Bank of Montreal (JETD)

Bank of Montreal is a bank. That might sound obvious, but it is worth stating plainly. The core job of any bank is straightforward: it collects money from people and businesses that have it, and it lends that money to people and businesses that need it. The bank charges the borrowers more in interest than it pays the depositors. That difference is profit.

Think of it like a borrowing arrangement between friends. You lend your friend $100 at no interest. Your friend lends that $100 to someone else at 5 percent interest. Your friend pockets the 5 percent as profit. Bank of Montreal does exactly this, but at scale, across millions of relationships, and with sophisticated machinery to manage the risk that the person borrowing will not repay.

Taking deposits and making loans

Bank of Montreal takes in deposits. You open a savings account and deposit $10,000. The bank pays you 1 percent interest per year, which costs the bank $100 per year. The bank then lends that same $10,000 to a homebuyer at 5 percent interest, which earns the bank $500 per year. The bank keeps the difference: $400 per year. That $400 is not all profit—the bank has operating costs, salaries, buildings, and computers—but it is the starting pool from which profit comes.

The bank does this millions of times over. It takes deposits from millions of customers, paying interest rates that vary depending on the type of account and current interest rates in the economy. It lends money for mortgages, car loans, business credit lines, and other purposes, charging higher rates to borrowers. The difference between what it pays on deposits and what it earns on loans is net interest income. This is the single largest source of profit for Bank of Montreal.

The tricky part is that the bank is making a bet. When it lends money for a mortgage, it is betting that the homebuyer will pay back that loan over thirty years. If the homebuyer loses their job, gets divorced, or faces some other hardship, they might stop making payments. Then the bank has a loss. Multiply that across millions of loans, and the risk is significant. In good economic times, few people default, and the bank makes good profit. In bad economic times, many people default, losses rise, and profits fall sharply.

Fees and other income

Beyond net interest income, the bank makes money from fees. When you maintain a savings account, you might pay a monthly fee. When you use your debit card to withdraw cash from another bank’s machine, you pay a fee. When you wire money internationally, you pay a fee. When the bank underwrites a bond offering for a large company, it earns an underwriting fee. When the bank manages your retirement portfolio, it charges a percentage of the assets under management.

These fees add up. For Bank of Montreal, non-interest income—which includes all fees—is a material part of total revenue. The importance of fee income varies with interest rates. When interest rates are high and the bank earns a fat spread between deposit rates and loan rates, net interest income is large and fee income is secondary. When interest rates are low and the spread is thin, fee income becomes more important to offsetting the lower net interest income.

Three businesses under one roof

Bank of Montreal actually operates three separate businesses, even though they are all under the same corporate umbrella.

The first is Canadian Banking. This is where the bank takes deposits from Canadians and makes loans to Canadian borrowers. A customer deposits a paycheque into a chequing account. A homebuyer borrows $500,000 to buy a house. A small business borrows $50,000 to buy equipment. The bank earns net interest income from the difference between deposit rates and loan rates, and it earns fees from account maintenance, transactions, and loans.

The second is US Banking. This is essentially the same business, but in the United States. Bank of Montreal owns BMO Harris, a bank that operates across the American Midwest and other regions. It takes deposits from Americans and makes loans to Americans. The advantage of having a US banking operation is that it diversifies the bank’s earnings—it is not entirely dependent on the Canadian economy. The disadvantage is that it adds complexity; the bank has to comply with US regulations, manage currency risk, and deal with a different competitive environment.

The third is Wealth Management. This is a different business model. Instead of taking deposits and making loans, the bank manages money on behalf of affluent customers and large institutional investors. A customer gives the bank $1 million to manage. The bank charges 0.5 percent per year to manage that portfolio—$5,000 per year. That 0.5 percent is profit for the bank (minus the cost of the advisors and analysts). The nice thing about wealth management is that the profit does not depend on lending spreads or net interest income. It depends on attracting more customers and managing more assets. It also has less credit risk—the bank is not lending money and betting that the borrower repays; it is managing the customer’s own capital.

Managing risk

The central job of management at Bank of Montreal is managing risk. The largest risk is credit risk—the risk that borrowers will not repay. The bank tries to manage this by lending to people and businesses with strong income and good payment history, by requiring collateral (like a house), and by not over-lending to a single industry or geography.

Another major risk is interest-rate risk. If the bank holds a portfolio of long-term mortgages at fixed rates, and then interest rates rise, the bank is stuck earning low returns while its competitors earn higher returns. The bank can hedge this risk using financial instruments, but hedging has a cost.

There is also funding risk. The bank depends on deposits to fund its lending. If many depositors suddenly withdraw money at once, the bank could face a funding crisis. Regulators require banks to maintain minimum levels of liquid assets and to show they can survive stress scenarios like a sudden withdrawal of 30 percent of deposits.

There is operational risk: the bank’s computer systems could fail; employees could commit fraud; a cybersecurity breach could expose customer data. There is legal and regulatory risk: new regulations could change the bank’s business model; a lawsuit could expose the bank to large liabilities.

Management’s job is to measure all these risks, set limits on how much risk the bank will take, and ensure the risk is monitored continuously. If things go wrong—the economy weakens, loan defaults spike, the bank loses money on a bad investment—management has to make sure the bank still has enough capital to absorb the losses and keep operating.

Why it matters

Bank of Montreal is important because it is one of the main vessels through which savings flow into productive lending in the North American economy. When you save money in a Bank of Montreal account, you are implicitly lending that money to other people and businesses. The bank acts as the intermediary, matching savers with borrowers and managing the risk.

The bank’s profitability depends on how well it manages that intermediation. In good times, profits are high. In bad times, profits are low or the bank might even lose money. Investors in Bank of Montreal shares are betting on management’s ability to manage this intermediation profitably and to adapt the business as the world changes.

Anyone analyzing Bank of Montreal should ask: How much are deposits costing the bank? How much is it earning on loans? What is the difference—the net interest margin—and is it stable or declining? How many borrowers are failing to repay? Is the bank controlling costs? Is management successfully growing the fee-generating businesses like wealth management? These are the core questions that determine whether Bank of Montreal will remain profitable and grow, or whether it will decline. The answers to these questions are in the bank’s annual 10-K filing (SEC CIK 0000927971) and quarterly earnings releases.