BMO bares all part 2

Maybe the original headline was a bit too perky (see post “BMO bares all“, February 19-08). The equity research analyst at Genuity Capital Markets doesn’t agree with my Bank of Montreal (BMO:TSX) “bares all” characterization one iota. Here is a summary of his damning report from earlier today. I certainly hope his $2 billion estimate of further exposure is off base, although I note that he did a far better job than CIBC (CM:TSX) management at estimating the CIBC subprime writedown figures late last year:

BMO pre-announced a $490 million pretax charge covering a) exposure to transactions hedged with ACA; b) trading and structured credit-related positions and preferred shares and other marked-to-market losses; c) investments in third-party sponsored ABCP conduits; d) investments in BMO-sponsored ABCP conduits to which BMO is not required to provide support; and, e) capital note exposure to the SIVs.

We are not particularly sensitive to the ACA charge as the bank has eliminated all exposure to ACA and transaction hedged with ACA. We are also not sensitive to BMO’s investment in third-party sponsored ABCP, as we believe the remaining exposure is approximately $300 million and cannot grow from this level. The credit trading losses are part of the ongoing business and, as such, we expect the other banks (particularly RY and BNS) to have similar issues this quarter.

In our view, the more important issues are the additional SIV support and the bank’s exposure to BMO-sponsored but not supported ABCP conduits Apex and Sitka. Regarding the SIVs, the bank has committed to proving $13.7 billion in additional liquidity support (in addition to the previously provided $300 million in support and $1.3 billion in senior note investments). As the assets do not contain a significant amount of subprime, have been sold at less than a 40-50 bps haircut to book value (management’s comments), and the liquidity support ranks above the capital notes and equal to the senior debt, the risk of material further loss is relatively low. We do, however, expect the bank to write-down the remaining $30 million in capital note exposure.

Regarding the BMO-sponsored but not supported ABCP, the bank characterized its remaining exposure as the net investment of $495 million. We do not agree with BMO’s characterization. We believe BMO’s exposure could climb to as much as $2.0 billion and result in an additional charge of $400 million plus. In our view, BMO has not been entirely open with investors regarding its exposure to Apex and Sitka and, accordingly, we would not rule out further significant charges.

MRM
(disclosure – I own BMO)