Bank of Montreal's $1.0 Billion AT1 Capital Raise: Strategic Value and Risk in a Post-Crisis Banking Landscape

In the wake of the 2008 financial crisis, regulators imposed stringent capital requirements to ensure banks could withstand economic shocks. A decade later, the Canadian and U.S. financial systems have adapted to these rules, with instruments like Non-Viability Contingent Capital (NVCC) Additional Tier 1 (AT1) securities emerging as critical tools for capital optimization. Bank of Montreal (BMO)'s recent $1.0 billion NVCC AT1 issuance, announced on July 21, 2025, underscores how large banks are leveraging these instruments to balance regulatory compliance, risk management, and shareholder returns. But what does this raise mean for investors, and how does it reflect broader trends in post-crisis banking?

The Structure of BMO's AT1s: A Double-Edged Sword

BMO's NVCC AT1s, set to mature in 2085, are designed to qualify as Additional Tier 1 (AT1) capital under Basel III regulations. The securities bear an initial coupon of 6.875%, resetting every five years based on the U.S. Treasury Rate plus a fixed spread. This structure offers BMO flexibility to manage its capital costs in a low-yield environment while maintaining regulatory compliance. However, the limited recourse nature of the notes—where investors' claims are restricted to a trust holding BMO's preferred shares—introduces a layer of complexity. If BMO defaults, holders of the AT1s would only have access to the trust's assets, not the bank's broader balance sheet.

The redemption terms further highlight the strategic intent: BMO can call the notes at par after 2030, subject to regulatory approval. This gives the bank significant control over its capital structure, allowing it to refinance or redeem the securities when advantageous. For investors, the risk lies in the NVCC clause, which permits the bank to convert the bonds into equity or write them down if BMO's solvency is threatened. While such events are rare, they are not unheard of—just ask holders of Swiss bank Credit Suisse's AT1s, which were wiped out during its 2023 collapse.

Strategic Rationale: Strengthening Capital While Navigating Uncertainty

BMO's decision to issue NVCC AT1s aligns with its broader capital management strategy. The bank's Common Equity Tier 1 (CET1) ratio stood at 13.6% as of October 2024, well above regulatory requirements, but the redemption of $1.25 billion in older NVCC AT1s (due in 2030) in June 2025 suggests a deliberate shift in capital allocation. By replacing older, higher-cost debt with new AT1s, BMO aims to reduce its funding costs and extend its liability duration, a prudent move in a world of unpredictable interest rates.

The strategic value of this approach becomes clearer when viewed through the lens of BMO's competitive positioning. The bank has been actively reallocating capital to high-growth sectors like technology and healthcare, while reducing exposure to cyclical industries. Its emphasis on short-duration, investment-grade bonds also reflects a hedge against rising yields, a concern given the Federal Reserve's recent signals about prolonged higher-for-longer rates. For BMO, the NVCC AT1s are not just a compliance tool—they're a means to fund strategic initiatives while maintaining a robust capital buffer.

Risk-Return Tradeoffs: A Tale of Two Instruments

The NVCC AT1 market is a double-edged sword for both banks and investors. For issuers, these instruments offer tax-efficient, long-term capital that can be converted to equity in a crisis—a flexibility that preferred shares lack. For investors, however, the risks are asymmetric. While AT1s offer higher yields than traditional debt, they expose holders to the possibility of total loss if a trigger event occurs. This asymmetry is particularly pronounced in the Canadian market, where the Big-6 banks are increasingly replacing preferred shares with AT1s.

Consider the reset spread dynamics. BMO's new AT1s carry a spread of 2.976% over U.S. Treasuries, a rate that reflects the bank's creditworthiness and market demand for risk. By comparison, older preferred shares with spreads above 4% are now more likely to be called, as banks like BMO seek to replace higher-cost debt with cheaper alternatives. This creates a bifurcated market: investors in higher-yield preferred shares face near-term redemption risks, while those in AT1s take on contingent conversion risks.

The regulatory environment further complicates the picture. While NVCC AT1s are designed to enhance financial stability, their limited recourse structure and conversion clauses have drawn criticism from some quarters. Critics argue that these instruments obscure true risk and may not provide the same level of investor protection as traditional debt. For instance, in a worst-case scenario where BMO's preferred shares (the trust's assets) are insufficient to cover AT1 claims, investors could see significant losses.

Investment Implications: Who Should Care, and How?

For institutional investors and sophisticated retail investors, BMO's AT1s present an intriguing opportunity. The 6.875% initial yield is attractive in a low-interest-rate world, and the bank's strong capital position suggests a low probability of trigger events. However, the contingent conversion risk means these instruments are unsuitable for risk-averse investors or those with a short time horizon.

A key metric to monitor is BMO's CET1 ratio, which is expected to remain well above regulatory thresholds. If the bank's capital buffer weakens in the future—due to economic downturns or aggressive lending—investors may see increased volatility in AT1 valuations. Similarly, the bank's ability to redeem the notes at par after 2030 could pressure prices if refinancing costs rise.

Conclusion: A Prudent Move in a Complex Landscape

BMO's $1.0 billion AT1 raise is a textbook example of how large banks are navigating the post-crisis regulatory environment. By issuing NVCC AT1s, the bank is optimizing its capital structure, reducing funding costs, and maintaining flexibility in a volatile market. For investors, the securities offer a compelling yield but come with risks that require careful consideration.

In a world where financial stability and shareholder returns are in constant tension, BMO's approach strikes a balance. However, the true test of these instruments will come in times of crisis. Until then, investors should treat NVCC AT1s as a strategic, high-conviction play—suitable for those who understand the risks and have the patience to ride out the uncertainties of a post-crisis banking landscape.