Financial Jungle

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

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

Okay. Maybe not thousands for everyone, but at least I will no longer have “hands in my pocket“. For the past 8 years, I’ve been paying the classic $29 per trade with one of the big banks. With a few trades here and there, the mountain of fees can easily add up to over $1,000. The more fees middlemen take, the less capital there is for future compounding. What’s a little retail investor to do?

Then came along a software-based online discount broker, Interactive Brokers. Technologies have enabled IB to run a lean and very mean operation, thus allowing them to pass on the savings to us. Each trade is only $1 for the first 100 shares, and $0.005 per share thereafter. There is a $10 per month minimum fee. However, if you’re a light trader, your annual transaction fees should amount to $120.

Although transaction fees are on everyone’s mind when choosing a discount broker, there are a couple of other less obvious culprits: the foreign exchange and margin interests.

If you want to convert your Canadian currency to purchase US securities, your broker will charge you a spread on the exchange rate. This rate varies by brokers. IB’s spread is 5 basis point, or 0.05%, while my big bank’s is 1.25%. That’s a difference of $120 when you convert $10,000 Cdn to US, each way!

IB’s margin rate calculation isn’t so straight-forward, and it depends on the balance of the margin loan and the prevailing Canadian LIBOR overnight rate. Let’s cut to the chase. For investors with margin loans less than $115,000, the current rate is 5.75%, while my big bank charges 7%. On a $10,000 margin, the difference is $125 per year. To find out more about IB’s margin rate, visit here.

Unfortunately, IB does not support mutual funds, but they do have ETFs. There have been many published studies citing that the vast majority of actively managed mutual funds under-performed their passive counterparts. Investors shouldn’t concern themselves with the lack of mutual funds support. Secondly, IB does not support RRSP. That’s why I’m keeping my non-registered account with the bank.

IB seems promising based on my research so far. I’ll write another post on this once I have a little more exprience with the platform.