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Bank of Montreal Has Trading Loss of C$450 Million (Update6)

Date: Monday, April 30, 2007
Author: Doug Alexander and Sean B. Pasternak, Bloomberg

April 27 (Bloomberg) -- Bank of Montreal said it lost as much as C$450 million ($404 million) from natural gas trading, just seven months after similar bets led to the collapse of hedge fund Amaranth Advisors LLC.

The pretax loss will reduce profit by 45 cents to 55 cents a share in the second quarter, or more than a third of forecast earnings, Canada's fourth-biggest bank said in a statement today. The Toronto-based company was expected to earn C$1.32 a share when it reports May 23, based on a Bloomberg survey.

``The loss that we announced today is outside our tolerance,'' said Chief Executive Officer Bill Downe, on a conference call with analysts. Downe took over last month when former CEO Anthony Comper retired.

Bank of Montreal has more at stake in commodities and foreign-exchange trading than any of its Canadian rivals, and its clients included Amaranth. The hedge fund collapsed last year after Calgary-based trader Brian Hunter lost about $6.6 billion betting on natural gas prices. Downe confirmed for the first time today the bank was a prime broker for the hedge fund in Canada.

Bank of Montreal shares fell C$1.27, or 1.8 percent, to C$70 at 4:10 p.m. on the Toronto Stock Exchange, the biggest drop in two months.

Trading Revenue

Bank of Montreal's overall trading revenue more than doubled in the first nine months of fiscal 2006 to C$564 million, outpacing gains at all of its rivals, before slowing after the September collapse of Amaranth. Trading revenue declined 59 percent to C$69 million in the fourth quarter and 62 percent to C$136 million in the first quarter this year.

``We think this raises significant questions about Bank of Montreal's trading business strategy and general risk oversight and management,'' UBS AG analyst Jason Bilodeau said today in a note to clients.

The bank said the energy trading market, primarily natural gas, became ``increasingly illiquid'' and price swings, or volatility, dropped to historically low levels. The bank also changed the way it estimates the market value of its trading portfolio.

``It's really in the last eight weeks that we have seen the move in the market and it's outside the range of what we have experienced,'' Downe said. He said the bulk of the commodities trading was done in the U.S., and the traders involved remain with the firm. Bob Moore, the executive managing director and head of the commodities group in New York, said he couldn't comment.

Narrow Range

Natural gas prices traded within a $1.22 range in the bank's fiscal second quarter. That compares to a range of $3.37 during the same period a year ago. Increased volatility makes it easier for traders to make bets on gaps in prices between different natural gas contracts. That volatility declined in the second half of 2006, and the bank was left with more ``out of the money'' natural gas options contracts, Downe said.

``When you have a more narrow range you definitely have less volatility,'' said Bruno Stanziale, an energy derivatives marketer at Bank of America Securities in New York. ``We've seen volatility dry up.''

Downe said the bank may post additional losses, or gains, as the size of the energy portfolio is reduced. Those losses would be ``in a substantially lower range'' than the C$350 million to C$450 million announced today, he said.

Downe said the bank will reduce its bets on commodities trading.

Lower Risk

``The amount of risk and the volume of trading risk in the commodity business is higher today than it's going to be, and when it comes down it's going to stay down,'' Downe said.

Bank of Montreal relied on trading, including equity and fixed-income, for about 6 percent of total revenue last year, tied with Bank of Nova Scotia and Toronto-Dominion Bank for the lowest rate among Canada's six biggest banks, according to Dundee Securities estimates.

``It's a bit of a double-edged sword,'' said Ian Nakamoto, director of research at MacDougall, MacDougall and MacTier Inc. in Toronto, which manages the equivalent of about $3.9 billion, including Bank of Montreal shares. ``When they call it right, it looks good for investors. When they don't call it right, it's not so great.''

The bank said its so-called Tier 1 capital ratio at the end of the first quarter was 9.9 percent, and the impact of the losses will be less than 20 basis points. The ratio measures a bank's equity as a percentage of assets.

Canadian Imperial Bank of Commerce, the fifth-largest bank, said in a statement it hasn't experienced any ``unusual'' gains or losses from commodities trading.

Other Losses

The trading loss for Bank of Montreal is one the largest ever for a Canadian bank, trailing some corporate lending losses at its rivals. In 2005, Canadian Imperial set aside $2.4 billion to resolve claims by Enron Corp. shareholders, leading to the biggest quarterly loss in its history. Toronto-Dominion, the country's second-largest bank, set aside C$2.93 billion in 2002 to cover loan losses after borrowers such as Teleglobe Inc. couldn't pay their debts.

National Bank of Canada spokesman Denis Dube said the Montreal-based bank hasn't had ``any unusual market behavior in any aspect of our commodities trading.'' Royal Bank of Canada spokeswoman Jackie Braden and Toronto-Dominion spokesman Simon Townsend declined to comment. Bank of Nova Scotia spokesman Frank Switzer didn't immediately return a phone call seeking comment.

To contact the reporter on this story: Doug Alexander in Toronto at dalexander3@bloomberg.net