DBRS Downgrades Marshall & Ilsley Corporation to BBB (high) –Negative Trend

DBRS has today downgraded all long-term ratings of Marshall & Ilsley Corporation (M&I or the Company) and its banking subsidiaries, including its Issuer & Senior Debt rating to BBB (high) from A (low). Concurrently, the short-term ratings of M&I were downgraded to R-2 (high) from R-1 (low), while the Company’s banking subsidiaries short-term ratings were confirmed at R-1 (low). The trend on all ratings is Negative. The rating action concludes a Review with Negative Implications initiated by DBRS in July 2009. DBRS notes that the downgrade would have been more severe absent the common equity offering, which raised a substantial $863 million in net proceeds.

M&I reported a net loss attributable to common shareholders of $248.4 million, down from a net loss of $234.0 million in the previous quarter and from net income of $83.1 million in Q3 2008. Driving the net loss were continued elevated loan loss provisioning needs, high costs associated with collection efforts and carrying nonperforming assets (NPAs), losses on loans held for sale and lower securities gains, which more than offset debt termination gains of $56.1 million and margin expansion. DBRS notes that with the loan portfolio shrinking and some fee-based businesses under pressure, the Company’s core (excludes securities gains/losses, debt termination gains and losses on loans held for sale) income before provisions and taxes (IBPT) has deteriorated to $170.7 million from $263.5 million a year ago, making it more difficult for M&I to earn its way through its credit problems. Positively, there are signs of credit quality stabilization within the loan portfolio, but DBRS anticipates continued elevated provisioning needs to result in additional quarterly losses.

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, albeit improving, reliance on wholesale funding.

The Negative trend reflects DBRS’s concern over the considerable asset quality issues at the Company. While there have been some signs of stabilization/improvement within the loan portfolio and a capital raise that appears sufficient to absorb losses in the coming quarters, the economic recovery remains fragile and significant downside risks remain. If the scale of quarterly losses do not show improvement over the next several quarters, the ratings are likely to be downgraded. Conversely, if credit quality does improve and the Company demonstrates that it is likely to return to profitability with an adequate capital cushion, the trend could be restored to Stable.

With the underwriters fully exercising their overallotment, the Company was able to raise net proceeds of approximately $863 million in common equity. While viewed positively, the offering marks the second time since June 2009 that the Company has tapped the equity markets, which reduces financial flexibility, as investors may not support further material capital contributions, if asset quality problems turn out to be greater than expected. On a pro-forma basis, the capital raise would increase the Company’s tangible common equity (TCE) ratio to a solid 8.4%, which is higher than most banking peers. Viewed a different way, the Company could lose almost $2 billion in equity and still maintain a 5% TCE ratio. Nevertheless, given the extent of the asset quality issues at M&I, the capital cushion is needed to absorb likely additional quarterly losses over the intermediate term. Moreover, the Company may also use some of the proceeds to repurchase its own debt, pursue FDIC-assisted deals, and/or repay TARP.

Of concern, DBRS notes that M&I may need to establish a valuation reserve against its deferred tax assets (DTA: net DTA was $762.7 million at June 30, 2009). Although a non-cash charge, a valuation reserve, if taken, would negatively impact net income and tangible common equity. The Company is in a cumulative loss over the past 36 months, which has increased the likelihood of a valuation allowance against the DTA. For regulatory capital calculations, the DTA has already been excluded. Mitigating this concern, management remains confident no further valuation allowance will be needed.

Asset quality issues remain a significant challenge for the Company even with recent signs of improvement. High levels of NPAs and net charge-offs (NCOs) have kept loan loss provisioning elevated in 2009. Specifically, NPAs as a percentage of period-end loans & leases & OREO was 5.60%, but did show an eleven basis point improvement compared to Q2 2009. This does not include $935.3 million in renegotiated loans, which would bring this ratio to 7.61%. Meanwhile, NCOs declined to 4.48% of average loans & leases from 4.95% in the second quarter. Positively, inflows of nonperforming loans (NPLs) decreased 35% to $843 million during the quarter and early-stage delinquencies have stabilized and even improved in the hardest hit construction and development (C&D) portfolio. Despite the improvement, M&I still provisioned $578.7 million in the quarter, of which $185 million was related to loans made to other banks. The bank loans and the problematic C&D portfolio accounted for 62% of total NCOs in Q3 2009. Management believes the bank loans have been aggressively dealt with and that the worst of the Arizona issues are behind them. DBRS notes that the Company has approximately $545 million in remaining exposure to bank holding companies and the problematic C&D portfolio has declined materially to $6.3 billion, or 13.7% of the total portfolio, from 23% in Q3 2007.

With the loan portfolio shrinking combined with deposit growth, the Company’s reliance on wholesale funding has declined. Nevertheless, reliance on wholesale funding remains higher than other similarly rated peers. DBRS notes that M&I has been particularly successful in growing non-interest bearing deposits over the past year. Indeed, average non-interest bearing deposits have increased almost $2 billion, or 33%, over the past year demonstrating franchise strength.

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.