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Rating Action:

Moody's reviews BMO for downgrade; lowers Harris BFSR

22 Oct 2009

Toronto, October 22, 2009 -- Moody's Investors Service (Moody's) placed the long-term ratings of the Bank of Montreal (BMO) and all its subsidiaries on review for downgrade. This rating action includes BMO's direct, rated subsidiaries as well as the rated entities of its primary U.S. holding company, Harris Financial Corp. (Harris). In a related action, Moody's also downgraded the bank financial strength rating of Harris National Association (Harris NA), BMO's primary bank operating company in the United States. The rating outlook for Harris NA's bank financial strength rating remains negative. BMO's and Harris' short-term ratings are unaffected by these rating actions and were affirmed by Moody's.

Moody's review will focus on: (1) the potential for continuing volatility in BMO's capital markets business, (2) the timeframe for Harris Financial's return to profitability on a consistent basis, (3) the prospect for continuing credit losses in Canada and the United States, and (4) BMO's prospective risk-adjusted profitability before and after loan loss provisions and taxes.

Moody's Senior Vice President, Peter Routledge, said "BMO's review for possible downgrade comes at a time when the bank has persistently reported lower risk-adjusted profitability, relative to similarly rated peers due to net losses in its US businesses. Furthermore, a prolonged period of above average credit costs could intensify pressure on BMO's profitability."

With regards to the downgrade of Harris NA's bank financial strength rating (BFSR), Mr. Routledge said "the downgrade of Harris NA's bank financial strength rating reflects a very low level of pre-provision profitability and the potential for continuing net losses associated with high credit costs. Harris NA has reported net losses in 4 of the last 5 quarters while its ultimate US holding company, Harris Financial Corp., has reported five consecutive quarters of net losses."

NEGATIVE PRESSURE ON BMO'S BFSR DESPITE IMPROVEMENTS IN CANADIAN RETAIL FRANCHISE

BMO's credit ratings have long been predicated on the view that its better-than-peer loan loss performance compensated for below-peer risk-adjusted profitability. In addition, BMO's profitability, though low, was less volatile than some of its similarly rated peers.

The recent period of financial and economic stress, however, revealed weaknesses in BMO's U.S. business (both retail banking and capital markets) which have, in turn, led to a deviation from the aforementioned rationale underpinning the ratings (i.e., low credit risk offsetting weaker profitability). Higher loan and trading losses in the bank's U.S. retail banking and capital markets arms, respectively, have led to two consecutive years of net losses in the U.S. and, in all likelihood, a third in 2009. Moody's notes that these costs may continue to depress the bank's risk-adjusted profitability.

The U.S. weighting in BMO's business mix has also contributed to the erosion of its credit advantage relative to similarly rated peers. BMO has produced a net charge-off ratio on loans that was well below peer medians every year between 1991 and 2007. In 2008 and 2009, Moody's notes that BMO lagged its domestic peers on this ratio. Although the bank still outperforms peers on many individual asset classes, the bank's mix (in aggregate) has a more pronounced weighting towards stressed asset classes (e.g., U.S. commercial real estate, residential mortgage, and commercial loans) which has resulted in credit losses above peer averages.

Moody's will evaluate these weakening rating factors in comparison to steady improvements in the bank's Canadian retail banking franchise, consistent performance in its Canadian wealth management arm, and strong capital ratios. The review will focus on whether the aforementioned deteriorating rating factors outweigh the strengthening Canadian franchise and its capital position.

HARRIS' FINANCIAL STRENGTH HAS WEAKENED APPRECIABLY

The downgrade of Harris NA's standalone bank financial strength rating (BFSR) reflects Harris' failure to improve the bank's very low level of pre-provision profitability, which is made worse by the expectation of high credit costs. Harris NA has reported a net loss in 4 of the last 5 quarters on rising provisions for losses on commercial real estate loans and residential mortgages. While these losses have been in-line, or better than, peer experience in relation to total loans outstanding, the impact on Harris' profitability has been material due to a low level of core earnings heading into the credit market downturn. Although the rating agency maintains its view that Harris' capitalization remains solid, it notes that the downgrade reflects an incrementally higher likelihood that capital injections from BMO may be necessary. The rating outlook on Harris NA's BFSR (only) remains on negative outlook, as a consequence. The remainder of Harris' ratings are on review for downgrade, consistent with the review for downgrade on BMO.

Moody's has also corrected the rating for one hybrid instrument issued by Harris Preferred Capital Corp. (HPCC), a USD non-cumulative exchangeable preferred stock issued on 5 February 1998 (CUSIP 414567206). The previous rating of A1, following the 25 February 2003 downgrade of Harris NA's long-term deposit rating to Aa3 from Aa2, did not take into account the preferred claim of HPCC's noteholders. The rating has been adjusted to A2, to reflect the ultimate priority of claim which is at the preferred share level of Harris NA and is unrelated to the downgrade of Harris NA's BFSR. HPCC's rating incorporates a very high probability, in Moody's view, that BMO would support Harris if required. As a result, Harris Preferred Capital Corp.'s rating remains on review for downgrade.

Moody's has followed the guidelines of the published methodology "Guidelines for Rating Bank Junior Securities" (published April 2007), to correct the rating of this instrument. Moody's noted that on June 16, 2009, it released a Request for Comment, in which the rating agency has requested market feedback on potential changes to its rating methodology for bank subordinated capital. If the revised methodology is implemented as proposed, the ratings of these securities (as well as other BMO subordinated capital instruments) could potentially be subject to a downgrade. Please refer to Moody's Request for Comment, titled "Moody's Proposed Changes to Bank Subordinated Capital Ratings," for further details regarding the implications of the proposed methodology changes on Moody's ratings.

Moody's took the following rating actions related to Bank of Montreal and subsidiaries:

Issuer: BMO Capital Trust II

..On Review for Possible Downgrade:

....Preferred Stock Preferred Stock, Placed on Review for Possible Downgrade, currently Aa3

..Outlook Actions:

....Outlook, Changed To Rating Under Review From Negative

Issuer: BMO Subordinated Notes Trust

..On Review for Possible Downgrade:

....Subordinate Regular Bond/Debenture, Placed on Review for Possible Downgrade, currently Aa2

..Outlook Actions:

....Outlook, Changed To Rating Under Review From Negative

Issuer: Bank of Montreal

..On Review for Possible Downgrade:

.... Bank Financial Strength Rating, Placed on Review for Possible Downgrade, currently B

....Multiple Seniority Medium-Term Note Program, Placed on Review for Possible Downgrade, currently Aa2, Aa1

....Multiple Seniority Shelf, Placed on Review for Possible Downgrade, currently (P)Aa2, (P)Aa1

....Preferred Stock Preferred Stock, Placed on Review for Possible Downgrade, currently Aa3

....Subordinate Regular Bond/Debenture, Placed on Review for Possible Downgrade, currently Aa2

....Senior Unsecured Deposit Note/Takedown, Placed on Review for Possible Downgrade, currently Aa1

....Senior Unsecured Regular Bond/Debenture, Placed on Review for Possible Downgrade, currently Aa1

....Senior Unsecured Deposit Rating, Placed on Review for Possible Downgrade, currently Aa1

..Outlook Actions:

....Outlook, Changed To Rating Under Review From Negative

Issuer: Bank of Montreal, Chicago Branch

..On Review for Possible Downgrade:

....Senior Unsecured Deposit Note/Takedown, Placed on Review for Possible Downgrade, currently Aa1

....Senior Unsecured Regular Bond/Debenture, Placed on Review for Possible Downgrade, currently Aa1

..Outlook Actions:

....Outlook, Changed To Rating Under Review From Negative

Issuer: Harris N.A.

..Downgrades:

.... Bank Financial Strength Rating, Downgraded to C+ from B-

..On Review for Possible Downgrade:

.... Issuer Rating, Placed on Review for Possible Downgrade, currently Aa3

....OSO Senior Unsecured OSO Rating, Placed on Review for Possible Downgrade, currently Aa3

....Subordinate Regular Bond/Debenture, Placed on Review for Possible Downgrade, currently A1

....Senior Unsecured Bank Note Program, Placed on Review for Possible Downgrade, currently Aa3

....Senior Unsecured Deposit Note/Takedown, Placed on Review for Possible Downgrade, currently Aa3

....Senior Unsecured Deposit Rating, Placed on Review for Possible Downgrade, currently Aa3

..Outlook Actions:

....Outlook, Changed To Rating Under Review From Negative

Issuer: Harris Preferred Capital Corporation

..Downgrades:

....Preferred Stock Preferred Stock, Downgraded to A2 from A1

..Outlook Actions:

....Outlook, Changed To Rating Under Review From Negative

The latest BMO and Harris rating action was on June 1, 2009 when Moody's changed BMO's and Harris' rating outlooks, and the outlooks of their rated subsidiaries, to negative.

The principal methodologies used in rating BMO and Harris were "Bank Financial Strength Ratings: Global Methodology" and "Incorporation of Joint-Default Analysis into Moody's Bank Ratings: A Refined Methodology", which can be found at www.moodys.com in the Rating Methodologies sub-directory under the Research & Ratings tab. Other methodologies and factors that may have been considered in the process of rating this issuer can also be found in the Rating Methodologies sub-directory on Moody's website.

Bank of Montreal, headquartered in Toronto, Canada, reported total assets of C$336 billion as of July 31, 2009.

New York
Robert Young
Managing Director
Financial Institutions Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Toronto
Peter Routledge
Senior Vice President
Financial Institutions Group
Moody's Canada Inc.
(416) 214-1635

Moody's reviews BMO for downgrade; lowers Harris BFSR
No Related Data.
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