Periods of rising interest rates are normally good news for bank stocks because it increases the spread between the amount they charge on loans and the interest rate paid to depositors (called the net interest margin or NIM), suggests Gordon Pape, Canadian stock specialist and editor of The Income Investor.
This time it’s different. Although the NIM is improving, investors are worried about the threat of a recession and the impact that would have on loan losses, new loan generations, investment portfolios, and business in general.
As a result, bank stocks have been selling off all summer. Bank of Montreal (BMO) is down 13.4% from $147.11 at the time of our last review in March. It’s not just Bank of Montreal stock that’s taking a beating. The S&P/TSX Capped Financials Index was down 9.2% year to date.
BMO’s third quarter financial results (to July 31) clearly indicated the problem areas. Predictably, NIM was up five basis points from the previous quarter, to 1.76%. But adjusted net income was $2.2 billion ($3.09 per share), down from $2.3 billion ($3.44 a share) in the previous fiscal year.
One reason for the decline in earnings was a swing of $206 million in credit loss provisions. A year ago, BMO reported a $70 million gain from a recovery of previous loan loss provisions. This year, the company booked $136 million against potential future losses, which amounts to 10 basis points as a percentage of average net loans and acceptances.
Another contributor to the downside was BMO Capital Markets, which reported adjusted net income of $266 million, compared with $559 million last year. Global Markets and Investment and Corporate Banking had reduced revenue. Adjusted return on equity was 13.8%, down from 17.6% last year. Common Equity Tier 1 Ratio was 15.8%, compared with 13.4% in the same period of 2021.
The decline in the share price has created one advantage for new investors: the yield on the shares has jumped to 4.4%, which is very attractive for a bank stock. The stock price is close to its 52-week low, and the p/e ratio is only 7.64. There may be a little more downside, but the shares appear to be good value at the current price.