CA - Bank of Montreal: Drop In Trading Revenues Place Pressure On Growth

2023-10-14 04:28:36 ET

Summary

• Bank of Montreal has continued to see downward pressure on non-interest revenues.
• A drop in trading revenues has placed significant pressure on non-interest revenues as a whole.
• I do not take a bullish view on Bank of Montreal at this time.

Investment Thesis: I take the view that Bank of Montreal has little prospects of upside in the short to medium-term, owing to a continued drop in non-interest revenue, along with modest growth in net interest income.

In a previous article back in May, I made the argument that Bank of Montreal ( BMO ) could see little, if any upside in the short to medium-term, on the basis of a significant drop in non-interest income.

Since then, the stock has descended to a price of $81.09 at the time of writing:

The purpose of this article is to assess whether Bank of Montreal has the ability to see continued growth from here, taking recent performance into consideration.

Performance

When looking at the most recent earnings results for Bank of Montreal, we can see that net interest income has seen a slight increase from that of the last quarter. However, non-interest revenue has seen a significant decline over the same period.

We can see that net income and diluted EPS saw growth over the same period, but this was primarily due to a drop in provision for credit losses from the previous quarter - revenue growth itself remained negative. However, it is also notable that provision for credit losses was still up to CAD 492 million in Q3 2023 from that of CAD 136 million in Q3 2022.

Additionally, when looking at the percentage of non-interest income to total revenue, we can see that this has seen a significant drop in 2023 as compared to previous years.

While net interest income accordingly has been accounting for a larger proportion of revenue than previously - we have seen that the decline in non-interest revenue has been outpacing that of growth in net interest income.

I had previously made the argument that investors would be paying close attention to how provision for credit losses trends from here - given that growth in this metric had been outsized relative to competitors such as Royal Bank of Canada ( RY ). Particularly, I had pointed out the risk that if we see loan demand fall as a result of a continuing rise in interest rates, then PCL on impaired loans could also rise accordingly.

PCL on impaired loans was CAD 333 million, which is an increase of CAD 229 million from that of the prior year. In addition, PCL on performing loans came in at CAD 159 million, which marks an increase of CAD 127 million from that of the prior year.

My Perspective and Risks

As regards my take on the above results and the implications for the growth trajectory of the stock going forward, my prior caveat that an increase in provision for credit losses could hinder growth going forward seems to have been the case up until now. Bank of Montreal has had to set aside further provisions across both performing and impaired loans, and this has been affecting net income growth.

When looking at non-interest revenue on a year-to-date basis, we can see that the major reason for the drop in non-interest revenue has been a sharp decline in trading revenues.

With higher interest rates continuing to place pressure on equity markets - Bank of Montreal can expect to continue seeing a lag in non-interest revenue until such time that the broader macroeconomic picture improves with respect to equities.

I had previously stated that when comparing to the rest of the Big Five - Bank of Montreal had been trading at the lowest price to book ratio and had been demonstrating the highest return on equity among its peers.

When looking at current trends, we can see that Bank of Montreal's price to book ratio is higher than that of Bank of Nova Scotia ( BNS ) and Canadian Imperial Bank of Commerce ( CM ), while return on equity has fallen substantially from that of last year and is now the second-lowest after the Canadian Imperial Bank of Commerce.

Price to Book

Return on Equity

From this standpoint, I take the view that Bank of Montreal will continue to see low prospects of upside for as long as equity market performance remains subdued.

Conclusion

To conclude, Bank of Montreal has seen a continued drop in non-interest revenue, while growth in net interest income has been modest. I do not take a bullish view on Bank of Montreal at this time.

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