30 April 2007

RBC CM Initiates Coverage of CIBC at Top Pick

RBC Capital Markets, 30 April 2007


We are initiating coverage of CIBC with a Top Pick, Average Risk rating on its shares.

Investment Opinion

• We believe that revenue growth will continue to lag the industry in the near term but that earnings will likely come in ahead of consensus estimates. We believe that the bank must deliver better relative revenue growth in order to sustain an industry valuation multiple over time.

• However, we do not believe this will be a dominant theme in 2007 given earnings drivers unique to the bank (declining retail credit losses, FirstCaribbean and improving revenue growth on flat expenses). The bank also has a lower credit risk profile and less exposure to potentially volatile wholesale revenue.

• Valuation. Our 12-month price target of $114 is a combination of our sum of the parts and price to book methodologies. It implies a multiple of 13.0x 2008E cash EPS, compared to the current 12.0x multiple on 2007E earnings and a 5-year average forward multiple of 11.9x. Our relatively high price to book target multiple of 3.2x reflects the bank's industry-leading ROE and low credit risk. Our sum of the parts target P/E of 12.4x is slightly below our target average for the banks of 12.6x, as lower exposure to low-multiple wholesale businesses is offset by slower than average revenue growth.

RBC CM Initiates Coverage of National Bank at Underperform

RBC Capital Markets, 30 April 2007


We are initiating coverage of National Bank of Canada with an Underperform, Average Risk rating on its shares.

Investment Opinion

• National Bank trades at a 1.5x P/E discount to the group, in line with its average of the last five years, and we do not believe the discount will narrow in the coming year as EPS growth should lag the group.

• National Bank's current provisioning rate is more at risk of rising than other banks' in our view, retail loan growth has slowed in Quebec due to increased competition, and the company's successful partnership programs with wealth management firms are not yet large enough to offset slower growth in the bank's base market. Securities gains were also abnormally high in 2006. Lastly, the new CEO is replacing one who was very well perceived by the Street, which may cause some unjustified unease among some investors.

• Valuation. Our 12-month price target of $65 is a combination of our sum of the parts and price to book methodologies. It implies a multiple of 11.2x 2008E cash EPS, compared to the current 11.4x multiple on 2007E earnings and a 5-year average forward multiple of 11.3x. Our P/B target of 2.3x in 12 months is at the low end of our target for banks given a lower ROE and a higher risk premium, based on more exposure to deteriorating credit quality. Our sum of the parts target of 11.4x 2008E earnings is below our target industry average of 12.6x, reflecting higher exposure to low-multiple wholesale businesses and slow revenue growth in retail banking.

RBC CM Initiates Coverage of Scotiabank at Sector Perform

RBC Capital Markets, 30 April 2007


We are initiating coverage of Scotiabank with a Sector Perform, Average Risk rating on its shares.

Investment Opinion

• Scotiabank's stock trades at 13.7x 2007E earnings, above its Canadian and U.S. peers (12.9x and 12.6x, respectively).

• Scotiabank holds the most excess capital of the Canadian group and has, in our mind, superior medium- and long-term growth prospects compared to its peers due to its presence in Latin America and the Caribbean. It also stands to benefit more than its peers from a flat to down Canadian dollar.

• However, domestic retail momentum is weaker than average, the bank is more exposed to normalizing business loan losses and Mexican operations are likely to be taxed at a higher rate and see higher loan losses in 2007 than in 2006. We also believe that the valuations of emerging markets assets have benefited from a worldwide decline in risk aversion, a phenomenon that is unlikely to be permanent.

• Valuation. Our 12-month price target of $57 is a combination of our sum of the parts and price to book methodologies. It implies a multiple of 13.3x 2008E cash EPS, compared to the current 13.7x multiple on 2007E earnings and a 5-year average forward multiple of 12.3x. Our P/B target of 2.7x in 12 months is higher than our target average for the banks given a higher ROE and strong capitalization. Greater exposure to emerging markets partly offsets those positives. Our sum of the parts target of 12.8x 2008E earnings is in line with our target average for the banks, as strong performance in the rapidly growing international division is offset by challenges in domestic retail banking relative to other banks and lower exposure to wealth management.
TD Newcrest, 30 April 2007


We are downgrading the stock from an Action List Buy to a Hold, and reducing the target price on the stock from $60 to $57.


Negative. Although our estimates remain unchanged, weakness this quarter in the earnings from the Mexican operation is concerning us and we are lowering our valuation multiples applied to the international division’s earnings. Furthermore, we find that explanations regarding increases in credit losses under Mexican GAAP unsatisfying. We believe greater upside exists in lower risk stocks in the group.


On June 6, 2006, we increased our rating on BNS from Hold to Action List Buy, joining Royal Bank on the Action List. Our rationale at the time was “the banks that will experience the best share price appreciation are those presently willing to take on additional risk to sustain growth”. As can be seen in Exhibit 1, these two banks have performed well over the last 11 months.

We are becoming increasingly nervous about BNS’s growth in lesser developed countries. While country risk premiums are presently at the lowest we’ve ever seen, at some point, we believe an event will eventually materialize that could put into question the valuation the market is placing on the bank’s international earnings. We are anticipating BNS’s international operation to earn 32% of consolidated earnings in 2007.

We believe that the growth that BNS has demonstrated in the international markets has been remarkable, a product of both strong-performing acquisitions and excellent organic growth. The issue we have is that the growth looks too good, and in areas that could be at the front end of the next credit cycle, like Mexican credit card and auto loan exposure. We believe BNS is one of the top providers of credit cards and auto loans in the market today, having ramped up sales efforts materially in the last two years. While the net interest margins earned are spectacular, it generally takes about 18 months for card portfolios to mature sufficiently to gain a good understanding of underlying loss trends.

We are not implying that BNS hasn’t been credit diligent in the Mexican markets. Rather, that present credit loss experience likely doesn’t necessarily reflect “normal” losses because the book is so new. And, if a credit event causes a rush to quality, investor reaction on BNS’s shares could be even more impacted.

Provisions for credit losses (PCL) under Mexican GAAP have increased materially in the last two quarters (Exhibit 2). Management has explained that Mexican GAAP provisions for credit losses can be recorded without an increase in impaired loan formations; that generally speaking, PCLs should increase in line with the growth of the loan book. We don’t quite understand, though, why these PCLs spiked so quickly last quarter, and continued to increase in the most recent period.

In Q1/07, despite increased credit losses under Mexican GAAP, BNS’s Mexican operation reported record earnings of $141mln under Canadian GAAP. On Friday, however, BNS announced that the Q2/07 contribution from the Mexican operations fell to $114million, also down from the year earlier period result of $124 million (see Exhibit 3). Little explanation for the variance has been provided, and we certainly are curious as to the level of credit losses under CGAAP. Acquisitions in Peru and Costa Rica and organic growth in other regions could partially offset the weaker numbers emanating from Mexico this quarter, but we view Mexico as being the key operation.

Competition does seem to be increasing in the Caribbean and Central America, which appears to be attracting more suitors for acquisition targets than before. Management’s decision to invest in Thailand recently, albeit not requiring a lot of capital, was troublesome for us to rationalize. Competitive interest in Asia is significant, BNS holds no advantage of scale, and we believe the challenges of different languages, regulations and systems are significant.

On a side note, BNS is the Canadian bank most exposed to currency translation earnings pressure (40% of BNS’s earnings are denominated in USD and USD correlated currencies).

Justification of Target Price

Our $57.00 BNS target price is a product of adding 50% of the $58.01 value derived from our 2008 P/E multiple of 13.4 times to 50% of the $56.79 value derived by our 2008 price-to-book of 3.06 times.

Key Risks to Target Price

We believe that the four key valuation risks include: a) a deterioration in the geopolitical situation in one of the bank’s international markets (most importantly Mexico); b) a tougher credit environment which could lead to credit losses due to the bank’s more aggressive U.S. corporate lending strategy; c) the bank paying a significant premium for an acquisition; d) the deterioration of the USD and e) a significant increase in interest rates.

Investment Conclusion

The two “over-weights” in our bank portfolio over the last year have been the two that we regard as taking on the greatest risk; RY equity risk, and BNS credit risk. It’s been a good run, but now we feel is the opportune time to begin moving into lower risk investments.

BNS has developed impressive scale and profitability in the Caribbean and Central American markets. Last quarter’s reported 23% ROE, despite holding roughly $4 billion in excess capital, reflects the strong profitability of the international operations.

While BNS management is taking multiple steps to improve their domestic retail and wealth operations, they are clearly second tier in our opinion. We believe the bull markets in equities and credit are long-in-the-tooth, and expect that investors will gradually begin to place greater value in the stability and growth of domestic operations. As a result, we are downgrading BNS to Hold.
Dow Jones Newswires, 27 April 2007

A 20% drop in earnings from Bank of Nova Scotia's Mexico unit "will produce some headwinds to growth" in the quarter, notes Dundee Securities. Although BNS's recent buying spree means Mexico losing ground in bank's overall earnings, it's still a material contributor. And with 1Q GAAP earnings not sustainable, Dundee says 2Q net likely to be 7% lower on sequential basis.

RBC CM Initiates Coverage of TD Bank at Outperform

RBC Capital Markets, 30 April 2007


We are initiating coverage of TD Bank with an Outperform, Average Risk rating on its shares.

Investment Opinion

• TD trades at an industry multiple in spite of having an above average outlook for earnings growth in 2007 and 2008, in our view. We believe TD can achieve above average earnings growth on TD Ameritrade synergies, increased TD Banknorth and TD Ameritrade ownership, and better retail banking momentum in Canada, while being less exposed to business loan loss deterioration and potentially volatile wholesale revenue.

• Ongoing weak fundamentals at TD Banknorth and recently lowered guidance at TD Ameritrade are reflective of market conditions, not permanent issues, in our opinion. We believe that weakness in TD's share price related to short-term issues at those two subsidiaries should be viewed as a buying opportunity.

• Valuation. Our 12-month price target of $78 is a combination of our sum of the parts and price to book methodologies. It implies a multiple of 13.1x 2008E cash EPS, compared to the current 12.9x multiple on 2007E earnings and a 5-year average forward multiple of 12.1x. Our P/B target of 2.4x in 12 months is at the low end of the bank sector given a lower ROE. Our sum of the parts target of 13.5x 2008E earnings is higher than our target industry average, reflecting a superior domestic retail franchise and lower exposure to low-multiple wholesale businesses.

RBC CM Initiates Coverage of Great-West at Outperform

RBC Capital Markets, 30 April 2007


We are initiating coverage of Great-West with an Outperform, Average Risk rating on its shares.

Investment Opinion

• We believe relative multiple (or earnings) upside could come from rapid acceleration in earnings as a result of more favourable currency conversion rates, the integration of announced acquisitions, lower volatility in earnings from accounting changes and potential improvements in U.S. managed care results, as well as lower relative credit risk and exposure to equity markets.

• The European business, which accounts for just under one-quarter of profits, continues to perform well and we feel more upside potential remains.

• We believe that Great-West's share price is temporarily held back by the potential for a share issue to help finance the Putnam transaction. Management indicated at the time of the transaction announcement that it may issue up to C$1.2 billion in equity to finance the transaction, which is a short-term risk to the stock price. This risk is mitigated by our belief that Power Financial will likely subscribe for a large portion of the offer, and we believe that management will favour other types of financing options, if available, and issue less equity than the $1.2 billion figure.

• Valuation. Our 12-month price target of $40 is a combination of our sum of the parts and price to book methodologies. Our P/B target of 3.1x in 12 months is at the high end of our target for lifecos given a higher expected ROE than average (19.3% versus 14.7%). Our target P/E multiple of 13.5x 2008E earnings is in line with the company's 5-year average forward P/E to reflect potential benefits from recent acquisitions, a more accommodating currency and limited exposure to deteriorating credit quality. Offsetting those positives are uncertain equity markets and increased pressure on U.S. healthcare earnings.

RBC CM Initiates Coverage of Manulife at Top Pick

RBC Capital Markets, 30 April 2007


We are initiating coverage of Manulife with a Top Pick, Average Risk rating on its shares.

Investment Opinion

• We believe that Manulife deserves the premium valuation it trades at compared to Canadian financial services companies and life insurers worldwide, based on the company's sales and earnings growth track record, excess capital holdings, growth prospects in Asia and the U.S., and lower credit risk profile than U.S. lifecos and Canadian banks.

• Diversity of operations limits downside earnings risk and reserves appear conservative, with large provisions for adverse deviations relative to reserves and a track record of booking experience gains. The company is well positioned to benefit from rising long-term interest rates and a flat to down Canadian dollar.

• Valuation. Our 12-month price target of $47 is a combination of our P/E, price to book and embedded value methodologies. Our P/B target of 2.8x in 12 months is at the high end of our target for lifecos given a higher expected ROE than average. Our target P/E multiple of 14.5x 2008E earnings is above the company's 5-average forward P/E to reflect potential benefits from higher interest rates, rapidly growing value of new business and a more accommodating currency conversion environment, partially offset by deteriorating credit quality, uncertain equity market performance and lack of benefits from transformational acquisitions. Our target multiple on embedded value of 2.0x is higher than for the other two Canadian lifecos, reflecting higher prospects for growth in value of new business, because of the company's positioning in Asia and the U.S.

RBC CM Initiates Coverage of Sun Life at Sector Perform

RBC Capital Markets, 30 April 2007


We are initiating coverage of Sun Life with a Sector Perform, Average Risk rating on its shares.

Investment Opinion

• The stock's slight discount against Manulife and Great-West is justified, in our view. International platforms are less well established than Manulife, while earnings quality and embedded value growth has been weaker.

• Compared to Great-West, Sun Life is more exposed to changes in accounting standards and deteriorating credit quality and has less upside potential from recent acquisitions.

• Positively, Sun Life is highly capitalized, has exposure to large asset management businesses and has a well-positioned domestic group platform. Also, the company would benefit more than banks from a flat to down Canadian dollar and rising interest rates, while it would be less impacted by deteriorating credit quality.

• Valuation. Our 12-month price target of $57 is a combination of our P/E, price to book and embedded value methodologies. We believe that Sun Life's valuation is likely to trend toward its 5-year average if credit quality weakens and if increases in equity markets slow from recent years. Our P/B target of 2.0x in 12 months is at the low end of our target for lifecos given a lower expected ROE. Our target P/E multiple of 13.0x 2008E earnings is above the company's 5-year average forward P/E to reflect potential benefits from higher interest rates and a more accommodating currency conversion environment, partially offset by deteriorating credit quality, uncertain equity market performance and lack of benefits from transformational acquisitions. Our target multiple on embedded value of 1.6x reflects the mature nature of the Canadian insurance industry and superior growth prospects in Asia.

BMO Commodity Losses Could Hit $450 Million

Financial Post, Jonathan Ratner, 1 May 2007

BMO announcement last week that it would incur a trading loss of $350-million to $450-million, primarily as a result of natural gas trades, not only surprised investors in Canada’s largest banks, it highlighted market risks that may be frequently ignored.

And while trading revenues are somewhat small in proportion to overall numbers, they still represent a hefty chunk of change for the Big Six banks.

For example, BMO’s trading revenue was $665-million in 2006, CIBC had $882-million worth, Bank of Nova Scotia came in at $1.031-billion and Toronto-Dominion Bank brought in $1.042-billion. Royal Bank of Canada topped the list with $2.117-billion, while National Bank had the lowest at $364-million.

These figures, from Desjardins Securities analyst Michael Goldberg, are expected to rise for most of the banks this year, from a total of $6.101-billion for the Big Six in 2006 to $6.589-billion in 2007.

He estimates that BMO’s 2006 trading revenue contributed 3% of its total net revenue of $8.6-billion, the smallest proportionally among its peers. National Bank topped the list with more than 6% from trading.

Mr. Goldberg is particularly troubled by the lack of useful barometers to gauge trading revenue, such as margin or volume, and finds it inconceivable that the banks do not have ways to benchmark their trading revenue, estimate or budget.

“But no one that we have asked has explained how they do it,” he said in a note to clients.

While maintaining a “buy” rating on BMO shares, Mr. Goldberg reduced his price target to $75 from $77, calling BMO “dead money” in the near term.
Financial Post, Duncan Mavin, 1 May 2007

Bank of Montreal's explanation for $450-million worth of natural-gas trading losses has been met with a wave of skepticism by energy-trading industry insiders who say the gaffe was more than a case of the market moving against the bank's star natural-gas trader, David Lee.

On Friday, Bill Downe. BMO chief executive, said the losses were caused by a drop in the volatility of natural-gas option prices to historically low levels, leading to a drying up of demand -- or liquidity -- in the naturalgas options market.

BMO also said the losses were partly caused by "a refinement in [the bank's] approach to estimating the market value of [the natural gas] portfolio."

But some industry insiders disagree with the bank's version of events. "First of all, volatility is not at historically low levels," said an executive of a U.S.-based energy trading business. "Secondly, there has been no dry-up in liquidity whatsoever."

Another executive with decades of experience in the U.S. energy trading markets said, "liquidity is not the issue at all. That's a go-to phrase people like to throw in as it makes it sound like it is not your fault."

Several analysts in the United States and Canada, speaking to the Financial Post on condition of anonymity, offered alternative explanations. BMO's traders simply made bad bets on natural-gas prices, or the bank has discovered that it previously valued their book of natural-gas trades inaccurately, they suggested.

"The meaningful question is, of the [$450-million] how much of it is related to revaluation, and why was the portfolio marked wrong to begin with?" said one energy trading industry insider. "Was it intentional, was it a mathematical model that blew up and no one caught it? It's definitely a lapse in risk management." BMO declined to comment.

Observers also questioned whether BMO exercised sufficient control over its energy trading team, and pointed out that the bank's energy traders were operating in a market that is normally considered high risk.

Standard & Poor's said there might be "some more profound structural issues with the bank's risk-management function."

Blackmont Capital analyst Brad Smith said the losses are "a wakeup call for investors who may not have appreciated how the risk profile of our domestic banks has shifted during the past 20 years, since being encouraged to enter the global capital markets."

The bank's natural-gas trading team is headed by Mr. Lee, considered to be the largest natural-gas option trader in the market. Mr. Lee's trading activity includes buying and selling options over the counter and on the New York Mercantile Exchange, and had proved a lucrative source of profits for BMO for much of last year.

Many of Mr. Lee's trades were conducted through Optionable Inc., a U.S. brokerage house whose stock fell 20% on Friday.
RBC Capital Markets, 30 April 2007


We are initiating coverage of Bank of Montreal with an Underperform, Average Risk rating on its shares.

Investment Opinion

• The stock trades at a slight premium to its peers on a P/E basis, whereas we feel it should be at a slight discount given retail banking challenges in both Canada and the U.S., less room for dividend increases and less earnings coming from retail businesses.

• Recently announced commodity-trading losses also bring into question the wholesale bank's earnings power as well as the strength of the bank's market risk management infrastructure.

• Bank of Montreal's valuation has historically been supported by the bank's potential as an acquisition target and a track record of improving efficiency. However, we do not believe domestic mergers are likely in the near term, and continued improvements in efficiency are proving difficult without hurting the franchise.

• The bank's high excess capital, combined with a conservative credit underwriting approach, limits downside.

• Valuation. Our 12-month price target of $70 is a combination of our sum of the parts and price to book methodologies. It implies a multiple of 12.2x 2008E cash EPS, compared to the current 13.0x multiple on 2007E earnings and a 5-year average forward multiple of 12.5x. Our P/B target of 2.3x book value in 12 months is at the low end of the banking sector given a lower ROE. Our sum of the parts target of 11.7x 2008E earnings is below our target industry average for banks, reflecting higher exposure to low-multiple wholesale businesses and retail banking execution challenges.
Scotia Capital, 30 April 2007

BMO Announces Large Natural Gas Trading Losses for Q2/07

• BMO announced mark-to-market commodity trading losses in the range of $350 million to $450 million or $0.45 per share to $0.55 per share in Q2/07. The losses were the result of positions in the energy market, primarily natural gas, that were hit by changes in market conditions.

• This is very negative given the magnitude of the loss and will likely further shake investor confidence in the operating capabilities of the bank.

• BMO management previously had stated and restated that the commodities trading business was a solid business driven by customer activity and the bank was not taking undue risk. BMO has stated this morning that it plans to reposition the portfolio to lower and sustainable levels.

BMO Valuation Implications

• We are reducing our Q2/07 earnings estimate to $0.83 per share from $1.33 per share to reflect the large trading loss.

• Our guesstimate is that commodity trading represented $0.20 per share in earnings in fiscal 2006 and reduced risk in this area will likely reduce the earnings run rate by $0.10 per share.


• We are reducing our 2007 earnings estimate to $4.90 per share from $5.40 per share while our 2008 earnings estimate remains unchanged at $5.80 per share. Our 12-month share price target is unchanged at $80 per share representing 16.3x and 13.8x our 2007 and 2008 earnings estimates, respectively.

• Reiterate 3- Sector Underperform based on low relative profitability, low revenue growth and weak operating performance in most of its business lines.
Financial Post, Duncan Mavin, 30 April 2007

Bank Of Montreal's $450- million energy trading losses are being linked to a New York based natural gas brokerage house whose stock plummeted 20% on Friday.

Optionable Inc. makes a quarter of its revenue working with BMO's energy trading desk.

Investors apparently made the link to BMO and punished Optionable's stock after BMO chief Bill Downe said the Canadian bank would take on less energy trading risk following the revelation that bad natural gas trades will slice as much as 55? a share off second quarter earnings and take a small bite out of the banks' regulatory capital.

The trading losses are estimated to be between $350-million and $450-million. But the bank said the cost could be even higher because of "subsequent gains or losses depending on future market conditions."

The trades at the centre of the BMO losses were conducted in New York, mostly on the New York Mercantile Exchange (Nymex) and the over-the-counter markets.

While BMO has not confirmed Optionable's involvement in the losses, the U.S. brokerage specializes in trading energy options in the over-thecounter broker markets and on Nymex.

Optionable's founder and chairman, Mark Nordlicht could not be reached for comment. Mr. Nordlicht is also a managing partner of Platinum Partners LP, where he manages an energy-focused hedge fund.

BMO has also been linked to Amaranth Advisors LLC, the U.S. hedge fund that collapsed last September after losing US$6-billion in a single week on natural gas futures.

Mr. Downe told investors on Friday that BMO was Amaranth's prime broker in Canada, meaning it was the primary processor of the hedge fund's energy trades.

Analysts have reacted with dismay to the announcement of BMO's losses from natural gas options -- a field regarded as high risk because it is effectively betting on the future price of natural gas.

The debacle "shakes our confidence," said Credit Suisse analyst Jim Bantis.

National Bank's Rob Wessel questioned how the losses could have happened at a bank where a low appetite for risk has often seemed its strongest asset.

"Given BMO's relatively poor operating performance, we believe many investors took solace in the bank's perceived very low risk profile," said Mr. Wessel. "This viewpoint will certainly weaken."

To explain how the losses arose, BMO's Mr. Downe said the bank ramped up its energy trading activity in the aftermath of Hurricane Katrina, which had caused volatility in the energy markets.

After volatility declined to "historically low levels", the bank said its positions quickly turned sour.

However, at least one senior executive in the commodity trading industry said it is not uncommon for the volatility in natural gas prices to flatten out, as was the case after Katrina

Others have questioned BMO's processes for controlling risk.

Ratings agency Standard & Poors said the losses "might suggest some more profound structural issues with the bank's risk management function."

BMO's Mr. Downe said the bank is conducting a thorough review and will take actions "to address the current situation and reduce the likelihood of a recurrence."

The bank said none of its staff have lost their jobs as a result of the losses.

Mr. Downe, who has only been in BMO's corner office for about two months, has had to endure a tough start to his tenure as chief executive.

In the first quarter of 2006, the bank took a $135-million hit to earnings and revealed plans to slash 1,000 jobs in efforts to revamp its under-performing domestic retail banking unit.

UBS investment research analyst Jason Bilodeau said the trading losses add to a growing list of challenges for the bank. BMO's stock will likely "re-rate" relative to the rest of the banking sector, said Mr. Bilodeau.
Financial Post, Duncan Mavin, Carrie Tait, John Greenwood, 28 April 2007

In late 2005, in the aftermath of the damage wreaked by Hurricane Katrina's passage through the Gulf, natural gas prices soared, and Bank of Montreal's energy trading group saw an opportunity to make some profits.

The increasingly volatile cost of gas was a concern to corporate gas customers. BMO's 25 strong group of energy traders located in offices in Houston, New York and Calgary was ready to cash in.

"Clients wanted to lock in prices and the bank increased its book of business related to this market," said Bill Downe, BMO's chief executive, who yesterday outlined how this lucrative source of earnings turned sour, resulting in trading losses estimated at between $350 million and $450 million.

Back in March, 2006, at BMO's annual meeting in Calgary, the same business was lauded as a success story.

In Canada's energy capital, the bank's then chief Tony Comper issued a first quarter earnings report that stated revenue at BMO's investment banking group increased $35 million, or 5%, "driven by much higher trading income due primarily to heightened volatility in commodities prices, particularly oil and gas."

However, the gas price volatility didn't last and by the latter half of last year, customer demand for the energy trading group's services slowed.

That alone wouldn't have been a problem. But BMO's energy trading business continued to grow, even as prices sank and volatility flattened out.

In particular, BMO's New York energy trading desk was buying natural gas options over the counter and on the Nymex, hoping for a turnaround in demand for energy derivatives that had been so profitable.

Now, Mr. Downe, who has been BMO's chief for less than two months, is the one having to pick up the pieces and explain what went wrong.

"As a bank we assume risk every day in our dealings with customers and the financial markets," Mr. Downe said in an e-mail to BMO staff. "That is the nature of our business and it's also true that things will sometimes have a different outcome than the one we planned for."

The bank's chief also said BMO is conducting a review of the events leading to the losses and is taking actions to prevent the same thing happening again. BMO said nobody has lost their job as a result of the announcement.

Still, some observers are questioning how the debacle could have happened.

Leigh Parkinson, an energy risk consultant at RiskAdvisory in Calgary, said the sheer magnitude of BMO's losses suggests the bank lost track of what its own traders were up to. "How all of a sudden does a $450 million loss just materialize like this?" he said. "Was it a lack of control from a risk perspective or was somebody hiding trades in a desk drawer?"

In recent years, natural gas trading has taken off, attracting players ranging from traditional oil companies to hedge funds and financial institutions.

Some on Bay Street say trading natural gas options is about as wild as it gets. "This is not for the faint of heart," said one oil and gas analyst yesterday.

Several observers also made the link to Amaranth Advisors LLC, the U.S. hedge fund that imploded last September after losing US$6-billion in a single week on natural gas futures.

BMO confirmed it was Amaranth's prime broker in Canada, meaning it was the primary processor of the hedge fund's trades, though not in the United States.

One of the factors behind the downfall of Amaranth and Brian Hunter, its Calgary-based star trader, was that it was common knowledge in the market that Mr. Hunter had made a huge bet on the direction of gas prices. BMO may have run into the same situation, according to Risk Advisory's Mr. Parkinson.

This isn't the first time BMO has been dogged by bad naturalgas trades. The bank posted a $30 million after-tax loss in the third quarter of 2000 after a single commodities trade went sour. The trade was in naturalgas futures, and originated out of BMO's New York investment banking group.

BMO's profit fell by 11 cents in that quarter, and the trader's involvement with the bank ended. The bad trade prompted the bank to put in fresh guidelines to avoid a similar blunder.

"We've got some new protocols so this won't happen again," said Joe Barbera, then a BMO spokesman.

Mr. Comper, who was BMO's CEO at the time, was criticized for the way he handled that situation and the timing of disclosure.

When the bank released its third-quarter results it referred to "weaker capital markets" performance and said there were "some losses" because of commodities, but the bank's executives did not discuss the magnitude of firm's trading troubles.

The details of the sour bet came out three days later.
Financial Post, Duncan Mavin, 28 April 2007

In Bill Downe's first couple of months as Bank of Montreal's chief executive, the corner office suite vacated by Tony Comper has not been a comfortable place.

Yesterday, Mr. Downe's initation at the top of Canada's banking hierarchy got a lot less comfortable as BMO announced it is taking a charge of up to $450 million in the second quarter as a result of commodity trading losses in energy markets.

"Ouch," said UBS Investment Research analyst Jason Bilodeau. The losses, equivalent to lopping about 45 to 55 a share off second quarter earnings, are "a negative data point out of nowhere," he said.

Mr. Downe took over the top job at BMO at the start of March. It is apparent he has inherited "a growing list of operational challenges," Mr. Bilodeau said.

The new chief's inauguration at BMO's annual meeting in Toronto came just weeks after his predecessor had announced 1,000 staff are to lose their jobs. The reorganization slashed $135 million from first-quarter profit, which fell 3.4% compared with the same period last year.

Meanwhile, BMO's Harrisbank subsidiary based in Chicago met with a potentially daunting threat this week. If all goes according to plan, Bank of America, the dominant retail bank in the United States, is set to muscle in on BMO's turf after announcing on Monday a proposed deal to pay US$21 billion for LaSalle Bank, one of Harris's main rivals.

In an e-mail sent to BMO staff, Mr. Downe expressed his disappointment at the latest problem. "In a situation such as this, the CEO must take responsibility," he said. "I take that responsibility."

Despite obvious concerns about the losses, Mr. Downe was keen to play down the impact. "The size of the loss is small in relation to the capital of the bank." The trading losses "will not impact the strategy or momentum of the company," he added.

Mr. Downe said BMO is "conducting a thorough review and actions have been taken to addess the current situation and reduce the likelihood of a recurrence." He said he is comfortable with "the direction the bank's trading activity has taken in the past."

He said there are no other businesses that BMO is in that would fit the same profile as the energy trading business, adding it will take on less commodity trading risk in future.
The Globe and Mail, Boyd Erman, 28 April 2007

Bank of Montreal has been steadily ramping up its trading business, but it is still among the lenders that is least reliant on trading to pump up profit.

In 2006, the bank brought in $633-million from trading, more than triple the total just two years prior, but that still was only 6 per cent of overall revenue.

By comparison, the massive trading desks at Royal Bank of Canada's operations in cities like Toronto, New York and London generated 14 per cent of overall revenue.

But Bank of Montreal has a much bigger exposure to commodities, with value at risk (the most the bank estimates it could lose in a single day) of $16.8-million, compared with $1-million at Royal Bank, according to figures compiled by Credit Suisse.

This isn't the first time the Bank of Montreal's commodity trading operations have cost the bank money. In the spring of 2000, it incurred a $30-million trading loss in commodities.

This time, according to Bank of Montreal, liquidity and volatility dried up in the natural gas market, driving down the value of derivatives it held.

Volatility is important because options, for example, are more valuable when there are wild swings in gas prices. That's because those big moves increase the chances of the commodity reaching the strike price of the options - putting them "in the money."

Liquidity, or the amount of trading, is important because it means there are willing buyers when a firm like Bank of Montreal needs to sell.

The problem is that when volatility dries up, liquidity tends to disappear too because traders need volatility to make money.

Traders at rival firms said there's a good chance that some of Bank of Montreal's losing positions are in gas trades based on the Alberta market, which is notoriously thinly traded and prone to causing such blowups.

What could bail Bank of Montreal out?

A big storm or hurricane that throws the gas market into turmoil would likely bring back volatility and liquidity in a hurry. June 1 is the official beginning of the Atlantic hurricane season.
Dow Jones Newswires, 27 April 2007

Several factors converged to cause steep losses for a Canadian bank in the natural gas futures market, bank executives said during a conference call Friday.

Bank of Montreal lost up to C$450 million ($403.4 million) in natural gas trades gone bad, company executives said in the conference call, ahead of the bank's second quarter earnings call on May 23.

The bank is said to have incurred the losses during its second quarter, which runs from Feb. 1-April 30, and as the portfolio is "repositioned," it could "experience subsequent gains or losses, depending on future market conditions."

The bank owed its losses to expanding its trading portfolio in gas futures in the latter part of 2006, said Bill Downe, the bank's president and CEO.

"Because of market making activities, we were unable to anticipate lack of liquidity would emanate from sharp decrease in volatility," he said.

Volatility dropped from 70% to 40% in the quarter.

Volatility in natural gas futures generally declines, if at all, during the "shoulder season," or in April and May, when demand for gas to heat or cool homes is generally slack and the market builds inventories to meet summertime cooling demand and wintertime heating demand.

"They must've had a view that the market would either maintain that level of volatility or exceed that level of volatility," said energy analyst Tim Evans, with Citigroup in New York. "That was their apparent position, if the source of their loss was a drop in volatility."

Natural gas futures traders capitalized on the bank's losses Friday, spurring a rally that boosted gas futures prices 3%. June gas futures on the New York Mercantile Exchange traded lower initially Friday morning, then began rallying in late morning floor trading.

Traders smelled blood in the water after the bank announced its losses and funds began "squeezing the shorts," sparking a rally, one trader said.

"If traders hear of a short squeeze because someone in trouble is getting out, they are not going to show offers in the market," the trader said. "There's not really much to say other than this is a classic squeeze."

On the first day of trading as the front-month contract, Nymex June gas futures settled 22.9 cents, or 3%, higher at $7.831 a million British thermal units. The sharp rally came as a surprise to some in the market that saw mild weather and low demand for the fuel amid an expected increase in gas inventories as reasons to sell the commodity.

BMO is the fourth-largest bank in Canada, but its commodity-trading business is about 15-20 times larger than that of Royal Bank of Canada, the largest bank in Canada, said Mario Mendonca, an equity analyst with Genuity Capital Partners.
Bloomberg, Doug Alexander and Sean B. Pasternak, 27 April 2007

Bank of Montreal said it lost as much as C$450 million ($404 million) from natural gas trading, just seven months after similar bets led to the collapse of hedge fund Amaranth Advisors LLC.

The pretax loss will reduce profit by 45 cents to 55 cents a share in the second quarter, or more than a third of forecast earnings, Canada's fourth-biggest bank said in a statement today. The Toronto-based company was expected to earn C$1.32 a share when it reports May 23, based on a Bloomberg survey.

``The loss that we announced today is outside our tolerance,'' said Chief Executive Officer Bill Downe, on a conference call with analysts. Downe took over last month when former CEO Anthony Comper retired.

Bank of Montreal has more at stake in commodities and foreign-exchange trading than any of its Canadian rivals, and its clients included Amaranth. The hedge fund collapsed last year after Calgary-based trader Brian Hunter lost about $6.6 billion betting on natural gas prices. Downe confirmed for the first time today the bank was a prime broker for the hedge fund in Canada.

Bank of Montreal shares fell C$1.27, or 1.8 percent, to C$70 at 4:10 p.m. on the Toronto Stock Exchange, the biggest drop in two months.

Bank of Montreal's overall trading revenue more than doubled in the first nine months of fiscal 2006 to C$564 million, outpacing gains at all of its rivals, before slowing after the September collapse of Amaranth. Trading revenue declined 59 percent to C$69 million in the fourth quarter and 62 percent to C$136 million in the first quarter this year.

``We think this raises significant questions about Bank of Montreal's trading business strategy and general risk oversight and management,'' UBS AG analyst Jason Bilodeau said today in a note to clients.

The bank said the energy trading market, primarily natural gas, became ``increasingly illiquid'' and price swings, or volatility, dropped to historically low levels. The bank also changed the way it estimates the market value of its trading portfolio.

``It's really in the last eight weeks that we have seen the move in the market and it's outside the range of what we have experienced,'' Downe said. He said the bulk of the commodities trading was done in the U.S., and the traders involved remain with the firm. Bob Moore, the executive managing director and head of the commodities group in New York, said he couldn't comment.

Natural gas prices traded within a $1.22 range in the bank's fiscal second quarter. That compares to a range of $3.37 during the same period a year ago. Increased volatility makes it easier for traders to make bets on gaps in prices between different natural gas contracts. That volatility declined in the second half of 2006, and the bank was left with more ``out of the money'' natural gas options contracts, Downe said.

``When you have a more narrow range you definitely have less volatility,'' said Bruno Stanziale, an energy derivatives marketer at Bank of America Securities in New York. ``We've seen volatility dry up.''

Downe said the bank may post additional losses, or gains, as the size of the energy portfolio is reduced. Those losses would be ``in a substantially lower range'' than the C$350 million to C$450 million announced today, he said.

Downe said the bank will reduce its bets on commodities trading.

``The amount of risk and the volume of trading risk in the commodity business is higher today than it's going to be, and when it comes down it's going to stay down,'' Downe said.

Bank of Montreal relied on trading, including equity and fixed-income, for about 6 percent of total revenue last year, tied with Bank of Nova Scotia and Toronto-Dominion Bank for the lowest rate among Canada's six biggest banks, according to Dundee Securities estimates.

``It's a bit of a double-edged sword,'' said Ian Nakamoto, director of research at MacDougall, MacDougall and MacTier Inc. in Toronto, which manages the equivalent of about $3.9 billion, including Bank of Montreal shares. ``When they call it right, it looks good for investors. When they don't call it right, it's not so great.''

The bank said its so-called Tier 1 capital ratio at the end of the first quarter was 9.9 percent, and the impact of the losses will be less than 20 basis points. The ratio measures a bank's equity as a percentage of assets.

Canadian Imperial Bank of Commerce, the fifth-largest bank, said in a statement it hasn't experienced any ``unusual'' gains or losses from commodities trading.

The trading loss for Bank of Montreal is one the largest ever for a Canadian bank, trailing some corporate lending losses at its rivals. In 2005, Canadian Imperial set aside $2.4 billion to resolve claims by Enron Corp. shareholders, leading to the biggest quarterly loss in its history. Toronto-Dominion, the country's second-largest bank, set aside C$2.93 billion in 2002 to cover loan losses after borrowers such as Teleglobe Inc. couldn't pay their debts.

National Bank of Canada spokesman Denis Dube said the Montreal-based bank hasn't had ``any unusual market behavior in any aspect of our commodities trading.'' Royal Bank of Canada spokeswoman Jackie Braden and Toronto-Dominion spokesman Simon Townsend declined to comment. Bank of Nova Scotia spokesman Frank Switzer didn't immediately return a phone call seeking comment.
Dow Jones Newswires, 27 April 2007

Standard & Poor's Ratings Services said today that its ratings on Bank of Montreal (AA-/Stable/A-1+) and its subsidiaries will not be affected by today's announcement of mark-to-market commodity trading losses estimated between C$350 million-C$450 million, pretax, which will be recorded in the second quarter of 2007. At the current ratings level, this one-time hit can be tolerated; however, this development might suggest some more profound structural issues with the bank's risk management function. We will continue to monitor developments in the company's trading risk management practices
The Globe and Mail, Tavia Grant & Tara Perkins, 27 April 2007

Bank of Montreal said Friday pretax commodity trading losses of between $350-million and $450-million will eat into second-quarter results.

The impact of this to the bank's second-quarter financial results, to be released May 23, is seen at between 45 cents and 55 cents a share. Much of the losses stemmed from betting the wrong way on natural gas.

Canada's fourth-biggest bank isn't the only one caught on the wrong side of a natural gas position. Amaranth Advisors LLC collapsed last year as more than $6-billion (U.S.) evaporated, in the biggest hedge fund failure ever.

But there do not appear to be any direct links between the Amaranth collapse and BMO's losses.

“We were not a prime broker to Amaranth in the United States, where our business centred,” said BMO chief executive officer Bill Downe on a conference call with analysts. “I do understand that we provided prime brokerage facilities to their Canadian operation.”

BMO shares slipped 1.9 per cent on the news.

Mr. Downe said that he's comfortable with the bank's trading strategy. “When I said that our trading revenue as a percentage of the total revenue of the company has historically been less than our competitors, that has been deliberate,” he said. “We have managed our trading businesses, all of them, for profitability, definitely not for league table status.”

The loss in the commodity business is “outside our tolerance,” he added, and “we will take less trading risk in the natural gas commodity area.”

Swings in commodity prices and a slowdown in the U.S. housing market may mean more financial institutions will take a hit, a money manager said.

Stephen Gauthier, a partner at Gauthier & Cie. in Montreal, which has cut its BMO holdings in recent months amid tepid revenue growth, said he “was surprised, it's quite a big number, it's certainly not positive for the bank.”

Analysts at Credit Suisse said they're “quite troubled” by the bank's risk management and oversight. It cut its rating on the stock to “underperform” from “neutral” and lowered its earnings estimates for 2007 and 2008.

“I guess you could look at it and say it's only 50 cents (Canadian) on a $70 stock, but one way of looking at it is that Bank of Montreal's total trading revenue last year was $665-million, and we've got a $400-million loss, so it's quite substantial compared to their trading revenue,” Bruce Campbell, president of Campbell & Lee Investment, told Business News Network.

Mr. Gauthier added that he thinks “financial institutions will see more and more problems like this down the road, so we have to be careful.”

CIBC said Friday that, to date, it “has experienced no material or unusual gains or losses in relation to its commodity trading activities.”

BMO's positions in the energy market in the quarter, primarily for natural gas, were sideswiped by changes in market conditions as the market became illiquid and volatility dropped to historically low levels, the bank said.

On top of that, BMO said it changed its approach to estimating the market value of this portfolio.

“The commodity trading losses were the result of decisions that did not adequately recognize the vulnerability of the portfolio to changes in market volatility,” Mr. Downe said.

“If you look at our business in the United States, and we have had an office in Houston since 1961, we're one of the most significant providers of capital on the banking side to the independent oil and gas sector, and that financing very often requires hedging at the same time as the financing is done,” he said.

“There are many transactions that actually hinge on price stability. And so, it is an integral part of the business, but I can say categorically that the amount of risk and the volume of trading risk in the commodity business is higher today than it's going to be and when it comes down it's going to stay down.”

It's been a bumpy start to the year, as BMO said in February it would cut 1,000 back-office employees and take a $135-million restructuring charge to boost efficiency. That was just before Mr. Downe took over from Tony Comper as CEO.

The bank is conducting a review and will take steps to cut the likelihood of a recurrence.

“The commodity trading losses are particularly disappointing as our company continues to experience good operating momentum,” Mr. Downe said.

BMO will reposition this portfolio to a “lower and sustainable level.” As a result, the portfolio could see more gains or losses depending on the market.

“However, BMO's expectation is that, even using adverse assumptions, any losses would be in a substantially lower range than those announced today,” the bank said.

John Aiken, an analyst at Dundee Securities, said in a note to clients that “the market will likely reassess its stance on the riskiness of BMO's operations. This, combined with anticipated lower than peer revenue growth will likely lead to a relative decline in BMO's valuation, with the end result of its current small premium multiple declining to a sustained discount.”

BMO also said its Tier 1 capital ratio at the end of the first quarter was 9.90 per cent and the impact of these losses will be less than 20 basis points on that ratio. “As a result this loss does not impair the ability of the company to pursue its strategic agenda,” BMO said.
Dow Jones Newswires, 27 April 2007

The huge commodity-trading losses that Bank of Montreal will take in the second quarter have raised a lot more questions than just who - or what - was at fault.

The banking industry's risk, metrics and calculations are now in question, said John Aiken at Dundee Securities, while Jason Bilodeau at UBS said the news raises concerns about Bank of Montreal's management, oversight and strategy.

And another immediate question was whether the losses were driving a rally Friday in the natural gas futures market.

Earlier Friday, Bank of Montreal said it will record mark-to-market commodity-trading losses estimated at C$350-C$450 million in its second quarter, or about 45-55 Canadian cents a share, cutting its net profit by about one-third.

The Canadian bank is to report its second-quarter results May 23. The Thomson First Call mean earnings estimate is for earnings of about C$1.33 a share.

"Given that BMO is generally regarded as the 'low risk' bank, what does this mean going forward?," Aiken said in a note.

Perhaps the bank wasn't such a low-risk candidate after all, said Rob Wessel of National Bank Financial. "Amazingly, this loss was within Bank of Montreal's risk limits," he noted. "This fact will call into question what is clearly the most important positive dimension to the bank's risk-reward profile."

He said many investors "took solace in the bank's (perceived) very low risk profile. In fact, it could have been argued that its below-average return on equity was a direct consequence of the bank's aversion to risk. This viewpoint will certainly weaken as a result of today's announcement."

The news hit Bank of Montreal's stock, as analysts suggested the bank's risk profile has now been raised, lowering its valuation.

All other banks were also trading lower, as industry watchers questioned whether their commodity-trading desks also could be using faulty algorithms, or overly-risky trading strategies. Canadian Imperial Bank of Commerce immediately issued a press release stating it hasn't experienced any material gains or losses in commodity trading.

But Wessel said in his note that he is "inclined to believe" Bank of Montreal's losses weren't relatable to its peers.

And Mario Mendonca of Genuity Capital Partners said he believes the issue "will be contained to BMO."

The bank's commodity-trading business is about 15-20 times larger than Royal Bank of Canada's (RY), the country's largest bank, Mendonca said in a note.

As well, Bank of Montreal's commodity VAR (value at risk) increased by C$8.4 million in the first quarter this year from a year-earlier. Mendonca estimated Royal Bank's VAR related to commodities is C$1 million, compared to C$17 million for Bank of Montreal.

Meanwhile, natural gas futures on the New York Mercantile Exchange reversed losses to gain 2.5%. Some traders attributed the jump, at least in part, to news of Bank of Montreal's natural gas market losses.

Speculative traders "are squeezing" other market participants who currently hold a lot of short positions in the market, one trader said. Traders who hoped prices would drop are buying back previously sold positions before prices rise any higher, he said.

Funds are "putting the pain to (BMO) knowing they have to get out," the trader said.

According to Bank of Montreal, its positions held in the energy market, mainly related to natural gas, were hurt by changes in market conditions. In particular, it said the market became increasingly illiquid and volatility dropped to historically low levels.

On a conference call to discuss the losses, bank officials said volatility dropped to 40% from 70% in the quarter.

"The markets moved very quickly," Chief Executive Bill Downe said. He said the bank had begun to manage its portfolio down, but was unable to do so in time to avoid the losses. Downe said that, after Hurricane Katrina in late 2005, volatility and prices in the natural gas market increased. Clients wanted to "lock in" prices and the bank increased its book of business. In fact, Bank of Montreal had historically high commodity trading revenues in the first half of 2006.

However, Downe said, as the bank's energy trading business grew "so did our position in out-of-the-money options."

Then, when prices declined, the market became very illiquid and volatility increased, he said.

"The commodity-trading losses were the result of decisions that did not adequately recognize the vulnerability of the portfolio to changes in market volatility," the bank said in a statement. "We are conducting a thorough review and actions have been taken to address the current situation and reduce the likelihood of a recurrence."

That probably means heads have rolled, said David Baskin of Baskin Financial. But he said it should come as no surprise that such losses could take place.

"Commodity trading is a zero-sum game," he said. "For every winner there has to be a loser. It shouldn't be surprising that this sort of thing is going to happen."

The greater concern, he said, is what sort of oversight is placed on commodities traders, and how much discretionary monies they have at their disposal.

Correct guesses in the commodity-trading market can net huge sums of money, Baskin said, which creates a "perverse incentive" for the trading desks.

However, he said the second-quarter charge could be viewed as a one-time event and shouldn't really hurt the bank's earnings going forward. Nor, said Baskin, should Bank of Montreal's dividend be at risk.

Company officials said on the conference call that the traders involved are still with the firm.

Bank of Montreal said the charge would lower its Tier 1 capital ratio by less than 20 basis points. Moody's Ratings Service reaffirmed its ratings on the bank's securities.

Aiken said he also viewed the losses as one-time in nature and does "not see this issue having an adverse impact on the bank in future quarters." He made no changes to his future earnings estimates.

But Bilodeau said the news adds to the operational challenges faced by the bank, including weak domestic retail operations and greater challenges facing its U.S. banking subsidiary Harris, as chief rival LaSalle Bank is likely to get new owners.

The bank also said it wasn't a prime broker in the U.S. to Amaranth Advisors, the US$9.3 billion hedge fund that imploded last September after losing US$6.5 billion on ill-conceived natural gas trades. However, it was a prime broker to Amaranth in Canada.

UBS makes a market in Bank of Montreal securities but doesn't have an investment-banking relationship with the company. It wasn't immediately clear whether Dundee or Desjardins has an investment-banking relationship nor whether the analysts own the bank's shares.

National Bank Financial does have an investment-banking relationship with the company, but the analyst doesn't own the bank's shares. Genuity doesn't have an investment-banking relationship nor does the analyst the stock.
Financial Post, Duncan Mavin, 27 April 2007

Bank of Montreal said on Friday that it is taking a charge of up to $450-million in the second quarter as a result of commodity trading losses in energy markets.

“We are conducting a thorough review and actions have been taken to address the current situation,” said chief executive Bill Downe, who took over the BMO hot seat last month.

The bank said the loss could range from between $350-million and $450-million, and would result in a hit of between 45 cents and 55 cents a share in the second quarter earnings due on May 23.

The losses relate to positions held primarily in natural gas markets, the bank said in a statement. Trading was “negatively impacted” as the market “became increasingly illiquid and volatility dropped to historically low levels,” the bank said.

BMO’s announcement will remind investors of the failure of Amaranth Advisors LLC, a hedge fund which collapsed last September after losing US$6-billion in a single week on natural gas futures.

Mr. Downe confirmed that BMO was Amaranth’s prime broker in Canada, though not in the United States.

UBS Investment Research analyst Jason Bilodeau said the losses will likely see BMO’s stock “re-rate to a lower multiple relative to the [banking sector] as concerns about management, oversight and strategy are raised.”

The trading problems adds to a growing list of operational challenges for BMO, he said. BMO's profits for the first quarter fell 3.4% to $585-million compared with $606-million a year ago.

The bank recently announced 1,000 job losses and a $135-million charge to earnings related to cost-cutting measures . And earlier this week, BMO’s U.S. strategy came into question with news that retail banking giant Bank of America could be about to buy LaSalle Bank, one of BMO’s main rival in its U.S.footprint in Chicago.

BMO’s executives were given a rough ride by analysts on a conference call to discuss the trading losses.

“When you think of the upper end range of this at $450-million, that’s nearly two thirds of the bank’s trading business in 2006,” said Jim Bantis of Credit Suisse.

“It just doesn’t seem consistent with how the bank has defined itself in the past as the best credit bank in Canada,” said TD Newcrest analyst Steve Cawley.

National Bank Financial analyst Rob Wessel said it is “amazing” that the losses are within the company’s limits and controls.

“I understand all the words it’s just when you put them together it’s not clear to me whether the [trading] models you were using were just wrong,” said Genuity Capital Markets’ Mario Mendonca.

Mr. Downe explained that the bank increased its energy trading book in the aftermath of Hurricane Katrina, which had resulted in greater volatility in the energy market, and lots of profits for the bank in the first half of 2006. However, as energy prices dropped and the market became less liquid, BMO’s energy trading positions have resulted in losses, said Mr. Downe.

“We were aware of the decay in the book and shrinking it down but the market moves very quickly,” he said. The markets turned against the bank only in the past eight weeks, he said.

BMO also confirmed that none of the traders involved has left the bank.

Mr. Downe said he is comfortable with “the direction the bank’s trading activity has taken in the past.” He said there are no other businesses that BMO is in that would fit the same profile as the energy trading business. The BMO chief also said the commodity trading losses are outside the bank’s tolerance and BMO will take on less commodity trading risk in future. The bank may also consider changing the way it discloses risk in its natural gas trading book.

Shares of Bank of Montreal were trading about 2% lower on the Toronto Stock Exchange in morning trading Friday.
Financial Post, Jonathan Ratner, 27 April 2007

Bank of Montreal’s announcement that it will record pre-tax trading losses between $350-million and $450-million in the second quarter, should reduce earnings per share by 45¢ to 55¢, it said. These results are due out on May 23, 2007.

BMO said the losses are primarily from natural gas trading, while Desjardins Securities analyst Michael Goldberg expects more losses in the future.

“The commodity trading losses were the result of decisions that did not adequately recognize the vulnerability of the portfolio to changes in market volatility,” Bill Downe, President and Chief Executive Officer of BMO Financial Group, said in a statement.

Mr. Goldberg interpreted this statement as “faulty trading algorithms were based on garbage in, and they generated garbage out,” he told clients in a note.

While he thinks BMO share’s high dividend yield may mitigate some of the negative reaction, he thinks the potential downside for the stock could be 5%.

Mr. Goldberg also thinks the news could produce a negative reaction for all major banks “as investors wonder where else there may be trading problems, or more importantly, where else there may be faulty algorithms.”

He reduced his 2007 earnings per share forecast for BMO to $4.50 from $5.15.

He rates BMO a “buy” with a $77 price target.

Meanwhile, John Aiken at Dundee Securities considers the losses a one-time event and at this point, does not think the announcement will have a material impact on his core earnings estimates for BMO.

However, he also notes that this development puts BMO’s, as well as the entire industry’s risk, metrics and calculations in question.

“The market will likely reassess its stance on the riskiness of BMO’s operations,” Mr. Aiken told clients in a note. “This, combined with anticipated lower than peer revenue growth will likely lead to a relative decline in BMO’s valuation, with the end result of its current small premium multiple declining to a sustained discount.”
Dow Jones Newswires, 27 April 2007

Canadian Imperial Bank of Commerce said that, to date, it "has experienced no material or unusual gains or losses in relation to its commodity trading activities."

The Toronto-based Canadian chartered bank said it will report its fiscal second-quarter results as planned on May 31.

As reported, another big Canadian bank, Bank of Montreal, said Friday that it will record mark-to-market commodity-trading losses estimated at C$350-C$450 million (US$312-US$401 million) in its second quarter.

26 April 2007

RBC Investor Day

Financial Post, Duncan Mavin, 26 April 2007

Royal Bank of Canada’s investor day held on Wednesday was a hit with Desjardins Securities analyst Michael Goldberg.

“If the objective was to highlight Royal’s leading market share and scale advantages in Canadian banking and wealth management, then the day was a success,” Mr. Goldberg said.

Some of the most impressive statistics are in domestic banking and include: RBC has a 26% share of the market for current accounts — a 9.3% lead over Toronto-Dominion Bank; it has a 12% share of loans, which is 2.3% more than Bank of Montreal; 19% of small business banking is with RBC, which is a 3% lead over TD; and in commercial banking, RBC leads with 23%, 10% more than TD.

“The message,” said Mr. Goldberg, “Royal has market share leadership and greater ability to spend money and devote resources in support of further strengthening this franchise.”

The other theme of the investor day was to introduce RBC’s new wealth management group. Formed out of a recent rejigging of reporting lines, the group is headed by George Lewis and includes all of RBC’s wealth management units in Canada and abroad. The group is focused on serving “affluent” and “high net-worth” clientele, Mr. Goldberg said.

In both Canadian banking and wealth management, returns — ROE of 32-35% and 28-30% respectively — are high, the Desjardins analyst said.

Mr. Goldberg maintains his “buy” rating on RBC, and his $60 target price is unchanged.
BMO Capital Markets, 26 April 2007


We are raising our target P/E to 14.5x 2007E earnings to reflect our increased confidence in the new structure. By more finely segmenting the businesses under focused management, we believe that Royal can continue to drive earnings - at or above industry growth rates. Our target price increases to $62.


We continue to recommend RY shares. Given the premium ROE, the above average growth and the leadership market positions, it is tough not to recommend RY shares.

Details & Analysis

Royal Bank held an investor day yesterday to highlight its Canadian Banking and Wealth Management segments. The purpose of the presentations was to shed more light onto the business activities that, when combined, make up over 60% of the bank’s earnings (see chart).

The timing of the event coincided with Royal’s decision to re-segment its financial statements, breaking out a new Wealth Management segment from under the Canadian and U.S. & International Personal and Business Banking segments.

The new segment will include Global Asset Management, Canadian Wealth Management and U.S. & International Wealth Management (which includes Global Private Banking), and will be headed by George Lewis, who previously ran RBC’s Canadian Wealth Management business. Management emphasized that the new reporting method would not change the responsibility lines in the field, and that the level of integration between the banking and wealth management segments would remain high.

The overall tone of the presentations was positive. The Canadian Banking segment, which includes personal and business banking, cards and insurance, continues to lead the industry in product breadth, distribution, and market share. On the personal side, the bank is committed to boosting core deposits, with increased sales and processing efficiency efforts and continued roll-out of new products to fit its customer base and profit targets (such as the limited high-interest saving account). Business banking also looks well positioned and should be able to maintain, and possibly even improve, its industry-leading market shares.

The Wealth Management segment, under its new head, has produced excellent long-term results, with tremendous success in Canada and in Global Private Banking, and reasonable performance in the U.S. Note that the Wealth Management business, in total, has grown earnings at close to over 25% compounded over the past three years, and this trend continued into first quarter of 2007. The mutual fund business remains best in class and has led the Canadian industry for 13 consecutive quarters, driven by tremendous distribution, strong investment performance and a full suite of products. Despite its leadership position, the bank is prepared to be a disruptive force in the market with various price reductions and enhanced distributor commissions. RBC Dominion Securities continues to lead the industry in full-service brokerage in terms of assets per broker, overall assets and profitability. The contribution made by the U.S. & International Wealth business is largely the result of Global Private Banking, which appears to have successfully integrated various selective acquisitions. Results out of Dain Rauscher appear to remain modest due to high levels of competition in the U.S. marketplace, and a less robust competitive position. Management indicated that they remain open to acquisitions to bolster this business—both in the U.S. and in Europe.

On the whole, the day served to confirm our views that retail banking and wealth management are good businesses in which to compete, and that Royal is well positioned to match, or exceed, overall industry growth. We are raising our target price to $62, to reflect a P/E multiple of 14.5x our 2007 estimate. We maintain our Outperform rating on RY shares.
TD Newcrest, 26 April 2007


Yesterday, RBC hosted its 2007 investor day which focused on the domestic retail banking and wealth divisions. The bank also provided new disclosure to reflect new business segments: Canadian Banking, Wealth Management, U.S. and International Banking, and Capital Markets.


Neutral. The presentation reconfirmed our positive sentiment on the domestic retail and wealth management operations (see Exhibit 1 for detailed financial highlights). Our earlier estimates regarding the size of the domestic wealth operation were proven optimistic; however, we remain confident with our 12-month target of $67.00 and Action List Buy recommendation.


Canadian Banking: Domestic retail banking contributed 54.1% to overall revenues in Q1/07 and close to 57% in 2006. Of note, the division’s operating leverage was an impressive 6.5% which we believe reflects the benefits of size and scale. We believe RBC is taking advantage of unmatched distribution capabilities (the bank operates the largest distribution network among financial services companies in Canada) to grab market share in key high margin businesses such as cards and business banking. We also note:

• RBC ranked first in consumer lending market share in 2006, surpassing other retailing giant TD. We believe a domestic duo-poly is being created in the Canadian market place, and the distance between RY and TD versus the competition will continue to widen. Perhaps the most important area in which the bank has rapidly grown share is the domestic cards business. While not providing a detailed financial breakout of this product, the bank offered the following information: 1) it is #2 in purchase volume market share (20%), and only trailing CIBC by 2%.

While obtaining third party market share data is impossible, we believe the bank’s growth in this area is remarkable. Significant credit was given to the bank’s advertising campaigns, which will remain constant. 2) Cards represent 14% of domestic banking revenues, but a greater share of profitability. Management added that cards earn better ROEs than the entire bank (27% last quarter), a clear demonstration that market share growth certainly has come at the expense of profitability.

• On the deposit front, strategies to grow deposits (introduction of a new high rate savings account, aggressive marketing campaigns, improved technology, and focus on lower cost e-banking) have led to significant inflows, according to management, of which 65% is new money. Management estimates that approximately 180,000 RY clients have accounts at ING Canada (which uses cheap sources of deposits to fund mortgage growth), and believes that it has come up with a competitive product to bring them back under the RBC umbrella, and we agree.

• Discount brokerage, which is still included in Canadian Banking results, is another focus for RBC. The bank’s internal research suggests that gradually more clients are using the discount brokerage services of their home bank, thus presenting it with an excellent cross selling opportunity. We believe RY could improve on existing products, services, and perhaps pricing in order to attract clients away from TD Waterhouse, by far the dominant player in the Canadian discount brokerage space.

Wealth Management: RY’s wealth operations generated $992 million in revenues last quarter and $217 million in profitability. While we acknowledge having been top heavy in our profitability estimate for the division, we remain unequivocally convinced by the size, growth, and future opportunities available to it. We note that management intends to grow revenues at 10% per annum while achieving 30% pre-tax margins, which is achievable in our opinion for the following reasons:

• Distribution: RBC owns the Canadian distribution network, with over 75% of sales of RBC mutual funds emanating from the Canadian Banking channels. In addition, the bank has forged relationships with over 8,700 investment advisors, which we believe provides the bank with healthy growth potential.

• The Domestic Mutual Fund Squeeze is on: There is no doubt that the bank intends on leveraging its scale to further grow its mutual fund business. A combination of strong performance, lower fees charged andstrong commissions will be key to future growth. We expect further announcements will come demonstrating that RY is serious about winning even more market share in this very profitable business.

• International Growth: We believe a key piece to generating sustainable revenue growth for the bank hinges on international expansion (generally a high ROE undertaking). Although acquisitions will be part of the strategy we get the feeling that product enhancement, organic growth, and recruitment (RBC added over 1,200 client facing professionals in 2006) will continue to be the focus.

Justification of Target Price

Our $67.00 target is a product of adding 50% of the $65.74 value derived from our 2008 P/E valuation of 14.3 times to 50% of the $68.02 value derived from our 2008 price-to-book valuation of 3.48 times.

Key Risks to Target Price

We believe the key risks are: 1) unfavorable interest rate movements; 2) a downturn in the credit cycle; and 3) additional US acquisitions at premium valuations.

Investment Conclusion

Yesterday’s investor day was an opportunity for RBC to showcase its dominant retail and wealth management operations, and we believe management did an excellent job. While we believe that the current retail banking environment has benefited all the Canadian banks, RBC is clearly exhibiting superior operating momentum and undoubtedly pulling away from the pack. The division is generating 30%+ ROEs while spending meaningfully on numerous initiatives which should produce “best-in class” revenue growth well into the future, in our opinion. We rate the stock an Action List Buy.
Reuters, Lynne Olver, 25 April 2007

Royal Bank of Canada plans to ramp up international investment to win more of the lucrative wealth management business outside Canada, executives said on Wednesday.

"We view wealth management as a good global opportunity," President and Chief Executive Gord Nixon said during a presentation to analysts and investors.

Earlier this year, RBC, the country's largest bank, said it would rearrange its business lines for reporting purposes. Results for its new wealth management segment, one of four divisions, will appear in the bank's second-quarter results, due for release May 25.

"We believe that by creating the wealth management structure, it will give us the ability to be more focused in terms of driving wealth management investment and growth outside of Canada," Nixon said.

Previously, that international business had been part of RBC's U.S. and international banking unit.

The bank provided "resegmented" first-quarter financial results on Wednesday to help future comparisons. Overall net income for the first quarter ended Jan. 31 was unchanged at C$1.49 billion ($1.34 billion).

George Lewis, the bank's head of wealth management -- which includes global private banking, full-service brokerages in Canada and the United States, and money manager RBC Asset Management -- said that he plans "aggressive growth" in revenue and earnings outside Canada.

To meet the bank's goals, "acquisitions will definitely be a consideration," Lewis said at the investor event.

These could come via smaller, "bolt-on" acquisitions in global private banking, he said.

For example, RBC will continue to look at trust acquisitions in Britain to complement its Channel Islands offshore trust service, and would also consider international investment management additions, Lewis said.

In the United States, brokerage RBC Dain Rauscher Inc., based in Minneapolis, Minnesota, has been adding financial consultants, most recently with the March acquisition of retail brokerage J.B. Hanauer, which had 300 employees at offices in New Jersey, Pennsylvania and Florida.

When Banks Merge, Investors Tend to Lose

The Globe and Mail, Derek DeCloet, 26 April 2007

It's about 7,500 kilometres from Toronto to Edinburgh, but for Bank of Montreal chief Bill Downe, it might as well be 70 million. His counterpart at the Royal Bank of Scotland, Fred Goodwin, is operating on a whole different planet now.

The Scottish bank leads a group that yesterday bid $98.5-billion (U.S.) for the Dutch bank ABN Amro, topping an earlier offer by Barclays. This is the kind of deal you can get into only if you are one of the world's largest banks. RBS, at $126-billion in market value, qualifies; it's four times larger than BMO. Nine years ago, the two were the same size. You could look it up.

Nine years ago is also when every large Canadian bank, save TD, was essentially frozen in time, denied the right to merge with each other by the Liberal government of the day. The takeover war in Europe drives home the cost of that paralysis: It means ABN-owned LaSalle Bank will either end up with the RBS group or with Bank of America, Barclays' bidding partner. BMO, whose Harris Bank unit is an undersized competitor to LaSalle in the U.S. Midwest, couldn't even get inside the auction room for LaSalle.

If only Paul Martin had just let the big banks merge in '98; if only the Liberals, and now the Conservatives, weren't so obsessed with electioneering that they allowed the merger question to fester for nearly a decade without resolving it. Wouldn't it be nice to have a Canadian bank operating on a world scale, like RBS or Barclays or BofA?

Sure would be. Economic nationalists would love it. Investors - not so much.

Here's the dirty little secret behind mega-deals in the banking sector: They don't work. Or at least, they don't work very often. Size is helpful, but only to a point.

If you don't believe it, ask the shareholders of Citigroup, J.P. Morgan Chase, Bank of America, Wachovia, Wells Fargo, HSBC, UBS, Royal Bank of Scotland or Barclays. Each one is a member of the $100-billion club, except for Barclays, which is nearly there. How many do you think have been a better investment than BMO over the past five years?

The answer is none. Over a longer stretch, 10 years, BMO's performance still fares better than average. Its 14.5-per-cent annual return, including dividends, beats the tar out of J.P. Morgan Chase (7.9 per cent) or Wachovia (6.9) or HSBC (10.8). Bank of America's Ken Lewis is a deal junkie who stole the headlines by agreeing to pay $21-billion for LaSalle, should Barclays win ABN. But no Bank of Montreal owner would trade his shares for BofA's 10-per-cent returns. Citigroup is a total mess. (All return figures are for the period ended March 31.) Understand that we're not comparing these companies' returns to that of a premier Canadian bank, or even an average one. We're comparing them to BMO, probably the worst-managed (and worst-performing) big bank in the country over the past decade. BMO's problems are numerous, but the biggest one is cultural, and as the only large bank to lose two attempted mergers (Royal Bank of Canada in '98, Bank of Nova Scotia in '02), it has been more affected by merger paralysis than any of the others.

"This bank has never gotten beyond, 'I'm selling myself,' " says one BMO insider, speaking on condition of anonymity. "There's zombies walking around here [waiting for mergers]. They've been dead for 10 years and they're still on the payroll." That's a hint, but only a hint, of why BMO last year had the slowest profit growth, the slowest revenue growth (except for CIBC), and the lowest return on equity of the five largest Canadian banks. By most measures, BMO has shrunk from No. 3 to No. 5 since the late 1990s - yet it has still been a terrific investment.

There are a few conclusions to draw from this. It's pretty hard to screw up a Canadian bank. Monstrous financial institutions are harder to manage than you might think. But it's also true that merger paralysis has a flipside. Canada's banks, by virtue of their size, may be shut out of the bidding for a LaSalle or similar-sized U.S. banks, but so too have they been protected from most foreign intrusion. (The few foreigners who've tried haven't had much luck. Ten years after its launch in this country, ING Bank earned $72-million last year. BMO earns that much every 10 days.) Canadian bankers want to merge so they can cut costs, get bigger and start competing with groups like RBS and HSBC for assets - all while keeping their comfortable oligopoly at home. They want to have it both ways (who doesn't?). But it's hard to argue that their smallish size is really hurting them; not a single large domestic bank had a return on equity below 19 per cent last year.

How long would that last if they, like BofA's Mr. Lewis, were running around offering to pay 22 times earnings for mid-sized U.S. banks like LaSalle? Not long. When it comes to mega-deals, Canadian bankers can't play. And thank goodness for that.

24 April 2007

TD Banknorth to Take Charge in Q2 on Job Cuts

Bloomberg, Doug Alexander, 24 April 2007

TD Banknorth Inc., the U.S. consumer-banking unit of Toronto-Dominion Bank, will take a pretax charge of $16 million to $20 million in the second quarter for job cuts and branch closures.

The costs are related to the decision by the Canadian bank to buy the shares of TD Banknorth it didn't already own and delist the stock, according to a filing sent to U.S. regulators today.

TD Banknorth said in March that it was closing as many as 24 branches and cutting 400 jobs as profit declined in five of the past seven quarters. TD Banknorth expects to record costs of between $40 million and $100 million in 2007 from the moves, the Portland, Maine-based bank said in the filing today.

The job cuts, equal to about 4 percent of the workforce, will be done in the next few months, and most of the branches will close by the third quarter, the bank had said. About 13 branches will be shut in New Jersey, where TD Banknorth bought Hudson United Bancorp and Interchange Financial Services Corp. last year.

Toronto-Dominion, which paid $3.2 billion to buy the 40.2 percent of TD Banknorth it didn't already own, is cutting expenses at the U.S. unit after profit fell because of rising costs for acquisitions and advertising, and lower demand for loans. TD Banknorth shares were delisted from the New York Stock Exchange on April 19.

Implications of BofA-LaSalle Deal for BMO

Scotia Capital, 24 April 2007

Bank of America Acquires LaSalle

• The much rumoured Bank of America acquisition of LaSalle Bank of Chicago was announced in conjunction with the Barclays merger with ABN Amro.

• LaSalle is the second largest bank in Chicago and Illinois with retail deposit market share of 14.1% and 11.2% respectively, slightly below JP Morgan Chase the largest with market share of 15.3% and 12.1%.

BMO/Harris Strong Third in Market Share

• Harris is a strong third in terms of market share at 9.5% in Chicago and 7.6% in Illinois with the next largest bank being Fifth Third in Chicago at 3.2% and State Farm in Illinois at 2.8%. Bank of America market share was extremely weak at 1.8% in Chicago and 1.6% in Illinois. Chicago and Illinois remain among the most fragmented retail banking markets in the U.S. Major U.S. banks such as Citibank have a weak presence in the region with market share of 2.6% in Chicago and 2.0% in Illinois. Thus they are a prime candidate to be an aggressive acquirer at some point.

• Bank of America, LaSalle and Morgan Chase are formidable competitors for Harris. However Harris has a strong strategic presence in the region with its third place ranking, with a wide gap between itself and the fourth position. However, the major questions are whether Harris has the operational capability to maintain and grow its market share and generate a higher level of earnings.

Outlook for BMO - Positive over Short Term, Uncertain over Long Term

• In the near term the BAC acquisition of LaSalle could be positive for Harris in terms of customer attrition at LaSalle if Harris is able to capitalize. In general, consolidation should be positive for a bank with Harris's market positioning but longer term implications could be very negative if Harris is not able to keep pace operationally with BAC and Morgan Chase and this is a real concern. Thus BMO/Harris needs to be pondering their strategic options and assessing their operating capabilities going forward in this market place.

Positive Valuation Implications for BMO/Harris

• BAC is paying US$21 billion or C$24 billion for LaSalle which generally precluded BMO from participating as the deal size would have represented two thirds of BMO's total market capitalization. In addition to the financial impediments for BMO, we would be concerned about the banks ability to execute an acquisition of this magnitude.

• BAC purchase price at 21.3x 2007E earnings appears quite high but after adjusting for $800 million after tax in expected cost synergies (45% of cost base) from LaSalle bloated cost structure the price is reduced significantly to 10.2x adjusted 2007E earnings. The purchase price is 2.2x book value, 3.4x tangible book with a 23% deposit premium.

• If we apply the 23% deposit premium paid for LaSalle (38% of business in lower priced Michigan) for BMO's US Personal & Commercial Banking Business Segment (Harris) we derive a value of $4.4 billion equating to 31x current earnings. Harris value would represent $8.80 per BMO share or 12% of market capitalization with Harris currently contributing only 5% of BMO earnings. This valuation applies to Personal & Commercial only as BMO has a U.S.wealth management component with $300 million in revenue and negligible earnings as well as a U.S.component in its Investment Banking Group with earnings of $350 million per annum in the past two years.

• If we apply a more generous 30% - 32% deposit premium (perhaps more applicable to Chicago market only) to Harris (US P& C) the value would be approximately $6 billion for implied P/E multiple of 43x. At this deposit premium Harris value would represent $12 per BMO share or 17% of market capitalization, significantly above the earnings contribution of 5%.

• It would seem that if BMO is not able to substantially improve its earnings from Harris, a very feasible strategic option from a shareholder perspective would be for BMO to sell Harris. The bank has to seriously weigh its option and determine how realistic it is for Harris to meaningfully improve its operating capabilities and its earnings.

• BMO shareholders, we expect, would be very amenable to a special dividend and redeployment of capital in its other businesses including high return wealth management and in its domestic retail operating platform.


• We maintain our 3-Sector Underperform based on weak relative earnings growth and profitability and slight P/E multiple premium. We believe the bank's higher dividend payout ratio has assisted in partially offsetting the bank's lower earnings growth over the past three years and has muted the degree of underperformance. However we believe the benefits of the higher dividend payout ratio are imbedded in the stock price and lower earnings and dividend growth going forward should cause the relative P/E multiple to decline to reflect the substantially lower profitability.

• We have no sell recommendations in the Bank Group on an absolute return basis as our BMO 12-month share price target is $80 per share for total expected return of 15%. BMO's absolute financial performance is very strong with its relative performance weak. Our 3-Sector Underperform is based on relative operating performance and profitability with a risk to the rating being strategic initiatives such as the sale of Harris, a special dividend and/or the possibility of BMO being acquired by another Canadian Bank. These initiatives appear to be highly uncertain at this time.
Financial Post, Duncan Mavin, 24 April 2007

Bank of Montreal's ambitions to dominate Chicago's retailbanking sector took a blow yesterday as one of the largest banks in the United States muscled in on the local market.

BMO's Harrisbank subsidiary is a big player in "Chicagoland," with about US$40-billion in assets and more than 200 branches.

But its U.S. operations face a new challenge after Bank of America announced the US$21- billion acquisition of Chicagobased LaSalle Bank.

"Bank of America is a very formidable competitor," said Tom Kersting, an Edward Jones analyst in St. Louis, Mo. "They have a very large suite of products and the size and scale to be efficient. It's going to make the longerterm outlook in the Chicago banking market that much more competitive."

While the deal marks Bank of America's push into the thirdlargest banking market in the United States, it is actually a result of a merger of two European banking giants.

LaSalle is currently owned by Dutch bank ABN Amro, which is merging with Barclays Bank PLC of the United Kingdom. Barclays does not want the U.S. bank, and Bank of America has snatched LaSalle to bulk up in the Midwest, one of the gaps in its existing franchise.

BMO was also considering a possible move for LaSalle, said Jason Bilodeau, a UBS Investment Research analyst. However, the price tag was too large for the Canadian bank's purse, he said.

The retail-banking sector in Chicago has become fiercely competitive and features franchises like Bank One, owned by JPMorgan Chase & Co., and Washington Mutual Inc., which has opened more than 100 branches in the area in the past five years.

Bank of America's acquisition of LaSalle will likely put a strain on the market share of all the banks in the region, said Edward Jones' Mr. Kersting.

"This isn't just changing the signage. Bank of America are going to cut costs, sell more products to their existing customers, and to new customers too," Mr. Kersting said. "They really are the leading dominant retail bank in the U.S."

Bank of America has a history of successfully integrating large acquisitions and runs the largest branch network in the United States. The latest deal will add 151 LaSalle branches to the 56 it already owns in Chicago. Bank of America is also swallowing more than 14% of the retail market share in Chicago and about US$113-billion in assets.

BMO's executives have said they want to grow Harris to about 400 branches throughout the Midwest. The bank bought 32-branch, Indiana-based First National Bank and Trust last September for US$290-million.

But the presence of another big U.S. bank with growth plans in Chicago could make it more difficult for BMO to expand its U.S. network by acquisitions too.

"It seems to me like any little branch network that becomes available, [BMO] would have more competition for it," said Genuity Capital Markets analyst Mario Mendonca.

One factor that could prevent Bank of America buying smaller banks is that U.S. banking rules bar any bank from an acquisition that would give it more than 10% of the total deposits in the country -- the LaSalle purchase would take Bank of America to that limit so any more purchases would require the bank to get rid of lower-margin deposits.

Also, "arguably the 10 or 20 branch deals that Harris has been doing could fly under the radar screen of Bank of America," Mr. Mendonca said.

A spokesperson for BMO said the bank "will continue to pursue our deliberate growth strategy, which includes acquisitions that are a good fit with our company, as well as investing in all areas of our business: personal and commercial banking, wealth management and investment and corporate banking."
Dow Jones Newswires, 23 April 2007

Things may have just gotten a wee bit tougher for Bank of Montreal's Chicagoland subsidiary Harris. ABN AMRO's deal with Barclays gives Bank of America control over LaSalle Bank, the 600 pound gorilla in Chicago's banking market. Analysts say BAC may be a more hands-on with LaSalle Bank, making it an even greater competitor in Harris's key region. That may push BMO to make a bigger bet in the US to maintain competitive position, UBS says.