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UPDATE: Regional bank shares rally on M&I Bank deal

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Shares in regional banks are rallying after Canada's BMO Financial Group agreed to acquire Marshall & Ilsley Corp. in an all-stock deal.

Regions Financial and KeyCorp added more than 3 percent each in early trading Friday, and Fifth Third Bancorp and Huntington Bancshares gained more than 1 percent.

The deal for the Milwaukee-based parent of M&I Bank, which has about 30 Indianapolis-area branches, would allow Canada’s fourth-biggest bank to double its U.S. deposits and branches.

It also has raised hopes among investors that well-capitalized banks may begin snapping up regional banks that have struggled to regain footing after the financial crisis. 

The agreement calls for Toronto-based Bank of Montreal to pay 0.1257 of its own shares for each share of M&I. The deal initially values M&I at $7.75 a share, or $4.1 billion, 34 percent higher than Thurday’s closing price of $5.79.

The Canadian bank’s shares fell 7 percent in early trading Friday, to $57.17 each. M&I’s were up about 18 percent, to $6.82. The fluctuation in share price translates into an up-to-the-minute deal value of about $3.8 billion. It was originally announced as a $4.1 billion deal.

M&I's ratio of nonperforming assets—about 5 percent—is one of the worst among large banks and a big reason the company had been trading at about half its book value, said John Reed, executive vice president in the local office of Chicago-based investment firm David A. Noyes & Co.

Meantime, BMO is a better-capitalized bank, trading at twice its book value—which makes its shares more valuable as currency for a deal.

BMO also plans to raise 800 million Canadian dollars (796 U.S.) in equity as part of the deal—suggesting the bank may have to cover some of M&I’s losses, Reed said.

M&I controls about 6 percent of central Indiana's bank deposits, according to the Federal Deposit Insurance Corp. The bank had nearly $1.8 billion in local deposits as of June 30. It ranks sixth among area banks in terms of employment, with about 400 workers.

M&I entered the Indianapolis market in 2008 when it acquired First Indiana Corp. for about $529 million.

Bank of Montreal also is the parent bank of Harris Bank, which has about 10 branches and 100 employees in Indianapolis.

It wasn't clear whether M&I will retain its name and branding.

“From [BMO's] perspective, I don’t think they’re buying M&I because they were seeking Indianapolis; it just came with the package,” Reed said.

With the purchase of the Milwaukee-based company, Bank of Montreal more than doubles its U.S. branches to 695, and increases its U.S. assets to $162 billion. Marshall & Ilsley has outlets in states including Indiana, Minnesota, Missouri, Kansas and Wisconsin.

The acquisition “transforms BMO’s competitive position in the U.S.,” said Bill Downe, CEO of BMO Financial Group.

It also looks to be a good deal by historical standards. The takeover has a price-to-book ratio of 0.61 for Marshall & Ilsley, less than half of the median ratio of 1.4 for 33 regional, commercial bank deals since the start of 2009, according to Bloomberg merger data.

Canadian banks, ranked the world’s soundest for three straight years by the World Economic Forum, have been expanding in the U.S., where companies faltered as the real-estate market tumbled.

M&I has posted eight straight quarterly losses while Bank of Montreal has reported six consecutive quarters of profit growth, a streak unmatched by Canada’s five other large lenders.

Bank of Montreal will raise about $794 million in shares to help finance the purchase, the largest takeover ever for the Canadian bank. The deal will add to earnings in 2013, excluding merger costs of $536 million.

Bank of Montreal said once the transaction is completed, Marshall & Ilsley president and CEO Mark Furlong will become the CEO of the combined banks' U.S. personal and commercial banking business, based in Chicago.

The Bank of Montreal said the transaction has been approved by the boards of both banks and is expected to close before July 31.

Many Canadian analysts have long been waiting for BMO to bulk up its U.S. assets.

"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," wrote Barclay's analyst John Aiken in a note.

The Associated Press and Bloomberg News contributed to this story.

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