Thursday, August 30, 2007

BMO Q3 2007 Earnings

Analysts' ratings and target prices for BMO:

• Blackmont Capital maintains "hold,"

• CIBC World Markets, 12 month target price reduced to $71.00 from $78.00

• Credit Suisse maintains "underperform," 12 month target price is $73.00

• Genuity Capital Markets downgrades to "sell" from "hold," 12 month target price is $69.00

• RBC Capital Markets maintains "underperform," 12 month target price is $69.00

• Scotia Capital maintains "underperform," 12 month target price is $80.00
Financial Post, David Berman, 30 August 2007

It is very unusual for analysts to give Canadian bank stocks "sell" recommendations, given that these investments have a stellar track record of outperforming the index and rewarding investors with steadily rising dividends.

But take a look at Bank of Montreal right now and you will see that no less than four of the 11 analysts who cover the stock have given it the thumbs-down, which is one of the most damning assessments of a bank stock in recent years.

However, rather than squirming over the thought that they may be stuck with a dog, BMO shareholders should take heart: Bank stocks are at their best when they are beaten up and friendless, proven by the recent rebound of Canadian Imperial Bank of Commerce after it wrote off huge losses due to its exposure to Enron.

What's more, while analysts tend to concentrate on the nitty-gritty of a bank's operations, bank stocks are affected far more by the macroeconomic climate. As long as that climate stays healthy, it is hard to envision BMO suffering while its competitors bask in glory.

Mario Mendonca, an analyst at Genuity Capital Markets, is the latest BMO naysayer, but his downgrade has little to do with the current credit crunch that is hitting most bank shares around the world. Instead, he switched his recommendation on the stock to "sell" from "hold" based largely on the bank's slow-growing revenue, too much reliance on trading revenue (which could be fickle) and its inability to grow its market share within Canada.

"Our target price of $69 is based on the bank trading at a 5% discount to its peers," he said in a note to clients.

The stock closed yesterday at $65.40, down 25¢. Curiously, that means Mr. Mendonca's target price still implies a 6% upside over the next 12 months -- more if you include BMO's generous 4.3% dividend yield.

There are certainly reasons to fret over a possible short-term setback in bank stocks. Higher borrowing costs could send the U.S. economy into recession, which would most certainly hit the Canadian economy as well. Also, exposure to investments tied to the U.S. subprime mortgage market, which is now walloping banks as far away as Germany, could blow big holes in earnings somewhere down the road.

"In our view, the prudent course is to wait and watch as the information leaks out over the next one, two or three months," said Nick Majendie, portfolio strategist at Canaccord Adams, in a note to clients yesterday. "During this period of uncertainty, we believe that the odds favour our getting the opportunity to re-establish long-term positions in the Canadian banks at lower and more attractive prices."

However, bank stocks are nothing if not resilient, thanks to their ability to generate huge profits through either growth or cutbacks. For example, BMO has been the poorest performer among Canadian bank stocks this year, with a stock price that is down about 5%. But since the start of the decade, the stock has outperformed the S&P/TSX composite index by a factor of three and still sports one of the best dividend yields in Canada.

The lesson? There may be good and bad Canadian bank stocks over short periods of time, but for anyone with a longer-term horizon just about any bank stock will do.
Financial Post, Duncan Mavin, 29 August 2007

Genuity Capital Markets analyst Mario Mendonca has downgraded Bank of Montreal from a “hold” to a “sell” after the bank’s third quarter earnings report.

BMO’s results showed “little promise on the revenue growth side of the equation” and “challenges in gaining market share,” said Mr. Mendonca. Cost savings from previously announced headcount reductions are not sustainable as the bank will likely redirect funds to initiatives to grow market share, he added.

Mr. Mendonca also highlighted BMO’s reliance on trading as a source of revenue growth as a cause for concern. Of the $193-million increase in revenue compared to the previous year, $107-million, or 85%, came from capital markets excluding trading, and a further $57-million was trading related, he said.

“If the capital markets environment is slowing as management suggested on the [earnings conference] call, how can BMO grow revenue going forward,” asked Mr. Mendonca.

BMO reported profits of $660-million for the quarter, a drop of $50-million from the same period last year. The bank blamed the decline on after tax losses of $97-million related to the winding down of its problem book of natural gas trades.

“Management stated that the fair value of the commodity derivative contracts [declined] from $22.7-billion to $11.5-billion, and stated that it may take a further two quarters to wind down the exposure,” Mr. Mendonca said.

The Genuity analyst’s target price for BMO’s stock of $69 is based on the bank trading at a 5% discount to its peer group, rather than the “modest” 2-3% discount it offers at present, he said.
RBC Capital Markets, 29 August 2007

BMO's core cash EPS of $1.46 were ahead of our expectations of $1.37, and up 13% versus Q3/06. We exclude commodity trading losses of $0.19 per share after-tax, clearly an operating event, although one we exclude given its magnitude. Divisionally, results were ahead of expectations, with growth strongest in capital markets (excluding the commodity losses) and in private client. The quarterly dividend was raised $0.02 to $0.70 per share. We have raised our 2007E cash EPS estimates by $0.10 and our 2008E EPS by $0.05 to reflect higher expected retail earnings.

Maintain Underperform Rating

We continue to believe that BMO's stock is likely to underperform its Canadian peers. The bank trades slightly below the industry median valuation (11.3x versus 11.5x 2008E EPS), a discount that we believe is likely to remain in place as (1) we believe that BMO will struggle to bring its domestic retail revenue growth up to the industry's leading banks at the same time as it embarks on cost cutting initiatives; (2) we expect slower dividend and earnings growth; and (3) the bank derives a higher proportion of earnings from wholesale banking. To be clear, our underperform argument is relative; our 12-month target price of $69 (unchanged) is 5% higher than the current stock price, and the stock's dividend yield is 4.3%.

We remain concerned that Canadian banks could trade sideways or down in the near term on negative news flow out of world financials, as well as potential earnings disappointments in Q4/07. The increased risk aversion and tightening of liquidity, if it continues, could have a much larger impact on wholesale revenues in Q4/07 than it did Q3/07, in our view. The biggest risk to our positive 12-month outlook is that capital market issues become economic issues; a scenario that our economists do not envision at this time.
Scotia Capital, 29 August 2007

• BMO reported cash earnings of $1.30 per share slightly below our estimate of $1.32 per share and below consensus of $1.39 per share. Earnings were impacted by a $149 million pre-tax ($97 million after-tax or $0.19 per share) commodity trading loss in the bank's natural gas portfolio. We expect losses in this portfolio to continue over the next few quarters with total losses reaching nearly $1 billion before the position is fully closed out.

• BMO increased its dividend a very timid 2.9% to $2.80 per share from $2.72 per share, below our forecast of $2.88 per share. BMO's dividend increase was the lowest increase of any bank in the past seven years.

What It Means

• Underlying earnings were solid driven by BMO Capital Markets up 45%, excluding the commodity trading loss, Private Client earnings increasing 26% with P&C Canada earnings up 14% aided by lower expenses.

• We maintain our 3-Sector Underperform rating on BMO based on expected lower earnings growth, low return on equity versus the bank group, and weak strategic positioning and no meaningful P/E multiple discount to the bank group.
AP, 29 August 2007

A CIBC World Markets analyst said Wednesday the big investment banking fees and trading revenue that strengthened Bank of Montreal's profit in the third quarter are not sustainable.

Bank of Montreal said Tuesday it earned $630 million in the third quarter. A big reason was growth in the company's capital markets business, which collected more fees for helping companies issue stocks and bonds and buy one another.

CIBC World Markets analyst Darko Mihelic said this kind of revenue in the capital markets segment is "unsustainable in the current environment."

The capital markets are suffering from fewer buyers and a greater aversion to risk, making it more difficult for investment banks to sell certain kinds of products, he said.

Mihelic cut his price target to $71 from $78. The stock, which lost more than 3 percent Tuesday, closed at $61.75.
The Globe and Mail, Tara Perkins, 29 August 2007

Bank of Montreal said it is working to clean up its natural gas portfolio and put its large losses behind it, but revealed yesterday that the threat of lawsuits or other charges could loom for some time.

BMO has received inquiries, requests for documents and subpoenas from a number of regulators and law enforcement agencies in connection with its surprise announcement in April that it had lost hundreds of millions of dollars from its natural gas-trading activities.

The bank said it's co-operating with the inquiries, which are in the early stages, and doesn't know whether any proceedings against it will arise.

The disclosure came in BMO's third-quarter earnings yesterday, which took a $149-million pretax hit from the commodities trading activities. About half of that loss came as BMO sold a chunk of its natural gas investments. BMO's attempts to reduce risk in the remainder of its portfolio contributed to much of the other half.

That brings the total losses from the trading problem so far this year to $829-million.

"We made considerable progress this quarter to reduce both the size and risk of our commodities portfolio," chief executive officer Bill Downe told analysts on a conference call.

"We're now much closer to where we want to be in our natural gas business," he said.

The bank expects it will take two more quarters to reduce its trading book to the level it wants, Mr. Downe said.

BMO did not name which regulators or law enforcement agencies were pursuing inquiries but, earlier this month, Optionable Inc. - the small New York-area brokerage that BMO used for much of its natural gas trades before the loss - disclosed that it had received a grand jury subpoena from the New York District Attorney's office, as well as requests for information from the U.S. Commodity Futures Trading Commission and the U.S. Securities and Exchange Commission.

Mr. Downe said an internal review of BMO's risk management practices is expected to be complete by the end of its fiscal year, but the bank has already acted on information that has been brought forward.

All told, the bank earned $50-million less this quarter than it did a year ago, after the impact of the commodity losses.

Not including the commodity losses, cash earnings per share were $1.49, while analysts had been expecting $1.39.

The bank also raised its dividend by 2 cents, to 70 cents a share.

BMO also said yesterday that it has $400-million of non-bank asset-backed commercial paper (ABCP) in its trading portfolio, amounting to about 0.1 per cent of its assets. That could expose it to potential paper losses.

Mr. Downe said BMO pioneered the asset-securitization business in Canada, and the bank is a leader in the bank-sponsored programs for short-term commercial paper here. The bank-sponsored programs have not fallen into the same trouble that has been plaguing the non-bank programs lately.

But a shadow has been cast on the whole asset category, Mr. Downe suggested.

"The experience in the subprime markets in the U.S. has coloured a much broader asset category, and many asset-backed securities that contain no subprime exposure are now trading below their intrinsic value," he said, adding that the market will take some time to rebalance.

BMO said it is comfortable with its exposure to U.S. subprime mortgages, which it added is not a material amount.

Meanwhile, the bank's main business line, personal and commercial banking in Canada, saw its earnings rise 1 per cent to a record $350-million. Mr. Downe said that its actual performance was better than those numbers suggest, because the same quarter a year ago included a substantial investment gain and tax recovery.

RBC Dominion Securities Inc. analyst Andre-Philippe Hardy said BMO's core domestic revenue growth trailed that of its rivals that have reported earnings so far. While BMO stole some market share in personal and business lending, challenges continue in mortgages and deposits, Mr. Hardy wrote in a note to clients.

Frank Techar, BMO's head of Canadian banking, said the bank is starting to see positive results from a recent move it made to offer customers Air Miles when they use their debit cards.

BMO's U.S. unit, Harris Bank, saw earnings fall this quarter as it attempts to integrate new acquisitions. Profit at BMO's investment banking division fell 3.4 per cent, partly related to the bank's commodity trading problems.

"With the exception of the commodities business, we had good results in BMO Capital Markets, with revenues in some of our investment banking businesses doubling from a year ago," Mr. Downe said.
Financial Post, Duncan Mavin, 29 August 2007

Bank of Montreal's natural-gas trading losses continue to cast a shadow over the bank as BMO revealed yesterday it may face legal or regulatory action related to the losses which put a dent in third-quarter profit.

Earnings fell to $660-million, a drop of $50-million, or 7%, compared with last year.

The bank blamed the shortfall on $97-million in after-tax losses related to reducing the size and risk of its commodities portfolio.

The bank's cumulative aftertax losses related to the trading activity now amount to $424-million.

BMO also said it could yet face "proceedings" related to the losses and revealed it has received inquiries, requests for documents and subpoenas from "securities, commodities, banking and law enforcement authorities."

Analysts said the natural-gas trading losses, which first came to light in April, continue to cloud the bank's performance.

"Headline risk remains related to the commodities portfolio," said RBC Capital Markets analyst Andre-Philipe Hardy in a note.

"Additional commodity trading losses are a very large spectre looming over the quarterly results," said Dundee Securities analyst John Aiken. BMO's exposure to natural gas trading still stands at more than $11-billion, Mr. Aiken said.

BMO initially estimated its total mark-to-market losses at about $350-million but that figure was later increased to $680-million.

BMO also fired two of its traders in connection with the losses, and suspended its business with Optionable Inc., a New York-based brokerage that had worked closely with the BMO employees who lost their jobs.

In May, Bill Downe, BMO chief executive, said the bank had hired a top New York law firm, Sullivan and Cromwell LLP, to unravel "irregularities" related to the losses.

Meanwhile, Optionable has became the subject of several class-action lawsuits and is also the focus of investigations by the Securities and Exchange Commission and the New York district attorney's office.

The bank said the process of winding down its book of trades will take another six months.

Excluding the trading losses, BMO's profit was up $47-million compared to last year, though the bank's business lines offered a mixed performance.

BMO's domestic retail bank -- which has underperformed compared to its peers in recent periods -- reported net income of $350-million, up $40-million, or 14%, after allowing for the impact of one-time items in 2006.

Personal loans grew 12% compared with last year, but the bank failed to increase its market share of deposits.

"Core domestic revenue growth of 5.2% trails that of the [other Canadian] banks that have reported so far (8% to 9%)," said RBC's Mr. Hardy.

In the United States, BMO's Chicago-based Harrisbank franchise also struggled. Profits were down $4-million or 17% to $26-million. The bank blamed the decline on the cost of recent acquisitions as well as a "difficult economic and competitive environment" in the United States for the decline. The private-client group provided a highlight, with profits up $22-million or 26% to $105-million.

BMO also increased its divided by 2 a share to 70 a share, a hike of 12.9% from a year ago.
Bloomberg, Doug Alexander & Sean B. Pasternak, 28 August 2007

Bank of Montreal, Canada's fourth- largest lender, said its commodities-trading losses swelled by C$97 million ($91 million), weighing on profit for the fourth straight quarter.

Bad bets on natural-gas have cut earnings by C$424 million this fiscal year in the biggest trading debacle for a Canadian bank, and the toll may rise as the company unwinds the remaining C$11.5 billion of investments. Toronto-based Bank of Montreal said in a statement today that it has been contacted by law- enforcement authorities and securities regulators in connection with the trading losses.

``It raises the question, is there more to come here?'' said Ian Nakamoto, director of research at MacDougall, MacDougall and MacTier Inc. in Toronto, which holds Bank of Montreal shares among $4.3 billion of assets under management. ``You would have thought they'd have cleaned that up in the second go-round.''

The mounting cost will make meeting annual profit targets ``extremely challenging,'' Bank of Montreal said. The losses swelled after the bank, which started trading commodities to meet clients' needs, started betting its own money on natural- gas contracts in an ill-fated effort to boost profit.

Bank of Montreal shares fell C$1.52, or 2.3 percent, to C$65.65 at 4:10 p.m. on the Toronto Stock Exchange. The stock has fallen 4.9 percent this year, compared with the 3.1 percent decline of the nine-member S&P/TSX Banks index.

Net income for the third quarter ended July 31 fell 7 percent to C$660 million, or C$1.28 a share, from C$710 million, or C$1.38, a year earlier, Bank of Montreal said in the statement. The company raised its dividend 2 cents to 70 cents a share.

The profit decline contrasts with other Canadian banks, which posted higher earnings in the quarter. Bank of Nova Scotia said today that profit climbed 10 percent to C$1.03 billion, or C$1.02 a share, from C$936 million, or 93 cents, a year earlier.

Toronto-Dominion Bank and Royal Bank of Canada said last week that profits beat analysts' estimates on higher fees from mutual funds and investment banking. Toronto-Dominion said net income rose 39 percent to C$1.1 billion. Royal Bank's profit climbed 19 percent to C$1.4 billion.

Bank of Montreal, which first disclosed the trading losses on April 27, has reported C$849 million in pretax losses for commodities trading in the last four quarters, including C$149 million in the most recent period.

The bank said in May that it failed to supervise commodity traders and relied too heavily on a single broker, Valhalla, New York-based Optionable Inc., to value its holdings. The bank said at the time it may have more losses, or gains, as it reduced the size of natural-gas investments.

Bank of Montreal has been targeting a 5 percent to 10 percent increase in earnings per share.

Excluding one-time items, third-quarter profit was C$1.49 a share, the bank said. That beat the median estimate of C$1.39 a share from nine analysts in a Bloomberg survey. Revenue was unchanged at C$2.6 billion.

Bank of Montreal Chief Executive Officer William Downe, who took over when Anthony Comper retired on March 1, has been trying to generate growth in consumer banking while cutting the bank's risk from commodities.

``We made significant progress in reducing our trading book during the quarter and while further reduction is still intended, it will occur within the ongoing trading activity of the business,'' over the next two quarters, Downe said in a statement today.

The bank reduced the market value of commodities derivatives contracts by about half in the quarter from C$22.7 billion. It incurred about 50 percent of the quarter's trading loss by buying offsetting contracts for ``large proprietary positions.'' The bank also appointed Jeff Poulsen as head of energy trading.

Bank of Montreal's Canadian consumer-banking profit rose 0.9 percent to a record C$350 million from C$347 million a year ago, when the unit benefited from a tax recovery and a gain on the initial public offering of MasterCard Inc. shares.

Profit from the Harris Bank unit, based in Chicago, fell 13 percent to C$26 million as the Canadian currency reached a 30- year high relative to the U.S. dollar.

Bank of Montreal set aside C$91 million for soured loans, compared with C$42 million a year earlier.

Profit from the private-client group, which includes brokerage, investing services and mutual funds, rose 27 percent to C$105 million.

Investment-banking profit fell 3.4 percent to C$196 million, dragged down by the trading loss. Underwriting and advisory fees at the BMO Capital Markets investment bank rose 74 percent to C$160 million, the bank said. Revenue from trading corporate bonds, government securities and interest rate derivatives more than doubled to C$117 million from C$52 million a year ago.

The bank may face ``some headwinds'' in the fourth quarter, BMO Capital Markets CEO Yvan Bourdeau said in a conference call with analysts.

``There's no question that there's turbulence in the financial markets and also there is some clouds on the horizon with regard to the potential credit crunch that may appear in the U.S.,'' Bourdeau said in the call.

Scotiabank's 23 percent increase in domestic banking profit, led by sales of mutual funds, was offset a 3.4 decline in international banking, where the firm had a year-earlier tax recovery in Mexico. It was the first drop in international banking earnings in more than two years. Scotiabank shares fell 62 cents, or 1.2 percent, to C$50.54.

``We'll probably not see the same amount of earnings growth,'' said Juliette John, who helps manage about C$19 billion in assets at Bissett Investment Management in Calgary. ``Capital markets are likely to be weaker going forward and, as loan growth slows and the cycle matures, we'll see some loan losses start to increase.''

Canadian Imperial Bank of Commerce and National Bank of Canada, the fifth- and sixth-biggest lenders, will report results on Aug. 30.
Financial Post, Duncan Mavin, 28 August 2007

Bank of Montreal continues to feel the strain of natural gas trading losses that first came to light earlier this year, with profits suffering as the bank unwinds its troublesome book of commodities trades.

“BMO reported normalized cash earnings per share of $1.30, flat with prior year and $0.13 below our expectation,” wrote Blackmont Capital analyst Brad Smith. Revenue of $2.6-billion also fell $100-million short of Mr. Smith’s forecast.

“Both the earnings and revenue shortfalls resulted from the incurrence of an additional $97-million of commodity trading losses,” Mr.Smith said. “The trade position unwinding process is expected to continue for tow more quarters. Additional losses cannot be ruled out.”

Profits for the third quarter were $660-million, 7% or $50-million down from $710-million last year.

Excluding the impact of the trading losses, earnings per share would have been $1.38. That’s still below the Blackmont analyst’s forecast – Mr.Smith blames the shortfall on “weaker interest margins and higher than expected operating expenses.”

He maintains his 12-month target price of $72.00 for BMO’s stock and leaves his “hold” recommendation unchanged.