Narrow-moat-rated Bank of Montreal (BMO) reported fairly strong third-quarter results, exceeding S&P Capital IQ consensus estimates. The bank managed to grow net revenue by 4% year over year, while expenses were down 2%, leading to an increase in preprovision pretax earnings of 12%. All things considered, this is a strong result, as lower interest rates and a more difficult economic backdrop have not managed to slow BMO down with its core earnings power. Provisioning remained elevated, coming in at a little over $ 1 billion, fairly close to second-quarter results, and still elevated compared with a prepandemic run rate of roughly $ 150 million to $ 300 million a quarter. Even with elevated provisioning, adjusted net income was only down about 20% year over year. We were already expecting another large reserve build in the current quarter, and barring a further deterioration in the macro environment, we wouldn’t be surprised to see provisioning trend lower for the next several quarters. There is, of course, a high degree of uncertainty here that will depend on the path of the virus and the economy. The adjusted return on tangible common equity came in at 11%, which is not bad, all things considered. Bank of Montreal's common equity Tier 1 ratio increased to 11.6% from 11% last quarter, as risk-weighted assets flowed off the balance sheet and internal profits both helped increase the ratio. Based on these results, we don’t expect to materially change our $72 ($ 100) fair value estimate for Bank of Montreal.
The biggest story remains the future trajectory of credit costs. The allowance for loan losses continued to increase as provisioning remained elevated, although the PCL was slightly decreased compared with last quarter. Net writeoffs as a proportion of average loans came in at 32 basis points, another increase compared with 25 basis points last quarter. Oil and gas saw elevated write-offs this quarter, as did the services industry. BMO also saw an increase in impaired loan formations and in gross impaired loans. Again, much of this adverse development is largely expected and is already accounted for in the higher provisioning and reserve levels. Management expects loss levels to trend toward a mid-40 basis points level over the next 12 months, so this trend should continue. The latest data from deferrals, as they reach the end of their deferral periods, has tended to be encouraging, as management reports that roughly 90% of commercial deferrals are not seeking to extend these deferrals and are generally not having major credit issues, with some similar stats on the consumer side. Roughly 5% of the loan book is exposed to industries that are more likely to be affected by COVID-19, which strikes us as a manageable level.
All segments of the bank essentially performed well, particularly when considering preprovision earnings. Capital markets made a comeback, reporting its highest net income levels in the last year, while wealth management also saw a strong bounce back in assets under management and net income was also at its highest level in the last 12 months. Canadian property and casualty and U.S. P&C have revenue that have held up well, expense control was very good on the U.S. side, and the main detractor from net income was provisioning for both segments, which both saw a decline in net income year over year.
