DBRS Confirms Bank of Montreal at AA and R-1 (high), Stable Trend

DBRS has confirmed the ratings of Bank of Montreal (BMO or the Bank) and related entities, including BMO’s Deposits & Senior Debt at AA and Short-Term Instruments at R-1 (high). All trends are Stable.

The ratings and trends are supported by BMO’s sizable domestic franchise and its financial risk profile. Over the last 18 months, BMO has been reviewing and implementing changes to its risk management system following charges related to its energy trading business. DBRS believes this scrutiny is positive in adding more rigour to the risk management framework, especially given the weakening credit environment.

Following a lengthy period of better credit performance than the industry, fiscal 2008 and H1 2009 witnessed a reversal of performance. It is too early to determine whether this reversal is a trend or whether BMO is being conservative by aggressively provisioning early in the credit cycle.

On May 13, 2008, BMO restructured Apex Trust, including providing additional funding in the form of a senior funding facility to satisfy collateral calls. BMO’s exposure at Q2 2009 was a $815 million (carrying value of $407 million) participation in $2.2 billion of medium-term notes and a $1.03 billion participation in $1.13 billion senior funding facility to fund collateral calls. Additionally, on March 3, 2008, BMO provided support to its two structured investment vehicles (SIVs), Links Finance Corporation (Links) and Parkland Finance Corporation (Parkland), in the form of liquidity facilities. The outstanding draw on the liquidity facilities by the SIVs is US$5.6 billion and EUR 458 million, respectively, at Q2 2009. Given the trickle of asset sales so far in 2009, the liquidity facilities provided by BMO are expected to peak in August 2009 at US$6.6 billion for Links and EUR 620 million in July 2009 for Parklands. Actual losses from assets in the SIVs have been absorbed by the capital notes, which continue to provide first-loss protection. If this first-loss protection was fully eroded, BMO may be required to record credit provisions against its loan facility.

BMO has solid domestic consumer, commercial and wholesale businesses. The Bank has been steadily growing market share in its retail bank by using a customer-focused approach to banking. It appears the investments in technology for front-line staff, changing the mix of staff (through reducing non-client-facing employees and redeploying these savings into front-line staff) and better training are starting to produce results. While mortgage market share continues to decline, the rate of decline is slowing as the mortgage-broker-originated portfolio runs off. DBRS believes any meaningful gains in productivity will take some time given the shift in the Bank’s culture.

In Q2 2009, BMO announced that it was reducing costs by simplifying its management structure in both the business lines and corporate support areas. The severance cost associated with this action was pre-tax $118 million and is anticipated to generate a greater level of annual savings. These actions are not unexpected given the slower revenue growth environment and most of its peers had already taken similar actions.

BMO’s long-term Deposits & Senior Debt rating at AA is composed of an intrinsic assessment of AA (low) and a support assessment at SA2 (reflecting the expectation of systemic and timely external support by the government of Canada). The SA2 results in a one-notch benefit to the senior debt and deposits and subordinated debt ratings, which benefit from this implied support.

On April 20, 2009, DBRS announced a change to the banking methodology, specifically to bank preferred shares and Tier 1 innovative instruments. Following a review, the change resulted in a downgrade of these instruments by one notch on June 29, 2009. Please see the related DBRS press releases for further details.

BMO is a full-service Canadian bank based in Toronto, with a sizable established U.S. retail-banking franchise through the wholly owned Harris Bankcorp, Inc. in Chicago.

BMO has four operating groups: Personal and Commercial Banking, Private Client Group, BMO Capital Markets and Corporate Services, accounting for 72%, 20%, 35% and -27%, respectively, of DBRS-adjusted operating net income in 2008.

Personal and Commercial Banking serves more than eight million retail customers in Canada and the United States. P&C Canada and P&C U.S. accounted for 93% and 7%, respectively, of Personal and Commercial Banking’s 2008 operating net income. The contribution has been relatively unchanged for the past four years. Private Client Group incorporates full-service brokerage and direct investing in Canada, North American private banking and investment management; a substantial portion of this operating net income is generated in Canada. BMO Capital Markets services corporate, institutional and government clients in Canada and middle-market clients within select sectors in the United States.

The Bank of Montreal is the fourth largest Schedule 1 bank in Canada, based on total assets ($432 billion) at the end of Q2 2009.

Notes:
All figures are in Canadian dollars unless otherwise noted.

DBRS ratings for Bank of Montreal Mortgage Corp. are based on the unconditional guarantee of Bank of Montreal.

The applicable methodologies are Rating Banks in Canada, Enhanced Methodology for Bank Ratings – Intrinsic and Support Assessment and Rating Preferred Shares and Equivalent Hybrids, which can be found on the DBRS website under Methodologies.

This is a Corporate (Financial Institutions) rating.