January 25, 2016 - 3:12 PM EST
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Fitch Affirms Bank of Montreal Ratings at 'AA-/F1+'; Outlook Remains Stable

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 remains 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), Caisse Centrale DesJardins (CCD), National Bank of Canada (NBC), Royal Bank of Canada (RBC) and Toronto-Dominion Bank (TD).

For more information, please refer to the Canadian Banks Peer Review Special Report available on www.fitchratings.com.

KEY RATING DRIVERS

IDRs, VRs AND SENIOR DEBT

BMO's rating affirmation and high ratings reflect the company's consistent financial performance over various credit cycles, sizeable franchise, 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.

However, Fitch believes that all Canadian Banks, including BMO, are vulnerable to credit deterioration in their domestic loan portfolios given pressures on the economy. In particular, Fitch sees that consumer indebtedness is at record high levels and believes the Canadian housing market is overvalued by about 20%. Should the rapid decline in global oil prices cause an economic slowdown in Canada, impacting employment levels, this could hasten potential credit deterioration. For 2016, Fitch believes most Canadian banks' earnings will be challenged given that provisions will likely increase, a persistent low rate environment, and potentially weaker economic activity in their home market.

Additionally, Fitch would note that BMO's direct exposure to oil & gas lending appears to be on the lower side compared to other Canadian banks, but it could still be susceptible to losses should the oil price decline cause economic weaknesses noted above.

While Canadian Mortgage and Housing Corporation (CMHC) insurance plays an important role in supporting the balance sheets of all Canadian Banks, including BMO, the company's large personal instalment and consumer loan portfolio could also be at risk. At present, this represents a sizable 23% of the company's Canadian loan portfolio. The performance of this portfolio will bear monitoring should the Canadian consumer environment begin to weaken. Fitch notes that excluding HELOCs, the portfolio would represent 10% of total Canadian loans.

The company's earnings performance for 2015 was good with modest revenue and net income growth compared to 2014, despite a challenging environment. BMO has benefited from low credit costs, although provisions were up by 9% compared to fiscal-year end 2014. While BMO's ratio of gross impaired loans to loans remains above the average of Canadian peers, it continues to compare well internationally. For 2016, the company will likely increase provisions to reflect some credit deterioration from the decline in oil prices.

During 2015, BMO experienced strong growth in its commercial loan book in the U.S. of roughly 16% year-over-year. Although Fitch views the diversity in the loan mix as favourable, growth rates are much higher than other U.S. large regional peers. Fitch has noted concerns with rapid growth in C&I lending particularly in light of the aggressive competition.

BMO's geographic revenue diversification through its U.S. based operations favourable, and could provide a buffer should the Canadian operations experience a slowdown from lower oil prices. However, Fitch notes that 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.

In December 2015, BMO completed its acquisition of General Electric Capital Corporation's Transportation Finance Business. Although the deal did not have a material impact to BMO's balance sheet (roughly only 1.7% of total assets and 3.5% of total loans), capital position is expected to declined but remained in line with management's capital targets. In Fitch's view the deal makes strategic sense for BMO given the challenges most Canadian banks are facing growing loans in their local market, we have expected asset growth to come from U.S. operations. Additionally, BMO has articulated its plan to pursue modest acquisitions as a growth strategy.

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. BMO also benefits from a significant amount of core retail deposits. In addition, BMO's expanded U.S. based retail franchise diversifies the funding mix and provides relatively low-cost, sticky deposits.

Fitch believes BMO's capital position is appropriate given its business mix and balance sheet risks. Further, the company's capital measures are in-line with other similarly rated global financial institutions, in Fitch's opinion. Fitch notes that Canadian Banks in general have risk-weighted assets (RWA) that may be lower given the 0% risk-weight assigned to mortgage loans that are insured by CMHC. However, OSFI has announced it plans to enhance its regulatory capital framework of residential real estate loans including risk sensitive floors to ensure capital requirements reflect underlying risks, which will likely take effect by the end of 2017.

SUPPORT RATING AND SUPPORT RATING FLOOR

The affirmation of BMO's Support Rating (SR) of '2' and Support Rating Floor (SRF) of 'BBB-' reflect Fitch's view that the likelihood of support remains relatively high for Canadian Banks due to their systemic importance in the country, significant concentration overall of Canadian banking assets amongst the institutions noted above, which account for over 90% of total banking assets, the 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 the domestic 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.

Fitch recognizes that the government's willingness to provide support for D-SIFI's in Canada has been reduced demonstrated by Department of Finance consultation paper which outlines the proposed bail-in regime as Canadian banking regulators seek to protect tax payers from the risk of a large financial institution failing. This is evidenced by the issuance of non-viability contingent capital (NVCC) instruments, resolution powers given regulatory authorities under the CDIC Act, and other initiatives that demonstrate the Canadian government's progress to reduce the propensity of state support for banks going forward.

BMO's IDRs and senior debt ratings do not benefit from support because their Viability Ratings (VRs) are all currently above their SRFs.

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 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 VR of 'aa-' for loss severity in accordance with Fitch's assessment of each instrument's respective non-performance and relative loss severity risk profiles.

The preferred securities of BMO Capital II are non-cumulative preferred securities which are notched five below the VR, made up of two notches down for non-performance and three notches down for loss severity.

LONG- AND SHORT-TERM DEPOSIT RATINGS

BMO Harris, NA's uninsured long-term deposit ratings are 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.

M&I Marshall & Ilsley Bank 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.

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 that 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.

RATING SENSITIVITIES

IDRS, NATIONAL RATINGS AND SENIOR DEBT

Given the already high level of BMO's ratings, Fitch does not expect any upside to ratings.

Similar to its peers, modest rating pressure could ensue should BMO's credit performance deteriorate such as an increase in impaired loans above the company's 10-year average. Fitch notes that this could potentially become more severe should macroeconomic risks continue such as pressure in the global oil and gas markets, a sharp increase in unemployment, or increases in interest rates.

Fitch also highlights that BMO has sizable contribution from capital markets to revenue, which is above its peer averages. 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 a shift in strategy that could lead to a higher risk profile. These factors would be viewed negatively and may prompt a rating review.

SUPPORT RATING AND SUPPORT RATING FLOOR

SR of '2' incorporates Fitch's expectation that there could be some level of support for Canadian Banks going forward although this has been weakened given credible resolution framework. Although Canadian authorities have taken steps to improve resolution powers and tools, they 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 implementation.

Fitch's view on support could change should the CDIC Act diminish powers of the CDIC to recapitalize a failing institutions leading to a downgrade of the SR and SRF.

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).

The preferred securities of BMO Capital Trust II are preferred securities, which Fitch gives five notches from BMO's VR given management and regulatory authorities' powers to suspend dividends.

SUBSIDIARY AND AFFILIATED COMPANIES

The subsidiary and affiliated company ratings including BMO Harris Bank National Association are primarily sensitive to any change in the VRs of the banks.

BMO Harris Bank National Association's VR is at 'bbb+' similar to other U.S. banks of like size.

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 and short-term deposits issued by M&I Marshall & Ilsley Bank and M&I Bank are primarily sensitive to any change in BMO's IDR.

Fitch has affirmed the following ratings:

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+';

--Commercial paper 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;

--VR at 'bbb+';

--Long-term deposits at 'AA';

--Short-term IDR at 'F1+';

--Short-term deposits at 'F1+';

--Support Rating at '1'.

BMO Subordinated Notes Trust

--Subordinated debt at 'A+'.

BMO Capital Trust II

--Preferred stock rating at 'BBB'.

Marshall & Ilsley Corporation

--Senior debt at 'AA-'.

M&I Marshall & Ilsley Bank

--Subordinated debt at 'A+'.

Fitch has affirmed and withdrawn the following ratings:

M&I Marshall & Ilsley Bank

--Long term deposit at 'AA';

--Senior debt at 'AA-';

--Short-term deposits at 'F1+'.

M&I Bank FSB

--Long-term deposits at 'AA';

--Short-term deposits at 'F1+'.

Additional information is available on www.fitchratings.com

Applicable Criteria

Global Bank Rating Criteria (pub. 20 Mar 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=863501

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=998358

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=998358

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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Fitch Ratings
Primary Analyst
Doriana Gamboa
Senior Director
+1-212-908-0865
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Justin Fuller, CFA
Senior Director
+1-212-368-5472
or
Committee Chairperson
Christopher Wolfe
Managing Director
+1-212-908-0771
or
Media Relations:
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[email protected]


Source: Business Wire (January 25, 2016 - 3:12 PM EST)

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