The roughly $763 billion asset Bank of Montreal (BMO 0.19%) recently announced that it plans to pay $16.3 billion in a blockbuster acquisition of the Bank of the West, which is the U.S. banking operation of the French bank BNP Paribas.
The acquisition comes with $105 billion in assets and will grow Bank of Montreal's (BMO's) U.S. banking operations to $424 billion in assets, making the Canadian bank the eighth-largest banking operation in the U.S. and the fourth-largest commercial bank in North America. Will this big move benefit shareholders? Let's take a look.
Does the deal make sense?
It's certainly easy to see why BMO is doing this deal. The U.S. footprint is a meaningful part of BMO's operations, and the acquisition of Bank of the West doubles its presence in the U.S. The pro forma bank will have 3.8 million customers and a physical presence in 32 states. Management is most excited about the fact that the acquisition gives BMO immediate scale in California, with a 5% deposit market share in San Francisco and a 2% deposit market share in both Los Angeles and San Jose.
Additionally, both banks have fairly similar loan books. Both are heavy in commercial and industrial (C&I) loans, and they have portfolios in residential mortgage lending, commercial real estate (CRE), and various other kinds of consumer loans.
With the similar loan mixes and the new scale in the U.S., BMO management seems to really think it can grow the Bank of the West franchise by enhancing it with BMO platforms and products. Management said it is excited about the prospects of bringing new business customers onto its loan origination and treasury management platforms, which it has invested hundreds of millions of dollars into over the years. Bank of the West also has only deployed about 63% of its deposits into loans, so there is plenty of runway to grow the franchise.
Questions surround the deal
The $16.3 billion purchase price values Bank of the West at 150% tangible book value (TBV, or what a bank would be worth if it were liquidated). That is not exactly cheap or expensive for a bank acquisition in today's market. But the cash deal is being funded from several sources, including excess capital at BMO, capital generation through earnings between now and when the deal closes, a future common equity raise of about $2.1 billion, and also about $2.94 billion of excess capital from Bank of the West's balance sheet that will be available to the combined entity when the deal closes.
This last source of funding for the deal is interesting because this excess capital isn't actually coming from BMO, but will be sent to BNP Paribas shareholders along with the other roughly $13.4 billion coming from BMO. If you remove this excess capital from the equation, the deal values Bank of the West at roughly 166% TBV.
Given Bank of the West's so-so performance over the years, analysts on the banks' call discussing the deal seemed to think this was a bit pricey, because Bank of the West will only boost BMO's earnings per share by 10% in fiscal 2024 (BMO's fiscal year ends Oct. 31). And the projected internal rate of return on the deal, 14%, is certainly smaller than what has been seen in other large bank deals in recent years.
It's also a bit odd that BMO purchased the branch-heavy Bank of the West when it operates a branch-light strategy. While the purchase of Bank of the West will extend BMO's physical presence into 32 states, BMO already has a digital presence in every state. It has 524 branches in the U.S., and Bank of the West brings another 510 branches to the franchise with very little overlap (the green dots on the map below are Bank of the West branch locations).
It would be one thing if management had plans to consolidate or close a lot of branches, but it said it currently has no intention of closing any Bank of the West branches. That surprised me, because BMO expects to cut 35% of Bank of the West's expense base -- not an insignificant number -- so you would think branch closures would be part of the savings. But management is getting most of the savings from centralized overhead and IT efficiencies.
Will the acquisition help BMO?
I think it's a bit early to tell how this acquisition plays out. Certainly, the U.S. makes up a big part of BMO's business, so it makes sense for it to try to build scale, and Bank of the West does operate in similar segments. But the financial metrics of the deal are not that compelling right now, and the decision to keep this many branches does not make a ton of sense. If BMO were to consolidate some of the branches, that would increase cost savings and therefore earnings accretion, which would make the financial aspects of the deal more attractive. And you never know: I wouldn't rule out branch consolidation in the future.
If management can eventually do some consolidation and come through with all of the revenue synergies it is promising investors, the deal will look a lot better, so it's going to come down to execution.