Source: The Canadian Press

Bank of Montreal (TSX:BMO) is expanding its presence in the U.S. banking industry with the acquisition of Marshall & Ilsley Corp. for US$4.1 billion in shares.

Investors have long been waiting for the Canadian banking giant to bulk up its U.S. assets, and the purchase of the Wisconsin-based bank will increase BMO’s U.S. branches to 695, adding 321 locations.

However, the announcement was met with a mixed reaction from analysts and the market.

BMO’s shares tumbled 6%, though some observers noted it’s common for an all-stock transaction to cause the trading price to weaken. Meanwhile, Moody’s ratings service launched a review of the bank over concerns about the potential risk tied to the transaction.

The Toronto-based bank said Friday it signed a definitive agreement with Marshall & Ilsley (NYSE:MI) under which it will exchange 0.1257 shares of Bank of Montreal for each share of M&I.

Before the deal closes, BMO intends to raise $800 million in equity and expects one-time costs of $540 million for the transaction.

“The combination of our two organizations crystallizes BMO’s strategy of expanding our North American footprint and positions us for future growth,” said president and CEO Bill Downe in a conference call with analysts.

“We’re bringing together highly complimentary businesses that align well with our U.S retail and commercial wealth management focus and we both share a long history of supporting our customers.”

BMO’s executive vice-president and chief risk officer Tom Flynn told analysts that the decision for an all-share transaction made sense for the bank.

“Essentially we’ve structured the transaction that way to maintain the strong capital position that we’ve got,” he said.

BMO said it expects the Marshall & Ilsley acquisition will positively impact earnings in 2013.

Marshall & Ilsley is headquartered in Milwaukee and has US$51.9 billion in assets. The bank has 192 offices throughout the state, as well as locations in Arizona, Florida, Indiana, Minnesota and other states.

BMO shares were down about 6%, losing $3.80 to $58.28 in heavy trading on the Toronto Stock Exchange.

However, the bank’s tumble on the stock market doesn’t necessarily mean that the agreement is considered a wrong move for BMO, said Sadiq Adatia, chief investment officer of Russell Investments Canada.

“It’s got nothing to do with the deal being bad,” he said in a phone interview.

“It’s probably the fact that they’re paying for something which will dilute their earnings a little bit and cause a downturn in the next quarter or two. But longer term, it’s probably going to be an additive for the stock.”

After the announcement, Moody’s said it would launch a review of BMO for a downgrade over concerns related to M&I’s exposure to the U.S. housing market and an otherwise shaky economy.

The acquisition is “compounded by the fact that M&I has significant asset quality issues, and BMO’s existing U.S. operations have underperformed and have not been consistently profitable in recent years,” the ratings agency said.

“If the economy weakens significantly, the asset markdowns totalling $4.7 billion may not be sufficient to absorb all losses.”

The road to success for Canadian banks in the United States has been littered with problems. Most recently, Royal Bank (TSX:RY) announced plans to focus on fixing its U.S. banking business before sinking any more money into the division.

TD Bank (TSX:TD) and BMO have both made acquisitions in the past year to expand their U.S. holdings, but uncertainty over the economy has dealt a list of challenges, partly in loan portfolios, which have been ravaged by the soft housing market.

Barclay’s analyst John Aiken said in a note that BMO’s latest move comes after much anticipation.

“One of investors’ long voiced complaints about BMO’s strategy had been the lack of movement around its U.S. banking operations under the Harris banner,” he said.

“Strategically, the acquisition makes a lot of sense, given the geographic overlap of the core operations, principally Wisconsin and Indiana as well as broadening BMO’s scope in other key regions such as Arizona and Florida as well as M&I’s focus on mid-market commercial lending.”

Once the transaction is complete, Marshall & Ilsley president and CEO Mark Furlong will become the CEO of BMO’s combined U.S. personal and commercial banking business in Chicago.

The acquisition has been approved by the boards of both banks, and is expected to close before July 31, 2011.