN and Xero. We’ve enhanced our online banking platforms, driving loyalty through improved functionality and growth through market-leading digital sales.

With over 90% of service transactions completed through self-serve channels, our frontline employees are able to focus on delivering leading advice when our customers need it most. As evidence of our progress, we received the highest customer satisfaction ranking in the J.D. Power 2022 Canada Retail Banking Advice Satisfaction Study and our Canadian Mobile Banking App was recognized as, the overall leader in the Q4 2022 Forrester Digital Experience Review for Canadian Mobile Banking Apps with the highest score in six areas. In support of our ambition to be our clients’ lead partner and a transition to a net-zero world, we’re leading the way with innovative advice and solutions. Through the BMO Climate Institute, we’re bridging the science, policy and economics of climate change and supporting our clients as they adopt and scale climate solutions.

BMO Capital Markets ranks as the number one sustainability structuring agent in Canada. And the announced acquisition of Radicle Group, which is expected to close later today, will add to our leadership in carbon credit development capabilities. Our progress in support of a just and sustainable economy was recognized at COP27, as the top-ranked financial institution globally by the World Benchmarking Alliance’s new Global Sustainability Benchmark. As we look ahead to 2023, the macro environment remains uncertain with inflation and higher interest rates expected to slow the economy in the near-term. Real GDP growth in both Canada and the US is expected to be close to zero, and we expect interest rates to peak by the end of the first calendar quarter with lowering rates starting in January of 2024.

At BMO, we’ll continue to dynamically manage our capital and resources just as we have through the last 205 years to grow our businesses and support our customers. So looking forward, 2023 brings tremendous opportunities to expand our reach, strengthen our businesses and deliver long-term value for our shareholders, both organically and through the addition of the Bank of the West. As we continue to grow our diverse client base, we have more opportunities than ever to support our financial progress for our customers and communities. I’m confident that guided by our purpose-driven strategy, we are uniquely positioned to deliver consistent financial performance over time. I’m proud to be part of a highly engaged, empowered and aligned team BMO, and I thank our employees for your dedication to providing exceptional service to our valued clients.

I’ll now turn it over to Tayfun for more details on our financial results for the quarter.

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Tayfun Tuzun: Thank you, Darryl. My comments will start on Slide 9. Fourth quarter reported EPS was $6.51, and net income was $4.5 billion. Adjusting items are shown on Slide 44 and include the impact of fair value management activities related to the acquisition of Bank of the West, which this quarter increased net income by $3.3 billion. As previously disclosed, we also recorded a legal provision, which decreased net income by $846 million. The remainder of my comments will focus on adjusted results. Adjusted EPS was $3.04, and net income was $2.1 billion, down from $2.2 billion last year, as pre-provision pretax earnings growth of 7% was more than offset by higher provision for credit losses, compared with a recovery in the fourth quarter of last year.

Performance in our P&C businesses continued to be very strong with year-over-year pre-provision pretax earnings growth of 13% in Canada and 33% in the US, as continued strong loan growth and margin expansion helped grow revenues at double digits. The muted market environment lowered results in Capital Markets as well as in Wealth Management. Total revenue was up 7% year-over-year, reflecting strong growth in net interest income, partially offset by lower fee income and securities gains as well as the impact of divestitures. Total PCL was $226 million, including a $34 million provision for performing loans, compared with a total recovery of $126 million in the prior year. Piyush will speak to these in his remarks. Moving to the balance sheet on slide 10.

Loan growth was 17% year-over-year and 6% quarter-over-quarter. On a constant currency basis, business and government loans increased 17% 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 4% sequentially, as we remain focused on growing our core deposit base. Looking ahead, we expect full year loan growth to be in the high single-digit range, reflecting strong diversified pipelines and matching similar growth rates in deposits. Turning to slide 11. Net interest income was up 18% and up 27% on an ex-trading basis from last year and up 7% quarter-over-quarter, driven by strong balance sheet growth and margin expansion.

Net interest margin ex-trading was up 20 basis points from last year and 3 basis points from last quarter, due to higher rate environment, partly offset by growth in lower-yielding assets. During the quarter, the increase in loan yields continued to outpace the increase in cost of customer deposits. In fiscal year 2023, based on the forward curves in Canada and the US, we expect high single-digit NIM expansion compared to full year 2022, based on expanded deposit margins and higher long-term rates. As we are approaching the end of this rate cycle, our NIM expansion in the next 12 months will be more moderate than the past 12 months, due to changing deposit mix and rising deposit betas. Moving to our interest rate sensitivity on slide 12. A 100 basis point rate shock is expected to benefit net interest income by $499 million over the next 12 months, including the impact of higher capital base pre Bank of the West closing.

We expect our asset sensitivity to decline post closing, while coinciding with the anticipated end of the current rate cycle. To date, deposit betas have outperformed our expectations, and we expect them to move higher for future rate hikes. Moving to slide 13. On a full year basis, expenses were in line with our expectations, up 4% from the prior year or up 2% excluding the impact of the stronger US dollar and higher performance-based compensation. Lower expenses related to the divested businesses were reinvested in targeted areas to drive revenue growth and efficiency improvement including in sales force expansion and technology. We delivered positive operating leverage for the year of 1.3% and improved our efficiency ratio by 70 basis points.

We expect to deliver positive operating leverage again next year. Moving to slide 14. Our capital position remained strong with a common equity Tier 1 ratio of 16.7%. Excluding the benefit from fair value changes related to the Bank of the West transaction, net of the legal provision, the CET1 ratio increased 37 basis points from the combined impact of strong internal capital generation and common shares issued under the DRIP, partially offset by growth in risk-weighted assets. Source currency risk-weighted assets were higher, reflecting growth in our commercial lending businesses, which was largely offset by capital management actions. As discussed previously, the cumulative incremental capital of 150 basis points generated by the fair value management actions since announcement last December is expected to be offset by higher goodwill on closing due to the impact of changes in interest rates since the announcement.

We remain well-positioned to close the Bank of the West transaction, which we expect will be later this quarter. Moving to the operating groups and starting on slide 15. Canadian P&C delivered net income of $917 million, down from $933 million in the prior year. Strong pre-provision pre-tax earnings growth of 13% was more than offset by higher provisions for credit losses. Revenue was up 11% from the prior year. Net interest income increased 15%, reflecting strong balance growth and higher margins. NIM increased three basis points from last year due to higher deposit margins. The six basis points decline sequentially reflected loan growth exceeding deposit growth, tighter loan margins and a shift to lower spread deposits, which more than offset higher deposit margins.

We expect NIM in our Canadian P&C business to expand in 2023 relative to our Q4 margin. Expenses were up 8% with continued investment in the business, including sales force expansion and in technology and higher salaries. Average loans were up 12% with 12% growth in residential mortgage lending and 18% in commercial loans. Deposits increased 9% year-over-year and 3% sequentially, with strong growth in term deposits. Moving to US P&C on slide 16. My comments here will speak to the US dollar performance. Net income was $489 million, up 19%, with very strong pre-provision pre-tax earnings growth of 33%. Revenue was up 18% with 26% growth in net interest income due to strong loan growth and margin expansion. The decline in non-interest revenue was mainly due to lower operating lease revenue and commercial deposit fees, which during higher interest rate periods, it’s largely offset in net interest income.

Expenses increased 4% due to higher employee costs and technology investments. NIM increased 42 basis points from last year and 18 basis points sequentially predominantly due to higher deposit margins. We expect continued NIM expansion but at a more moderate pace as deposit betas increase. On the balance sheet, average loans were up 14% from the prior year, reflecting very strong commercial growth. Average deposits declined 3% year-over-year and 2% from last quarter, in line with our expectations. Moving to Slide 17. BMO Wealth Management net income was $298 million, down from $349 million last year. Wealth and Asset Management net income was $221 million, down $70 million, as growth in net interest income and new client assets were more than offset by divestitures and weaker global markets.

Insurance net income was $77 million compared with $58 million in the prior year. Expenses were down 9% mainly due to the impact of divestitures, partially offset by investments in the business. Turning to Slide 18. BMO Capital Markets net income was $363 million, compared to $536 million in the prior year, reflecting the impact of the ongoing weakness in the market environment, but up 35% quarter-over-quarter. Compared with the prior quarter, revenue and investment in corporate banking was up 23%, down to higher corporate bank — down due to higher corporate banking revenue and lower markdowns on loan commitments. And Global Markets was up 4% on higher client activity. Expenses were up 19% due to higher technology investments and higher employee-related costs.

Turning now to Slide 19. Corporate Services net loss was $104 million, compared to $107 million in the prior year. To conclude, our overall results for the quarter and the full year were strong and continue to demonstrate the advantage of our well-balanced diversified business mix. We continue to focus on managing our company dynamically to continue growing profitably. Looking ahead to 2023, we expect the economic environment to remain challenging in the near-term with continued increases in interest rates, slowing growth and volatility in markets. We expect loan and customer deposit growth in the mid- to high single-digits on a year-over-year basis, and total bank NIM ex trading to expand during the year as interest rates continue to rise.

Overall, we expect the pace of expense growth to continue to slow while sustaining investments in key growth areas. At the same time, we will be maintaining our commitment to achieve positive operating leverage for the year. And with that, I will turn it over to Piyush.

Piyush Agrawal: Thank you, Tayfun, and good morning, everyone. We had strong risk performance this fiscal year, supported by the steady economic recovery during the first half of the year and the strong risk management discipline across the bank. Starting on Slide 21. For the fiscal year, the total provision for credit losses was $313 million or 6 basis points. Impaired provisions for the year were $502 million or 10 basis points, compared to 11 basis points in 2021. We recognized a release of $189 million from the performing loan provision this year largely due to the economic recovery and reduced uncertainty from the pandemic on credit condition in the first half of the year. In the second part of the year, we started building provisions on performing loans reflecting the weaker economic environment.

Gross impaired loans decreased to $2 billion or 35 basis points compared to 46 basis points a year ago. Turning now to the current quarter on slide 22. Despite headwinds from inflation and interest rates, Q4 was another strong quarter in terms of credit performance. Total provision for credit losses was $226 million compared with a provision of $136 million last quarter. Impaired provisions for the quarter were $192 million or 14 basis points, up from $104 million or 8 basis points in the third quarter. Although, our impaired provisions for credit losses were up from very low levels in Q3, they remain lower than pre-COVID levels. Similar to last quarter, the strong impaired loan performance is due to low formations and low loss rates on those formations.

Retail impaired losses were $117 million in Canadian P&C and $10 million in US P&C. The modest increase in impaired PCL is consistent with the underlying measures such as a modestly increasing delinquency rate in some unsecured products, which remain well below our pre-pandemic levels. In our corporate and commercial businesses, we reported impaired loan provisions of $25 million in Canadian commercial, $37 million in US commercial and $5 million in capital markets. And while up from last quarter, they represent a gradual normalization that we have been expecting with no systemic concerns. Moving to slide 23. The provision for credit losses on performing loans was $34 million this quarter, reflecting the weaker economic outlook and portfolio growth, largely offset by continued reduction in pandemic uncertainty and portfolio credit improvement, including the benefit of risk transfer transactions this quarter.

Given the strong credit profile of our current portfolio and our own forecast for impaired losses, we remain comfortable that our $2.5 billion of performing loan allowances provides adequate provisioning against loan losses. And to put that into perspective, this $2.5 billion provides coverage of 44 basis points over our gross performing loans compared with a coverage of 36 basis points before the pandemic. On slide 24, impaired formations were $499 million, and gross impaired loans were flat relative to previous quarter. Both formations and the gross impaired loan rates are still below pre-COVID levels and are low compared to our last decade of performance. Turning to our mortgage portfolio. Our delinquency rates remain very strong. On Slide 26, you can see that over the coming year, only 12% of our portfolio is maturing.

And of that, a very small portion is of lower credit quality. We are proactively reaching out to customers who we think are most likely to have future challenges at renewal. And we have had a positive customer response to this outreach. And there have not been any observable increase in delinquency at mortgage renewals. Over the past several months, I’ve had a chance to review our portfolios and underwriting standards and see for myself the high quality of the portfolio overall, the robust structures and underwriting practices, as well as the strong risk management capabilities and discipline. This sound foundation will serve us in good stead as consumers and businesses adapt to the impact of high inflation and interest rate increases, while the macroeconomic environment and geopolitical situation remains uncertain.

So while we are pleased with the low impaired losses this quarter, we do expect our impaired PCL rate to gradually move towards our pre-pandemic experience through fiscal 2023 in the range of high teens to low 20s in terms of basis points. I will now turn the call back to the operator for the Q&A portion of this call.

Operator: Thank you. We will now take questions from the telephone lines. And your first question is from Ebrahim Poonawala from Bank of America. Please go ahead.

Ebrahim Poonawala: Good morning. I had a question around just commercial customer base. One, give us a sense, maybe Darryl or Dave Casper if you’re on the line around how the commercial borrowers are holding up in face of the higher interest rates? And secondly, just a sense of where the demand is coming from. I think, Darryl, you mentioned 0% GDP growth next year. In that backdrop, where are you seeing loan demand coming from? And are there areas where the bank is tightening lending? Thank you.

Darryl White: Ebrahim, thanks for the question. It’s Darryl. Dave is on the line. So Dave, why don’t you give it a start? And if I have anything to add, I will.

Dave Casper: Sure. It’s a great question. And the first part of it, the clients, both in Canada and the US, are holding up quite well. Their capital bases are strong, probably stronger than pre-pandemic rates have been so far kind of a modest impact. It will impact some more than others. But in many cases, our borrowers have interest rate protection. The demand across our businesses, and I’m talking about the demand our customers see is probably dropping a little bit as the economy weakens. And I would expect that to probably continue into the New Year to some extent as we move into more of a recessionary period. And I think that correspond would probably — we had very strong loan growth this year, very strong in terms of client acquisition as well as large increases in some of our businesses that are revolving.

For example, asset-based lending, or our auto dealers where they’ve built that up. But I expect that to diminish a little bit next year, still good growth, still good client acquisition, but overall, probably less than loan growth next year. And lastly, just to kind of put a — we spent an awful lot of time in the last couple of months, Darryl, myself, Dan Barclay, Del, everyone, spending time with our clients. There’s still optimism. There’s still lots of good things going out there. But there’s definitely a little bit less optimism than there was a year ago, just as they wade through all of the dynamics going on in both the US and Canada. The health is strong. I feel very good about our broad-based growth. And the momentum continues to be very good on both sides of the border and adding the right kinds of clients that will be good clients, both for commercial, wealth, capital markets, where we really have done a great job, I think, of putting all the businesses together as we think about our clients.

That’s a long answer. I hope I gave you a good start, and maybe Darryl have some more to add?

Darryl White: Yeah. The only thing I would add, Ebrahim, is when I listen to Dave, I agree with all that. And I would say you should think about it in the category of what you might naturally expect to happen. We do see a little bit of slowing down in the client base. We do not see a slamming of the brakes. The consequence of that is we come from a pretty healthy position. The book is healthy. The momentum is good. We tend in this business to outperform the market in most environments. And I would expect that we’ll do the same going forward next year. You probably won’t see the loan growth next year that you saw this year. But you’re still going to see loan growth because the customers that we select tend to be the good ones, and they tend to have good performance through time. And we tend to go where they go. That’s what I think you should expect.