Canada's fourth-biggest bank lost its balance this year. CEO William Downe, who succeeded Comper in March, said last week that the Toronto-based company will report a trading loss of as much as C$450 million ($403 million) from betting on natural gas. The bank failed to ``adequately recognize the vulnerability of the portfolio,'' he said on April 27.
The biggest trading debacle in Canadian history may wipe out at least a third of Bank of Montreal's pretax profit for the quarter that ends today, and shows deposit-taking institutions may be unprepared for the kinds of risks that led to record first-quarter profits on Wall Street.
``Do I want Bank of Montreal to be swashbuckling traders? No. Pinstriped bankers? Fine, they know that business,'' said James Hall, who helps oversee $4.2 billion at Mawer Investment Management in Calgary, which holds Bank of Montreal shares. ``It's a red flag for risk-management models.''
Bank of Montreal said it will record a pretax loss of C$350 million to C$450 million, or 45 cents to 55 cents a share. The loss will reflect the reduced value of its natural gas options contracts.
Shares
Bank of Montreal shares fell 54 cents to C$69.46 at 4:10 p.m. today on the Toronto Stock Exchange, and have gained 0.7 percent this year, compared with a 0.9 percent gain in the Standard & Poor's/TSX Banks Index.
Canada's Office of the Superintendent of Financial Institutions, which regulates banks, has contacted Bank of Montreal about the trading losses, spokesman Jason LaMontagne said in an interview from Ottawa. He said it was part of the regulator's ``ongoing relationship'' with the bank, without elaborating.
``Any issue that comes up, whether it be large or small, that we have a concern with,'' is brought to the attention of the bank, LaMontagne said today.
Bank of Montreal, founded in 1817 in the country's second- biggest city, began promoting itself as an energy trader after Hurricane Katrina in August 2005 caused natural gas to surge. Natural gas contracts traded in New York doubled in six months, to an all-time high of $15.78 per million British thermal units in December 2005.
Paid Off
The bet on natural gas initially paid off. Profits from the commodity group, led by Executive Managing Director Bob Moore, with a team of traders in New York, Houston and Calgary, helped trading revenue more than double in the first nine months of the fiscal year ended Oct. 31 to C$564 million. Bank of Montreal's trading revenue grew faster than all of its domestic rivals. Moore declined to comment.
``As a result of the volatility in the oil and gas prices recently, our clients have come to us to hedge their own exposures,'' Chief Financial Officer Karen Maidment said after the bank's annual meeting in Calgary in March 2006. ``So while the trading revenue has been higher than it typically was in the past, it really reflects the quality of the franchise.''
Bank of Montreal also started trading with hedge funds, including Amaranth Advisors LLC, the $9.5 billion fund that collapsed last year because of bets on gas prices. Bank of Montreal cleared and settled trades in Canada as one of Greenwich, Connecticut-based Amaranth's brokers.
Risk Model
Mario Mendonca, a Toronto-based analyst at Genuity Capital Markets, began questioning the bank last year about the heightened risk from commodities trading after the Amaranth collapse. Credit Suisse Group analyst James Bantis estimated that Bank of Montreal took 17 times more risk trading commodities in the fiscal first quarter than Royal Bank of Canada, the country's biggest bank.
Bank of Montreal managed its trades according to a value- at-risk, or VaR, a model that gauged how much the bank could lose in a day if markets moved against it. The company increased its commodities VaR to C$5.9 million in 2006 from C$1.3 million in 2004, according to Dominion Bond Rating Service.
Downe, 55, said on the conference call that energy trading is the bank's ``most volatile business.''
``Risk management isn't an easy game in the energy business,'' said Shannon Burchett, president of Dallas-based energy consultant Risk Limited Corp., who traded oil for JPMorgan Chase & Co. and Citigroup Inc. in New York during the 1990s. ``The wheel came off the model. They didn't exactly understand how to manage the risk.''
Not Commenting
Bank spokesman Ralph Marranca said executives wouldn't comment on the trading losses.
Robert McGlashan is the chief risk officer at Bank of Montreal. He joined the company in 1972 and was given his current job in July 1, 2005. He had no experience in trading until about four years ago, according to a biography on the company's Web site.
Bank of Montreal's natural gas bets began to unravel after the Amaranth collapse, sparked by the 53 percent decline in gas prices in August and September. The bank continued to make a market in commodities, buying and selling gas futures contracts and options when clients wanted to trade during the second half of last year.
Traders
Amaranth's meltdown in September eliminated one the market's biggest traders, making it harder for Bank of Montreal to exit positions. The company's options contracts lost value because prices swung less.
``As the bank's energy trading business continued to grow, so did our position in out-of-the-money natural gas options,'' Downe said on the conference call with analysts. ``We're conducting a thorough review, and actions have been taken to address the current situation and reduce the likelihood of a recurrence.''
Downe said the bank may be able to recover some of the money as it reduces its holdings of natural gas options.
``It's somewhat like a roach motel. You can get in but you can't get out,'' said Craig Pirrong, a professor of finance at the University of Houston who has advised the Chicago Board of Trade. ``You might have to hang on to it a long time or dispose of it at fire-sale prices.''
Not Fast
Bank of Montreal's value-at-risk calculations signaled the growing risk of losses on the gas trades, McGlashan said on the April 27 conference call. The company wasn't able to act fast enough to limit the damage before volatility dried up.
``This is a very narrowly traded market and it is difficult to obtain transparency and price points in that kind of an environment,'' McGlashan said on the call. ``The analysis that we have gone through since we started to grow this made it clear to us that the VaR methodology in isolation wasn't going to be adequate for this particular book, which is why we've made some changes.''
Bank of Montreal's management of its bets contrasts with, Goldman Sachs Group Inc., the world's most profitable securities firm. Lloyd Blankfein, who took over as chairman and CEO a year ago, spent most of his career in the commodities and fixed- income trading department and elevated two executives with trading experience, Gary Cohn and Jon Winkelried, to become his most senior deputies.
``We spend a lot of time trying to avoid problems in our business, trying to say how much risk can we take, what is our downside?'' Blankfein told analysts and investors at a conference in New York on Nov. 14. ``At the senior leadership at Goldman Sachs, you will not find a person who did not spend a part of his career or her career really focused on this.''
Volatility
Burchett, the former oil trader, said the history of natural-gas prices, which go through periods of rapid changes followed by trading doldrums, show that Bank of Montreal's risk models should have accounted for the decline in price swings.
Bank of Montreal's strategy of increasing trading and taking more risks hasn't paid off for shareholders.
The bank's stock was the worst performing among the country's six biggest lenders last year. Bank of Montreal has considered itself the lowest-risk Canadian bank, with the highest dividend yield and the lowest provisions for credit losses last year.
``It's been a matter of consistency, which has been aided by the fact that we have very good risk management,'' Comper, 62, said in an October 2005 interview. ``That allows us to be consistent in good times and in bad.''
Reputation
Some analysts said the trading losses tarnish that reputation.
``It just doesn't seem consistent with how the bank has defined itself in the past as being the best credit bank in Canada,'' said Steve Cawley, an analyst at TD Newcrest in Toronto, on the conference call.
The losses ``demonstrate deficient risk management,'' Cawley said today in a note, in which he lowered his 12-month price target to C$71, from C$73.
``This came as an absolute surprise to me,'' said John Aiken, an analyst at Dundee Securities Corp., who rates Bank of Montreal ``market neutral.'' ``It brings into question that, even if they were able to see the risks that were coming, it was not timely enough for them to be able to address the situation.''
BajaeNergyBLOG
OiL,Baja
eNergy
BLOG
