Thursday, March 20, 2008

BMO Restructures Apex & Sitka Trusts

RBC Capital markets, 20 March 2008

BMO announced yesterday that all four swap counter-parties and certain investors in Apex/Sitka signed agreements to restructure the trusts.

• By doing so, the bank avoids a near-term write-down of $495 million, saves its clients from losing large sums, reduces the potential of losing clients and facing lawsuits, and eliminates two disputes totaling $1 billion.

• The worst case scenario for BMO is now much worse, although we view the probability as low. The worst case financial loss previously was $1.5 billion. BMO will now own $815 million out of $2.1 billion in subordinated notes, it will be on the hook for a potential $850 million out of $1.15 billion margin facility which will be senior to the subordinated notes ($200 million has already been drawn), and, if mark to markets were to imply losses of 16% or more (or if losses reached that level), BMO has provided protection to swap counter-parties for the remaining $17.4 billion in net notional exposure.

• In essence, BMO avoided crystallizing losses and will be proven right if credit spreads tighten over the next five years and/or North America avoids a deep recession (it would probably reverse much of the write-downs to date as well). It will, however, suffer greater losses down the road if BBB-rated bond defaults surge to record levels.

• If bond defaults were to reach levels that cause losses above 16%, we would expect severe losses across all banks' business loan portfolios, not just in Apex/Sitka.

• We expect an overhang on BMO's share price to remain related to its various off-balance sheet conduits.

Restructuring highlights:

• The term of the notes will be extended to 5 - 8 years to match the term of the swaps.

• A senior funding facility is established, as described above.

• The bank's $705 million ($495 million net) has grown to $815 million.

• The Tier 1 ratio impact of the investment in subordinated notes and senior funding facility is expected to be 25 basis points (currently 9.48% at Jan 31/08).

• The two disputes totaling $1 billion related to the trusts are settled.

• Swap counter-parties appear to no longer have risk.
Scotia Capital, 20 March 2008

Restructuring of Apex/Sitka Trust - No Further Writedowns Expected

• BMO announced that it has reached an agreement in the restructuring of its Apex/Sitka Trust. The bank does not expect to take any further writedowns on the $495 million remaining net investment. Each of the underlying tranches has been rated AAA by DBRS.

• We view the restructuring agreement as a positive for the bank given the alleviation of uncertainty surrounding this issue and the avoidance of future writedowns.

• The terms of the restructuring are as follows:

• Note maturities will be extended to approximately five to eight years.

• An additional $1.15 billion senior funding facility will be provided to satisfy collateral calls. BMO will provide $850 million for this facility, $200 million of which has been advanced.

• BMO will have exposure to the swap counterparties for realized losses that exceed first-loss protection and the posted collateral. First-loss protection threshold is 17% of underlying positions with a range of 9% to 38%. Collateral and senior funding above the first-loss protection levels total approximately $3.3 billion and represent 16% of net notional credit positions.

• BMO will not be providing protection against actual realized credit losses to subordinated note holders.

• Restructuring includes resolution of two commercial disputes for the amount of $1.0 billion which were previously disclosed.

Tier 1 to Decline by 25 Bp

• BMO's total investment in the restructuring is $850 million in the senior funding facility and $815 million in the subordinated notes of the trust. The restructuring will reduce BMO's Tier 1 ratio by 25 bp. The bank's tier 1 ratio is expected to remain strong at 9.23% versus 9.48% at the end of Q1/08.


• Our 2008 and 2009 earnings estimates remain unchanged at $5.05 per share and $5.65 per share, respectively. Our share price target is $65 per share representing 12.9x our 2008 earnings estimate and 11.5x our 2009 earnings estimate.

• BMO is rated 3-Sector Underperform.
The Globe and Mail, Andrew Willis, 19 March 2008

Beleaguered Bank of Montreal finally has some good news, having skirted potential writedowns of up to $1.5-billion by successfully restructuring two asset-backed commercial paper trusts.

BMO announced late yesterday that it has reached a deal that will transform the ABCP trusts in a similar fashion to the restructuring that's being attempted in the rest of the $32-billion third-party ABCP sector.

DBRS structured finance analyst James Feehely said this is "another positive step in the restructuring of the ABCP market."

BMO's shares have been rising this week, moving against the general direction for bank stocks, closing at $42.10 yesterday on the Toronto Stock Exchange, up from Monday's close of $39.15.

The news comes after a lengthy standoff among investors in the Apex and Sitka Trusts. Earlier this month, BMO chief executive officer Bill Downe said the bank had offered to provide additional support to Apex and Sitka, and "we would expect other investors to do the same. The parties have been basically sitting in a standstill mode, and I don't think you can stay that way forever."

By fixing the trusts, BMO has managed to avoid a $495-million writedown that it had warned the market it might have to take.

But it's also cleared up $1-billion in related potential losses. One of Apex's investors had been hanging on to a $400-million funds transfer that BMO wanted back, while a counterparty was not paying back $600-million BMO claimed it was owed. Both of those situations have been resolved.

The restructuring will see investors who hold the trusts' short-term commercial paper exchange those investments for notes with maturities of five to eight years. The longer-term notes are a better match for the underlying assets, and this solution is similar to the proposal to fix the broader third-party ABCP sector.

BMO will supply about $850-million of a new $1.15-billion credit facility to support Apex and Sitka. The bank has already lent $200-million through this credit line.

The bank said that all four counterparties and "certain investors" have signed agreements for the restructuring.

"We are very pleased with the agreement to restructure," stated Tom Milroy, head of BMO's investment bank. "This was a complex deal that was achieved through the efforts of both the investors and the swap counterparties. It is beneficial to these stakeholders and supports the smooth functioning of Canadian capital markets.

"The restructuring will avoid unnecessary losses and will preserve the trusts' underlying positions," he added. "Based on BMO's own evaluation of the credit quality of the approximately 450 obligations and after incorporating the benefit of the substantial first-loss protection, we consider the risk of credit loss to BMO to be low."

Analysts expected pain from Sitka and Apex to be even worse than what BMO had forecast. Blackmont Capital's Brad Smith wrote last week: "It would appear that the potential loss amount is something higher than the remaining $500-million net carried value of the investment in the conduits."

After the restructuring, BMO said its total investment in the notes of the trusts will be about $815-million, and it will have the $850-million in the funding facility. All told, the effect on its Tier-1 capital ratio will only be 25 basis points, the bank said, which will leave it well above the minimum level that regulators require.
Financial Post, Duncan Mavin, 19 March 2008

Bank of Montreal says it has successfully restructured two asset-backed commercial-paper trusts known as Apex and Sitka that had threatened to cost the bank further writedowns.

"We are very pleased with the agreement to restructure," said Tom Milroy, the head of BMO Capital Markets. "This was a complex deal that was achieved through the efforts of both the investors and the swap counterparties."

The bank has already taken $210-million in charges related to the two trusts. BMO had warned more losses would follow if it could not restructure the trusts, although the bank insisted there is still "underlying economic value" in the assets of the trusts. Those writedowns will now not be necessary, the bank said.

The bank has provided additional funding and extended the terms of the two trusts.

BMO's stock price closed Wednesday at $42.10, down more than 42% from its twelve month high. On Monday, it closed at a low of $39.15 as investors punished the bank because of its exposure to the credit crunch.

Last month, the bank reported net income for the first quarter of 2008 fell 27% or $93-million from the previous year. BMO took $490-million of writedowns in the first quarter and announced it has agreed to provide more than $12-billion in funding to two structured investment vehicles (SIVs) that have been hit by the credit crunch.

Citigroup analyst Shannon Cowherd said investors should anticipate continued volatility at BMO in a note issued before the announcement about Apex and Sitka. Ms. Cowherd reduced her target price for the bank's stock from $54.00 to $43.00

The bank has endured a tough twelve months. BMO lost $850-million on a natural-gas trading scandal last year, cut 1,100 jobs at a cost of $159-million as it restructured its domestic retail franchise, and took a $318-million writedown linked to the credit crunch.

Chief executive Bill Downe has vowed to improve the bank's risk management operations in response to the series of costly problems.

"We are reducing the size of our off-balance sheet businesses and seeking a better balance between risk and return," he said last month. "Our risk management group will assume increased direct corporate oversight into risk-return decisions made by the businesses."