BMO Inherits More Bad Loans from M&I

BMO Financial Group played up the promise of its acquisition of Marshall & Ilsley Corp., but an uptick in nonperforming assets in the U.S. raised some eyebrows.

BMO's report Tuesday of $108 million of new nonperforming assets related to the purchase was surprising, says Brian Klock, an analyst with KBW Inc.'s Keefe, Bruyette & Woods. The Toronto company had previously taken a $3.7 billion credit markdown on M&I.

"That is a little troubling in their U.S. franchise. I figured that the purchase accounting mark would have covered that," Klock says. "It is something I want to keep an eye on."

Still, it is too soon to determine whether it's a reflection of the economic slump in the second half of the year or if BMO was being particularly aggressive in its accounting as it wrapped up the fiscal year, which ended Oct. 31, Klock says.

"There has been some market deterioration since the transaction was completed on July 5. There has been a significant change in the global outlook," Klock says. "So, they could be more conservative in the context of what is happening since the deal closed. But it is unclear if it is a trend or if it is just a fourth-quarter kitchen-sink phenomenon."

Bill Downe, the president and chief executive of BMO Financial Group, said in an interview that new nonperforming assets are to be expected. The amount was consistent with the company's expectations, he says.

"Any performing loan portfolio will have new formations because over time some percentage of the borrowers that were previously in the performing category will move into the impaired category," Downe says. "But relative to the size of the book, it is not a significant issue. … [The acquisition] has been totally consistent with the projections we laid out at the time we announced it."

During a conference call with investors on Tuesday, Downe said the acquisition has "exceeded our base case."

BMO plans to complete the integration of M&I in late 2012. It is on track to boost earnings in 2012, Tom Flynn, the company's chief financial officer, said during the call. When announced in late 2010, the deal was not expected to be accretive until 2013.

Several of the BMO executives were optimistic about the U.S. economy and said it will offer fertile ground for its U.S. unit, BMO Harris Bank, to thrive.

"Recent U.S. data has been encouraging, and assuming the European challenge plays out in a somewhat orderly fashion, we expect sustained economic expansion, led by increasing business investment," Downe says. "In our Midwest market, we expect the economy to grow slightly faster than the national average."

Though the company appears satisfied with its acquisition and hopeful about the signs of economic stability in the U.S., there was not much discussion about further acquisitions to flesh out its Midwest network, where it holds the second-largest market share in Chicago and the largest market share in Wisconsin.

"A bank like BMO is always looking for acquisitions. It built Harris Bank through small acquisitions, but I do think they are on 'pause' mode until M&I is integrated," Klock says. He added that the company would likely target banks in the $10 billion to $20 billion range once it moves off the ropes.

In the interview, Downe reaffirmed BMO's reticence to do any new deals until the integration is complete.

"We have a full desk," he says. "We are not putting a lot of attention into the acquisition file at this time."

Still, BMO remains interested in the long-anticipated market consolidation, he says. When it is ready, BMO will look for Midwest banks with attractive deposit franchises and those who have a particular focus on customers "in the wealth formation phase of their lives."