BMO's AT1 Capital Raise: A Strategic Move for Resilience and Growth in a High-Yield Environment?

In a bold move to fortify its capital structure and align with evolving regulatory demands, Bank of Montreal (BMO) has priced a USD 1.0 billion issuance of non-viability contingent capital (NVCC) Additional Tier 1 (AT1) Limited Recourse Capital Notes, Series 6 (LRCNs). The offering, set to close on July 29, 2025, features an initial coupon rate of 6.875% for the first five years, resetting every five years thereafter based on the 5-year U.S. Treasury rate plus a fixed spread of 2.976%. With a maturity of 60 years (until 2085), this issuance underscores BMO's commitment to maintaining a robust capital base while navigating a shifting interest rate landscape.

Capital Structure and Regulatory Resilience

As one of Canada's six Domestic Systemically Important Banks (D-SIBs), BMO operates under stringent capital requirements. The Office of the Superintendent of Financial Institutions (OSFI) mandates a minimum Common Equity Tier 1 (CET1) ratio of 11.5% for D-SIBs in 2025, combining the base 8% CET1 requirement with a 3.5% Domestic Stability Buffer (DSB). This elevated threshold reflects OSFI's focus on systemic risk mitigation amid global economic uncertainties.

The LRCNs, classified as Additional Tier 1 (AT1) capital, directly bolster BMO's Tier 1 capital ratio, which is critical for meeting both the CET1 and Total Capital ratios under Basel III. By issuing AT1 securities, BMO strengthens its ability to absorb losses without diluting equity, a feature that becomes increasingly valuable in a low-growth or recessionary environment. The limited recourse structure—where investors' claims are restricted to the trust's assets (primarily the NVCC preferred shares)—ensures that the bank's broader balance sheet remains insulated from potential defaults, aligning with OSFI's loss-absorption expectations for AT1 instruments.

Strategic Alignment with Interest Rate Dynamics

The timing of BMO's AT1 issuance coincides with a uniquely favorable interest rate environment. As of July 2025, the U.S. 10-year Treasury yield stands at 4.44%, while the 5-year rate is at 4.01%, reflecting a steep yield curve. The LRCNs' initial 6.875% coupon is significantly higher than current market rates, offering investors a compelling yield in a high-yield climate. However, the structure's reset mechanism—tying future coupons to the 5-year Treasury rate plus 2.976%—introduces a layer of flexibility. If U.S. Treasury rates remain elevated or trend upward (as projected by consensus forecasts of a 4.36% 10-year yield by year-end and 4.17% in 12 months), the resetting coupons could maintain the securities' attractiveness.

Conversely, a decline in Treasury rates could pressure the bank to redeem the LRCNs, given its option to do so starting in 2030. While this provides BMO with capital management flexibility, it introduces reinvestment risk for investors. The 10–60 day redemption notice period also means that holders may face liquidity constraints if the bank exercises its option during periods of favorable borrowing costs.

Investor Returns and Risk Mitigation

For income-focused investors, the LRCNs' high initial coupon and long maturity present a compelling case. The 6.875% yield, payable quarterly, offers a hedge against inflation and outperforms traditional fixed-income alternatives in a high-yield environment. However, the limited recourse feature—a key distinction from standard senior debt—means investors' claims are confined to the trust's assets (the NVCC preferred shares). While this structure reduces exposure to BMO's broader credit risk, it also caps upside potential compared to unsecured senior bonds.

The redemption clause further complicates the risk-reward profile. If the 5-year Treasury rate drops below 3.9% (making the spread-adjusted coupon less than 6.875%), BMO may redeem the notes to refinance at lower rates. Investors must weigh this possibility against the long-term yield potential. For those seeking stable, inflation-protected income, the LRCNs' structure may align well with a diversified portfolio, particularly in a scenario where central banks maintain elevated rates for an extended period.

Regulatory Compliance and Long-Term Strategic Fit

BMO's AT1 issuance is not merely a capital-raising exercise but a strategic response to regulatory tailwinds. The 2024 OSFI Capital Adequacy Requirements (CAR) emphasize CET1 dominance for capital buffers, but AT1 remains a vital tool for maintaining Tier 1 and Total Capital ratios. By issuing AT1 instruments that meet Basel III loss-absorption criteria, BMO ensures compliance with both domestic and international standards, safeguarding its reputation as a systemically important institution.

Moreover, the proceeds from the LRCNs—allocated to general banking purposes, including the redemption of existing capital securities—allow BMO to optimize its capital structure. This flexibility is critical for managing liquidity and supporting long-term growth initiatives, such as expanding digital banking services or investing in sustainable finance, which align with the bank's “Boldly Grow the Good” ethos.

Conclusion: A Prudent Move in a High-Yield Era

BMO's USD 1.0 billion AT1 issuance represents a calculated step to reinforce its capital resilience while capitalizing on favorable interest rate conditions. The 6.875% initial coupon, combined with the 5-year reset mechanism, positions the LRCNs as a high-yield asset in a market where traditional fixed-income alternatives struggle to compete. For investors, the offering balances attractive returns with structural safeguards, though redemption risk necessitates careful consideration of holding periods.

From a regulatory standpoint, the issuance aligns seamlessly with OSFI's evolving capital requirements, ensuring BMO remains well-positioned to navigate macroeconomic volatility. As central banks grapple with inflation and growth uncertainties, BMO's proactive capital management strategy—bolstering Tier 1 reserves while maintaining operational flexibility—exemplifies the kind of foresight required to thrive in a post-pandemic, high-yield world.

For investors seeking yield and resilience, BMO's LRCNs offer a compelling case—provided they are prepared for the long-term horizon and potential redemption dynamics. In a landscape where capital preservation and regulatory compliance are paramount, this issuance stands out as a strategic win for both the bank and its stakeholders.