DBRS Places Marshall & Ilsley Corporation Under Review with Negative Implications

DBRS has today placed all ratings of Marshall & Ilsley Corporation (M&I or the Company) and its bank subsidiaries Under Review with Negative Implications. The ratings action follows the Company’s second quarter earnings release.

The rating action reflects DBRS’s concern over M&I’s asset quality, which continues to deteriorate faster than most banks in our rated universe. Indeed, nonperforming assets (NPAs) increased another $440 million to an elevated 5.87% of total loans & leases and OREO from 4.88% the prior quarter. As a result, the Company’s loan loss provisioning remained high at $468.2 million and drove another quarterly net loss available to shareholders. Specifically, M&I reported a net loss available to common shareholders of $139.3 million, as compared to a net loss of $116.9 million in the previous quarter and a net loss of $393.8 million in Q2 2008.

The Company’s ratings are underpinned by M&I’s dominant market position within Wisconsin that produces a solid recurring and diversified revenue stream. DBRS notes that the vast majority of the asset quality problems have originated outside of M&I’s home market of Wisconsin primarily in Arizona, Florida and the Company’s correspondent banking business. The ratings also take into account worse than peer asset quality and a heavy reliance on wholesale funding.

Importantly, M&I raised $552 million of common equity in the quarter, boosting its tangible common ratio 90 basis points (bps) to 7.3%, which enhances the Company’s ability to cope with further quarterly losses. Nonetheless, DBRS notes that income (excludes one-time items) before provisions and taxes (IBPT) has come under pressure, which has reduced M&I’s ability to earn its way out of its asset quality issues. Given the persistent deterioration in asset quality at M&I, DBRS does not expect the Company to return to profitability over the intermediate term.

The Company’s problematic construction and development (C&D) portfolio, which declined to 14.1% of total loans, remains a significant exposure and continues to weigh heavily on asset quality and earnings. Management is in the process of bringing this exposure below 10%. Nonperforming loans (NPLs) in this portfolio were $996 million at the end of the second quarter, or 40% of total NPLs. Positively, M&I reported that early stage delinquencies in the C&D portfolio declined during the quarter on both a percentage and dollar basis, which could point to lower future credit costs associated with this portfolio.

DBRS notes that outside of residential real estate-related loans, the Company’s loan portfolio has, in general, performed satisfactorily though there has been some deterioration even in Wisconsin as the deep recession continues. Despite problem loan sales and renegotiated loans, total NPLs increased $427.6 million to 5.18% of period-end loans and leases in the second quarter from 4.21% in the previous quarter and 2.00% in Q2 2008. While elevated, M&I has conducted specific impairment analysis (FAS 114) on $1.7 billion of loans and marked them to net realizable value, either through charge-offs or specific reserves. When these loans are excluded, the reserves (net of specific allocation) more than cover other NPLs (135%). DBRS acknowledges that M&I has been aggressive in recognizing problem loans and their associated loss content. For instance, 17% of all NPLs are either current or past due less than 30 days. However, DBRS expects NPLs to remain elevated over the next several quarters given the Company’s exposures and rising unemployment.

Meanwhile, total Q2 2009 NCOs were $452.6 million, or 3.71% (annualized) of average loans, up from $328.0 million, or 2.67% of average loans, last quarter. In the second quarter, the problematic C&D portfolio represented 52% of total NCOs. M&I also pulled forward $47 million of residential real estate and home equity NCOs in the second quarter that otherwise would have been charged off in the third quarter. M&I’s total provision for loan losses of $468 million added $15 million to reserves, leaving a reserves/loans ratio of 2.83%, which compares favorably to peers. With housing and land values still dropping, especially in Arizona where the Company has considerable exposure, and unemployment increasing, DBRS expects asset quality to remain a headwind despite the positive signs emerging with respect to early stage delinquencies.

During the quarter, margin compression of 3 bps to 2.79% and a decline in earning assets caused a 2.5% drop in net interest income. Looking forward, the Company expects some stability in the margin. Deposit pricing floors have prevented M&I from realizing the full benefits of the Fed’s rate cuts and the Company has seen a shift in deposit mix towards higher yielding products. Moreover, pricing on both loans and deposits remains competitive within M&I’s footprint. That said, M&I’s deposit trends were mostly positive as period-end deposits grew $1.6 billion from Q1 2009 to $41.2 billion.

DBRS’s review will focus on the deterioration within the Company’s loan portfolio and whether M&I can generate enough IBPT to help offset expected future elevated credit costs. Specifically, DBRS will look to determine if the common equity raise provides a sufficient cushion to absorb future credit costs, while maintaining adequate capital for its rating level. DBRS notes that further significant increases in NPLs will result in downward ratings pressure and could potentially result in up to a two notch downgrade depending on the extent of deterioration. Conversely, a return to profitability could result in the restoration of the trend to Stable.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The applicable methodologies are Rating Banks and Bank Holding Companies Operating in the United States, and Enhanced Methodology for Bank Ratings – Intrinsic and Support Assessments which can be found on our website under Methodologies.

This is a Corporate (Financial Institutions) rating.