BMO and Scotiabank third quarter profits pressured by mounting expenses, higher loan-loss provisions

Open this photo in gallery:

Two of Canada’s largest banks – Bank of Montreal BMO-T and Bank of Nova Scotia BNS-T – saw their profits stunted in the fiscal third quarter by mounting costs and climbing reserves for loans that could go bad.

Those higher costs and larger-than-anticipated provisions for potentially sour loans are dragging on earnings across the sector as customers reel under the pressure of higher interest rates and inflation.

Bank of Montreal expenses surged 46 per cent to $5.64-billion from the same quarter a year prior, offsetting a 39 per cent boost in revenue as the bank integrates its takeover of California-based Bank of the West, which it expects to complete by early September.

The lender also booked $162-million in severance costs as it shed 2.5 per cent of its work force. The costs related to the staff cuts stretched across the bank, but largely stemmed from the bank’s Canadian personal and commercial banking unit, its corporate division and its capital markets business.

BMO, Scotiabank, RBC: A breakdown of the big banks’ third-quarter earnings so far

The reduction could save the bank about $200-million in expenses in 2024, BMO’s chief financial officer, Tayfun Tuzun, said during a conference call with analysts. The move is part of a broader effort to rein in spending, including reducing the bank’s real estate footprint and finding ways to cut costs as it weaves Bank of the West’s operations into its own.

“As the revenue trends this year have continued to weaken based on the macroeconomic conditions and market conditions, we have signalled that we are paying very close attention to our expense base,” Mr. Tuzun said in an interview. “And that attention is very broad-based. It’s not only about headcount.”

In recent weeks, analysts cut their estimates for the banks’ third quarter results amid concerns that growing economic unease and rising interest rates would bolster risk in lending portfolios and weigh on demand for borrowing. Both BMO and Scotiabank ramped up provisions for credit losses – the funds that lenders set aside to cover loans that may default – more than analysts expected as banks rebuild their reserves from their lows in 2021 during the pandemic.

Defaults have remained low and provisions in previous quarters were driven by loans that were performing, or still being repaid. This quarter, the majority of the reserves that the banks set aside were earmarked for loans that are impaired – at greater risk of not being paid on time.

BMO set aside $492-million in provisions, higher than analysts anticipated. The bank included $333-million against loans that are impaired – a 37 per cent jump from the previous quarter – based on models that use economic forecasting to predict future losses. In the same quarter last year, BMO had set aside $136-million in provisions.

BMO made $203-million of those provisions in its U.S. personal and commercial businesses, up from $69-million in the second quarter.

“We’re proactively addressing the period of volatility that we’re in to deliver consistent and sustained performance,” BMO chief executive officer Darryl White said during a conference call with analysts.

Analysts pressed BMO on the conference call for an updated outlook on the financial benefits that it expects from Bank of the West takeover, but executives said that would appear in next quarter’s results.

During the interview with The Globe, Mr. Tuzun cited increasing activity from Bank of the West customers even before BMO has fully integrated its newest business.

“What usually happens right before conversion is that clients become more hesitant to engage with the bank,” said Mr. Tuzun said. “But the Bank of the West branches have seen a pretty decent uplift in metrics, like the sales performance.”

Scotiabank shed 475 jobs in its Canadian banking unit as expenses increased 9 per cent to $4.56-billion year-over-year. That overshadowed a slimmer 4 per cent hike in revenue driven by narrowing net interest margins – the difference between the amount that banks charge on loans and pay on deposits – as high interest rates cool demand for loans.

Under the tenure of new CEO Scott Thomson, Scotiabank has focused on increasing its weakened deposit base – a valuable source of funding for lenders. The bank’s deposits climbed 9 per cent compared with the same quarter last year, primarily in longer-term savings products that cost more for banks to service.

Rising costs are hitting Scotia’s rivals across the sector as growth in expenses consistently outpaces increases in revenue. Last week, RBC reported that its number of full-time employees fell 1 per cent from last quarter, as workers left the bank. It said it expects to further decrease its work force by 1 per cent to 2 per cent next quarter.

Scotiabank set aside $819-million in provisions, surpassing analysts’ expectations, and included $738-million against loans that are at risk of not being repaid – a 19 per cent increase from the previous quarter. Scotiabank set aside $412-million in provisions in the same quarter last year.

A large portion of Scotiabank’s provisions build came from its international unit, in which loan losses have been higher as many of its markets struggle with heated interest rates and, in some cases, recessions.

Mr. Thomson said during a conference call with analysts the bank has seen recessions in international markets, where interest rates have risen more quickly than in Canada. He said the bank’s “investment-grade bias” and “conservative underwriting standards” in commercial lending has it “very well positioned to manage through this phase of the rate cycle.”

BMO posted a rise in profit that fell below analyst expectations, while Scotiabank narrowly met estimates but booked a drop in net income.

BMO earned $1.45-billion, up 7 per cent from the same quarter a year prior, or $1.97 per share. Adjusted to exclude certain items, including acquisition-related costs, the bank said it earned $2.78 per share. That fell below the $3.09 per share analysts expected, according to Refinitiv.

Scotiabank’s profit fell 15 per cent to $2.21-billion, or $1.72 per share. Adjusted to exclude certain items, including additional income taxes, the bank said it earned $1.73 per share. That matched the $1.73 per share analysts estimated, according to Refinitiv.

BMO and Scotiabank are the third and fourth major banks to report earnings for the three months that ended on July 31. Royal Bank of Canada released results last Thursday, posting a year-over-year increase in profit that beat analyst expectations. Toronto-Dominion Bank also unveiled earnings last week, booking profit that was lower year-over-year and missed analyst estimates.

National Bank of Canada is set to report on Wednesday, and Canadian Imperial Bank of Commerce will do so on Thursday.