BMO and Barings

by Mike Holman

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I decided to make Bank of Montreal (BMO) the first stock that I bought for my leveraged investment portfolio. I also own small amounts of BMO in various mutual funds but the 100 shares of BMO I bought recently represent the first time I’ve directly owned part of a company.

The reasons I bought BMO were mainly because it was one of the big five banks with proven dividend increases and it had the highest dividend yield of the banks. In my mind it is a very safe investment because it’s unlikely that any of the big banks will ever fail.

Having said that, BMO recently just lost $680 million from commodity trading losses, which sounds like there might be some fraud involved. This sort of debacle raises the question, are the banks really as safe as we think they are?

In this case, BMO had no problem coming up with other earnings to make up for the huge loss so I’d say they are still pretty safe, although I’m guessing there was some fancy accounting footwork going on to be able to still increase their profits.

I was reminded of another bank that had some trading losses not too long ago. Barings Bank of London failed in 1995 because of a rogue trader named Nick Leeson who lost $1.4 billion speculating on futures contracts. This is roughly $2 billion in today’s Canadian dollars which is a lot more than the $680 million BMO loss. I don’t know how big Barings was in comparison to BMO but I do know that it was the oldest merchant bank in London (est. 1762). Apparently Leeson was a regular back-office worker who managed to trade large sums of money on the banks behalf. He eventually got caught and served time in jail. You can find out what he’s up to now on his website. I’m not sure if he has a personal financial blog as well :)

I think the important thing to learn from Barings & BMO (and Enron and so on, and so on) is that diversification is important. It doesn’t matter if you own the best stock in the world, all it takes is one big fraud and your losses could be significant.

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{ 12 comments… read them below or add one }

1 Mr. Cheap

Its great that you’re acknowledging a worst case scenario and factoring it into your planning. Congrats on your BMO purchase!

2 FourPillars

Thanks Mr. C – I’ll be looking forward to the thrill of receiving my first dividend cheque…

Mike

3 Average Joe

If CIBC can survive the Enron debacle and still increase their dividend, it almost makes you think that the banks are invulnerable! Compared to that, the BMO ‘scandal’ doesn’t seem like much.

4 Mr. Cheap

The first dividend check is “oh so sweet” ;-)

5 Canadian Capitalist

In my opinion the CIBC Enron write-down is much less worrisome than the BMO trading losses (though I don’t follow either company, it won’t stop me from giving my opinion :) )

Where was the trading oversight? How much of BMO’s capital was at risk? How many more cockroaches are in BMO’s kitchen? If I held BMO, it would surely give me a few sleepless nights.

AJ, what makes you think that CIBC was worse than BMO?

6 FourPillars

Given that Enron was a fraud situation, CIBC can be cut some slack. BMO – we’ll have to wait to see what happened and how the trading losses occurred. If it was just lack of supervision then that’s bad news. On the other hand if it’s fraud then maybe some slack should be cut for them as well.

Mike

7 moneygardener

As far as share price goes, the whole nat. gas trading fiasco was not really a major event for BMO. As far as I can see the stock hit ~67.80 after it occured, and is now trading at $68.23 after some good earnings. Technically the chart looks horrible, and I would not be too surprised to see it break below $67.

8 FourPillars

That’s true MG. The price did drop from around $72 before the fiasco but that was a recent high.

All I know is that those dividends should keep coming and hopefully increasing too!

Mike

9 moneygardener

It’s just interesting that I commonly hear people talk about this nat. gas trading fiasco, like it was such a big hit to the stock, and such a great time to get in on weakness. I beg to differ. The dividend props the stock up to the point that it became a non event.

Compare it to what happened in January, 2007 to IGM Financial, (my most proud stock entry point) and you can see what I mean.

10 FourPillars

I just looked up the chart for IGM – looks like u got a steal.

You’re right about the dividend propping up the stocks. I’d be curious to know how the banks did in 2001-2002 compared to the rest of the market.

Mike

11 moneygardener

I guess we all get lucky sometimes. However the IGM example is my most convincing experience yet, on how the market is not 100% efficient in the short term, or it could have just been a 50/50 bet, I’ll never know. Good company to take that chance on though.

12 FourPillars

I just reread the latest edition of Random Walk Down Wall Street which was updated to include the dot com bubble. Malkiel’s explanation for the market’s inefficiency during that time was that since the market eventually went down, it was eventually efficient. I like the book but that explanation was a bit lame.

Mike

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