RY - Bank of Montreal: Non-Interest Income Headwinds Remain

2023-05-27 23:45:18 ET

Summary

• Bank of Montreal has seen a substantial rise in provision for credit losses in the most recent quarter.
• Non-interest income has taken a significant hit due to a fall in trading revenues.
• I do not see upside for the stock in the short-to-medium term.

Investment Thesis: While Bank of Montreal could have room to rise once non-interest income starts to recover, I take the view that the stock may continue to face headwinds in the short to medium-term.

Bank of Montreal ( BMO ) is one of the leading banking institutions in Canada - forming part of the "Big Five" - the five largest banks in the country by market capitalization.

When looking at the stock's price trajectory, we can see that Bank of Montreal saw significant upward momentum up to 2022, but price has been on a downward trajectory since then - down to $82.90 at the time of writing.

The purpose of this article is to assess whether Bank of Montreal could have the capacity to see a rebound in growth under the current macroeconomic environment.

Performance

When looking at the Bank of Montreal's revenue breakdown - we can see that while net interest income is up by 11% on a year-to-date basis, non-interest revenue is also down by 33% over the same period, with overall revenue down by 12.5%.

Moreover, we can also see that for the year-to-date of 2022, non-interest revenue accounted for a greater share of overall revenue than did net interest income.

Additionally, we can also see that a higher provision for credit losses coupled with a higher non-interest expense has resulted in much lower net income and diluted EPS figures as compared to the previous year-to-date.

When we look at a breakdown of non-interest revenue on a year-to-date basis, we can see that trading revenues - which accounted for almost half of total non-interest revenue for YTD 2022, saw a sharp drop into negative territory for YTD 2023.

While the drop in revenue was partially offset by gains across the Insurance revenues segment, non-interest revenue over the period was still down by 33%.

From a broader standpoint, while Bank of Montreal has been able to grow net interest income in line with a rising rate trajectory - the sharp drop in trading revenues has significantly dampened revenue growth.

Moreover, it is notable that while other banks across the Canadian market are facing similar pressures, Bank of Montreal's provision for credit losses has seen quite a large jump since the previous quarter - up to $1,023 million in Q2 2023 from that of $217 million in Q1 2023.

By contrast, we can see that competitor Royal Bank of Canada ( RY ) had a more modest increase in PCL from $532 million in Q1 2023 to $600 million in Q2 2023.

CBC News also reports that while the Bank of Nova Scotia ( BNS ) also had a higher PCL than the Bank of Montreal in the previous quarter - the latter has now overtaken the former on this metric.

Risks and Looking Forward

Going forward, I take the view that investors will be paying particular attention to how the PCL metric for Bank of Montreal trends going forward - we have seen that growth in this metric has been outsized relative to that of competitors. Particularly, PCL on impaired loans was up significantly due to higher provisions in Personal and Business Banking to $243 million - an increase of $123 million from that of the previous year.

Should we see loan demand fall in the event that interest rates continue to rise, then there is the possibility that we could see PCL on impaired loans also rise accordingly. In addition, there is the possibility that equity markets may also see modest growth in the short to medium-term as recessionary concerns remain. In this regard, the decline that we have seen in trading revenues could persist - which in turn would be expected to weigh on overall non-interest income.

When compared to other banks making up the Big Five, we can see that the Bank of Montreal is currently trading at the lowest price to book ratio, and also demonstrates the highest return on equity.

Price to Book

Return on Equity

In this regard, the stock could have significant scope for upside if we start to see a recovery in revenue growth and provision for credit losses starts to fall. Ultimately, while PCL has been rising for banks in the Big Five more generally - the sharp growth that we have seen in this metric for Bank of Montreal in the most recent quarter may cause concern for investors.

Conclusion

To conclude, Bank of Montreal has seen significant pressures under the current macroeconomic environment. While net interest income has been rising, this has been outweighed by the drop in non-interest income and a rise in provision for credit losses.

Longer-term, BMO stock could have significant value relative to its peers - both on a price to book and return on equity comparison. However, I take the view that the stock may continue to face headwinds in the short to medium-term.

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