Banks become growth stocks part 2

It pains me to read, but a favourite bank (Bank of Montreal, BMO-TSX) has discovered that the joys of trading revenue can also quickly turn to sorrows.

On April 4, 2007, we posted a blog regarding the reliance that banks now have on such revenue streams; here’s an excerpt:

“U.S. commercial banks saw their trading revenue increase by over 30% in 2006. Primarily driven by commodities and hedge funds. Pretty exciting stuff, and hard for a bank CFO to factor into their business plan. Or their capital allocation budget.

And it is also difficult to predict how sustainable this revenue is. Unlike the predictability of checking accounts (they will be there in 3 years), it would be hard for a bank CFO to know where oil or natural gas will trade 3 years from now….”

A Bloomberg story this morning had a quote from a shareholder making the same point:

“People want Bank of Montreal to be a bank, and not in the business of speculative commodities,” said Doug Davis, president of Davis-Rea Ltd. in Toronto, which manages C$470 million in assets, including Bank of Montreal shares.

For decades, Canadian banks have made a good market on currencies, but the missteps in commodity trading give one cause for pause. Didn’t Amaranth go down the drain for the same reason, albeit magnified a couple of times?

If the risk models don’t work as well as they do in the credit division, perhaps trying to fix the risk algorithm is the wrong way to go? Just put that capital into a less volatile business.

Your trading multiple might just expand.

There’s a reason that Goldman Sachs trades around 10x eps, despite being a wonderful business. Investors worry about predictability of revenue and income.

MRM
(disclosure – I own BMO and GS)