BMO results lower bar for bank sector

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Bank earnings season is off to a bumpy start as Bank of Montreal , the first of the major lenders to report third-quarter results, missed the mark set for it by Bay Street, causing a sudden lowering of expectations across the sector.

Canada's fourth-largest bank reported a 20-per-cent increase in profit, to $669-million, but the performance of BMO's investment banking division fell short of the bleak predictions analysts had already been making for the quarter.

Analysts and investors were expecting profit of around $1.21 a share from the bank, but BMO came in under at $1.13. The headwinds came as profit plunged 58 per cent to $130-million in the investment banking business, fuelled by a swift drop in trading revenue.

Despite its overall profit, the disappointing numbers pushed down BMO's shares by 6 per cent - their biggest drop in nearly two years. They also shaved a few percentage points off several of BMO's rivals ahead of earnings from Canadian Imperial Bank of Commerce Wednesday followed by Royal Bank of Canada and National Bank on Thursday.

The investment banking slump is driven by investor jitters over European economies and a squeeze in profits on fixed-income trading. It was telegraphed by weak trading profits announced by U.S. banks last month, yet markets were caught off guard by the magnitude of BMO's drop Tuesday.

Trading revenue fell to $145-million in the quarter from $407-million, overshadowing an increase in profit at the retail operations.

"It was the weakest quarter of the year," BMO chief executive officer Bill Downe acknowledged in an interview. "It reflected the reality of markets. I think you saw at the U.S. banks, pretty much across the board, trading revenues were down."

Mr. Downe cited the Greek debt crisis and investor anxiety - particularly in May when European economies reeled - as reasons for the drop in wholesale banking earnings. Smaller profits on fixed-income trades in particular led the declines.

The results further call into the question the sustainability of higher trading revenues, which some analysts have been concerned about in recent quarters given the uncertainty in global markets. To be hit hard on the wholesale side in the third quarter is a reversal of fortunes for the banks, since that business helped them ride out periods of the economic crisis.

"Trading revenue giveth and then trading revenue taketh away," wrote analyst Sumit Malhotra in a research note to clients after the earnings were announced.

BMO's overall profit of $669-million compared with $557-million a year ago. Revenue fell 2.4 per cent to $2.91-billion. As expected, though, smaller loan-loss provisions - the money banks set aside to cover defaults - helped offset the trading declines and push BMO to a profit.

Provisions for credit losses were $214-million in the quarter, an improvement on $417-million last year.

One bright spot for BMO was its Canadian retail banking operations. While its U.S. lending business in the Illinois and Wisconsin region slumped about 27 per cent to $38-million on loan losses, the Canadian side gained. Profit there rose 17 per cent to $426-million, a sign the economy is improving, Mr. Downe said.

Soon after the earnings were unveiled, however, the unexpected drop in trading revenue sent minor shivers through the sector, on fears that banks with significant exposure to trading revenue could also disappoint. It was the first time BMO missed the Street's expectations in nearly two years.

"BMO's results set a poor tone for headline earnings this quarter, particularly for the banks with the largest exposure to trading, such as Royal Bank and Scotiabank," Barclays Capital analyst John Aiken wrote in a research note to clients.

The bank doesn't provide earnings guidance ahead of its quarterly report, so Mr. Downe said he knew the Street would be jarred by the results when they were announced.

"My view going into the quarter was 'it is what it is.' It would come out in the disclosure. I won't say it's without apologies, but it just happens to be what the numbers are," Mr. Downe said.

That said, he figures the sluggish performance in investment banking is a short-term phenomenon that will be less of an issue in the fourth quarter and beyond. "The quarter's over and we're looking forward … and we still feel good about the business," Mr. Downe said.