Downgrade Coming for Bank of Montreal?

Oct.23.09 | About: Bank of (BMO)

By Andrew Willis

Bank of Montreal (NYSE:BMO) chief executive officer Bill Downe may remember this as the year he kept proving his doubters wrong.

Last quarter, BMO’s boss squashed the speculators who tossed around rumours of a dividend cut by rolling out better-than-expected profits and a solid 13% return on equity.

Now credit rating agency Moody’s is raising flags, announcing late Thursday that it is reviewing BMO’s rating for a possible downgrade.

Moody’s raised a number of issues, including the volatility of BMO’s capital markets business and a weak outlook for profits at its U.S. retail banking franchise.

In the hyper-competitive domestic banking industry, BMO would feel pain if its Aa3 rating at Moody’s is cut. A lower score would mean the bank pays investors more to borrow than its rivals, and an increased cost of funding means either charging more to its own borrowers or face tighter margins, both of which are guaranteed to hamstring profitability.

A downgrade is also an issue for BMO’s capital markets business, as Canadian banks that have been able to keep high credit ratings have seen business flow in from traders who are now far more conscious of the strength of banks that they deal with. If BMO’s credit rating slips, some of this business may disappear, and with it trading profits.

The challenge for Mr. Downe: Proving Moody’s wrong by showing that U.S. retail banking and capital markets units are on the upswing. The bank’s fiscal year ends on Oct. 31, and fourth quarter earnings are scheduled for release on Nov. 24.