Weakness in capital markets hurts BMO's Q3

TORONTO - The Bank of Montreal's (TSX:BMO) third-quarter profit rose 20 per cent to $669 million, but still fell short of analyst expectations as weak trading revenue dragged down its capital markets division.

TORONTO - The Bank of Montreal's (TSX:BMO) third-quarter profit rose 20 per cent to $669 million, but still fell short of analyst expectations as weak trading revenue dragged down its capital markets division.

"Obviously the third quarter was a disappointment. It didn't meet our expectations after two quarters that were particularly strong," Tom Milroy, CEO of BMO Capital Markets, said Tuesday on a conference call after the bank reported its quarterly results.

"In the quarter we experienced more volatility, increased client uncertainty and fewer opportunities."

The first major Canadian bank to issue its third-quarter results, BMO reported Tuesday cash earnings per share of $1.14, about seven cents lower than analysts polled by Thomson Reuters had estimated.

In the same period a year earlier, the bank reported net income of $557 million or 98 cents in cash earnings per share — a measure of cash-flow performance. Revenue was down slightly to $2.91 billion from $2.98 billion.

The bank's shares dropped six per cent Tuesday on the Toronto Stock Exchange, closing down $3.56 to $55.50.

BMO Capital Markets was hit particularly hard in the third quarter, with a 58 per cent decrease in profits to $130 million as it contended with weaker trading revenues hurt by the economic uncertainty in Europe. The division had been riding high on several quarters of optimistic trading, but market activity has pulled back in recent months.

The capital markets divisions of Canadian banks are expected to face ongoing challenges in amassing revenue, which largely comes from fee-based services for corporate clients, including trading services, corporate financing, underwriting share offerings, and financing mergers and acquisitions.

Milroy said the decline in BMO Capital Markets' profits was largely the result of widening credit spreads and weakness in the bank's bond-trading business.

"We saw both narrowing margins and declining trading activity and, quite frankly, fewer trading opportunities," he said.

However, Milroy struck a note of optimism, noting that May was a "particularly weak month," while June and July saw improvement.

"We wouldn't expect to see a repeat of Q3 in Q4," he said.

President and CEO Bill Downe said he expects a "business-led recovery" to drive improvements in the bank's results, particularly in the U.S. market, going forward.

"There's a lot of cash in the hands of corporate America.... When you start to see a pickup in capital investment, which I think is inevitable because it has been stalled, we'll see greater (credit) utilization," Downe said, adding that he doesn't expect a double-dip recession south of the border as many economists have been predicting.

Don Reed, president and CEO of Franklin Templeton Investment Corp., said the $180-million drop in revenues is understandable given the thin profit margins available on U.S. Treasurys and bonds.

"The capital markets area isn't a huge surprise, is it?" Reed said.

"It must be difficult to make a dollar in your capital markets division of any firm today. (With) 10-year rates around three per cent, there's not a lot of wiggle room, is there?"

The yield on a 10-year note continues to hover around levels not reached since March 2009, when the stock market hit a 12-year low and investors were concerned about the deepening recession.

On a positive note, BMO said its domestic personal and commercial banking division saw a 17 per cent increase in profits to $426 million, aided by higher revenues across its personal, commercial and credit card businesses.

The bank also reduced its provisions for credit losses during the quarter ended July 31 as the economy improved from last year. The provisions were $203 million lower than a year ago, at $214 million.

U.S. personal and commercial banking profits dropped 27 per cent to US$38 million on higher provisions for credit losses, impaired loans and adjustments to its mortgage portfolio because of lower long-term interest rates, the bank said.

The bank said it will keep its quarterly dividend unchanged at 70 cents per common share.

Barclays Capital analyst John Aiken said the results were "well below" his forecast of $1.27 per share.

"Despite significant declines in provisions and an unusually low tax rate, BMO was unable to offset the declines in its capital markets revenues," Aiken wrote in a note to clients.

However, he said he doesn't expect the weakness in the capital markets' division to last.

"While the trading declines experienced by BMO this quarter reflect the challenging and volatile market environment, we believe that trading revenues will ebb back as conditions improve, albeit at a still much lower run rate than Q2," Aiken said.

Bank of Montreal has more than 37,000 employees across its North American operations, which include retail banking, wealth management and investment banking products, as well as its Chicago-based Harris Bank subsidiary.