Good afternoon, ladies and gentlemen. We're going to start the session off. Very pleased to have Tayfun Tuzun, CFO of Bank of Montreal. Tayfun, welcome back. We're always pleased to have you.
Thank you. Thanks for having us.
So, Tayfun, I'm going to start the line with what I presume is taking up a lot of your time recently is the Bank of the West acquisition. Can you give us an update in terms of how the integration is going and, I guess, like, how the systems conversion went a couple of weekends ago?
So now that the conversion is behind us, I will tell you that I will be very happy to give you an update. By all means, we had a very good week at BMO last week. Conversion took place over the Labor Day weekend, and by all means, by all accounts, including the comb through of social media, I think we have achieved the best outcome that we could have achieved and could have expected. Our teams have done a very good job in identifying where we needed to allocate the resources and where we need to double up on resources.
In technology, given the intensity of the transfer of the old Bank of the West systems onto ours, and in customer service, the focus and allocation of resources onto call centers, et cetera, in combination, have resulted in a great outcome. The weekend went very smoothly. You have to realize that there were three mock trials before this one, one full- dress rehearsal in August. So, there was a lot of preparation, but at the end, we are very, very happy with the outcome. We are on one platform now. Moving forward, we have unified the brands. We are no longer Bank of the West or BMO Harris. We are BMO. We are BMO in Canada, we are BMO in the U.S. We have launched a very active brand marketing campaign in California.
We will probably keep it at a high level of share of voice in California for a few quarters, because frankly, they don't know BMO in California. And given our history, given the scale that we operate in the U.S., all the safety and soundness issues in U.S. banking, our profile is a very attractive one, and we intend to leverage that to its fullest extent. And with the conversion behind us, our teams can now focus on exactly delivering the outcomes that we shared with you and with our investors when we announced the transaction. And one additional comment that I'll make, and I'll be happy to get into the details about our expectations both on the cost synergies and the revenue synergies.
But one change since the announcement, which was in December of 2021, is the change in the U.S. environment and especially the regulatory environment. With the added constraints on capital in the next few years, with the added constraints on liquidity and also the heightened regulatory environment that is moving even Category IV banks onto a more stricter operating platform, we feel that the advantage that we gained by acquiring Bank of the West and operating at a larger scale is even more productive. As you know, we operate at a much higher capital constraint given OSFI's minimum capital requirements of 11.5% starting in November. Our liquidity constraints are at a higher level compared to our U.S. regional peers.
We already had made the commitment to elevate the regulatory platforms because we're moving from Category IV to Category III. So all of those were already in place even before the U.S. regulators have signaled and announced the intended changes, which we believe are going to put a few constraints on the ability, you know, to grow for our U.S. peers. Well, we don't have—we will not have the same constraint. So coming back to Bank of the West, level of excitement about larger footprint, the larger balance sheet, bringing also the power from our parent company, I think is going to be meaningfully value creating for our shareholders, going forward. So with that all together, I think that, you know, I think we're right to feel very good about the transaction.
Tayfun, and you, w e could unpack that probably for our entire session, but, and I'll get into the expense synergy points in a moment. But the scale which you bring up is very interesting and not terribly surprising to benefit. How important was Bank of the West acquisition for BMO in the U.S. to get that level of scale? And then talk about the other ancillary benefits you mentioned in terms of the increased footprint. Talk about what business the Bank of the West brings to the U.S. table.
It clearly was a very important transaction for the future of our U.S. franchise. But more importantly, I think the timing of being able to execute this transaction is going to be more instrumental going forward. Because what we did not want to do was to add more scale to our U.S. franchise befo re we actually improve the operating performance of our legacy U.S. franchise. As you know, leading into December 2021, when we announced this transaction, the performance metrics of our U.S. franchise have changed very significantly. You know, we started operating at 15%, 17%, 18% ROE. We brought the efficiency ratio down to below 50%. So it was the right time for us to add that scale. Adding the scale by itself maybe would not have been as effective as it now will be.
But having made that comment, we all know, and even before these regulatory changes, the cost pressures significantly elevated the advantage of scale. Whether it's technology, whether it's marketing, or other discretionary expenses, and the ability to put out a larger sales force into the business. I'd rather be a $400 billion bank than a $100 billion bank. The longevity of the profitability, the outlook for profitability, gets significantly, you know, enhanced with size. And also, again, in the near term, we will operate, you know, with this expanded size. We need to, you know, show our investors that we can deliver the promised financial outcomes. But you know, we can grow more than this, and the scale enables us to do that.
Now, you have the top four banks in the U.S., and we are right in that next category with U.S. Bank, PNC Bank, Truist, et cetera. And our ability to compete with them and with banks of smaller size clearly is a lot more enhanced. Plus, you know, let's be honest, although we are talking about our U.S. presence, we operate our business as North South. So we have a CAD 1.2 trillion balance sheet that we bring to the U.S. with a strong profitability in Canada. So you put all this together, I think the future is quite bright for BMO in the U.S.
And then, can you talk about the synergies that you're expecting, too? S o where that's coming from on both the revenue expense side, and if you can talk as much as you can about what you alluded to on last quarter in terms of the likelihood that we should be able to meet your targets?
Yes. So, when we made the announcement about the acquisition, we were very specific and clear about synergies. We said we expect to capture $670 million , and we will do so in the first 12 months following the closing date, so that we will start year two with the full run rate of those synergies. We have kept that commitment, feel even more strongly today. And also, during the earnings call, we signaled that our work since closing is indicating that cost savings is probably going to exceed that $670 million number. So that is a positive development. In terms of, revenue synergies, we had a couple of updates for our investors.
Back in 2022, we mentioned that we expect $450 million-$500 million in revenue synergies from Bank of the West, you know, in a three- to-five -year timeframe. And then we came back, actually, I believe, at the end of last year, and we said that even pulling the timing of that back a little bit will translate into a $2 billion PP&T on a run rate basis as we exit 2025. And what we have seen so far, since the closing, the elevated productivity at the old Bank of the West branches. Once we started our training programs, established our performance targets and sales practices, and also started enhancing their digital tools.
Plus, the revenue synergies that started almost day one across our commercial banking and capital markets business, committed transactions, whether it's bond issuance, M&A, advisory business, or even just transactional, you know, interest rate risk management products, foreign exchange products, et cetera. And also the conversations and the engagement that commercial RMs are showing us on the commercial side have really increased our confidence in the commitment that we made to these revenue synergies. Now, admittedly, the current macro environment is weaker than we would have anticipated when we announced the transaction, so we may see a quarter or two delay in achieving these outcomes. But we are still confident that the level of outcome that we anticipate, whether it's measured in PP&T or revenue synergies, is real.
And we intend to get there. We'll get there faster if the environment allows us, but at the moment, I think the more important part is that we are increasingly confident of the revenue synergies in connection with the higher cost synergies. I think the transaction is hitting both, you know, our financial targets, obviously, and supporting our priority needs.
When we talk about the macro or the operating environment that you're currently in, can you talk about working in terms of deposits, funding, you know, the pressures on the system earlier in the year, how that's filtering through ?
Yeah.
What Bank of the West may or may not provide for you that you didn't have previously?
I'll answer that question both from the Canadian side of the border as well as the U.S. side. The Canadian side, from a balance sheet perspective, has been a lot more predictable, a lot more stable. Deposits have been growing in Canada, loans have been growing in Canada, since basically the end of COVID. I think in general, Canada very successfully avoided the turmoil that we experienced, the system experienced in the U.S. On the U.S. side, immediately following the initial stages of the turmoil in early March, we have seen actually positive into our U.S. business. We've seen some weakness towards the end of April into early May. That may have also coincided with the tax season.
Hard to tell exactly what the cause was, but since then, since the early part of May, it's been a lot more stable. Our end- of- period counts are a lot more favorable, and now that we are operating on one platform, our projection and our guidance for deposits is growing. Before we suspect that it will both in our personal business as well as commercial business, I think the combination of having doubled our branch count and also supporting a larger branch count with a highly effective national digital deposit platform gives us, I think, a competitive advantage. We will fully leverage that. On the commercial side, you know, we have a very advanced treasury management platform that operates south. Bank of the West clients have converted to that platform.
It gives them expanded capabilities, and I think it enhances our ability to attract new customers. So we are quite optimistic, from a deposit perspective. We're both pricey, price competition continues to be very fierce. It's not a balance issue. On the loan side, similarly, there are differences between Canada and the U.S. In Canada, we have continued to experience loan growth, more so on the personal side, both mortgages and cards have been growing in Canada, but also, commercial loans have grown at a more modest level. But, on a quarter-over-quarter basis, we have been on a growth mode. In the U.S., it's been more challenging to grow.
Loan demand overall has come down in the U.S. over the past couple of quarters, and I suspect that may continue to be the case for a few more quarters until we get a bit more clarity around, you know, the Fed rate decisions, the inflation outlook. Although in general, the level of optimism regarding a soft landing is growing, I think our clients will need a few more tangible clarifications. Before they probably invest their business, and, you know, our business will reflect that. But overall, I think, we feel that our business is positioned well, even for this environment. You know, look forward to again, going into more, both in Canada and the U.S., addressing our clients' needs.
Tayfun, can you expand a little bit more on the online deposit gathering system that you're implementing in the U.S. and whether or not it's actually being fully enacted? Because I think the last time that I had heard it wasn’t completely rolled out.
Yes, last time I was here, actually, I touched upon that a little bit. The time was not right. So we invested in that platform pre-COVID. Because, you know, we have a very, very strong, commercial business in the U.S. that tends to outperform our peers in loan growth. And, given the fact that at that time, before we acquired Bank of the West, we had a smaller, personal business, we wanted to enhance our deposit-generating capabilities with an advanced, national deposit platform. The platform was put in place. It became a bit dormant during COVID because nobody needed to activate a national platform.
As we came out of COVID and towards the end of last year, way before, you know, the deposit turmoil started in the U.S., we started getting ready to turn on an engine. The engine basically is a national, both term and transactional deposit- generating platform. We have the ability to reach out nationally to clients without having to reprocess our own base. It continues now. It's fully in place. It's activated. It enables us not only to go on a national basis purely digitally.
But it enables us now to test this thin branch business model in personal banking. Because when we acquired Bank of the West, we basically expanded our branch network from the Midwest all the way to California. Bank of the West's retail branch network was a lot more intensive in California. There's a thin distribution of branches in states in between. Now, bringing this deposit platform, digital platform, and covering a thin branch network is a very good business model for us to test in real. And we're quite optimistic that combining the ability for our clients to use both the branch network as you go to the branch as you need to, but take full advantage of digital capabilities will give us a competitive advantage.
Tayfun, before I throw it open to the audience for their questions, I wanted to ask you about U.S. retail banking versus Canadian retail banking, because you as an American, coming from the U.S. system, you dropped into the Canadian system. You've got a unique perspective in terms of the differences. Can you speak about the universal bank model in Canada and whether or not you think U.S. banking will move more towards what's happening in Canada?
Yeah, very different business models resulting in different performance metrics. In Canada, for those investors who are here who are more U.S.-oriented, the branch still is the main outfit where we conduct business. Whether it's sales, you know, service, less of service these days, as digital banking has clearly, you know, improved all geographies. But when the customer comes to the branch, you still connect with the customer across different products. Mortgage continues to be an anchor product in Canada, unlike the U.S., where we lost that, y ou know, a decade ago.
When the customer, on a proprietary basis, acquires a mortgage at a branch, now you have basically that full relationship open, credit cards, HELOCs, personal lines, mutual funds, ETFs, insurance. So the lineup of products and services now that you offer to the client and her willingness to actually engage with the bank to acquire these products, is significantly different than what we experienced - what my experience has been in the U.S. We have given up on mortgage being the anchor product a while ago in the U.S. The credit card business is a lot more concentrated in the U.S. You know, we have the big three or four credit card originators capturing a large portion of that market. Investment products tend to be very clumsy. You're connecting to private banking, but it's not as a direct linkage.
We have a lot of opportunities to cross-sell between private banking and retail banking, but the lineup of products is not quite the same, you know, insurance and ETFs and mutual funds. So deposits are really the main drivers. When you talk about client acquisition in the U.S., you go to checking accounts. That's the anchor product. Well, in Canada, that's a more enhanced experience. Our goal is we carry the experience from Canada into the U.S. Although the picture may not quite enable you to penetrate that relationship as widely and as deeply as you can in Canada, we have a set of digital capabilities and the deep experience that we bring back from Canada to be able to connect with our retail client base.
We also, although not necessarily in the same manner, we have a lot of focus on connecting the wealth business with the private banking business. We have a premier banker position that bridges that gap and addresses that mass affluent segment. And again, I mean, I don't wanna every time go to Bank of the West, but the new Bank of the West platform enhances our capability to do that as well.
Well, I'm going to ask if there's any questions from the audience. This is your chance to ask about Canadian housing, because I'm massively long Canadian housing myself, and I don't want to hear any bad news about it. Okay. Well, on credit risk, BMO strategically has over-indexed itself on commercial.
Yes.
And as you alluded to earlier, you've been very successful in being able to grow that book of business as well as the acquisitions you've taken on. How do you feel about the outlook for credit in commercial? And then the flip side to that is you talked about lower growth expectations in lending in the U.S. on the commercial side. How long do you think it would take to revert back to being a strong driver of growth?
Yeah. So, I mean, our commercial focus has always been there. It's, you know, we have not necessarily... It's not a near-term phenomenon. We've always been more commercially focused, and we have a long history of credit performance. You know, we have data in our disclosures going back 30+ years. And we have outperformed our peers in terms of credit experience in that commercial book. There were a lot of questions coming into COVID, whether COVID would, you know, change that picture. Understand the COVID process worked differently than initially anticipated, but regardless, I think we are good commercial bankers with deep credit underwriting experience to the business in a very diversified manner.
So I'm quite optimistic that our future performance in commercial will match our past performance in maintaining you know a level of credit that you know outperforms our peers. As we look at it, our Chief Risk Officer, Piyush Agrawal, at the call, you know, said, "My expectation is the normalization that we are seeing today will continue into the next number of quarters." We have defined a normalized level of impaired provisions somewhere between low- 20s and mid-20s basis points. So that's actually, compared to my previous experience in U.S. regional banking, that's a wonderful level of... It's a great level of credit performance. Look, I mean, I think on either side of the border, we're seeing, you know, significantly outsized or red flag performance in any industry.
Commercial real estate clearly has captured the majority of the attention. We have spent a significant amount of time on commercial. We have about CAD 67 billion in commercial real estate. CAD 11 billion came from West, and the portfolio is divided 51% Canada, 49% U.S. The largest asset class is multifamily, and I think 70% of that is in Canada. As you know, you know, the demographics in Canada and population growth continues to support multifamily, so it's a relatively healthy asset class. The second asset class is industrial. That also continues to do well. The third one is office. You know, we have about a little over CAD 7 billion in office, and I think about 65-70% of that is in the U.S. But we have re-underwritten every loan above CAD 10 million.
We have a pretty granular portfolio. We actually disclose the top five cities, and there were no big concentrations there. Also at Bank of the West, yes, we have taken on more California exposure there, but remember, we have double suspenders there because we took a credit mark, and we established a day two provision. So overall, we feel, you know, things are gonna normalize, but I think the range is going to be still within our historical performance ranges, and we should not see any outsized credit underperformance.
In terms of when loan growth turns, in the U.S., look, I mean, I think if the more optimistic outlook about, soft landing, comes true, if, inflation is effectively under control such that the Fed can declare, an end to this rate cycle, those are clarifications that will help our customers make longer-term decisions. And so, a more muted inflation outlook should take some pressure off the consumer balance sheets. Relative to that now, you have a $90+ oil price, so we have to be cognizant of that. Oil prices tend to keep headline inflation numbers, you know, in the forefront.
My hope is that core inflation will continue to show signs of stabilization, such that, again, the Fed declares an end, and then we can move on cycle, which should help loan growth eventually.
I do know the high oil price limits the number of questions you have in your energy portfolio.
That is correct. Yes, yes. We e are not complaining about our energy portfolio. It's been actually a very good.
So Tayfun, I wanted to talk about the restructuring position last quarter. N ot in the vein of what this is going to mean for savings going forward, or even the fact that you take a restructuring charge. But the philosophy behind taking a restructuring charge and not flagging it as non-core, which again, investors can treat it however they want. But I think this is a change in the Canadian industry, and notably from what BMO has actually done in the past. Can you talk about your rationale for this? And is this a change in philosophy, or am I just making a mountain out of a molehill?
Yeah, look, I mean, I think I don't know if I would necessarily describe it as a change in our philosophy, but we've been very transparent about the circumstances that led to this decision. At the very end of last year, as we looked ahead to 2023 and assessed revenue growth prospects, we saw a more muted trend compared to 2021. In 2021 and 2022, we significantly expanded our sales force. We accelerated some of the technology investments, which led to a higher expense growth, but we also had higher revenue growth, which enabled us to achieve positive operating leverage. When we basically put a pause on that expansion at the end of November and December last year, revenue growth has declined faster than...
And we have an outstanding commitment to positive operating leverage, which then came to the spring, and we hinted at this in our second quarter earnings call. We were looking at some actions. When we came to the third quarter, and as we assessed the next four to six quarters, we felt uncomfortable having operated at a negative operating leverage for two quarters in a row. We had to make a change, and it just happened to be in line with the revenue outlook, and therefore, we took the action when we needed to take the action, and we believe it was the right time. So the form of how we disclose this, look, we own it. We are very transparent about it. This is part of our core, the way we run our business. It's dynamic expense management.
We didn't see a reason why we should adjust for it, because our groups own it, our functions own it, and we just wanted to be transparent. Because ultimately, the savings that are associated with this charge is also going to flow through, you know, the income statement for each group and function. So, we felt like this was the right decision. I'm not sure if this is necessarily a change in the philosophy of it, but I think the way we run the company today, with full transparency with our investors, we thought this was the best.
And then with the expected benefits of this and the expected benefits of West, can you talk about your degree of confidence in terms of being able to generate positive operating leverage moving forward?
I'm very confident that we will generate positive operating leverage next year. And, you know, we have been very transparent about the impact of Bank of the West. But we are also not shying away from establishing expense discipline at what I would call. This distinction is disappearing quite fast, but the old, you know, legacy BMO. So, we are making that commitment because we have to make sure we still have a long-term efficiency ratio target to get to mid-50s. We need revenue help for that, but I think as we look forward to 2024, the ability to contain the efficiency ratio is very important to us. And I think we have shown even this quarter, our numbers were actually, we had negative operating leverage, but it was a better negative operating leverage picture compared to our peers.
Although the fourth quarter, we'll get through the fourth quarter, there's some post-conversion expenses that are going through, but we'll get to that run rate, you know, in early part of 2024. Then we'll be able to show you the progress that we make fairly clearly. But in terms of the positive operating leverage for the year, I feel very confident about that.
We have, I think, time for one last question. This is your last chance. Canadian Housing, going once, going twice. I'm going to be really upset if it doesn't happen.
Well, it's really more about the consumer, right? Because I assume that it is their discretionary spending that will be affected first. And so what are your views on your consumer book and, you know, sort of its relationship to rates- And similarly as we sort of move forward into 2024, and where do you see a, you know, like a real make or break pitch point?
I assume the question is more on the Canadian consumer. All right. Okay. So look, the rate impact in Canada is very clearly coming through, mortgage. And, the mortgage stress is real, although the timing of it for BMO is later out, you know, in 2025 and 2026. But overall, the way I describe... the stress on consumer is less about bank credit, because I believe that banks are well protected because there is very low default risk with high FICO scores, and LTV is around, you know, 55%-56%. We leave a lot of room for banks. This is more of a consumer health within the macro picture question. And as such, it is real that especially in cities like Vancouver and Toronto, the rate impact on, household balances is putting stress.
But we have fairly detailed financial analysis that looks across the portfolio of our mortgage borrowers, monitors the unsecured credit that our mortgage borrowers have with us, credit cards. We're not seeing a distinction in the credit behavior of those borrowers who may be experiencing more rate pressure through their mortgage payments. So credit card performance is actually, I think, if I'm not mistaken, to a better than mortgage borrowers. What also appears to be the case, more systemically in Canada, is that unlike a little bit in the US, the Canadian consumer, especially at the upper end of the income distribution, is still preserving a decent amount of assets.
They may have moved some of those assets into more liquid investments because rates have made it more attractive. Bank deposits have become more attractive, but there is still a reasonable amount of cushion left on the balance sheet. And I believe some of that movement into liquid assets is really in preparation for potentially a higher mortgage payment down the road, whether it's a higher payment or a down payment that is maybe a bit more higher than they originally intended. So for now, it appears that the consumer is able to support herself, and if the employment picture continues to be healthy and there is continued cash flows in attachment to a relatively healthy portfolio, we should see a stable picture. But I'm not disputing that there is stress in the system because larger and larger portion of cash flows, income goes towards mortgage payments.
That's the reason why I highlight the impact of oil price and headline inflation, because although we focus on core inflation numbers from a monetary policy perspective, from a growth perspective, we need to keep that headline inflation still, you know, in check.
Well, I think you're perfectly timed. We'll end it here and let you get off to your flight delay.
Thank you.
As always, Tayfun, great conversation.
Very nice to see you.
Thank you.