BMO - Bank of Montreal: Excellent Company For Dividend Growth Investing

2023-05-30 10:16:26 ET

Summary

• Bank of Montreal is the 8th largest bank in North America with $1.25 trillion in assets, serving 13 million customers globally, and has a significant US presence.
• BMO is diversified on four business lines: Canadian banking, US banking, Wealth Management, and Capital Markets.
• BMO's strategy emphasizes maintaining a well-capitalized balance sheet, commitment to positive operating leverage, and a digital-first operating model.
• The bank has a strong dividend record, continuously paying dividends for 194 years, and currently offers a 4.8% dividend yield.

Introduction

The Bank of Montreal (BMO) is the 8th largest bank in North America by assets, with a total of $1.25 trillion on its books. It serves 13 million customers across the globe, with an emphasis on digital first service that speed and scale. The largest portion of its business is Canadian banking, while it also has a significant US presence. It has three operating groups:

• Personal & Commercial Banking
• BMO Wealth Management
• BMO Capital Markets

As one of the leading banks in the North American market, BMO has a strategy that emphasizes three things:

• Maintain a well-capitalized balance sheet (risk management)
• Commitment to positive operating leverage (economies of scale)
• Digital first operating model that drives efficiency, speed, and scale

While BMO is primarily known as a Canadian Big 5 bank, one of the five players in the Canadian oligopoly, it has a surprising amount of US exposure - US$419B of its total C$1,250B of assets are located in the US. I've included a map below of its US branches and geographic distribution to really hammer this point home:

BMO's Business Lines

Here is a breakdown of BMO's net revenues, as of Q2 2023:

• Canadian Personal & Commercial Banking - 31%. Two thirds of this is personal & business banking, with the rest commercial banking.
• US Personal & Commercial Banking - 32%. Two thirds of which is commercial banking, with the rest personal & business banking.
• BMO Capital Markets - 20%. Two thirds of this is global markets, with the rest in investments & corporate banking.
• BMO Wealth Management - 20%. The vast majority of the revenue comes from managing personal wealth.

Fully 46% of its revenues come from the US, while the other 54% comes from Canada and other countries. 48% of net revenues come from business, while 52% of net revenues come from consumer segments. This makes BMO an attractive prospective investment for those seeking exposure to multiple developed markets and multiple business lines at the same time. There is a lot of diversification to be found here. I will present some summarizing facts and figures about each of its business lines below.

I will take the figures available from only the Q2 2013 and Q2 2023 investor presentations and highlight the growth, returns, and efficiency in these segments during these 10 years.

Canadian Personal & Commercial Banking

Out of the four business lines, Canadian Personal & Commercial Banking is the biggest and brightest spot in BMO. By net income, it grew at a CAGR rate of about 15.6%/year, by far the fastest of all of its lines. The return on equity is 27.8%, which is an eye-watering amount compared to the average US banking return on equity, which is around ~15%. This outcome that is so favorable to shareholders is the result of the oligopoly, which limits competition in banking in Canada.

Last but not least, the efficiency ratio on Canadian banking is a very low 43.3%, which is very favorable when we consider that an excellent efficiency ratio for banks in the US is 50%. This means that noninterest expenses are a smaller portion of gross income than usual for banks. This ratio reflects the emphasis on digital banking by BMO.

US Personal & Commercial Banking

BMO's US banking operations sport ROE and efficiency ratio figures that are closer to those of US only banks. US banking is also the slowest growing segment of BMO, by net income. Still, it is very significant as a fraction of BMO's overall net income.

BMO Capital Markets

BMO Capital Markets is the third fastest growing segment of BMO. Notable is its increased net profit margin compared as compared with 10 years ago: 32.3% in 2013, as compared with 55.7% now.

BMO Wealth Management

BMO's smallest segment by net income is Wealth Management. However, by net income it has grown by 14.8%, which makes it a sizeable chunk of overall net income. Also noteworthy is the high ROE of 18.6%.

Loan Portfolio Statistics & Diversification

No business line overview would be complete without some information about diversification.

The loans show a wide scattering in terms of industry, clientele, and geography. About 1/3 of loans are in the US for commercial purposes, and 1/4 of the loans are in Canadian real estate. The large allocation to Canadian residential mortgages may be a concern, though, because rising interest rates recently decimated housing prices in Canada. Let's dig a little more into this.

• Canada's big banks have been logging higher provisions for credit losses recently. However, just to put things in perspective, the collective PCL for the Big 5 in Canada in Q2 2023 are still about 1/2 of the PCL from the peak of the COVID-19 crisis:

• Quote: "From a credit-quality perspective, the residential mortgages on Canadian banks' books are very solid, and pretty recession proof," said John Aiken, Barclays' head of research in Canada.
• Additionally, in retrospect by about a month, the housing market correction is almost over in Canada. A recent slight jump in housing prices was likely caused by the Bank of Canada's decision to pause rate hikes , which was the recent driver of the correction.

So overall it would seem that the Big 5 banks (including BMO) are expecting some credit market turbulence in the near future, but certainly nothing catastrophic. In fact, historically speaking, mortgage delinquencies in Canada are very muted compared to rates for the US and the UK. Hence, there is probably little to worry about:

Capital Ratios & Credit Quality History

There are several metrics of credit quality that bank investors should examine. Let's first examine the PCL (provision for credit loss) for BMO as a long term time series data:

The blue dotted line represents BMO, while the grey dotted line represents the aggregate statistic for the other 4 peers in the Canadian Big 5: ( TD ), ( CM ), ( RY ), ( BNS ). The most notable long-term trend is BMO's significantly higher credit quality than its peers, with a 0.36% historical average rate of PCL as % of net loans, versus the peer average of 0.49%. Since BMO has an extremely high exposure to the US markets, this explains why BMO's ratio was slightly higher than that of its peers in 2008 - 2011: the subprime mortgage financial crisis was a US event.

BMO is also very well capitalized, sporting a ~16% CET1 ratio up until very recently. This strength allowed BMO to finance a large recent acquisition, Bank of the West:

Bank of the West is a US bank headquartered in San Francisco - this acquisition will add about 600 branches and offices in the Midwest and Western USA to BMO's US business.

Dividend Record & Shareholder Returns

The fact that the Canadian banking system is oligopolistic and strongly favors stability is reflected in its dividend record: it has continuously paid a dividend for 194 years in a row. It currently sports an attractive dividend yield of 4.8%, and for the past 15 years has on average raised its cumulative annual dividend by about 5%/year:

Let's look at the stock return. I have run portfolio visualizer on the top 10 North American banks for the period Dec 2015 - Apr 2023, and ordered them by Sharpe ratios. I have included the American banks ( JPM ), ( BAC ), ( C ), ( USB ), and ( WFC ).

In terms of return, BMO has recently ranked top 3 out of 10. In respect with risk-adjusted returns, BMO ranks about top 4 out of 10. Worth noting also is the distribution of how the return is given to the shareholder: income vs. capital gains. Given that the dividend yield of BMO is about 4.8%, about half of the returns to the shareholder are in the form of income.

This means that BMO as a stock holding should be favored by investors who want an even balance between income and capital gains. Finally, let's look at BMO's dividend history:

BMO sports roughly a 35% payout ratio currently, which is on the somewhat lower end for a bank, and has had a two-decade long history of increasing its dividend per share payout. Hence, this company is very suitable for dividend growth investors.

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