25 November 2009

BMO Q4 2009 Earnings

Scotia Capital, 25 November 2009

Q4/09 - Earnings Very Strong - Large Beat

• Bank of Montreal (BMO) reported a 4% decline in cash operating earnings to $1.13 per share, in line with our estimate but significantly above consensus of $0.96 per share. Operating ROE was 14.2% with Tier 1 at 12.2%. This is the first clean quarter since the financial crisis began.

• Fiscal 2009 operating earnings declined 11% to $4.20 per share from $4.70 per share in fiscal 2008. Operating ROE for the year was 13.5%. Reported earnings were $3.14 per share down 18% from $3.83 per share a year earlier. Reported ROE was 10.0% for fiscal 2009.

• Fourth quarter earnings were driven by a 22% YOY increase in P&C Canada with P&C U.S. earnings increasing 55% and Private Client earnings increasing 8%. BMO uses expected loan loss provisions. BMO Capital Markets earnings declined 3% due to lower trading revenue. The loss in the Corporate and Other segment moderated due to lower balance sheet carrying costs. Credit losses were in line remaining below Q3/08 and Q1/09 levels reinforcing our view that they have peaked. Impaired loan formations did increase QOQ due to one large account but remained lower than previous highs.

• Our 2010 earnings estimate is unchanged at $4.80 per share. We are introducing our 2011 earnings estimate at $5.50 per share. Our 12-month share price target is unchanged at $65 representing 13.5x our 2010 earnings estimate. We maintain our 1-Sector Outperform rating based on strong earnings momentum from retail banking as the bank restores its retail brand and franchise. In addition, the bank has a solid wholesale platform, strong capital, and leverage to improving credit.

P&C Canada Earnings Increase 22%

• P&C Canada earnings increased 22% to $394 million from a year earlier, driven by volume growth and improvement in the retail net interest margin (NIM). BMO uses expected loan loss provisions and not actual. If we used actual loan loss experience of $124 million, P&C Canada earnings would have increased 20% versus 22%.

• The retail NIM in Canada improved 34 bp from a year earlier and 5 bp sequentially to 3.22% due to higher deposit growth rate versus loan growth and securitization of low-margin mortgages. The retail NIM improved 29 bp in fiscal 2009 to 3.13%.

• Personal loan growth was strong at 13%, however, market share declined YOY. Personal deposits were also up 13% from a year earlier, resulting in a market share gain from a year earlier.

• Fiscal 2009 P&C Canada earnings improved 15% to $1,395 million from $1,212 million a year earlier.

P&C U.S. Earnings Increase YOY

• P&C U.S. cash earnings increased 55% from a year earlier to $31 million using expected loan loss provisions. If we use actual loan loss provisions of $149 million versus $15 million, P&C U.S. earnings would have been a loss of $60 million.

• The P&C U.S. retail NIM improved 26 bp year over year and 13 bp sequentially to 3.26%.

• P&C U.S. earnings increased 10% in fiscal 2009 to $137 million from $124 million a year earlier.

Overall Net Interest Margin - Flat In Q4/09; Improves in 2009

• The overall net interest margin for the bank was relatively flat at 1.78% versus 1.79% in the previous quarter and 1.77% a year earlier. The net interest margin for fiscal 2009 was 1.69% up 7 bp from 1.62% in 2008.

Private Client Group Earnings Improve YOY

• Private Client Group (PCG) earnings in Q4 improved 8% YOY to $112 million but declined sequentially from $120 million.

• Revenue increased 7.7% YOY, with expenses increasing 0.5%, for positive operating leverage of 7.2%.

• Mutual fund revenue declined 9% YOY to $128 million. Mutual fund assets under management. (as reported by IFIC) increased 9% YOY to $33.6 billion.

• Fiscal 2009 earnings declined 16% to $396 million from $474 million.

BMO Capital Markets Earnings Solid

• BMO Capital Markets earnings declined a modest 3% to $289 million from $298 million a year earlier, and 16% from Q3/09 levels of $344 million. If we used actual loan loss provisions of $93 million versus $41 million, earnings would have increased 7% from Q3/09.

• BMO Capital Markets earnings increased 42% to $1,489 million in fiscal 2009 from $1,049 million a year earlier.

Trading Revenue Declines

• Trading revenue declined to $262 million from $391 million in the previous quarter and from $283 million a year earlier.

• Fixed income trading revenue remained strong at $144 million. Equity trading revenue improved to $81 million in the quarter from $71 million in Q3/09. FX trading revenue was weak at $65 million versus $85 million in the previous quarter.

• In fiscal 2009, trading revenue increased a significant 70% to $1,493 million from $877 million.

Capital Markets Revenue

• Capital Markets revenue was $366 million versus $341 million in the previous quarter and $336 million a year earlier.

• Underwriting and advisory fees increased 76% YOY to $116 million, and securities commissions and fees declined 7% to $250 million.

• Capital markets revenue in fiscal 2009 declined 6% to $1,370 million from $1,458 million a year earlier.

Security Gains

• Security gains recorded in the quarter were a gain of $14 million or $0.02 per share versus a loss of $0.01 per share in the previous quarter and a loss of $0.03 per share a year earlier. Security gains for fiscal 2009 were a loss of $128 million or $0.16 per share.

• Unrealized security surplus increased to $655 million versus $381 million in the previous quarter and a deficit of $121 million a year earlier.

Loan Loss Provisions in Line

• Specific loan loss provisions (LLPs) were in line with expectations at $386 million or 0.91% of loans versus $357 million or 0.82% of loans in the previous quarter and $315 million or 0.67% of loans a year earlier.

• Specific loan loss provisions for fiscal 2009 were $1,543 million or 0.92% of loans versus $1,070 million or 0.57% of loans a year earlier. Total LLPs were $1,603 million or 0.96% of loans including $60 million in general provisions versus $1,330 million or 0.71% of loans including $260 million in general provisions.

• Our 2010 LLP forecast is unchanged at $1,600 million or 0.90% of loans. We are introducing our 2011 LLP forecast at $1,200 million or 0.63% of loans.

Impaired Loan Formations Increase Modestly

• Gross impaired loan (GIL) formations increased to $735 million from $549 million last quarter (one large U.S. financial services client, CIT) but remained below levels in Q4/08.

• Net impaired loan (NIL) formations increased to $719 million from $316 million in the previous quarter but declined from $976 million a year earlier.

• Gross impaired loans increased modestly in the quarter to $3,297 million or 1.96% of loans. Net impaired loans were also up slightly to $1,395 million or 0.83% of loans.

• The coverage ratio (ACLs as a percentage of GILs) deteriorated slightly to 58% versus 62% in the previous quarter and 73% a year earlier.

Capital Ratios Strong

• Tier 1 Capital increased to 12.2% from 11.7% in the previous quarter due to a 3% decline in risk-weighted assets sequentially. Tier 1 Capital was 9.8% a year earlier. TCE to RWA was extremely high at 9.2%.

• Risk-weighted assets declined 13% YOY and 3% QOQ to $167.2 billion. Market-at-risk assets declined 42% YOY to $6.6 billion.

• The total capital ratio was strong at 14.9% at the end of the quarter versus 14.3% in the previous quarter and 12.2% a year earlier.

BMO to Acquire Diners Club From Citigroup

• On November 24, 2009, BMO announced its intention to acquire the Diners Club North American franchise from Citigroup. The agreement would give BMO net credit card receivables of US$1 billion (mainly U.S.) and approximately US$7.8 billion in card transactions. These cards are corporate Travel & Entertainment and are accepted by Mastercard merchants. The loss ratio on this platform is relatively low due to nature of cards (corporate T&E). BMO acquired the brand plus travel & entertainment system which presents a cross sell opportunity with U.S. corporates. The details of the transaction were not disclosed. The transaction is expected to close before March 31, 2010 subject to regulatory approval.

SIVs – Exposure Declining

• The pace of asset sales remained slow this quarter. Links and Parkland structured investment vehicle (SIV) market value of assets were largely unchanged at US$5.5 billion and €0.63 billion, net of cash, respectively, versus US$5.6 billion and €0.60 billion in the previous quarter. BMO believes the first-loss protection exceeds future expected losses.

• Liquidity facilities extended by BMO for Links and Parkland as at October 31, 2009, declined to US$6.0 billion and €0.63 billion, respectively, versus US$7.9 billion and €0.69 billion at the end of July 2008.

Credit Protection Vehicle – Apex

• BMO provides a senior funding facility of $1.03 billion. As at October 31, 2009, $112 million had been advanced through BMO’s committed share of the senior facility to fund collateral calls. During the third quarter, BMO hedged the first $515 million of losses on the senior funding facility.

• BMO also has exposure of $815 million through investment in mid-term notes. In the fourth quarter BMO entered into an agreement to hedge its total exposure to the notes.

• BMO recorded $50 million of charges, comprised of a one-time $25 million cost to enter into the hedge on $815 million of notes and $25 million mark-to-market loss on the hedge on $515 million of exposure on the loan facility.

• BMO believes the credit quality of the trust is sound, with over 70% considered investment grade and a substantial first-loss protection in place. First-loss protection for the 10 tranches ranges between 13.0% and 29.4%, with a weighted average of 23.5%. Only two tranches have first-loss protection lower than the others.

Fairway – U.S. ABCP Conduit

• Fairway is a BMO-sponsored U.S. ABCP conduit. At the end of October, backstop liquidity facilities were US$5.7 billion, down from US$6.1 billion in the previous quarter.

Monoline Exposure

• BMO has direct notional exposure to monolines and credit derivative counterparties of $3.8 billion, with $256 million mark-to-market exposure. Counterparties: 28% rated AAA or better.