We're going to start our next session with Bank of Montreal. Delighted to have Piyush Agrawal here, the Chief Risk Officer for BMO. Piyush, welcome to the conference.
Oh, good. Thanks for having us. Good morning. Good morning, everybody.
So, you know, a unique opportunity here with Piyush up on the stage. I mean, you have a bit of a background in working in credit risk in the U.S., and now for a Canadian bank. We do have a little bit of a different accounting approach, and sometimes we see some things happening. So I thought maybe we can just kick off with a quick question on, you know, how do you see it now that you've been working for a Canadian bank, the differences in terms of IFRS 9 versus CECL accounting. And then we'll dovetail that into what we saw in the just recent quarter, with a performing allowance loan loss build.
But over to you if you can just give us a brief tour of how you see it, and we'll walk through why Bank of Montreal built reserves in Q1.
Sure. So it's a little bit of a technical question, and I'll try and simplify it for our investor base. IFRS 9 and CECL are very close cousins because at the end of the day, they are the methodology of how you get into your provisions. And it's obviously supported by hundreds of pages of literature and guidance by the different regulators who look at it. But very simplistically put, the biggest difference between IFRS 9 and CECL is the duration of the portfolios and how long you reserve for. So under CECL, you take lifetime losses. If you've got a 5-year duration, you'll probably see something which is 5 years in length, whether you're performing or whether you have a credit weakness or whether you're in default. You just have to look at the entire lifetime. In IFRS 9, there's a dual treatment.
For the current book, it's a one-year loss. But then when you start seeing changes in credit deterioration, stage two or stage three, is when you move from one year to lifetime. So for any book, you'd have about 90%-94% in stage one, 5% probably stage two, 1% stage three. And the difference then becomes for that 90%-94%, you're booking a one-year timeline as compared to CECL, you're booking a lifetime. So Canadian banks, BMO included, you see our allowance coverage as a blend of the stage one, stage two, stage three at around 55-60 basis points for the banks performing coverage. If you were to take our U.S. peers, U.S. banks, given the duration, of the book, you would see three to four times higher coverage. U.S., and we comply with CECL in the U.S. And so our U.S. coverage is in line with U.S.
Peers in the 3-4 times Canadian bank peer coverage. And, you know, to give you an example, Canadian mortgages are 3-5 years. We take a 1-year loss, as long as they're performing. And as you know well, most of them are performing in Canada. But in the U.S., where mortgages are longer in nature contractually, 15 years or 30 years, you're holding a lot more provision. The fun part is for us and probably our peers, we use exactly the same models. We use exactly the same scenarios. The biggest difference out there comes into the duration. And then those have its advantages and disadvantages in terms of what the regulator has in their intent of do you want to lend more or lend less because you're reserving so much more under CECL.
And then there's volatility aspects depending on how CECL might work or IFRS 9 might work. So it's really the coverage difference based on duration of the book, lifetime versus one year.
Okay. That's hopefully a really good compact answer. So now we can talk about the trends that you're seeing.
Sure.
Talk about sort of what we saw in the first quarter, because one of the things, you know, you saw in the quarter wasn't a massive build of reserves, but it was bigger than peers. So over to you and maybe a discussion on what you're seeing.
Yeah. So the provision process is a quarterly process, you know, high in governance internally because it's such a big element of any bank in what we do and what we signal. And if I just want to break it down simplistically, because both CECL and IFRS 9 are very forward-looking, it's really based on a couple of forward-looking scenarios that you have to take in. And so we begin with where BMO Economics for us projects out what the base case might be or what an adverse case might be. And you take a mix of those and you put weights around it. And I think our investors would probably appreciate that the economy is getting better. So our macroeconomic scenarios going out are better than they were in the previous quarters. We've averted a recession in the soft landing mode. So things are getting better.
So that's a big element of how you think of the forward scenarios. Then you've got portfolio size, portfolio quality sizes. You know, we've sort of grown a bit. It's flattish. So that wasn't a big driver. And so portfolio quality becomes then a very big driver, especially for us in Q1. And I can break it down into more detail, but just at a very high level, there is softness, as you're seeing, in the unsecured portfolios. So as the transmission of the entire rate cycle and the hike of 5%, consumers haven't fully absorbed it. They are still absorbing it. And you can see that in data and delinquencies, whether it's in their cards, in unsecured loans. We're not seeing it in secured mortgages. And I know it's a big topic of discussion. We've spent time in the past. We can talk about that again.
That's doing very well. Similarly, on the wholesale side, commercial customers are feeling the pain of both inflation and higher interest rates. So anybody who postponed decisions thinking rates will come down, it's a year later, rates are still high up. And it just eats into operating cash flow, which then reflects into risk rate. So credit migration has been a big piece. And so about half of our build, performing build, was on account of credit migration, which has been happening, and we've been building provision for the last one year. There was a second component to it. And the second component, just very quickly, is, as many of you know, we had a very successful integration of Bank of the West out in California. It's a $100 billion bank. Came in.
As we integrated Bank of the West and all the models of Bank of the West within the broader Bank of Montreal, you don't want to lose the richness of data that now comes in also with Bank of the West. So, one time, we do these while model refreshes are an ongoing feature, you don't see it in a big way. One time, we took that data. We brought that in. It gives you much more visibility of default rates or recovery rates over different environments. And so, as we upgraded the models, what we were doing through credit judgment all along, a little bit of what things might be in the future, now it's flowing into the model. So half of that was the model. But the way I sort of bring this together is the environment is still soft. We've all agreed on that.
There is going to be continued softness as we'll see more deterioration on unsecureds. So I look at the outcome of where are we on the coverage. And our coverage was 54 basis points, from a performing allowance last quarter. And we're at 55 basis points. So we're not off at all. In fact, it gives me great comfort that, you know, from a prudence perspective, we are in the mid-50s coverage on, overall performing allowance. So yes, a slight build, but I think going into the environment we are, it's good to be where we are. And then we'll see how the environment unfolds and how portfolios react to those environments in the future.
When we think about the richness of data that you just pulled in from Bank of the West, it seems to me like it's a one-off, but could there be other model refinements that have to happen from here on in, or is this really just a one-off and we should really think more about a performing build that's more in line with, let's say, half of what you just saw?
Yeah. I would say, so this is truly one-off. I don't expect this to happen. I joked on the call, until you see our next M&A, when we get the next set of data, you know, we'll do it again. I don't see that. There are many models underlying so many of these calculations. Those get updated, you know, every year we get new data of our own default rate. So those get updated. But those I don't expect to be major shifts. So yes, don't expect model updates, going forward, anytime soon in this quarter of that magnitude. It's really going to be now our impetus on portfolio growth. We're beginning to see some growth come through. We'll see how macroeconomic shifts, you know, we've talked about in our assumptions, we expect rate cuts in the second half of the year. Those are embedded in our assumptions.
That trajectory is not linear. And, you know, market's betting a little bit now softer on the rate cuts and the timing of those. So those will change. At the end of the day, even with rate cuts, how that will impact credit is going to be something that we continue to watch. So credit migration, credit growth, both of those will be big going forward.
And so then, maybe we can just turn our attention to actually what would impaired.
Yeah.
So, maybe you can talk a little bit about the trends you're seeing in the impaired port and what we specifically saw more recently and what you're thinking about in the next couple of quarters.
So the impaired portfolio, I'd say this is a classic credit cycle. I haven't been surprised by our impaired trends. In fact, if you think about our long-term averages, we've outperformed, our peer group. And our long-term impaired loss rates, we've said, is in the mid-30s averages. And there obviously they spike at bad times. We had an impaired loss performance of about 29 basis points this quarter, which, I have indicated or signaled that we expect 2024 to be in the low 30s, which so they will trend up a bit. But overall, I think, with some intra-quarter volatility or variability, I feel pretty good about that. And the reason I think the 29 basis points in the low 30s is our visibility on impaireds for the type of lending we do and the risk culture we have gives me confidence. And I'll just explain that in a second.
Impaireds don't show up from performing to impaired overnight, right? You have a trend where you start to see delinquencies come through the pike. So if it's unsecured or secured, somebody's 30 days delinquent, their roll rates go into 60, 90, and so on. And so you've got a pretty good handle on what's going on in the underlying portfolio, on why then on how much of that might flow into impaireds. It's the same thing for even the wholesale side. There's ratings migrations. We would be shocked if I saw somebody go down 5 or 6 notches in a risk rating overnight, right? It's a very slow trajectory. And we continue to work with clients, see where the challenges are. So you can tell how much is going down. It's going to be in watchlist from watchlist into an impaired formation.
So when we look at the impaired formation and look at our history of data of how much of the formation really becomes a loss, we get pretty good ranges to signal where impaireds might be. There'll be idiosyncratic losses. That's always the case. There might be a fraud event or so. We haven't seen that. But that's why I feel much better about providing impaired guidance on the quality of the book, and the migration we've seen. And that's why the, the low 30s.
And so picking up on that, maybe we can just drill down into some of the portfolios and talk maybe more specifics. And you mentioned earlier, you know, there's been a lot of attention on Canadian mortgages. I've been pretty involved in the space myself. And so one of the things that we continue to look at and think about with the Canadian mortgage portfolio is this renewal schedule that we can all see. We can all calculate how much of an increase we're seeing in mortgage payments.
Yeah.
We are starting to see some increases in delinquency. So maybe you can walk through some of the trends that you're seeing there and why they're not translating into loss and why they may not translate into loss.
Yes. So our book is about CAD 150 billion of mortgages. And, you know, in the peculiarity of the market, there's obviously, you know, a variable rate mortgage, 3-5 years. We have a fixed payment that results in negative amortization. And that's why the reset of the negative amortization every 3-5 years results in what Darko, you're referring to as the payment pickup. You're beginning to see that payment hike in the renewal. We've seen about 20%-25% depending on a fixed rate or a variable rate because both of them are going through the higher rate environment. The anecdotal data, which I've talked about, we've had about CAD 18 billion-CAD 19 billion of resets in the last 4 or 5 quarters. And the payment performance at the higher rate is much better than those that are still continuing.
And again, it's a low delinquency portfolio, but it's I'm just giving you a sense that there is something about the Canadian consumer and the Canadian mortgage that has a very tight correlation of good payment performance. You're seeing now on the other side choices being made by Canadian consumers on cards. So we get daily data on card spend. We know exactly where money's being spent. And you can see discretionary items, D&E, travel, AFF come down, grocery go up. You'll see a little bit uptake in the revolve rate, right? People are revolving a bit more to take cash, pay the mortgages. So while delinquencies have moved up a bit, I'm not concerned, really because some of it's administrative. And even in the NegAm book, we've got now digital tools that are more friction-free for consumers.
So almost 50% of our variable rate NegAm book has taken some action. Our NegAm book was, you know, larger in size. And I think almost $17 billion reduction in the total NegAm came in the last one or two quarters alone by just people taking action and either topping up payments, resetting the payments. So it's a huge positive. The last one I'll make is there's still extra cash in consumers' accounts from COVID. It's come down. It's still extra cash. FICO scores remain high, 790, 795. Even on the way down, and we stress test this all the time, even if there's inflation in FICO by a few points, it takes time to catch up. Even at the lower FICO, it's still a very healthy book. But the best part is there is equity in the houses. The LTV is about 50-55.
You can stress test at 5%, 10%, 15%. You saw the data today or yesterday. Vancouver's up. Toronto's up in HPI. So even though our HPI base case thinks there might be a slight decline, there is enough equity. And so the value or your net wealth is invested in your house. It's the last thing you want to walk away from. And there's no substitute. There's no housing available for folks. So folks are really embedded into that housing, as their asset class, putting more money in. And I think the rate cycle is going to be now the big driver of seeing some of that softness, you know, come down. And it'll take some time. Even if rate cycles came down, the transmission will take some time. So, so that's why I feel very good about our Canadian mortgage portfolio.
We've, you know, stress tested it in many different ways. We've looked at international markets to see what's happened there. But there's something very unique and very precious about our Canadian mortgage market that seems to be doing very well.
Everybody's working.
Everybody's working. I think so. Look at unemployment, right? We just talked about unemployment before. Unemployment's been surprisingly low. Even though we think it'll go up, there are yet, you know, businesses looking for employees. I mean, there is still a shortage of employees, everywhere, both here in the U.S. especially, but even in Canada.
So with that discussion on the mortgage book, maybe we can talk a little bit more about the commercial side. So, BMO is known to be much more involved in the commercial side. And maybe we can get very specific because, you know, we've had some discussions during this conference about commercial real estate.
Yeah.
and you do have a portfolio of commercial real estate, some office, some in the U.S. Maybe you can walk us through maybe you can size it for us. And recently, one of your peers basically said, you know what, we're substantially past the issues of commercial real estate. Can you say that today?
I think a risk officer should never say that. So I won't say we're past all the issues. What I'll tell you is, the number thing the number one rule for risk management really is concentration, right? As long as you stick to your limits and the culture of underwriting, which has stood the test of time, that's what's going to be the winning formula at the end. So for us at BMO, our total CRE we've said commercial real estate is about CAD 65 billion-CAD 70 billion. It's about 10% of our total lending book. So that's a good lower number to be. I don't feel we are overly concentrated. But then commercial real estate, as many of you know, is not one asset class. It's a combination of multiple asset classes. So I'll take office. Office is about CAD 7 billion.
So that's another 1% of the total book for lending, 14% of CRE. I'll break office up then into suburban, urban, medical facilities. Medical facilities you can't get enough of. There's more demand right now. And there's actually more transactions happening there. So doctors' offices and medical facilities are full up. And so in these, what we've done is we've looked at each of our large properties and re-underwritten them in the last 18 months. And when we re-underwrite them, there's a parallel team that stress tests the hell out of them by saying, what happens if vacancy rates go down another 30%-40%? What happens if cap rates move? What happens if interest rates move? And so we've already identified in this CAD 7 billion cohort minus, medical minus some of the suburban to see where are the challenges.
I'll tell you, I can count those properties that we've been watching on my fingers in terms of where we see potential stress. Now, through the last six quarters, you may not have noticed, but we've taken very minute size losses already in some of those through that stress mechanism in the impairment. But we've also reserved in our performing provision, for those areas where we feel there could be potential stress. So I feel pretty good looking back at all of the actions we've done. So if our allowance coverage today of 55 basis points for the entire book, I would say for CRE, we are over 2x. For office, there are probably a couple of, you know, multiples of that provisioned already for office. And so I don't expect any surprises. We're working our workout team and our bankers are working with some of the borrowers.
We're working. These are relationships that are not a one-off relationship, 30, 40 years. So from that perspective, I feel like it's a very small contained problem if it is. And we're not in areas that are, you know, hurting. I mean, even though we've got a portfolio from Bank of the West, San Francisco has been in the news, it's not the city alone that matters. It's the type of property you're in. And we've seen two Class A properties in the same city can behave very differently. Forget if you're a Class B or a Class C. And I think those are the things that we're saying. So are we out of the woods? Is the industry out of the woods? No, there's more to come.
But now, in addition to that, you're seeing a revival of interest from players who are saying, I think values have been beaten up. I'm ready to get back in the market. You're getting interest from private equity. You're getting interest from buyers who think that there's a steady IRR in this. And, you know, work habits are changing. People are coming back to office. So I think that's a positive playing out. So I think to the end of 2024, you should see much more of this even out. And we'll find a new equilibrium where we are.
Multifamily has made a little bit of noise recently. I mean, we can talk a little bit about it.
Yeah. Well, I, you know, the multifamily we love multifamily. It's, I think, about a third of our total CRE book. I want to say over 2/3 or at least over half is investment grade. You know, we're sitting here in New York. I'll tell you, we don't have this is a place where rent control was a big deal that played out for some of our peers. We're not in any of those. So we began looking at our multifamily. More than half is in Canada. Canada, as you know, vacancy rates are very low. So there's no challenges that we're seeing in Canada. In the U.S., there's probably a little bit of oversupply, overbuild in the Southeast.
But, you know, we've gone through and looked at any names that have a lower debt service coverage, any names that are large in size, any names that have geographic concentration, any names that have rent control attached to them. None of that has filtered up right now as something as a problem. We'll continue to review them. If more is needed to be done, we'll do it. But at the moment, I can tell you that I don't see any concern in our portfolio that's imminent around multifamily. It's the rent control areas. Those are very, very limited in our portfolio.
Is it a situation where, the maybe it's different from the commercial, like the office space in terms of reserves? Are you as adequately reserved there as you would be for the office space portfolio?
So because we haven't seen any problems at all in multifamily, CRI overall is 2x. So you've got already higher coverage for multifamily built in. And office has, as I said, significant more coverage built in. So, so if it's needed, we'll take the actions. But I don't see, multifamily getting into the same kinds of news items or trouble, barring some pockets. And again, like I said, New York, because the rent control was in the news, we, we don't have an exposure to New York.
Okay. I'm going to pause here and see if there's any other follow-up questions on that line of questioning or any other question for viewers before I continue with my questions. If you have a question, please raise your hand. If not, okay, with the question out of the way, one thing that's sort of interesting to me is when you closed the Bank of the West transaction, it brought more consumer.
Yep.
More consumer in California. So maybe you can just talk about that dynamic, what that that's. I mean, obviously, we just saw the whole influx of data come in and hit the performing. But other than that, I think I'm wondering just how that changes, if at all, how you view and growth prospects and in general, how you view that. I mean, I guess you're not really tracking any differences anymore. And you kind of run the bank north-south, right?
Yes.
So, but curious to see what you can tell me on that.
Sure. So I think, so number one, overarching strategically, if you think about it, California is one of the largest economies in the U.S. or in the world now, gave us a footprint that, you know, we were missing. And now it's part of the BMO, angle. So we're very excited. You can't have strong U.S. GDP growth. We didn't have strong California growth, right? So there's an embedded, setup there. And so both our consumer and commercial footprint now at, in California has been, very impressive. You've heard Darryl and Tayfun talk about expense synergies. We are probably ahead of that and, you know, the PPPT that we will get. From a portfolio perspective, we've been very pleased. I think, it's exactly in line with our U.S., BMO U.S. footprint. The important aspect of any of these acquisitions, it comes down to our the people and the culture.
The people in the culture and I was last week in California with our legacy Bank of the West, now BMO team. There's a huge amount of excitement. I mean, I think you're seeing both on the revenue side, higher productivity, but just on a portfolio management side, the integration that's been pretty world-class. So I can tell you sitting up in Toronto or wherever else, what we are doing in California on any given day. We inherited a very good RV book. That business continues. Even though we did a transaction, we are top three. And we plan to be top three in our originations coming in right now through the door of very high quality. So overall, I'm very pleased with the performance of the book that we've inherited.
We are growing it now similar to what we are growing anywhere else in the U.S., similar to what we are seeing in Canada. But the U.S., you know, growth is a little different, better growth right now than Canada. So having Bank of the West with us is actually a helpful feature because, you know, we're now embedded into the California growth. The portfolios are doing pretty well.
You mentioned the RV portfolio sale. It's also something else you did though. I'm just curious, you know, as a CRO, when you put the indirect auto into runoff, for example, we saw some losses in the quarter. I think now you're booking them into corporate. How should we think about that progression from here now that it's in runoff?
I thought it was a very good proactive action on our part because one of the things we've always wanted to do is to be cross-selling to other consumers or customers. I think indirect auto, as you'll see, benefited during COVID. And so a little bit of that benefit of COVID with when there were cars in short supply and people going into, you know, buying anything you could during that time, is playing out now. And so as an industry, autos is seeing delinquencies increase, especially on the second-hand. It's been a good business, but not core to what we want to do with our capital allocation. So we've taken some of those losses through the corporate section. I don't think that's going to continue for a long period of time. The book is becoming smaller. Things will get paid off.
Any book in liquidation will see a little bit higher losses. But as a percentage of the overall BMO, I think it's a rounding error. So I wouldn't worry about the indirect auto from that perspective. We obviously continue to report on that. We manage that because the book is still ours, but yeah, everything else is, you know, tracking to what, you know, our risk appetite has been.
So then maybe just, we've only got a few minutes left here. So maybe just dive into, you know, the risk transfers that have been pretty topical, got a lot of airtime in the conference call. Maybe you can just give us an overview of how you are involved in these transactions and the benefit, and, you know, BMO seems to say that we do these transactions so we can grow, right? Is there a limit to how many of these transactions are? Are we reaching that limit? Maybe you can talk a little bit about how we should think about this going forward. Should we see less of this activity or more or about the same?
Yeah. So if you go back in time and how we began, this is not new to BMO. BMO has been doing this for many years. It ramped up. And it ramped up really because of, you know, getting ready for a very large acquisition. But it doesn't only have capital ramifications. It's also a risk management trade that helps, significantly. So when you think about loans on the book, we don't tell our bankers what loan is going to get, put into an SRT, a significant risk transfer. We book to originate and hold the loans. And the quality, therefore, is never diluted because something might be in an SRT. So that's a very important principle. The second piece is then there are various risk mitigation activities available to us.
Standing through our investor lens, was a very attractive mutual, I'd say, meeting of the minds where they came in and we put things into the risk transfer bucket. They are both capital enhancing. So the RWA benefit that you get can be significant. The provision benefit that you can get from SRTs can be significant. And in fact, last quarter, we actually had a benefit even without impairment. For some names that are in impairment, you basically get full protection for those names. I just want to tell you, there isn't any even counterparty risk as we think about counterparty because these are all cash escrowed pretty much. So it's very positive. So we've got a decent size in the risk transfers. We still manage the portfolio. We still run the client relationship.
And if anything, over time, you'll see that the capital velocity of the release of what we get is more ROE enhancing than a book and hold. So I can give you the same amount of loan a couple of times over and make more fees with the same client than the limitation that I can't lend more because of capital. So I can manage concentrations. I can manage industry limits. I can manage single quarters, 12 quarters. You'll actually see the benefit of SRTs as a very positive trade. And that's why you're seeing our peers get on the same thing, right? So they're all seeing the benefit of what an SRT can do. You still own the relationship. You're never not, you know, passing over the relationship. You're keeping the relationship. You're keeping the fee opportunity. And you're able to lend much more.
Your activity levels, you think, will be more or less constant or?
Yeah. At the moment, I mean, there's always investor interest. It's a function of liquidity. We're always looking at some. We did a small transaction in Q1, but it's not big on the agenda because we have a very healthy capital ratio. And, you know, we don't need to do anything right now unless a situation comes up where, you know, it's beneficial for the bank overall.
Okay. On that, I think we've run out of time. I see some flashing numbers at me here. So Piyush, thank you very much for the, for the opportunity.
Darko, thanks for having me.
Thank you very much. Cheers.