Bank of Montreal kicked off third-quarter earnings for the banking sector by blowing past Bay Street's profit expectations. But the question now hanging over the Big Six banks as they unveil results for May through July is not how good the past quarter was – but exactly how bad August is looking so far.
With worsening debt problems roiling the financial markets of Europe and the United States in recent weeks, investors and analysts have already started looking beyond this earnings season to the quarter ahead to gauge the full impact of the global economic crisis.
As BMO reported a 19-per-cent jump in profit for the second-quarter, driven by soaring earnings at its capital markets division, the bank's executives were asked bluntly during a conference call with analysts to share just how slow August has been.
One worry is that surging trading revenue that led the bank to beat analysts' expectations in the second quarter are sure to come under pressure if global markets continue to face the kind of uncertainty seen in August.
"When we look forward, obviously we're not oblivious to all of the stresses that have come from the recent extreme volatility in the market," Thomas Milroy, chief executive officer of BMO's capital markets division, told analysts. "There's obviously some negative in that volatility. … It also, importantly, sends clients to the sidelines."
The bank is now watching closely for signs of a return "to normality" after August ends, Mr. Milroy added.
BMO earned $793-million, or $1.27 a share, in the second quarter, compared with $669-million, or $1.13, during the same period a year ago. Revenue rose 13 per cent to $3.27-billion. The second quarter ended July 31, before several key events shook global markets, such as the U.S. debt downgrade and a deepening sovereign debt crisis in Europe.
Adjusted profit was $1.36 a share, which does not include special items such as costs associated with its recent purchase of Midwestern U.S. bank Marshall & Ilsley Corp. Analysts were expecting BMO to earn about $1.31 a share for the quarter.
In a clear sign investors weren't sticking to the sidelines for most of the summer, profit at the bank's capital markets division jumped to $279-million in the quarter, an increase of $149-million over last year. The increase was due to sharply higher trading revenue, along with fees from advising on mergers and acquisitions.
BMO chief executive officer Bill Downe said the bank is carrying very little exposure to the European debt crisis – only about $300-million – and he remains optimistic that the U.S. economy is not headed toward a recession. Mr. Downe said August is typically a slow quarter, and September will be much more vital to the outlook for the Canadian and U.S. economies.
"I think the tale will be told in the next couple of weeks," Mr. Downe said. "I do believe that most businesses have been holding back, waiting for some confirmation," Mr. Downe said. "I think there is business in the pipeline. … The consumer is spending less and saving more and that only puts them in better shape."
BMO also saw a jump in earnings at its U.S. retail banking business, due mostly to the acquisition of M&I, a deal which closed July 4. Though M&I was only on the books for 26 days before the quarter ended, profit at the U.S. operations more than doubled to $95-million over last year. The newly acquired M&I business was responsible for $27-million of the $45-million increase.
Retail bank earnings in Canada, which are derived from BMO's network of branches, were relatively flat, however, rising by $8-million to a total of $432-million, a gain of just 1.8 per cent. With interest rates low, Canadian banks have been feeling pressure on their margins. That trend ate into Canadian bank profits last quarter, and is expected to have the same impact across the sector as the other banks report earnings in the next two weeks.
Though BMO's net interest margins, the difference between the money it makes on loans and the interest it pays out on deposits, fell slightly, analysts noted the decline was smaller than expected. "We view BMO's relatively insignificant one-basis-point compression in the second quarter quite positively, in context," Barclays Capital analyst John Aiken said in a research note. (A basis point is 1/100th of a percentage point.)
BMO's provisions for credit losses, or the amount of money banks set aside to cover bad loans, fell to $174-million, a drop of $40-million from a year ago, as fewer loans were in default.
Profit at the bank's private client group rose by $15-million to $120-million, while the bank reported a loss of $130-million in its corporate services division, That included a $38-million loss related to the integration of the M&I assets, and foreign exchange hedges.
The bank did not raise its dividend, but analysts were not expecting an increase from BMO this quarter. That's because the bank is still digesting the M&I purchase, which also required it to pay back $1.7-billion in funding M&I received under the Troubled Asset Relief Program (TARP) in the United States.
BMO has not boosted its dividend in the wake of the 2008 financial crisis, while most of its rivals have. An increase in the payout is not expected until late this year or early in 2012.
BMO'S CAPITAL MARKETS UNIT PUTS 'FOOT ON THE GAS' IN U.S.
Bank of Montreal's splashy $4.1-billion acquisition of Marshall & Ilsley Corp. has focused a spotlight on the bank's U.S. retail expansion, but the bank's capital markets business has also been expanding south of the border.
BMO Nesbitt Burns has quietly been pouring significant resources into U.S. growth in the wake of the credit crisis. Roughly half of its employees are now based in the United States.
"It really was during that difficult time in the market where we put our foot on the gas to expand and improve our team," said Bill Butt, executive managing director and global head of investment and corporate banking. "In that time period, we've hired about 200 senior professionals worldwide, and about 135 of those were in the United States."
The hiring spree is not over yet, he added. BMO's U.S. capital markets business is still looking to bolster its capabilities in certain industries, having recently created teams dedicated to areas such as fertilizer and insurance. The bank has also put resources into food, consumer and retail capabilities as it works to improve its brand recognition.
The bank is trying to carve out a niche in the mid-capitalization corporate space – companies with a value of roughly $200-million to $5-billion – which are smaller than the bracket U.S. firms tend to target. It is pitching itself as a solid, well-capitalized Canadian bank that can provide both investment banking and lending. And with offices at 3 Times Square, one of the busiest spaces in Manhattan, it is trying hard to get noticed.
"We're bringing services to a set of clients, a client size, who aren't necessarily that well served by other firms," Mr. Butt said.
He's not concerned about putting new resources into the clearly struggling U.S. economy. "We have a magnificent opportunity to take share in this very large market," he said. "Whereas in the domestic Canadian market we're a higher-market-share player and there is less opportunity to grow by way of stealing share from others."
David Weiss, managing director and head of U.S. leveraged finance distribution and trading, suggested that fears about the financial system are somewhat overblown, a sentiment shared by a number of the top people at BMO's capital markets unit in the U.S. Corporations are sitting on a lot more cash and a lot less debt than they were in 2007, Mr. Weiss said.
Besides, investment banking is a service business, and that means that the heart of a financial mess is the place to be, said James Moglia, head of leveraged finance and U.S. debt capital markets.
"If you're a construction guy and there's Hurricane Katrina, you should be in New Orleans," he said.
With files from Tara Perkins
Grant Robertson