Good morning and welcome to BMO Financial Group’s Q1 2022 Earnings Release and Conference Call for March 1, 2022. Your host for today is Christine Viau. Please go ahead.

Thank you and good morning. We will begin the call today with remarks from Darryl White, BMO’s CEO; followed by Tayfun Tuzun, our Chief Financial Officer; and Pat Cronin, our Chief Risk Officer. Also present to take questions are Ernie Johannson from Canadian P&C; Dave Casper from U.S. P&C; Dan Barkley from BMO Capital Markets; and Deland Kamanga from BMO Wealth Management. As noted on Slide 2, forward-looking statements maybe 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 an 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 will turn the call over to Darryl.

Thank you, Christine and good morning everyone. Before I begin, I want to acknowledge the humanitarian crisis taking place in Ukraine. The news of Russia’s invasion of Ukraine and war in Europe impacts us all, but particularly the citizens of Ukraine, the citizens of Russia and Ukrainians around the world, including here in Canada. At BMO, we stand with our Ukrainian and Russian employees, customers and members of our community in this time of need. To help support global aid efforts, BMO has committed $200,000 to the Canadian Red Cross’ Ukrainian humanitarian crisis appeal and we are accepting donations on behalf of the Red Cross at BMO branches across Canada. Turning to our Q1 results. Today, we announced another quarter of very strong performance as we continue to build on our operating momentum to start the year. First quarter adjusted earnings per share of $3.89 were up 27% from last year with pre-provision pre-tax earnings of $3.3 billion, which increased 18%. Results were driven by strong performance in Canadian and U.S. P&C, including double-digit commercial loan growth on both sides of the border, continued strength in BMO Capital Markets as well as good underlying performance in wealth management. Our growth is underpinned by our consistent risk and underwriting practices and continued strong credit quality. We are executing well on our strategic plan and the targeted investments we are making across our businesses in sales capacity, in marketing and an award winning digital capabilities are contributing to our stronger revenue growth, up 12% this quarter. Expenses remain well managed, up 2%, excluding higher performance-driven compensation as we are reinvesting the savings from the exit of lower return businesses. At the same time, we delivered strong operating leverage of 4.8% and improved efficiency by 250 basis points over the last year to…

Thank you, Darryl. Good morning and thank you for joining us. My comments will start on Slide 12. First quarter reported EPS was $4.43 and net income was $2.9 billion. On an adjusted basis, EPS was $3.89 and net income was $2.6 billion, up from $2 billion last year, driven by record revenue of $7.1 billion, up 12%. Expenses increased 7%, impacted by higher performance-based compensation in line with strong revenue growth. The divestiture of our asset management business in EMEA and the U.S. this quarter and our private banking business in Hong Kong and Singapore last year reduced total bank revenue by approximately 2.5% and expenses by 4% with a nominal impact on net income. We have now delivered double-digit PPPT growth for five quarters in a row, with particularly strong performance in our P&C and Capital Markets businesses. Credit continues to be benign. This quarter, we had a recovery in the provision for credit losses of $99 million. Pat will speak to these in his remarks. Before getting into the details of the performance in the quarter, let me take a moment to go through the adjusting items related to the announced acquisition of Bank of the West on Slide 13. Under purchase accounting, the difference between the purchase price for Bank of the West and the fair value of its assets and liabilities at close is recorded as goodwill. Since goodwill is deducted from capital, changes in fair value, relative to the assumptions at announcement, will impact our capital ratios at close. The fair value of fixed rate loans, securities and deposits is largely dependent on interest rates. If rates rise, the fair value declines and goodwill increases. However, the fair value of floating rate assets and liabilities and non-maturity deposits are accounted for at par, providing…

Thank you, Tayfun, and good morning, everyone. We were pleased with our risk performance again this quarter, with many of our key risk metrics continuing at levels equal to or better than pre-pandemic. This strong performance reflects the combination of disciplined risk origination from prior periods, strong risk management discipline through time and a solid economic environment in the markets we serve. Starting on Slide 27. The total recovery of the provision for credit losses was $99 million or negative 8 basis points, down from a recovery of $126 million or negative 11 basis points last quarter. Impaired provisions for the quarter were $86 million or 7 basis points, flat compared to Q4 and remain well below pre-COVID levels. Similar to last quarter, strong impaired loan performance is due to low formations and delinquency rates. We are pleased with these results, but do expect impaired provisions to return to more normal levels over time. We recognized a release on the provision for performing loans of $185 million this quarter that reflected reduced uncertainty around future credit conditions and positive credit migration, partially offset by balance growth and slight changes in the economic outlook due to Omicron. Given the consensus for continued economic strength and our specific forecast for impaired losses in the year ahead, we remain comfortable that our $2.3 billion of performing loan allowances provides ample provisioning against loan losses in the coming year. Turning to the impaired loan credit performance in the operating groups. We saw unusually low loss provisions across most business segments. In Canadian P&C, Personal and Business Banking impaired loan losses were $79 million, flat relative to Q4. The U.S. Personal and Business Banking business had impaired loan losses of $4 million, down from $6 million in the prior quarter. This strong credit performance across…

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

Good morning.

Good morning, Ebrahim.

Tayfun just a question around your outlook for the margin for the back half, I think you mentioned it should gradually see expansion – modest expansion in the back half ‘22. Just talk to us, one, in terms of what you’re making in terms of rate hikes as we think about both the Canadian and the U.S. segment margins? And then when you think about the deposit franchise today, any differences that are meaningful today versus back in 2016 when rates were going up, that would lead you to have a lower deposit beta back compared back then ex Bank of the West, obviously?

Ebrahim, in terms of the rate outlook, the number of increases and the timing of increases we typically use market expectations. Obviously, they are a little bit different in the last couple of days based on the Ukrainian crisis. But up until last week, the market was expecting about four increases probably maybe depending upon today, both in the U.S. and in Canada, the last one probably at the very end of the year, which would make a big difference. So that was the underlying assumption. We always update that in our modeling. In terms of the different businesses, P&C businesses, a couple of items. If you were looking at individual NIMs, we need to keep in mind that in the U.S., we had a very strong PPP contribution last year. And given the fact that we’re down to about $0.5 billion in loans, this year, we will not have the same. So on a year-over-year basis, we will feel the impact of that. And against that, we have expanding loan spreads, both businesses in Canada and the U.S. have done a very good job in maintaining pricing discipline, as you can see in this quarter’s numbers. But given the fact that PPP is going to have a fairly large impact, I would expect in the U.S. somewhat of a down drift in NIM. And in Canada, again, we’ve done a great job in maintaining spreads. You may see some lower impact from mortgage prepayment rates. And then in both – on both sides, just remember, as loan growth is picking up and exceeding deposit growth, that by itself is going to have some negative impact on individual business NIMs, which, in turn, is actually a good thing from the consolidated perspective because we’re using existing cash to fund loan growth. So that will help consolidated NIM and that was the basis for our – in our forecast that it will be expanding through the second half of the year.

Got it. So the year-over-year decline, but we should see sequential expansion ex-PPP going from here?

If you’re talking about consolidated, yes, you should see year-over-year expanding them in the second half of the year.

Got it. And just one quick follow-up on capital markets, I know that Darryl, you’ve talked about structural changes at KGS-Alpha Clearpool, but PPPT extremely strong. Just if you don’t mind, remind us if this is how we should think about the run-rate or was this an unusually stronger quarter even relative to what we have seen over the last year?

Yes. Ebrahim, I’ll start, and I’ll actually have to end up typing on this question, because it’s an important one. The markets are and have been constructive. I think we performed relatively well as compared to peers even in those constructive markets. Your question on where do we go from here? I think what’s really important to remember is that this isn’t the business we had going into the pandemic. We have invested in it with some of the features that you just summarized. We’ve also focused the business more tightly, and we really do have a new expectation for the run rate going forward. Why don’t I ask Dan you to come in on the question more particularly?

Sure, thanks, Darryl. And as you said, Ebrahim, we’ve had great investments, and then it’s very rewarding to see that performance come. The performance over the last quarter and the last year has been very diversified across many of our businesses. Quarter-to-quarter, there is some variability, but what we’ve seen is just outstanding performance for most, if not all our businesses as we go. We’ve had the opportunity through the cycle to invest in technology and people new products, new clients. And so we’re reaping the benefit of that as we go. As I mentioned last quarter, we see guidance for PPPT as we look forward in the mid-600s, maybe even high 200s. As we go forward, those dynamics continue to play out as we go. We continue to invest. We continue to build our businesses. And so I’m looking in the long-term to continue to see positive growth and positive outlook on the business.

Thank you.

Thank you. Following question is from Scott Chan from Canaccord Genuity. Please go ahead.

Good morning. So you talked about like a lot of modernizing with tech projects. And I think you just talked about on the capital markets side. I was just wondering different update in terms of if you’re spending more on projects now versus pre-pandemic basically looking just for an outlook over the next 12 to 18 months on that front?

So Scott, this is Tayfun. As I mentioned, based on the results that we are seeing from our investments over the past four, five, six quarters, both in technology and in sales force, we will continue to invest. Technology investments have resulted both in helping us grow revenues and take market share as well as create efficiencies in our businesses, and the results are fairly self-evident and we will continue. Those expenses are built into my guidance of 1% to 1.5% expense growth year-over-year. .

Okay, thank you very much.

Sure.

Thank you. Following question is from Meny Grauman from Scotiabank. Please go ahead.

Hi, good morning. If I look in the Capital Markets segment, average loans down 0.5% quarter-over-quarter, that’s different than what we’re seeing across peers. And I’m wondering what’s driving that decline sequentially?

Go ahead, Tayfun.

Yes, I was just going to note that in that number, many, there are two items. One is the continued decline in our non-Canadian Energy portfolio. And the second one is the deconsolidation of the customer securitization program. That happened at the last day of the year last year, so therefore, the quarter-over-quarter comparisons will reflect both of them.

And if you ex those out, what would you say is that underlying sequential loan growth existing for those items?

For capital markets, I don’t have that right in front of me, but we will get back to you on that.

Yes. I actually have if you want Tayfun. It’s something roughly 5% quarter-over-quarter in our core loan growth.

Sounds good. And then maybe just more broadly on the subject of loan growth. I think there is a little bit of discussion last quarter. But if we look at commercial loan growth, what we’re seeing is very strong numbers. It doesn’t look like supply chain issues are having an impact on those numbers. So I’m wondering why we’re not seeing that come through? And are there specific portfolios still where if you dig in, you actually had that impact and I’m curious about that?

So Meny, this is Dave. The supply chain issues are real and they are still there. And despite those, we have had on both – in both Canada and the U.S., really strong loan growth. As Darryl mentioned in his comments, the loan growth in the U.S. this quarter was almost half related to new business. So that means we’re out continuing to grow. And throughout the pandemic, we’ve done that. And back to your question, our utilization in our core diversified businesses in the U.S. is still well below where it was pre-pandemic. So, had that utilization been at the same level as pre-pandemic, our loan growth would have been probably more 75% existing clients and 25% new. So, there is still untapped utilization that will come back. And it’s specifically in some of our businesses like our floor plan business for autos, our floor plan for trucks, our asset-based lending business, which continues to grow. But still is not where we would expect it to be when the supply chain issues subside, which, by the way, I don’t see necessarily happening in the next quarter or two quarters. I think this is still an area where we have issues. And despite that, we have had good loan growth. Hopefully, that helps and gives you a little more color.

Yes. I mean so you are saying – so there is still upside to loan – commercial loan growth in your view?

Yes. No, I believe there is as the supply chain issues work out. Now obviously, demand over time will have some impact, but there is definitely clearly in our auto business for one, there is still very few cars on the lot that we finance. And at some point, that supply/demand will reverse itself and there will be more there.

Thanks so much.

Thank you. The following question is from Paul Holden from CIBC. Please go ahead.

Thank you. Good morning. So, going back to the discussion on loan growth and this question applies to both commercial and retail. I think one of the common questions we are starting to hear is the potential impact from higher interest rates on loan demand. So it would be great to hear your thoughts there, again, both on commercial and retail in terms of how higher rates might impact the demand?

So, this is Dave. I will start and then Ernie will pick up. I would say it’s going to have some effect, but not a significant impact. For most of our clients, they hedge themselves on rate increases, whether it’s our real estate business, our diversified business. And the rate increases that we are forecasting we don’t think we will have a significant impact on loan demand in the near-term. So, Ernie?

Thanks, David. And if I think about the lending business and the retail side, I will start with mortgages. We still believe that there will be a strong mortgage market, particularly in Canada over the next little while, slightly lower than we have seen over the past year, but it’s certainly going to be a market that’s growing with immigration and some upside on some housing starts. So, we are prepared for that growth in terms of our investments we have made in our mortgage specialists, our sales teams to be able to capture our share of that growth as we continue forward. I think about unsecured lending, we are starting to see a little bit of rebound on that as consumers get back into the marketplace. And credit cards would be starting off with consumer spending there. We are seeing the retail spend come up. We will see the revolving balances take a little bit of time, but outstandings have been improving this year, for example, Canadian P&C. We are seeing about 9% year-over-year growth, and we will continue to see that change into revolving balances as some of the surplus deposits that get used up going forward, so overall, feeling confident that we will be in a growth position in lending on the retail side.

And then sort of related question, going back to something, another analyst asked earlier in the call just regarding deposit betas and I guess particularly in the U.S. Maybe you can give us some updated thoughts on how you are thinking about deposit retention and a rising rate environment and how much of that might had to disclosed NII sensitivities?

So, as I mentioned, we have changed our modeling assumptions with respect to net interest rate sensitivity. I used to tell this audience that our numbers, prior to this quarter, did not include any retention assumption about the surge deposits. But we knew that we were going to retain a portion of them. So, we now are actually including a portion of the deposits that we think we are going to retain. And therefore, our asset sensitivity has increased. In terms of betas, at the moment, I don’t think that necessarily we are thinking that betas in this cycle are going to be significantly different than the previous cycle. I have seen some assumptions that were disclosed by U.S. banks that indicate that they are expecting lower betas now. We have not made necessarily that particular adjustment. Our betas are based on products, and they reflect the sensitivities, whether it’s on the commercial side or the retail side of the deposits that we actually have the ability to model. I would say that the range of the beta assumptions, both, I would say, in Canada and in the U.S., are very appropriate, I would say, maybe a little bit on the conservative side. But I think, given the potential steepness of the rate increases, it is worth maintaining a relatively conservative approach here.

Got it. Thank you and I will leave it there.

Thank you. The following question is from Doug Young from Desjardin Capital Markets. Please go ahead.

Hi. Good morning. I think Tayfun, you mentioned in your remarks on NIMs that Canadian mortgage spreads was a positive to NIMs in Canada, which I think is a bit different than what we have heard from others. So, I am just hoping to get a clarification of that and just to get more detail in terms of what you are seeing from a loan yield perspective in the mortgage market in Canada?

Yes, Doug, it’s Ernie. I will take that question. As we look at our NIMs, we are seeing some very strong performance across the various elements in NIM. One of those is the prepayment of mortgages. And you think about it as Canadian consumers were looking at interest rates, taking an opportunity to be able to adjust their mortgage and taking advantage of that. That’s part of our growth, but there has also been some strong pricing capabilities across our lending business and also deposit growth as well in that NIM. As I think about that prepayment, that will come down over time just simply as rates level out and consumers have already made those choices. So, as we think about the P&C, NIM going forward, we will see a little bit of downward pressure, but anticipate as rates go up at the back end and have an impact on NIM, we might see a little bit of a downward and a little bit of an increase in the fourth quarter. That’s how we are thinking about our NIM.

Okay. So, that was more related to the prepayment. Have you disclosed what the prepayment might be in your disclosure, I apologize if it is, but have you disclosed what the prepayment impact was in the quarter?

I don’t believe we have.

Okay. And then second, just on the CET1 ratio. When I look at your capital supplement, it looked like the methodology and policy changes. There are some changes that happened on the AIRB side that was, I guess a negative impact and then there was some positive changes that happened from again a methodology and policy perspective on a standardized basis. Just hoping to get a little color as to – was that just related to the fair value adjustments or changes in the hedges related to the Bank of the West, or is there some methodology and policy updates that went through on the calculation this quarter?

Hi, it’s Pat. Maybe I will just jump in on that one. It’s really a function of a model approval for a chunk of the portfolio that was previously based on standardized, it relates to the M&I portfolio we acquired. So, that’s been unstandardized for a while. And during the quarter, we received approval to move that to AIRB. So, that’s why you see that movement.

And what was the net impact? I guess I could calculate that look at the net positive impact that, that had.

Sorry, in terms of the RWA?

On the CET1 ratio.

I would – it’s positive. I don’t have the number in front of me, but it was a mild positive.

And is there anything else that’s happening from standardized to AIRB? I don’t know, I forget what’s left, but is there anything else that could occur through the rest of this year that would be a positive impact or movement from standardized to AIRB?

Yes. There I mean we always are looking at our models. There is nothing in the pipeline at the moment, nothing imminent to the next quarter or so that I would put in the material category.

Okay, great. Thanks.

Thank you. Our following question is from Mario Mendonca from TD Securities. Please go ahead.

Good morning. If I could take you to your domestic retail segment, so, Canadian P&C, specifically the other income, I appreciate that we are seeing a lot of growth there year-over-year, and it’s been going on now for four straight quarters. And I think I understand that a lot of that just relates to how challenging it was last year in 2021, when we saw that come off. But it just seems to me like that growth is running well above what I would have expected. And again, I am referring to your non-interest revenue, non-interest income in domestic retail. Is there anything in there that’s outside your sort of normal fee income categories. What I am getting at is things like were there any real estate sales like the gains on which would be recorded in that line, or is this mostly just lending fees really kicking in? How would you describe the strong pace of growth?

Yes, it’s Ernie. I will take that question. So, as I look at the line, there is – so overall, if you look at P&C Canada’s revenue growth, really strong, mean they are in the neuro line, in particular, as you are referring to, we are looking at really broad-based growth across all the categories, if you think of the mutual funds, consumer activity fees are there. A big portion of this is the return of credit card spend into that number as well. And so it’s a very balanced growth. We obviously think that, that will come down a little bit over the next little while because it’s a year-over-year factor with the credit card growth. And seeing a more normalized as we go forward. And in that number, as you recall, there are investment gains in that number as well that we include, but again, it was a broad base this year – this quarter, I should say, mix all of those elements of just general good strong business performance.

And those investment gains, those are the ones that relate to co-investing with your accounts with your customers?

Yes. It’s Dave. That’s what those would be. And those are, I guess if you annualize it, they are modestly higher than they might have been last year, but this is a lumpy business. So, it’s nothing that’s outside of what we would expect.

Okay. So, when I look at growth in that line, it’s been like 21%, 28%, 26% this quarter, and these are all year-over-year. When the gains on co-investing with your accounts subside or return to normal, presumably, they will mean I guess what I am getting at is how much of those really added to that revenue line?

Well, I don’t have it right in front of me, but those go, as we said, they go up and down. it’s been a part of our business for the last 10 years. So, you have seen it over a long period of time. But as you – but to your point, I mean these are – oftentimes these are our fair market value gains. So, if the market would go down, you could have decline offset against when an investment is sold. But it’s really – it’s pretty hard to predict, but it’s not a core part of our business, but it’s an important part and it’s there to support the growth in our commercial business.

Hey Mario, they were about the same as last quarter. So, it’s really quarter-over-quarter, we didn’t see much of an increase relative to last year’s first quarter date, they were only up about $10 million.

Yes, they just have such a flattering effect on the domestic retail numbers. And we have seen this from other banks in the past when gains of this nature go away, it obviously doesn’t look that good. But I think it’s just – it would be helpful to understand how important these are. So, we are not surprised going forward.

Yes. I mean our total non-interest income, I think in Canadian P&C last year was $2.2 billion. This line item was just a little over $100 million.

Okay. Maybe one for Darryl, I found that very helpful on that slide where you show that the equity raise doesn’t change regardless of how the fair value changes unfold. That was helpful. But maybe going one step further is there a scenario where the equity raise could be materially lower than what you have contemplated or maybe even zero. Is that conceivable?

That’s a good question, Mario. Is it conceivable? Sure. The way – I am not predicting that, by the way, but I am answering your question. Is it conceivable, yes, I mean it’s conceivable what would have to be true for that to occur, for example, relative to what we have modeled, we end up with less organic RWA deployment into the marketplace and more fee generating income and/or Bank of the West does the same, and we end up in a position where our CET1 ratio takes care of itself, and we don’t need to top it up with the equity offering. The opposite could be true. We could go in the other direction, and we could need a little bit more. As we sit here today, we did that work both on the hedge as well as on our business as usual forecasting to give you the point of view that we have given you today, which is the assumptions we made a couple of months ago, we announced the transaction stand today. We don’t have an updated point of view because we checked our math and it still is the same. But the answer to your question, could it move is it conceivable, sure it is. But things would have to change relative to our outlook.

And do you have a timing outlook on the equity ratio?

Yes. No, look, we said at the time of the acquisition announcement that it was a year or so estimate to close. It’s less than 3% of our market cap. We have had investors express some interest and say to us that they are there when we are ready. So, we will just take it all into consideration, and we will pick the time that we think is best for our shareholders, Mario. I don’t have a better update than that at this point.

Thank you. Our last question is from Gabriel Dechaine from National Bank Financial. Please go ahead.

Hi. Good morning. Thanks for the rate sensitivity disclosure change there, but I have had a question about the surge deposits. Like have you ever – can you quantify that deposit base against which we are evaluating an additional benefit and like how do you define a surge deposit?

Typically, we define surge deposits as the net increase in the deposit base since the beginning of the COVID environment. And the change that we have made in our modeling really took only about maybe a third of those and moved it into the more non-rate sensitive category. So, it was not a big chunk of it.

Okay. So, the total increase since the pandemic started, that’s a third of that amount is considered surge?

No. Just remember, along the way, we have continued to make investment decisions. So, I am talking about basically what remains out of that. And it’s not a big number, Gabriel. It’s probably, I would say in the teens in terms of billions of dollars. So, it was not a huge number.

Alright. And just to clarify on the – this fair value and hedging kind of offset, you will see fluctuations in the core Tier 1 ratio. There is an important timing difference there. We should be aware of, I think anyway, that you will see fluctuations in the core Tier 1 ratio until you close when you have gains or losses on those swaps, but then the goodwill adjustment is the offset of that close, whether that’s up or down, like they move – that’s correct, right?

That is correct. The actions are designed to maintain the CET1 ratio at closing.

Okay. But it’s important for investors to know that you will not panic if rates go down and your core Tier 1 ratio goes down because there is an offset at the end of the line.

Yes, that’s precisely why the hedge is in place.

Got it. Okay. Alright. I got to go another call now.

Thank you.

Thank you. I would now like to turn the meeting back over to Mr. White. Go ahead.

Thank you, operator. I will be quick as I am respectful of the fact that you all have to go to another call. So, I will conclude with a very quick comment on the key themes. Number one, our results for the first quarter are very strong. In fact, they are pure leading ROE, EPS growth and operating leverage are all above our mid-term targets. Number two, we are strategically investing, as you have heard, to deliver growth and efficiency. Number three, our superior risk management and improving credit quality remains a differentiator and we believe it will continue to be. And number four, we have got strong momentum and an advantaged business mix that’s positioned for growth and performance in any environment. So with that, thank you all for participating in today’s call. We look forward to speaking to you again in May.

Thank you. The conference has now ended. Please disconnect your lines at this time and we thank you for your participation.