So how much of a problem does the BoM have with SIVs?  It’s on the same scale as the Israeli problem with Iran’s nuclear program.

According to the BOM’s published Q3 Supplementary Financial Information, the total Regulatory Capital of the bank is $24 B.  That’s the amount of real investor capital put into the BoM.  As previously described in earlier posts, banks inflate this asset by also counting the loans that they have made as “assets” since those loans generate interest revenue.

The total BoM’s “asset” base of $334 B includes $65 B of derivatives of which $49 B are securitized assets.  According to the Q3 Supplementary Report, 90% of the $49 B is impaired and a full $37 B is rated as having a high risk of default ( Risk weight >7%).

Prudently the BoM has reserved $735 M of capital against this risk, however, that provision will be about as effective as a fart in a thunderstorm should these derivatives prove worthless.

Given the recent signs of economic recovery, it is likely that not all of the $37 B will tank.  A risk weight of >7% means that roughly 1/2 of these loans will likely default in 5 years (1.07^6 = 1.50).  Many analysts believe that the $6 B in SIV loans made to support Link SIV and Parkland SIV are at greatest risk however.

To put the danger posed by $6 B in bad loans in perspective, the BoM’s entire quarterly revenue in Q3 was $3 B and its net income is currently approximately $1 B / quarter.

Hence, a $6 B default can cause a life-threatening liquidity crisis that would require a government bailout to prevent outright bank failure.

BMO’s Q3 results are not encouraging.  At best, the bank is treading water.

For example, despite having $413 B in assets, it’s cash position of $10.7 B is basically flat compared to the previous quarter.  Although liquidity improved by about $500 M, 80% of this was due to the fact that BMO issued $400 M in preferred shares during the 3rd quarter.

Thin liquidity is very dangerous for a bank.  A bank may crow about Tier 1 capital ratios, but it is liquidity that determines whether they stay in business or not.

BMO’s loan book is still toxic.   The sum of PCL+GIL (sick and sicker loans) is 3.3 B largely unchanged from Q2 to Q3.  PCL is Provision for Credit Losses (loans the bank admits are dead) and GIL is Gross Impaired Loans (loans that are not being paid back).  And of the loans that BMO has yet to admit are bad, according to the BMO’s own risk weights, $37 B (nearly 10% of the entire loan book) are so risky that they are statistically likely to default within 5 years.

To put this in perspective, BMO’s non-investment grade loans  is 10x higher than the amount (in total dollars) the Royal Bank has in the same risk categories.

Looking at BMO’s Canadian delinquency ratios, Q3 personal loan and mortgage delinquency ratios are unimproved in Q3 over the past 3 quarters, and credit card delinquency ratio has increased quarter over quarter for the past 4 quarters.  BMO’s US delinquency ratios have deteriorated in all categories quarter over quarter for the past 4 quarters.

Meanwhile BMO’s market share is slipping with quarter over quarter declines in Canadian personal loans, mortgages, retail deposits and commercial loans.

Overall Moody’s rates the BMO’s financial strength as B-grade risk with a negative outlook.  For the most part, BMO’s ratings by S&P, Moody’s,  DBRS and Fitch are generally one notch less than the Royal Bank’s ratings.

The impact of Nortel on the global economy across the 115 year history of the company is impossible to count. 

Every time you pick up a touch tone phone, use digital communications of any kind, experience broadband Internet access enabled by optical technology, or DSL, or high speed wireless – you are using technology invented by Nortel.

Every time you access your bank or brokerage account online, or use your mobile phone, you are riding on one or more protocols designed by Nortel. 

The first corporate email system in the world was built by Bell Northern Research.  So was the first use of digital packet communications, high-speed fibre optic rings, etc.  These are the very foundations of the Internet.

Nortel’s impact on the tech sector extends far beyond communications.  Engineers at Bell Northern Research contributed enabling technology to the electronic design community, distributed computing, advanced man-machine interfaces such as speech recognition, visualization graphics, dignital signal processing, etc. 

Nortel’s patent portfolio extends across Wireline, Wireless, Datacom, Enterprise and Optical technologies and services.  As of December 31, 2007, Nortel had approximately 3,650 US patents and approximately 1,650 patents in other countries. In fact Nortel has consistently ranked in the top 70 in terms of number of granted U.S. patents since 1998. 

Nortel has received patents covering standards-essential, standards-related and other fundamental and core solutions, including patents directed to CDMA, UMTS, 3GPP, 3GPP2, GSM, OFDM/MIMO, LTE, ATM, MPLS, GMPLS, Ethernet, IEEE 802.3, NAT, VoIP, SONET, RPR, GFP, DOCSIS, IMS, Call-Waiting Caller ID and many other areas.  The term “standards-essential” means that the technology would not be viable without the contribution of Nortel’s engineers.

My own career at Nortel was relatively brief, but in the less than 10 years that I was there I personally witnessed meetings where Nortel’s engineers educated IBM, HP, Intel, Cadence, Mentor Graphics, Microsoft, and a hundred other companies on advanced technology.  The spin off impact of those meetings alone on the tech industry was incalcuable.  Intel actually modified silicon designs, HP introduced new products, and Cadence & Mentor acquired new technology to rev up their revenues.  These were non-patent related discussions.

Nortel was the largest spender on R&D in Canada through both direct investment in its own labs and through leveraged investment in university interaction.  Literally thousands of doctoral degrees in Canada were made possible though collaborative research with Nortel over the years.  Even the scaled back Nortel of today spends more than 1/3 of its salaries on R&D jobs for Canadians.

Yet McGuinty is proud of denying Nortel’s call of distress?  Shame on him.

We get what we vote for.  Our politicians both federally and provincially have demonstrated that they would rather prop up the resource sucking industries of the past than enable a modern Canadian economy of the future.

The fact that the digital economy can create more numerous, more interesting, and higher paying jobs for Canadians compared to the back-breaking and mind-numbing jobs of the resource and manufacturing sectors is completely lost on our politicians. 

Perhaps it is because we elect lawyers and not engineers to parliament?

Is the real problem with Canadian voters who sleepwalk their way to the polls if they bother to vote at all? Do Canadian parents not care about the quality of jobs that will be available for their children? 

Why do we tolerate this ineptitude from our politicians?

Yes Nortel’s management laid the seeds for its destruction.  John Roth in particular is to blame, as is his successor Frank Dunn who is now facing charges for misleading shareholders and gross stupidity. 

Nonetheless, allowing Nortel to die is the wrong policy decision for both the Canadian economy and the high technology sector of Canadian industry.  Write your MPP and MP and give them a shake!

According to the BMO’s 2008 Financial Report, the BMO is carrying about $8.7 B in bad assets – fully half of its market capitalization:

• Bad loans total $3.7 B.  Of significant concern is that $2 B of this amount is so-called “formation of new impaired loans” – i.e. was suddenly added in 2008 alone.  Half of these new impaired loans are attributable to losses in the manufacturing sector and in US real estate.
• Collateralized debt and loan obligations total $4.5 B.  Most of this is hedged with other banks which is great in theory as long as there is no counter-party risk.  However, in October inter-bank lending actually dried up due to fear of counter-party risk!
• Subprime mortgages and asset backed securities total another $0.5 B.

The BMO also has $99 B in off-balance sheet credit loaned to its clients.  If only 10% of these default, then the total bad loans of the bank will double.  Remember Enron?

The final straw that broke Wachovia’s back was when bad debts equalled more than the paid in equity of the bank.  When that happens, the bank is insolvent.  The BMO is halfway there!  If its market capitalization falls by another half in another month, or if 10% of its off-balance-sheet lending defaults, or if some combination of these two events occur, the First Canadian Bank will be history.

A quick health test of the other Candian banks shows that they are in much better shape than the BMO:

• Royal Bank has a
  • market cap of $45.5 B which is almost 2x shareholder equity at $24.4 B.
  • yield of 5.5% which is below the peer group average for Canadian banks
• Scotiabank has a
  • market cap of $29 B which is 1.5x shareholder equity at $18.8 B
  • yield of 6.5% which is roughly equal to the peer group average
• CIBC has a
  • market cap of $18.5 B which is 1.3x shareholder equity at 13.8 B
  • yield of 7.3% which is above the peer group average (suggesting risk)
• TD has a
  • market cap of $33.4 B which is slightly more than shareholder equity at $31.6 B
  • yield of 6% which is below the peer group average.