27 May 2009

BMO Q2 2009 Earnings

RBC Capital Markets, Andre-Philippe Hardy, 27 May 2009

Q2/09 results exceeded our low expectations, led by lower than expected loan losses and taxes. Capital ratios were higher than estimated and core pre-tax, pre-provision profitability was in line with our normalized estimates for 2010.

• Forgetting expectations, results reflect a difficult environment, with a core ROE of 12.3% and reported EPS that remain below the dividend.

• Reported cash EPS of $0.63 were above our $0.46 estimate; many unusual items affected results and core earnings power was above $0.63 in our view (closer to $0.95-$1.00).

The reasons for our Outperform rating remain. The biggest worry of a few months ago (the dividend being cut given a high payout ratio) has become less of a worry as the economic outlook has improved and capital markets have shown signs of stabilization. BMO has more capital than other banks, which will allow it over time to recognize some of the losses it might have to take in its off balance sheet vehicles, in our view. The bank has one of the largest exposures to U.S. lending and gross impaired loans continued to climb in Q2/09, but other banks are also likely to see increasingly higher losses, as Canadian credit is deteriorating also and U.S. credit losses are spreading beyond early problem areas. As a result, credit is likely to be less of a negative for BMO relative to peers in 2009.

• Our 2009 core cash EPS estimate of $3.60 is up marginally from our prior $3.50 forecast. Our normalized 2010 EPS estimate (i.e., using normal loan losses rather than predicted) remains just above $5.50.

• As is our customary practice, we will undertake a full review of earnings estimates, ratings and target prices for all of the banks we cover as part of the industry review we will publish once all banks have reported. Directionally, the results were largely in line with trends we expected going into the quarter for the industry for (1) credit (pressure primarily from U.S. exposures, Canadian consumer deterioration, stable Canadian commercial exposures), (2) capital markets (YoY growth, QoQ decline), (3) wealth management (YoY declines). In Canadian retail banking, margins were higher than we had anticipated, but loan growth was lower.
Financial Post, Scott Deveau, 27 May 2009

Despite beating the Street’s expectations this week with its first quarter result, Blackmont Capital analyst Brad Smith downgraded the stock to a “sell” Wednesday.

BMO reported adjusted diluted cash earnings per share of 93¢ Tuesday, 3¢ ahead of consensus.However, Mr. Smith warned of some issues going forward.

BMO’s ratio of allowances to trailing two-year net write-offs fell to 87% from 102% in the first quarter, their lowest level since 1996, he noted.

In addition, its structured investment vehicle exposure, which now totals US$7.9-billion in funding/commitments, could “very likely pressure earnings and capital in the coming quarters, as assets are currently valued at a US$1.9-billion discount to commitments," he said.

The recent outperformance of the bank’s share price also has it trading at 6% premium to its peers, and its highest level since October 2007.

“Based on its premium valuation, ongoing SIV exposure, and the inadequacy of the bank’s allowance levels, we are reducing our investment recommendation on BMO,” Mr. Smith said.

He maintained his $32 price target, but reduced the stock’s rating from a “hold” to a “sell.”