The Bank of Montreal (TSX:BMO) stock is experiencing what should be a temporary weakness this year. Down 10.3% year-to-date, the Canadian bank stock has significantly decoupled from the Hamilton Canadian Bank Equal Weight Index ETF’s performance since May 2024. Income-oriented investors may take this opportunity to load up on the magnificent TSX dividend stock and lock in a lucrative 5.3% yield before Bank of Montreal stock recovers to its historical performance levels.
The Bank of Montreal remains a dividend darling after 195 years of consistent dividend payments, following two consecutive years of dividend growth that could form a foundation which ushers BMO stock into prestigious Canadian dividend aristocrat status. However, the eighth largest North American bank (by assets) is beaten down this year, and dividend investors could find good entry points for a multi-decade holding period of passive income.
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Why is Bank of Montreal stock down?
The Bank of Montreal suffered an unexpected hit in its credit portfolio metrics this year. Heading into fiscal year 2024, BMO expected its provisions for credit losses (PCL) ratio to be in the 30 basis points range. However, subsequent earnings results have shown higher-than-expected provisions for credit losses, and the losses could worsen within the next six months.
What went wrong? The Bank of Montreal’s CFO, Tayfun Tuzun, discussed the challenge during the Barclays Global Financial Services conference this month. While the bank boasts over 55,000 corporate loan customers, 15 loans in its commercial loan book had issues and they accounted for about half of the impairments.
The troublesome loans originated during a period of market exuberance when cheap money flooded markets following the COVID-19 pandemic in 2021 and 2022. Lenders extended credit based on enterprise values to companies, including some private-equity-held companies with business models that thrived during the pandemic but are no longer as viable today.
Worse still, the loans were larger than BMO’s traditional lending profile, and most were shared national credits, meaning the bank had no direct client relationship with the debtors.
Although PCLs may peak over the next two quarters, the worst could be over within the next six months, and the bank expects a return to normalcy sometime in 2025.
A temporary setback?
The recent surge in loan impairments is unusual for the Bank of Montreal. Historically, BMO stock has outperformed peers in loan quality, with PCLs on impaired loans coming in lower than Canadian peer averages in 29 of the past 33 years. This year marks the fifth time BMO underperformed its peers on loan quality in more than three decades. The blip could be temporary.
The COVID-19 era, with its unique opportunities and challenges, is now behind us. Investors expect the bank to review its policies to prevent a repeat of the “deals” that contributed to its current loan health challenges.
Most noteworthy, BMO retains a high credit rating, is well-capitalized, remains profitable, and boasts strong market clout in commercial loans. Despite the recent spike in loan provisions, the overall loan book remains of good quality. The few affected loans will soon be a thing of the past as normalcy returns and the bank works towards achieving its 15% return on equity (ROE).
Why I’d buy BMO stock for the dividend
Canadian bank stocks are traditional sources of reliable and recurring investment income and have lived up to this promise for decades. They are among the well-established dividend-paying stocks that have anchored the TSX’s performance through all economic regimes, and the Bank of Montreal remains one of the best dividend stocks to buy on the TSX today.
The dividend yields 5.3% annually. Its earnings payout ratio has crept up close to 70%, but remains safe and should track back to historical levels of around 60% or below once the current headwinds pass.
Bank of Montreal stock has consistently paid quarterly dividends for 195 years. The bank has recently completed two consecutive years of dividend increases, and investors could expect growing dividend payouts if management sustains this new momentum.
