3rd UPDATE: Bank Of Montreal To Buy Marshall & Ilsley In $4.1 Billion Deal

Bank of Montreal (BMO), Canada's fourth-largest bank in assets, said it's buying Milwaukee, Wis.-based lender Marshall & Ilsley Corp. (MI) in a share swap valued at US$4.1 billion, making a long-anticipated move to expand its operations in the U.S.

BMO said Friday that, under the definitive agreement, it's offering 0.1257 of a share for each M&I share. Based on Bank of Montreal's closing stock price in Toronto Thursday of C$62.05, the deal values M&I at US$7.75 a share. To keep capital strong after the acquisition, the bank plans to issue an additional C$800 million in equity before the deal closes prior to July 31, 2011.

BMO will also repay around US$1.7 billion that M&I received from the U.S. government's Troubled Asset Loan Program.

The purchase bolsters BMO's position in the Midwestern states, where it's operated Chicago-based Harris Bank since 1984. The acquisition, which makes BMO the 15th-largest U.S. bank in assets, nearly doubles BMO's deposit base in the U.S., to US$92 billion, and more than doubles BMO's branches in the U.S., to 695. It's the latest in a string of U.S. purchases by Canadian banks, which have weathered the financial crisis and recession far better than most of their peers to the south.

"BMO had to do something. They've been in the Midwest for a long time, and this is the time to take the plunge," said John Kinsey, who helps manage C$1 billion at Caldwell Securities Ltd. in Toronto. "The U.S. is extremely competitive, and most Canadian companies have not fared well at all in the U.S. So, there may some execution risk. Let's see how they handle it. It could be kudos to them if it works."

BMO shares dropped sharply amid concern over the bank's ability to integrate M&I and expand in the U.S. where the economy has been weak.

In Toronto Friday, BMO is down C$3.93, or 6.3%, to C$58.12 on more than 4.7 million shares. In New York, M&I is up US$1.10, or 19%, to US$6.89.

Milwaukee-based M&I, the largest bank in Wisconsin, has 374 branches in Arizona, Missouri, Indiana, Florida, Kansas and Minnesota and about US$52 billion in assets. BMO has 321 branches in the U.S. and US$110 billion in assets. The acquisition "transforms our U.S. business," BMO Chief Executive Bill Downe said on a conference call.

"It's been a natural for us to think about Missouri and Kansas, and I would say that the size of the branch network in those two states, in Kansas is really a toehold, in Missouri is the beginning of a presence. From our perspective, this solidifies our position in Wisconsin and Indiana, really strengthens that part of the footprint and I think Missouri and Kansas are little bit of a bonus," he said.

The U.S. regional lender in October reported its eighth-straight quarterly loss as revenue fell and a drop in its loan-loss reserve wasn't enough to lift it into the black. It has seen its results improve of late, though not as much as some other banks.

"M&I is a very well run bank that got caught up in the real estate downdraft," Downe said.

BMO intends to divest much of M&I's real estate portfolio and has a team working on segregate out its non-performing loan portfolio, he said.

M&I's retail, or consumer, loans represent about 30%, or US$11 billion, of M&I's US$40 billion loan portfolio, while commercial loans account for 41%, or US$16 billion. The remaining 30%, or US$12 billion is commercial real estate loans, of which the developer portfolio is about 9%, or US$3.5 billion, BMO said. The developer portfolio, which was more than US$9 billion three years ago, has declined steadily. BMO has estimated future losses at US$4.7 billion, or just under 12% of the portfolio.

The Toronto-based bank expects the M&I acquisition to be accretive to earnings in 2013, excluding one-time merger and integration costs of about C$540 million. The purchase is expected to generate annual cost savings of about C$250 million, which would be fully phased in by the end of fiscal 2013.

The transaction is expected to lower its fourth-quarter 2010 pro-forma Basel III Tier 1 capital ratio to 8.9% from 10.4%, while Basel III common equity ratio falls to 6.7% from 7.8%. On a Basel II basis, the Tier 1 ratio falls to 11.7% from 13.4% and the common equity ratio declines to 9.2% from 10.3%.

On closing, M&I Chairman and Chief Executive Mark Furlong will become chief executive of the combined U.S. personal and commercial banking business, based in Chicago. Ellen Costello will become chief executive of Harris Financial Corp. and BMO's U.S. country head.

Earlier this year, BMO bought Rockford, Ill.-based Amcore Bank NA in a Federal Deposit Insurance Corp.-assisted deal that extended its reach in Illinois and Wisconsin. It also said earlier this month when it reported better-than-expected fiscal fourth-quarter results that it would continue making small "tuck-in" acquisitions to build its business.

-By Caroline Van Hasselt; Dow Jones Newswires; 416-306-2023; [e-mail]

(Carolyn King and Nathan Becker contributed to this article.)