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BMO looks to U.S. for growth

Bank of Montreal is making a big bet south of the border.

(Photo: Louie Palu/The Globe and Mail/Canadian Press)

(Photo: Louie Palu/The Globe and Mail/Canadian Press)

The most successful Canadian banks have an edge. The Bank of Nova Scotia is the most international of the Big Five, with an extensive presence in the Caribbean and Latin America. Toronto-Dominion bills itself as the most convenient and has the largest reach in the U.S. But the Bank of Montreal, the country’s fourth-largest lender, hasn’t distinguished itself in any major way—and it shows. “BMO has lagged its peers in terms of growth,” says Brian Klock, an analyst at Keefe, Bruyette & Woods.

While its larger rivals posted quarterly profit gains between 8% and 13% over the past year, BMO eked out 7%. However the bank recently has gone to great lengths to set itself apart by making a play for a significant presence in the U.S. In July 2011, BMO closed the $4.1-billion acquisition of Marshall & Ilsley, a struggling regional bank with a strong presence in the Midwest. The purchase, which doubled the number of BMO’s U.S. branches to 695, expands the bank’s international reach at a critical time, since growth is projected to slow down at home. Low interest rates have sent Canadians on a borrowing binge the past few years, particularly to buy real estate, resulting in gangbuster profits for lenders. But Canadian households are stretched thin, and the federal government has made repeated moves to cool the housing market. (BMO’s recent attempts to juice its domestic business by offering a cut-rate 2.99% mortgage was met with a stern rebuke by Finance Minister Jim Flaherty.) All of these changes could curb the banks’ stellar growth. “What BMO has in the U.S. is certainly interesting from a long-term perspective, provided they can execute,” says Robert Sedran, a financial analyst at CIBC.

Still, Canadian lenders have had mixed success south of the border—RBC bailed in 2011, selling its retail banking operations and taking a $1.6-billion paper loss—and the U.S. market may not prove to be much of a buffer against a slowdown in Canada. “How banks feel that they’re going to achieve above-average growth levels by pursuing capital intensive strategies in a market that is as slow as the Canadian market is a mystery to us,” says Brad Smith, an analyst with Stonecap Securities in Toronto, who has an Underperform rating on the stock. Worse, there are signs that BMO’s newly integrated U.S. business has already hit a rough patch, posting weak market-share gains and declining customer satisfaction. (BMO declined to make executives available for interviews, citing a quiet period before quarterly earnings.) It’s too early to say how the bank’s foray south of the border will play out, but it’s clear that a misadventure in the U.S. will leave BMO in the same spot it’s in today: lagging its peers.

While rival TD gets a lot of the credit for its U.S. presence, BMO was actually there first. In 1984, the company purchased Harris Bancorp in Chicago under then CEO Bill Mulholland. “He saw the globalization trend early on, before most people embraced it,” Smith says. But in the intervening years, BMO didn’t focus on the U.S., beyond acquiring small, regional banks in a cautious manner befitting a Canadian lender. Investors didn’t give the U.S. business much consideration, either.


Current CEO Bill Downe continued that approach—at least until the M&I acquisition, the biggest U.S. deal the company ever completed. Downe chose the right moment to strike. M&I, based in Milwaukee, historically stuck to its base in the Midwest. However, it succumbed to the same fate of many of its peers, offering real estate loans in places like Arizona and Nevada, where housing markets cratered in 2008. M&I was stuck with rotten loans, and needed $1.7 billion in funding under the U.S. government’s Troubled Asset Relief Program. (BMO repaid the loan when it closed the deal.) “It was on life support for a while,” says Ohad Lederer, an analyst at Veritas Investment Research. Still, the losses were manageable for BMO, and because of M&I’s troubles, the acquisition price was cheap.

BMO rebranded its entire U.S. operation under the BMO Harris Bank banner, and appointed Mark Furlong, M&I’s CEO, to run it all. Since taking over, Furlong increased ad spending to promote the renamed operation, and in the first quarter, the company said it had completed its largest U.S. advertising campaign to date. Integrating the two operations took months, but with that largely complete, BMO can now focus on growing its U.S. loan portfolio. Prior to its acquisition, M&I was particularly strong in commercial and industrial lending—loans to small and medium-sized businesses. As the U.S. economy picks up steam, companies will require loans for expansion, hiring and other expenditures, Klock says, and BMO should be able to pick up some of that business. The Midwest is also a stable market that isn’t prone to boom-and-bust cycles like the South, where RBC established its U.S. presence.



AGE: 61
PAY: $9.2 million ($1.3 million salary plus additional incentives)
STRATEGY: While fighting aggressively for market share in Canada (BMO recently promoted five-year mortgages at the low rate of 2.99%), Downe focused on the U.S. His goal: to earn $1 billion annually in the U.S. over the “medium term,” nearly double what it earned last year.
BIGGEST ACHIEVEMENT: Some analysts credit Downe with snagging U.S. bank Marshall & Ilsley at the right time , though how that decision will ultimately play out for BMO is uncertain.
GREATEST OBSTACLE: Growing profits in a slowing market while braving the competitive U.S. banking environment.

But U.S. expansion may not prove to be much of a boon for shareholders—BMO’s included—according to Smith at Stonecap. For one, growth by acquisition is an expensive strategy. The regulatory and disclosure requirements are much steeper in the U.S. than in Canada, increasing costs and creating headaches. Smith also isn’t optimistic about the U.S. market, pointing out that it’s a mature economy, and demographics are not in its favour. The U.S. is a much bigger market than Canada, so there is more business for the taking—but banks will have to fight for it. Since neither BMO nor M&I was on top in any particular business segment, the benefit of combining them is unclear. “Bringing two sub-performers together is very unlikely to lead to an outperformer,” he says.

One worrying sign according to Smith is that the percentage of M&I branches that grew market share between June 2008 and June 2011, just before BMO closed the acquisition, was 40%. One year later, the percentage fell to just 27%. Meanwhile, 41% of all American bank branches grew market share over the same time period. A customer satisfaction survey released by JD Power and Associates in April shows even more problems. Out of the 23 banks surveyed, BMO’s ranking in the Midwest plummeted from a top 10 spot in 2012 to second-last.

While the integration of M&I hasn’t been entirely smooth, BMO has time to improve its U.S. performance. It could also make more purchases in the future. “Even though there’s a recovery going on, a lot of smaller lenders are facing a big strain,” Lederer says. “So I’m sure BMO is watching.” The key for BMO will be to stick to its conservative strategy and not throw away money chasing U.S. expansion. That would be a mark of distinction worse than having none at all.