Canadian banks started reporting their fiscal first-quarter (Q1) 2023 earnings this week. The theme seems common so far — higher provisions and lower earnings. Provisions have risen for the last three quarters and indicate a gloomy growth outlook.
Canada’s third-largest Bank of Montreal (TSX:BMO) reported its first-quarter earnings on February 28. It reported an adjusted net income of $2.27 billion for the quarter that ended on January 31, 2023. Its adjusted net income of the same quarter last year came in at $2.58 billion.
BMO amid macroeconomic challenges
Higher interest rates generally tend to drive banks’ earnings higher. However, this time, we’ve seen a subdued impact on banks’ earnings, despite the rapid rate hike spree. And that’s because it is coupled with record-high inflation.
The inflation growth has been mindbogglingly steep since last year, which has forced policymakers to raise interest rates faster. However, only time will tell whether they have been successful or not. Because even after these rate hikes, the economy appears hot, and inflation still seems out of control.
As a result, borrowers’ repayment capacity is expected to go down, ultimately increasing loan losses. So, banks have set aside a specific amount called provisions for loans that could go bad.
Higher provisions across the board
BMO reported a provision for credit losses of $217 million compared to $226 million in Q4 2022. In the year-ago period, Bank of Montreal had a recovery from provisions worth $99 million. This has been the trend across the sector and even with south of the border banks. Bankers increasingly seem to be laying ground to play safe in an impending recession.
Bank of Montreal looks well placed when it comes to allocation to provisions. Because peer Royal Bank of Canada and Bank of Nova Scotia have significantly upped their provisions in the latest quarter. RY has set aside $532 million, while Scotiabank has provisioned $638 million.
Growth prospects
BMO’s lower provisions and relatively minimal change to last year indicate its superior credit quality. Its common equity tier-one (CET1) ratio was 18.2% in the reported quarter — way higher than regulatory requirements and the industry average. The ratio compares bank’s core capital against its assets and indicates a capacity to sustain shocks.
BMO stock has lost 11% in the last 12 months, while the TSX Financial Index has dropped 9%. However, BMO stock looks attractive from a valuation standpoint. It is currently trading at a price-to-book value ratio of 1.3 — much lower than the industry average. Its five-year historical average ratio comes to around 1.4 and implies that the stock is undervalued. From a dividend perspective, BMO stock yields 4.4% and has the longest payout streak of 194 consecutive years.
Conclusion
Moreover, BMO has been aggressively expanding in the U.S., with a footprint now in over 32 states. Its U.S. operations are growing at a much faster pace compared to the Canadian personal banking segment. During the quarter, BMO witnessed a decent 2% loan and deposit growth compared to earlier three-month period. It reported an adjusted net interest margin of 1.79% in fiscal Q1 2023 — a decline from 1.86% in the earlier quarter.
Like peer bank stocks, BMO stock will likely continue to trade subdued for a few quarters, mainly due to macroeconomic woes. However, it is an attractive long-term bet given its expanding U.S. operations, strong balance sheet, and stable dividend profile.
