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 of AA (low) and a Support Assessment 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 BMO’s Long-Term Issuer Rating.

KEY RATING CONSIDERATIONS
The rating confirmations and Stable trends reflect BMO’s diversified franchise, ranking as the eighth-largest bank in North America by assets, consistent solid earnings, and strong balance sheet fundamentals. BMO’s footprint spans across Canada, while the U.S. franchise is focused on states in the U.S. Midwest with some national businesses. BMO’s ratings are further supported by a conservative risk profile, reflecting a strong and prudent underwriting culture, which has been tested in the current downturn. DBRS Morningstar views both the Bank’s funding and liquidity profile—which benefits from a stable deposit base that is sourced in both Canada and the U.S.—and its capitalization profile as strong.

The ratings also consider the recovering economy, which still reflects the disruption caused by the Coronavirus Disease (COVID-19) pandemic. Positively, unprecedented support measures put in place by governments and regulators around the globe have mitigated much of the negative impacts of this crisis. 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.

RATING DRIVERS
Over the longer-term, a sustained outperformance by BMO compared to global bank peers, while maintaining its current risk profile, would lead to an upgrade of the ratings.

Conversely, BMO’s ratings would be downgraded following a sustained deterioration in asset quality, especially from an increase in risk appetite. Additionally, a shift toward a potentially more volatile earnings mix, including a material increase in the contribution from capital markets, or a decline in profitability levels to below that of its peer group would result in a downgrade of the ratings.

RATING RATIONALE
BMO consistently generates solid earnings and profitability metrics underpinned by its highly diversified business franchise, which contributes to the Bank's ability to absorb credit losses. BMO reported Q2 2021 net income of $1.3 billion, a 35% decline quarter over quarter (QOQ), mainly due to the impact of divestitures, including a goodwill write-down of $747 million. The write-down is related to the previously announced sale of BMO's EMEA Asset Management business. BMO's underlying operating performance remains sound, with the adjusted net income increasing almost 3% QOQ to $2.1 billion, primarily driven by a decline in the provision for credit losses (PCL). As compared with the linked quarter, BMO's adjusted revenues and expenses were flat, as the Bank continues to exhibit prudent expense control.

Overall, DBRS Morningstar views BMO's risk profile as conservative, reflecting a strong risk culture and prudent underwriting standards as the Bank has historically maintained asset quality metrics that are better than the Canadian bank peer average. BMO's credit quality remains strong, with total PCL continuing its declining trend. During the quarter, the Bank reported $60 million total PCL as compared with $156 million in the linked quarter. The Bank recorded a recovery of PCL on performing loans of $95 million during the quarter because of strong credit performance and an improving economic outlook. As a result, BMO's PCL on impaired loans ratio and total PCL ratio declined sequentially to 13 basis points (bps) and 5 bps, respectively, representing the lowest levels over the past eight quarters. Gross impaired loans remain low and declined 9 bps sequentially to 0.65% of gross loans and acceptances as new formations were modest and repayments remained stable.

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 U.S. 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 peer average. BMO's liquidity position is solid, including a liquidity coverage ratio (LCR) of 129% as at April 30, 2021. Since last quarter, Canadian domestic systemically important banks (D-SIBs) are required to disclose their net stable funding ratio (NSFR), which, unlike the LCR, looks at funding resilience over the medium to longer term. BMO's NSFR was 119% as at April 30, 2021, which readily exceeds the regulatory minimum of 100%.

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. For Q2 2021, the CET1 ratio increased 60 bps QOQ to 13.0%, largely driven by strong internal capital generation and lower risk-weighted assets (RWA). At this level, BMO has a sizable capital cushion of approximately $12.8 billion above regulatory minimums. DBRS Morningstar expects capital levels will continue to build until the Office of the Superintendent of Financial Institutions (OSFI) relaxes its restrictions on capital management activities for the D-SIBs. While the Bank's total loss-absorbing capacity as a percentage of RWA declined marginally to 24.2% from 24.6% in the linked quarter, it remains strong and above the current minimum of 22.5% (21.5% plus 1.0% Domestic Stability Buffer) set by OSFI, with compliance required by November 1, 2021.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

The Grid Summary Grades for Bank of Montreal are as follows: Franchise Strength – Very Strong/Strong; Earnings Power – Strong; Risk Profile – Strong; Funding & Liquidity – Strong; Capitalisation – 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 8, 2020; https://www.dbrsmorningstar.com/research/362170). Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (February 3, 2021; https://www.dbrsmorningstar.com/research/373262).

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 for use in the United Kingdom, and by DBRS Ratings GmbH for use in the European Union, respectively. The following additional regulatory disclosures apply to endorsed ratings:

Each of the principal methodologies/principal asset class methodologies employed in the analysis addressed one or more particular risks or aspects of the rating and were factored into the rating decision. Specifically, the Global Methodology for Rating Banks and Banking Organisations (June 8, 2020) was used to evaluate the Issuer, while the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (February 3, 2021) was used to assess ESG factors.

The last rating action on this Issuer took place on June 4, 2020, 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. DBRS Morningstar understands further information on DBRS Morningstar historical default rates may be published by the Financial Conduct Authority (FCA) on its webpage: https://www.fca.org.uk/firms/credit-rating-agencies.

Lead Analyst: Maria Gabriella-Khoury, Senior Vice President
Rating Committee Chair: Michael Driscoll, Managing Director, Head of NA FIG
Initial Rating Date: December 31, 1980

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

DBRS Limited
DBRS Tower, 181 University Avenue, Suite 700
Toronto, ON M5H 3M7 Canada
Tel. +1 416 593-5577