Tuesday, April 24, 2007

Implications of BofA-LaSalle Deal for BMO

Scotia Capital, 24 April 2007

Bank of America Acquires LaSalle

• The much rumoured Bank of America acquisition of LaSalle Bank of Chicago was announced in conjunction with the Barclays merger with ABN Amro.

• LaSalle is the second largest bank in Chicago and Illinois with retail deposit market share of 14.1% and 11.2% respectively, slightly below JP Morgan Chase the largest with market share of 15.3% and 12.1%.

BMO/Harris Strong Third in Market Share

• Harris is a strong third in terms of market share at 9.5% in Chicago and 7.6% in Illinois with the next largest bank being Fifth Third in Chicago at 3.2% and State Farm in Illinois at 2.8%. Bank of America market share was extremely weak at 1.8% in Chicago and 1.6% in Illinois. Chicago and Illinois remain among the most fragmented retail banking markets in the U.S. Major U.S. banks such as Citibank have a weak presence in the region with market share of 2.6% in Chicago and 2.0% in Illinois. Thus they are a prime candidate to be an aggressive acquirer at some point.

• Bank of America, LaSalle and Morgan Chase are formidable competitors for Harris. However Harris has a strong strategic presence in the region with its third place ranking, with a wide gap between itself and the fourth position. However, the major questions are whether Harris has the operational capability to maintain and grow its market share and generate a higher level of earnings.

Outlook for BMO - Positive over Short Term, Uncertain over Long Term

• In the near term the BAC acquisition of LaSalle could be positive for Harris in terms of customer attrition at LaSalle if Harris is able to capitalize. In general, consolidation should be positive for a bank with Harris's market positioning but longer term implications could be very negative if Harris is not able to keep pace operationally with BAC and Morgan Chase and this is a real concern. Thus BMO/Harris needs to be pondering their strategic options and assessing their operating capabilities going forward in this market place.

Positive Valuation Implications for BMO/Harris

• BAC is paying US$21 billion or C$24 billion for LaSalle which generally precluded BMO from participating as the deal size would have represented two thirds of BMO's total market capitalization. In addition to the financial impediments for BMO, we would be concerned about the banks ability to execute an acquisition of this magnitude.

• BAC purchase price at 21.3x 2007E earnings appears quite high but after adjusting for $800 million after tax in expected cost synergies (45% of cost base) from LaSalle bloated cost structure the price is reduced significantly to 10.2x adjusted 2007E earnings. The purchase price is 2.2x book value, 3.4x tangible book with a 23% deposit premium.

• If we apply the 23% deposit premium paid for LaSalle (38% of business in lower priced Michigan) for BMO's US Personal & Commercial Banking Business Segment (Harris) we derive a value of $4.4 billion equating to 31x current earnings. Harris value would represent $8.80 per BMO share or 12% of market capitalization with Harris currently contributing only 5% of BMO earnings. This valuation applies to Personal & Commercial only as BMO has a U.S.wealth management component with $300 million in revenue and negligible earnings as well as a U.S.component in its Investment Banking Group with earnings of $350 million per annum in the past two years.

• If we apply a more generous 30% - 32% deposit premium (perhaps more applicable to Chicago market only) to Harris (US P& C) the value would be approximately $6 billion for implied P/E multiple of 43x. At this deposit premium Harris value would represent $12 per BMO share or 17% of market capitalization, significantly above the earnings contribution of 5%.

• It would seem that if BMO is not able to substantially improve its earnings from Harris, a very feasible strategic option from a shareholder perspective would be for BMO to sell Harris. The bank has to seriously weigh its option and determine how realistic it is for Harris to meaningfully improve its operating capabilities and its earnings.

• BMO shareholders, we expect, would be very amenable to a special dividend and redeployment of capital in its other businesses including high return wealth management and in its domestic retail operating platform.


• We maintain our 3-Sector Underperform based on weak relative earnings growth and profitability and slight P/E multiple premium. We believe the bank's higher dividend payout ratio has assisted in partially offsetting the bank's lower earnings growth over the past three years and has muted the degree of underperformance. However we believe the benefits of the higher dividend payout ratio are imbedded in the stock price and lower earnings and dividend growth going forward should cause the relative P/E multiple to decline to reflect the substantially lower profitability.

• We have no sell recommendations in the Bank Group on an absolute return basis as our BMO 12-month share price target is $80 per share for total expected return of 15%. BMO's absolute financial performance is very strong with its relative performance weak. Our 3-Sector Underperform is based on relative operating performance and profitability with a risk to the rating being strategic initiatives such as the sale of Harris, a special dividend and/or the possibility of BMO being acquired by another Canadian Bank. These initiatives appear to be highly uncertain at this time.
Financial Post, Duncan Mavin, 24 April 2007

Bank of Montreal's ambitions to dominate Chicago's retailbanking sector took a blow yesterday as one of the largest banks in the United States muscled in on the local market.

BMO's Harrisbank subsidiary is a big player in "Chicagoland," with about US$40-billion in assets and more than 200 branches.

But its U.S. operations face a new challenge after Bank of America announced the US$21- billion acquisition of Chicagobased LaSalle Bank.

"Bank of America is a very formidable competitor," said Tom Kersting, an Edward Jones analyst in St. Louis, Mo. "They have a very large suite of products and the size and scale to be efficient. It's going to make the longerterm outlook in the Chicago banking market that much more competitive."

While the deal marks Bank of America's push into the thirdlargest banking market in the United States, it is actually a result of a merger of two European banking giants.

LaSalle is currently owned by Dutch bank ABN Amro, which is merging with Barclays Bank PLC of the United Kingdom. Barclays does not want the U.S. bank, and Bank of America has snatched LaSalle to bulk up in the Midwest, one of the gaps in its existing franchise.

BMO was also considering a possible move for LaSalle, said Jason Bilodeau, a UBS Investment Research analyst. However, the price tag was too large for the Canadian bank's purse, he said.

The retail-banking sector in Chicago has become fiercely competitive and features franchises like Bank One, owned by JPMorgan Chase & Co., and Washington Mutual Inc., which has opened more than 100 branches in the area in the past five years.

Bank of America's acquisition of LaSalle will likely put a strain on the market share of all the banks in the region, said Edward Jones' Mr. Kersting.

"This isn't just changing the signage. Bank of America are going to cut costs, sell more products to their existing customers, and to new customers too," Mr. Kersting said. "They really are the leading dominant retail bank in the U.S."

Bank of America has a history of successfully integrating large acquisitions and runs the largest branch network in the United States. The latest deal will add 151 LaSalle branches to the 56 it already owns in Chicago. Bank of America is also swallowing more than 14% of the retail market share in Chicago and about US$113-billion in assets.

BMO's executives have said they want to grow Harris to about 400 branches throughout the Midwest. The bank bought 32-branch, Indiana-based First National Bank and Trust last September for US$290-million.

But the presence of another big U.S. bank with growth plans in Chicago could make it more difficult for BMO to expand its U.S. network by acquisitions too.

"It seems to me like any little branch network that becomes available, [BMO] would have more competition for it," said Genuity Capital Markets analyst Mario Mendonca.

One factor that could prevent Bank of America buying smaller banks is that U.S. banking rules bar any bank from an acquisition that would give it more than 10% of the total deposits in the country -- the LaSalle purchase would take Bank of America to that limit so any more purchases would require the bank to get rid of lower-margin deposits.

Also, "arguably the 10 or 20 branch deals that Harris has been doing could fly under the radar screen of Bank of America," Mr. Mendonca said.

A spokesperson for BMO said the bank "will continue to pursue our deliberate growth strategy, which includes acquisitions that are a good fit with our company, as well as investing in all areas of our business: personal and commercial banking, wealth management and investment and corporate banking."
Dow Jones Newswires, 23 April 2007

Things may have just gotten a wee bit tougher for Bank of Montreal's Chicagoland subsidiary Harris. ABN AMRO's deal with Barclays gives Bank of America control over LaSalle Bank, the 600 pound gorilla in Chicago's banking market. Analysts say BAC may be a more hands-on with LaSalle Bank, making it an even greater competitor in Harris's key region. That may push BMO to make a bigger bet in the US to maintain competitive position, UBS says.