Entries from August 2009 ↓

What a bank run looks like: UK

More on the banks. And your money.

As you may know, enough people worried about BMO on Monday to drive the stock down 3% in one session. The options market flooded with about 25,000 orders to sell shares short. The puts beat the calls by a margin of 13.

Some people, believing the web-based rumours that I told you to ignore, took their money out of the bank and stuck it in others. Only Beemo knows how much cash moved.

If anything, this should remind us that banks are financial intermediaries. They do not take your cash and put it in a safe room with a honking big lock and then pay you interest. Instead they accept your money and give it to other people in the form of mortgages, loans, lines and a host of other products. The bankers make money on the spreads.

That means a run on a bank in which 95% of the deposits have been turned into loans, is a recipe for disaster.  This should surprise nobody. But it does. Which always surprises me. (Take a look at the picture above, when this happened a few months ago to Britain’s Northern Rock Bank.)

Some visitors to this blog asked about deposit insurance and what protection Canadians have in the event of a bank collapse or, for that matter, the insolvency of an investment dealer holding your investment funds or a mutual fund company with your retirement nestegg. So, let’s take a minute and review that. Then a couple of comments. First, this:

So much for blog terror: BMO profits jump
5,500,000 shares trade - up 6.8%

Regarding your bank accounts.

CDIC will only insure deposits in Canadian funds, payable in Canada and for term deposits of five years or less. Your limit is $100,000 and it covers money in savings or chequing accounts, GICs, money orders, traveller’s cheques, bank drafts or accounts which hold funds for property taxes or mortgages.

Of course, you can exceed the hundred grand in a number of ways. For example, an account in your name is insured, plus one in your spouse’s name, and a third one held jointly. Or money in a trust account for your kid has its own insurance, as does an RRSP or a RRIF – to a max of $100,000.

But not insured: Mutual funds, stocks, marketable bonds, T-bills or any debentures or debt issued by governments or corporations. Also SOL is anything in US dollars or other currencies.

So, what happens with your investment portfolio? After all, the big banks all own brokerages – like BMO Nesbitt Burns – so it’s logical to believe trouble with one might mean grief with the other. Here’s where CIPF comes in, an insurance scheme set up by the investment industry.

This is intended to cover securities that you might lose, plus cash balances, if a broker or dealer, discount brokerage or other accredited company goes paws-up. You have 180 days to make a claim, which can be for a million bucks.

As with deposit insurance, you can goose that coverage fairly easily. For example, a general account can be insured for $1 million, and then a separate account can cover retirement savings for another million (on a combined basis). Joint accounts are also covered, but the percentage proportion is added to each person’s general coverage.

And as of four years ago, there’s another plan run by the mutual fund business. The MFDA-IPC gives investors some recourse if a fund company kicks. Like the CIPF, you can claim a million for a general account and still have an equal amount for registered retirement plans.

BTW, the total paid out to investors of failed investment firms over the last 40 years amounts to a mere $36 million. See what a boring country this is?

Obvious point: If you hand over money to an investment outfit, ensure it’s part of CIPF. This is a lesson learned the hard way by Earl Jones victims. That guy was operating as a financial advisor with absolutely no credentials – and yet people entrusted their life savings to him.

Another one: CDIC has got to get with the game and dramatically increase its coverage. A hundred grand just doesn’t cut it anymore. In the US, the FDIC provides $250,000 worth of coverage each on a range of accounts. Some countries, like Ireland, have insured every dollar deposited at every bank. If Ottawa is quite convinced our banks are the best in the world (which we’re incessantly told), then what’s the problem? Cough it up, Jim.

Finally: No major Canadian bank is going to fail. Earnings this week may be lousy, and stockholders may get beat up for a while, but no depositors will be left on the sidewalk. There is no longer a government in the developed world ready to tolerate a bank failure in which public liabilities go unmet. If you don’t know that by now, you’ve not been paying attention.

This is also why I’ve been saying financials strike me as one of the safest sectors in which to invest. No limit now to the public money which would be shovelled in.

This means, of course, you might wish to stick that put, and long a call.

Garth's latest podcast is here.

US blogs speculate BMO going down. Credible?

When the storm hit last autumn, Bank of Montreal has $6.9 billion in cash. At the same time it had an obligation to pay, on demand, $65 billion to business and government for deposits, and another $65.5 billion to folks like us.

Taking into account the cash the bank also had on deposit with other banks (including the Bank of Canada) plus cheques which had not yet cleared the system, BMO could muster a quick $21.1 billion. But, added to the money it owed Canadian depositors, it also owed another $115 billion to American customers.

In short, deposit liabilities of $397 billion. Cash assets of $21 billion.

It doesn’t take long to see why a run on a bank is certain death.

Puts beat calls 13-1, but no collapse

If enough people believed the bank was in trouble, and only 5% of the deposits it had taken in could be repaid tomorrow in cash at the wicket, queues would appear in an instant. That’s just what happened with Northern Rock in the UK last year, as it did with IndyMac in California. In both cases, the banks were taken over by government to avoid public panic.

Over the last few days rumours have been circulating, fed by breathless US financial blogs, that Beemo is going down. The point of ignition is supposed to be Tuesday, when quarterly results are announced. According to the current merchants of fear, BMO will announce it’s missing a fat dividend payment of $1.5 billion. That will cause the stock to drop like a stone, and start a cascade of cash exiting the bank.

The words being used to hype this event are worth noting. This is from Stockgumshoe.com:

On Monday, August 24th, at noon, Dan Amoss will expose the biggest banking lie of the past 64 years. Given the past 21 months of market action — that’s no small claim. If recent mainstream headlines make you believe that banks have weathered the storm. You better think again. Dan’s caught another major bank he thinks is lying about being able to pay their massive $1.5 billion dividend scheduled for 2009. He believes this bank’s using every shady accounting trick possible to hide losses from their shareholders.

Amoss adds this, on Pennysleuth.com:

If you think Canada escaped the downward trend in U.S. banking, think again. While the country may not have plunged headfirst into subprime mortgages, it did dip heavily into risky derivatives. The leverage it took on generated impressive returns on equity in good times, but that same leverage is set to wipe out equity today.

Shareholders in one “safe” Canadian bank will have to rethink their loyalty. Its looming solvency crisis practically guarantees a dividend cut. And that’s our catalyst for this month’s short play action – offering us a chance for 200% profit potential.

Accounting secrets have not yet obliterated Canadian bank earnings – like those of U.S. banks – because the Canadians have not yet accounted for the coming tsunami of mortgage, consumer loan, and corporate loan losses. Here’s how they loaded those loan books with hidden risk.

A Canadian bank failure would, of course, be global news, coming just months after our financials were touted as being among the best capitalized and most secure in the world. American stock bloggers are salivating over this story since the US banking sector has been shattered in the past year, and come close to de facto nationalization. As you might imagine, a collapse of one of the Big Five – even a run on its stock, let alone its assets – would be ruinous for Bay Street, for the federal government, for shareholders, bondholders and the value of the dollar. In short, we’d all be reamed.

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So, what are the facts?

Without a doubt BMO’s been stressed by the financial tsunami we’re living through. Its last quarterly results showed that – net income of $358 million was down a massive $284 million from the same period a year earlier. The money it had to set aside for doubtful loans shot up by over $220 million to a whopping $372 million.

And since then, it’s believed the situation has worsened – for all the Canadian banks.

When earnings flow this week, analysts expect the saddest numbers in some time with BMO down another 14%, CIBC off 16% and Royal lower by 20%. It’s widely believed we may see the bottom of the earnings curve for all these guys, thanks largely to commercial real estate. Since that sector sucks up huge bank loans, and lags the residential market, the impact of empty offices and cancelled condo towers is just now hitting balance sheets.

So should you worry if you own BMO stock, or have an RRSP sitting there?

I guess we’ll see on Tuesday.

But I’d say this web ‘alert’ is crap. BMO has managed to stay within about 6% of its year-ago performance and still earned a pre-tax return of half a billion in the last reporting period. It (and CIBC, the other bank with large US exposure) has been scoped continuously by the Bank of Canada and the Finance Department guys. The banks have sold bushels of stock in recent months to bolster their capital positions and, as you know, received tens of billions in cash for swapping CMHC-insured mortgages with the feds.

The odds of BMO crumbling are akin to Stephen Harper asking me over for a beer. Just ain’t gonna happen in this lifetime.

In any case, do your own research.

Here is the bank’s latest annual report. It is required by law to be as transparent as Paris Hilton.

Here is the transcript of the conversation between senior bank execs and Bay Street analysts following release of its last quarterly.

And here is how you can monitor the situation in real time this week.

Finally, ask yourself why guys like Don Amoss and sites like GumShoe and PennySleuth engage in this kind of stuff.

Right. They ran out of US banks.