Narrow-moat rated Bank of Montreal (BMO) reported worse-than-expected fiscal third-quarter results, missing consensus EPS estimates by a little over 4%. Revenue was up 4.5% while expenses were up 4%, however, year-over-year share repurchases helped EPS to grow roughly 5%. The biggest miss came from provisioning, which shot up to $306 million in the quarter, from a range that was consistently below $200 million in previous quarters. Management emphasized that it does not see any patterns of systemic weakening in its portfolios. A good chunk of the extra provisioning was due to some issues related to a new collections system, where problems making collections in the current quarter caused losses to increase, but management states that those issues are largely solved at this point, and it does not see any evidence of further weakening in its early delinquencies. As such, we would expect this is likely to dissipate over the next several quarters. After making some minor adjustments to our projections, we are lowering our fair value estimate to $103 from $104 for Canadian shares . BMO reported a 13.5% adjusted return on equity for the quarter, bringing year-to-date ROE to 13.7%, roughly 90 basis points below 2018 results. We were already projecting declines in ROE. The bank remains on track to achieve operating leverage for the year, and management stuck to its longer-term goal of a 58% efficiency ratio. The bank did break through the 60% barrier for the first time, coming in at 59.9% in the current quarter.
As we covered above, credit quality did seemingly deteriorate a bit during the quarter, however, it appears to be largely due to idiosyncratic factors, mainly the collection system issues, one commercial credit, and a slightly worse economic outlook. We have long expected credit costs to tick up and normalize for the Canadian banks and do not see anything too alarming in current results. Loan growth continues to be outsized in the U.S. commercial portfolio, but so far this portfolio has performed well.
On a segment level, most areas generally performed fine. Canadian personal and commercial banking had revenue growth of 6% and expense growth of 4%, while net income was up only 1% due to the increases in provisioning. Average deposits were up 11%, while commercial loans were up 16%, both strong numbers. For U.S. P&C banking, loan growth was quite strong, as average loans were up 13%, driven by growth of 16% in commercial lending. However, adjusted net income was down of 1%, due to increases in provisioning as well as declining net interest margins, which were down 25 basis points year over year.
We can appreciate the growth here for BMO, but the bank continues to outgrow the market in the U.S. commercial space, even as NIMs compress (due at least in part to compressing loan spreads), and we are likely closer to the end of a credit cycle than the beginning. So far, credit metrics in the U.S. look fine for the bank, but it will be an area worth watching. The capital markets segment’s performance was solid considering the industry backdrop, with revenue up almost 9% and net income up 5%. Again, this number is still being affected by BMO’s acquisition of KGS in September 2018. Wealth management’s assets under management were up 3%, and net revenue was down 4%, largely due to issues within insurance results. Management announced it has decided to exit the reinsurance space, which should be ROE accretive over time.
