Fitch Affirms Bank of Montreal's 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. This affirmation is reflective of BMO's relatively good operating performance, strong funding and liquidity position, and adequate capital ratios. At the same time, Fitch has kept the Rating Outlook for BMO at Stable.

This rating action follows a periodic review of the Canadian Banking sector. Fitch will publish the main findings of this review in a report 'Canadian Banks: Nearing a Tipping Point' available at www.fitchratings.com.

KEY RATING DRIVERS - IDRS, VRs, AND SENIOR DEBT

The affirmation of BMO's ratings reflects the company's good operating performance over multiple operating cycles and somewhat good earnings diversity relative to some other banks given the contribution from its U.S. based operations.

Fitch believes that the earnings contribution from BMO's U.S.-based operations could help to support the company's earnings and ratings should there be weakness in the company's Canadian operations due to either a slowing consumer and/or housing market as well as if lower oil prices affect the company's commercial lending operations. That said, Fitch does note 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.

Further supporting today's rating action is the company's adequate Basel III Common Equity Tier 1 (CET1) ratio, which BMO worked to increase in the wake of the closing of its acquisition of F&C in early 2014. Fitch believes this additional capital should help shelter the company's balance sheet in the event of economic stress. That said, should the company deploy more capital into another large acquisition, , Fitch would closely monitor the impact on the company's common equity (numerator) and risk-weighted assets (RWA) (denominator) to determine if the resultant capital ratios had an impact on ratings.

Fitch believes that BMO, as well as other Canadian Banks, benefits from a strong and diverse funding profile which supports today's ratings affirmation and Stable Outlook. For BMO, Fitch notes that the deposits gathered by the company's U.S. operations are relatively low-cost and sticky, further supporting the company's funding profile.

However, Fitch believes that all Canadian Banks, including BMO, are vulnerable to credit deterioration in their domestic loan portfolios given high levels of consumer indebtedness in Canada, combined with Fitch's view of some overvaluation in the Canadian housing market. This limits housing affordability and makes consumers particularly susceptible to negative shocks to their income levels.

Additionally, should the rapid decline in global oil prices cause an economic slowdown in Canada that impacts employment levels, it could hasten potential credit deterioration. 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 portfolio 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.

RATING SENSITIVITIES - IDRS, VRs, and SENIOR DEBT

Given the already high level of BMO's ratings, Fitch does not expect any upside to ratings over a medium-term time horizon.

Ratings could be modestly downgraded should BMO's credit performance deteriorate at a faster rate than other Canadian banks as the housing market and consumer eventually slows, and given sizable personal credit as well as a large number of residential mortgages on the balance sheet.

Fitch notes that this could be hastened or potentially more severe should largely exogenous macroeconomic risks such as continued pressure in the global oil and gas markets, unexpected increases in interest rates which affect consumers' ability to service debt obligations, as well as macroeconomic weakness in China or Europe that flows through to adversely impact the Canadian economy occurs. This could also affect credit performance of BMO's wholesale credit loan portfolio given the strong growth it has also had over the last couple of years.

Fitch would note that BMO has sizable contribution from capital markets to earnings, which in 2014 was approximately 23%, including funding valuation adjustment (FVA) charges. 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.

Similarly, should the retail business' earnings begin to decline such that capital markets assumes a greater proportion of overall earnings, this could also increase the earnings volatility, which Fitch would view negatively from a credit perspective. This could result in some modest ratings pressure over time.

KEY RATING DRIVERS - SUPPORT RATINGS AND SUPPORT RATING FLOORS

The affirmation of the BMO's SRs and SRFs reflect Fitch's expectation that there remains an extremely high probability of support from the Canadian government (rated 'AAA', Outlook Stable) if required. This expectation reflects Canada's extremely high ability to support its banks especially given its financial flexibility, though the probability is becoming less certain.

Specific to BMO, Fitch's view of support likelihood is based mostly on the banks' systemic importance in Canada, significant concentration overall of Canadian banking assets amongst the institutions noted above (which account for over 90% of banking assets), the large size of the banking system with banking assets at 2.1x Canada's GDP, and the Canadian Banks' position as key providers of financial services to the Canadian economy. BMO's IDRs and senior debt ratings do not benefit from support because their Viability Ratings (VRs) are all currently above their SRFs.

However, in Fitch's view, there is a clear intention to reduce support for D-SIFIs in Canada, as demonstrated by commentary and actions from Canadian banking regulators seeking to protect taxpayers from the risk of a large financial institution failing. This is further supported by the issuance of non-viable 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. Fitch believes this increases the likelihood of NVCC and potential senior debt losses if one or more of the Canadian Banks run afoul of solvency assessments.

RATING SENSITVITIES - SUPPORT RATING AND SUPPORT RATING FLOOR

Fitch is classifying Canada as a Path 2 country as defined in its September 2013 report, Bank Support: Likely Rating Paths, and given the factors noted above, Fitch expects there to be some level of support for the BMO going forward, and as such does not expect the SR to be affected.

The SRF ratings are more likely to be impacted and are sensitive to progress made in completing NVCC issuances and any additional regulatory initiatives that may be imposed on the Canadian D-SIFIs. Fitch's assessment of continuing support for Canadian D-SIFIs has to some extent relied upon resolution powers granted regulators under the CDIC ACT as well as the potential size, structure, and feasibility of the ultimate and final NVCC implementation.

Fitch expects that the continued regulatory action to ensure sufficient contingent capital will be implemented for all Canadian banks in the near term, but regardless, Fitch believes that sufficient regulatory progress continues to be made over the ratings time horizon. Therefore, Fitch expects to downgrade the BMO's SRFs to 'BBB-' at some point over the next 12 months.

Absent a material in change economic conditions or the companies' stand-alone credit profiles, a downgrade of the SRFs to 'BBB-' would mean no change to the BMO's long-term IDR and debt ratings because their VRs are all above the SRF.

KEY RATING DRIVERS - SUBORDINATED DEBT AND PREFERRED SECURITIES

Subordinated debt and other hybrid capital issued by the banks and by various issuing vehicles are all notched down from the banks' (or bank subsidiaries') VRs in accordance with Fitch's assessment of each instrument's respective nonperformance and relative loss severity risk profiles.

KEY RATING SENSITIVITIES - SUBORDINATED DEBT AND PREFERRED 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 D, E, and II are trust preferred securities, which Fitch gives five notches from BMO's VR given management and regulatory authorities' powers to suspend dividends.

KEY RATING DRIVERS - SUBSIDIARY AND AFFILATED COMPANY RATINGS

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.

KEY RATING SENSITIVITIES - SUBSIDIARY AND AFFILIATED COMPANY RATINGS

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+' as its peers are closer to other similarly rated U.S. banks of like size.

KEY RATING DRIVERS AND SENSITIVITIES - LONG- AND SHORT-TERM DEPOSIT RATINGS

BMO Harris National Association's uninsured 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.

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.

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 '1';

--Support Floor at 'A-'.

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 E

BMO Capital Trust II

--Preferred stock rating at 'BBB'.

Marshall & Ilsley Corporation

--Senior debt at 'AA-'.

M&I Marshall & Ilsley Bank

--Long-term deposits at 'AA';

--Senior debt at 'AA-';

--Subordinated debt at 'A+';

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

M&I Bank FSB

--Long-term deposits at 'AA';

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

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Global Financial Institutions Rating Criteria' (January 2014)

--'The Evolving Dynamics of Support for Banks' (September 2013)

--'Bank Support: Likely Rating Paths' (September 2013)

--'2015 Outlook: Canadian Banks' (December 2014)

--'Assessing and Rating Bank Subordinated and Hybrid Securities' (January 2014).

Applicable Criteria and Related Research:

Assessing and Rating Bank Subordinated and Hybrid Securities Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=732137

2015 Outlook: Canadian Banks (Stable Rating Outlook, Negative Sector Outlook Remains for 2015)

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=810389

Bank Support: Likely Rating Paths

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715001

The Evolving Dynamics of Support for Banks

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715000

Global Financial Institutions Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=732397

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=978335

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