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Morningstar | High Loan Growth Persists for Bank of Montreal; Expense Growth Should Subside in Latter Half of Year

Narrow-moat-rated Bank of Montreal reported decent fiscal second-quarter results that generally fit within our long-term thesis, and after some minor adjustments, we are decreasing our fair value estimates to CAD 104 from CAD 105 for Canadian shares and $77 from $79 for U.S. shares. The bank had decent EPS growth of 5% for the quarter, with adjusted earnings increasing to CAD 2.30 per share. BMO reported a 13.9% adjusted return on equity for the quarter, exactly in line with adjusted results from the first quarter of 2019. The bank remains on track for continued operating leverage for the year, although largely due to a severance charge, the bank may fall below its medium-term 2% goal for fiscal 2019.

Credit quality remained strong, with the provision for credit losses ratio remaining range-bound in the mid- to upper teens. Gross impaired loans did increase a bit, but the ratio remains within the range we have seen over the last year. Delinquency rates picked up again slightly in the quarter for the Canadian real estate portfolio, going from 21 basis points in the first quarter to 24 basis points in the current quarter. Delinquency rates also picked up for the Canadian consumer installment portfolio, increasing to 0.46% from 0.42%, although they were still net down year over year. Canadian mortgage balances returned to growth, up 2.4% year over year, still in the low-single-digit range, which we would expect going forward.

On a segment level, all areas of the business generally saw growth. Canadian property and casualty banking had revenue and expense growth of 5% each, and average deposits were up 8%, while commercial loans were up 15%, both strong numbers. Net interest margins have been relatively stable, and expenses have been increasing in line with revenue, leading to a roughly stable efficiency ratio as well. For U.S. P&C banking, loan growth was also quite strong, as average loans were up 12%, driven by growth of 15% in commercial lending. This led to adjusted net income growth of 12%. We can appreciate the growth here for BMO, but the bank continues to outgrow the market in the U.S. commercial space, even as NIMs compress (due at least in part to compressing loan spreads), and we are likely closer to the end of a credit cycle than the beginning. So far, credit metrics in the U.S. look fine for the bank, but it will be an area worth watching. Management reiterated multiple times on the call that they have not adjusted their credit standards, and that the growth is well diversified across industries and geographies. On the surface, the capital markets segment’s performance did not look great, with expense growth of 31% far outweighing revenue growth of 18%. However, this was largely due to a one-time severance charge. Excluding this, net income would have been closer to up 19% rather than down 12%. A good chunk of this growth was due to BMO’s acquisition of KGS in September 2018. Wealth management’s assets under management increased 6% and had higher expenses and lower performance fees, which led to an increase in adjusted net income of 3%.