Bank of Montreal

Bank of Montreal reported strong fiscal third-quarter results, with adjusted earnings per share of CAD 3.96 up 23% from the prior-year quarter. These results translate into an adjusted return on equity of 14.0%, up 200 basis points year over year but still below the bank's 15% medium-term target.

Why it matters: Adjusted earnings growth was particularly strong in the capital markets and wealth management segments, at 45% and 22% respectively from the prior-year quarter. The capital markets segment's year-to-date adjusted ROE was 16.5%, well above its 15%-plus medium-term target. Global markets revenue increased 27% year over year, mostly driven by higher equities trading revenue. Although the third quarter is usually seasonally weaker in the trading business, we surmise high-profile US IPO filings and artificial intelligence-related trades were strong drivers of higher equity trading volume. Management attributed the bank's strong capital markets performance to market conditions and investments in the business. BMO recently announced the acquisition of the Australia-based capital markets business of Euroz Hartleys Group, adding equity distribution to its strong metals and mining investment banking franchise.

The bottom line: Following third-quarter results, we plan to increase our CAD 197/USD 142 fair value estimate for narrow-moat BMO by a low- to mid-single-digit percentage. We continue to view the shares as overvalued. The valuation increase will mostly be driven by higher capital markets and wealth management revenue, partially offset by the divestiture-related charges and higher compensation expense growth in fiscal 2026. We plan to maintain our outlook for a provision for credit losses ratio of 44 basis points. Amid new tariff announcements between the US and Canada, management guided that the bank's fourth-quarter impaired PCL ratio would be in line with the 41 basis points posted in the third quarter.

A continued and severe tariff situation would lead to higher credit costs and lower balance-sheet growth for BMO as well as the other Canadian banks. That said, potential government support measures would help alleviate the negative impact on the Canadian banks' profitability and returns. BMO also has a strong capital position to weather potentially higher credit costs, with the bank ending the third quarter at a common equity Tier 1 ratio of 13.0%, which is 200 basis points above its current regulatory minimum of 11.0%.

Balance-sheet growth was still somewhat sluggish in the third quarter, with average loans up 3% year over year. We expect loan growth to pick up to around 4% in fiscal 2027 after the bank finishes its US balance-sheet optimization. BMO also announced a new buyback program of 25 million shares, equivalent to around 3.6% of its shares outstanding. We continue to view share repurchases around the current stock price level as being expensive.

We are increasing our fair value estimate for Bank of Montreal to USD 148 from USD 142 per share. Around 22% of the increase is driven by the time value of money, around 67% by higher near-term profitability, and the remaining 11% by a higher terminal-stage return assumption, up from 12.5% to 13%. We raise our adjusted fee income CAGR by 1% to 5.7% from 4.7% from 2025 to 2030, mostly driven by higher wealth management fees and investment banking fees. We also increase our expense CAGR by 0.2% to 3.6% over the next five years. Our fair value estimate is equivalent to 2.5 times the tangible book value as of July 2026. We use an exchange rate of USD 0.72/CAD 1.

We expect loan growth of around 3.1% in 2026, up from the 0.1% decline in 2025, as the bank’s tepid US loan growth weighed on its overall balance sheet. The bank completed most of its US balance-sheet optimization in the first two quarters of 2026, and we expect loan growth to turn positive in the second half of 2026. For net interest margin, we expect 1.63% to 1.65% over the next five years, relatively stable from 1.65% in 2025. Taken together, we forecast a net interest income growth of 2.6% in 2026 and a five-year CAGR of 3.5%.

We expect provisioning for credit losses to be around 42 basis points of loans in fiscal 2026, which is lower than the more than 50 basis points in the past two years but still elevated. On a normalized basis, we expect around a mid-30s PCL ratio for the bank.

We project adjusted noninterest income growing at a CAGR of 5.7% (prior: 4.7%) from 2025-30. We have increased our 2026 fee income forecast in trading and underwriting to incorporate strong results in the first three quarters of 2026. We now expect trading income to grow by 24% and underwriting income to increase 11%. Given the high operating leverage of these capital markets businesses, a negative revision in these revenue forecasts will lead to a larger decline in profitability.

Turning to expenses, we expect total expense growth of 9.8%, or 5.6% excluding the impairment charge related to its divestiture of US vendor finance and intangible amortization. We think the acquisition of Bank of the West added scale to its US banking business, and this better scale should ultimately help BMO's efficiency ratio improve a bit, getting to 55.9%, which is better than the bank’s historical average adjusted efficiency ratio (adjusting for insurance claims out of revenue) of above 60%. However, this misses the management team’s medium-term target of low-50s. Our forecasts lead to an average return on tangible common equity of around 17.8% for the bank in the next five years. Our medium-term ROE forecast for BMO is 13.8%, again lower than its 15% ROE target. We use an 8.6% cost of equity in our valuation.

We believe Bank of Montreal has a Narrow Morningstar Economic Moat Rating because it possesses durable cost advantages and switching costs that are consistent with our bank moat framework. We award the bank a narrow moat rating rather than wide because of its greater exposure to US banking, which we view as less moaty than its Canadian operations, as well as its less dominant market position in its domestic market compared with larger peers such as Royal Bank of Canada or Toronto-Dominion. Nevertheless, we are confident that the bank will consistently earn returns on tangible common equity in the high-teens range and that these returns are comfortably above its 8.6% cost of equity through the cycle.

Bank moats are derived primarily from cost advantages and switching costs, and we believe the Canadian banking environment offers systemic cost advantages and switching costs that lead to returns above the cost of capital, allowing the big banks operating under its jurisdiction to possess moats. In Canada, switching costs stem from a tightly regulated, oligopolistic market structure (the Big Six Canadian banks control more than 95% of market share), which limits competition, stabilizes prices, and reduces customers' incentive to switch banks. Cost advantages stem from a low-cost deposit base, strong operating efficiency, and conservative underwriting, reinforced by a Canadian regulatory environment favorable to the big banks. This combination produces lower operating, credit, and regulatory costs, along with lower and better-diversified risk, supporting higher risk-adjusted returns for the big Canadian banks.

Canada's favorable banking environment stems from several factors. First, barriers to entry are very high. Nonresidents may not own more than 25% of a bank's shares without government approval, and foreign banks face operating restrictions. Domestic competition is also controlled, as exclusive federal chartering control has entrenched a few large banks. Secondly, a protective, efficient regulatory system also drives cost advantages by reducing risk. Regulators need only monitor the Big Six banks, far simpler than overseeing thousands of US banks, fostering collaboration and coordinated responses to strain. Regulators also help control mortgage pricing, limiting pricing wars that erode underwriting standards. Rules curb bad credit issuance through mandatory insurance on riskier mortgages, the absence of a GSE-like subsidized securitization market, and requirements that banks hold more risk on the balance sheet. A higher-tax, stronger safety-net model has fostered a more stable middle class, supporting political stability and further reducing systemic risk. Combined with government subsidies for deposits and mortgage insurance, and the implicit too-big-to-fail subsidy (all Big Six banks are domestic systemically important banks at a minimum), these factors create an environment in which excess bank returns are almost certain in Canada.

Scale further reinforces these cost advantages. Larger scale spreads fixed costs, improving efficiency, as the five largest Canadian banks are all bigger than the largest US regional bank. Nationwide branch networks lower customer acquisition costs. The banks span nearly every major financial product, generating economies of scope in addition to economies of scale.

We view BMO’s Canadian personal and commercial banking segment (contributing around 40% of its revenue) as worthy of a narrow moat. As the fourth-largest Canadian bank, BMO holds around midteens of market share in domestic deposits and loans and doesn’t have dominant shares in most banking products. The bank’s average commercial client tenure exceeds 15 years, which supports the presence of switching costs.

Beyond Canadian banking, BMO derives around 30% of revenue from US banking, % from capital markets, and % from wealth management, and we view each as moaty.

BMO's US business is worthy of a narrow moat, in our view. The bank has a footprint in the Midwest and Western states, with more than USD 280 billion in assets as of Dec. 31, 2025. BMO has built out a decent deposit franchise in the Midwest, as it holds the No. 2 deposit market share in the Chicago-Naperville-Elgin MSA, which accounts for more than 50% of BMO’s US deposits. The bank also has a relatively successful cross-selling of its private wealth to its commercial clients (a penetration rate of 30%), which is better than that of some of its peers. A multiproduct relationship increases customer switching costs.

The wealth management and asset management business' primary moat source is switching costs, and we view BMO as moaty in both businesses. BMO is the third-largest Canadian asset manager and the second-largest ETF provider (shares are fairly close to RBC/iShares). Within its wealth management segment, private wealth management contributes to around half of revenue, with the other half from US wealth, asset management, and discount brokerage and insurance. Domestically, RBC/iShares, BMO, and Vanguard collectively account for more than 65% of the total ETF industry AUM. While Vanguard has taken some share from the other two, we think there’s growth and room for all three large players.

Lastly, BMO derives around 20% of its revenue from the capital markets business. We think BMO's brand recognition provides a competitive advantage in securing investment banking deals and recruiting top talent. It is one of the dominant investment banks in Canada and has particular strength in the mining and materials sector. BMO derives 40%-45% of revenue from the US and mostly competes with boutique investment banks. Of its capital markets segment revenue, around 40% is from its investment banking business and 60% is from its market/trading business. While we don't view its trading business as moaty, it's deeply intertwined with its investment banking business and serves as a crucial part of the bank's value proposition to institutional clients.

Growth and opportunities in the bank's US markets could outweigh any slowdown in its native Canada as US subsidiaries gain market share.

BMO has a lower exposure to the Canadian housing market than peers.

BMO's presence in the Canadian ETF market should pay off as passive investment options gain share in Canada over the next decade.

A large correction in the stock market can lead to an oversized decline in BMO's trading income and overall profitability, given the high operating leverage nature of the business.

BMO is targeting low-single-digit expense growth in its US segment in the medium term, which might lead to underinvestment in its US franchise.

If tariffs are implemented for a prolonged period, the Canadian economy could enter a recession and make the bank see lower growth and higher credit costs.