BMO and Scotiabank earnings disappoint as economic hurdles weigh on growth

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Canadian bank earnings season launched with a pair of disappointments, as economic uncertainty, inflation and higher interest rates combined forces to hit profits at Bank of Nova Scotia BNS-T and Bank of Montreal BMO-T.

Both banks reported second-quarter earnings that missed analysts’ estimates Wednesday, results driven by escalating expenses and cooling loan growth. The lenders also set aside more reserves for loans that could turn sour in a downturn, though these provisions for credit losses are still low relative to historical norms.

Despite the recent banking turmoil in the United States, which has resulted in three bank failures since March, Canadian lenders have remained relatively unscathed. Deposits at BMO and Scotiabank were up 8 per cent and 11 per cent year over year, respectively.

Here’s a breakdown of the big banks’ second-quarter earnings so far

But inflation and the fallout from the U.S. failures have cast a chill over the sector in recent months. Even though deposits have been stable at larger banks, the institutions sometimes have to pay more interest to keep those deposits, which can eat into profit margins.

Also, the economic outlook is worsening and starting to constrain growth, as evidenced by weaker commercial loan demand in the U.S.

“Since we spoke last quarter, the impact of persistent inflation and rising rates, a slowing global economy and increasing deposit competition on the industry has accelerated,” BMO chief executive officer Darryl White said during a conference call with analysts. “We’re not immune to these market forces, which are putting pressure on revenue growth and near-term operating leverage.”

BMO earned $1.06-billion, or $1.30 per share, in the three months that ended April 30, compared with $4.76-billion, or $7.13 per share, in the same quarter last year. On an adjusted basis, excluding acquisition and integration costs, the bank said it earned $2.93 per share. That fell below the $3.16 per share analysts expected, according to Refinitiv.

Scotiabank’s net income fell 21 per cent year over year to $2.16-billion, or $1.69 per share, in the three months that ended April 30. Adjusted to exclude certain items, the bank said it earned $1.70 per share, missing the $1.77 per share analysts expected, according to Refinitiv.

BMO and Scotiabank are the first major Canadian banks to report earnings for the fiscal second quarter. Three more will announce their results Thursday. BMO’s shares lost 3.9 per cent of their value Wednesday, and are now the worst performing of the Big Six bank stocks this year. Scotiabank’s share price slumped 1.3 per cent.

The quarter marked the first time BMO has reported earnings that include results from its takeover of California-based Bank of the West, providing investors with an initial glimpse at the impact of the deal. Profit from BMO’s U.S. arm climbed 34 per cent year over year to $789-million. Bank of the West contributed $107-million in net income.

As BMO works toward its fall deadline to fully integrate the new business, it is absorbing other costs that come with the deal. In the second quarter, BMO booked $1.02-billion in provisions for credit losses, the bulk of that amount inherited from Bank of the West.

BMO’s expenses surged 50 per cent year over year to $5.57-billion, driven by integration costs related to the Bank of the West deal, as well as investments last year in the bank’s sales force and technology platforms. The boost pushed BMO’s operating leverage – a key industry metric that measures whether expense growth is outpacing revenue growth – further into negative territory.

Tayfun Tuzun, BMO’s chief financial officer, told analysts that the bank’s operating leverage is expected to remain negative for the rest of the year and turn positive in February, 2024, as it blends Bank of the West’s operations with its own, trimming costs by streamlining similar products and services.

“We have a well-planned execution of Bank of the West cost synergies, and we intend to fully execute those actions,” Mr. Tuzun said in an interview after the conference call.

Scotiabank’s BNS-T expenses climbed as well. They rose 10 per cent year over year, boosted by hiring, higher base salaries and advertising costs.

“This will be one of those years where inflation has an outside impact, not just in Canada. You’ve got to remember, in international banking, we operate in a highly inflationary environment,” Scotiabank chief financial officer Raj Viswanathan said on a conference call with analysts. Scotiabank’s international footprint is largely based in Chile, Colombia, Mexico and Peru, and both Colombia and Chile are in recessions.

The lender’s new chief executive officer, Scott Thomson, has been working on rejigging the company’s strategy by growing its deposit base in Canada and in Latin America, where Mr. Thomson has said lagging results in recent years have been unacceptable.

In Canada, demand for credit is slowing as the high cost of borrowing deters customers. Scotiabank’s loan growth fell to 6 per cent from 9 per cent in the first quarter, largely because of a slim 3-per-cent rise in mortgages. But net interest margins – the difference between what banks charge on loans and pay on deposits – grew 8 basis points year over year as consumers paid more on higher interest rates. (A basis point is one-100th of a percentage point.)

In the quarter, Scotiabank set aside $709-million in provisions for credit losses, up from $219-million in the same quarter last year. That was higher than analysts anticipated. It included $88-million against loans that are still being repaid.

In the U.S., where stability concerns among regional banks thrust deposit levels into the spotlight, deposits with Canadian lenders slipped by 3 per cent from the previous quarter, in line with U.S. bank trends, according to regulatory filings.