Recently, most of the Canadian banks have made a point to temper growth expectations, especially for their domestic businesses. This should come as no surprise. The Canadian consumer is extremely overleveraged, and with a debt-to-household income ratio of 163% (one of the highest in the world), a recent report by McKinsey described the situation as unsustainable.
With total household debt now exceeding the GDP, the Canadian consumer is significantly overleveraged, and as a result, has very little room to take on more debt. This is bad news for banks, not only because it results in slower loan growth, but because it also raises the prospect of deleveraging occurring, which refers to consumers using income to pay down debt and save, rather than consume. This can weaken GDP growth and harm banks’ broader business.
Bank of Montreal is already experiencing these effects
Add this to falling crude prices, low interest rates, and an overvalued housing market, and earnings growth in Canada is a difficult proposition. For Bank of Montreal (TSX:BMO)(NYSE:BMO), some of these effects are already evident. The bank saw domestic personal and commercial earnings up only 1.6% year over year (lower than most estimates).
In addition, consumer domestic loans were down 0.5% quarter over quarter (which is partially related to reduced exposure to auto loans), and the above factors are all part of a broader trend of BMO seeing both its loan growth and net income from its Canadian domestic business trend downwards over the past several quarters.
While BMO has actually exceeded its peers throughout 2013 and 2014 in loan growth thanks to an intense focus on retail banking and aggressive mortgage pricing, the weaker Canadian macroeconomic environments means that banks will need focus on other areas of their operations to achieve growth. TD Bank is largely looking to its expansive U.S. segment for growth, whereas RBC is looking towards its global capital markets and wealth management business. Like TD, BMO is also looking south of the border for growth, but it will not be able to find it as effectively.
BMO has some of the lowest projected growth of its peers
Although analyst estimates for growth vary, there seems to be a general consensus that BMO will underperform its peers in earnings growth for both 2015 and 2016. For 2015, analysts at TD Bank are estimating an average 3.9% earnings growth from 2014 for Canada’s banks, and projecting BMO to show essentially 0% growth over the same time period. For 2016, projections are 4.5% growth for the group of banks, compared with only 2.4% for BMO.
More importantly, BMO significantly underperforms its large-cap peers in the Big Four, with TD Bank and Royal Bank expecting 5% and 6.4% growth for 2015, respectively. In addition to low growth, BMO shares also seem expensive compared with its peers, given its fairly low growth rate, which could mean less share price appreciation for BMO shareholders.
Currently, BMO is trading at 11.8 times its 2015 earnings, which is a premium to the overall peer group average of 11.6 times. This premium exists even though BMO is expecting lower overall growth than the peer average for 2016, with a 2.4% growth rate compared with 4.5% for the peer group. The end result is BMO shareholders are paying more for less growth, and as a result there is a risk that BMO could see some compression in its overall valuation.
It is best to look elsewhere for growth
One of BMO’s biggest challenges is that they are a largely Canadian retail-oriented bank, which will limit their growth going forward. BMO does have exposure to the U.S. through its U.S. personal and commercial segment (which represents about 17% of net income), as well as some wealth management and capital market activity, but their scale and quality within the U.S. is not as strong as a bank like TD Bank, which has larger operations and is better situated geographically. TD has operations in seven of the 10 wealthiest U.S. states, compared with BMO, which is largely exposed to the U.S. Midwest and their weak manufacturing sector.
