DBRS Morningstar Confirms Bank of Montreal at AA with a Stable Trend

DBRS Limited (DBRS Morningstar) confirmed the ratings of the Bank of Montreal (BMO or the Bank) and its related entities, including BMO’s Long-Term Issuer Rating at AA and Short-Term Issuer Rating at R-1 (high). The trend on all ratings is Stable. The Bank’s Long-Term Issuer Rating, which is composed of an Intrinsic Assessment (IA) of AA (low) and a Support Assessment (SA) of SA2, reflects the expectation of timely, systemic support from the Government of Canada (rated AAA with a Stable trend by DBRS Morningstar). This results in a one-notch lift to the BMO’s Long-Term Issuer Rating. Once the Bank has issued a sufficient level of Bail-inable Senior Debt to provide for an adequate buffer for nonbail-inable obligations under the Canadian Bank Recapitalization Regime, DBRS Morningstar expects to remove the systemic support.

KEY RATING CONSIDERATIONS
The rating confirmations and Stable trends reflect BMO’s strong North American franchise, with the Bank ranking as one of the five largest banks in Canada with assets of $987.1 billion as at April 30, 2020. In the U.S., BMO has a strong focus on states in the U.S. Midwest—Illinois, Wisconsin, Indiana, Minnesota, Missouri, and Kansas—while it also has branches in Arizona and Florida and operates some businesses beyond its branch footprint. The Bank has the number two market share in deposits in both Illinois and Wisconsin. BMO’s ratings are further supported by a conservative risk profile, reflecting a strong risk culture and prudent underwriting standards; a strong funding and liquidity profile, which benefits from a stable deposit base that is sourced in both Canada and the United States; and strong capital levels.

The ratings also reflect the likely impact of the wide and growing scale of the economic disruption caused by the Coronavirus Disease (COVID-19) pandemic. In addition, there has been unprecedented support measures put in place by governments and regulators around the globe, which will mitigate some of the negative impacts of this crisis. The implications for the medium to long term will depend on the evolution of the outbreak, the length of the economic shutdown, as well as the transition phase of the recovery. The ratings also consider that BMO’s loan portfolio is more weighted toward commercial lending as compared with its Canadian bank peers; however, DBRS Morningstar notes that the Bank has the lowest exposures to residential real estate-secured lending in Canada relative to its Canadian bank peers. In addition, the overall financial performance of BMO’s U.S. business continues to lag compared with other DBRS Morningstar highly rated U.S. regional banks, despite the improvements seen in this business over the last few years.

RATING DRIVERS
Given the current environment, DBRS Morningstar views an upgrade of BMO’s ratings as unlikely. Over the longer term, a sustained improvement in financial performance in BMO’s U.S. banking operations to levels similar to highly rated U.S. regional bank peers or outperformance by BMO compared to its Canadian bank peers while maintaining its conservative risk profile would lead to an upgrade of the ratings.

The ratings would be downgraded as a result of a sustained deterioration in BMO's asset quality or a prolonged adverse impact from the coronavirus pandemic, which would have a significant impact on the Bank's financial performance. An increase in BMO’s risk appetite or a shift toward a potentially more volatile earnings mix, including a material increase in the contribution from BMO Capital Markets would result in a downgrade of the ratings.

RATING RATIONALE
BMO consistently generates strong earnings and profitability metrics underpinned by its highly diversified business franchise, which contributes to the Bank's ability to absorb credit losses. In F2019, earnings were $5.8 billion, with the Bank generating a solid return on average common equity of 12.6%, although this metric remains below those of its Canadian bank peers. In H1 2020, the Bank reported earnings that were down 24% compared with the same period last year, reflecting higher provisions for credit losses (PCL) and lower revenue. DBRS Morningstar notes that the operating environment is now significantly more pressured, which will negatively affect BMO's earnings over the intermediate term.

Overall, DBRS Morningstar views BMO's risk profile as conservative, reflecting a strong risk culture and prudent underwriting standards. Historically, the Bank’s asset quality metrics are better than the Canadian bank peer average. In H1 2020, BMO reported a sharp increase in PCL of $1.2 billion to $1.5 billion, with PCL on performing loans rising to $730 million compared with a provision of $36 million in the prior year. Overall, the increase in PCL primarily reflects the weaker economic outlook. DBRS Morningstar will continue to monitor the adverse impact of the coronavirus pandemic on the economies of both Canada and the United States as well as its future impact on the Bank’s credit fundamentals. While PCL levels in F2020 will be elevated, it is uncertain whether these higher levels of provisions will translate into higher loan losses, as this will be driven by the duration of the economic downturn.

BMO has a strong funding and liquidity profile, which is underpinned by a high level of client-sourced deposits garnered in both Canada and the United States. The Bank supplements this through a wide range of wholesale funding sources, with BMO's usage within an acceptable range and in line with the Canadian bank peers average. In addition, liquidity remains strong as the Bank’s liquidity coverage ratio (LCR) in Q2 2020 rose to 147%, which remains near the top of its Canadian bank peers and is well above the regulatory minimum. During Q2 2020, the Bank accessed several of the new programs offered by the Government of Canada to supplement BMO's funding, with BMO holding $187.5 billion in high-quality liquid assets for LCR, a 10% increase sequentially.

DBRS Morningstar views BMO's capitalization as strong, reflecting the usually significant levels of internal capital generation, which remains sufficient as a cushion to absorb potential losses. In Q2 2020, BMO’s CET1 ratio declined 40 basis points (bps) from the linked quarter to 11.0%, largely from growth in risk-weighted assets (RWA) and remains well above regulatory minimums. On March 13, 2020, the Office of the Superintendent of Financial Institutions (OSFI) lowered the Domestic Stability Buffer (DSB) requirement for Domestic Systemically Important Banks (D-SIBs) to 1.0%, which effectively reduces the CET1 regulatory minimum to 9.0% for D-SIBs. As the DSB was intended, OSFI is providing the D-SIBs with more flexibility to extend loans to their customers during the coronavirus pandemic. Simultaneously, OSFI announced that it expects all D-SIBs to halt any new common share dividend increases and buyback activity. In Q2 2020, the Bank's total loss-absorbing capacity as a percentage of RWA increased 60 bps to 21.4%.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

The Grid Summary Grades for the Bank of Montreal are as follows: Franchise Strength – Very Strong/Strong; Earnings Power – Strong; Risk Profile – Strong; Funding & Liquidity – Strong; Capitalization – Strong.

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

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (June 11, 2019) https://www.dbrsmorningstar.com/research/346375/global-methodology-for-rating-banks-and-banking-organisations.

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found on the issuer page at www.dbrsmorningstar.com.

The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

This rating is endorsed by DBRS Ratings Limited (DBRS Morningstar) for use in the European Union. The following additional regulatory disclosures apply to endorsed ratings:

The last rating action on this issuer took place on June 20, 2019, when DBRS Morningstar confirmed the Bank’s ratings.

Generally, the conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. DBRS Morningstar’s outlooks and ratings are monitored.

For further information on DBRS Morningstar historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Lead Analyst: Robert Colangelo, Senior Vice President
Rating Committee Chair: Michael Driscoll, Managing Director
Initial Rating Date: December 31, 1980

For more information on this credit or on this industry, visit www.dbrsmorningstar.com.

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