DBRS Limited (Morningstar DBRS) confirmed its credit ratings on 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 trends on all credit ratings are Stable. BMO's Long-Term Issuer Rating is composed of an Intrinsic Assessment (IA) of AA (low) and a Support Assessment of SA2, which reflect the expectation of timely systemic support from the Government of Canada (rated AAA with a Stable trend). As a result of the SA2 designation, the Bank's Long-Term Issuer Rating benefits from a one-notch uplift to the Bank's IA.

KEY RATING CONSIDERATIONS

The credit rating confirmations and Stable trends reflect BMO's diversified franchise, solid earnings, strong balance sheet fundamentals, and ranking as the eighth-largest bank in North America by assets. BMO's strong position in Canada is complemented by a significantly expanded and enhanced U.S. franchise following the February 2023 Bank of the West (BOTW) acquisition. BMO's credit ratings are further supported by a conservative risk profile, despite its loan portfolio being weighted more toward commercial lending, evidenced by asset quality metrics that have typically been better than those of its peers. Additionally, the Bank benefits from a relatively stable deposit base that is sourced in both Canada and the U.S. Overall, Morningstar DBRS views both BMO's funding and liquidity profile and capitalization as solid.

The credit ratings also consider the challenging macroeconomic and geopolitical environments, which could lead to an adverse impact on profitability and asset quality. Morningstar DBRS remains concerned about the commercial real estate (CRE) market, particularly the U.S. office sector, along with the combination of highly leveraged Canadian consumers, elevated home prices (particularly in the greater Toronto and Vancouver areas), persistent inflation, and materially higher borrowing costs that are eating into consumers' disposable income. Morningstar DBRS believes that the CRE office sector and housing prices remain somewhat vulnerable and, as a result, views BMO, like its Canadian bank peers, as susceptible to any material adverse changes in these markets.

RATING DRIVERS

Over the longer term, BMO's credit ratings would be upgraded if the Bank were to continue to build the depth and scale of its franchise, resulting in a sustained improvement in financial performance, while maintaining a similar risk appetite.

Conversely, a credit ratings downgrade would occur if BMO's execution of its strategic initiatives in the U.S. were to lead to heightened risk or a weaker franchise. Additionally, BMO's credit ratings would be downgraded if there were a sustained deterioration in earnings or asset quality.

RATING RATIONALE

Franchise Combined Building Block (BB) Assessment: Very Strong

BMO is the fourth-largest Canadian bank and a top 10 U.S. bank by assets, providing all major product lines, including commercial and retail banking, wealth management, and capital markets. With its emphasis on commercial banking, BMO is a top five commercial lender in North America. BMO is also the most integrated North-South bank in North America, with a business model which drives efficiencies by leveraging its enterprise capabilities and scale in areas like digital, marketing, analytics, and product capabilities. In the U.S., BMO operates under its U.S. holding company, BMO Financial Corp. (BFC). The BOTW acquisition added geographic diversity and critical scale in the U.S., adding presence in affluent, albeit highly competitive, markets such as California.

Earnings Combined Building Block (BB) Assessment: Strong/Good

BMO typically generates solid earnings and profitability metrics underpinned by its diversified business franchise that generates nearly half of its revenue and earnings from the U.S. BMO reported Q1 2024 adjusted net income of $1.9 billion, a 16% decrease on a quarter-over-quarter (QOQ) basis, reflecting higher provisions for credit losses (PCL) and lower revenue, partly offset by lower expenses driven by the realization of BOTW cost synergies and enterprise operational efficiency initiatives. Adjusted net interest margin (NIM), excluding trading and Insurance, decreased 6 basis points (bps) QOQ to 1.84%, resulting primarily from continued deposit pricing pressure with the shift to term deposits and the impact from risk transfer transactions. Morningstar DBRS expects NIM to contract slightly in F2024. BMO reported an adjusted efficiency ratio that deteriorated QOQ and year over year but remains sound at 60.9%.

Risk Combined Building Block (BB) Assessment: Very Strong/Strong

Overall, Morningstar DBRS views BMO as having a sound risk profile with a loan portfolio that is well diversified by geography, industry, and product. Credit quality metrics have normalized and are at or beyond pre-coronavirus pandemic levels. However, BMO's asset quality metrics remain sound and the Bank has experienced lower-than-peer average loss rates over time. In Q1 2024, the gross impaired loans (GIL) ratio increased 6 bps QOQ to 65 bps, driven by the services and manufacturing sectors. Additionally, the total PCL ratio increased 11 bps QOQ in Q1 2024 to 38 bps, reflecting PCL on impaired loans at 29 bps and higher PCL on performing loans. CRE and the office sector represent a manageable 11% and 1.2%, respectively, of total loans and acceptances (L&A). The CRE exposure is well diversified by geography, business, and property type. BMO's Canadian real estate secured lending (RESL) portfolio represents approximately 30% of L&A, at the lower end of the peer range. The RESL portfolio is of high quality and an uninsured average loan-to-value ratio of 51% provides a substantial buffer if property values decline.

Funding and Liquidity Combined Building Block (BB) Assessment: Strong

BMO has a strong funding and liquidity profile, which is underpinned by broad-based client-sourced deposits in both Canada and the U.S. The deposit mix continues to shift from demand to higher-cost term deposits in the higher-for-longer interest rate environment. At the enterprise level in Q1 2024, average customer deposits of $656 billion were up 2% QOQ from higher balances in capital markets and Canadian banking, partly offset by lower balances in wealth management. Approximately 52% of U.S. deposits were insured at December 31, 2023. Augmenting its deposit funding, BMO also enjoys ready access to diversified wholesale funding sources, with BMO's usage within an acceptable range and in line with the Canadian bank peer average. BMO's liquidity profile remains strong as at January 31, 2024, with a liquidity coverage ratio of 129% and a net stable funding ratio of 116%, both comfortably above the regulatory minimum thresholds.

Capitalization Combined Building Block (BB) Assessment: Strong

Morningstar DBRS views the Bank's capitalization as strong, reflecting current capital levels as well as its significant internal capital generation ability. In Q1 2024, BMO's CET1 ratio was 12.8%, an increase of 60 bps since closing the BOTW acquisition. Additionally, BMO's risk-based total loss-absorbing capacity ratio was at 27.6% and its leverage ratio was 4.2%. All ratios remain comfortably above the required regulatory thresholds. Morningstar DBRS notes that BFC has recently transitioned into a Category III firm in the U.S. and will be required to comply with higher regulatory expectations, including biennial company-run stress testing, annual supervisory tress testing, supplementary leverage ratio, and a counter-cyclical buffer.

Further details on the Scorecard Indicators and Building Block Assessments can be found at https://dbrs.morningstar.com/research/433192.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS

There were no Environmental/Social/Governance factors that had a significant or relevant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (January 23, 2024) at https://dbrs.morningstar.com/research/427030.

Notes:

All figures are in Canadian dollars unless otherwise noted.

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (April 15, 2024; https://dbrs.morningstar.com/research/431155). In addition, Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (January 23, 2024; https://dbrs.morningstar.com/research/427030) in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

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 https://dbrs.morningstar.com

The credit ratings were initiated at the request of the rated entity.

The rated entity or its related entities did participate in the credit rating process for these credit rating actions.

Morningstar DBRS had access to the accounts, management and other relevant internal documents of the rated entity or its related entities in connection with these credit rating actions.

These are solicited credit ratings.

These credit ratings are 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 credit ratings:

The last credit rating action on this issuer took place on June 2, 2023, when Morningstar DBRS confirmed the Bank's credit ratings.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS' outlooks and credit ratings are monitored.

For further information on Morningstar DBRS historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: https://registers.esma.europa.eu/cerep-publication. For further information on Morningstar DBRS historical default rates published by the Financial Conduct Authority (FCA) in a central repository, see https://data.fca.org.uk/#/ceres/craStats.

Lead Analyst: Carl De Souza, Senior Vice President, Sector Lead, North American Financial Institution Ratings

Rating Committee Chair: Michael Driscoll, Managing Director, North American Financial Institution Ratings

Initial Rating Date: December 31, 1980

For more information on this credit or on this industry, visit dbrs.morningstar.com.

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