BMO’s U.S. expansion begins, with a focus on cost cutting and capitalizing on California’s hot economy

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The largest-ever purchase of a U.S. bank by a Canadian lender hit a few snags along the way. Bank of Montreal BMO-T had to drum up more money than planned, and the closing date was pushed into 2023 as regulatory hurdles weighed on the deal.

Despite the setbacks, chief executive Darryl White can finally focus on rejigging San Francisco-based Bank of the West now that the deal has closed. BMO completed its $17.1-billion purchase of the U.S. bank from BNP Paribas SA Wednesday, broadening its footprint beyond the U.S. Midwest by expanding into fast-growing California.

The takeover boosts BMO’s U.S. assets by more than 50 per cent, helping Mr. White cement his long-standing plan to grow the bank south of the border. But Bank of the West also requires housekeeping, and Canada’s third-largest lender will have to cut costs to make its new business more lucrative. Bank of the West’s efficiency ratio, a key metric of productivity that measures expenses as a percentage of revenues, has been relatively high at 68 per cent as of June.

BNP had not invested in the business leading up to its sale. Before BMO struck its deal, Bank of the West’s loan book had shrunk slightly over the preceding five years, and its return on equity was only 7 per cent. BMO’s equivalent return in the U.S. was 10 per cent.

Mr. White is optimistic, though, because adding such a large business gives BMO more scale in the U.S. – and scale matters in banking because it means more revenue can be derived from the same number of expenses.

BMO is doubling the size of its U.S. branch network to more than 1,000 locations and expects its U.S. arm will contribute almost half its total earnings, ballooning from about a third.

“One of the things that we were lacking was enough customers, and we were doing a good job of building that day by day, but here we can welcome 1.8 million customers in one shot,” Mr. White said in an interview. “When you roll it all up into the bigger picture for BMO, it’s pretty attractive.”

Most of the boost comes from Bank of the West’s focus on California, which accounts for 70 per cent of its deposits. The state’s economy is lucrative, with a gross domestic product of about US$3-trillion annually – Canada’s is roughly US$2-trillion – and Bank of the West is the eighth-largest bank in the state by deposits, with a 2.6-per-cent market share, according to data from the Federal Deposit Insurance Corporation. Royal Bank of Canada, meanwhile, has a 3.5-per-cent share after its acquisition of City National.

The acquisition also allows BMO to grow assets and keep pace with its larger rivals, which are doing the same. Toronto-Dominion Bank expects its US$13.4-billion takeover of Tennessee-based First Horizon Corp. to close in the first half of this year, and RBC recently signed a deal to acquire HSBC Bank Canada, the seventh-largest bank in the country by assets, for $13.5-billion.

Although slashing expenses is a tricky exercise, because doing so can starve a bank of the oxygen needed to grow, Mr. White has cut costs before without harming BMO’s ability to make money. Since taking on the top job in 2017, BMO’s efficiency ratio, after adjusting for certain items, has dropped to 57 per cent from 64 per cent, largely due to a revamped U.S. strategy and cost-cutting in the segment.

“It’s one of the factors that allowed us – a little over a year ago – to say that we’re ready for this,” Mr. White said.

At Bank of the West, BMO sees savings from technology costs, because the two banks use many of the same platforms. Mr. White added that BMO also plans on saving about $500-million in revenue “synergies,” which includes efforts such as streamlining similar products and services.

However, with U.S. regulators increasing scrutiny on bank mergers, and BMO had to push back its closing date while it made efforts to appease them. In November, the lender revealed a US$40-billion commitment to underserved communities, largely focused near Bank of the West’s operations in California, which included boosting credit services for low- and moderate-income households, small businesses and minority groups.

And while BMO hopes that cutting costs will make the deal accretive – that is, boosting its earnings per share – it has also faced headwinds on this front. Late last year the Office of the Superintendent of Financial Institutions, Canada’s banking regulator, raised the amount of money that banks must hold as an extra buffer to protect themselves during an economic downturn. BMO had to sell $3.35-billion in shares to boost its capital reserves to meet that requirement after it closed the Bank of the West deal.

The acquisition was expected to boost earnings per share by 10 per cent in 2024, but now that more shares are in the market, that figure has dropped to about 6 per cent, RBC analyst Darko Mihelic said in a note to clients in December.

The hope, however, is that BMO will also have ample opportunities to boost revenues, which will reduce some of the pressure on streamlining costs.

After decades of muted performance under BNP Paribas’s watch, Bank of the West should benefit from BMO’s experience south of the border, BofA Securities analyst Ebrahim Poonawala said in an interview. And that expertise can help deliver growth. “Now [Bank of the West] is moving toward a parent who is a lot more involved and engaged in the U.S. markets,” he said.