Reporting season for the Canadian banks has begun with the Bank of Montreal (TSX: BMO)(NYSE: BMO) reporting its fourth-quarter and full-year fiscal 2014 results earlier this week and Royal Bank of Canada (TSX: RY)(NYSE: RY) reporting its results shortly afterward. The Bank of Montreal reported fourth-quarter net income that was flat relative to last year and Royal Bank reported an 11% increase in fourth-quarter net income, to $2.33 billion.
There were four themes that are worth noting as we prepare for the remainder of the banks’ reports.
Capital markets a drag on earnings
Revenue at BMO Capital Markets increased 2%, while net income decreased 12% versus last year. Respectable revenue growth was seen in Investment and Corporate Banking but was partially offset by lower revenues in Trading. In fact, trading revenue saw a decrease of 21%, hit by a 79% decrease in fixed income trading.
Net income declined due to higher expenses and lower loan recoveries. Capital Markets accounted for 25% of the company’s net income coming into the quarter. This quarter it represented 17%.
Royal Bank also saw weakness in the Capital Markets division. Net income decreased 14% versus last year and 37% versus the prior quarter mainly due to lower investment banking activities, poor trading results and higher provision for credit losses (PCL).
Canadian retail environment mixed and costs rising
Net income at Bank of Montreal’s Canadian Retail division increased 14%, with healthy loan and deposit growth in both Personal Banking and Commercial Banking.
Net income at Royal Bank’s Personal and Commercial Banking segment increased 8% versus last year, with Canadian Banking up 11% but was flat compared to the prior quarter reflecting higher marketing and infrastructure costs.
Wealth management showing strong results
The Bank of Montreal reported that adjusted net income for the Wealth Management segment increased 25% including the F&C acquisition and 6% organically, and assets under management increased 17%, due mostly to market appreciation and new client assets.
Over at Royal Bank, net income in its Wealth Management division increased 41% compared to last year due to capital appreciation, net sales, and lower PCL. Of note is the fact that the bank is closing its international Wealth Management business in the Caribbean.
Strong capital position
The Bank of Montreal and Royal Bank still have strong capital positions, as seen in their reported Basel III Common Equity Tier 1 Ratio of 9.9%.
There are two other unrelated points that deserve a mention as we look forward.
Effects of oil price decline
If oil continues its slide or even stays at current levels, this would have repercussions for the Canadian banking industry. Since the energy sector is such a big part of the Canadian economy, we know that the banks have a significant amount of business with them.
If and when energy companies begin to struggle due to the sharp decline in oil prices, this would translate to increased loan losses. So the quality of bank loans to this sector could be a concern going forward. Furthermore, the banks’ capital markets divisions would suffer as well, as investment and corporate banking revenue would be negatively affected.
Crunching some numbers
Return on equity is declining. Royal Bank’s ROE in fiscal 2014 was 19.3%, down from 19.7 in 2013, and the Bank of Montreal’s ROE was a lackluster 14.4%. Dividend yields are attractive, with Royal Bank at 3.7% and Bank of Montreal at 3.9%. In terms of valuation, Royal Bank trades at a trailing P/E of 14 times and a forward P/E of 13.2 times, and Bank of Montreal trades at 12.6 times trailing and 11.6 times forward P/E.
Looking ahead as the remaining banks report, we should expect those banks with the least exposure to capital markets to outperform. Canadian Imperial Bank of Commerce ranks well on this measure, as the company has taken clear steps to lessen its exposure to this volatile segment and focus more on wealth management.
