Marshall & Ilsley Stays Neutral - Analyst Blog

We continue to maintain our long-term Neutral recommendation on Marshall & Ilsley Corporation (MI). Although the turnaround in credit quality in the recent quarters has been impressive, the lack of core deposit growth and the ongoing interest rate volatility will likely keep net interest margin (NIM) under pressure.

Despite the fact that management is meeting most of the challenges with the help of low cost funding and its strong capital base, pressure on core revenues and higher credit costs will weigh on upcoming results. However, the impending merger with Bank of Montreal (BMO) would provide some relief to the company.

In December 2010, Marshall & Ilsley announced its acquisition by Bank of Montreal for a stock-for-stock deal valued at $4.1 billion. As per the terms of the deal, shareholders of Marshall & Ilsley will receive 0.1257 shares of Bank of Montreal common stock in exchange for each Marshall & Ilsley share.

Furthermore, Bank of Montreal would assume responsibility for $1.7 billion of TARP money and repay the amount before the closure of the deal. The merger is expected to close by July 31. Overall, we believe that the merger would mitigate much of the company’s woes.

We are encouraged to see a sustained turnaround in credit quality in the recent quarters, caused mainly by a decline in nonperforming assets ratio. Also, management’s ongoing aggressive and proactive approach to identify and deal with credit issues is expected to improve credit losses outlook over the coming quarters.

Hence, with the gradual improvement of economy and the recovery of housing markets, Marshall & Ilsley will likely experience a faster-than-peers earnings recovery.

Additionally, given the new Basel III requirements, the company appears to keep options open for a potentially higher capital base. With management implementing various risk-management strategies to reduce its exposure to construction and development loans, we expect Marshall & Ilsley to remain adequately capitalized, even in a stressed scenario.

However, Marshall & Ilsley has been experiencing high levels of operating expenses over the last few years due to increase in costs associated with collection efforts and carrying nonperforming assets. Though the company is taking several expense reduction initiatives, the costs related to the high level of nonperforming assets will likely offset the benefits from these cost curtailment initiatives.

NIM contraction has been another area of concern for Marshall & Ilsley. However, NIM inched up to 3.15% in the fourth quarter of 2010 and management anticipates NIM to improve further in the near term as a result of the company’s debt restructuring activities. But we believe that there will be increased margin pressure in the upcoming quarters, mostly due to a lack of core deposit growth and the ongoing interest rate volatility in the market.

Currently, Marshall & Ilsley retains its Zacks #3 Rank, which translates into a short-term ‘Hold’ rating. The company’s peer, Northern Trust Corporation (NTRS), also retains a Zacks #3 Rank (a short-term Hold’ rating).

BANK MONTREAL (BMO): Free Stock Analysis Report

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