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BMO expansion plans could be delayed as capital levels fall

Signage hangs outside an older building of the Bank of Montreal, also known as BMO Financial Group, next to the company's First Canadian Place headquarters, in Toronto in this file photo.

NORM BETTS/BLOOMBERG NEWS

Bank of Montreal has revised its capital levels downward for the previous three fiscal quarters, raising the prospect that the lender may have to raise additional funds and delay possible acquisition plans and share buybacks.

The shares fell 1.6 per cent in early trading on Tuesday, even as most of BMO's peers in the banking sector saw their share prices gain, suggesting some disappointment from investors.

While the correction pertains to complex regulations stemming from measures introduced by the Basel Committee on Banking Supervision, the impact could slow BMO's expansion plans and its ability to return cash to shareholders.

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"We determined a need to amend our capital ratios and are correcting the record," a bank spokesperson said.

BMO's risk-weighted assets, which are used by regulators to determine the bank's exposure to potential losses in the event of a financial crisis, were understated in the first, second and third quarters of 2016.

There is no change to profit. However, BMO said that its common equity tier 1 (CET 1) ratio – a measure of financial health watched closely by regulators – was 10 per cent at the end of the third quarter, revised downward from 10.5 per cent when the figure was initially reported in August.

According to Darko Mihelic, an analyst at RBC Dominion Securities, the half-percentage point amendment can be translated to $1.3-billion.

"We view BMO's amendment to its capital ratios as an isolated 'error' and view a similar occurrence for other Canadian banks as possible but unlikely," Mr. Mihelic said in a note.

While BMO's CET 1 ratio is slightly above the minimum threshold established by regulators, observers expect that BMO will be required to add a safety buffer given that the ratio is at the low end of its peers.

One way to improve the ratio would be to raise capital through the sale of preferred shares. Analysts at RBC expect the bank will raise between $500-million and $700-million in the near term. Mr. Mihelic also erased his expectation of a share buyback from BMO, driving down his profit estimates on a per-share basis.

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The analyst now expects BMO to report a profit of $7.87 a share in 2018, down from his previous estimate of $7.95 a share.

As well, observers believe BMO may have to delay making any acquisitions in the near term, following a string of large deals in recent years.

"Investors that had been looking for an incremental lift from capital deployment or greater returns to shareholders may be disappointed," John Aiken, an analyst at Barclays, said in a note.

Last year, BMO agreed to buy GE Capital's transportation finance unit for an undisclosed amount. BMO acquired Britain-based investment manager F&C Asset Management PLC in 2014 for $1.3-billion and Marshall & Ilsley Corp. in 2011 for $4.1-billion.

In a conference call with analysts in August, BMO's chief executive officer suggested that the bank was capable of making further deals.

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About the Author
Investing Reporter

David Berman has been writing about business and investing since 1995. He has written for a number of magazines, including Canadian Business and MoneySense. He worked at the Financial Post as an investing writer and daily columnist before moving to the Globe and Mail in 2008. More

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