Bank of Montreal (TSX:BMO) stock slipped more than 11% in March after the U.S. banking crisis created a selloff in bank stocks. The U.S. banks failed because of concentration risk. The Silicon Valley Bank collapsed because its customers were concentrated in the tech space, and its assets were in long-term bonds.
As SVB’s majority of customers were from the same business circle, fear of a few tech customers created panic within their business circle, causing a bank run. Although the Bank of Montreal has a significant presence in California, its assets and consumers are well-diversified in Canada and the United States.
Should you be worried about the Bank of Montreal holdings in your portfolio?
Bank of Montreal’s U.S. exposure
BMO stock fell more than 11% in March, as it has the largest exposure to the U.S. markets among the Big Six. BMO increased its U.S. revenue from 27% in 2017 to 45% in 2022, with 10% of the U.S. revenue coming from its latest acquisition of the Bank of the West.
Before the U.S. banking crisis, BMO expected Bank of the West to add US$2 billion in run rate pre-provision pre-tax earnings (PPPT). The PPPT shows the operating profit from banking operations before factoring in the credit risk and tax.
BMO expected Bank of the West to bring US$61 billion in loans and US$77 billion in deposits as of May 2023. Its loans and deposits are diversified across various sectors, which reduces the risk of a bank run. But if the SVB failure creates a broader bank run in California, BMO might revise its growth outlook from the acquisition.
BMO’s strategy to tap the U.S. markets could take a fall back in the short term. But its Canadian risk-management roots could prevent it from facing a similar fate as other regional U.S. banks. Here’s how.
The bank’s risk-management efforts
Founded in 1817, BMO is the oldest bank in Canada, with the longest-running dividend-payout record of 194 years. The bank offers personal and commercial banking in Canada (36%) and the United States (24%), wealth management (19%), and capital market services (21%). It is helping people new to Canada by partnering with Immigration.ca., complementing its existing partnership with NewStart and SmartProgress.
In the first quarter, BMO’s loans and deposits increased and wealth management revenue decreased due to a weak stock market. There is a significant gap between its reported net income of $247 million and its adjusted net income of $2.27 million (40% from the U.S. segment). This gap was because of the $1.46 billion loss in the fair value of the changes on the purchase of Bank of the West.
BMO knew the risks the U.S. acquisition brought. Hence, it enhanced its credit and liquidity ratios:
- BMO increased the common equity tier-one ratio to 18.2% from 14.1% last year to include the impact of fair-value management actions related to the acquisition.
- It increased the provision for credit loss to $217 million after recovering $99 million from high-credit-risk loans in the same quarter the previous year.
- It increased the liquidity coverage ratio to 144% to pay for immediate obligations while keeping a 44% buffer for extra withdrawals.
Should you worry about your BMO holdings?
The large exposure to the United States could stress BMO’s earnings in the short term. The bank might revise its outlook in the short term, as a majority of its U.S. business comprises commercial banking.
However, the Bank of Montreal has experience managing risk several times bigger than the current stress. The bank stock can withstand the current weakness and recover with the economy.
The 11% plus dip has created an opportunity to buy the stock at the dip and lock in a 4.9% dividend yield. The bank can also grow its dividend in the long term. It increased its dividend at an average annual rate of 4.9% in the last 15 years; it paused growth in four years (2009-2011 and 2021), when the interest rate was at a record low.
Investing tip
Like BMO, you should diversify your portfolio across sectors and asset classes that react differently to a given situation.
