BMO reaps bonanza from recovery of U.S. loans

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Bank of Montreal posted a sharp jump in first-quarter earnings, but the results relied heavily on a windfall from soured U.S. loans – and masked slumping profits in Canada.

Canada's fourth-largest bank by assets reported a surprising 34-per-cent increase in profit during the quarter, with earnings hitting a record $1.11-billion or $1.63 a share. That compared with a profit of $825-million or $1.34 during the same period last year. Revenue rose 18.7 per cent to $4.12-billion.

But as analysts pointed out Tuesday, the profit numbers were perhaps not as spectacular as they seemed. A drop in the number of bad loans in the United States helped prop up other parts of BMO's results, making the overall picture look rosier than it was.

When BMO bought Milwaukee-based Marshall and Ilsley Corp. last year, it took a multibillion-dollar writedown on the U.S. bank's portfolio of loans, expecting that many of them would not be paid back. Less than a year later, however, BMO says it is recovering more of the money than it expected.

That provides a well-timed windfall for the bank. BMO's provisions for credit losses – which are the amount of money set aside to cover bad loans – fell to $141-million from $323-million a year ago.

The extra $182-million at the bank's disposal helped mask more sluggish earnings at its other divisions, including Canadian banking and capital markets – traditionally two of the biggest engines of the bank's balance sheet.

The question facing the sector now is what BMO's performance might say about the broader outlook for banking in the first quarter.

"Over all, it was a solid, if uninspiring start to earnings season," Barclays Capital analyst John Aiken said in a research note to clients. Though BMO's earnings beat some analysts estimates, Mr. Aiken said he did not view the performance as a "high-quality" surpassing of expectations.

BMO is the first bank to report earnings for the quarter, followed by a trio of lenders on Thursday, including Royal Bank of Canada, Toronto-Dominion Bank and National Bank of Canada. Bank of Nova Scotia and Canadian Imperial Bank of Commerce finish off earnings season for the Big Six next week.

BMO's sizable drop in U.S. loan losses made the bank's profits a "noisier number than usual," National Bank Financial analyst Peter Routledge said in a research note. Strip away the boost from those credit provisions and a picture of slimming lending margins and slumping capital markets emerges. Indeed, these are two forces that analysts were expecting would hurt the banking sector in the quarter.

Profit at BMO's Canadian personal and commercial banking segment fell 6.7 per cent to $446-million, amid low interest rates and heated competition for borrowers, which has been shrinking margins for banks. The Canadian banking division also benefited from a significant gain on securities last year, which made this quarter's number suffer by comparison.

BMO chief executive officer Bill Downe brushed off the drop in profit, saying the first quarter for Canadian banking was better than the fourth quarter of 2011. The CEO said the bank's move to introduce five-year fixed-rate mortgages at historically low rates of 2.99 per cent in January helped bring new business in the door. Those rates also caused a price war among banks who rushed to match them.

"We did some things in the new year that I think created energy among the sales force," Mr. Downe said in an interview. He said the bank could not prepare for the massive loan recoveries BMO enjoyed in the quarter, but that it deserved credit for them.

"Recoveries are very lumpy. They occur in some quarters and they don't occur in others," he said. "But I think you deserve credit for those recoveries when you achieve them. You just can't build in an assumption that they are going to occur on a regular basis, quarter by quarter."

However, profit also dropped at BMO's capital markets business, which includes trading and underwriting operations. Earnings fell to $198-million, a drop of nearly 24 per cent from the high trading revenues a year ago, fuelled by upheaval in Europe that heated up the bond market. Analysts expect to see capital markets profits slump across the banking sector this quarter.

BMO capital markets results also reflect a $46-million charge for restructuring the business booked during the quarter. The bank laid off 60 people in the division last week, and has been looking to cut costs.

Profit at the U.S. retail banking division rose to $137-million from $54-million a year ago, helped by the acquisition of Milwaukee-based M&I, which gives BMO a network of several hundred branches throughout the U.S. Midwest.

BMO's private client group, which includes wealth management and insurance operations, made $105-million, down 28 per cent from the same quarter a year ago. Part of the drop was due to lower interest rates, which have been sapping growth from the insurance sector. The bank left its quarterly dividend unchanged at 70 cents.