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 are 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 ratings confirmation and Stable trends reflect the relative improvement in BMO’s U.S. franchise following the announced acquisition of Bank of the West (BOTW, unrated). Specifically, the combination enhances BMO’s existing U.S. franchise, doubling its branch network and expanding its geographic reach. Upon close, the pro forma financial results are expected to be immediately accretive to earnings per share. In DBRS Morningstar’s view, the combination does not add incrementally to credit risk because both companies have a strong lending track record. However, as with all acquisitions, there are integration risks, especially for an acquisition of this size.
Over the longer term, sustained outperformance by BMO compared with global bank peers, while maintaining its current risk profile, would lead to an upgrade of the ratings.
Conversely, BMO’s ratings would be downgraded if there were significant operational issues with acquisition integration or an inability to rebuild capital post acquisition. Additionally, a sustained or significant deterioration in asset quality, especially from an increase in risk appetite, or a decline in profitability levels to below that of its peer group, would result in a downgrade of the ratings.
BMO announced the acquisition of BOTW for approximately USD 16.3 billion in cash. The transaction is expected to close during fiscal Q1 2023, subject to customary closing conditions, including regulatory approvals. The acquisition adds approximately USD 105 billion in total assets, USD 89 billion in deposits, and more than 500 branches in California and the western half of the U.S. Approximately 70% of total deposits are in California. Overall, DBRS Morningstar views the announced acquisition as improving the franchise strength of BMO’s U.S. operation through better scale and an enhanced presence in affluent, although highly competitive, markets.
The Company has identified approximately $860 million in annualized cost savings, representing approximately 35% of BOTW’s cost base, and expects to incur integration costs of approximately $1.7 billion (pretax). Cost savings will come from integration of systems and overhead with no branch closures planned. BMO is not including any revenue synergies in its assumptions, although these could be significant as the Bank rolls out its broader product mix, including wealth and capital markets capabilities, to the BOTW’s customer base.
Despite the impact of the current operating environment, both banks have been performing well in recent periods. Additionally, both banks have exhibited strong asset quality through previous business cycles. The combination incrementally increases BMO’s exposure to commercial real estate to 10% of pro forma loans. DBRS Morningstar considers this as a highly manageable number and indeed views the overall pro forma loan portfolio as remaining well diversified.
BMO will likely continue building capital between now and the transaction close but will also need to issue additional tier 1 instruments, including common stock, to remain sufficiently capitalized post acquisition. While capital ratios will initially come close to regulatory minimums at close, we expect capital levels to be rebuilt and note that capital will likely benefit from Basel 3 reform rules in fiscal Q2 2023, pending OSFI’s publication of final rules.
Franchise Combined Building Block (BB) Assessment: VS/S
Earnings Combined Building Block (BB) Assessment: S/G
Risk Combined Building Block (BB) Assessment: S
Funding and Liquidity Combined Building Block (BB) Assessment: S
Capitalization Combined Building Block (BB) Assessment: S
Further details on the Scorecard Indicators and Building Block Assessments can be found at https://www.dbrsmorningstar.com/research/390056.
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.
All figures are in Canadian dollars unless otherwise noted.
The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (July 19, 2021; https://www.dbrsmorningstar.com/research/381742). 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).
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 (July 19, 2021) 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 3, 2021, 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.
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