At the Top of the Heap in Banking

08/04/2009 10:26 am EST

Focus: GLOBAL

Tom Slee

Retired- Financial Advisor, Money Manager, Gordon Pape Enterprises LTD

Canada boasts some of the world's strongest banks, and none looks better now than the Bank of Montreal, writes Tom Slee in Internet Wealth Builder.

Finally! Some really good, concrete news! Canadian banks had a very good second quarter. The deeper you scratch the numbers, the better they look. True, earnings were down 8% year over year, but that was much less than the 17% that some analysts were expecting, and the figures were solid. There were signs that the tainted asset bloodbath is over!

Some of the capital improvements were impressive, and returns on equity (ROE) averaged a respectable 16%. Industry book value per share increased 10% over 2008. We are not out of the woods yet, but those results were a big step in the right direction.

The consensus is that Bank of Montreal (NYSE: BMO; TSX: BMO) had the best second quarter. Its credit and capital were better than anticipated, and cash earnings came in at 63 Canadian cents a share, up sharply from 40 cents in the previous quarter.

Bank of Montreal is Canada's fourth-largest bank with assets of approximately C$416 billion. Overshadowed in recent years by the more dynamic Bank of Nova Scotia (NYSE: BNS; TSX: BNS) and TD Bank (NYSE: TD; TSX: TD) as well as industry flagship Royal Bank of Canada (NYSE: RY; TSX: RY), BMO is now well positioned to outperform most of its peers.

As the recession drags on, it's apparent that all the banks will keep increasing their general reserves, as opposed to specific provisions, for future loan losses. After allowing for the present reserves, analysts think that this could cost the industry almost C$2 billion over the next few quarters, with Scotiabank, for instance, having to pony up C$600 million. BMO, by comparison, is in good shape and will have to find C$200 million at most.

At the same time, BMO has an exceptionally strong balance sheet mainly as a result of improved loan and investment experience. The shares have a book value of approximately C$33, 64% [of] the current market value. CIBC has a 50% ratio and Royal a mere 48%. These days, with bank earnings increasingly volatile, book values are much more important. 

Perhaps BMO's big advantage is its strong Canadian retail business. The bank has a history of tight domestic controls, and Canada is in much better shape than other countries. As a result, commercial loan-loss experience is likely to be better than expected and BMO will be a prime beneficiary.

[At] about 17.2x this year's forecast earnings [the stock] at first glance seems fully priced. [That was up to 18 times earnings based on Monday's Toronto closing price of C$54.02—Editor.] My feeling, however, is that the market will soon start to reflect 2010 numbers and the general improvement in banking results. There is, therefore, upside potential in the shares even if the multiple remains unchanged. The stock also offers a handsome 5.4% yield. [That was down to 5.2% as of Monday—Editor.]
 
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