Royal Bank and BMO profit cut in half as loan loss provisions spike by 500%

Profits at Royal Bank and Bank of Montreal were cut in half from last year in the fiscal second quarter, the banks reported Wednesday, as both said the money they are setting aside to cover bad loans had risen sharply because of COVID-19.

Royal, Canada's biggest bank, and BMO, the fourth-biggest, posted quarterly earnings on Wednesday for the three-month period that ended April 30, a quarter that saw Canada's economy walloped by the coronavirus that causes COVID-19.

The banks are seen as bellwethers for the economy, because their earnings tend to reveal what's really going on at the ground level with companies they lend to. And the numbers for both banks suggest they have growing worries about the loans on their books.

Royal Bank reported adjusted earnings of $1.03 per share, well below the $1.58 that analysts were expecting. All told, Royal made a profit of more than $1.4 billion last quarter. But that's a drop of 54 per cent from what the bank made in the same stretch in 2019.

A big reason for the profit plunge is a spike in loan loss provisions. That's the amount that banks set aside to cover bad loans. Royal hiked its provisions to $2.8 billion in the quarter, a huge jump from $426 million last year.

Almost all parts of Royal's business units saw profits plunge, but most of the damage came in the core personal and commercial banking units, the capital markets division, and wealth management.

On the other side of the ledger, Royal's investor andtreasury services division saw profit rise by 50 per cent to $226 million. And profits in the insurance division rose by 17 per cent to $180 million.

BMO results

Not all of those $2.8 billion worth of loans will necessarily default. But Royal is setting aside that much money to cover potential losses that aren't currently being paid back the way they are supposed to be.

It was a similar story at BMO, which posted adjusted profit of $1.04 per share. Like Royal, BMO's profit was lowerthan the $1.22 analysts were expecting.

All in all, BMO earned $689 million in the quarter, well down from the $1.5 billion last year.

And Bank of Montreal saw the same trend in loan loss provisions, with its figure rising from $176 million last year to $1.11 billion this quarter.

No part of the bank's operations is immune to the damage of COVID-19, as BMO said its personal and commercial banking division in the U.S. and Canada saw smaller profits, as did wealth management. The capital markets unit swung to a loss after being profitable last year.

Shares rise

Both banks maintained their dividends, despite the profit slump. Royal will pay a dividend of $1.08 a share, and BMO will pay $1.06 a share.

While the soaring loan losses were concerning, investors seemed in a mood to focus on the positives on Wednesday, as shares in both banks rose on the TSX on Wednesday even as the S&P/TSX Composite Index fell slightly.

Royal Bank shares were trading at just over $90 apiece nearing midday, up almost three per cent on the day. BMO shares, meanwhile were just below $71 each, up about one per cent.

Analyst John Aiken at Barclays offered one explanation for the optimism, saying in a note to clients on Wednesday that the bad times may have hit bottom. "While we believe that [Royal's] conservatism will allow for better earnings going forward, we are concerned that the earnings comparison to peers this quarter will weigh on its valuation."

As credit downgrades and drawdowns on credit facilities increased, Royal Bank saw a 30-basis-point decline in its common equity Tier 1, the measure of a bank's capital strength, to 11.7 per centof risk-weighted assets from the earlier quarter. BMO's ratio fell to 11 per centfrom 11.4 per cent.

Legally, chartered Canadian banks have to keep those ratios above nine per cent. Otherwise they are obligated to raise more money to keep in their reserves.

Two other banks, Scotiabank and National Bank, reported quarterly earnings on Tuesday that painted a similar picture to the one Royal and BMOpainted lower profits and much higher loan loss provisions.

Canada's two other big banks, Canadian Imperial Bank of Commerce and Toronto-Dominion, will post their numbers in the coming days.