DBRS Confirms Ratings of Bank of Montreal, Negative Trends

DBRS Limited (DBRS) has today confirmed the ratings of Bank of Montreal (BMO or the Bank) and related entities, including the Deposits & Senior Debt at AA and Short-Term Instruments at R-1 (high). Trends on senior long-term debt ratings, short-term instruments and older-style subordinated debt remain Negative, while other capital instruments whose ratings are notched down from the Bank’s intrinsic assessment continue to have a Stable trend. Additionally, DBRS has discontinued the rating for BMO Capital Trust’s BOaTS - Series D, due to its recent repayment. BMO’s ratings are supported by the Bank’s sizable domestic franchise and its strong financial risk profile. Although typically not a market share leader in consumer retail banking, BMO has solid domestic consumer, commercial and wholesale businesses. Additionally, BMO benefits from a North American personal and commercial banking platform, given the Bank’s growing presence within the United States.

BMO’s long-term deposits and senior debt rating, at AA, is composed of an intrinsic assessment of AA (low) and support assessment of SA2 (reflecting the expectation of systemic and timely external support by the government of Canada). The SA2 ranking results in a one-notch benefit to the senior debt and deposits ratings. The Negative trend reflects DBRS’s view that anticipated changes in Canadian legislation and regulation mean that the potential for timely systemic support for these systemically important institutions is declining and is likely to eventually result in a change in DBRS’s support assessment to SA3 from SA2 for this institution. At the same time, DBRS notes that additional protection for non-bail-in-able debt and deposits may eventually be provided by bail-in-able senior debt under the anticipated bail-in debt regime. DBRS will assess the impact of the Taxpayer Protection and Bank Recapitalization Regime rules as more details are made available by the authorities.

BMO is a well-diversified bank which has a good position in the top tier of lenders in Canada. A sizable Canadian personal and commercial franchise, with a distribution network of 937 branches and 3,222 automated banking machines (ABMs) as at April 30, 2015, BMO has the number-two market share in small to medium business lending. The market share of the personal banking franchise is typically lower than most of the other four large Canadian banks, and the Bank is challenged because sustainable material market share gains are difficult to come by over the longer term in the highly competitive Canadian market. BMO Harris provides BMO with a solid platform to grow in U.S. retail and business banking and wealth management, providing the Bank with geographic diversification, albeit in a materially more challenging banking environment than Canada.

BMO continues to deliver excellent returns, with return on common equity generally in the mid-teens. BMO continues to have the highest efficiency ratio of the big six Canadian banks, with earnings easily covering provisions with a high degree of diversity, adding to the Bank’s ability to weather tougher times.

Risk Management culture appears to be strong at BMO, with very strong asset quality measures, although provisions and impaired loans are admittedly at unsustainably low levels and will eventually increase. Management described having an appropriate reporting and control structure for the type of risks found in both the credit and capital markets.

As with other Canadian banks, BMO has a notable exposure to the Canadian residential mortgage market. Any slowdown in this market may slow earnings generation, while a downturn in the residential mortgage market could hurt asset quality indicators and ultimately have an impact on provisioning levels. Direct exposure to oil and gas (O&G) is manageable within a well-diversified portfolio. Asset quality within the Canadian market will be determined by the extent to which any deteriorating consumer credit quality trends materialize in the Canadian market, including potentially as an indirect result of volatility in O&G. At this point, there are no material observable problems.

The Bank’s financial risk profile remains robust as a result of solid internal capital generation, reasonable quality of capital and strong capital ratios. The Bank has a good funding profile and handily meets the new liquidity regulations.

BMO’s rating could be positively influenced if the Bank were to improve returns in its U.S. banking operations without substantively increasing the risk profile of its lending portfolio and a successful execution of the wealth management strategy. In addition to the support and other considerations noted earlier with respect to the negative trend, other factors with negative rating implications include an increase in risk appetite or notable weakening of asset quality, or franchise.

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

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

The applicable methodologies are Global Methodology for Rating Banks and Banking Organisations (June 2015), Rating Bank Capital Securities - Subordinated, Hybrid, Preferred & Contingent Capital Securities (February 2015), and DBRS Criteria: Support Assessments for Banks and Banking Organisations (March 2015), which can be found on DBRS’s website at www.dbrs.com.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.