.png)
Update: BMO + Bank of the West = ?
- Jun 17, 2024
- 6 min read
Updated: Jul 10
June 18, 2024 | A couple of readers have asked us to look at Bank of Montreal (BMO) since they closed the acquisition of Bank of the West from BNP Paribas (BNP) in Q1 2023. BMO ranked 52nd in the WGA Bank Top 100 in Q2 2024. As the financials slowly give up ground from the May 2024 highs, the WGA Bank Top 25 is still up 8.5% YTD through yesterday's close vs 5% for Invesco KBW Bank ETF (KBWB).
Before we delve into the mess at BMO, however, we wanted to highlight two discussions of note from last week. The first was a conversation with Bill Bymel of First Lien Capital. We were joined by Ocwen Financial founder Bill Erbey and Bill Moreland from BankRegData to talk about the outlook for credit in the mortgage industry. That’s right, three guys named Bill and Chris.
*** To Our Readers ***
We have discontinued the monthly Premium Plan to The Institutional Risk Analyst.
Subscribers who wish to migrate to a new annual plan at the equivalent
subscription rate, please contact us: info@rcwhalen.com
Note that during the discussion, Moreland talks about the burgeoning commercial real estate (CRE) exposure at Bank of America (BAC) and Wells Fargo (WFC), CRE is not a small bank problem. Neither one of these banks is adequately reserved compared with their peers, meaning that more of future income will be put aside to cover losses. The black line in the chart below is the Peer Group 1 average of loss provisions vs loans. BAC is in red.
BAC vs Peers | Q1 2024
Source: FDIC/BankRegData
Second, we joined Yahoo Finance later in the week to talk about the banking sector and where to deploy capital. Of note, we sold our common equity stakes in Wells Fargo (WFC) and U.S. Bancorp (USB) on the premise that we’ll be able to re-enter these names after the storm blows over in commercial real estate. Below we spoke with Zacks Investment Management Client Portfolio Manager Brian Mulberry and Josh Lypton on Market Domination.
Of note, Bank OZK (OZK) and Related Fund Management just inked $668 million in construction financing for the planned Waldorf Astoria Hotel & Residences in downtown Miami, reports The Real Deal, marking the largest ever condo construction loan in Florida.
Note please media peeps that this is construction finance, not a commercial mortgage. No matter what the fundamentals may say about a given bank, the financial media are going to paint this sector with a very broad brush. Control your natural disappointment.
A considerable dichotomy persists between the 100% loss severity rates in the commercial sector and the very low loss rates in residential mortgages, basically zero for bank-owned loans due to high home prices. Will this continue in Q2 2024? Yes and this situation will persist until home prices begin to weaken.
Just because home price inflation due to the Fed is keeping visible credit costs low for 1-4s, consumers are being kicked around pretty badly today. More than 80% of residential mortgage payoffs are sales today vs 80% refinance in 2021. A tough economy is forcing Americans to sell their homes.
Bank of Montreal + Bank of the West = ?
BMO is a $1.3 trillion total asset Canadian bank that has expanded in the US over the past three decades. Acquisitions include the wreckage of Suburban Bancorp in 1994, Marshall & Ilsley in 2011, and Bank of the West in 2023. BMO purchased Bank of the West from BNP Paribas (BNP) and thereby increased US assets to over $290 billion.
Bank of the West performed at or below peer over the past five years, with net income vs average assets in the bottom decile of Peer Group 2. By acquiring Bank of the West, BMO has essentially bought a mistake from another foreign bank that unsuccessfully attempted to expand in the US. Foreign banks have attempted to gain a foothold in the regional banking market for much of the past half century and with decidedly mixed results.
Bank of the West had high personnel costs and modest equity returns. In Q1 2023, BMO paid $16 billion for a bank with about $10 billion in book equity and just $5 billion in tangible capital. You can view the Q1 2024 Bank Holding Company Performance Report for the US business of BMO below:
The most successful foreign bank business models have been focused on institutional markets and securities, such as BNP’s NY operations or Barclays Capital. Most recently, Banco Santander (STD), the largest retail bank in the Eurozone, has focused on auto loans and other securitization markets. The truth of the matter is that none of the foreign banks operating in the US over the past fifty years have particularly profitable operations. The competition from incumbent US regionals and money center banks is simply too intense to surmount.
How does BMO Financial look on the hot-off-the server report from the FFIEC? Net income just below 1% ROA was in the middle of the pack, operating expenses are in the bottom third of Peer Group 1 and net credit losses are elevated. The bank’s efficiency ratio is well-below peer, a good sign, and the gross spread on the loan book is in the middle of the pack. The bank’s cost per employee is one-third that of SoFi Technology (SOFI) and the $15m in assets per employee also earns a thumbs up.
Delinquency on the loan book is high and rising relative to peers, which is really the big concern. The BMO franchise in the US has never been particularly good at credit, at least looking at the metrics from the FFIEC, but the bank is clearly a large institution for US regulatory purposes.
But here’s the real problem, if you subtract the $45 billion in other assets and goodwill from the $34 billion in book equity, then BMO Financial Corp in Chicago, IL, is insolvent. BMO reports $19 billion in intangibles for BMO Financial but "other assets" is 16% of total assets and 2x the average for Peer Group 1. Restructured and Nonaccrual Loans and Leases + OREO in Q1 2024 was more than 100% of loss reserves, meaning that BMO faces some rough sailing ahead.
BMO Financial Corp | Q1 2024
Source: FDIC/BankRegData
Given that BMO has eliminated the Bank of the West brand, why hasn’t the bank written off the related goodwill? Good question. But the real question we have is why the Federal Reserve Board allows banks to purchase layer upon layer of old, intangible equity without any adjustment to reflect the clear diminution of value. The tangible book value of parent BMO is just over $50 billion vs $1.2 trillion in assets, illustrating the extreme leverage of the group. Why does the Fed even allow BMO to buy US banks with such weak capital?
"Bank of Montreal missed analysts’ estimates after setting aside more money than expected for potential credit losses as consumers and businesses struggle with higher interest rates," Bloomberg reported. "The Toronto-based lender earned C$2.59 a share on an adjusted basis in the fiscal second quarter... falling short of the C$2.77 average estimate of analysts in a Bloomberg survey."
Bottom line: Look for more disappointments from BMO through 2024 as credit losses climb faster than earnings. BMO arguably has the weakest reserve position among the large Canadian banks, writes Paul Gulberg of Bloomberg. "Credit is weakest in commercial real estate and larger idiosyncratic US credits, and more provisioning or charge-offs may be needed." Ditto.
The Institutional Risk Analyst (ISSN 2692-1812) is published by Whalen Global Advisors LLC and is provided for general informational purposes only and is not intended for trading purposes or financial advice. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The Institutional Risk Analyst. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The Institutional Risk Analyst are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The Institutional Risk Analyst represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The Institutional Risk Analyst is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The Institutional Risk Analyst is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The Institutional Risk Analyst. Interested parties are advised to contact Whalen Global Advisors LLC for more information.