Capital markets slowdown dents BMO’s quarterly profit and overshadows strong lending trends

Capital markets slowdown dents BMO’s quarterly profit and overshadows strong lending trends

A steep drop in revenue from capital markets dragged down Bank of Montreal’s BMO-T -2.57%decrease third-quarter profit despite strong demand for loans from retail clients, bringing a tepid earnings season for Canada’s large banks to a close and underlining the uncertainty those lenders face in the coming months.

An abrupt slowdown in underwriting and advisory work for investment bankers, compounded by weaker revenue from trading, loomed large over BMO’s quarterly results. Capital markets revenue fell 20 per cent year-over-year and profit was down 53 per cent, to $262-million. The drop-off was most acute in the investment and corporate banking unit, where revenue fell 36 per cent, as many corporate clients sat on the sidelines to wait out market upheavals.

In a possible sign that BMO doesn’t expect deal-making to return any time soon to the booming levels seen last year, the bank reported $49-million in severance pay in its capital market division as it trims staff in an effort to maintain profitability. The bank did not reveal how many jobs it is cutting.

The slowdown in capital markets was not unique to BMO – revenues from investment banking and trading divisions fell at most Canadian banks in the fiscal third quarter, which ended July 31. It was most pronounced at banks such as BMO and Royal Bank of Canada, which have built a larger part of their business on serving U.S. clients in capital markets.

However, there are “early signs” that activity among clients in Canada and the United States could be starting to pick up, BMO’s chief financial officer Tayfun Tuzun said in an interview. “Capital markets typically don’t stay closed for lengthy periods of time. So I think history is on our side. At one point, the wheels will start turning.”

Downbeat capital markets results overshadowed what was otherwise a good quarter for the bank’s core retail-banking business, which caters to commercial and personal borrowers in Canada and the U.S. Demand for new loans was robust, driving revenue up 13 per cent in Canada and 12 per cent in the U.S. division, while profit margins on loans also improved.

BMO is the last of Toronto’s major banks to report its third-quarter earnings, capping off a string of mixed results. Three of the Big Six banks, including BMO, fell short of analysts’ expectations for profits. And each bank reported earnings that were hobbled by weak capital markets activities and modest increases to provisions against loan losses, in spite of good underlying trends in retail lending.

But with growing uncertainty about the prospect of an economic slowdown as central banks rapidly raise interest rates to beat back high inflation, investors are looking for clues about how much that could reduce demand for new borrowing.

“That is the big question, in terms of how higher interest rates, by slowing down economic growth, will impact loan growth in different parts of our business,” Mr. Tuzun said in an interview. “The market is still, to a certain extent, struggling to measure the impact of higher interest rates and the timing of that slowdown.”

BMO’s shares fell 2.6 per cent to $124.49 on the Toronto Stock Exchange on Tuesday, and rival banks have also suffered declines in their stock prices after reporting quarterly results.

“The market reaction has been negative, as the [Canadian] banks have underperformed the TSX over the past week,” said Jim Shanahan, an analyst at Edward Jones.

BMO joined rival banks in building its reserves against possible losses from defaulting loans, though actual write-offs are still at unusually low levels. The bank earmarked $136-million in provisions for credit losses – the funds banks set aside to cover loans that could go bad. Of that sum, $32-million was set aside largely because the economic forecasts that BMO uses to predict future losses got slightly worse, requiring more provisions against loans that are still being repaid today.

Although credit losses are expected to tick higher in the coming quarters, returning to more normal levels, “that normalization probably will be orderly,” Mr. Tuzun said.

BMO’s quarterly results also suffered from the impact of two accounting items recorded as large losses. BMO booked a $649-million after-tax loss related to a hedging strategy to offset the risk to capital from rising interest rates when it closes its $17.1-billion acquisition of California-based Bank of the West. In the previous quarter, the bank recorded a $2.6-billion gain on the same hedge, however. And last week, Toronto-Dominion Bank recorded a $505-million after-tax loss on a similar hedging strategy tied to its pending US$13.4-billion deal to acquire First Horizon Corp.

BMO also took $88-million in writedowns on underwriting commitments from its role in loan syndicates, though about 90 per cent of those losses are unrealized, and the value of the underlying assets could change. Similarly, Royal Bank of Canada reported $385-million of markdowns in its disclosures last week, with three-quarters of them unrealized.

BMO earned $1.37-billion, or $1.95 per share, in the fiscal quarter that ended July 31. That compared with $2.28-billion or $3.41 in the same quarter last year. After adjusting to exclude one-time items, including the accounting loss on its hedging strategy, BMO said it earned $2.13-billion or $3.09 per share. On average, analysts expected $3.17 per share, according to Refinitiv.

“Although BMO’s quarter fell shy of consensus forecasts, the negative elements of the period were isolated to the capital markets business,” said Gabriel Dechaine, an analyst at National Bank Financial Inc., in a note to clients. That weakness should be “transitory,” he added, but the tailwind from rising interest rates, which should boost profit margins on loans, “is a more sustainable driver for the bank.”

BMO’s net interest margins – the difference between what it charges on loans and pays on deposits – increased by 10 basis points in Canada and 21 basis points in the U.S. during the quarter. (100 basis points equal one percentage point). That helped drive profit from Canadian personal and commercial banking up 17 per cent to $965-million, and 3 per cent to $568-million in the U.S.


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