Bank Deals are Proving Profitable (Update 1)

Updated to include additional analyst comments and earnings estimates.

NEW YORK ( TheStreet) -- Bank of Montreal's ( ORCL) $4.1 billion acquisition of Midwestern lender Marshall and Ilsley is turning out to be a big earnings driver, proving the benefits of U.S. bank deals.

That is good news for Capital One ( COF), PNC Financial ( PNC) and First Niagara ( FNFG) as they try to close billion dollar-plus acquisitions.

In Tuesday earnings, Bank of Montreal reported record first-quarter net income of $1.1 billion, or $1.65 a share, on a doubling of earnings at its U.S. operations (called BMO Harris Bank), which was bolstered by the Marshall & Ilsley acquisition that closed in 2011. Profit at Chicago-based BMO Harris Bank more than doubled to $138.6 million -- from $54.6 million in the quarter -- on an earnings lift and a fall in U.S. loan loss provisions.

"Although it is early to declare that BMO has turned around Marshall & Ilsley , underlying results are encouraging. This trend is not only critical for improved sentiment towards BMO, but is also important for revenue growth, which is currently weak," wrote Credit Suisse analyst Gabriel Dechaine in a Tuesday note.

The acquisition of Marshall & Ilsley is the third largest bank deal in the last 24 months following Capital One's ING purchase and Toronto Dominion's ( TD) $6.3 billion acquisition of Chrysler Financial, according to Bloomberg data.

U.S earnings and falling loan loss provisions at Bank of Montreal from its Marshall & Ilsley acquisition overshadowed its overall weak capital markets revenue. The deal also gives BMO a U.S. growth channel in consumer lending and wealth management that may be a hedge against a possible credit slowdown in the Canadian market.

Bank of Montreal's Marshall & Ilsley earnings lift may further prove the acquisition rationale of Capital One, which is closing in on its $9 billion acquisition of ING Direct. and First Niagara's HSBC U.S. bank branch acquisition.

Those acquisitions cut against a tepid overall market for bank consolidation in the U.S. Both bank's shares have benefitted from expectations of an earnings boost off of the acquisitions of U.S.-based assets previously held by European mega-banks. First Niagara shares are up over 10% year-to-date to $9.64, while Capital One shares are closing in on 20% 2012 gains after posting a 2011 stock gain that contrasted with sector weakness.

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Capital One shares trade for 1.4 times tangible book value according to HighlineFI, and for eight times the consensus 2012 earnings estimate of $5.84, among analysts polled by Thomson Reuters. Meanwhile, First Niagara's shares trade for 1.3 times tangible book value, according to HighlineFI, and for 10 times the consensus 2012 EPS estimate of 87 cents.

The Federal Reserve recently approved Capital One's acquisition of ING Direct, giving insight into what it deems as a Too Big to Fail bank. In its approval, the Fed said it had also taken account Capital One's subsequent agreement to purchase HSBC's $30 billion U.S. credit card portfolio. Those two deals would turn Capital One into the fifth largest U.S. bank by assets.

In a Feb. 15 note, Citigroup analyst Donald Fandetti said that Capital One will see "~16% earnings accretion" from its pending acquisitions of ING Direct and HSBC's U.S. credit card portfolio. The ING Direct purchase "bolsters COF's deposit franchise, bringing deposits north of $200B," and will "reduce COF's cost of funds which is around 1.4% currently and above many large bank peers," wrote Fandetti.

First Niagara is awaiting regulatory approval for its deal to purchase roughly 200 branches from HSBC. The company working to divest roughly 100 branches, in order to trim overlapping offices and also to address Justice Department concerns over regional competition concerns.

"With the branch divestitures behind the company, and a solid, well communicated, commitment to organic growth over the next 18-24 month, we expect continued execution on market share expansion in the commercial arena will improve sentiment further, driving trading multiples to levels more in-line with the industry," said Deutsche Bank analyst Dave Rochester of First Niagra in a January note. He rates First Niagara a "Buy," with a $12 price target.

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For Bank of Montreal, the Marshall & Ilsley acquisition may be a hedge to its regional businesses, in addition to a strongly timed U.S. based growth push.

In a February report, the Bank of Canada warned that a Canadian housing slowdown was the country's top economic risk because of a decade long increase in home prices and a recent surge in household debt.

Bank of Montreal, which has held its quarterly dividend steady at 70 cents, may use improved earnings from its U.S. business may help it lift its payout that lags peers like Toronto Dominion ( TD). "BMO has the flexibility to raise the dividend. The Board/management needs to see further progress on the M&I integration before increasing the dividend, which we believe could take place in the second half of 2012," says Dechaine of Credit Suisse in his note.

Still, risks remain if Canada's housing market were to slow. "We believe 2012 is poised to be a challenging year, marked by pressured margins and muted revenue growth... Credit costs could creep higher given an over-extended Canadian consumer and frothy property market," write KBW analysts in a Wednesday note.

Overall, analysts expect Bank of Montreal to grow revenue and profits over 5% to $15.3 billion and $3.7 billion in 2012, according to analysts polled by Bloomberg, who give the bank a $63.57 a share price target.

-- Written by Antoine Gara in New York