Tuesday, March 28, 2006

Veritas on BMO's Q1 2006 Earnings

National Post, Duncan Mavin, 28 March 2006

In the numbers Bank of Montreal's above-expectations earnings for the first quarter of 2006 didn't impress Veritas Investment Research analyst Ohad Lederer too much.

Although BMO reported diluted earnings per share of $1.22 compared to analysts' consensus forecast ranging from $1.17 to $1.21 per share, the figures "were not greeted with applause," noted Mr. Lederer in a report.

In fact, even though BMO also announced an 8.2% dividend hike, it was the only Big Five bank to see its share price decline after the earnings dust settled, he said.

The reason? Perceived low-quality earnings -- too much reliance on trading revenues -- and flat performance in personal and commercial banking, said Mr. Lederer.

"Quarterly trading revenues were $231-million, or $100-million higher than the average quarterly trading revenue of the previous ten quarters," he noted.

Furthermore, while domestic banking revenues were a key earnings driver for Canadian banks in 2005, domestic revenue was up only 0.1% quarter on quarter at BMO. "One main reason for the flat performance was falling deposit market share resulting in increased usage of higher cost wholesale funding, thus crimping margins," said Mr. Lederer.

However, it could have been even worse, if BMO had followed rival Royal Bank of Canada's lead when it comes to accounting for stock options. After carefully comparing BMO's report to RBC's, Mr. Lederer was able to deduce that BMO is continuing to "smooth out" certain stock option expenses for retiring employees, whereas RBC is taking the hit for the same stock options the way companies in the U.S. do -- expense them right away.

The result, according to Mr. Lederer's calculations, is that BMO's results were $42-million ($29-million after tax) better than they would have been if RBC's accountants had prepared BMO's numbers.

"In short," said Mr. Lederer, "the earnings per share effect of [BMO's accounting] was a boost of 5.7 cents, or 4.6% of earnings. Put another way, all else being equal, BMO's results would have fallen short of expectations."

Of course, Canadian accounting principles are sufficiently vague on the matter to allow both banks to report as they see fit.