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The Bank of Montreal (NYSE:BMO) was the first Canadian bank to report Q4/13 results and the bank easily beat analysts' EPS estimate of $1.58. Adjusted EPS came in at $1.64, which is lower than the $1.65 in Q4/12 but higher than the consensus estimate of $1.58 (see table 1 below). The Q4 results mark a strong finish to fiscal 2013. The bank earned $4.25 billion in fiscal 2013 compared to $4.19 billion in 2012, setting a new profit record this year. Concurrent with the release of the Q4 results, BMO also announced a 2 cent hike in its quarterly dividend from 74 cents to 76 cents. The current dividend yield on BMO is 4.33%, the highest among the big 5 Canadian banks after accounting for the latest dividend hike. Furthermore, the bank announced a 15 million share buyback program.

This article presents a comprehensive analysis of BMO's Q4 results and presents my investment thesis for BMO. Please note all dollar amounts are in Canadian Dollars except for the share price target which is presented in U.S. dollars and represent the price target for BMO's NYSE listed shares. The company's reporting and functional currency is the Canadian Dollar so comparing financial results using Canadian dollar is more representative of the underlying fundamentals. However, the share price target is in U.S. dollars.

Table 1: EPS with Q/Q and Y/Y Comparisons

Q4/13 Q4/12 Q3/13 Y/Y(%) Q/Q(%)
Adjusted EPS $1.64 $1.65 $1.68 -0.6% -2.4%

Source: BMO Q4 Results Press Release. Y/Y represents year-over-year change while Q/Q represents quarter-over-quarter change.

Graph 1: Quarterly Adjusted EPS and Adjusted ROE

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Source: BMO Investor Relations

Graph 2: Annual Adjusted EPS and Adjusted ROE

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Source: BMO Investor Relations

Graph 3: Earnings By Division (Fiscal 2013)

Source: BMO Investor Relations

Regarding BMO's Q4 and fiscal 2013 results, Bill Downe, BMO's CEO, commented in the Q4 press release:

BMO's fourth quarter results mark the finish to a year in which the Bank achieved record revenue, net income and earnings per share, while generating the best one-year total shareholder return among the Canadian banks at 29 per cent. This performance reflects a well-executed growth strategy and the benefits of a diversified business model.

Canadian P&C Banking:

Canadian P&C banking reported adjusted net income of $472 million in Q4/13 and $1,864 million for fiscal 2013. The adjusted net income in Q4 is a healthy 6.3% Y/Y increase but is down 5.6% Q/Q. BMO has made good progress on reducing expenses and has produced positive operating leverage in the past 2 quarters. Loan growth was up 10.5% Y/Y and 2.9% Q/Q. The negative news for the quarter was the decrease in NIM (Net Interest Margin), which decreased 3 bps Q/Q and 13 bps Y/Y. Management has guided for 1-2 bps of NIM compression in the next few quarters as interest rates remain low and competition in the domestic market increases. The net income for this segment is likely to remain in the mid $400 million level for the next few quarters as high single digit loan growth is offset by the decline in NIM. Most of BMO's loans (see graph 4) are residential mortgages, which has extremely low margin because BMO is only allowed to lend to the most creditworthy customers, unlike regulations in the US. Management stated on the conference call that they are tackling the decline in NIM by focusing on cost reduction. As shown in table 2, the efficiency ratio, which is calculated by dividing non-interest expense by total revenue, improved 130 bps since Q4/12.

Table 2: Canadian P&C Banking Data

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Source: BMO's Q4 Press Release and Investor Relations

Graph 4: Canadian P&C Loan Book ($182.5 billion) at End of Q4/13

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Source: BMO Investor Relations

U.S. P&C Banking:

US P&C banking reported adjusted net income of $118 million in Q4/13 and $646 million for fiscal 2013. The Q4 results represent a decline of 24.4% Y/Y and 28.5% Q/Q. The earnings decline was due to larger PCL (Provision for Credit Losses), lower NIM and negative operating leverage. Loan growth was still healthy at 3.6% Y/Y and 2.0% Q/Q but the increase in the efficiency ratio was clearly not positive. A higher efficiency ratio means higher expense relative to revenue. In addition, NIM decreased 39 bps Y/Y and 10 bps Q/Q, which largely contributed to the decline in net income. Management stated that the decline in NIM is due to shifts in the product pipeline. Management expects conditions in its U.S. P&C banking division to improve in the second half of 2014 because of higher rates and a brand new pipeline to meet the needs of its commercial and retail customers. In my opinion, BMO needs to invest heavily in its U.S. P&C banking division to achieve long-term profitability. As RBC (NYSE:RY) learned in the past decade, it needs to go big or go home. Unwilling to invest further, RBC chose to go home instead in 2011 by selling its entire U.S. P&C business to PNC Financial (NYSE:PNC). BMO's poor results in its U.S. P&C banking division is one of the big negatives in its Q4 results.

Table 3: U.S. P&C Banking Division Data

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Source: BMO Investor Relations

Capital Markets:

BMO Capital Markets reported adjusted net income of $229 million in Q4/13 and $1,096 million for fiscal 2013. The Q4 results represent a decline of 27.3% Y/Y and 18.5% Q/Q. The decline in earnings was largely attributable to BMO's trading business, which experienced revenue decline of 17.5% Y/Y and 14.6% Q/Q. The trading business was poor because of worries about the tapering of QE in September and the U.S. debt ceiling debate in October. These two main events eroded confidence in the financial markets and made the trading environment more challenging. BMO's investment banking business performed well as M&A and origination activities are still strong. Despite the profit decline in the capital markets division in Q4, future quarters will improve as the decline in trading revenue experienced in Q4 is temporary. However, the 6.5% increase in the efficiency ratio since Q4/12 is discouraging, which is another negative for BMO.

Table 4: BMO Capital Markets' Data

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Source: BMO Investor Relations. CIB represents the corporate and investment banking division within BMO Capital Markets

Wealth Management:

BMO's wealth management division reported adjusted net income of $319 million in Q4/13 and $1,096 million for fiscal 2013. The Q4 results represent an increase of 88.8% Y/Y and 41.8% Q/Q.

BMO's wealth management division is the best division in my opinion because it generates a high return on capital and is the only division facing a sizable tailwind compared to other divisions which face headwinds. The sizable tailwind is the favourable market conditions, which attract assets under management and result in higher fee income. BMO also managed to reduce expenses in this division as shown by the 13.9% decline in the efficiency ratio since Q4/12. The large positive operating leverage in this business is a bonanza for shareholders.

Table 5: Wealth Management Division Data For Past 5 Quarters

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Source: BMO Investor Relations


There is no doubt that better credit conditions have benefited BMO's bottom line. As shown in table 6, provisions for credit losses have decreased in the past year, although it appears to have bottomed out at $150-200 million per quarter or about 0.25%-0.3% of average total loans. Gross impaired loans, often called non-performing loans, continued to decrease, which is positive. Gross impaired loan formations, which is the amount of new loans classified as impaired in the quarter, also showed a significant decline of 22% Y/Y.

Table 6: Credit Related Data For Past 5 Quarters

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Source: BMO Investor Relations


OSFI, the regulator of Canadian banks similar to OCC/Fed in the U.S., ordered Canadian banks to be fully compliant to Basel III at the start of fiscal 2013. Therefore, BMO's Tier 1 Common Equity Ratio is calculated according to Basel III rules and may appear lower compared to U.S. banks because U.S. banks still use Basel I. As shown in table 7, the Tier 1 Common Equity Ratio improved 30 bps Q/Q to 9.9% but it will be 20 bps lower in Q1/14 due to the CVA (Credit Valuation Adjustment) phase-in. Furthermore, OSFI announced in March that the big six Canadian banks (consists of big 5 plus National Bank of Canada) will be required to maintain a Tier 1 Common Equity Ratio of 8% compared to the Basel committee's recommended 7% guideline. Although none of the Canadian banks were classified as global SIFIs (Systematically Important Financial Institution), OSFI decided that the big 6 banks should be designated as domestic SIFIs, which required them to hold additional Tier 1 capital compared to smaller Canadian banks like Laurentian Bank and Canadian Western Bank. Furthermore, OSFI recently announced that the Canadian banks must meet the Liquidity Coverage Ratio (LCR) requirement of 100% by January 2015, which is earlier than most countries. The LCR was part of the Basel III framework that requires banks to hold enough cash or cash equivalent to pay off short-term liabilities.

Table 7: Capital Ratio (Basel III)

Q1/13 Q2/13 Q3/13 Q4/13
Tier 1 Common Equity Ratio 9.4% 9.7% 9.6% 9.9%

Source: BMO Investor Relations


As discussed above, BMO increased its quarterly dividend by 2 cents and initiated a stock buyback program. The bank declared dividends of $2.96 in fiscal 2013, which represents a payout ratio of 47% and in-line with the payout ratio in 2012 (See graph 5 below). BMO's CEO told investors on the Q4 conference call that the bank is targeting EPS growth of 7-10% in the medium term. Given the bank has a payout policy of 40-50%, I think it's entirely reasonable to expect the current annualized dividend of $3.04 to increase to $3.10-$3.15 by the end of next year.

The bank bought back 10.7 million shares in fiscal 2013 and total capital return to shareholders represented 60% of 2013's adjusted earnings.

Graph 5: EPS vs. Dividends Per Share

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Source: BMO Investor Relations

Investment Thesis:

BMO is a good name to own for dividends and dividend growth. It has been paying dividends for over 140 years and is likely to grow its dividend each year. I expect BMO to continue to raise its dividends in fiscal 2014, with possible hikes in Q2 and Q4. Given BMO's medium term EPS growth target of 7-10% and the 40-50% targeted payout ratio, I believe BMO can bring the annual dividend up to $3.12 from the current $2.96. BMO's investors will benefit from its excellent wealth management division and strong capital markets franchise. BMO's P&C businesses are performing well but the lack of operating leverage is a clear negative. If BMO can grow its P&C revenue and limited expenses as promised on today's Q4 conference call, solid positive operating leverage can be obtained.

Based on price-to-book (PB) multiples, BMO is trading at 1.6X book and 1.9X tangible book. BMO is still the cheapest among big 5 bank stocks due to the fact it also has the lowest ROE. Nonetheless, as shown in graphs 6 and 7, BMO's multiples did expand over the past few months. My 12 month target for BMO is $C80 or US$75.27 using today's USD/CAD rate of 1.066, which is 13.9% higher than the current price of $70.25 and represents a total return of 18.2%. My $75.26 price target is 1.7 times my estimated book value of US$44.29 (fiscal year end 2014). The 1.7 PB multiple is reasonable and in-line with BMO's average PB multiple in the past few years (see graph 7). Table 8 below shows a sensitivity analysis of the U.S. dollar price target. Readers should note that the price target is extremely sensitive to shifts in the PB multiple.

Table 8: Sensitivity of the U.S. Price Target to Changes in EPS Growth Rate and PB Multiples

Source: Author's calculations

Graph 6: BMO's PB Ratio vs. Peer Average

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Source: Bloomberg Data. Peers consist of RBC, TD (NYSE:TD), Scotiabank (NYSE:BNS) and CIBC (NYSE:CM)

Graph 7: BMO's Historical PB Ratio

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Source: Bloomberg Data. SD represents standard deviation


Despite the 4.5% drop in the share price today, BMO reported stellar Q4 and full year results. Its shares advanced 29% (Total Return) in the past year so a short-term price correction should be normal. BMO is still the cheapest Canadian bank stock based on price-to-book multiple. If prices continue to decline, long-term investors may be interested to add BMO to their portfolio given its dividend yield of 4.33% is 1.5 times more than the 10 year Treasury yield.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. This article is for informational purposes only and does not constitute an offer to buy or sell any securities discussed in the article. The stock mentioned in this article does not represent financial advice. The target price presented in this article is based on current information and are subject to change without further notice. Investors are recommended to conduct further due diligence before committing capital to any investment.