October 27, 2017 / 5:48 PM / a year ago

Fitch Affirms Bank of Montreal Ratings at 'AA-'/'F1+'; Outlook Stable

(The following statement was released by the rating agency) NEW YORK, October 27 (Fitch) Fitch Ratings has affirmed Bank of Montreal's (BMO) Long- and Short-Term Issuer Default Ratings (IDRs) at 'AA-' and 'F1+', respectively. The Rating Outlook is Stable. This rating action follows Fitch's periodic review of the Canadian Banks Peer Group, which includes Bank of Montreal (BMO), Bank of Nova Scotia (BNS), Canadian Imperial Bank of Commerce (CIBC), Federation des caisses Desjardins Quebec's (FCDQ), National Bank of Canada (NBC), Royal Bank of Canada (RBC) and Toronto-Dominion Bank (TD). For additional information, please see "Fitch Affirms Canadian Banks; Fundamentals Outweigh Persistent Housing Risks" at 'www.fitchratings.com'. Fitch will publish company-specific rating rationales for the other banks separately. In addition, Fitch will publish its "2008 Outlook: Canadian Banks" special report in the near future. KEY RATING DRIVERS IDRs, NATIONAL RATINGS AND SENIOR DEBT BMO's rating affirmation and high ratings reflects the company's consistent financial performance over various credit cycles, sizeable franchise and market position, and good revenue diversification relative to its peer banks given its U.S. based operations. BMO's ratings also benefit from Canada's strong regulatory environment as well as a stable domestic banking market. Additionally, Canadian Mortgage and Housing Corporation (CMHC) insurance plays an important role in supporting the balance sheets of all Canadian banks. In Fitch's view, BMO might be in a better position to navigate through recent mortgage market changes, which could have less of an impact to its balance sheet, compared to its Canadian peers. BMO has the lowest percentage of mortgage loans to gross loans at 31% compared to a peer average of 46%. The company's Canadian insured book totaled 52% of total Canadian mortgages. Further, BMO reported an average LTV of 67% for originations during the quarter for the uninsured residential mortgage portfolio. BMO's geographic revenue diversification through its U.S. based operations is viewed favorably. This revenue diversification could provide a buffer should the bank's Canadian operations experience a slowdown due to the economy and/or a gradual decline in housing activity. However, BMO's U.S. operations have to date been somewhat dilutive to the overall enterprise's return on equity (ROE), as it incurs some additional regulatory and operating costs relative to more domestically focused banks. Further, BMO's commercial & industrial (C&I) loan growth in the U.S. segment has outpaced large U.S. regional peers. Fitch has raised concerns regarding C&I industry loan growth in the U.S. given the fierce competition, loosening of underwriting and growth trajectory that is above the level suggested by macro-indicators. Asset quality has improved compared to the same period a year-ago given the energy portfolio has stabilized. BMO's ratio of gross impaired loans and loan impairment charges continue to compare well internationally and in-line with expectations. However, compared to Canadian bank peers, its gross impaired loans (GIL) and loan impairment charge (LIC) ratios over the past 10 years tends to have a higher standard deviation driven mainly from its U.S. franchise. In more recent years, these measures have trended better as the U.S. segment has seen a slowdown in the inflow of problem credits. During the first nine months of 2017, the company's earnings performance, supported by revenue growth, continues to be solid despite a challenging environment. BMO's Canada and U.S. Personal & Commercial (P&C) banking segment has been a strong contributor to earnings accounting for roughly 40% and 18% of operating group adjusted net income over the last 12 months. The company's results were also boosted by strong organic loan growth in the U.S., and a jump in capital markets revenue. BMO's capital position is considered solid and supportive of its ratings. The company's CET1 ratio has continued to trend higher (similarly to its Canadian peers) reaching 11.2% in 3Q17. In Fitch's view, this ratio is more conservative than given its higher risk-weighted asset density at 37%, which ranks better than others in the peer group. Further, the company has solid internal capital generation, which averaged 6.9% over the last five years. Similar to its Canadian peers, Fitch views BMO's funding profile and liquidity as solid. The company maintains a large portion of assets in cash and liquid securities, which is evidenced by its solid LCR ratio of 148% at 3Q17. BMO also benefits from a solid funding base, including a sizeable amount of retail deposits. In addition to its Canadian retail franchise, BMO's expanded U.S. based retail franchise diversifies the funding mix and provides relatively low-cost, sticky deposits. SUPPORT RATING AND SUPPORT RATING FLOOR The affirmation of the BMO's Support Rating at '2' and Support Rating Floor at 'BBB-', reflect Fitch's view that the likelihood of support remains high for Canadian banks. This is due to the following: systemic importance in the country, overall significant concentration of Canadian banking assets amongst the institutions noted above (accounting for over 90% of total banking assets), large size of the banking sector with banking assets at 2.1x Canada's GDP, and the Canadian banks' position as key providers of financial services to its local economy. In Fitch's view, Canadian banking authorities, through the CDIC Act, have wide latitude to resolve a troubled bank including re-capitalizing an institution, creating a bridge bank, or imposing losses on creditors. Nonetheless, bail-in initiatives demonstrate the Canadian government's progress to reduce the propensity of state support for banks going forward. Fitch recognizes that the government's willingness to provide support for D-SIFI's in Canada has decreased as demonstrated by the Department of Finance's recent Resolution Framework, which has received parliamentary approval. The proposal seeks to protect tax payers from the risk of a large financial institution failing with guidelines recently published by OSFI for issuing non-viability contingent capital (NVCC) instruments and defining securities that could be used for "bail-in". In Fitch's view, the bail-in proposal enhances resolution powers given to regulatory authorities under the CDIC Act. SUBORDINATED DEBT AND OTHER HYBRID SECURITIES Subordinated debt and other hybrid capital issued by BMO and its subsidiaries are all notched down from the common Viability Rating (VR) in accordance with Fitch's assessment of each instrument's respective non-performance and relative loss severity risk profiles, which vary considerably. BMO's subordinated debt is notched one level below its 'aa-' VR for loss severity in accordance with Fitch's assessment of each instrument's respective non-performance and relative loss severity risk profiles. BMO's preferred stock is five notches below the VR, two notches down for non-performance and three notches down for loss severity. BMO Capital Trust II's trust preferred securities are five notches down from BMO's VR reflecting management and regulatory authorities' powers to suspend dividends. These ratings are in accordance with Fitch's criteria and assessment of the instruments non-performance and loss severity risk profiles and have thus been affirmed due to the affirmation of the VR. SUBSIDIARY AND AFFILIATED COMPANY All of the subsidiaries and affiliated companies, including BMO Harris Bank National Association, reviewed as part of the Canadian Bank peer review factor in a high probability of support from parent institutions to the subsidiaries. This reflects how performing parent banks have very rarely allowed subsidiaries to default. It also considers the high level of integration, brand, management, financial and reputational incentives to avoid subsidiary defaults. LONG- AND SHORT-TERM DEPOSIT RATINGS BMO Harris, NA's uninsured long-term deposit ratings are rated one notch higher than the company's Issuer Default Rating and senior unsecured debt because U.S. uninsured deposits benefit from depositor preference. U.S. depositor preference gives deposit liabilities superior recovery prospects in the event of default. M&I Marshall & Ilsley Bank and M&I Bank FSB's uninsured long-term deposit ratings are also rated one notch higher than the company's IDR and senior unsecured debt because U.S. uninsured deposits benefit from depositor preference. U.S. depositor preference gives deposit liabilities superior recovery prospects in the event of default. RATING SENSITIVITIES IDRs, NATIONAL RATINGS AND SENIOR DEBT Given the already high level of BMO's ratings, Fitch does not expect any upside for the ratings. Today's rating action incorporates Fitch's view that uncertainties remain on what the impact of recent mortgage reform announcements will be to the broader mortgage market. As such, a faster price correction that is prolonged and/or a slowdown in the housing market will likely impact earnings growth for all the banks. Further, these changes would also affect the broader economy through the link between housing wealth and consumer consumption, and the real estate sector, which are important drivers of GDP growth. Fitch notes that the Canadian banks' ratings are sensitive to negative pressures in the housing market. BMOs ratings would could be affected should the company deploy more capital into another large acquisition and/or manage capital more aggressively through increased dividends and/or repurchase activity, such that total payout ratio exceeded 100%. Modest rating pressure could also ensue should BMO's credit performance deteriorate, evidenced by impaired loans and loan losses trending to levels above its 10 year average of 1.10% and 0.42%, respectively. This could potentially become more severe should macroeconomic risks such as unexpected increases in interest rates, a severe housing price correction, as well as macroeconomic weakness in the overall Canadian economy that leads to a material rise in unemployment. Similarly to peers, BMO has good contribution from capital markets to net income. Should capital markets expand materially or should BMO look to move more from the middle market to larger clients, this could potentially increase the volatility of the company's earnings and result in ratings pressures. SUPPORT RATING AND SUPPORT RATING FLOOR A SR of '2' incorporates Fitch's expectation that there could be some level of support for the Canadian banks going forward although it has been weakened given expected passage of bail-in legislation. Although Canadian authorities have taken steps to improve resolution powers and tools, they intend to maintain a flexible approach to bank resolution. Fitch's assessment of continuing support for Canadian D-SIFI's has to some extent relied upon resolution powers granted regulators under the CDIC ACT as well as the potential size, structure, and feasibility of NVCC and TLAC implementation. Further, continued regulatory action to ensure sufficient contingent capital has been implemented for all Canadian banks. Therefore, SRs and SRFs are sensitive to the implementation of TLAC requirements. To the extent that these are deemed more than sufficient to recapitalize a non-viable bank, SRs and SRFs may be lowered. SUBORDINATED DEBT AND OTHER HYBRID SECURITIES The subordinated debt and hybrid capital ratings are primarily sensitive to any change in the VRs of the banks (or bank subsidiaries). BMO Capital Trust II's trust preferred securities are rated five notches from BMO's VR, given management and regulatory authorities' powers to suspend dividends. LONG- AND SHORT-TERM DEPOSIT RATINGS The ratings of long- and short-term deposits issued by BMO Harris National Association and its subsidiaries are primarily sensitive to any change in BMO's IDR. The ratings of long-term issued by M&I Marshall & Ilsley Bank and M&I Bank are primarily sensitive to any change in BMO's IDR. SUBSIDIARY AND AFFILIATED COMPANIES The subsidiary and affiliated company ratings including BMO Harris Bank National Association are primarily sensitive to any change in the banks' VRs. Bank of Montreal --Long-Term IDR at 'AA-'; Outlook Stable; --VR at 'aa-'; --Short-Term IDR at 'F1+'; --Senior unsecured debt at 'AA-'; --Subordinated debt at 'A+'; --Short-term debt at 'F1+'; --Support Rating at '2'; --Support Floor at 'BBB-'. BMO Harris Bank National Association (formerly Harris N.A.) --Long-Term IDR at 'AA-'; Outlook Stable; --Long-term deposits at 'AA'; --Short-Term IDR at 'F1+'; --Short-term deposits at 'F1+'; --Support Rating at '1'. BMO Capital Trust II --Preferred stock rating at 'BBB'. Marshall & Ilsley Corporation --Senior debt at 'AA-'. Contact: Primary Analyst Doriana Gamboa Senior Director +1-212-908-0865 Fitch Ratings, Inc. 33 Whitehall Street New York, NY 10004 Secondary Analyst Justin Fuller, CFA Senior Director +1-312-368-2057 Committee Chairperson Sean Pattap Senior Director +1-212-908-0642 Media Relations: Sandro Scenga, New York, Tel: +1 212-908-0278, Email: sandro.scenga@fitchratings.com. Additional information is available on www.fitchratings.com Applicable Criteria Global Bank Rating Criteria (pub. 25 Nov 2016) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here Solicitation Status here Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. 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