Profit margins tighten at BMO; U.S. deal a bright spot

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Bank of Montreal kicked off second-quarter earnings for Canada's major banks with a 27-per-cent increase in profit, but amid the numbers were clear signs that the country's banking sector faces a sluggish environment for growth.

Revenue at Canada's fourth-largest bank grew much slower than earnings as BMO stepped up its efforts to cut costs. Meanwhile, low interest rates and a recent price war over mortgages in Canada have eaten into profit margins.

"Margins were down notably on both sides of the border," analyst John Aiken said in a note to clients after BMO reported a profit of $1.03-billion for the quarter.

"While we anticipate that the other banks will likely experience [margin] declines … as they will all likely be affected by the mortgage rate 'special pricing' to some degree, we do not expect it to be nearly to the same extent as BMO's experience."

Indeed, bank officials acknowledged the fierce competition for mortgages this spring has hurt margins, but BMO chief executive officer Bill Downe said he is comfortable with the strategy.

BMO moved aggressively into the market with record-low prices on fixed-rate mortgages in a bid to expand its market share, which forced many of its competitors to also slash their rates. "We saw good uptake on that, better traffic in our branches, and better growth," Mr. Downe said in an interview Wednesday. "I think we did the right thing."

However, BMO is also seeing pressure on the profit it derives from deposits. Low interest rates and heightened competition among lenders for term deposits are also squeezing margins there.

"The real issue with deposits is the low interest rate environment… as we earn less," Frank Techar, head of retail banking at BMO told analysts on a conference call. "We expect that to continue for at least two or three more quarters."

Still, BMO's quarterly profit exceeded most analysts' expectations. The $1.03-billion profit was equal to $1.51 a share, compared with earnings of $813-million, or $1.32, during the same quarter last year. Revenue increased 19 per cent to $3.96-billion.

To book those profits, BMO got help from some unexpected areas of its operations, namely its U.S. expansion through the acquisition of Wisconsin-based Marshall & Ilsley Corp. last summer.

When BMO purchased the bank it began writing off or writing down large quantities of distressed loans that it felt could not be recovered. However, bank officials acknowledge a surprising amount of those bad loans are now being recovered.

Provisions for credit losses, or the amount banks set aside for unpaid loans, fell $102-million to $195-million, compared with last year. That represented nearly half of the bank's $217-million increase in net earnings.

Profits grew slightly at BMO's core Canadian retail banking business, the largest of its operations, which made $446-million, up 7.8 per cent from last year, despite slimming lending margins.

The bank's U.S. retail bank operations made $121-million, compared to $53-million a year ago, driven by the higher loan recoveries.

Profit fell slightly at BMO's capital markets division, dropping 2 per cent to $225-million amid uncertainty in global markets.

BMO also reported higher profits at its private client division, which caters to high net worth banking customers. That division made $145-million, up 59 per cent.

Adjusted earnings, with unusual items removed, were $1.44 a share. Analysts had expected the bank to make about $1.36 a share on average.

In addition to the loan recoveries BMO reported, Stonecap Securities analysts Brad Smith said in a note to clients that the bank relied on income tax reductions of about $46-million to help "save the day."

While there is a tendency among investors to shrug off the boost banks get from loan recoveries, since they are unlikely to repeat in future earnings, BMO's U.S. loan book is showing positive signs, analysts said. "We do not view the boost that BMO's earnings get from these temporary sources as reason to dismiss the bank's performance," National Bank Financial Peter Routledge said in a research note. "We found signs of organic loan growth in the U.S. this quarter, and we believe investors should focus on this."

Editor's note: BMO's net earnings increase has been corrected in the online version of this story.