Darryl White has been adamant from Day 1: Bank of Montreal has gigantic growth prospects in the United States. “I can’t emphasize enough the U.S. opportunity,” he declared at an investor conference in January, 2018, two months after he took over as chief executive officer.
At the time, it sounded a little like marketing shtick. BMO has run a sizable retail and commercial bank in the United States for decades. Of course the new CEO was going to talk it up.
But Mr. White had some serious housecleaning to do before he could get to growing. For years, the thing that went unsaid inside BMO’s halls was that its Midwest outfit was bloated and mostly treading water – particularly in its retail division. The operation was near and dear to former CEO Bill Downe’s heart, so it was a touchy subject.
Mr. White has been much less sentimental about it all, and the second he took over, he started stressing efficiency – that is, slashing costs. This effort, coupled with a rejigged U.S. strategy, has paid off. BMO’s efficiency ratio, a measure of expenses to revenues, is down sharply over the past four years.
True to his word, Mr. White is now expanding in the United States with the major acquisition of California-based Bank of the West. Yet the lender he’s buying is a bit of a fixer-upper, which means all the progress he just made is going to have to be replicated.
Like many mid-sized regional banks in the United States, Bank of the West is predominantly a commercial lender, and this sector has grown, yet its loan book has actually shrunk slightly over the past five years. Its size is also a limitation, because digital capabilities are crucial to winning business these days, as well as for streamlining back-office and regulatory functions. Mid-sized banks don’t have the scale to invest in technology the way mega lenders do.
Complicating matters, Bank of the West is currently owned by French banking giant BNP Paribas, and European banks have struggled for more than a decade. BNP’s share price is still down 35 per cent from its 2007 peak, and its travails have limited investments in its subsidiaries. Rather than shell out money, BNP is taking a $21-billion cheque from BMO and running, as ING Group did when it sold Tangerine to Bank of Nova Scotia in 2012, and Spain’s BBVA did when it sold its U.S. regional lender to PNC Financial last year.
Because Bank of the West wasn’t getting much attention, its efficiency ratio is currently 62 per cent – that is, non-interest expenses are 62 per cent of revenues, which is rather high. BMO’s, meanwhile, is now 55 per cent, down from 69 per cent when Mr. White took over.
To reduce it, BMO shifted its U.S strategy toward its commercial banking roots, where it had expertise, and stopped trying to be all things to all people in its retail division. The bank also revamped its digital offerings in the U.S. to make it much easier for new clients to join. In essence, the bank repositioned its retail operations to focus on growing deposits from digital clients across the country, not just the Midwest, and those deposits are now used as cheap funding for its commercial loans.
Replicating this success will be crucial, because Bank of the West didn’t come all that cheap – BMO is paying 1.5 times the book value, after adjusting for excess capital on the target’s balance sheet, versus roughly book value for Wisconsin-based Marshall & Ilsley in 2010. “Realizing on cost synergies is an important part of the equation,” CIBC World Markets analyst Paul Holden wrote in a note to clients, referring to the acquisition of Bank of the West.
BMO has a plan for this. When announcing the acquisition on Monday, executives stressed the ample cost savings – particularly for technology expenses, because the two banks use many of the same vendors. On a conference call, chief financial officer Tayfun Tuzun – who recently joined BMO from rival Midwest bank Fifth Third Bancorp – told investors he’s been involved in many mergers and acquisitions pitches. Of all these, the deal for Bank of the West “came across as a much more straightforward synergy analysis,” he said. “There is a significant overlap on the technology side.”
For now, BMO projects that the deal will boost its earnings per share by 10 per cent in 2024. But the truth is, whether BMO hits that target in 2024 or two years later isn’t all that crucial, so long as progress is continually made.
Toronto-Dominion Bank is proof of that. TD bought New Jersey-based Commerce Bancorp for US$8.5-billion in 2007, when bank valuations were extremely frothy, and 14 years later, TD’s U.S. division is delivering a return on equity of only 6.5 per cent, which is fairly weak. Yet investors haven’t punished its shares.
Why? There are many variables, but ultimately, investors and analysts like growth potential – and that is pretty constrained in Canada.
Expanding in the U.S. can certainly backfire – as it did with Royal Bank of Canada after it bought Centura Banks in 2001. But BMO’s track record over the past few years offers some hope that it can tidy up Bank of the West over time.
“We like this bold deployment of capital,” RBC Dominion Securities analyst Darko Mihelic wrote in a note to clients.
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