Wednesday, August 27, 2008

BMO Q3 2008 Earnings

RBC Capital Markets, 27 August 2008

Bank of Montreal's GAAP EPS of $0.98 were well below our $1.20 estimate on much higher than expected loan losses.

• Offsetting the higher loan losses were better than expected revenues in Canadian retail banking and the wholesale division.

• The Tier 1 of 9.9% was up from 9.4% in Q2/08, which is a strong capital position in our view.

Lowered EPS estimates; Maintain Underperform rating

We do not expect loan losses to be this high in Q4/08 and in 2009 but have nonetheless lowered our core cash EPS estimates to $4.70 in 2008E and $5.15 in 2009E (from $4.90 and $5.20, respectively) to reflect the Q3/08 shortfall versus our estimates and model tweaking.

Our 12-month target price of $44 is unchanged. It is based on a P/BV multiple of 1.35x, versus the current 1.5x multiple, and it implies a NTM P/E of 8.6x, whereas the stock currently trades at a NTM P/E of 8.8x.

We maintain our Underperform rating on Bank of Montreal's shares. We believe that BMO's share price is likely to lag its peers' given:

• Our outlook for greater deterioration in credit quality near term, based on the bank's U.S. exposures (although we do expect Q4/08 provisions for credit losses to be lower than in Q3/08);

• Domestic retail banking results that are likely to continue lagging those of the leading banks on a combination of revenue and bottom-line growth (Q3/08 revenue YoY growth was 3% and core earnings were flat);

• Greater concerns over the sustainability of wholesale earnings than most peers as the bank will likely reassess risk appetite; and

• Continued overhang from off-balance sheet exposures (Links, Parkland, Apex, Fairway).
Scotia Capital, 27 August 2008

• BMO cash operating earnings were $1.06 per share versus $1.49 per share a year earlier. Operating earnings were well below our estimate of $1.23 per share and consensus of $1.21 per share due to a $247 million or $0.33 per share credit charge related to two real estate loans purchased from Fairway (BMO sponsored U.S. ABCP conduit) in Q2/08.

What It Means

• Underlying earnings adjusted for U.S. ABCP related LLPs, unusual items and higher trading revenue were strong in the $1.30 per share range. Earnings declined 29% YOY and even on an underlying earnings basis earnings were down 13% YOY. Operating leverage was a negative 1.2%.

• Private Client Group earnings increased 8% with P&C U.S. earnings improving 9% and P&C Canada earnings declining 4% year over year. BMO Capital Markets declined 7% excluding net charges.

• Operating ROE was 14.9% with underlying operating ROE of 17.8%.

• We maintain our 3-Sector Underperform rating on BMO based on lower earnings growth outlook, lower profitability, higher off balance sheet risk, higher dependence on wholesale (36%) and relatively weak operating platforms.
Dow Jones Newswires, Monica Gutschi, 26 August 2008

Bank of Montreal's third-quarter earnings sank by more than 20% in the third quarter, as the lender sharply raised its credit provisions and posted yet another charge for valuation adjustments in its capital-markets division.

The Toronto-based Canadian chartered bank reported third-quarter net income of C$521 million or 98 Canadian cents a share, down from C$660 million or C$1.28 a share a year earlier.

The bank said its cash earnings (a non-GAAP measure) amounted to C$1.00 a share versus C$1.30 a year earlier.

Bank analysts on average had expected Bank of Montreal to earn C$1.21 a share in its latest third quarter.

The results, which were badly hurt by the battered U.S. housing market, bode poorly for the remaining Canadian banks that will report their third-quarter financials this week.

"This is not a very auspicous start to the third-quarter bank earnings," said Fred Ketchen, managing director of stock trading at Scotia Capital Markets. "It does not set things off on a pleasant footing for the rest."

Bank of Montreal is the first of the big six Canadian banks to report third-quarter earnings. It will be followed later Tuesday by Bank of Nova Scotia. Canadian Imperial Bank of Commerce reports Wednesday, and Royal Bank of Canada, Toronto Dominion Bank and National Bank of Canada will release results Thursday.

Shares of all banks were down in early trading in Toronto. Bank of Montreal, which lost 3% at the start, is now off 76 Canadian cents or 1.7% to C$43.30.

Dundee Securities slashed its outlook on Bank of Montreal to sell from neutral, noting the bank "no longer wears the crown of 'low provision bank.'"

Bank of Montreal said its provision for credit losses soared to C$484 million in the latest quarter from C$91 million a year earlier. Analysts had only expected an increase to C$195 million. The bank said C$247 million of those provisions were for two corporate accounts related to the U.S. housing market that were identified as impaired.

That will "obviously raise concerns" about credit provisions at Royal Bank and TD, the other Canadian banks with large U.S. retail operations, Dundee analyst John Aiken said in a note. While there are regional differences in the banks' various exposures, he said speculation would likely hit Royal's and TD's shares "despite the fact that each has reported meaningful increases in provisions over the past few quarters."

Bank of Montreal had also sharply increased its provisions in the first and second quarters and said in May that provisions for the balance of the year would be above the C$170 million recorded in the first quarter given the continued deterioration in the credit environment. It had initially set a target for the year for credit-related provisions of C$475 million; so far, provisions have totaled C$755 million.

The bank also fell short of its goal for return on equity of 18-20%. ROE, a key measure of bank profitability, was 13.5% in the third quarter, while cash ROE was 13.7%. Those results compared with ROE of 18% and cash ROE of 18.2% a year earlier.

Still, the news may not be all bad. Blackmont Capital noted that stripping away all charges and the credit-related provisions, the bank's core cash earnings came in at C$1.42 a share, mainly on strong trading results and better net interest margins.

Aiken at Dundee also noted the bad headline news overshadowed some key improvements in the bank's operations.

"What is truly disappointing is that the operations outside of capital markets and its U.S. real estate business appeared to have performed quite well, generating enough earnings to almost offset the substantial increase in provisions," Aiken said. "However, with little hope that credit issues will fade in the coming months, this positive is unlikely to provide much support as cracks continue to appear in BMO's loan portfolio."

Neither Blackmont nor Dundee have any investment-banking conflicts with Bank of Montreal, nor do the analysts own the bank's shares.

Bank of Montreal said P&C Canada, its Canadian personal and commercial banking unit, had one of its best quarters ever even though earnings of C$343 million were down C$13 million from a year earlier. After adjusting for a recovery of prior years' income taxes in 2007, it said net income in the division improved slightly from a year earlier and was up 3.4% from the second quarter.

Analysts have pointed out that, due to weakness in the capital-markets business and rising risk in the U.S. platforms, the importance of the Canadian banks' domestic retail operations has increased.

Bank of Montreal's U.S. personal and commercial banking operations showed improvement, with earnings up 12% from a year earlier on "solid" volume growth and early signs of spread stabilization in both loans and deposits.

The bank said its private client group delivered record net income in the quarter.

Meanwhile, BMO Capital Markets' results were up from a year earlier but continued to reflect current market conditions with low activity levels in some of its investment-banking businesses. The bank recorded a charge of C$134 million, (C$96 million or 19 Canadian cents a share after tax) in the latest quarter related to the capital-markets environment.

Citing the challenging economic environment, the bank reiterated that it doesn't expect to achieve its annual earnings target, which was for earnings-per-share growth of 10-15% in fiscal 2008.