Enough with pounding the CDN banks

Shares of BMO are down more than 5% again today, and the shares are closing in on a 5 year low. BNS, Commerce, Royal and TD are off 2% or more as well.

The backdrop? SIVs (BMO, Commerce), ABCP, (BNS, Royal), credit derivatives and re-insurance (CIBC, Royal, etc.), impending U.S. recession (BMO, TD, Royal), currency moves (BMO, BNS, Royal, TD)….

To make matters worse, the bank research analyst at Genuity Capital Markets has clearly convinced more than a few insitutional money managers that BMO may soon be undercapitalized. Here’s an excerpt from his quite detailed note of yesterday:

“The bank did not raise the quarterly dividend this quarter. We would not rule out an equity issue and/or a cut in the dividend. We believe that Apex and Sitka exposure is not in fact $495 million, but rather, through erroneous transfers to note holders and a swap counterparty, closer to $1.5 billion. If the bank takes in the remaining ABCP, the exposure could climb to $2.4 billion. We also believe that the loss profile is all or nothing. Without a restructuring, the bank could lose the entire $1.5 billion. Exposure to a previously undisclosed U.S. ABCP conduit (Fairway) also exposes the bank to further calls for liquidity ($624 million has already been drawn) and losses. The bank has also taken in an asset from the conduit and taken a charge. We would not rule out a $400 million loss on this exposure.

Assuming pretax losses of $1.5 billion on Apex and Sitka and $400 million on the Fairway security, as well as a $10 billion increase in RWA from all of BMO’s off-balance sheet vehicles, we can see the bank’s Tier 1 ratio declining to 8.3% from 9.5% currently. Accordingly, we would not rule out an equity offering of $1.0-1.5 billion. We lowered our target price by 19% [to $51 from $63].”

I’m not a bank analyst, so it is hard to poke holes in Genuity’s research without detailed/inside knowledge of the banks plans for these various vehicles (and I have none). But what must be said is that BMO’s situation doesn’t look anything at all like that of the CIBC’s in the lead up to their equity offering. Give the fellow at Genuity credit, though. He’s been negative on BMO from $65 to $45, so it shouldn’t surprise us shareholders that he’s feeling a bit emboldened now.

With a yield of 6.46% at the moment, the dividend would need to be cut almost in half before it dropped well below the 3.90% yield offered by Scotiabank, for example. Or, BMO would have to issue several billion dollars of new equity before the yield dropped below even 4%.

With Merrill Lynch’s analyst cutting the stock to a sell yesterday, and National Bank to an underperform, there may be some switching underway right now as PMs trade out of BMO into TD, Royal Bank or even Royal Bank of Scotland (which is trading at book value last time I checked).

Based upon BMO’s disclosure, it would appear that the worst is over for the SIVs and whatnot. Assuming the $495 million is written off this quarter, there is still no need for an equity offering or a dividend cut. Which tells me the worst news is behind Bill Downe and his battle-hardened team.

As for the stock, BMO is down 41% from the one year high. But they’re not alone. Goldman Sachs is down 36% over the same timeframe. Not bad company to be in the penalty box with. And if these analysts are right, BMO’s going to be up almost $10/share (20%) by this time next year, plus a $2.76 dividend.

MRM
(disclosure – I own BMO and GS)