Bank of Montreal's AIG Acquisition Favorable but Not Transformational

Calling Bank of Montreal’s (BMO) C$375-million cash purchase of AIG’s Canadian insurance business “a bit of a steal,” Dundee Securities analyst John Aiken highlighted the fact that management’s calculated price to book was under 1.1 times. That compares to an average price to book multiple of 1.3x for Canada’s four publicly traded insurers.

More importantly given the current environment, however, is the fact that the acquisition of AIG Life of Canada will only have a modest impact on BMO’s capital ratios, Mr. Aiken told clients. The bank’s management anticipates a less than 15 point decline in its Tier 1 ratio. On a pro forma basis including recent capital issues and changes in risk-weighted assets, the analyst said BMO’s Tier 1 capital is above 10.2%, “still above the market’s apparently mandated 10% minimum threshold.”

Mr. Aiken said:

We view the acquisition favourably as it will benefit BMO by diversifying its revenues, gaining access to additional customers and add to earnings. However, this is not a transformational acquisition but does put the bank in good stead if the Canadian Bankers Association can lift the restriction of branch sales of insurance at some future point.

Nor does it change the analyst’s position on BMO, which he said has been leading the charge in credit deterioration among the Big 6 banks so far in the current downturn. So while this deal may help explain why BMO issued common equity in December, Mr. Aiken said it still does not justify the bank issuing shares below book value. He continues to rate BMO at “neutral” with a C$28 price target.

Desjardins Securities analyst Michael Goldberg notes that bank investments in insurance subsidiaries are not consolidated under Basel II rules. However, those rules will change in 2011 when 50% of an investment would be deducted from Tier 1 capital, which he said would produce a further 10 basis point reduction.

“BMO’s intent is to become a one-stop shop for its clients, allowing it to expand its insurance and wealth management offerings,” Mr. Goldberg said in a research note.

He views the acquisition as immaterial to near-term earnings but positive for optics. “For BMO, optics are relatively more important as its uncertain outlook is reflected in the stock’s 8.5% yield,” the analyst said. Nonetheless, he thinks the near-term impact will be positive, as optics should outweigh the small near-term fundamental impact. Mr. Goldberg rates BMO at “hold” with a C$44.50 price target.

He also believes that markdowns and the losses incurred aside, earnings in the Canadian banks are prolific. “The question remains: how large are the holes that are to be filled.”

RBC Capital Markets analyst Andre-Philippe Hardy noted that AIG’s life insurance business is small with earnings of C$48-million in 2009 and a loss of C$17-million in the last 12 months. This compared to BMO’s annual earnings of more than C$2-billion.

He told clients:

AIG’s range of individual life and annuity products allows BMO to broaden its range of insurance products, which has primarily been credit life and disability insurance, but the small scale will not have a large impact on the growth outlook.

Since Canadian banks cannot sell life insurance in their branches nor share databases with their life insurance subsidiaries, revenue synergies will be limited, Mr. Hardy said. However, BMO intends to offer insurance products as an extension of existing wealth management offering and can sell through its brokerage channel, he added.

RBC maintained its “underperform” rating on BMO. It views the bank’s stronger capital position positively but believes the bank has more exposure to “potentially problematic off-balance sheet assets” and to U.S. lending.

Comments

[abcde_98:]

"Holes" ... watch out BMO and all Canadian banks with US exposure, if the commercial loan market (strip malls, retails stores, etc) starts defaulting or declaring bankruptcy . eg. look at Circuit City, apparel retailers like LIZ/ANN/TLB, lesser known/non-listed exchange companies, etc

Jan 14 12:52 PM