Friday, April 07, 2006

BMO NB Report is Food for Thought on Banks' Futures

The Globe and Mail, Andrew Willis, 7 April 2006

Ed Clark, one of the more free-thinking bank CEOs, can look forward to some interesting weekend reading courtesy of the bank analyst at BMO Nesbitt Burns.

In a report that speaks to the way smart analysts are plying their craft these days, Nesbitt's Ian de Verteuil made a strong case this week for one of the Canadian banks to retreat from investment banking by selling out to one of those big, dumb American investment banks. To illustrate his point, Mr. de Verteuil modelled the sale of TD Securities, and the resulting benefits for Mr. Clark's employer, TD Bank.

Before diving into the argument for this radical move, a caveat is needed. Mr. de Verteuil opened his report by explaining that his thesis is pure speculation. No one at TD Bank has given him the slightest indication that the bank is considering selling its so-called wholesale operations. The Nesbitt report is a piece of original thinking, meant to give investors a fresh perspective on the structure and valuation of the Canadian banks. On this front, it is a fabulous piece of work.

It must also be noted that Mr. de Verteuil's report kicked off a hilarious whirlwind of rumours. By co-incidence, the report emerged on Wednesday at the same time TD Securities senior executives were asked to set aside time the following day for an "urgent conference call" on "good news for our domestic growth strategy." Speculation swirled late Wednesday that the call would unveil the sale of TD Securities to Lehman Brothers. In fact, it was to announce that the bank had snagged the eminently connected Frank McKenna as a deputy chairman.

At the heart of Mr. de Verteuil's report is the question of just where a bank's shareholders get the best bang for their capital buck. The Nesbitt analyst argues, quite persuasively, that these are the best of times for the investment dealers. He shows that capital markets are notoriously fickle, and there's a good chance that the credit cycle, underwriting revenues and takeover fees are all heading down from where we are today.

"We are witnessing a once-in-a-lifetime opportunity for the Canadian banks to sell their wholesale business, the whole kit and caboodle, at premiums to book value," wrote Mr. de Verteuil, and he named houses such as Lehman, Bear Stearns or Goldman Sachs as likely buyers. The huge sums raised in these sales could be used to fund share buybacks and expansion of the shareholder-friendly retail banking network, which generate far more dependable profits.

Breaking down the numbers at TD Securities, the analyst said the business is less integrated with the bank parent than other Canadian dealers. Mr. de Verteuil put a price tag of up to $7-billion on the business, and explained that exiting the business would bring strategic benefits, along with an upward move in the price-to-earnings ratio that TD Bank commands.

Will it happen? I'd argue that the banks will avoid radical domestic moves for at least another 24 months, as they test the waters on mergers. But no bank CEO can be permanently wedded to the wholesale business. There's always room to rethink business lines . . . Mr. de Verteuil's bit of original thinking is going to make for interesting conversation in the bank boardrooms.