Bank of Montreal BMO-T shares slumped Wednesday after the bank raised its provisions for loans that are unlikely to be repaid, with the lender expecting pressure to continue as consumers and businesses wait for central banks to cut interest rates.
The ratio of impaired loans to the bank’s overall lending portfolio has exceeded the expectations BMO set last year, signalling rising risk in its consumer and business debt segments. Meanwhile, waning loan demand and higher costs to hold customer deposits dragged on second-quarter profit in the bank’s U.S. business, which added California-based Bank of the West last year.
Last year, the bank anticipated central banks in Canada and the United States would issue several rate cuts in 2024, but those hopes are waning. Economist expectations for rate cuts are easing as central banks work to tame inflation, and BMO’s outlook now includes a more tepid, drawn-out drop in borrowing costs.
“That then changes the psychology or the sentiment of the consumer,” chief risk officer Piyush Agrawal said during a conference call with analysts.
BMO reported higher second-quarter profit Wednesday but missed analysts’ estimates. Adjusted to exclude certain items, the bank said it earned $2.59 per share, falling below the $2.77 per share analysts expected, according to S&P Capital IQ.
The bank’s share price dropped 8.9 per cent Wednesday in Toronto, while the S&P/TSX Composite Bank Index edged lower by 2.5 per cent.
In the quarter, BMO set aside $705-million in provisions for loan losses – the funds banks set aside to cover loans that may default. That was higher than analysts anticipated, and included $658-million against loans that the bank believes may not be repaid, based on models that use economic forecasting to predict future losses.
In the same quarter last year, BMO set aside $1.02-billion in provisions.
Mr. Agrawal said that impaired loan provisions should remain elevated but stable in the near term as unemployment edges higher, homeowners grapple with ballooning mortgage payments and business insolvencies increase.
Impaired provisions were also driven higher by deterioration in larger loans in commercial real estate and transportation. As those sectors continue to struggle with higher interest rates and lower demand, BMO may need to set aside a few more sizable provisions.
Office vacancies have ticked up as people continue to work remotely or in hybrid settings, putting pressure on property valuations as borrowing costs have spiked. While BMO has seen stress rise in its office portfolio, the bank’s impaired provisions are lower than those of its peers in the U.S. market, according to Mr. Agrawal.
“We’ve looked at every large loan in the office space, which is where most of the stress has been in the U.S. market, and we only have a handful and we’ve been working with our borrowers,” Mr. Agrawal said. “In fact, over the last few quarters, several borrowers have refinanced several of the loans which we had on our watch list.”
It was “a tough quarter for BMO at first look with a sizable miss on credit losses and underwhelming results in U.S. lending overshadowing an otherwise roughly in-line quarter,” Keefe, Bruyette & Woods analyst Mike Rizvanovic said in a note to clients. “We expect BMO’s shares to underperform the peer group today.”
BMO is the third major Canadian bank to report earnings for the second quarter. National Bank of Canada also released earnings Wednesday, topping expectations.
Toronto-Dominion Bank and Bank of Nova Scotia posted second-quarter results that beat analysts’ estimates. Royal Bank of Canada and Canadian Imperial Bank of Commerce report on Thursday.
A boost from BMO’s capital markets division helped prop up earnings as the unit’s profit rose 24 per cent to $459-million on higher revenue, primarily driven by global markets with higher interest-rate trading, rising debt and equity issuance activity and lower expenses. Profit in the bank’s wealth management and Canadian banking divisions also grew.
But the lender’s U.S. business dragged on earnings as profit dropped 26 per cent to $543-million from the same quarter last year. Heated competition in the market has put pressure on the unit’s net interest margin, or NIM – a measure of the difference between the amount that banks charge on loans and pay on deposits.
“The U.S. business, which is larger and includes more asset leverage due to the [Bank of the West] acquisition, is meaningfully detracting from financial performance,” CIBC analyst Paul Holden said in a note to clients. He added that “this does not make [Bank of the West] a bad acquisition,” but it does imply that it will weigh on profit this fiscal year. “Macro factors that are impacting results are expected to continue for a couple more quarters, resulting in muted loan growth, further NIM compression and elevated credit losses.”
Higher interest rates have prompted U.S. banks to pay customers more for their deposits, and BMO has had to compete with higher prices. The U.S. segment’s net interest margin slumped 23 basis points to 3.76 per cent from the same quarter last year. (A basis point is one-100th of a percentage point.)
Rising borrowing costs have also dampened loan demand, and BMO’s U.S. commercial loans and acceptances fell 3 per cent from the same period a year prior.
“I do not expect that phenomenon – although competition will continue – that it will impact quarterly NIM as much as it did this quarter,” said Tayfun Tuzun, BMO’s chief financial officer. “I suspect that there is a little bit more contraction left in the U.S., but we probably will not see a quarter-over-quarter compression similar to what we just saw.”