Earnings Call Transcript
BANK OF MONTREAL /CAN/ (BMO)
Earnings Call Transcript - BMO Q3 2022
Operator, Operator
All participants please standby, your meeting is about to begin. Please be advised that this conference call is being recorded. Good morning, and welcome to BMO Financial Group's Q3 2022 Earnings Release and Conference Call for August 30, 2022. Your host for today is Christine Viau. Please go ahead.
Christine Viau, Host
Thank you, and good morning. We will begin today's call 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 Barclay from BMO Capital Markets; and Deland Kamanga from BMO Wealth Management. As noted on slide 2, forward-looking statements made during this call 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 adjusted basis and considers both 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.
Darryl White, CEO
Thank you, Christine, and good morning, everyone. Our performance this quarter continues to demonstrate the strength and quality of our advantaged and diversified business mix, credit excellence, and the resilience of our earnings power. Third quarter adjusted earnings per share were $3.09, driven by a very strong performance in our North American P&C businesses. Robust loan growth and margin expansion drove record revenue and over 15% pre-provision pretax earnings growth in both Canadian and U.S. P&C more than offsetting lower revenue in capital markets, which was impacted by more challenging market conditions. While the economic environment remains uncertain, there are signs that Central Bank action aimed at taming inflation are having an effect. While economic activity is moderating, low unemployment and still high consumer and business savings are likely to provide some buffer to the downturn. In the context of slower growth for the Canadian and U.S. economies, we at BMO are operating from a position of strength. Credit remains benign with strong reserves for loan losses, to which we added modestly this quarter. Our consistent PPPT performance positions us to support customers while delivering growth through the cycle. For the year-to-date, PPPT of $9.1 billion is up 7% with 1.5% operating leverage and an efficiency ratio of 55.4%. While operating leverage this quarter was impacted by underwriting markdowns due to changing market conditions and severance in capital markets, we continue to expect to deliver positive operating leverage for the year. Year-to-date, ROE was 16%, above our midterm target as we remain focused on driving improved returns and managing the bank for sustained growth. We're actively managing our capital position, balancing the dynamic environment to support client-driven balances and the pending acquisition of Bank of the West. We expect post-closing, our CET1 ratio to build comfortably above 11% during Q2 of 2023. We continue to make significant progress in building a high-performing digitally enabled future ready bank and believe that our relentless focus on employee engagement and customer loyalty is the key to the health of our organization and will deliver sustained advantage over time. Our highly engaged BMO team is activating our winning culture aligned to a One Client, One Bank approach, which has been a key contributor to resetting the bank's performance to a higher level. In a recent comprehensive, high-performance cultural employee survey, our results improved from the third to the first quartile, placing us among the world's best financial institutions. These results are a testament to our focus on a culture that creates conditions for sustained performance and differentiates us in attracting and retaining the best talent. Our commitment to providing our customers with exceptional experience and personalized advice in every interaction is now driving world-class client loyalty. This quarter, we received the highest customer satisfaction rating, ranking in the J.D. Power 2022 Canada Retail Banking Advice Satisfaction Study, reclaiming the top spot among Canada's largest banks. In addition, we were again recognized by World Finance Magazine as the best Commercial, Private, and Retail Bank in Canada. These recognitions reflect the investments we're making across our businesses with expanded teams and enhanced digital and marketing capabilities that are driving record new customer acquisition in our North American Personal and Business Banking businesses. We're introducing new products to help customers progress, including our Smart Money Account, which offers a low fee and no overdraft or NSF charges for our U.S. customers and in Canada, Same-day Grace, the newly launched mobile and online banking feature that proactively helps customers manage their cash balance and avoid missing payments. Our North American Commercial Banking businesses are delivering strong loan growth, up 16% in Canada and 15% in the U.S. Growth is broad-based and has been driven by the quality and reputation of our experienced bankers with deep local market and industry expertise who bring the full strength of BMO's capabilities and provide outstanding client service and quick execution. All of which is underpinned by a differentiated risk culture and a consistent risk appetite that has delivered strong credit quality over time. The result can be seen in the consistently strong performance of our P&C businesses, with peer-leading year-to-date PPPT growth of 15% in Canada and 11% in the U.S., fueling ongoing strategic investments and positive operating leverage. Investments in our high-return North American Wealth businesses delivered good underlying revenue growth despite market declines and a moderation of client trading activity, with growth in net new client assets, loans, and deposits. Last spring, we introduced a broad suite of free-to-trade ETFs together with enhanced investor education. A year later, this offering is driving strong new client acquisition and growing ETF assets on the platform. In our Asset Management business, we're expanding our Canadian franchise, adding more than 50 experienced investment professionals in key growth areas, including our global equity team who focus on delivering higher returns for our clients. BMO Capital Markets results this quarter were impacted by market conditions and lower client activity. Our well-diversified businesses have delivered an average of over $630 million of PPPT over the last four quarters and remain positioned to build on the investments we've made to expand capabilities and grow client relationships. This quarter, we further advanced our leadership position in sustainability and our climate ambition to be our clients' lead partner in the transition to a net-zero world. The announced acquisition of Radicle Group will make BMO a leader in carbon credit development capabilities and the environmental commodity market. The advantage of our diverse business mix is also evident in the performance of our U.S. segment overall, which is consistently contributing in the range of 35% of the bank's earnings with a year-to-date ROE and efficiency that is in line with the bank overall. We remain strongly positioned for the addition of the Bank of the West. As we continue to grow the bank, our purpose-driven commitments to a thriving economy, a sustainable future, and an inclusive society remain our guiding principle. This quarter, BMO was once again named to Corporate Knights' ranking of Canada's 50 Best Corporate Citizens, ranked first among major Canadian banks. To conclude, our high-performing bank is well positioned for an evolving economic environment, with a proven track record of superior risk management, strong capital and liquidity, engaged employees, and loyal customers. We continue to strategically invest for growth to deliver long-term returns for our shareholders and enable progress for the communities we serve, including preparing for the closing and integration of our acquisition of Bank of the West. I'll now turn it over to Tayfun.
Tayfun Tuzun, CFO
Thank you, Darryl. Good morning, and thank you for joining us. My comments will start on Slide 9. Third quarter reported EPS was $1.95, and net income was $1.4 billion. Adjusting items are shown on Slide 41 and include the impact of fair value management activities related to the acquisition of Bank of the West, which this quarter reduced net income by $694 million, due to changes in interest rates compared with the prior quarter end. The remainder of my comments will focus on adjusted results. On an adjusted basis, EPS was $3.09 and net income was $2.1 billion, down from $2.3 billion last year. Performance in our P&C businesses was very strong, with adjusted year-over-year pre-provision, pre-tax earnings growth of 15% in Canada and 16% in the U.S., as continued strong loan growth and margin expansion helped grow revenues at double digits. Revenue this quarter is a record in both businesses. Continued weaker microenvironment lowered results in capital markets, including the impact of severance costs and lower loan commitments made earlier in the year and higher PCLs. Early indications quarter-to-date are more constructive. Total PCL was $136 million, including a $32 million provision for performing loans compared with a total recovery of $70 million in the prior year. Pat will speak to these in his remarks. Moving to the balance sheet on Slide 10. Loan growth accelerated, up 14% year-over-year and 4% quarter-over-quarter. Business and government loans increased 17% from the prior year, with strong growth across all operating groups. Consumer balances were up 10%, reflecting diversified growth in the P&C businesses and in wealth. Average customer deposits increased 7% year-over-year. Looking ahead, we expect loan growth to continue in our P&C businesses, reflecting strong diversified pipelines. Turning to Slide 11. Net interest income was up 18% and up 22% on an ex-trading basis from last year, driven by strong balance growth and margin expansion. Net interest margin excluding trading was up 10 basis points from the prior quarter, primarily reflecting higher deposit margins in the P&C businesses. On a sequential basis, NIM was up six basis points in Canadian P&C and up 20 basis points in U.S. P&C, with wider deposit margins, partially offset by lower loan margins. Looking into the fourth quarter and next year, NIM in both our P&C businesses and at the all bank level is expected to continue to widen, given the rising rate environment. Moving to our interest rate sensitivity on slide 12. A 100 basis point rate shock is expected to benefit net interest income by $525 million over the next 12 months. To date, deposit betas have been slower than our expectations, but we expect them to move higher for future rate hikes. During the quarter, we incrementally added fixed rate investments, locking in higher term rates and reducing our exposure to lower rates in the future. Turning to slide 13. Noninterest revenue, net of CCPB, was 19% lower compared to the prior year and 16% on an ex-trading basis, primarily due to the impact of divestitures. In addition, higher card and deposit revenue was more than offset by lower revenue in Capital Markets and lower securities gains, reflecting the market environment. Lower revenue in Capital Markets includes $88 million of markdowns on prior loan underwriting commitments in the U.S., due to widening credit spreads. Moving to slide 14. Expenses were up 3% from the prior year. Lower variable compensation was partially offset by higher severance costs in our capital markets business. Targeted investments that are driving revenue growth, including sales force expansion and technology were partially offset by divestitures. Sequentially, expenses were up 3% due to higher technology spend, severance, and three more days in the quarter, partially offset by lower performance-based compensation. On a year-to-date basis and net of divestitures, performance-based compensation and severance, expenses are up 2.4%. This quarter, the two items in capital markets moved our operating leverage from being positive to negative 1.9%. Assuming constructive markets, we expect to move to positive operating leverage in Q4 and as Darryl said, delivered positive operating leverage also for the year. Moving to slide 15. Our capital position remains strong with a common equity Tier 1 ratio of 15.8%, down 20 basis points from the prior quarter. As shown on the slide, increases from internal capital generation and common shares issued under the DRIP were more than offset by growth in risk-weighted assets and a reduction in the benefit from fair value changes related to the Bank of the West acquisition due to changes in interest rates. As discussed previously, the incremental capital of 70 basis points generated by the fair value management actions is expected to be offset by higher goodwill on closing due to the impact of changes in interest rates since the announcement. Source currency risk-weighted assets were higher, reflecting strong growth in our commercial lending businesses. Moving to the operating groups and starting on slide 16. Canadian P&C delivered net income of $965 million, with strong pre-provision pretax earnings growth of 15%. Revenue was up 13% from the prior year. Net interest income increased 17%, reflecting strong balance growth and higher margins, while non-interest revenue increased 2%. Expenses were up 10% with continued investment in the business, including in the sales force and in technology. Average loans were up 12%, with 12% growth in residential mortgage lending and 16% in commercial loans. Deposits increased 9% year-over-year and 4% sequentially. Moving to U.S. P&C on slide 17. My comments here will speak to the U.S. dollar performance. Net income was $446 million, down 1% from the prior year due to a higher provision for credit losses on performing loans. Pre-provision pre-tax earnings growth was strong, up 16%. Revenue was up 12%, reflecting strong growth in net interest income, partially offset by lower non-interest revenue. Expenses increased 8% due to higher employee costs and technology investments. On the balance sheet, average loans were up 13% from the prior year, reflecting very strong commercial loan growth. Average deposits were stable year-over-year and declined 2% from last quarter, in line with our expectations. Moving to slide 18. Wealth Management net income was $325 million, down from $384 million last year. Traditional wealth net income was $264 million, with underlying revenue growth of 3% excluding the impact of divestitures, reflecting higher net interest income, partially offset by weaker global markets. Insurance net income was $61 million compared with $79 million in the prior year. Expenses were down 6%, mainly due to the impact of divestitures, partially offset by investments in the business. Turning to slide 19. BMO Capital Markets net income was $266 million compared to $559 million in the prior year, reflecting the impact of continued weakness in the market environment. Revenues in Global Markets declined mostly reflecting lower trading revenue and the impact of a decline in new debt and equity issuances. Similarly, underwriting and advisory revenue in investment and corporate banking was lower due to slow issuance activity. We also had markdowns on loan commitments that were made earlier in the year, which were partially offset by higher core banking revenue. Expenses were relatively flat as lower performance-based compensation was offset by severance and business development expenses. The environment so far this quarter is more constructive, and we expect results to show signs of normalization as we approach the end of our fiscal year. Turning now to slide 20. Corporate Services net income was $7 million compared to a net loss of $35 million in the prior year. To conclude, our overall results were strong, boosted by record year-to-date revenue growth in our P&C businesses. Recognizing the pause in revenue growth related to market-sensitive businesses, we continue to focus on managing our company dynamically to continue growing profitably. Our business and geographic diversification continues to be an advantage in maintaining strong performance levels. And with that, I will turn it over to Pat.
Pat Cronin, CRO
Thank you, Tayfun, and good morning, everyone. We were very pleased with our risk performance again this quarter, and key portfolio metrics remain strong. This strong performance reflects the combination of disciplined risk origination from prior periods and strong risk management discipline over time. Starting on slide 22. The total provision for credit losses was $136 million, or 10 basis points, up from $50 million or four basis points last quarter. Impaired provisions for the quarter were $104 million or eight basis points, down from impaired provisions of $120 million or 10 basis points in Q2. Similar to last quarter, the strong impaired loan performance is due to very low formations and delinquency rates. We are pleased with these results but do expect impaired provisions to return to more normal levels over time. Provision for credit losses on performing loans was $32 million this quarter, reflecting a deteriorating economic outlook relative to the prior quarter and strong portfolio growth. This was largely offset by positive credit migration this quarter as well as a reduction in the judgment we have been applying specific to COVID-related uncertainty. Given the strong credit profile of our current portfolio and our forecast for impaired losses, we remain comfortable that our $2.3 billion of performing loan allowances provides adequate provisioning against loan losses in the coming year. Turning to the impaired loan credit performance in the operating groups. Loss provisions remained low across all business segments again this quarter. In Canadian P&C, Personal and Business Banking impaired loan losses were $94 million, up from very low levels in Q2, but still well below pre-COVID levels. U.S. Personal and Business Banking had impaired loan losses of $1 million, flat relative to the prior quarter. Consistent with prior quarters, the strong credit performance across our Personal and Business Banking businesses was driven by continued low delinquency rates. Overall, we saw little indication of consumer stress in Q3 from interest rate changes or inflation. Our consumer segment credit quality remains very strong, with delinquency and insolvency rates still well below pre-COVID levels. With that said, for most RESL products, we do expect the recent interest rate changes to impact borrowers when they refinance or renew, which could ultimately lead to increased delinquency in PCL. We view that risk as modest for several reasons. First, 25% of our installment RESL book is insured; second, renewals are spread out over time, and only 10% of our uninsured installment RESL products are up for renewal in the next 12 months, giving borrowers time to adjust. Finally, we have a high credit quality borrower base with an average credit bureau score of $7.93 and an average LTV of 48%. In fact, less than 2% of our Canadian RESL book is to borrowers with a combination of a credit bureau score less than 680 and an LTV greater than 70%. As you can see on Slide 32, the riskier segment renewing over the next 12 months is nominal, given our portfolio quality. In our commercial and corporate businesses, we also saw very strong credit performance. In Canadian commercial, we reported impaired loan provisions of $10 million, slightly up from $7 million last quarter, but well below pre-COVID levels. In our U.S. commercial business, we had impaired loan provisions of $21 million, down from $34 million last quarter. Our Capital Markets business had excellent impaired loan credit performance this quarter with a net recovery of $22 million, driven by zero new formations this quarter and some modest recoveries. Overall, we saw a little indication of commercial or corporate borrower stress in Q3, and our wholesale credit quality remains very strong with impairment rates at 15-year lows this quarter and PCL rates well below pre-COVID levels. We continue to benefit from very strong geographic and sector diversification, as well as strong structural protections that have consistently driven peer-leading loss rates. We continue to see net positive risk rating migration in Q3, and the portfolio has now migrated to an average credit quality better than pre-pandemic. Our percentage of investment-grade rated borrowers now stands at 62%, more than 10 percentage points higher than what we saw in fiscal 2017, highlighting that more recent origination has been of a higher average credit quality, notwithstanding our very good loan growth in both Canada and the U.S. over that time period. On Slide 24, bank-wide impaired formations were low again this quarter at $341 million, leading to a gross impaired loan balance of $2 billion, or 36 basis points. Both formations and gross impaired loan rates continue to be well below pre-COVID levels. Despite market challenges and high levels of volatility, there was only one trading loss date this quarter, as you can see on Slide 26. The macroeconomic environment and geopolitical situation remain highly uncertain. Consequently, our performing allowances for the coming quarters will likely depend on how the economic outlook changes noting, however, that we do still have some COVID-related overlays in our overall balance. We remain comfortable even in the current uncertain environment that our performing loan provision is adequate relative to our expectations for impaired loan losses in the coming year. While we are pleased with our very low impaired losses this quarter, we do expect high inflation, rising interest rates, and other headwinds to result in higher impaired PCL in the coming year. Impaired PCL rates are expected to slowly move up to a level more in line with our pre-pandemic experience, which was in the range of high teens to low 20s in terms of basis points. Despite these headwinds, we are well positioned to manage current or emerging risks given the quality of our portfolio, adequate allowance, and strong risk management capabilities. I will now turn the call back to the operator for the question-and-answer portion of the call.
Operator, Operator
Thank you. We will now take questions from the telephone lines. Our first question is from John Aiken from Barclays. Please go ahead.
John Aiken, Analyst
Good morning. Dave, I wanted to discuss the U.S. deposits. Can you speak to what you saw in terms of customer behavior in the quarter? And what this leads you to believe in terms of growth moving forward?
Dave Casper, CRO
Good morning, John. I think actually, I would say, both in Canada and the U.S., the deposit profile matches exactly the way we modeled the deposits in this rate environment. In the U.S., we have seen a small decline quarter-over-quarter. We are not quite aggressive in terms of matching some of the competitors' rate offers. We have not moved, for example, our digital deposit offers to an active state yet. Therefore, the betas actually have been below where we have modeled them. We do expect the betas to go up with each additional rate increase. At one point, obviously, we will switch our digital offering on. But at this point, the slow outflow matches exactly the way we thought about how the deposits would behave. The margin expansion that you have seen, the 21 basis point margin expansion in the U.S., reflects that effect.
Operator, Operator
Thank you. Following question is from Ebrahim Poonawala from Bank of America. Please go ahead.
Ebrahim Poonawala, Analyst
Hi, good morning. I guess I just wanted to follow up. I heard you loud and clear in terms of the outlook for positive operating leverage in 4Q. But when we look beyond and we look at your year-to-date adjusted efficiency ratio of around 55.4%. Give us a sense of should we expect incrementally more improvement over the next year or two years in a backdrop that doesn't get materially better either for capital markets and just overall for the economy? And if so, what are the drivers that would lead that efficiency ratio from the 55.4% into the low 50s?
Darryl White, CEO
Hi, Ebrahim, it's Darryl. Maybe I'll try to help you with that. Thanks for the question. So as I think about the future and how we travel on our PPPT performance and our operating leverage, look, we'll fall short here of giving 2023 outlook. We do that at the end of the year, but I can give you some considerations as we look at our business planning. We think we've got a lot of good momentum in our businesses, both on the revenue and the cost side. You're right, we're at 55.4% year-to-date. That compares to a peer set that I think averages only 100 basis points lower than that. So on the one hand, I would say that number used to be several hundred basis points the gap and now it's pretty narrow. At the same time, it's a little higher than the average. I think we continue to have a little bit of opportunity there. As we build our plan as we go into 2023, we continue to think about operating leverage, and we do have levers that we can continue to push on. We'll update you more on that as we get into the beginning of 2023.
Ebrahim Poonawala, Analyst
Got it. If I can just quickly follow up in terms of Tayfun, on your comments on the margin. I guess one near term, is it possible that we see a similar level of expansion through consolidated in the segments in the fourth as we did in 3Q? And beyond that, as we think about the deposit pricing and some of the comments you made earlier. Give us a sense of does Bank of the West, when you look at their deposit betas, not very different from U.S. regional bank deposit betas last cycle? How does that inform your deposit strategy in the U.S. as you move towards deal close?
Tayfun Tuzun, CFO
Yes, our net interest margin performance remains very strong. In fact, it looks even better when considering how effectively we have protected against downside risks since the onset of the COVID situation. We anticipate margin expansion heading into next year, as I mentioned. I prefer not to provide quarterly updates since it largely depends on the timing and scale of rate increases. However, we do expect net interest margin growth next quarter and into the following year. Regarding Bank of the West, they have a robust core deposit portfolio, which typically supports margin maintenance depending on the rate cycle stage. Once we integrate that balance sheet and begin planning ahead, bolstered by our national digital deposit gathering initiative, I believe we will achieve an even better net interest margin profile compared to the strong levels we have today after acquiring Bank of the West.
Ebrahim Poonawala, Analyst
Got it. Thanks for taking my questions.
Operator, Operator
Thank you. The following question is from Doug Young from Desjardin Capital Markets. Please go ahead.
Doug Young, Analyst
Hi. Good morning. I wanted to start by asking about the book where you recorded a mark this quarter, specifically the leverage lending book. Can you provide any additional details on it, such as sector-wise information or other specifics? I would appreciate some insight or quantification regarding why you feel confident about these marks. It seems like you're optimistic and that things are improving as you progress through Q4. I'm just looking for a bit more detail on that.
Pat Cronin, CRO
Sure, Doug, it’s Pat Cronin. Thanks for the question. I will address two points. First, I'll discuss the loan book, which is quite different from the underwriting markdowns. The size of the loan book was disclosed in the annual report; it was slightly over $20 billion. This includes sub-investment-grade loans to companies backed by financial sponsors. You can apply the wholesale loan growth rates observed since that report to estimate the current portfolio. We categorize the portfolio into two segments: the first consists of highly secured loans such as asset-based lending, real estate secured loans, and some capital call loans, which we treat differently. The leverage lending limit we set excludes these because we consider them to have a different risk profile, supported by years of data on impaired loan rates and provision for credit losses. The majority of the loan book we restrict with our internal limit consists of traditional cash flow deals with those same financial sponsors, making up roughly 55% of the total. We are very comfortable with the entire book. Currently, the condition is strong despite what you may read about the broader environment. Our impaired loan rates continue to decrease and are about 100 basis points lower than a year ago. The provision for credit losses has been minimal; while we don’t share details of this segment's PCL, our overall wholesale PCL this quarter indicates a nearly negligible amount from this segment. This portion represents just over 4% of our business and government loans, excluding some risk transferred to third parties. The portfolio is well diversified by sector and hold size, averaging less than $20 million per hold. We have observed strong performance from our sponsor clients, including during stressed times, when they contribute additional capital. They currently have significant resources to draw from, and we anticipate they would respond similarly under stress. Now, regarding the underwriting book, these are positions we don’t plan to hold but intend to distribute to investors. This has been a solid business for us over time. In terms of fee revenue versus risk, I believe we are well compensated for the risks we undertake. However, in quarters like this, where market dislocation is severe, we aren't immune. At the end of the quarter, the underwriting book was valued at just over $4 billion. The markdowns we took were primarily in deals made before Russia's invasion of Ukraine, aligning with broader declines in the leverage lending market. Subsequent deals have been made with better terms, and we have not encountered valuation concerns from these. We regularly review these marks, ensuring a rigorous, independent valuation process at quarter-end, and we feel comfortable with the marks taken for Q3. Approximately 90% of the markdown was unrealized, and we have noted some modest improvement in the market in Q4. While I’m not predicting a recovery, at least we are seeing positive movement. If market opportunities for distribution arise, we will continue to reduce that book while also originating new deals under favorable terms that we feel good about. Hopefully, that addresses your question.
Doug Young, Analyst
Thank you for the detailed information. If I may ask one more question regarding corporate, it seems there were positive earnings in that area this quarter. I believe there was an earlier guidance suggesting a quarterly loss of $50 million to $75 million, but I could be mistaken. I would like to understand the factors influencing this, such as whether there were any impacts from fund transfer pricing, interest rate hedging gains, or any unusual events affecting corporate earnings.
Tayfun Tuzun, CFO
I think the corporate segment can fluctuate a bit. This quarter saw some favorable mark-to-market valuations in our CRA investments in the U.S., which positively influenced the results. In comparison to the last quarter, we included underwriting fees from our equity issuance in corporate last time. These two factors essentially affect the quarter-over-quarter numbers, but there is nothing particularly unique this quarter that would affect the results.
Operator, Operator
Thank you. The following question is from Scott Chan from Canaccord Genuity. Please go ahead.
Scott Chan, Analyst
Good morning. My question is for Darryl on Walter or Asset Management. You talked in the opening remarks having 50 investment people on the equity and fixed income team, and just wondering kind of the strategy there because obviously, it's a pretty big investment. Is there like internalized asset opportunities, or is it mostly opportunities to gather assets over the medium-term?
Darryl White, CEO
No, no, great question, Scott, and thank you. And you're actually right on both accounts. When we sold the EMEA business, that took away a lot of the expertise we had in managing a lot of international portfolios, growth portfolios. We took this opportunity to restack that. It allows us to internalize a bunch of mandates that we have and then also expand the mandates to our distribution within our branches. So really, it’s going to solve both issues for us.
Scott Chan, Analyst
Is the focus on all segments, like in particular, retail or institutional or both?
Darryl White, CEO
Actually, so it's going to allow us to do both. We have very good institutional capability with the EMEA team. With that gone, that reduced the amount that we could do, especially with international portfolios, equity and fixed income. So it's going to solve both retail and institutional for us.
Operator, Operator
Thank you. A following question is from Gabriel Dechaine from National Bank Financial. Please go ahead.
Gabriel Dechaine, Analyst
Hi there. I have a couple of questions. First, for Pat regarding credit. In analyzing the migration and the performing portfolio, I noticed that Stage 2 classified loans have increased by 18%, which is about $7 billion in loans. The performing provision has many moving parts, but I observed that the increase in pro forma sales went from approximately $26 million to $22 million this quarter. Could that number have potentially been higher? Secondly, I have a margin-related question focused on the U.S. business. Deposit margins are rising, which is driving the expansion in demand. However, I see that deposits are down 2% sequentially, remaining flat year-over-year, and appear weaker compared to some peers. I'm curious about the outlook for deposit growth. Are you noticing any commercial clients withdrawing money from investments, and how might this trend evolve in the coming quarters? If the deposit base changes, how much could that impact the net interest margin?
Pat Cronin, CRO
Hi Gabe, it's Pat. I'll address your first question. The audio quality wasn't great. But I believe you were inquiring about the increase in Stage 2 balances from one quarter to the next. The explanation is quite straightforward. This increase is primarily due to the decline in the economic outlook we use to determine the provision. As you're likely aware, this impacts staging. It's not really migration in the traditional sense because, as you may have seen, particularly in the regulatory capital supplement, the credit risk risk-weighted assets actually decreased this quarter, and we experienced actual positive risk rating migration in both consumer and wholesale. So, this is purely a result of the deteriorating economic outlook. Regarding the second part of your question, if you were wondering why this did not translate into a more significant increase in the provision, that's essentially…
Gabriel Dechaine, Analyst
Yeah.
Pat Cronin, CRO
Okay. That's really a function of the fact that, that economic deterioration would have all else being equal increased the size of the provision. But as I said in my prepared remarks, that was largely offset by a reduction in the overlays this quarter. As you can imagine, as we get farther out of COVID, some of those specific COVID related uncertainty overlays are starting to come down. That's why you didn't see the provision itself go up as much as you might have expected.
Tayfun Tuzun, CFO
On the question about net interest margin, Gabriel, if I understood your question correctly, in the U.S., deposit betas have been slower than anticipated. You mentioned the 2% decline, which we did expect. We continue to maintain our position and are not actively raising rates to attract more deposit growth, as we still have excess deposits in the U.S. The 20 basis point margin expansion was robust this quarter, but we should not expect that level of expansion every quarter for the next three to four quarters. That is unlikely to happen. However, we do expect some level of expansion moving forward, particularly in our Personal and Business Banking segment, which is benefiting more than our commercial sector. Regarding client behavior on deposits, Dave, would you like to share your insights from the client perspective?
Dave Casper, CRO
Sure. On the commercial side, we've had very modest decline, but very consistent with our peers on the commercial side. We had surge deposits. We maintain a large portion of those surge deposits larger than actually we thought, but our core deposits, which is really our bread and butter, where our clients are using us for their operating continues to grow, and we feel real good about that. So the loan-to-deposit ratios are still stronger today than they were pre-pandemic. So we feel very good and expect to be able to manage this quite well. I hope that helps.
Operator, Operator
Thank you. Following question is from Paul Holden from CIBC. Please go ahead.
Paul Holden, Analyst
Thank you. Good morning. A real quick one to start. Just to clarify, the loan markdowns. Was that purely mark-to-market or did include some realized losses as well?
Pat Cronin, CRO
Hi, Paul, it's Pat. About 90% is unrealized. These are rough numbers. Then about 10% unrealized – realized, excuse me.
Paul Holden, Analyst
Perfect. Thank you. And then I want to ask you a question on competitive dynamics in the commercial loan segment, both U.S. and Canada. We've heard some comments from Canadian competitors that the markets are awfully competitive right now and risk-adjusted margins are not particularly attractive in certain pockets. Some data points in the U.S. almost point to the opposite sort of conclusion that the banks are tightening up underwriting criteria in commercial loans. Just wondering, what your perspective is on both of those markets?
Dave Casper, CRO
This is Dave. I would say, for our business, both in Canada and the U.S., we see actually similar dynamics. Most of our clients, particularly the larger clients do business on both sides of the border, competing in similar industries. It is more competitive. And yet, if you go back over time, that's almost always said. From my perspective, and I go back a long way in time, I actually don't think it's much more competitive for us. We really – and you'll always hear this too. We never compete on price. You hear that all the time. The reality is, in our business, price is an important part, but the clients that we're actually attracting and maintaining are looking at who can do the best job for them, helping them grow over the long term. So yeah, price is important. But having a long-term perspective and being in the business as long as we have is actually more important. So is it competitive? Yeah. Is it more competitive in the U.S. or Canada? I actually don't think it is. I think we just particularly, I can't really talk about other banks. But for BMO, I actually see really strong continued momentum on new client acquisition for clients that are really looking for long-term supporters. So I wouldn't get overly exercised over what's happening today. I actually think the bank – our bank will do very well through the cycle and not substantially, certainly not change our risk appetite, but not change our risk reward to any extent as well. Hopefully, that helps. Might not be what you wanted to hear, but that's what's going on.
Paul Holden, Analyst
It does help. Thank you.
Operator, Operator
Thank you. Following question is from Meny Grauman from Scotiabank. Please go ahead.
Meny Grauman, Analyst
Hi. Good morning. Just two questions on the U.S. P&C business. Two aspects of the results that I was hoping to get a little bit more color on. One is the sequential decline in non-interest revenue. And the other one, if I look at expenses in U.S. dollars, up I think about 6% quarter-over-quarter. So I'm wondering if you could provide more detail on that expense jump. Is there anything unusual going on in the quarter in the U.S. P&C business from an expense point of view?
Dave Casper, CRO
This is Dave again. Let me address the expense question first. We experienced slightly higher expenses this quarter, but nothing out of the ordinary. When looking at the year overall, we continue to maintain positive operating leverage. I'm quite proud that our efficiency ratio has consistently been below 50 for the past several quarters, which is a strong performance. I expect positive operating leverage in the U.S. to continue moving forward. Regarding the NIR question, there are a few points to discuss. It's not overly complicated, but one key aspect is that our NIR decreased by approximately $14 million from the previous quarter. This decline is mainly due to a $14 million drop in what we refer to as lease revenue. To clarify, when clients purchase equipment, they can either buy it directly, in which case we provide a loan, resulting in all that revenue being classified as NII. Alternatively, if they choose to lease the equipment, that revenue is counted as NIR because they assume the risk of the residual value at the end. Over time, more of our clients have opted to purchase equipment rather than lease it, which shifts revenue from NIR to NII and accounts for a significant portion of the decline. Additionally, we had a record first quarter for syndication fees and M&A fees, but those have dropped a bit in the current market, as we anticipated. Lastly, while it may not be significant, we have eliminated all of our overdraft fees, which also contributes to the decline in earnings, and I believe this is the right decision for our business. I hope that clarifies things. Does that help?
Meny Grauman, Analyst
Yeah. That's good detail. Just on the overdraft, would you be able to size that in terms of the impact?
Dave Casper, CRO
This quarter, I think it's relatively modest. I couldn't give you the exact number, but we can get back to you with some further detail. But it's a portion of the NIR decline.
Operator, Operator
Thank you. Following question is from Mario Mendonca from TD Securities. Please go ahead.
Mario Mendonca, Analyst
Good morning. Tayfun, your comments about BMO being able to protect the margin on the way down, but still benefiting on the way up. That's an important one. Could you help me understand like breaking out the NIM, help me understand what's happening with asset yields over the last, say, the last couple of quarters relative to the positive cost and funding costs generally? Is there a way to break that out or do you provide that in your report to shareholders that I just haven't seen yet?
Tayfun Tuzun, CFO
Yeah. We can provide you with more details on that, Mario. In general, I think, there are two factors that typically are important to note. One is the mix change as we look into our loan portfolio. That helps, as well as spread changes. But I'm happy to follow that up with a more detailed discussion around both the commercial business as well as the retail business and give you directional comments on that.
Mario Mendonca, Analyst
Okay. Sort of a follow-up to there. I'd like to look at the margins in various parts like your domestic retail, U.S. retail and then everything else, which I'll just call non-retail. The margin there has been really strong. Can you talk a little bit about what's happening to the bank in the, say, the treasury function or just everything non-retail that's supporting the net interest income?
Tayfun Tuzun, CFO
Yes. Look, I mean, on the treasury side, as we shared with all of you in the past, our focus has been to manage our NIM to a stable direction. We have done an excellent job in protecting the NIM, and that has helped us maintain support as rates have moved up. At the same time, we also left room for more asset sensitivity. I think the strength of the deposit franchise, you mentioned the loan side and the asset side, has helped us tremendously in that sense. That comes true very much so in the U.S.; Canada has been more stable. In general, when I look at the composition of our loan portfolios in our P&C businesses, I believe that, to a certain extent, our smaller mortgage portfolio is helping us to also have a bit of an outperformance in the way the margin is behaving as well.
Mario Mendonca, Analyst
If I could just quickly follow up then. BMO is the only bank where the all-bank margin today is above where it was in Q1 2020. Every other bank would be slightly below to meaningfully below where it was in Q1 2020. Would I be correct in suggesting that this is really can be explained by the different loan composition, BMO's heavier commercial exposure? Is that a structural advantage part of the story?
Tayfun Tuzun, CFO
I actually think that period-to-period, our hedging strategy and our very close focus on maintaining stability in our NIM is a big factor in that. In addition to that, I think in general, our more commercial heavy exposure in our loan portfolio would also provide some help.
Darryl White, CEO
Mario, I'm going to add to that, it's Darryl. We talk about this a lot around here in terms of being margin managers as a core competency. The mix does matter. You're on to an important point. Whether it’s in the wealth business, capital markets business, or commercial business. When you think about them as high-touch relationship businesses, I mean we've been fond of reminding most of you that, for example, in our commercial business, 90% of our relationships are sole or lead relationships. Dave talked about how we manage those relationships over time. You heard earlier how we talk about managing deposits. I think the way we approach the relationship manager is a significant input to the question that you're asking.
Mario Mendonca, Analyst
Appreciate your help. Thank you.
Darryl White, CEO
We think it's an advantage.
Operator, Operator
Okay. We have time for one more. Thank you. Our following question is from Lemar Persaud from Cormark Securities. Please go ahead.
Lemar Persaud, Analyst
Thanks for taking my question. I appreciate the update on the status of the Bank of the West acquisition. I noticed you guys still think it's going to close by the end of the year. What are the greatest risks to that getting pushed out? Given the big move in interest rates from when the deal was announced today, how should we think about the impact on the accretion estimates? Thanks.
Darryl White, CEO
Sure, I'll address the first part, and then I’ll ask Tayfun to provide insights on the second. To be honest, there's not much more to add regarding the timing. When we announced the acquisition on December 20th, we estimated it would take about a year. Based on our current activities and observations, we maintain that outlook. We will keep you informed if anything changes, but for now, this is our position.
Tayfun Tuzun, CFO
In terms of the impact of the rates on accretion, I just want to remind you that the way we've hedged the exposure to higher rate mark and higher goodwill has basically neutralized the impact from the moment we closed the transaction. I would say the accretion estimates, with respect to rates is the same as we have assumed. Now, going forward, depending on the rate environment once we close the transaction, we may get more strength if interest rates continue to go up, bringing asset sensitivity to us. But at this point, our accretion estimates stay the same as we announced.
Lemar Persaud, Analyst
Okay. Thanks for that. Then for Pat, I think you mentioned, you saw some of those COVID-related overlays in PCL. Can you put some numbers around that? Can you help us think about what the performing PCL would have been if you didn't release some of those COVID overlays?
Pat Cronin, CRO
Sure. The two factors that would have otherwise contributed to a build, as I mentioned, were a deterioration in the macroeconomic variables and loan growth. Those two things together would have been roughly about $185 million. That was offset by positive credit migration and the reduction in the overlays. I probably don't want to get into the size of the overlay. I would tell you, going into COVID, we were pretty close to zero on that, plus or minus 5% of our total provision made up of judgment. That would have hit a high back in Q4 of 2021 as we came out of COVID, and it's been reducing for three quarters in a row now. We are heading into an environment. While it's uncertain, we expect our loss estimation models can understand the difficult recession. All I can tell you is, I would expect it to continue to come down, all else being equal, but I'm going to stop short of giving out specific numbers.
Lemar Persaud, Analyst
That’s fair. Appreciate the time. Thanks, guys.
Operator, Operator
Thank you. That's for the time we have for questions. I would now like to turn the meeting back over to Darryl White.
Darryl White, CEO
I'm just being advised that we do have time for one more question, if there is someone in the queue.
Operator, Operator
Certainly. We do have Darko Mihelic from RBC Capital Markets. Please go ahead.
Darko Mihelic, Analyst
Hey, thanks for squeezing me in. My main questions have been asked and answered, so I'm going to be very quick, especially in the interest of time. Just wanted to pin down on a couple of things though that I heard this morning. First, Tayfun, in your answer to the question regarding corporate, one thing you left out was the expected earnings per quarter if you can just give us a hand with that? And then on the question with respect to the marks that we're taking in capital markets. If I heard correctly, it sounds like the levered lending loan book was around $4 billion. Can you just confirm, when I look at those marks versus those indices that are out there, do your marks include fees accrued or not? Thank you.
Pat Cronin, CRO
Hi Darko, it's Pat. First, on the leverage lending loan book, the sizing I gave is for the loan book in particular. On that loan book, we only take provision for credit losses. The markdowns you’re talking about, the $88 million apply to the underwriting book. That's a very separate book, and that is where I sized that at just over $4 billion. Think of those as two very separate things. One takes PCL, and the other one takes mark-to-market losses that flow through Dan's business. I think that was your question or no. Did I answer it?
Darko Mihelic, Analyst
Sorry, I went on mute. Are there fees accrued in that mark or not?
Pat Cronin, CRO
The answer to that is yes. That's inclusive of fees.
Darko Mihelic, Analyst
Okay. Thanks. And then just over to Tayfun on the corporate.
Tayfun Tuzun, CFO
Yes. On the corporate side, Darko, this quarter clearly was a little bit of an aberration. We'll probably go back to the average of the prior two quarters in the near term, then we'll give you guidance for 2023 when we get to year-end.
Darko Mihelic, Analyst
Okay, great. Thanks very much for squeezing me in.
Operator, Operator
So, that's all the time we have for questions. Back to you Mr. White.
Darryl White, CEO
Thank you, operator, and I want to thank all of you for your questions. I hope you're not running off the call because before we close, I do want to take a moment to recognize Pat Cronin, who recently announced his intention to retire after nearly 30 years with BMO. Throughout his career, Pat has made a significant impact across our bank, including having expertly steered our COVID-19 response and our risk function through the complex credit and market environment and all of these calls that have defined the last few years. He's a trusted adviser, and he's one of the strongest bankers I have ever worked with. I look forward to introducing Piyush Agrawal, our incoming CRO, to you next quarter. I'm going to conclude with the key themes, as I always do. Credit performance remains strong. We have significant allowance coverage that enables us to protect and grow the bank. Overall results were fundamentally strong, with year-to-date PPPT growth of 14% in our P&C business taken as a whole. Expenses remain really well managed, particularly given the inflationary pressures, and we're committed to delivering positive operating leverage for the year. Lastly, we're going forward from a position of strength with our advantaged mix. We believe it's set to perform in any environment and deliver consistent financial performance. Thank you all for participating in the call, and we look forward to speaking to you again in December.
Operator, Operator
Thank you. The conference has now ended. Please disconnect your lines at this time, and we thank you for your participation.