26 August 2009

BMO Q3 2009 Earnings

TD Securities, 26 August 2009

Looking for a C$1.00 run rate; modest ROE. There were a few gives/takes on the quarter (see Exhibit 5). We are increasingly reluctant to look through general reserves here (given we are in the midst of a credit downturn, and coverage ratios at BMO are thin). We see Q3/09 at C$0.95 and remain comfortable with our C$4.00 number for 2010. However, this still implies a relatively modest 12-13% ROE; a constraint to valuation in our view and management will have to find ways to rev-up earnings and/or deploy capital more aggressively.

Updating Apex. Quarter saw a small net charge of C$8 million. BMO has now hedged the first C$515 million of losses on their exposure under the funding facility (up to C$1.03 billion) and hedged their C$815 million in exposure to the medium term notes.

Updating Links/Parkland. As at Q3/09, the amounts drawn on the liquidity facilities increased to US$6.4 billion for Links and €622 million for Parkland relative to market values of US$5.6 billion and €598 million respectively (up slightly). Management continues to believe the capital notes offer sufficient first loss protection. No reserves have been taken at this point.

Quarterly Highlights (growth is year on year unless noted)

• Canadian P&C - A solid bottom-line.
NI was up 13% (adjusting prior periods for re-class of insurance to Wealth) on 8% revenue growth (+10% NII, +4% Other). Margins continue to drive the revenue story, improving 33bp over Q3/08 helped by improved funding, rate environment, loan mix and re-pricing.

Earning Assets in the segment were down slightly. In managed balances, personal loans grew a strong 15%, but mortgage balances were down nearly 2% (ongoing exit of broker network). Cards were +4% and Commercial loans were flat.

Commercial continues to be a strong revenue driver with 17% growth helped by re-pricing in the loan book, with Cards +11% while Personal was a modest +2%.

• U.S. P&C. Decent revenue growth at 10% (on back of improved loan spreads, deposit retention and gains on sale of mortgages) offset by higher credit costs. NI was down 11%.

• Wholesale. Driven mostly by strong trading numbers in interest rate products, NI was up 20%. The quarter also saw several capital markets related adjustments that largely offset.

• Wealth/Insurance. Adjusting for an income tax recovery, NI was down 22%. Top line growth was down 8% reflecting continued challenges in equity markets.

Operating Outlook. Our updated Q4/09 adds C$0.02 (primarily on slightly lower PCLs). 2010 remains unchanged at C$4.00. Key drivers in 2010 are a move to peak credit costs in 1H10 and some easing of Trading/Capital markets revenues while NIMs trend slightly higher from current levels. With above normal capital levels, ROE is likely to remain modest (12-13%). More aggressive volume growth/capital deployment offer potential upside to our forecast.

Segments. Canadian P&C appears positioned to deliver at a slightly higher pace. We assume modest uptick in Q4. The addition of Insurance (including a full quarter of the AIG acquisition) has lifted Wealth which should be helped by improving markets. Wholesale has room to ease following a very strong Trading quarter.

Credit. Encouraging trends as Gross Formations continue to ease. GILs declined with further write-offs and decent recoveries. However, the GILs/Loans ratio ticked up slightly and coverage ratios remain relatively thin. We remain concerned about U.S. Consumer Loans (US$16 billion, 10% of Total Loans) where delinquency ratios continued to climb and U.S. C&I/Commercial Real Estate (US$17.8 billion, 11%/US$4 billion, 2%) where we expect conditions to deteriorate over the coming quarters. We took down our Q4 PCL estimate slightly, but still expect credit costs to remain elevated.

Capital. The bank is over-capitalized, helped by lower RWA (including some favorable FX moves). Management expects ratios to decline as growth picks-up through 2010 and/or additional acquisition driven growth.

Justification of Target Price

In determining our Target Price we establish a Fair Value P/BVPS multiple based on our expectations regarding long-term sustainable ROE, growth and COE. Our expectations currently stand at 13.0%, 3.0% and 10.25% respectively implying a Fair Value P/BVPS multiple on the order of 1.55x.

Key Risks to Target Price

1) Additional losses or write-downs from key risk exposures 2) significant competition in the Chicagoland market and 3) adverse changes in the credit markets, interest rates, economic growth or the competitive landscape.

Investment Conclusion

Despite decent earnings, we still see relatively modest ROE (12-13%). At 1.7x book, the stock looks fully priced to us and we have made no changes to our 2010 estimates or Target. Maintain Hold.
Scotia Capital, 26 August 2009

• BMO reported a 5% decline in cash operating earnings to $1.05 per share significantly above consensus of $0.95 per share but below our estimate of $1.16 per share due mainly to a loss from securitization.


• Underlying earnings were extremely strong at $1.18 per share adjusted for securitization losses, security losses, CDS hedge loss, mark-to-market loss on balance sheet hedge, FDIC special assessment, P&C Canada severance costs, CVA gains, a tax recovery in the Private Client Group and a restructuring charge reversal. We estimate the December 2008 equity issue diluted earnings this quarter by $0.07 per share.

• Reported cash earnings were $0.98 per share including a general allowance of $60 million ($39 million after-tax or $0.07 per share).

• Earnings were led by BMO Capital Markets with YOY growth of 16%, P&C Canada at 13%, with Private Client Group earnings declining 4% and P&C U.S. earnings declining 11%.


• Strong underlying earnings, absence of capital charges of note, stabilizing credit, improving net interest margin, and large capital position support higher valuation. We reiterate our 1-Sector Outperform rating.
Financial Post, David Pett, 26 August 2009

Looking for quality not quantity, some analysts are expressing concern about Bank of Montreal's future profits in the wake of better-than-expected third quarter results that sent markets soaring on Tuesday.

"We believe earnings quality continues to be below average," said Brad Smith, Blackmont Capital analyst.

"In particular, we are concerned about the adequacy of credit allowances and the sustainability of reported net interest margins, which have benefited heavily from the steepening of the yield curve.

With BMO shares trading at valuations modestly higher than its peers, Mr. Smith thinks the market is not adequately discounting for the noted risks to BMO's future earnings, dividend growth and profitability.

"This leaves us little choice but to maintain our Sector Underperform investment rating and $43.00 per share target price."

Of the 16 analysts covering Bank of Montreal, five have Sell ratings, seven have Hold ratings and four analysts recommend the bank as a BUY.

Jim Bantis, Credit Suisse analyst, also reiterated his Underperform rating on the stock, but did raise his target price from $36 to $42 to reflect an increase in his 2010 earnings forecast.

"We note that despite this quarter’s record revenues ($2.98 billion) and low tax rate (16%), earnings momentum remains flat and profitability remains challenged (only a 12% ROE)," he told clients in a research note.

He said BMO's current valuation ignores reduced earnings power due to continued balance sheet de-leveraging, increasing credit losses from the bank’s US commercial mortgages and C&I loan portfolio, and unsustainable trading revenues.