Canadian Rate Cut Winners：BMO， Standing Out Amid Rate Cuts with High Dividend Yield

BMO's business is mainly divided into the following parts:

（1）Canadian Personal and Commercial Banking Services (P&C): Provides savings, loans, insurance, and investment services to retail customers; offers a range of services including business loans and cash management to corporate customers.

（2）U.S. Market Business: In the U.S. market, BMO provides retail and commercial banking services, as well as wealth management services through its subsidiaries.

（3）Capital Markets: Through BMO Capital Markets, it provides corporate clients with equity and bond issuance, mergers and acquisitions advice, and other investment banking services.

（4）Wealth Management: Offers customized investment management, estate planning, and philanthropic services to high-net-worth individuals.

Chart: Composition of BMO's Main Business (%)

In the second quarter of the fiscal year 2024, BMO's net revenue was 7.988 billion Canadian dollars, up 1.68% year-on-year. Thanks to good customer activity and a record performance in debt underwriting, the revenue of BMO's capital markets division increased by 4.73% year-on-year to 1.661 billion Canadian dollars; the adjusted net profit reached 466 million Canadian dollars, up 20.1% year-on-year.

However, in the second quarter, due to strong expectations of interest rate cuts by the Bank of Canada and the Federal Reserve, BMO's personal and commercial banking business in the U.S. and Canada experienced a slowdown in loan growth and intensified deposit competition. The adjusted net profit of the P&C business in both countries was only 1.49 billion Canadian dollars, down 14% year-on-year, which had a significant negative impact on the bank's overall performance.

In terms of profitability, in the fiscal quarter of 24Q2, BMO's adjusted net income was 1.886 billion Canadian dollars, down 9.59% year-on-year, and the adjusted earnings per share were 2.59 Canadian dollars, down 11.6% year-on-year, showing a significant decline in profitability. In addition to the drag of the P&C business, the intensified deposit competition in Canada and the U.S. led to BMO's continued provision of high-interest deposits to retain customers, and the interest expenses also increased accordingly. In 24Q2, this expense amounted to 11.65 billion Canadian dollars, up 30% year-on-year.

In terms of shareholder returns, the dividend amount of BMO in the fiscal quarter of 24Q2 increased by 0.04 Canadian dollars, up 4% compared to the same period last year, showing BMO's determination to increase shareholder returns. Based on BMO's share price of 118.85 Canadian dollars on June 6th, the expected return on investment for shareholders after the increase in dividends is expected to reach 5.23%.

At the end of this quarter, BMO increased its dividend amount by 0.04 Canadian dollars, and the adjusted shareholder return is expected to reach 5.23%, higher than the Canadian risk-free rate of 4.75%. At the same time, at the end of the second quarter, BMO's free cash flow on the books was 3.958 billion Canadian dollars, which can ensure sufficient dividend payments.

Under the background of the Bank of Canada's interest rate cut, BMO's increase in dividend distribution is undoubtedly very good news for investors, which can help investors avoid the loss of investment returns brought by the interest rate cut.

Looking at the performance of the latest quarter, in order to retain customers in the competitive North American banking market, BMO continues to adopt a high-interest deposit policy to compete with peers, leading to an increase in BMO's interest expenses of more than 30% in recent quarters. Fortunately, it was reported that on June 5th, the Bank of Canada took the lead in cutting interest rates by 25 basis points, which is expected to become a timely rain for BMO to save its deposit and loan business.

Generally speaking, in the early stage of interest rate cuts, the deposit rates of banks will not be immediately reduced, so it is expected that BMO's deposit interest expenses will still be under pressure in the short term. However, as time goes on, the decline in deposit rates and the improvement of interest expenses will definitely be a good news, which will help the bank to narrow the loss.

In addition, after the interest rate cut, the loan rates will fall in the short term, which will stimulate customers to apply for higher amounts of mortgages or car loans and other types of loans. If BMO can seize the development opportunities brought by the interest rate cut, attract more loan amounts, and successfully compensate for the decline in single transaction income caused by the decline in interest rates with the increase in new loan amounts, it will further expand its own interest income, and the net interest spread is also expected to return to the previous level.

According to Bloomberg Intelligence, at the end of the fiscal quarter of 24Q2, BMO's exposure to commercial real estate loans in the U.S. was 35.3 billion Canadian dollars (total loans without margin), ranking second among the six largest banks in Canada, equivalent to about 5% of BMO's total loan amount, and the potential bad debt loss is conservatively estimated at 1.8 billion Canadian dollars. Bloomberg analyst Kay said that this may have an impact of up to 15% on the company's earnings in the fiscal year of 2024.

In addition, in the fiscal quarter of 24Q2, the revenue of BMO's U.S. personal and commercial banking business department was only 2.8 billion Canadian dollars, down 10.72% year-on-year. If the bank cannot adjust the development of its business in the U.S. market in time, and avoid the potential impact of bad debts on its U.S. market business, then BMO's future performance will be at great risk.

Facing the current market environment and business challenges, BMO urgently needs to adopt more accurate and flexible strategic adjustments to achieve its own profit growth and market competitiveness. In the U.S. market, BMO needs to deeply analyze the reasons for the current business weakness and formulate corresponding improvement measures, which may include product innovation, optimization of customer service, adjustment of market positioning, or strengthening of partnerships. In addition, although BMO's high-interest deposit policy helps to attract and retain customers in the short term, it also brings greater pressure on the bank's interest expenses.

Under the trend of interest rate cuts, the reduction of interest rates will help the bank's loan amount to increase. If the increase in loan amount is greater than the impact of the decline in single interest income, it can increase the bank's interest income. At the same time, the decline in deposit rates in the future will also reduce BMO's interest expenses, further helping BMO to restore its net interest spread. Therefore, BMO should seize the opportunity of the current interest rate cut in Canada, explore more diversified sources of funds and more cost-effective capital structures, and enhance income by increasing loan yield and optimizing asset allocation.

The current Canadian interest rate has been reduced to 4.75%, and it is expected to be further reduced later. And BMO's expected adjusted dividend rate is 5.23%. In the environment of interest rate cuts, the dividend rate far higher than the risk-free rate will be very attractive. It is recommended that everyone can keep an eye on it.