There was a widely held view that Bank of Montreal (NYSE:BMO) was going to expand its U.S. business, and the company did exactly this today - announcing that it was acquiring Wisconsin's Marshall & Ilsley (NYSE:MI) in an all-stock deal. Provided the deal closes as expected, this deal will make BMO the 15th-largest bank in the United States (it is already No.3 or No.4 in Canada, depending on the metric used to measure this), and the No.1 bank in Wisconsin (with 20% deposit share), as well as a leading bank in Arizona and several Midwestern states like Illinois.

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The Terms of the Deal
To acquire Marshall & Ilsley, BMO will exchange 0.1257 of its own shares for each share of MI - a deal that gives an implied value of $7.75 per share to MI. That's a 34% premium to where MI closed Thursday afternoon, although movement in BMO shares will change that imputed valuation and premium. All in all, it is a $4.1 billion deal for BMO, though the company will also be launching a nearly $800 capital raise as part of the deal and will be repaying MI's $1.7 billion TARP obligations.

A Weak Bank = No Premium
Like the earlier deal between M&T Bank (NYSE:MTB) and Wilmington Trust, BMO is paying a fairly minimal premium to do this deal. In fact, BMO is taking out Marshall & Ilsley at a price that is roughly equal to its tangible book value. (For related reading, see Willmington Trust Sold For Tangible Book Value.)

So why is MI selling for so little? Well, BMO's comments about the deal suggest that MI was still in rough shape. In fact, BMO will be writing off about 12% of MI's loan book right off the top - a charge that will cost about $4.7 billion and means that cumulative losses for MI will be around 21% (if things get no worse from here). That is a pretty staggering amount of bad debt and a sharp indictment of management's decision to expand from the "boring" Midwest into hot real estate markets like Arizona and Florida. (For more, see Banking Merger Mania.)

That BMO saw so much bad debt on the books at MI is also an indication that not all U.S. banks are cleaning up their balance sheets to the same degree. Then again, MI was trading at one of the lowest valuations for a bank of its size, so it is not as though this is a huge surprise to the Street.

Where to From Here?
When the deal closes, BMO's U.S. operations will have 695 branches in eight states (assuming no overlapping branches are closed) and upwards of $177 billion in assets. BMO believes, though, that it will reap significant cost-savings and long-term value from the deal, estimating an internal rate of return of at least 15%. That may be ambitious for a company that does not have a lot of experience with integrating large U.S. banks (unlike, say, Toronto-Dominion (NYSE:TD)) but it may be achievable given the purchase price.

It also seems entirely reasonable that 2011 will see many more acquisitions in the regional bank space, and perhaps some deals that go off at better than 1 times tangible book value. Banks like KeyCorp (NYSE:KEY), Synovus (NYSE:SNV) and Regions (NYSE:RF) are all desirable targets, but already trade at or near book value. Other banks, including Comerica (NYSE:CMA), First Horizon (NYSE:FHN), Zions (Nasdaq:ZION) and Washington Federal (Nasdaq:WFSL), may find themselves on the hit list as well.

The Bottom Line
Unfortunately, it is difficult for retail investors to screen for banks by tangible book value, so finding the next Wilmington or Marshall & Ilsley will take a fair bit of work (though starting off by looking at low price-to-book is a good idea). That said, instead of trying to guess about who may get the next bid, investors might be better-served simply finding those banks that have the best chance of recovery and are still underappreciated by The Street; at that point, any M&A activity would just be a bonus to the story. (For more, see The Evolution Of Banking.)

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