BMO Is Feeling The Heat On Derivatives Losses
The market has a magnifying glass over Bank of Montreal’s recent confession on its commodity trading losses, which will likely cut second quarter earnings by $350 million to $450 million, or around $0.50 per share. BMO has traditionally been a more conservative bank, so this news came as a surprise to shareholders. Credit Suisse analyst Jim Bantis explained:
Profit growth at its bread-and-butter Canadian consumer banking operations has lagged its rivals, and that’s likely what led the bank to take on extra risk in its commodity trading business as it hunted for other ways to boost the bottom line.
On the bright side, the new BMO Chief Executive Officer Bill Downe reassured investors:
The commodity trading losses were the result of decisions that did not adequately recognize the vulnerability of the portfolio to changes in market volatility. We are conducting a thorough review and actions have been taken to address the current situation and reduce the likelihood of a recurrence. The commodity trading losses are particularly disappointing as our company continues to experience good operating momentum. We remain committed to providing the high level of service that our clients in the energy sector have come to expect from BMO Capital Markets.
BMO’s stock fell by $1.58 to $69.69 as a result of the negative news, which improved the dividend yield to 3.9%. BMO had traded roughly between 2% to 4% over the past decade, therefore I’d classify $70 as cheap, though not necessary a bargain. I think the $1.58 drop is an over-reaction, since the pre-tax $0.50 is a one-time paper loss, and Mr. Downe is taking steps to mitigate derivative risks. The best time to buy banks is when they’re down and out. It was 2004 when Royal Bank was struggling with its US operations, 2005 when CIBC was taking 10% haircut with the Enron scandal, and now possibly BMO with it losing market shares, and getting their hands slapped on derivatives trading. Since I already have a position from the summer of 2006 correction, I’ll hang tight for now, but will accumulate more below 68 bucks.
Table: BMO’s five year dividend history
| Ticker | 2006 | 2005 | 2004 | 2003 | 2002 |
| BMO | $2.26 | $1.85 | $1.59 | $1.34 | $1.20 |
Further Reading Materials
- BMO Hammered By Derivatives Trade (Globe and Mail)
- BMO Financial Group To Report Mark-to-Market Commodity Trading Losses (Yahoo Finance)
- BMO Commodity Losses Could Hit $450 Million (Canadian Banks and Insurance)
- BMO trading loss - buying opportunity? (A Canadian and Her Money)
- BMO Takes a Hit (Investoid)
- BMO Investor Relation
I made further comments from Money Diva’s blog on BMO:
Based on PE ratio, the market has high hope for RY and BNS. With the bar set so high, any hiccup will send these stocks tumbling. Conversely low expectation for BMO makes it a more conservative stock. Since it’s already priced in to the price, any dismissing is double-counting. BMO’s higher dividend yield means you can drip more shares to make up for the (anticipated) slower growth.