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Oct 4, 2009 
Banks are experts at financial obfuscation when reporting their results. The latest Q3 reports from the Bank of Montreal are a great example of this.
On page 11 they describe their exposure to risk in interest rates in a reasonably positive light: for each negative change in interest rates by 100 basis points they lose $231 M on their loan book, but if interest rates go down the same amount (highly unlikely by the way), they make $204 M.
What they don’t tell you is that due to the structure of their interest rate gap position (which you can see if you dig into BMO’s Q3 supplementary statistics) the actual exposure is $333 M decrease in asset value for the first 100 basis point increase and a whopping $706 M decrease for a 200 basis point increase.
But asset value is only part of the story when it comes to Banks. The real question is how is the bank making money on those loan “assets”? After all it doesn’t matter if the asset is more valuable if the bank loses liquidity by carrying it.
So what is really revealing in the supplementary statistics is the fact that the Bank’s interest earnings will go down no matter which way interest rates move!!
A 100 basis point increase causes earnings to drop $27 M while a 100 basis point decrease causes earnings to drop by $51 M!! Heads you lose and tails you lose.
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.
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