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

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

The ratings and trends are supported by the Bank’s sizable domestic franchise and its strong financial risk profile. Although typically not a market-share leader, BMO has solid domestic consumer, commercial and wholesale businesses.

The US$4.1 billion (approximate) acquisition of Marshall & Ilsley Corp. (M&I), which was completed on July 5, 2011, brings with it both opportunities and risks for BMO’s U.S. personal and commercial banking operations. The acquisition increased the U.S. portfolio to about 28% or 29% (DBRS estimate) of the Bank’s total loans, up from 17% at the end of Q2 2011. M&I is being combined with BMO Financial Corp. (formerly Harris Financial Corp. (Harris)). In addition to the US$4.1 billion purchase price, BMO also repaid US$1.7 billion in Troubled Asset Relief Program (TARP) preferred shares.

While the acquisition of M&I materially increases the scale of the Bank’s U.S. operations, possibly positioning it to earn a more reasonable profit, it further exposes the Bank to the challenging U.S. economy, real estate market and interest rate and regulatory environments. In addition, it exposes the Bank to integration risk, although this risk is to some extent mitigated by the Bank’s previous integration experience in the United States and deep knowledge of the regional market given its longstanding ownership of Harris. (Please see the December 17, 2010, DBRS press release confirming Bank of Montreal following the announcement of the agreement to acquire M&I.)

BMO recorded an 11.1% increase in H1 2011 pre-tax earnings compared with H1 2010, almost entirely due to a reduction in loan loss provisions; pre-provision earnings over the period increased just 1.3%. The annualized return on equity (ROE) of 16.2% in H1 2011 is up from 15.3% in H1 2010. The increase thus far in 2011 follows an improvement of 57% in net income for the full-year 2010 compared with a depressed 2009.

Loan loss provisions declined to $393 million in the first half of 2011 from $582 million in H1 2010, following a material decrease in 2010 compared with the prior year. Gross impaired loans-to-gross loans, while improved, are high relative to the Bank’s Canadian banking peer group, reflecting the challenged U.S. operations.

BMO’s capital ratios were solid and the quality of capital was strong relative to its Canadian bank peers at the end of Q2 2011. However, the acquisition of M&I resulted in a reduction in the pro forma Basel II tangible common equity (TCE) and Tier 1 ratios to 9.4% and 11.9% (based on April 30, 2011), respectively, which are at the low end of BMO’s Canadian bank peer group, albeit still well in excess of regulatory requirements. On a Basel III basis (also based on April 30, 2011), the pro forma TCE and Tier 1 ratios were 6.9% and 9.2%, respectively.

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

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

The applicable methodologies are the Global Methodology for Rating Banks and Banking Organisations (January 14, 2010), Rating Bank Preferred Shares and Equivalent Hybrids (June 29, 2009) and Enhanced Methodology for Bank Ratings – Intrinsic and Support Assessments (February 11, 2009), which can be found on our website under Methodologies.

The sources of information used for this rating include information provided by the Bank of Montreal, Bank for International Settlements and Office of the Superintendent of Financial Institutions Canada. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

For additional information on this rating, please see DBRS Limited: Banks and Banking Organisations Linking Document by clicking the link under Related Research at the right of the screen or by contacting us at info@dbrs.com.

Lead Analyst: Robert Long
Rating Committee Chair: Kent Wideman
Initial Rating Date: December 31, 1980
Most Recent Rating Update: December 17, 2010